Fitch: Saudi Aramco's SABIC deal echoes oil majors' vertical integration
Fitch Ratings looks at vertical integration among international oil companies, and why we are seeing this trend repeated among the region's national oil companies
Saudi Aramco's acquisition of SABIC (both rated A+/Stable) echoes efforts made by global oil majors and national oil companies to integrate further into downstream and petrochemicals, Fitch Ratings says. Refining and petrochemical margins are countercyclical to oil prices and represent a hedge against low oil prices.
The importance of vertical integration was demonstrated in 2015-2016, when oil prices collapsed and companies with pure upstream operations, such as ConocoPhillips (A/Stable), were under more stress compared to integrated producers. Furthermore, investments in petrochemicals represent a hedge against the long term 'peak oil demand' scenario. Companies that have lower production costs and are more integrated into petrochemicals would be better positioned to withstand ensuing declining demand, although it is difficult to predict how the market could change if demand for oil peaks; this, however, is unlikely to happen for at least 10 years.
Oil majors are more advanced in their efforts to further vertical integration, but national oil companies are catching up.
Saudi Aramco has intensified investments in downstream and petrochemicals in line with the country's Saudi Vision 2030, which calls for diversification of the kingdom's economy beyond oil production. Saudi Aramco has focused on markets that could offer vertical integration opportunities for the company's upstream productions, such as the US (the acquisition of Motiva), South Korea (S-Oil), China, India and Japan.
Although we believe the SABIC transaction could have been motivated partly by the government's decision to raise cash to fund investments elsewhere, we assume the transaction will be funded largely from Saudi Aramco's free cash flows, and the company's leverage will remain very conservative by industry standards.
We estimate that with SABIC, the share of downstream in Saudi Aramco's total EBITDA will increase to 9%, compared with 3% previously (based on 2018 numbers). For comparison, Shell, Total and BP derived on average around 23% of their EBITDA from the downstream and petrochemical segments.
ADNOC (AA/Stable) is another national oil champion that has been increasing investments in downstream and petrochemicals. This integration strategy is supported by Abu Dhabi's national tax regime, whereby refining operations are exempt from most taxes, including royalties and income tax.
ADNOC plans to double its crude oil refining capacity and triple its petrochemicals production. We estimate its share of downstream should rise to above 25% of FFO in 2019, from around 12% in 2017, as ADNOC's main Ruwais refinery fully re-starts following a fire in early 2017.
Eni (A-/Stable) and OMV (A-/Stable) in January 2019 acquired stakes of 20% and 15%, respectively, in ADNOC Refining subsidiary for a total of USD5.8 billion. This fits into ADNOC's strategy of bringing in minority partners to its operating companies as a way to attract funding, improve access to overseas markets and share industry know-how.