Imagine how shareholders would react if Exxon Mobil gave away a third of the oil it produced, rather than selling it at market prices. There would be hell to pay, right?

But state-owned Saudi Aramco does something almost as ruinous, selling a third of its oil inside the kingdom for less than $6 a barrel. That’s a discount of 87 per cent on the international price.

For would-be subscribers to Saudi Arabia’s forthcoming initial public offering (IPO), the national oil company’s huge subsidy burden is emerging as a major bone of contention.

A few decades ago, providing discount oil and gas to Saudis wasn’t such a big problem. Only 6pc of Aramco’s oil was consumed domestically in 1980. The rest was exported. But the exported share of Saudi Aramco’s production declines every year.

Now the kingdom only gets full price for two-thirds of the oil it produces. Next year it will probably be even less.

What about Aramco’s natural gas exports? There are none. One hundred per cent of Saudi Aramco’s natural gas is consumed domestically, which is unsurprising because it is priced under $2 per million British thermal units, which means there is more demand than supply.

Countries that border Saudi Arabia, including Kuwait and the United Arab Emirates, currently import LNG at international prices around three times as high.

The kingdom’s lavish energy subsidies ought to give pause to investors giddy over the prospect of buying into the world’s largest IPO, and the world’s largest company, period, in revenue terms.

Domestic prices are shaping up as a major sticking point between private investors and Aramco’s management. Ultimately, Aramco shareholders must contend with the Saudi public, which views ultra-cheap energy as a birthright.

The kingdom’s crown prince, Mohammed bin Salman al-Saud, understands the stakes. He aims to dismantle some of the more onerous state claims on Aramco. In March, the government cut Aramco’s tax rate from 85pc to 50pc. Mr Salman has also said the government aims to gradually take away energy subsidies, replacing them with cash.

The kingdom made impressive strides in this direction in 2016, raising prices on energy products across the board. Unfortunately, Saudi prices were so low in 2015 that the new prices still remain a fraction of international benchmarks.

It remains to be seen whether the royal family can go all the way — imposing full international prices on citizens already vexed by the doubling of gasoline prices and the near-doubling of residential electricity bills.

Retracting energy subsidies is a well-known trigger for social unrest. Regimes that attempted similar austerity measures in the Organisation of the Petroleum Exporting Countries (OPEC)-member states Indonesia and Venezuela found themselves overthrown by angry mobs. Gasoline price riots in Nigeria in 2012 and in Mexico earlier this year provide further warnings. Saudi Arabia understandably treads with caution.

The values of Aramco’s publicly traded shares are ultimately going to revolve around the giant company’s ability to maximise profits. When share price disappoints, foreign investors are bound to demand that Saudi Aramco start treating domestic consumers the same way it treats everyone else.

Of course, foreign investors’ voices might be loud, but their influence won’t be huge. The Saudi state will retain a 95pc stake in Saudi Aramco. The company will continue to bankroll the kingdom’s budget.

Investor interests will bump against Aramco’s typical operating strategy in other ways.

A Saudi decision to go along with an OPEC production cut might be irksome to shareholders, particularly if competing producers like Venezuela or Russia aren’t sharing the load.

Saudi Aramco’s vaunted spare oil production capacity, a strategic asset that allows the kingdom to balance oil markets during price swings, could be another irritation.

Private shareholders might grumble that valuable capital assets are sitting idle, instead of producing oil and profits.

A big attraction of Saudi Aramco stock is the juicy dividend payment expected to flow to shareholders. What if Aramco someday finds it necessary to cut those dividends? You can bet foreign investors aren’t going to sit quietly, especially if Saudi drivers are still paying less than $1 a gallon at the pump.

Elsewhere, Aramco officials have pointed out that the company is actively trying to jettison its role in nation-building projects around the kingdom, such as erecting museums, stadiums and universities.

Saudi Aramco’s domestic subsidisation problem eclipses these other risks. Subsidies, if left unreformed, pose a major threat to the long-term health of Aramco. Shareholders will soon be a party to those risks.

Saudi domestic oil consumption has increased by an average of 5pc a year since 1970. In the 2000s, domestic oil demand grew an average of 6pc per year. In the 2010s, it has slowed, averaging just percent 4pc.

Potential investors can take heart that last year Saudi oil demand grew by just 1pc, due to the increased local prices as well as an increase in natural gas production, which substitutes for oil in electricity generation.

Still, decades of compounding growth has left Saudi oil demand on a par with that of Russia, a comparable oil producer that has five times the population and a much larger economy.

On a per capita basis, Saudi residents consume 46 barrels per year versus 8 barrels per capita in Russia. In contrast, per capita oil demand in the United States is 22 barrels per yr.

What happens if Saudi energy subsidies cannot be reformed? At some point, continued growth in domestic demand could leave only half -- or even less than that -- of Aramco’s oil production for export.

There have been rumblings among Saudi citizens who oppose selling off of a portion of the company, seeing it as inviting foreign interference in the kingdom’s sovereign affairs.

A lot is at stake. On the one hand, the Aramco IPO could be rocket fuel for the Saudi economy, providing the cash for a long-promised diversification into businesses that can soak up the legions of Saudi unemployed.

On the other hand, the IPO will insert foreign investors into the peculiar internal politics of an absolute monarchy. Many Saudis will resent it, especially if it means the end of cheap gasoline and electricity.

Bloomberg-The Washington Post Service

Published in Dawn, August 10th, 2017