Good news for Aramco IPO as tax rate is cut

March 27 was a historic day for the oil industry in Saudi Arabia. The government approved a new tax regime for oil and natural gas producers in the Kingdom. This will see the tax rate applied to Saudi Aramco fall to 50 percent from 85 percent.
This move was anticipated as the chief executive officer of the company, Amin H. Nasser, said in an interview with Bloomberg in February that talks with the government were underway to lower its taxation in order to prepare it for the sale of shares to the public next year.
But why is a cut in the tax rate applied to Aramco a necessary step for the share sale? The answer is simple: It has to bring in more cash to investors.
Saudi Aramco is the world’s largest oil producer. The company produces daily around 10 million barrels of oil and this generates annual revenues of more than $150 billion based on oil prices of $50 a barrel.
So the company generates a lot of cash from oil sales alone, but the value of the initial public offering (IPO) of the company’s shares will depend heavily on its ability to generate profits for the shareholders.
The slashing of Aramco’s income tax rate will increase its net income by 300 percent, according to one estimate from Bernstein research firm. This will be positive news for the valuation of the company, which the government already estimated at $2 trillion or more.
Another benefit of the change in the tax regime is that it will bring Aramco closer to its global peers. The average income tax rate for oil producers is around 35 percent, so with the 50 percent rate Aramco is not far off.
Despite all the good news, some concerns were raised regarding state finance. How can the government compensate for the lost revenue from the income tax knowing that Aramco is its main source of cash?
The government not only taxes Aramco’s income, but it also gets 20 percent of its direct revenues in royalties. The royal decree that was issued on March 27 did not mention anything about royalties so the valid assumption until now is that this condition is still there and this will ensure that the government will still be able to get sustainable cash flows from the company. Moreover, the government will maximize the amount of dividends it gets from the company, as it will still own at least 95 percent after the IPO. So, with royalties and dividends, state coffers will still be filled.
However, the whole reason that Saudi Aramco’s shares are being sold to the public is to move the state away from depending on oil revenues. The Public Investment Fund (PIF) will own Aramco after the IPO. This means that at a certain point in future, what the company generates in cash will not go directly to state accounts but to the PIF. The fund will, in turn, invest that money, and the state will benefit from those investments. It seems a complex scheme — but it is a necessary one for a country that wants to survive in a complex post-oil world.

Source: Arab News