Saudi Aramco and the risk of inflation

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The deluge of bids for the debut issuers shows how reliant investors have become on primary allocation.

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There was no question that Saudi Aramco’s long-anticipated debut bond issue would be oversubscribed, but even the most seasoned market observer must have been slightly taken aback by the size of the order book for the deal.

Bookrunners Citi, Goldman Sachs, HSBC, JPMorgan, Morgan Stanley and NCB Capital famously attracted $92 billion of orders for what ended up as a $12 billion issue.

Six months is clearly a long time in the international bond markets: last October JPMorgan’s Jamie Dimon was one of the first financiers to withdraw from the Future Finance Initiative conference in Riyadh in protest at the murder of Washington Post journalist Jamal Khashoggi. He was, however, very happy to put in an appearance at the launch of this deal.

For any bank or investor with even a half-hearted commitment to environmental, social and governance (ESG) criteria, a deal for an oil and gas producer based in a country with a toxic human rights record should have been a no-no. But this is Saudi Aramco: responsible for producing one in every eight barrels of crude oil in the world. It has five times the reserves of western rivals Total, Shell, Chevron, BP and Exxon combined. The firm’s ebitda of $224 billion in 2018 makes Apple, at $80 billion, look like a minnow.

This bond issue, which is nominally to finance the purchase of a 70% equity stake in Saudi Arabian Basic Industries Corporation (SABIC) from the Saudi Public Investment Fund (PIF) for $69.1 billion in cash – although Aramco certainly does not need to raise money to do this – has been long expected and everyone knew that orders would be inflated. The scale of demand saw initial price talk tighten 20 basis points from 75bp to 175bp to between 55bp and 155bp over US Treasuries across three-, five-, 10-, 20- and 30-year tranches. It priced at around 10bp to 20bp inside the Saudi Arabian sovereign curve.

Allocation

Perhaps not altogether surprisingly, much of that investor demand quickly vanished into thin air once allocation (for an average of 13% of the amount ordered) had taken place. Some bonds actually widened after issue as many fast money accounts sold, but even $80 billion of disappointed bids wasn’t enough to sustain the issue price across the board. The shorter-dated tranches were flat or down in secondary immediately post-launch.

Clearly orders were padded for a high-profile deal. Its sheer size promises some liquidity going forward. But the more important lesson from the bookbuild is the extent to which the buyside’s reliance on the primary market has become embedded into the system. 

The reduction in secondary bond market liquidity since the financial crisis has made allocation in primary the holy grail of all asset managers. The Saudi Aramco deal is only one of the more extreme examples of how that scramble can distort the true demand for an issue and impact its performance thereafter.