Saudi Aramco the largest oil company in the world

“Saudi Aramco -It’s History, Joint Ventures, Future Expansion and Value”

Saudi Aramco is the largest oil company in the world and possesses the largest oil reserves of any oil company. It suppliers 10% of global demand and its ability to as a swing producer (ability to produce excess), regulates global markets. Annually Saudi Aramco produces 3.4 billion barrels of petroleum. It manages 264 billion barrels of oil reserves and 253 quadrillion scf of natural gas. The company dates back to 1933 when the Standard Oil Company of California was given concessions to explore for oil in Saudi Arabia by King Abdulaziz Al Saud. Over the next 25 years a coalition of oil companies acquired stakes in the company. These corporations included: The Texas Oil Company, Soconoy Vucuum, and Standard Oil of New Jersey. In 1973 the Saudi Arabian government acquired a 25% stake in the corporation. This stake was increased to 60% in 1974. By 1980, the company was fully acquired and renamed from Aramco (Arabian American Oil Company) to Saudi Aramco.

Saudi Aramco like all NOCs seeks to maintain control of upstream activity. It is heavily vertically integrated. When international oil firms enter into agreements with national oil companies (NOCs) their tacit hope is the investment will provide valuable upstream access. NOCs and governments rarely give concessions to exploration activities. The financial strength of the super majors and NOCs is proportional to their ability to extract value from each section of the petroleum value chain. Upstream control is crucial to a company’s strength and vertical integration commonplace in the industry.

Figure 1: Oil Industry Value Chain

Since NOCs do not give this access up easily, why has Saudi Aramco been entering into a large number of joint ventures? This paper exams the reasons why and extrapolates the results of this alliance strategy on future value.

National Oil Company Characteristics

At its inception Saudi Aramco was a joint venture of leading multinationals. Today however, it operates as a NOC and its actions and strategies are consistent with other NOCs. As part of a government owned oil company Saudi Aramco’s purpose is to make a profit and to support the development of the Saudi economy.

“The national oil companies typically do not operate strictly on the basis of market principles. Because of their close ties to the national government, in many cases their objectives might include wealth re-distribution, jobs creation, general economic development, economic and energy security, and vertical integration”, Pirog (2007)

Whilst these interests are not necessarily incongruent with shareholder value they are not equivalent to it. As a result of the governmental drive for development, Saudi Aramco maintains interests in core and non-core activities which the super majors have long since divested. This creates inefficiencies and value loss.

Like all NOCs, Saudi Aramco controls most of the upstream activity in Saudi Arabia. It holds 80% of Saudi Arabia’s oil reserves. Saudi Aramco has been opposed to significant competition of any foreign companies in upstream oil or gas activities. Conveniently the strength of multinational oil companies is in refining and distribution (downstream). This represents a delineation between Saudi Aramco and its multinational partners. This demarcation occurred early on the in development of the oil industry and has impacted every aspect of these organizations; from the cultural to the operational.

Creating a link partnership provides opportunities for value creation but cultural fit issues are inevitable. Multinationals are selectively vertically integrated while NOCs are less selectively integrated. Governmental, cultural and development pressures being the main reason for them remaining integrated rather than value maximization.

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Vertical Integration in the Oil Industry

The aim of vertical integration is to spread risk and capture value from the entire value chain. A vertically integrated petroleum company can save on storage, refining and transactions costs. It can be more efficient in coordinating planning and capital investments.

Although the early oil monopolies where vertically integrated, they realized the administrative costs of doing so were too great. To be efficient an organization must selectively chose elements of the value chain to vertically integrate and in which geographies. National oil companies are more vertically integrated than multi-nationals. Indeed nationals have made concerted efforts to become even more vertically integrated.

Saudi Aramco has followed the industry trend to take part in joint ventures and strategic alliances. Benefits include – sharing risk and increasing competitiveness. Despite the benefits Saudi Aramco didn’t open the door to foreign investment solely for the purposes of value creation.

Joint Venture Political Motives

The recent support for foreign investment in the petroleum sector goes back to 1997 when Prince Sultan visited Washington. In a series of scenario planning exercises, his staff considered the implications of Saudi Arabia being less able to buy military hardware from the United States. Under these circumstances, would the United States continue to support the royal family? What options where available to sweeten any disappointment. The decision to open elements of the Saudi oil industry has its roots in politics and not in the decision to extract greater value from the oil value chain.

Value Loss in Saudi Aramco

Saudi Arabia possessed limited infrastructure in the 1930s. There were no railways, highways, modern sea ports, and electricity or telecommunication companies. All of these had to be built and operated by the Aramco. The development that has taken place in Kingdom mean that many of these activities can now be performed by third parties, however, Saudi Aramco still maintains these operations. In so doing the organization operates less efficiently than its super major competitors.

Current inefficiencies are driven by different intents: including wealth distribution, job creation, economic and technological development, and even support for Saudi foreign policy.

There is a growing belief that Saudi Aramco is pursuing a short term strategy by aggressively exploiting oil fields – maximizing short term revenues at the expense of long term value. As scarcity becomes a pressing issue, the quantity and quality of reserves will translate into pricing power and Saudi Aramco will become an even more significant player. The company must maintain a focus on efficiency, cost reduction and sustainability to maximize its long term value.

High oil prices have masked the company’s inefficiencies. As the oil price reduces the inefficiencies will be a supply constraint and risk significantly damaging the oil markets.

How Does Efficiency Compare?

Market demand for petroleum is set to expand. Efficient firms are more likely to capture this value. Analysis comparing relative efficiencies of Saudi Aramco and international oil companies indicates that levels of efficiency are significantly lower for Saudi Aramco. In fact Saudi Aramco falls below the industry average level of efficiency (0.40).











Saudi Aramco


Table 1: Relative Efficiency of Saudi Aramco, Pirog (2007)

Value Creation – Human Resources

Oil and its derivatives products are commodities. Their value is driven by market forces and thus both willingness to pay and price are proportional to the commodity price which is driven by demand. The investments international oil firms place in developing organizational capabilities stimulate innovation thereby increasing efficiency and minimizing costs.

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Saudi Aramco is committed to helping Saudi nationals through developmental programs. 87% of the company’s 51,000 employees are Saudi nationals. The majority of its local suppliers are run by Aramco alumni.

Despite this investment, organizational capabilities have not resulted in competitive advantage (Hallowell, 1996). Aramco’s efficiencies still lag behind those of international oil majors. It is however, the most efficient of the NOCs. Had these investments not been made, the company will be less able to capitalize on current market opportunities. The company’s returns will be received over the long term, especially given the increasing dominance of national companies as oil becomes a scarcer resource.

Governmental pressures for revenues have resulted in a failure to invest in human resources. As was noted by Marcel (2008):

“A senior E&P (Exploration and Production) director acknowledged a difference in views: ‘The political leadership pressures the companies to develop their fields quickly and not to develop people. The government has to encourage the company to develop its people’s skills and to develop its fields without a rush.’ An unspoken concern on the part of NOC managers is that the government’s preference for quicker generation of revenues will lead them to turn to IOCs.”

A joint ventures strategy provides the mechanism to increase organizational capabilities and skills of Saudi Aramco’s personnel.

Linked Alliances

Saudi Aramco’s partners include other national oil companies and international oil corporations. In partnering Saudi Aramco hopes to build capabilities, and reach new markets. All of Saudi Aramco’s JVs are link alliances (based on the Dussauge et al definition). In link alliances a particular aspect of the value chain is exploited. Examples of Saudi Aramco link alliances include developing new refineries, petrochemical plants. Typically, Saudi Aramco provides capital, raw materials and local infrastructure while partners provide downstream channels and expertise. Dussauge(2002) hypothesized that competing firm alliances that leverage production resources and marketing resources are more likely to be alliances of this type.

Multinational oil companies must partner with national oil companies to build relationships and secure access to reserves. Marcel (2006), noted that “58% of oil and gas reserves are presently held by NOCs in countries where IOCs have only limited involvement through service contracts or technical service agreements”. As a result multinational oil companies often accept terms that are unfavorable in the hope of long term access.

The lack of favorable terms for multinationals destroys value. Multinationals refuse to bid on many NOC projects due to poor terms. This refusal to bid reduces competition and quality; and increases costs. Marcel (2006), “A Saudi Aramco executive explained they were disappointed the Saudi gas initiative did not attract more investors; ‘We wanted more players. It’s too bad ConocoPhilips opted out of the gas initiative. It’s a good company. [But they explained that] the bid didn’t have the expected returns”.

Although Saudi Aramco and multinational oil companies profess the desire to work together, in truth the joint ventures that Saudi Aramco has entered into with multinational oil companies are fraught with tensions. Marcel (2006) noted that, “In private, however, both groups detail the difficulties in finding common ground. IOC frustration with previous joint exercises and NOC increased confidence in their own capacity had led many on both sides to privately question the terms of engagement.”


In our opinion Saudi Aramco’s strategy will lead to greater vertical integration and not less. As was noted by Al-Moneef (1998), strategic joint ventures increase the degree of vertical integration in national oil companies. The joint ventures will be absorbed as Saudi Aramco forward integrates its operations. It is unlikely that the multinationals will receive the long term access they hope for. As was noted by Dussauge et al. (2004) “link alliances are often more volatile and lead to more asymmetric alliance outcomes than scale alliances.” Link alliances often result in reorganization and take over. Saudi Aramco joint ventures are positioned downstream in refining and distribution. Upstream activities will remain very much under Saudi Aramco control. As Grant (2010) noted, the inevitable vertical integration will result in additional administrative costs. Barrera-Rey (1995), “vertical integration reduces the level of efficiency of companies while it also reduces its variability.” However integration contributes to increased knowledge and the development of distinctive capabilities. Integrating a high margin efficiently run operation is a valuable prize for any NOC.

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This is not to suggest Saudi Aramco will follow the example of Venezuela, political alliances the West are too deep for that. What is more likely is that Saudi Aramco will acquire and reorganize the joint venture.

Given that joint ventures are a source of long term value, Saudi Aramco must revisit its terms of its commercial agreements so that foreign investment can be attracted. This is important to increase its organizational skills and capabilities. Marcel (2006), “NOCs want capital, management skills, and technology – with various countries ranking those priorities differently”. Dussauge et al (2000):

“…firms must use alliances in a more offensive way, not as substitutes for mergers and acquisitions but combined with mergers and acquisitions. Indeed, using complementary alliances to expand, rather than acquiring firms in new albeit related fields, is less risky, less costly and offers greater opportunities to learn valuable skills.”

The Saudi government should openly encourage competition upstream. The government should attract foreign investment upstream in direct competition to Saudi Aramco. However this upstream investment should be in exchange for the guarantees of development in the non-petroleum economy.

Saudi Aramco must divest of non-core operations, improve efficiency and reduce costs. It must select high value elements of the value chain to focus on. It should spin off low value aspects of its business and follow the example of the super majors that are able to maintain profitability even in periods of low oil prices.

The political intentions of Prince Sultan will not be met. Saudi Aramco’s linked joint ventures and asymmetric relationships with partners, will result in ownership or control of the joint entity. They will provide limited returns to the United States.

The Saudi government and royal family must limit their control of Saudi Aramco’s strategy. Taxation, grants and tax concessions ultimately provides the best mechanisms to allow the industry to operate effectively while supporting development objectives.

To be efficient and maximize value, Saudi Aramco must adopt more corporate and less nationalist behaviors. However, nationalistic pressures are increasing in parallel to its need for increasing efficiency. Pirog (2007), “Oil-producing nations seem to be displaying an ever more nationalistic attitude toward their natural resource endowments”. Vertical integration is costly and inefficient; however it is the right strategy for Saudi Aramco at this time. After consolidating and becoming vertically integrated, the mature businesses can be divested to local shareholders to support the wider Saudi economy.

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