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The Biggest Deal of the Century:
& How to Make it Work
J. Pettit (May 2016)
1
Deputy Crown Prince Muhammad bin Salman’s
remarks about an initial public offering (IPO) for
a stake in Saudi Aramco is a shot across the bow
for many – the world’s major international oil
companies (IOCs), other nations and their state-
owned national oil companies (NOCs), and all
those within the Kingdom of Saudi Arabia whose
fate is tied to a successful outcome.
With oil prices so low it may seem an odd time
to sell share shares in the world’s largest oil
company. But this, the biggest deal of the
century, is not about market timing. Nor is this
principally a financial transaction. This deal will
serve as a catalyst for change, mapped out by
“Vision 2030” – cultural change, organizational
transformation, and economic evolution and
development. The giant has awoken and the only
thing that is certain is that the world will never
be the same.
An Aramco IPO, now tentatively slated for 2018,
revives the decades-old debate about the merits
of publicly-traded company ownership and the
unique case of state-led enterprises. NOCs and
other state-led enterprises already face an
enormous challenge in balancing the needs of
their public mission with the demands of
commercial and economic success.
i
ii
iii
The
additional burden of publicly-traded ownership
raises the stakes with the difficult balance
between public good and public shareowners.
Why We Care
The role and ownership of NOCs has been a point
of debate since their creation nearly 100 years
ago. This debate is critical – not only to the
economic well-being of the citizens of oil-
exporting nations but to the prosperity and
security of people around the world.
NOCs account for the majority of the world’s
conventional oil production and proven reserves
and are playing an increasingly active and
important role.
iv
They are leading domestic
efforts toward economic development and
diversification, as well as increasingly investing
beyond their own national borders.
v
Moreover, as renewable energy gains a greater
share of the world’s primary energy mix, we
might expect NOC charters to be expanded, or
that new entities will be created, to foster similar
The Biggest Deal of the Century:
& How to Make it Work
J. Pettit (May 2016)
2
leadership roles in this emerging but vital energy
segment.
The lens of a publicly-traded company makes
Saudi inaction on low oil prices for the past 18
months appear rational and even predictable. It
may be a relatively straight forward economic
decision rather than retailesque strategies about
“market share.” Aramco recognized its
advantaged cost position on the world’s evolving
supply curve, expanded by US tight oil and CDN
oil sands, and waited for classic economic theory
to restore a supply-demand balance instead of
fighting market forces and risking not only lower
prices but also lower volumes.
National Oil Companies and the Elusive Search
for a Perfect Ownership Model
The ownership of NOCs continues to be fluid,
with no ownership model emerging as an ideal
form. There have been many cases of change,
and even reversals, such as in the cases of BP,
YPF and Petro-Canada.
British Petroleum (BP) began in 1908 as the
Anglo-Persian Oil Company (APOC) but in 1913
the British Government acquired a 50%
controlling interest. The company expanded
rapidly over the next several decades, with the
help of Winston Churchill, with upstream
development in Iran, Iraq and Scotland, plus
investment in shipping, pipelines, and refineries.
In the 1970s, the company’s oil assets were
nationalized in Iran, Iraq, Libya, Kuwait and
Nigeria, representing a loss of direct access to
OPEC country resources. After flirting with
diversification into coal, minerals, and even
nutrition, the British Government sold a 5%
stake in 1979, and remaining ownership in 1987.
Argentina’s YPF S.A. was established in 1922 as a
state enterprise to promote economic
independence and the domestic ownership and
control of resources. In 1930 YPF was the target
of military coup backed by foreign oil trusts. It
was then privatized in 1993, bought by Spanish
Repsol S.A. in 1999, and re-nationalized (51%) in
2012 – its history highlights the challenge of
reconciling the needs of a publicly traded
company with a domestic mission premised on
the state control of natural resources and the
unwieldy expectations that this often brings.
Petro-Canada was founded in 1975 as a state oil
company as an element of Prime Minister Pierre
Trudeau’s economic nationalism with hopes to
more directly benefit from high world oil prices.
It was initially capitalized with the government’s
stakes in Panarctic Oils (45%) and Syncrude
(12%), plus C$1.5 billion in cash. As an energy
policy tool under the National Energy Program, it
acquired Atlantic Richfield Canada (1976), Pacific
Petroleums (1978), Petrofina (1981), and BP
Canada’s (1983) downstream refineries and
retail network. It became one of the largest
operators in the Canadian oil sands and offshore
Hibernia. But in 1991, a new Tory government
began to privatize Petro-Canada – the state kept
a 19% stake and no other shareholder was
allowed to own more than 10%, with foreign
control capped at 25%. This was a difficult era for
the industry, characterized by low oil prices, and
the company reduced its staff from 11,000 to
about 5,000, sold down assets, booked large
losses on the revaluation of assets, and saw the
value of its shares decline. In 2004, the
government sold its remaining 19% stake.
Investor Risk in State-led Companies
Analysts tend to be very cautious about
recommending investment in any type of state-
run company, and despite its pre-eminent
position, Aramco is no exception.
vi
State-run oil
companies have a checkered history that has
included political interference, corruption, poor
investments and under-investment. Investors in
Brazil’s Petrobras (NYSE:PBR) have seen shares
decline almost 90% over the past ten years,
amidst a major scandal at this once iconic
company. But there have also been successful
long-term returns on state owned companies –
Warren Buffett's investment in Petro China
The Biggest Deal of the Century:
& How to Make it Work
J. Pettit (May 2016)
3
(NYSE:PTR) returned more than 600% in the
early 2000s as the price of oil rose from $30 to
$75 per barrel.
Making it Work: Preparing to go Public
In preparing for the successful transition to a
public company, there is much to be learned
from those who have already made the journey
– both successfully and unsuccessfully. But there
may be even more to learn from cases of state-
owned enterprises that successfully completed a
“commercialization journey” without the benefit
of a change-in-control, which can help force
necessary but difficult change. Without the
catalyst of an IPO, the transformation must be
that much more planned and purposeful.
In the 1990s, Postmaster General Marvin
Runyon successfully led a broad
commercialization transformation of the United
States Postal Service. And a decade later, CEO
Moya Greene led Canada Post (and more
recently the Royal Mail) on a comprehensive
transformation program toward
commercialization. While there were marked
differences in their scope and emphasis, in both
cases, service levels were improved, employees
engaged, costs cut, and capital efficiency
enhanced, through sweeping changes in both a)
business strategy (“the what”) and b) operating
model (“the how”).
A) Business Strategy change, including the
portfolio – what businesses to be in,
assets to own, and activity to in-source –
was exceptionally difficult in such a
charged political climate created by the
media, advocacy of special interests, and
chronic political gridlock. Moreover,
data was exceptionally difficult to collect
and validate, there were always people
who felt that we never had enough data,
and there were long histories of
economic considerations not driving
most decisions. Now, in E&P, we face the
additional complexity of reconciling the
opportunity and needs of the underlying
resource portfolio, with the business
strategy, and the organizational
capabilities and operating model.
vii
B) Operating Model change tends to be
much easier to design than to
implement.
viii
ix
Moreover, we found that
the successful commercialization of a
state-led enterprise requires a
significant investment in workforce
education, training, and
business/economic literacy. Educating
people on why the commercialization is
needed, how it can benefit the
workforce and other stakeholders
personally, and what they can do to help
(that is within their line-of-sight), had a
profound impact on program outcome
and longer-term enterprise success. In
both cases, as much as we did, we still
needed to do more of this.
Ultimately, our operating model re-design here
encompassed four key areas:
1. Business Unit Delineation (e.g.
identifying, aligning, and measuring, the
respective contribution sources of
revenue, unit and period costs, and
underling physical assets related to
these, including allocations and transfer
prices, and key performance indicators)
2. Organization Structure (e.g. the layers
and spans, reporting lines, functional
roles, etc.)
3. Management Processes (e.g. planning &
budgeting, performance measurement
and management, total compensation,
talent development, etc.) and
4. Decision Rights (e.g. the responsibilities,
accountabilities, etc. involved for each
management process)
However, the E&P sector is quite unique, and so
appropriate operating models must be designed
accordingly. For example, in E&P we make great
use of joint ventures (i.e. JVs) and non-operated
The Biggest Deal of the Century:
& How to Make it Work
J. Pettit (May 2016)
4
ventures (i.e. NOVs but also known as OBO or
operated-by-others).
x
JVs tend to be used to
syndicate subsurface risk and/or capital needs –
both of which can be extremely large and
daunting in upstream projects. NOVs may be
used to lower operating costs in regions or in
resource types where the company doesn’t have
the scale for an efficient critical mass. They are
also used as a safe, low-cost way for early-stage
exploration and exploitation in a new region or
resource type.
And so their use by an IOC tends to mirror its
regional strengths and weaknesses in different
parts of the world – greater use in regions of the
world where the company has less of an
operational footprint, and less use in regions of
the world where the company has more of an
operational footprint. Recognizing the growing
importance of NOV production and reserves in
upstream O&G, super majors tend to have a
separate NOV organization and operating model
to coordinate and share best practices. In some
cases, an asset moves out of the NOV group
when it goes into production.
NOC Key Success Factors
The optimal corporate ownership and operating
model isn’t only elusive in the case of NOCs –
many companies struggle with these. We can
infer many useful key success factors for NOCs
from the literature, as paraphrased below.
1. Don’t forecast earnings (aka No Wall Street
guidance). CEOs must focus on long-term
performance, not Wall Street Analysts.
xi
JPMorgan’s CEO advises, “Don’t make earnings
forecasts. You don’t know what’s going to
happen every quarter. I don’t even care about
quarterly earnings.” The tone he sets from the
top is not about how earnings compare with
analysts’ estimates, but whether they are serving
their clients and winning business in the
marketplace. He goes on to say that CEOs “start
making promises they shouldn’t make.” And
while many JPMorgan shareholders “completely
appreciate” long-term management, others in
the stock market are likely to overreact to short-
term results. Legendary investor and CEO of
Berkshire Hathaway, Warren Buffett offers the
same advice against issuing financial predictions,
saying that his annual letter to shareholders tell
investors what they need to know.
2. Don’t let your investor relations pitch
become your business strategy. CEOs must
reclaim the conversation about strategy and
execution and “just say no” to Wall Street.
xii
Managers up and down the hierarchy work hard
on strategies, plans, and their execution, but
when the figures are tabulated they often fall
short of Wall Street expectations. All too often
executives react by “encouraging” middle and
lower level managers to redo plans, budgets, and
forecasts. Ultimately, constructive dialogue
about strategy and execution is effectively
supplanted by an investor relations pitch laced
with Wall-Street-speak, characterized by GAAP
accounting and endless metrics, promising
outcomes unrelated to a plan of specific actions.
Lost is any constructive debate about industry
direction and needs, requisite organizational
capabilities, resource and talent development,
or vision for the company’s “right-to-win.”
Discussion of actionable inputs is replaced by
discussion of outcomes. CEOs must reclaim the
conversation about strategy and execution.
3. Align the interests of managers with owners.
CEOs must resolve the conflict between the
owners and managers of company resources.
xiii
Industries such as E&P, where business decisions
are confounded by technical considerations, are
exceptionally difficult places to get things done
(IT Departments suffer the same challenges). For
example, whether farming down portfolio assets
that lack the critical mass for low-cost (i.e. per
bbl.) operation, or moving assets of certain
resource type/geography into NOVs because the
enterprise lacks the relevant organizational
capabilities for efficient exploitation, it’s all-too-
easy for technical experts to raise internal
The Biggest Deal of the Century:
& How to Make it Work
J. Pettit (May 2016)
5
barriers against change or action, unless these
outcomes are in their own self-interest.
Furthermore, a traditional twentieth-century
model of corporate governance – dispersed
public ownership, professional managers
without substantial ownership, and a large board
of directors dominated by management-
appointed outsiders – is more suited to high-
growth sectors where profitable investment
opportunities exceed the cash they generate
internally. These businesses are unlikely to
systematically invest in marginal or unprofitable
projects, especially when they must regularly
return to the capital markets for more money.
Alternative corporate organizations and
operating models have emerged where agents
with a shared interest to optimize the use and
distribution of cash make remarkable gains in
operating efficiency, employee productivity, and
economic performance.
4. Reward your stars. A world without A’s,
praise, gold stars, or incentives? No thank you.
xiv
The Soviet economy collapsed, despite vast
natural resources, in part because people did not
see or feel benefit from their collective efforts,
“they pretend to pay us, and we pretend to
work.” With entrepreneurial efforts stifled by
bureaucracy, and the gains of personal initiative
harvested as a public good, innovation ceased
and productivity froze.
xv
The modern approach
to operating model design is more enabling, and
aligns workforce interests with the
organizational mission. It also ensures that
outcomes are rewarded and success is
celebrated. In economic terms, the best
incentive is “a piece of the action.” When the
context is conducive, people act in unison to
carry out their organization’s mission. However,
company stock is not an effective incentive “at
the shop floor” – it offers a poor linkage between
pay and performance because it is both too
intangible and beyond the “line-of-sight” of all
but a handful of staff. A better approach is to
share in the economic contribution of a business
unit (i.e. economic profit contribution). This can
provide three clear and actionable incentives: to
improve profitability, to grow profitability, and
to withdraw from uneconomic activities.
5. Keep the stay/go private option. CEOs may
stay private, or go private, to enable greater
focus on long-term success.
xvi
In the face of the
rise of predatory hedge funds, mainstream 24/7
business media coverage, equity analyst
influence, and rapid turnover in the C-suite,
corporate executives increasingly sacrifice the
long-term prospects of their companies to meet
the short-term expectations of the stock market.
Moreover, the burden of being a public company
has also grown, in terms of the rising costs and
complexity of disclosure, regulatory compliance,
and unwelcome public scrutiny. In his Harvard
Business Review article, “Eclipse of the Public
Corporation,” Michael Jensen called for new
models to employ pay-for-performance
compensation systems, substantial equity
ownership by the Board and leadership, and
governance mechanisms to limit cross-
subsidization between business units and
wasted free cash flow. Institutional investors
have widely adopted private ownership as a
strategy. Berkshire Hathaway took Burlington
Northern private in 2009 in a $44 billion deal and
privatized HJ Heinz ($28 billion) in 2013.
Founder, Michael Dell, took his company private
in a $25 billion deal. Though many deals involved
private equity partners, a return to the public
markets has not been part of their logic.
Conclusions
With oil prices so low it may seem an odd time
to sell share shares in the world’s largest oil
company. But this deal is not about market
timing; nor is it principally a financial transaction.
This deal has more to do with cultural change,
organizational transformation, and economic
evolution and development than it has to do
with any financial calculations. NOCs and other
state-led enterprises face an enormous
challenge in balancing the needs of their public
mission with the demands of commercial and
The Biggest Deal of the Century:
& How to Make it Work
J. Pettit (May 2016)
6
economic success. The additional burden of
public ownership will underscore the difficult
balance between public good and public
shareowners. The outcome has potential to
affect people around the world.
J. Pettit is an advisor to the oil & gas industry and a former Partner of Booz & Company.
i
Guthrie, James and English, Linda M. and Laughlin, Richard and Broadbent, Jane, “Performance Audit of the Operational Stage
of Long Term Partnerships for the Private Sector Provision of Public Services” (2010). Available at SSRN:
http://ssrn.com/abstract=1742169 or http://dx.doi.org/10.2139/ssrn.1742169
ii
Pettit, Justin, “Private Sector Capital Strategies for Public Service Infrastructure” (October 20, 2011). Available at SSRN:
http://ssrn.com/abstract=1944317 or http://dx.doi.org/10.2139/ssrn.1944317
iii
Saud M. Al-Fattah, “National Oil Companies: Business Models, Challenges, and Emerging Trends,” January 2013.
iv
Tordo, Silvana and Tracy, Brandon S., and Arfaa, Noora, “National Oil Companies and Value Creation,” World Bank Working
Paper No. 218, 2011.
v
Markwell, Paul and Pettit, Justin and Swanson, Andrew and Thomas, Jim, “The New Frontier for National Oil Companies”
(January 1, 2014). Available at SSRN: http://ssrn.com/abstract=2380850 or http://dx.doi.org/10.2139/ssrn.2380850.
vi
Neely, Luke, “Potential Saudi Aramco IPO Highlights the Perils of State-Run Company Investing,” Motley Fool, March 2016.
vii
Pettit, Justin, “Can E&P Cut Costs Grow Stronger?” (November 1, 2015). Available at SSRN:
http://ssrn.com/abstract=2689106 or http://dx.doi.org/10.2139/ssrn.2689106
viii
Gary L. Neilson, Bruce A. Pasternack, and Decio Mendes, “The 7 Types of Organizational DNA,” Strategy + Business, June
2004, Issue 35.
ix
Tollman, Peter and Toma, Andrew and Roghé, Fabrice and Morieux, Yves and Maaseide, Steve and Tamboto, Eddy and Koike,
Jink, “Smart Design for Performance: A New Approach to Organization Design,” April 2016.
x
Jelinek, Mark and Pettit, Justin, “The Joint Venture (JV) Handbook” (2012). IHS Energy, September 2012. Available at SSRN:
http://ssrn.com/abstract=2127281 or http://dx.doi.org/10.2139/ssrn.2127281
xi
Jamie Dimon, Chief Executive Officer, JPMorgan Chase & Co., in “Dimon Says CEOs Should Focus More on Long Term, Not
Analysts,” by Son, Hugh and Boston, Claire, Bloomberg, October 19, 2015.
xii
Joe Fuller and Michael C. Jenson, renowned authors and management gurus, Harvard Business School, in “Just Say No to
Wall Street: Putting a Stop to the Earnings Game” (February 17, 2002). Journal of Applied Corporate Finance, Vol. 14, No. 4, pp.
41-46, Winter 2002. Available at SSRN: http://ssrn.com/abstract=297156.2 or http://dx.doi.org/10.2139/ssrn.297156
xiii
Michael C. Jenson, renowned author and management guru, Harvard Business School, in “Eclipse of the Public Corporation,”
Harvard Business Review, September-October 1989 Issue.
xiv
G. Bennett Stewart III, author of The Quest for Value, management guru, in “Rethinking Rewards,” Harvard Business Review,
November–December 1993 Issue.
xv
Ibid.
xvi
Roger L. Martin, coauthor of Playing to Win, University of Toronto, Rotman School of Management, in “The Public
Corporation Is Finally in Eclipse,” Harvard Business Review, April 2014 Issue.
