News of Saudi Aramco's interest in acquiring a majority stake in Saudi Basic Industries Corporation (Sabic) [TADAWUL:2010] might have normally garnered little international attention. The potential USD 70bn deal is chunky by any account but is essentially two adjacent state-owned behemoths swapping paper.

However, it is a clear sign of something bigger going on with downstream M&A and capital markets. The transaction is the latest in a series of deals that have seen energy companies unlocking value in the downstream segment or reinvest into it. What’s more, and a no small detail, it comes amidst Aramco’s run for the largest public listing ever.

The deal risks pushing back the IPO timeline or even making a complicated situation more so. It would also broaden the set of comparables and metrics used to benchmark the company’s price tag.

Oil and gas majors are largely valued on their reserves and production, and Aramco has yet to officially reveal either of these. Its valuation has been pegged at USD 2tn by the Saudi government, based on long rumoured reserves of around 270bn barrels of oil. These number have been questioned by industry observers, with some giving Aramco a valuation closer to USD 1.2tn.

But this disparity could be softened as the core focus of the business shifts towards downstream, i.e. refining, petrochemicals and fuel retail, with Sabic.

The company will still likely publish an independently verified reserves report, but removing this as the defining factor of the IPO lessens somewhat the impact, and embarrassment, should the figures be lower than expected.

In early 2016, when Aramco announced its plan to list, gainsayers threw doubt on the idea, suggesting it would only list a division – probably downstream. However, Aramco stuck to its word and reiterated the whole business is to come to the market – only now, the focus of the business will be downstream.

Looking downstream

Aramco aside, a spate of other deals show companies seek to realise value by shifting their focus towards downstream. This is both a result and a reaction to oil prices and their effect on deal making. When the oil price was low, integrated players with a refining arm were able to better balance the books than those weighted towards upstream, because as margins closed on one end, they opened on the other.

With prices now up, oil and gas players can make a decent buck out of selling upstream assets and reinvest in downstream to hedge against future cyclical price drops.

In the Middle East, the most notable player is the champion of 1H18 MENA dealmakers, ADNOC, which, so far this year, has already announced seven concession sell-downs for USD 6.2bn.

Energy-dominated M&A activity in the region so far this year is already higher than that seen across the whole of last year in both value (USD 10.2bn vs USD 3bn) and volume (21 vs 20).

ADNOC is divesting upstream assets, now that the oil price is up, to shift capital allocation to other areas. It recently announced a five-year investment plan of AED 165bn (approximately USD 45bn) in downstream projects.

The company is investing downstream outside the region too, having come in as partners on another mega refinery, the USD 44bn Ratnagari project in India, alongside - guess who - Aramco.

Apart from weaning off the capricious price volatility of the upstream, shifting the focus lower down the value chain positions oil and gas companies for an uncertain demand landscape, in which crude oil is less likely to become transport fuel.

Electric vehicle development and roll out is here to stay. International oil majors are positioning themselves for this reality, putting the upstream emphasis on gas, and acquiring power generation, customer facing, and charging technology businesses.

Two of the top 20 EMEA 1H18 energy deals are a clear example of such: Total [EPA:FP] buying Direct Energie for approximately USD 2.2bn, and Repsol [BME:REP] buying a suite of gas-fired power generation and retail assets from Viesgo Espana for USD 871m.

The Sabic-Aramco deal goes in the same direction, to a certain extent. It shifts the focus to other petrochemical-derived products such as plastics, the future of which may be unclear, but at least at a lower risk of extinction than petrol and diesel fuels.

Capital markets have, tentatively, supported downstream deals, with equity stories tied to demographic-led growing demand in emerging markets. ADNOC again is the most apt example, having successfully listed ADNOC Distribution [ADSM:ADNOCDIS] earlier this year, for proceeds of AED 3.1bn (USD 851m) and a market cap of AED 31.25bn (USD 8.5bn).

Another example was Vivo Energy [LON:VVO], the Africa-focused fuel retail company, which listed in London in May. There are others in the pipeline. Mubadala owned-CEPSA is predominantly downstream focused and is gearing up to list in Madrid later this year, while the failed listing of Varo Energy in Amsterdam could return should other deals get away.

by Patrick Harris with analytics by Jonathan Klonowski and Aleksandra Duda