Shares of Saudi Aramco have shot up 10% since its record-setting $25.6 billion initial public offering earlier this month. That’s got bearish traders wondering whether they can short shares of the Gulf oil giant.
The answer: Not easily.
Normally, you wouldn’t even need to ask the question. Short sales -- when an investor borrows shares, sells them and then tries to buy them back at a lower price and profit from the difference -- are an established feature of exchanges across the world and practically a requirement for inclusion in MSCI indexes.
But when the company is Saudi Arabia’s crown jewel and when shares are listed on the kingdom’s Tadawul exchange, the answer is anything but obvious.
The Tadawul exchange does, on paper, permit short-selling, introducing it in 2017. But in practice the market for borrowing and lending shares in Saudi Arabia is illiquid, according to Marie Salem, head of institutions at Daman Securities in Dubai.
That’s because of a lack of familiarity with the concept of shorting shares. Religious scholars in Saudi Arabia long perceived short sales as a violation of Shariah although it’s permitted in other Islamic countries like Malaysia, according to Muhammed-Shahid Ebrahim, a professor of Islamic Finance at Durham University.
“The basic idea about Islamic finance is that you need to be equitable to people,” said Ebrahim. “You can’t sell what you don’t own is in the Koran.”
So investors with a pessimistic outlook on the value of a Tadawul-listed stock have to look abroad for shares to borrow to cover a short position.
But in the case of Aramco, finding a foreign holder willing to lend shares is no small challenge. Only 0.19% of Aramco’s shares are held by foreign investors, according to data disclosed by the exchange as of Dec. 26. And it will be more expensive than usual because of that limited pool held by investment houses.
“In the case of Aramco, it will definitely be expensive to short as it has recently listed and bets on price fluctuations are wide,” said Salem.
Both the exchange and Saudi Aramco didn’t respond to requests for comment.
If the cost of borrowing shares is usurious, one can still take a bet on the price of Aramco shares falling by creating a so-called synthetic short -- when instruments like options, futures and swaps are used to mimic a bearish position without having to borrow shares.
Good luck on that, too. Since there aren’t publicly traded Aramco options you’d have to find a bank willing to sell an over-the-counter product. That adds a level of counterparty risk to an already dangerous position to take. And in a situation where borrowing shares is hard to come by, the price of putting on a synthetic short still wouldn’t be cheap. Any counterparty will charge a premium because of the difficulty of obtaining shares to cover the position through either borrowing or going long the stock.
None of this is to say that betting Aramco will fall is a wise idea. Its exploration risk and production costs are both exceptionally low, according to Samantha Gross, a fellow at the Brookings Institution who covers foreign policy, energy security and climate.
And any potential bearish position would have to account for the kingdom’s implicit guarantee to protect a Saudi citizen’s Aramco investment, said Jim Krane, energy research fellow at Rice University’s Baker Institute.
“They’ve created a moral hazard here by offering low interest financing and bonus shares and other gimmicks that suggest that Aramco shares are a no-lose proposition,” Krane said.
That sentiment was echoed by Asha Mehta, a senior portfolio manager at Acadian Asset Management LLC in Boston.
“There’s broad awareness that the government is a large investor and that they’re willing to step in during times of market volatility to protect prices,” Mehta said.
None of that, however, has stopped analysts such as Neil Beveridge and Oswald Clint at Sanford C. Bernstein Co. from warning that a near term top might be close -- if it hasn’t happened already. Aramco shares are down 7% from their highest closing price on Dec. 16.
“For investors who have benefited so far, we would take profit here,” the Bernstein analysts wrote in a note to clients shortly after the IPO. “For those who have not, we would wait until a better entry point, which will inevitably come.”
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