April 2019

Oil and gas in the capitals

Norwegian contradictions
Dr. Øystein Noreng / Contributing Editor

Norway is giving confusing signals about petroleum policies. On one hand, the government announces licensing of large areas, to boost exploration, and hopefully development and production. On the other hand, the Finance Ministry proposes that the Sovereign Wealth Fund divest from E&P activities. The world has paid more attention to the divestment statement than to the licensing.

The Norwegian government does notintend to sell off its stock in petroleum companies, contrary to some initial market reactions, but to divest from exclusively upstream companies. Motives are both business-related and political. Already in 2017, the Bank of Norway (the Central Bank) had proposed to let the Fund divest from petroleum activities for reasons of risk diversification. The same reason was given by Finance Minister Siv Jensen, aiming at reducing the economy’s total oil price risk exposure, and vulnerability to an enduring oil price decline. Instead of divesting all energy stocks, the move will be limited to companies engaged exclusively in E&P. If implemented, the sell-off will take time.

Fund performance. During 2018, for the first time, the Fund lost money, about 6% of its value. The equity portfolio had a negative return of 9.5%. Even if the Fund value has rebounded 7% in a few months, the experience has been sobering. Oil and gas make up Norway’s major earnings; the Fund has been built up by oil and gas revenues; in recent years, investment income has balanced petroleum earnings.

The investment portfolio is about two-thirds in equity, 30% in fixed income assets, and 3% in real estate. During 2018, the Fund’s total income was NOK 464 billion ($57 billion), of which NOK 259 billion ($31.8 billion), 56%, was from petroleum revenues, the remainder, NOK 205 billion ($25.2 billion), comes from investments. Transfers to the governmental budget amounted to NOK 234 billion ($28.7 billion) or 51% of Fund income. The rest, NOK 229 billion ($28.2 billion), is to be invested by the Fund.

Norway has reached its objective of reducing risk exposure to petroleum, as the transfer to the budget is almost fully covered by investment income. Yet, Norway remains dependent on petroleum. Against this backdrop, it has been considered unwise to put money back into oil and gas. In 2018, the major government revenue source was the State Direct Financial Involvement, SDFI, at NOK 123 billion ($15.1 billion). This is a vehicle for passive, direct investment by the government. Since inception in the 1980s, it has proved a robust source of money. The second source is the Special Tax, followed by the ordinary corporate income tax.

Nevertheless, Norway remains dependent on petroleum activities, directly and indirectly. Ten percent of the workforce is in oil and gas. Along the Norwegian coast, many communities have their economic backbone in oil and gas, rather than fishing.

Political machinations. For the industry, the problem is not the resource base, nor taxation, nor regulation, but politics. A recent report from the Norwegian Petroleum Directorate assesses that after close to 50 years of activity, at least one-half of the resources remains in place. Because of limited exploration, so far, the upside potential is considerable. The stable tax system provides predictability. The problem is political risk, due to a vocal environmental lobby that seems to be more inspired by ideology than by facts.

The Norwegian decision to divest from exclusively upstream oil companies can best be explained by Norwegian parliamentary politics. The minority right-wing government led by Mrs. Solberg of the Conservative Party, at first with the Progress Party, had—since beginning in 2013—conducted business-friendly policies. After the 2017 elections, Mrs. Solberg decided to enlarge her parliamentary base, first by the Liberal Party, subsequently by the Christian People’s Party. The current four-party coalition government lacks a common philosophy, but is held together by a pragmatic interest in power.

The Liberal Party has, in recent years, developed a green, environmentalist profile. It advocates a stricter petroleum policy—less exploration, development and extraction, but it does not favor terminating Norway’s oil and gas industry. The party would have wanted more, but it can present the partial divestment from upstream companies as a score. Even if the Conservative and Progress Parties are favorable to petroleum, the divestment decision could be considered a small concession to yield for keeping a majority coalition, facing parliamentary elections in 2021.

The opposition Labour Party is split on petroleum policy, with the industrial trade unions favorable to oil and gas as a generator of employment and money. The service sector unions and the youth organization are more negative to an industry that they consider harmful to the environment and climate. This view is shared by the Environmentalist Green Party and the Left Socialist Party, both of which are potential coalition partners from 2021. The other potential partner, the agrarian-based Centre Party, has a moderate view, essentially supporting current policies. The far-left Red Party wants to gradually build down the petroleum industry, regardless of economic effects.

Bottom line. The majority of Norwegians view oil and gas favorably, which is not surprising, given that each Norwegian represents a value of almost $200,000 in the Fund and government accounts. In 2018, close to 15% of the budget was covered by transfers from the Fund, within the 3% rule. For the country, this is like taking dividends from an inheritance without touching the principal. Politicians can spend money, a seventh of the budget, that does not need to be financed by taxation or by borrowing. That is a good incentive to continue. WO

About the Authors
Dr. Øystein Noreng
Contributing Editor
Dr. Øystein Noreng is a professor emeritus at BI Norwegian Business School. He has been an advisor or consultant to the International Monetary Fund; The World Bank; the governments of Canada, Denmark, Norway, Sweden and the U.S.; and energy companies, including Equinor, PDVSA and Saudi Aramco.
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