Oil and gas in the capitals

Through the concurrence of the Coronavirus epidemic and the oil price war, Norway faces multiple challenges in oil and finances. The special structure of the Norwegian economy includes a petroleum sector that in 2019 accounted for 15% of GDP, and a sovereign wealth fund close to three times the size of the GDP. It is no longer a petroleum fund—revenues being based about equally on petroleum, and on investment in stock and bonds.

In 2019, the outtake, the transfer to the budget, was 2.8% of the Fund value, below the agreed ceiling of 3%. It amounted to about half of the Fund income. Thus, the Fund had become a money machine, largely independent of oil and natural gas. It has facilitated economic policy. In 2019, the transfer made up 16% of the budget. Diversification apparently provided security. If oil prices were to fall, the world economy would gain, and the Fund’s equity portfolio would benefit. That was the idea.

In the budget for 2020, presented in early October 2019, the oil price (Brent spot) for 2020 was estimated around $58/bl. Because of rising volumes, the export value of oil and natural gas was projected to increase by 14%. The outlook was a budget surplus and a current account surplus. The intention was to transfer more money, but less as a percentage of the Fund, assuming it would grow further.

Coronavirus/oil price effects. The Coronavirus disrupted the picture. Even a well-diversified portfolio is not immune to worldwide distress, such as a pandemic. In the first quarter of 2020, the Fund lost 16%; on equity, the loss was 23%. On fixed income investment, there was no loss nor gain.

The oil price war provides the next blow. It has a double effect on the Norwegian economy: current oil and gas tax revenues will decline significantly, and petroleum investment will slow down. To sum up, both the financial revenues and the petroleum revenues of the Fund are at risk, as well as the level of economic activity.

Falling currencies. The risk to the Norwegian economy has been reflected in the currency markets. The Norwegian krone has depreciated against the U.S. dollar from 9:1 in January to 11:1 in the middle of March 2020. The driver is hardly the Coronavirus, but the low oil price. In times of distress, capital will seek refuge in the U.S. dollar. Oil price risk will induce capital to flee oil exporters. The precedent was in 2014–2015, when oil prices fell, and the Norwegian currency depreciated by about 20% against major trade partners. Russia, likewise, let the rouble depreciate, restoring competitiveness in the petroleum industry.

These experiences indicate that a floating currency can benefit an oil exporter. When oil prices fall, currency depreciation is an alternative to austerity. The inconvenience in an open economy, as in Norway, is inflation. In Norway, about one-half of goods consumed is imported. Already, upward pressure is evident on food prices. On the other hand, currency depreciation will support the value of the Fund and the out-take, measured in Norwegian currency, enhancing freedom of choice in economic policy. Because of the Fund, government expenditure for many years could significantly exceed revenues without any need to borrow, just using part of the return from an inheritance invested. The Fund has enabled a comprehensive aid package to the distressed part of the Norwegian economy.

Lasting effects. The “world after” will depend on the duration and seriousness of the twin crises. Considering experience from Asia, the Corona crisis might well last through 2020. The risk is an ensuing recession, followed by inflation—in the worst case, stagflation like in the 1970s. Oil demand will suffer, and oil prices will, for years, not be restored to pre-crisis levels. On the other hand, low prices will make oil and natural gas more competitive, and in the longer run, boost demand.

Thus, the ground will be ready for a resumption of a familiar pattern in oil prices—downs and ups alternating. The oil price war between Russia and Saudi Arabia will be decisive in the short run. The two might agree on an oil price useful for their finances, but less so for U.S. shale, in the range of $40–45/bbl. In real terms, this was the price in 2016. The alternative is oil prices hovering around $25 for some years, at real prices from 1999, until the next crisis.

In such a context, Norway should be reasonably comfortable. The petroleum industry has most of its costs in local currency because of a high level of local content. In recent years, progress in technology and organization has reduced investment and operational costs. The current crisis provides incentives for further cost-cutting.

The market response is another issue. “The world after” will suffer from debts and an investment backlog. Economic policies are likely to favor expansion and inflation over stagnation. Energy policies are likely to favor cost-effectiveness over climate concerns. Because of costs and low emissions, natural gas is likely to gain favor. In a world giving priority to economic recovery, oil will benefit from an infrastructure in place. The costs of renewable energy are likely to get more attention, maybe even in the European Union.

Activist mischief. In Norway, the political response is not granted. Some climate activist politicians salute the Coronavirus for justifying actions to change the world, implicitly wanting some temporary emergency measures taken, to curb the epidemic, to be permanent, regardless of economic and social consequences. This might backfire, as people realize the discomfort and inconvenience of life according to some “green” ideas. Last, but not least, people realize that wise handing of petroleum revenues has enabled the comprehensive economic package in response to the crises. The lesson is that oil equals money, equals economic security.

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.