Statens Pensionsfund Utland: A Cornerstone of Norway’s Energy Policy
March 20, 2015
January 2015 ushered in not just a new year, but also the continuation of a precipitous drop in oil prices. By the end of the month, the WTI Crude Oil index bottomed out at below 45 USD per barrel and concerns over a prolonged period of price deflation emerged. While falling oil prices provide both positive and negative economic stimuli, they are generally detrimental for producers, both public and private. For governments reliant on unhedged oil revenues, this pricing environment can lead to budget deficits, economic recession, and interest rate hikes. Yet, as Russia faces a potential recession and a flight of foreign capital, other nations, including Saudi Arabia, have been able to weather the current pricing environment by relying on reserve funds. This Wonk Tank analysis focuses on the most prominent public oil fund, the Norwegian Government Pension Fund Global (Statens pensjonsfond Utland), and its unique structure.
The sheer size of The Government Pension Fund Global (GPF) is extraordinary. On March 11th 2015, the market value of the assets under control was about 6.962 trillion Norwegian Krona or about 849.50 billion USD. The annual after cost and inflation return for the fund was 3.7% from the start of January 1998 to the end of the third quarter 2014. The Fund’s annual return in 2013 was 15.95% and in 2014 was 7.6%. In total assets under control, the GPF is the world’s largest sovereign wealth fund. In fact, the GPF is estimated to own over 1% of the world’s total market cap. Yet, as mentioned above and like the other two largest sovereign wealth funds, this fund receives external funding from petroleum revenues.
A Short History of the Norwegian Oil Economy & Sovereign Wealth Fund
After decades of failures, oil was first successfully drilled off the coast of Norway on December 23rd, 1969, at the Ekofisk field. For the first few years, Norway, like many other new oil producers, relied on foreign oil companies to explore and produce reserves. Yet, on July 14th, 1972, the Norwegian parliament established both a national-oil company, Statoil, and a regulatory authority, the Norwegian Petroleum Directorate, in addition to creating the “ten oil commandments,” which thus granted Statoil significant control over Norwegian oil reserves.
Within decades, the Norwegian government faced a financial conundrum: oil revenues were a significant driver of growth and government spending for the country, yet oil prices fluctuated greatly and reserves were expected to eventually diminish and deplete fully. In response, the Norwegian parliament created the Petroleum Fund via the Government Petroleum Fuel Act of 1990. The Petroleum Fund, which would later be renamed the Government Pension Fund Global, was formed to invest profits from the national petroleum sector and is now administered by the Norges Bank Investment Management (NBIM). On an annual basis, Norway’s entire net cash flow from petroleum, including taxes on private firms, dividends from Statoil, fees, and proceeds from the State’s Direct Financial Interest (SDFI), minus the non-oil fiscal deficit are transferred to the fund.
The cash flows from Statoil and SDFI are particularly interesting from a public policy perspective. Statoil was initially founded as a private limited company owned and regulated by the Norwegian government with hopes of encouraging the development of the Norwegian petroleum sector by means of preferential government treatment and investment. However, by the mid 1990s, Statoil had become a fully integrated oil company, and in 2001, Statoil was privatized and listed on the NYSE and the Oslo Stock Exchange in order to raise additional capital to fund international reserve exploration. At the time of the June 18th, 2001 privatization, the government retained an 81.7% share of the company with the shareholder rights managed by the Ministry of Petroleum and Energy; currently, it has a 67% ownership share. All dividends remitted from these shares are included in the cash flows to the GPF.
Initially, Statoil had a 50% ownership right to any field developed in Norway; however, in 1985, due to political pressure the Norwegian government created the “State’s Direct Financial Interest” (Statens Direkte Okonomiske Engagement) that managed exploration and production licensing. The SDFI would control all licenses and hence receive all revenues related to them. Until Statoil’s privatization in 2001, Statoil managed these assets; however, a new fully state-owned corporation, Petero, was established to administer the SDFI. Petero’s licensing revenue is remitted back to the Norwegian government and hence the GPF.
Petroleum and the Wealth Fund Today
Today, Norway stands as a significant player in the international oil market. The country is the 12th largest exporter of oil, and in particular the 3rd largest exporter of natural gas. Proven reserves in Norway are estimated at greater than 5.8 billion barrels of oil. Primarily, Norwegian oil exports flow to western European countries; the United Kingdom imports a substantial 42% of Norwegian exports, 21% go to the Netherlands, and 10% are exported to Germany. Statoil still remains the largest force in Norwegian energy. As noted above, many of the unique advantages initially bestowed upon the company, including the right to 50% of any oil field, have progressively been removed. Nevertheless, Statoil has continued to grow, and following a merger with the oil and gas division of Norsk Hydro, the state-owned company controlled 80% of production in the Norwegian Continental Shelf, which collectively comprises the North Sea, Norwegian Sea, and Barents Sea zones that harbor all Norwegian oil reserves.
The Government Pension Fund Global was created in 1990 through an act of Parliament, and it was placed under the control of the Ministry of Finance. In its initial year, the fund was managed through a strategy similar to that used by the Norges Bank for Norwegian foreign currency reserves. In the years to follow, though, the Ministry of Finance would introduce equities to its exclusively government bond holdings, and a new entity, Norges Bank Investment Management, was established to manage the growing fund in 1998. The core governance structure for the fund has remained in place such that NBIM still directs the management of the fund and reports to the Ministry of Finance. However, the Ministry of Finance has continued to alter the guidelines that it sets to outline how the fund may invest. Today, the guidelines from the Ministry of Finance call for a portfolio composed of 60% equities, 35% bonds, and 5% real estate holdings. In reality, the portfolio deviates from guidelines such that in 2014 it comprised holdings of 61.4%, 37.3%, and 1.3% respectively. The GPF is expressly prohibited from investing within Norway, a provision intended to avoid potential political conflicts of interest and to prevent the massive fund from inducing inflation locally.
Over the past few years, the fund has moved increasingly into emerging markets; most recently in the fall of 2014, the fund indicated plans to “significantly” increase investments in India. Performance of the fund is closely monitored, which, along with regulatory requirements, has made the GPF one of the most transparent sovereign wealth funds in the world. Fairly consistent annual returns for the fund as a whole have allowed it to grow to its current size. In 2014, the fund had a 7.58% return, as equities and real estate investments, which returned 7.9% and 10.4% respectively, helped to counterbalance investments in bonds that lagged at a 6.9% return due to weakness in government bond markets. Study of the fund’s performance has indicated responsible management, though it seems that active investing strategies have not been dramatically superior to passive strategies. Though real estate continues to offer stronger returns, the ability to manage and monitor such investments could increasingly become a challenge in years to come. Analysis of sovereign wealth fund investments suggests that larger investments requiring greater active monitoring or corporate governance yield lower returns than a more passive small-scale investment strategy.
The GPF can be a significant fiscal policy tool given the size of the fund relative to the size of the state. The state-control of the oil industry has allowed the government to use oil related revenues to fund government programs. The Norwegian Petroleum Directory concluded in its 2014 annual report that “the petroleum activities have been key to the emergence of Norway’s current welfare state.” In 2001, the Stoltenberg government made the decision to enact a limit on the amount of funds that can be withdrawn from the fund for fiscal spending each year, in hopes of preserving the fund for perpetuity. The “budgetary rule” (handlingsregelen) allows the government to spend annually only the cyclically adjusted real return from the fund, which was estimated at 4 percent. Basic financial theory dictates that withdrawing the same amount as the fund returns on a real basis would allow for the fund to remain at a constant real size for perpetuity. However, the 4% estimate includes a significant risk factor, especially when macroeconomic changes result in increased structural non-oil budget deficits such as in the mid 2000s. In recent years, the Norwegian government has been able to exercise more accurate fiscal projections in order to avoid over withdrawing.
As the GPF continues to grow, the financial management of the fund will remain critical. Recently, questions have emerged concerning how active this fund should be as a voting shareholder, especially given the fund’s commitment to social responsibility.  For the world’s largest sovereign wealth fund, such a decision can have a particularly acute impact on corporate decision making. Moreover, the nature of investing from a financial perspective remains ambiguous: since its founding, the fund has tended to invest more passively in fixed income securities and equities as mentioned above. Given the fund’s goal of maintaining the financial benefits of Norway’s depleting natural resources, calls for riskier investments – and higher rewards—have been made. The current strategic allocation provides for only five percent of the total fund’s investment in real estate and other more active ventures.
With an unknown horizon of energy reserves, the Norwegian Government Pension Fund Global remains a fascinating model of combining seemingly conflicting interests. In order to provide for national stewardship of economic resources, the fund has preserved oil revenues with a strict reinvestment and growth policy. This fund has been an abundant source of wealth for the Norwegian people: such that the fund’s present value per Norwegian citizen is about 170,000 USD. Given the current fiscal crises experienced by both oil producing and non-oil producing countries throughout the world, the GPF has been a testament to the financial value of strong fiscal discipline and forward thinking.
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