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IEEFA update: Norway’s recognition of a declining oil and gas sector sends a message

December 21, 2018
Tom Sanzillo

The government of Norway has identified a problem that will preoccupy it for the next fifty years, and that should also cause the rest of the world to sit up and pay attention.

THE PROBLEM:  The revenues and dividends from Norway’s vast oil and gas holdings that have fueled the country’s economy and balanced its budget for almost three decades will no longer be sufficient to meet these needs.

The oil and gas industry currently accounts for 17% of the Norwegian economy and the annual revenues from dividends and investments provide 21% of the government’s annual revenues.

These revenues are now beginning to decline, and the industry will cease to be the economic engine that fuels economic growth and fills the gap in the country’s annual budget. (See table). The Norwegian government believes the trend is clear and will continue over the next forty years, as the era of oil and gas comes to an end. To make ends meet, the country will need to begin drawing down on its $1 trillion fund, the Government Pension Fund Global (GPFG), a fund that has grown due to the surpluses created by state owned oil and gas development and investment of those surpluses.

Even a trillion dollars can go quickly.

Underlying this recognition are deep-seated changes taking place in the global oil and gas sector that portend lower revenues and profits. This financial reality must be dealt with independent of climate issues, but the issues are tightly connected.

Norway is acknowledging publicly what the markets have been telling us for a while. In 1980, seven of the companies in the top ten S&P 500 index were oil and gas companies. Today there is one, ExxonMobil, and it remains near the bottom.

THE DEBATE: WHAT DOES THE FUND DO TO HANDLE THE CHANGE IN ITS INVESTMENT STRATEGY? The answer will also play a big part in how the government sees its options as it faces the need to replace the fossil fuel industry, both in term of the jobs directly and indirectly created by that economic activity and the support for Norway’s expansive social expenditures.

The question is: how to manage the fund? One choice being considered is to remove fossil fuel stocks from the fund’s equity holdings index. The logic is that fossil fuel investments no longer possess the qualities required by the fund to meet its investment targets. Instead fossil fuel investments pull down the overall annual returns of the fund. Also, given their volatility, they cause instability.

When the fossil fuel stocks are removed, the equity index is shielded from this downward spiral and attendant volatility. The fossil fuel holdings that remain in the overall portfolio outside the index can be separated and managed independently and speculatively, akin to a day trading scheme.

This proposal, which is being advanced by Norges Bank, GFPG’s financial advisor, has already been the subject of much discussion and will be further debated and changed. If adopted, it would serve as a complicated divestment plan.

The Storting (Norwegian Parliament), Finance Ministry and Norges Bank may make the decision this spring, and, of course, they may choose to stay with fossil fuels in their index.

WHATEVER THEY DECIDE, THE ECONOMIC OUTLOOK IS BLEAK. This debate raises the issue that the prosperity of this currently wealthy country, made so by the oil and gas sector, is coming to an end after an extraordinary period of growth. This reality is not going away whether or not the fund divests from fossil fuels. The country’s leaders need an alternative to fossil fuels not simply to replace lost revenue, but to replace 17% of the Norwegian economy. The country has some time to adjust, as the $1 trillion fund is a significant rainy day fund. But even a trillion dollars can go quickly as annual budget deficits grow and a down economy compounds societal pain and governmental costs.

The removal of fossil fuel stocks from the pension fund index will help, but it is not a cure. Without fossil fuel stocks, the index returns should improve. In addition, managing a diminishing portfolio of oil and gas stocks on a speculative basis should produce annual profits, even as the industry declines, but only for a few more years. Bolstering the Fund returns with this kind of investment should buy time by slowing the rate of drawdown on the fund’s principal.

But replacing a large segment of the economy will require steps of far greater consequence than changing the composition of the GPFG index or its investment strategy. Those steps are only now beginning to be discussed in Norway. The path Norway follows will serve as either a positive or negative model for other countries with large state owned oil operations.

THE FINANCIAL STRESS ON THE FUND AND NORWAY’S ECONOMY WILL ALSO CHALLENGE ITS COMMITMENT TO DEMOCRACY AND TRANSPARENCY. The Norwegian fund takes great pride in its commitment to ethical investing. Its processes for ethical vetting are transparent, robust and formal. The substantive outcome of those deliberations defines the fund to the business community and also define Norway to the world. As the nascent reality of an oncoming economic downturn grows, Norway’s public institutions will be tested. Will its democratic institutions draw people together or pull them apart during a period of prolonged economic contraction?

Norway’s willingness to disclose the decline in the fossil fuel industry as a significant public problem stands in stark contrast to other state owned oil enterprises that are governed by authoritarian regimes. Authoritarian states are unlikely to acknowledge the structural nature of oil and gas industry deterioration. In those systems, the acknowledgement of long-term economic uncertainty carries with it a challenge to the political legitimacy of ruling elites. Rather than solutions, authoritarian leaders faced with ever weakening oil and gas surpluses are likely to turn to scapegoats. Such a strategy has its own risks. Will the economic weaknesses that attend a long term downward spiral serve to fracture the hold of authoritarian leaders?

The decline of fossil fuels due to economic changes or climate policy initiatives will have profound financial and economic implications around the world. It is also becoming clear that the change away from fossil fuels will test governance structures and their prevailing values. Neither democratically elected nor authoritarian governments will remain unchanged.

Tom Sanzillo ([email protected]) is IEEFA’s director of finance.



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Tom Sanzillo

Tom Sanzillo is Director of Financial Analysis for IEEFA. He has produced influential studies on the oil, gas, petrochemical and coal sectors in the U.S. and internationally, including company and credit analyses, facility development, oil and gas reserves, stock and commodity market analysis, and public and private financial structures. He also examines such areas as community and shareholder activism, institutional investment, public subsidies and Puerto Rico’s energy economics.

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