Sovereign Wealth Funds The Case of the Norwegian

Sovereign Wealth Funds The Case of the Norwegian Sovereign Wealth Fund Presentation Maputo, 27 th February 2013: Jan Isaksen, Norwegian Embassy Zambia / CMI

Overview • Has Norway really avoided the «curse» and the «disease» ? • How? – Initial conditions – Strategy and policy – The Institutions and the Sovereign fund • Future perspectives • Conclusions

Did Norway avoid the disease and the curse?

• Curse and disease – Tendency for resource rich countries to grow slower than others. Many reasons. Graft; corruption; (Overlapping with definition of Disease) • Dutch Disease a) a movement of capital and labour from other traded sectors to the resource sector b) increase in aggregate demand leading to overheating of the economy and inflation and appreciation of the currency, c) less analysed is the “spillover loss effect” crowding out of the non- resource-traded-goods sector, leading to permanent loss of capacity and technological progress.

Growing slower after resource discovery? Per capita, current PPP, 1970 -2006 Denmark, Norway Sweden (OECD=100)

Currency Appreciation? USD / Krone rate 1971 - 2011 10, 00000 9, 00000 8, 00000 7, 00000 6, 00000 5, 00000 USD / Krone rate Linear(USD / Krone rate) 4, 00000 3, 00000 2, 00000 1, 00000 20 11 09 20 20 07 20 05 20 03 20 01 19 99 19 97 19 95 19 93 19 91 19 89 19 87 19 85 19 83 19 81 19 79 19 77 19 75 19 73 19 71 0, 00000

1971 1972 1973 1974 1975 1976 1977 1978 1979 1980 1981 1982 1983 1984 1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 Axis Title Rampant Inflation? Consumer Inflation Norway and OECD 1971 -2011 16, 0 14, 0 12, 0 10, 0 8, 0 Norway OECD 6, 0 4, 0 2, 0 0, 0

Wiping out non oil industries (GDP, million NOK, 1970 - 2010, current prices) 2500000 2000000 Oil and natural gas incl services Axis Title 1500000 Other primary Manufacturing Industry Power Water Building and construction 1000000 Shipping Transport communication and services Pub adm and defence Educ Health social 500000 19 72 19 74 19 76 19 78 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06 20 08 20 10 0

Manufacturing squeezed out by oil industry? (GDP Manufacturing 1970 to 2010, million NOK, current prices) 300000 Food, drinks, tobacco 250000 Textile and Garment industries Wood and woodworking industries Paper and pulp 200000 Oil Chemicals etc 150000 Chemical raw materials Metal working industry 100000 Engineering Building of ships and drilling platforms Furniture and other industries 50000 Service in connection with Oil and gas (incl in oil and gas) Pipe transportation (incl in services 0 19 72 19 74 19 76 19 78 19 80 19 82 19 84 19 86 19 88 19 90 19 92 19 94 19 96 19 98 20 00 20 02 20 04 20 06 20 08 20 10 Axis Title Publishing and printing

How?

My «Model» Oil Revenue Outcomes Policy Initial Conditions

• Economy Initial Conditions – High income country – Low unemployment – Faltering mechanical /shipbuilding industry • Human resources – High level of education (cheap engineers) • Norwegian «DNA» – Small, Homogenous: 4, 7 million inhabitants , 323 802 square kms (a bit smaller than Zimbabwe) very few ethnic divisions worth mentioning. – Young country, independence 1905 – Lutheran Church state religion under the 1814 constitution. 83% of the population members of the Evangelical Lutheran Church – Labour Party key in politics since before the war. The party can be said to be social-democratic but, as some have said, all the parties in Norway are really social democratic. Egalitarian policies – Centralisation of wage bargaining probably the highest in the world • Near 60% of the labor force of around 2. 6 million unionised • Membership of the main employers’ organisation in Norway at around 60%. . – Relation to the sea: Coast line of 50 000 km. That makes it longer than the entire west coast of Africa from the Cape to Gibraltar.

Principles The 10 Oil Commandments form a declaration of principles underpinning Norwegian oil policy, Storting White Paper June 1971. This was what was perceived as needed to make sure that the oil activities would “benefit the entire nation”: 1. That national supervision and control of all activity on the Norwegian Continental Shelf must be ensured. 2. That the petroleum discoveries must be exploited in a manner designed to ensure maximum independence for Norway in terms of reliance on others for supply of crude oil. 3. That new business activity must be developed, based on petroleum. 4. That the development of an oil industry must take place with necessary consideration for existing commercial activity, as well as protection of nature and the environment. 5. That flaring of exploitable gas on the Norwegian Continental Shelf must only be allowed in limited test periods. 6. Petroleum from the NCS as a main rule, be landed in Norway, if not socio-political considerations warrant a different solution. 7. State involves itself at all reasonable levels, coordinating Norwegian interests within the Norwegian petroleum industry, and developing an integrated Norwegian oil community with national and international objectives. 8. That a state-owned oil company be established to safeguard the State’s commercial interests, 9. That an activity plan must be adopted for the area north of the 62 nd parallel where there are unique socio-political factors 10. That Norwegian petroleum discoveries could present new tasks to Norway’s foreign policy

Key policy lines • Industrial policy: Focus on upstream activities and Norwegianisation • Labour market: The State-employer-union cooperation on incomes policy • State Capitalism: Statoil; SDFI; Petoro • Macro management/fiscal policy: Pension Fund and Fiscal rule.

Industrial Policy: Going Upstream • Early focus on upstream activity. – Niche in North Sea in stead of competing with global petroleum industry – Nature-made comparative advantage: building of installations for oil exploration and extraction in the deep and rough waters. Norway (Statoil) now “world class” • • Major imports of expertise but rapid nationalization using our high general level of education The use of local goods and services was explicitly ensured by law (discontinued 1994 under the Agreement on the European Economic Area). Goods and Services Office in The Ministry of Industry to ensure that qualified Norwegian companies were included as bidders (Local content in Norway that at times exceeded 70%) Requirement to transfer competence and to cooperate in the development of new technology was introduced from the third licensing round in 1973 – – – "50 % agreements" required operators to conduct at least 50 % of the research and development needed to develop a prospect in Norway at Norwegian institutions. specified research effort in advance of new licensing. "goodwill agreements", where the oil companies made an attempt to conduct as much petroleum related research and development as possible in Norway,

Incomes policy cooperation • Centralized wage bargaining system underpinned with the strong links between the ruling party and the unions, a key mechanism being the “exposed trades model” • Coordination through a permanent Contact Committee between unions and employers. We have since 1967 also had the “Technical Committee for Income Settlements” • Social contract between citizens and government, and the success of increasing standards of living has ensured acceptance and popularity

Oil tax Capturing natural resource wealth but not scaring away investors

State ownership I: Statoil • Traditional agreement across political spectrum that the state play a crucial role in the development of both electricity and petro based industrialisation of Norway. • Statoil ASA was founded as a limited company owned by the Government of Norway on 1972 by an act passed by the Norwegian Storting with the political motivation… – to hold 50% state participation in each production license – to build up Norwegian competency within the industry – to establish the foundations of a domestic petroleum industry. • Company under close scrutiny by government, required to submit an annual report to the Storting. • Statoil ASA became (partly) privatised and made a public limited company in 2001, listed on both the Oslo Stock Exchange and the New York Stock Exchange. The state ownership share of 81. 7% reduced to 70. 0% in 2004 -2005 and 67% later.

State ownership II: State Direct Financial Interest (SDFI) / Petoro • Statoil became too big: ownership interests transferred to the State’s Direct Financial Interest (SDFI) set up in 1985, directly owned by the government but at first managed by Statoil. • When Statoil was partially privatised in 2001 the company’s management of SDFI was no longer desirable and a new stateowned management company called Petoro was created to manage SDFI. • Petoro is registered as owner for the state’s ownership shares with presently shares in 93 licences. • State will keep ownership interests in production licenses that, based on information available at the time of award, have high expected profitability, and in production licenses with a high volume upside

But what to do with the cash flow to state coffers? The answer…. . Billion NOK Estimate Dividend from Statoil Royalty and Area tax SDFI Environmental tax Petroleum tax State net cash flow GPF-G

The State Pension Fund - Global “The function of the Government Pension Fund is to support government saving to finance public pension expenditure and underpin long-term considerations in the use of petroleum revenues. A long-term and safe management of the fund helps to ensure that petroleum wealth can benefit both current and future generations. ” “The Fund is an instrument for general saving. The Fund does not have clearly defined obligations in the future. The aim of the investment is to maximize the purchasing power of the fund's capital at a moderate level of risk. A responsible investment practices underpins this. ”

The GPF-G is: • Not a pension fund! (Norway’s state pension is not funded) but… • a tool for handling financial challenges connected with the expected further rise in public pension expenditures and declining petroleum revenues in coming years • Only Established 1990, as Petroleum Fund. Before that, we wanted to slow down resource flow by physical ceiling. Mo. F did not want a Fund. Government Pension Fund – Global since 2006. • The first net deposition in the fund came only in 1996. • The Ministry of Finance is responsible for the management of the fund, and has delegated responsibility for the operational management to Norges Bank (the central bank of Norway) under Norges Bank Investment Management (NBIM). NBIM also manages the foreign exchange reserves’ investment portfolio. • Government structural non-oil budget deficit shall correspond to the expected real return on the Government Pension Fund Global, estimated at 4 per cent. A way of insulating spending from oil revenue fluctuations • Fiscal rule not exercised mechanically, however, and considerable emphasis is placed on stabilising economic fluctuations

Source: Norges Bank

Source: Norges Bank

Source: Norges Bank

Structure of oil cash flows and Fund Petroleum Tax revenue SDFI surplus dividend Statoil dividends Oil related revenue - Oil related expenditure + Interest and Dividend from Fund - State Budget oil corrected surplus = Surplus of state Pension Fund Non oil revenue - Non oil expenditure Governed by fiscal rule =

State Pension Fund – External. Market value end month (Jan 1998 – Jan 2013) Billion NOK Source: Governor NB annual speech

Fund Real return, annualized since 1989 (pct) 89 90 91 92 93 94 95 96 97 98 99

The future: adjustments and threats • Fund management: – Changing benchmarks – Possible change from 4 to 3 percent • Tax system: – Country and project reporting, – Transparency guarantees • Labour markets: – Preservation of the «frontier trades model» • Political: – Slide into populist spending

Value of Norwegian experience ? • The fiscal rule has worked – so far. Fiscally sucessful breaking the link betwen oil-revenue and public spending. • But is value store and modest contribution to the budget enough for a developing country? Collier: “You need to build up capital investments within the country, not financial assets in New York!” Absorptive capacity key • The dangers and blessings of national ownership • The «going upstream» has worked, but favourable initial conditions. • Norway has not avoided building oil dependence • Setting up institutions was no «rocket science» . Running institutions is key. (On Statoil: being 67% state owned and avoid political interference is difficult) • Shape and size of trees depend on the soil they grow in.

Thank you!