Norway’s sovereign wealth fund is being forced to come to terms with fundamental contradictions: its dependence on fossil fuel revenue and the need to transition to a greener future. 

Norway oil

Norway’s sovereign wealth fund, Government Pension Fund Global (GPFG), is the largest in the world. On October 25, its market value passed NKr10,000bn ($1066bn), having quadrupled in size within a decade. It made a 19.9% return on investment in 2019, “the highest return measured in kroner in a single year in the fund’s history”, according to the Norwegian central bank. The fund is now bigger than Norway’s total household wealth, including the value of all dwellings, and three times the size of the Norwegian mainland’s gross domestic product.

The GPFG owes its gargantuan scale to three main features. It has been prudently nurtured by a management team from Norges Bank, the central bank, aided by some favourable winds in the securities markets. Norwegian governments have been unusually restrained in safeguarding the fund’s capital, all of which is invested outside Norway. Except in cases of dire economic need, the Ministry of Finance can only spend up to 3% of the fund each year to support the fiscal budget. Finally, the fund owes its very existence to an abundance of undersea petroleum wealth in Norway’s continental shelf. All the government’s considerable tax and revenue from oil and gas continues to be deposited into the GPFG.

This year alone, it is estimated that NKr245bn will be ploughed into the GPFG, commonly called ‘the Oil Fund’. More than half will be from taxes on oil companies (Nkr132.4bn) and ‘area fees and environmental taxes’ (NKr7.5bn). The rest is likely to come from state holdings in oil and gas fields, pipelines and onshore infrastructure (NKr85bn). Dividends from Equinor, the Norwegian oil and gas company in which the government owns 65%, are expected to yield another NKr20.4bn.

Environmental considerations

The reliance on fossil fuel revenue presents Norway with an awkward conundrum. Norwegians pride themselves on their environmental stewardship and are concerned by the global threat of climate change from carbon dioxide emissions. Sales of electric vehicles in the country are booming; thanks to a waiver of heavy purchase taxes, electric cars now account for about half of new car registrations. The government also wants to end sales of petrol and diesel cars by 2025. Almost all of Norway’s power comes from renewable sources, mainly hydroelectricity, and it is banning the use of oil and paraffin to heat buildings as of this year.

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“There is certainly a tension between, on one the one hand, pursuing progressive policies for use of electric vehicles and hydroelectric power and, on the other, relying on oil and gas exports to other markets,” says Dennis Nilsson, a Nordic credit analyst at S&P Global. “I guess it is about using Norway’s natural resources, even if the country is quite advanced in its use of renewables.”

Inevitably, the political consensus that has always cocooned the GPFG has started to weaken under the tension. Acrimony surfaced at a November 2019 conference, hosted by environmental foundation Zero, where the leader of the Labour party, Jonas Gahr Støre, told activists that Norway should get used to saying that the Oil Fund is “a political tool”. Mr Støre called for the fund to invest more in renewables.

In 2019, the Storting (the Norwegian parliament) authorised the fund to invest in unlisted renewable energy infrastructure, but still within an envelope of environment-related mandates, for which the ceiling was doubled to Nkr120bn. Currently, only about 1% of the fund explicitly targets companies that contribute to energy transition or energy efficiency.

Prime minister Erna Solberg of the Conservatives responded to Mr Støre that it would be “dangerous” for the fund to invest too much in risky enterprises, and that politics needed to be kept out of the fund’s investment decisions.

Cross purposes

The Oil Fund's investment policy is overseen by an ethics committee appointed by the Ministry of Finance, and the fund has applied stringent corporate vetting on issues such as human rights, child labour, reliance on coal, tobacco, nuclear weapons, corruption and causing ‘severe environmental damage’. Norges Bank Investment Management (NBIM) publishes a long list of global companies either ‘excluded’ or under ‘observation’ on such grounds. “In terms of sovereign wealth funds, Norway is unparalleled in its transparency about the Oil Fund’s holdings and investment policy,” says Gabriel Forss, a credit analyst colleague of Mr Nilsson at S&P Global.

Climate change is the thorniest challenge given the fund’s own umbilical link to fossil fuel extraction and export from Norway. But the central bank has been gradually taking steps to address this issue. A first step in 2015 was to exclude mining companies and utilities that derive more than 30% of their revenue or energy mix from thermal coal.

In November 2017, Norges Bank advised the Ministry of Finance to exclude the whole oil and gas sector from the fund’s benchmark index, “to reduce the oil price risk”. The ministry quickly handed over this dilemma to an 'expert group' and 'public consultation'. In 2019, it was decided to restrict a gradual divestment plan to companies dedicated to oil and gas exploration and upstream production. Investment in oil giants such as BP, Shell and Exxon would be exempt.

The justification was that almost of all the growth in listed renewable energy for the next decade would be driven by companies that do not have renewables as their main business, and the fund should be able to participate in this growth.

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At a time when many global pension and investment funds are trumpeting their divestment from fossil fuels, this sent out a far more nuanced and conflicted message. “The ruling Conservative Party is solidly behind the oil industry,” is the straightforward explanation of Mr Nilsson of S&P.

Energy spokesperson for the Norwegian Green Party, Ask Ibsen Lindal, believes the reluctance to phase out fossil fuels has deep economic roots. “As long as we are so tied to oil and gas extraction and export, there is a very strong inertia inhibiting any strong climate action,” he says. “As long as people’s salaries rely on the industry, they don’t do anything. That’s why we get this hypocrisy. We want to be nice and kind and do the right thing internationally, but at the same time we are trapped.”

Structural changes

Nevertheless, there is no doubting the build-up of pressure. State-controlled Equinor recently unveiled a ‘climate roadmap’ that promises to at least halve the net carbon intensity of its energy products by 2050, and to increase tenfold its renewable energy capacity by 2026. Norges Bank governor Øystein Olsen used his annual address on February 13 to echo the prime minister’s admonishment of political manipulation of the GPFG, and to counsel against any “abrupt” reduction in Norway’s fossil fuel dependency.

“Norges Bank’s mandate is clearly defined. The capital is to be invested with one and only one aim: the highest possible return at an acceptable risk. There has been broad political agreement that the fund should not be used to promote other objectives,” Mr Olsen said. It had long been acknowledged by policy-makers that Norwegian oil production would eventually decline, and in recent years, “known oil reserves have shown little increase”, while a question hangs over “how much of what remains would be profitable to extract”, he conceded.

Mr Forss of S&P adds: “Norway will have to structurally reduce its reliance on hydrocarbons, both because of climate change and because of the acknowledgment that oil and gas are finite resources.”

These structural changes will take time, as Mr Olsen cautioned in his concluding remarks: “Companies have to seek out new markets, new businesses need to be established and workers have to move into new jobs. As long as the transition to a less oil-dependent economy is gradual, the business sector will have the chance to adapt. The challenges will be much greater if there are abrupt changes in operating conditions or policies.”

Mr Olsen combined a detailed and revealing account of the transformative changes brought by oil and gas to Norway’s economy with a stark warning that the GPFG’s stellar performance may not be long sustained. “The fund is not immune to a broad-based downturn,” he said. “A fall in global equity markets comparable to the decline in 2008 would alone reduce the fund’s value by almost NKr3000bn.”

If that were to occur, almost one-third of the fund would be wiped out.

An interview with Trond Grande, deputy CEO, Norges Bank Investment Management:

Norway discovered oil back in 1969, but it took a long time for the government to begin hoarding the windfall wealth for the benefit of future generations. “Through the 1970s and 1980s, as with other countries, Norway spent the revenues on building the welfare state,” says Trond Grande, deputy CEO of Norges Bank Investment Management (NBIM).

Even after the Government Pension Fund Global (GPFG), or Oil Fund, was established by law in 1990, six years went by before it received its first capital deposit. “In 1998 it was decided this was a savings account for the long term, so we can take some more risk, and equities were introduced,” says Mr Grande.

At the beginning, all the equity investments were handled by external managers. As internal competency has grown, that proportion has been brought down to about 4% of the funding. NBIM now has 600 staff, drawn from 38 countries, spread across offices in Oslo, London, New York, Singapore, Shanghai and Tokyo, with English as their common language.

Hierarchy and remuneration have remained remarkably flat even as NBIM and the fund have expanded. “We don’t have too many layers of management in the fund, and it is also informal in the sense that it reflects Norwegian society, which is pretty much egalitarian,” says Mr Grande.

Compensation policy is to “try to be competitive in the markets where we have our offices and employees, but we can’t compete with the top salaries in brokerages based in London and New York,” he adds.

Sharp rises

The GPFG has benefited from rising oil prices, but its quadrupling in value in the past decade is also due to higher returns driven by a sharp rise in global equity prices. In 2007 the equity share was increased from 40% to 60%. Large equity purchases were made in the period to June 2019, about the time when markets bottomed out after the global financial crisis. As Norges Bank governor Øystein Olsen has noted, “the fund bought equities on the cheap”. In 2017, it was decided to raise the equity allocation again, to 70%.

“What drives the rate of return of the fund is for all practical purposes the strategic asset allocation of 70% in global equities and 30% in global bonds,” says Mr Grande.

The fixed-income part “is really there to dampen some of the volatility of the portfolio, given that we have 70% in equity, to provide liquidity and, if possible, harvest some of the potential risk premia in the fixed-income market,” he adds.

Thirty per cent of fixed income is in corporate bonds, with the rest allocated to sovereigns. Mr Grande says: “We are typically exposed to investment-grade corporate issuers. That is a strategic decision; it has nothing to do with our view of the market just now. We stay away from those collateralised, more exotic instruments.”

In 2010, the mandate was opened for investment in unlisted real estate. The allocation was raised from 5% to a maximum 7% of the portfolio. Property now makes up just 3%. NBIM’s latest strategy plan calls for 5% in both unlisted and listed real estate.

“We take a very long-term view,” explains Mr Grande. “We have identified eight global cities that we will continue to be invested in. Four in the US, plus London, Paris, Berlin and Tokyo. The point is we want to be somewhat diversified in terms of geographic exposure, and somewhat diversified in terms of commercial, retail, logistics and residential.”

Risk versus return

Unlike some other sovereign wealth funds, the GPFG holds no gold. “It is not part of our investment strategy. Our investment strategy is to be invested in something that will have an expected positive return over the long run and it is about anchoring our strategy. Through bonds, and especially investment-grade bonds, is our way to reduce the volatility of the total portfolio,” says Mr Grande.

He insists the decision to exclude dedicated oil and gas companies has nothing to do with a green agenda. “That was purely based on risk characteristics of the entire wealth of Norway. It’s a simple argument: we have enough of our wealth tied to oil and gas prices, so we could do a little better if we don’t increase that by investing additional wealth in oil producers,” he says.

Widening the scope of fossil fuel divestment would be outside NBIM’s remit. “There is obviously debate in Norway about these issues, as well as these issues in relation to the investment strategy of the fund,” says Mr Grande. “But that would be a parliamentary or political decision.”

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