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Norway's sovereign wealth fund.

14/8/2018

 
Norway landscape
​In 1990 the forward thinking Norwegian government  established the Government Pension Fund of Norway (also known as the Oil Fund) to invest the surplus revenues of the Norwegian petroleum sector. The purpose of the fund is to invest parts of the large surplus generated by the Norwegian petroleum sector, mainly from taxes of petroleum companies but also payment for licenses to explore for oil as well as the State’s Direct Financial Interest and dividends from the partly state-owned Equinor. Current revenue from the petroleum sector is estimated to be at its peak and is envisaged to decline in the future decades. The Oil Fund was established to counter the effects of the forthcoming decline in income, as the oil reserves eventually run out completely, and to smooth out the disruptive effects of highly fluctuating oil prices.
So back in the 1980’s, the Norwegian’s could foresee a time well into the future where the revenue generated from petroleum resources would decline significantly.  To overcome this problem, they decided to establish an investment fund that they could contribute to, to grow and later harvest the profits from to supplement declining oil revenues.

The first investment into the fund occurred in 1996 when the government injected an initial amount of $18 Billion Kroner (approx.. USD$2.2 Billion) in 1996.  Since the initial investment, the fund has grown to be valued at over 450 times the initial investment amount and as at 2017 was worth $8,400-Billion-Kroner, or roughly USD$1 Trillion (This sum of money is so vast I had to double check what $1 trillion looks like in numbers.  It’s actually 1,000-x-$1 Billion, or, 1-with-12-zero’s $1,000,000,000,000)

The history
In 1969, oil was discovered in the Ekofisk offshore field in the North Sea, marking the beginning of Norway’s oil wealth. It soon became apparent that the management of oil assets and revenues would be decisive for the Norwegian economy.
Revenues from natural resources such as oil, gas and minerals are known to be finite and volatile. When generated revenues are large enough, there are three main risks for the host country, the first two concerning governance, the third economic stability:
  1. From an ownership view, natural resources assets belong to the public. Politicians acting as trustees for the public have to make sure the asset values are managed sustainably so that future generations also can participate in the revenue generated by these assets.
  2. From a governance perspective, there is a risk of falling into “the resource curse”, by which countries mismanaging revenues suffer corruption, poverty of the local population, and even conflict.
  3. From an economic angle, the country can experience the wasteful spending of wealth, inflation, and deindustrialisation. This phenomenon is known as the “Dutch disease”, in reference to the 1960s economic crisis in the Netherlands after the discovery of North Sea natural gas (Once again, the Dutch make an appearance in this publication).
The policies that were put into place in establishing the Sovereign fund were smart and implemented at the right time.  As at 2017, it is estimated that 50% of Norway’s vast oil reserves have already been consumed and will be completely exhausted at some time in the  next 50 years.

The fund’s investment strategies and growth over time
The Oil fund invests in a range of diversified assets, however, the majority of the fund’s investments are held in growth assets with approximately 65% of the assets held in global equities (various diversified global companies around the world).  In 2017 alone, the fund’s earnings (eg. The money that was made by the investment returns) equated to USD $130 Billion.   Because the fund has a long-term investment objective, it can handle the sometimes-significant volatility that comes with holding such a large percentage of growth assets.

To avoid being subject to “Dutch disease” and future governments being able to pilfer the fund to overspend on the economy for their own political gain, the ministry of finance implemented a fiscal law in 2001 capping the amount that can be withdrawn in any one year to 4% of the value of the fund.  Given the investment strategies of the fund could be expected to average 6% – 7% pa. over time, a 4% maximum withdrawal rate in any one year ensures that the fund will continue to grow over time.

Oil Fund facts:
2017 fund value in USD:                               $1 Trillion
Norway’s population:                                     5.23 million
Fund value for every 1 Norwegian:               USD$191,000
2017 fund earnings in USD:                          $130 Billion
2017 fund earnings for every 1 Norwegian:  USD$25,000

Historical value’s of the fund in USD:
2017:                            $1 Trillion (1,000 Billion)
2015:                            $900 Billion
2013:                            $600 Billion
2011:                            $400 Billion
2009:                            $317 Billion
2007:                            $240 Billion
2005:                            $168 Billion
2003:                            $101 Billion
2001:                            $74 Billion

Lessons for aspiring retirees  
Despite the scale of Norway’s Oil fund being vastly different from that of the average 50-something-couple’s retirement savings,  the investment policies of the fund are strikingly similar to how aspiring retirees should behave.  The similarities that I can see are:
  1. Norway planned ahead of time. They knew that their oil resources were finite and decided to start seeding their investment fund well in advance of when the oil would run out.  Similarly, individuals in their 40’s and 50’s should plan ahead as their resources (wage income) have a finite timeframe.
  2. Smaller amounts added frequently compound to be worth a lot over time. Norway started the Oil Fund with an initial investment of $18 Billion Kroner (approx.. USD$2.2 Billion) in 1996.    From 1996 – 2017 total net contributions of USD$395 Billion have been added to the Oil fund..  The total contributed to the fund ($395B) has increased 2 ½ times to be worth over USD$1-Trillion today.  Similarly, a 50-year-old that contributes $100 per week to their retirement savings can accumulate an additional $140,000 by age 65, just by adding a smaller amount regularly and allowing it to compound over time.
  3. They held a long-term focus, even during the Global Financial Crisis. Heading into the GFC the Oil Fund held about 40% of it’s assets in Global companies.  These companies temporarily declined by some  -57% during the GFC.  During this time, Norway increased it’s Global companies asset percentage to 60%, effectively buying more whilst the prices were down.  They now hold approximately 65% of the fund’s assets in Global companies as they prefer their money to work hard for them especially considering that shorter term volatility is not such a concern, but rather the ability to fund future obligations when oil revenues run out.  Aspiring retirees often cannot foresee that they are likely to spend 25 – 30 years in retirement, and therefore need to take a longer-term focus and not be as worried about shorter term volatility as much.
  4. Norway set a maximum withdrawal rate of 4% from the fund in any one year. With expected average investment returns of 6% – 7% pa, by allowing maximum withdrawal from the fund capped at 4% pa., the fund can be expected to still grow by some 2% – 3% pa. in years when the maximum withdrawal of 4% occurs.  Ideally, retirees would adopt a similar financial plan whereby the maximum withdrawn each year as retirement income is capped at nor more than 5%.

Why isn’t Australia doing the same thing as the Norwegian’s? 
On one hand Australia is very similar to Norway.  We both have small populations by world standards; both have valuable levels of natural resources; we both rank high in the world Livability/Human Development index (Norway is ranked #1 and Australia #2).  Yet Norway is investing it’s Oil taxes for the future whereas both major political parties in Australia have shown in the recent past that natural resources taxes are fritted away.

This is just my theory, however, I believe that the Norwegian’s focus on the future has to do in part with their history.  In particular, the “Little Ice Age” between AD1150 – AD1850 occurred where the earth’s climate was significantly cooler than the preceding period. The little ice age affected Scandinavia considerably:  Plague was prevalent; crops struggled to grow and the population of Scandinavia declined significantly.  These stories are no doubt still passed down in Norwegian society today.  I cannot help but think that it is this history that has led Norwegian government’s decision to invest heavily in their fund whilst times are good, so that they can fall back on it in the future when times aren’t as good.

Sources: Wikipedia; Norges Bank Government Pension Fund Annual report 2017; United Nations Human Development Index.

​Written by Michael Hogue.

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