Sovereign Wealth Funds The Case of the Norwegian Sovereign Wealth Fund

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

2. 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

3. Did Norway avoid the disease and the curse?

4. Curse and disease • Curse • Tendency for resource rich countries to grow slower than others. Many reasons. Graft; corruption; (Overlapping with definition of Disease) • Dutch Disease • a movement of capital and labour from other traded sectors to the resource sector • increase in aggregate demand leading to overheating of the economy and inflation and appreciation of the currency, • 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.

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

6. Currency Appreciation?

7. Rampant Inflation?

10. How?

11. My«Model»

12. Initial Conditions • Economy • High income country • Lowunemployment • Falteringmechanical /shipbuildingindustry • Human resources • High level of education (cheapengineers) • Norwegian «DNA» • Small, Homogenous: 4,7 million inhabitants , 323 802 squarekms (a bit smallerthan Zimbabwe) veryfewethnicdivisionsworthmentioning. • Youngcountry, independence 1905 • LutheranChurch state religion under the 1814 constitution. 83% of the populationmembers of the EvangelicalLutheran Church • Labour Party key in politicssincebefore the war. The party can be said to be social-democraticbut, as some have said, all the parties in Norway arereallysocialdemocratic. Egalitarianpolicies • 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: Coastline of 50 000 km. That makes it longer than the entirewestcoast of Africa from the Cape to Gibraltar.

13. 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 independencefor 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 developingan 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 62nd parallel where there are unique socio-political factors 10. That Norwegian petroleum discoveries could present new tasks to Norway’s foreign policy

14. 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.

15. 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%) • Requirementto 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,

16. 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

17. Oil taxCapturingnaturalresourcewealthbut not scaringaway investors

18. 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 ASAwasfounded as a limitedcompanyowned by the Government of Norway on1972 by an actpassed by the Norwegian Storting with the politicalmotivation… • to hold 50% state participation in each production license • to build up Norwegian competencywithin the industry • to establish the foundations of a domestic petroleum industry. • Company under closescrutiny by government, requiredto submit an annual report to the Storting. • Statoil ASA became (partly) privatised and madea publiclimitedcompanyin 2001, listedonboth 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.

19. 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 waspartially privatised in 2001 the company’s management of SDFI wasno longer desirable and a newstate-owned management companycalledPetorowascreated to manage SDFI. • Petorois registered as owner for the state’sownershipshareswithpresentlyshares 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

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

21. 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.”

22. 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. MoF 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 NorgesBank (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

23. Source: Norges Bank

24. Source: Norges Bank

25. Source: Norges Bank

26. Structure of oil cash flows and Fund Petroleum Taxrevenue SDFI surplus dividend Statoil dividends Non oilrevenue - Non oilexpenditure Oil relatedrevenue - = Governed by fiscal rule Oil relatedexpenditure + Interest and Dividend from Fund - State Budget oilcorrectedsurplus = Surplus of statePension Fund

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

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

29. The future: adjustments and threats • Fund management: • Changingbenchmarks • Possiblechange from 4 to 3 percent • Tax system: • Country and projectreporting, • Transparencyguarantees • Labour markets: • Preservation of the «frontier trades model» • Political: • Slide into populist spending

30. Value of Norwegian experience ? • The fiscalrule has worked – so far. Fiscallysucessfulbreakingthe link betwen oil-revenue and publicspending. • But is value store and modest contribution to the budgetenough 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 nationalownership • The «goingupstream» has worked, but favourable initial conditions. • Norway has notavoidedbuildingoildependence • Setting up institutionswasno «rocket science». Runninginstitutions is key. (On Statoil: being 67% stateowned and avoidpoliticalinterference is difficult) • Shape and size of treesdependon the soiltheygrowin.

31. Thank you!