BRIAN MILLNER and JEFF LEWIS take an in-depth look at the oil funds of two, on the face of it, drastically different places: Norway and the Canadian province of Alberta, asking what they could learn from each other’s schemes.
Brian Milner and Jeff Lewis
As world oil production outstrips demand, China’s outlook darkens and prices plumb levels not seen since the Great Recession, energy-exporting countries around the world face a prolonged period of thinner revenues and deepening economic woes.
The chill winds have now reached Norway, long regarded as the world’s most prudent manager of an economy heavily exposed to the ups and downs of commodity prices. Faced with the steepest decline in oil and gas spending in a decade and a half and the biggest job losses since the global financial meltdown, the centre-right Norwegian government is pledging to tap more of the country’s accumulated resource wealth in an effort to stanch the bleeding.
The sudden decline in its fortunes has put a spotlight on Norway’s unusual handling of its gusher of resource cash over the years, parking 100 per cent of the government’s revenue from royalties and dividends in a fund that is barred from investing a single krone in the domestic economy.
It’s a vastly different approach to that of Alberta, which set little aside from their energy windfall and are now facing bleaker fiscal and economic conditions without much of a cushion to soften the blows of tumbling oil prices. The Alberta Heritage Savings Trust Fund, the province’s rainy-day umbrella, barely has enough capital to deal with a few scattered storms. Norway’s equivalent, which was partly modelled on Alberta’s when it was set up in the early 1990s, could handle a deluge of almost biblical proportions.
“The Alberta Heritage Savings Trust Fund, the province’s rainy-day umbrella, barely has enough capital to deal with a few scattered storms. Norway’s equivalent, which was partly modelled on Alberta’s when it was set up in the early 1990s, could handle a deluge of almost biblical proportions.”
Consider the fortune amassed by Norway’s prosperity fund. Norway’s petroleum treasure chest holds assets totalling some 7m NOK (£613 billion), making it the world’s largest sovereign wealth fund. It’s a potential shock absorber of a size and scope not available to any other energy producer outside the Arabian Peninsula.
The fund has grown so huge that it now owns 1.3 per cent of the global equity market, covering more than nine thousand companies in seventy five countries. At the end of 2014, its Canadian equity holdings alone totalled $CAD 14 billion (£8 billion) spread across 270 companies. An equally diversified bond portfolio contains everything from more than $CAD 1 billion (£557m) worth of Canadian government bonds, $CAD 100m (£55m) of Alberta paper and $CAD 38m (£21m) of Toronto municipal debentures to a smattering of Greek debt. Its only other investments are in real estate, mainly in major cities, amounting to 2.2 per cent of its assets.
There was a time when Alberta policy makers faced the same central question as Norway’s. But they came up with radically different answers.
“Do you want to have this benefit the generation that happens to be around while this is happening, or do you want to distribute the gains over multiple generations?” is the way the question is framed by Leo de Bever, the former head of Alberta Investment Management Corp., which manages $CAD 70 billion (£40 billion) in Alberta assets, including the Heritage Fund.
“It depends whether you are concerned with a geographical entity called Alberta and its long-term future after oil, or whether you think we’re all sort of camping out and when the oil runs out we’re going to pick up stakes and move somewhere else.”
Norwegians are so determined to leave something behind when the oil and gas income dries up that any effort to withdraw more money from the Government Pension Fund Global – the awkward moniker given to their prosperity fund – than the rules allow would be akin to a Canadian politician trying to change the public health care system. Despite its name, the fund has no specific pension liabilities to meet.
“What is most surprising is that in the current state, there seems to be a general consensus that the money should be kept where it is and the rules should not be changed,” said Bruno Gerard, a professor of finance at the Norwegian Business School in Oslo. “So you don’t hear claims [outside the oil sector] that more money should be pumped into the economy … for the current generation. The general population thinks it’s perfectly fine as it is.”
Still, if the industry’s troubles mount, job cuts deepen and the damage sends the sputtering Norwegian economy into reverse gear, it could test that long-standing consensus. Under current rules, the government can withdraw no more than 4 per cent in any given year, which not coincidentally matches the fund’s expected average annual real return.
“Under current rules, the government can withdraw no more than 4 per cent in any given year, which not coincidentally matches the fund’s expected average annual real return.”
“It’s a flexible rule. It’s not 4 per cent come whatever,” says Trond Grande, the low-key deputy chief executive officer of Norges Bank Investment Management, an arm of the central bank that manages the fund. “During the  financial crisis, they went above the 4 per cent. That’s how the fund functions as a kind of stabiliser, a buffer mechanism.”
In her first budget back in 2015 Norwegian Prime Minister Erna Solberg said the government would transfer 3 per cent of the value of the oil fund into its budget this year – up from 2.8 per cent in 2014 – to help cover the costs of tax cuts designed to spur growth. Now, as the official forecasts look shaky, there are rumblings that the takeout could go higher.
Right-leaning politicians in Norway have argued that the withdrawal cap should be boosted to 5 per cent to put more cash to work in the domestic economy today, while others say it should be lowered to ensure there is enough capital to meet future spending needs. All operate on the thesis that the oil will stop flowing in the next couple of decades. In the fund’s early years, when oil prices were relatively low and the fund relatively small, the Norwegian government could get its hands on more cash during downturns, provided it took less than the target level when the economy was expanding.
“The wiggle room actually didn’t work,” Mr. Gerard said. “Every year, they said we were in a recession” and spent as much as 6 per cent. But then policy makers became “much more religious” about sticking to the target, he said. And today, it is a matter of Norwegian national pride.
In the midst of their own worst economic slump in years, Albertans are tired of hearing how much better Norway has been at managing its oil riches. They point to the significant differences between the two jurisdictions, not least of which is the fact Alberta is a province without complete control over its revenues. Then, there are the vastly higher costs of oil sands development, which required more public investment, as well as the political decision in Alberta to use part of the oil wealth to reduce taxes and spur investment – something Norway is only getting around to now. There are also questions about whether the Norwegians can sustain their model if the oil slump deepens or another global recession hits. “They have a small population, relatively, and I would say that for the interim period, it seems to be working,” said Michal Moore, professor of energy economics at the University of Calgary’s School of Public Policy. But in the face of a prolonged downturn, “they might look again at freeing up some of the revenues generated from interest and investments.”
As for most Albertans, “they care much more about the future of the province than they do about international comparisons,” said Kara Lilly, a strategist at Mawer Investment Management in Calgary who tracks global oil trends. “And if you look at the last election, you saw a pretty clear response from Albertans on how their future, including the Heritage Fund, has been managed.”
Indeed, the Heritage Fund has strayed a long way from its original intent. It was conceived in the early 1970s during then Progressive Conservative premier Peter Lougheed’s first term in office. He ran for re-election in 1975 on a pledge to stash a share of Alberta’s resource wealth in an emergency kitty, hoping to convert what was believed to be a fleeting oil boom into a lasting legacy. Initially, the idea was to save as much as 30 per cent of energy revenues to start with and use a portion of the fund as an investment vehicle for diversifying the provincial economy. But over time, successive Conservative governments propped up dubious ventures in sectors ranging from forestry to aviation and food processing.
Contributions ceased entirely when oil prices tanked in the mid-1980s, and the Heritage Fund has been frozen in time ever since. The government now pockets most of its oil revenue, using the bulk of it for general expenses. In 2014 the fund was valued at $CAD 17.9 billion (£10 billion) and it generated a healthy return of 12.5 per cent, amounting to about $CAD 1.7 billion (£948m) . Of that, $CAD 1.5 billion (£836m) was siphoned into the government’s general revenues, with $CAD 210m (£117m) saved. Since its inception, income transfers to government have totalled $CAD 38.2 billion (£21m). The result has been a damaging pro-cyclical fiscal policy: hefty spending in good years and deep cuts during lean times. The province famously has no sales tax – even in the current downturn, it’s a verboten concept – but is routinely exposed to volatile swings in commodity prices.
For all their frustration with the way the resource wealth has been managed, Albertans have shown an aversion toward beefing up the Heritage Fund. In May, they rejected then Conservative premier Jim Prentice’s plan to shrink the province’s dependence on energy revenues by 50 per cent while doubling the fund’s size to more than $CAD 30 billion (£16 billion) within a decade. Mr. Prentice lost a snap election to the New Democratic Party (NDP) led by Rachel Notley, who inherited an economy in freefall as a result of skidding oil prices.
The NDP is expected to release a budget this fall showing the full extent of oil’s steep decline. Finance Minister Joe Ceci insists the deficit this year will be in the range of $CAD 5.4 billion (£3 billion), even as cutbacks in the energy sector intensify and world and American crude prices remain at less than half the levels of a year ago. Outages at a large refinery in the American Midwest in 2015 and pipeline snarls pushed prices for Western Canada Select oil sands crude below $CAD 30 (£17) a barrel.
The darkening outlook could add as much as $CAD 1 billion (£560m) to the provincial deficit per year, said Robert Kavcic, senior economist at Bank of Montreal. The bank expects the provincial economy to contract by 1 per cent this year, before rebounding to post moderate growth of 1.9 per cent in 2016.
“The more important thing is that the budget had also assumed that by 2017 we would be back into a much firmer oil price environment and a stronger economic growth environment,” Mr. Kavcic said.
The NDP has yet to detail plans for the Heritage Fund, but it’s clear the party faces stark choices over how to divvy up a shrinking pie – despite raising corporate and personal income taxes earlier this year.
“The NDP has yet to detail plans for the Heritage Fund, but it’s clear the party faces stark choices over how to divvy up a shrinking pie – despite raising corporate and personal income taxes earlier this year.”
“For decades when oil was strong, the PCs failed to appropriately invest in the Heritage Fund,” Mr. Ceci said in a statement, referring to the 43-year Tory dynasty. “Now with the drop in oil prices, it will take some time for our government to reverse the damage. We are committed to appropriately investing resource revenues for future generations and are working on a fiscal plan to that end.”
Meanwhile, the Norwegian government, which gets enough cash from the oil fund to cover about 20 per cent of its annual budget needs in a typical year, continues to run surpluses and has no external debt.
“Imagine if Alberta had followed a similar formula, even sticking to [Mr. Lougheed’s target of] 30 per cent of oil royalties for the fund,” said Greg Poelzer, executive chair of the International Centre for Northern Governance and Development at the University of Saskatchewan and a harsh critic of Alberta oil investment policies.
When the Norwegians were setting up their own heritage fund, they had similar concerns to Alberta policy makers, said Mr. Poelzer, who has studied various resource savings schemes in Canada, Norway and the USA.
Would the electorate support taking oil revenues and investing them outside Norway, rather than putting them to work in the domestic economy?
“When confronted with such a choice, Norwegian politicians thought the electorate might not be supportive of a plan that deferred investment,” he said. But they were wrong.
“Politicians underestimate citizens when it comes to these [long-term funds]. People get it. I think Albertans understand the importance of deferred gratification.”
Tying the hands of the Norwegian government before the wave of oil money started flooding in “was, in hindsight, a great thing to do,” Mr. Gerard said. “I’m sure Norway will be able to withstand even a further lowering of activity without too much hardship.”
BRIAN MILLNER is a journalist, author and ghost writer, whose publications include Shifting Gears (2008), an examination of the technical boom’s impact on the economy, and The Hidden Establishment, profiling secret but wealthy immigrants in Canada. He has also written a history of Toronto, is a frequent commentator on radio and television and writes for The Globe and Mail.
JEFF LEWIS also writes for Canadian national daily The Globe and Mail, as a special reporter in energy for its Report on Business section. He is based in Calgary, but has travelled widely in Norway and the Canadian Arctic.