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The Norwegian Government Pension Fund -- A Success Story

01/19/2015 05:18 EST | Updated 03/21/2015 05:59 EDT
Ismail Akin Bostanci via Getty Images

The history of the oil and gas industry in Norway is a saga of bold political decisions, rapid world-class industrial development, and investing oil income for future generations. We Norwegians might be boring -- but with that comes a love for saving and long-term thinking.

Norway is Europe's largest oil producer, the world's third-largest natural gas exporter after Qatar and Russia, and an important supplier of both oil and natural gas to other European countries.

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source: Statistics Norway 2014

According to the Oil & Gas Journal (OGJ), Norway had 5.83 billion barrels of proven crude oil reserves as of January 1, 2014, the largest oil reserves in Western Europe. The enormous income to the state from the industry made it possible to create a global pension fund that now owns more than one per cent of global share value.

During the last generation, Norway's economy has been based on large revenues from oil and gas exports, deriving from the early exploration in the 1960s and 70s. The production in the Norwegian sector of the North Sea, and later moving northwards towards the Barents Sea, gave grounds for a surplus in the national economy. The Norwegian parliament, Stortinget, concluded that the surplus was not to be used in the national economy.

Stortinget established the Government Pension Fund in 1990. The political consensus has only broadened over time amongst all political parties. The reason for the creation of the fund was to counter the effects of the possible forthcoming decline in income, and to smooth out the disruptive effects of highly fluctuating oil prizes. The purpose of the fund is to invest parts of the large surplus generated by the Norwegian petroleum sector in different investment choices abroad. The main part of the surplus is comprised of taxes collected from companies, but also payments for licenses to explore and the State's direct financial interest contributes to the fund.

Investments for Norwegians in the future: Long-term, spread of risk, full transparency.

The fund has a long-term perspective, and its primary objective is security for Norwegians in the future. In 2006, the Fund got its current name: "the Government Pension Fund Global (GPFG)". This was part of a broader pension reform, highlighting also the Fund's role in supporting government savings necessary to meet the rapid rise in public pension expenditures in coming years. A sound long-term management of the Fund contributes to intergenerational equity, by allowing both current and future generations to benefit from the petroleum revenues. However, the Fund is not earmarked for pension expenditures.

100 percent of the government's petroleum revenues goes directly into the GPFG.

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source: Norwegian Ministry of Finance 2014

The government has set a limit on annual withdrawals from the fund of 4 per cent of the fund's assets, regardless of whether the fund actually earned more or less than that in a given year. The average tax percentage for the companies in question is 78 per cent of the surplus.

Managing the Fund: Challenges and Opportunities

The numerous challenges in managing the fund have been resolved in different ways. First ,investments are long-term. Good financial return over time hinges on sustainable development in economic, environmental and social terms. It also hinges on well-functioning, efficient and legitimate financial markets.

Second, the strategy is to purchase relatively small blocks of shares in many companies;on average, the GPFG owns 2 per cent of a company`s shares and never more than 10 per cent. This is a policy in order to both spread the risk and to avoid creating a perception of Norway as a threatening investor. The capital of the GPFG is in its entirety invested abroad in foreign currency. The fund holds 60 per cent of its assets in equities, 35 per cent to 40 per cent in fixed income and as much as 5 per cent in real estate abroad.

The management of petroleum revenues in general and the GPFG in particular is characterised by a high degree of transparency and disclosure of information. This helps build public support for a sound management of petroleum revenues, and reduces the risk of poor governance. Transparency is also important in order to gain trust from the global community. Internationally, it can often be a perception that funds managed by states think in political terms when constructing an investment strategy. Norway has by being open and transparent managed to create trust from the global market.

The size of the GPFG and setting a golden standard in ethics

In 2014, the GPFG passed the 6000 billion NOK milestone. The GPFG market value has grown substantially the last year, from 5,038 billion NOK at end of 2013 to more than 6,000 billion NOK today. The market value equals about 1000 billion Canadian dollars.

An important political guideline is the agreed budgetary rule that states that no more than 4 per cent of the capital value should be spent each year for national purposes. The total value will under this conservative management rule reach 7140 billon NOK by January 2019.

As one of the biggest national investments funds in the world, the GPFG has the potential to make a huge impact on corporate governance markets such as Europe, and China. With huge impact comes huge responsibility, and Norway has acknowledged this responsibility by establishing an ethical council and creating ethical guidelines for the Fund. Stortinget established these guidelines in 2004, and they receive broad political support. The fund cannot invest money in companies that directly or indirectly contribute to killing, torture, deprivation of freedom, or other violations of human rights in conflict situations or war. Contrary to belief, the Fund can make investments in a number of arms-producing companies. However, there are restrictions and the Fund cannot invest in weapons such as nuclear arms. Child labour, forced labour, gross environmental degradation and corruption would mean exclusion from the fund's portfolio.

Internationally this way of managing a financial fund has raised questions. Should the Fund make such decisions at all? In Norway, the perception is different and the debate often includes the question whether or not to exclude more companies. The Ministry of Finance decides on whether companies are to be excluded from the investment universe, based on recommendations from the Council on Ethics. The guidelines contain the exclusion mechanism for companies that produce specific products or that are responsible for or contribute to grossly unethical behaviour. Walmart was, for example, screened out some years back based on its violations of employment and human rights. In 2010, 17 tobacco companies were banned from the Fund's portfolio.

The fund will make its investments in international equity and fixed-income markets and real estate worldwide. Risk diversification and sound financial return shall still shelter the domestic non-oil economy from unsound fluctuations in inter alia oil prices. In Canada, the GPFG has made investments in close to 300 companies with approximately 11 billion Canadian dollars.

Looking Ahead: environmental responsibility

Early this December the Minister of Finance of Norway, Siv Jensen from the Progress Party, received recommendations from an expert panel on how the government should address the issue of climate gas emissions from coal and petroleum companies and the investments in such companies. The panel believe that active ownership and engagement are appropriate tools for the Fund to use to address climate-related issues. They recommend ways of enhancing the Fund's efforts in this area, and propose that the Fund continues to support relevant climate change research. They also propose a mechanism, which excludes the worst cases of climate offenders from the Fund on a case-by-case basis.

The Fund will continue to be a well-diversified, global financial investor and not a policy tool for the government, says Finance Minister Siv Jensen.

Proud of its savings for the future.

The Norwegian people, across party lines, are generally proud of the Fund. Even when Norway voted in a new government last year, the rules for the fund stayed intact. Discussion around the fund is a daily exercises wherein Norwegians engage easily. Should more petroleum revenues be spent in Norway, and in that case, would really inflation grow? Is the fund financially safe, given the abrupt and unforeseen changes we have seen in the international stock markets during the last years? What ethical, if any, guidelines should be in place? In addition, can we still invest in non-renewable energy, like coal? As we engage in the discussions around the fund, it is clear that Norway's Government Pension Fund is more than a national instrument for savings - it represents a nation-wide philosophy to safeguard and build financial wealth for future generations.

As oil prices are deeply plunging, the effect on Norwegian economy is not as devastating as in other oil economies. Still, income from the oil companies, designated to furnish the Pension Fund in 2015, could easily not reach 4 per cent. This could, in the long run, diminish the government's possibility to spend up to 4 per cent of its value in the state's yearly budget.