The Norwegian Oil Fund. A Principal-Agent Analysis of Political Decisions

Table of Contents

I. Executive Summary

III. List of Figures

IV. List of Abbreviations

1 Introduction

2 Problem Definition

3 Objectives

4 Methodology

5 Main Part
5.1 A Brief Overview of Norway
5.2 Facts About the Oil Fund
5.2.1 About, Governance, History
5.2.2 Facts, Investments
5.2.3 Market Value and Inflow/ Withdrawal
5.3 Principal-Agent Theory
5.3.1 Basic Idea of Asymmetric Information and Trust
5.3.2 The Consumption-Saving Decision
5.4 Analysis of Political Decisions

6 Results

7 Conclusion

Appendices
I. ITM
i. Human Resource Management
ii. Marketing
iii. Corporate Finance
iv. Strategic Corporate Management
v. Business Law
vi. Soft Skills & Leadership Qualities
vii. Research Methods
viii. Management Decision Making
ix. Business Ethics and Sustainability

Bibliography
Analog
Digital

I. Executive Summary

This assignment investigates the decisions, that were made by Norway's Finance Minister Siv Jensen and Prime Minister Erna Solberg in 2016 to withdraw money from the Government Pension Fund Global in order to compensate for a governmental budget deficit. The starting point will be a brief overview over Norway’s economic situation and a look into the structure and the investment strategy of the oil fund.

The analysis of the decision to plunge into the fund is based on the Principal-Agent Theory and the Consumption-Saving Decision and therefore these theories are explained further on. The political decision is then analysed based on these theories, and outcomes of alternative decisions are depicted.

III. List of Figures

Figure 1 - First edition of "Sokkelkartet" from 1965, ©Norwegian Petroleum Directorate

Figure 2 - Investment strategy of the Government Pension Fund Global, ©NBIM 2016

Figure 3 - The fund's market value from 1998 to 2015 in bNOK, ©NBIM 2016

Figure 4 - The Principal-Agent Theory, own work, derived from Mankiw, 2006, Schmalen, Pechtl, 2009 and Mayer, Davis, and Schoorman, 1995

Figure 5 - Intertemporal choice given the utility preferences and the budget constraint (Wikipedia 2017, creative commons license)

IV. List of Abbreviations

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1.Introduction

A small country in northern Europe made the global news in 2014, when it made all of its citizens millionaires through its sovereign wealth fund, the Government Pension Fund Global (Doyle 2014). Only theoretically and only expressed in the country’s own currency, the Norwegian Krone, but it still was something unusual in the world of global governmental saving.

The fund’s money comes from the Norwegian oil industry, mostly from taxes on oil and gas production, and is saved for Norway’s future generations. Global oil resources are estimated to suffice for another 40 to 55 years (Clemente 2015), but through its long term strategy the fund will continue to benefit the population of Norway long after the oil has run out.

Norway’s era of oil began over 50 years ago and some of the first oil fields that were developed are still active. The first oil fields were in the North Sea, and over the years the industry expanded to the Norwegian Sea and the Barents Sea. Figure 1 shows a map from 1965 of the division of the continental shelf into quadrants and blocks for oil drilling.

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Figure 1 - First edition of "Sokkelkartet" from 1965, ©Norwegian Petroleum Directorate

2. Problem Definition

Who decides what happens with the revenues generated from sales of a natural resource such as oil and who owns the resources to begin with?

In modern civilisation this problem is usually solved by implementing governmental structures which - hopefully - act in the best interest of the people. The difficulties arising from this implementation can be approached from two different, yet connected angles:

1. The Principal-Agent Theory
2. The Consumption-Saving Decision

The Principal-Agent Theory describes the asymmetry of information between the agent, “a person who is performing an act for another person, called the principal” (Mankiw 2011, p.468) and the principal, “a person for whom another person, called the agent, is performing some act” (Ibid.). It also describes the moral hazard in this setting of principals and agents, as an occurring habit of poorly supervised people to “engage in dishonest or otherwise undesirable behavior” (Ibid.).

The Consumption-Saving Decision deals with the choice between present consumption or saving up for future consumption, which in our case refers to present generations living now, and future, following generations. It takes into account the effect of interest rates and budget constraints.

3.Objectives

Discovering trade-offs and discrepancies within the political decisions which are supposed to benefit a country’s population is the main objective of this assignment. It will provide the fundamental theory behind the setting and shed some light at the outcome thereof. Occurring difficulties in the relationship between principals (as in the people), and agents (as in the government) will be analysed, and a conclusion will be given.

This paper will attempt to improve our current understanding of political decisions concerning a country’s welfare, based on the implementation of the Principal-Agent Theory and provide an overview of the Consumption-Saving Decision in such a setting.

4.Methodology

Starting off, a brief overview of Norway and its economic situation will be given and the sovereign wealth fund will be explained in detail. Facts and numbers are taken from The World Factbook by The Central Intelligence Agency and Norges Bank Investment Management. The Principal-Agent Theory will be described, explaining the idea of asymmetric information and moral hazard. Explanations are based on relevant literature. The conflict between present consumption and saving for the future will be shown and the actual decisions in Norwegian fiscal politics corresponding to the conflict will be analysed.

5.Main Part

5.1.A Brief Overview of Norway

Situated at the north-east of the Scandinavian Peninsula, Norway shares land borders with Sweden, Finland and Russia and takes up an area of roughly 324kKm2. The population is approximately 5m, which leads to a population density of 15.4/Km2. Norway’s GDP is 365b$, which puts it at the 22nd place in the world. To put these numbers in perspective, Germany is at the 4th place with a GDP of 3.400b€ (all numbers from Central Intelligence Agency, 2016).

About 26% of Norway’s GDP and slightly more than 50% of its exports in 2012 were generated by the petroleum industry, including crude oil and gas extraction (Norwegian Government Administration Services 2013). In the same year the country’s production of petroleum summed up to roughly 225msm3 and Norway ranked at the 7th place among the world’s oil exporters (Ibid.).

Norway is not a member of the EU but forms EFTA together with Iceland, Liechtenstein and Switzerland. Norway has its own currency, the Norwegian Krone, NOK, which was called the “world's safest currency“ by TIME (Smith 2009). Factors for this safety are the low risk of government default and the „weaknesses of rival currencies“ (Ibid.). Norway is not a member of OPEC.

The unitary constitutional monarchy has a parliamentary system of government with King Harald V of Norway as the head of state and Prime Minister Erna Solberg as the head of government. Norway ranks first on the OECD Better Life Index (OECD 2017), the Index of Public Integrity (European Research Centre for Anti-Corruption and State-Building 2017), and the Democracy Index (The Economist 2015).

5.2.Facts About the Oil Fund

5.2.1 About, Governance, History

The fund was set up in 1990 to secure the long term development of the Norwegian economy through petroleum revenues and to give the government room for action in fiscal policy when oil prices drop or the mainland economy declines. It serves as a tool to manage the financial challenges of an ageing population and is managed by NBIM for the Ministry of Finance, which owns the fund on behalf of the Norwegian people.

It is the world’s biggest sovereign-wealth fund and is designed for long term investment with the possibility of withdrawal when necessary. This withdrawal is regulated through the budgetary rule (handlingsregelen) which states that 4% of the fund’s inflation-adjusted return can be used in the national budget (Finansdepartementet 2013). The fund’s investment strategy mainly focusses on equity investments with about 60%. Fixed-income investments make up about 30% of the fund and real estate investments make up for another 3% (Figure 2). The result of this strategy is a truly long-term fund:

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Figure 2 - Investment strategy of the Government Pension Fund Global, ©NBIM 2016

Despite its name, the fund has no formal pension liabilities and no political decision has been made as to when the fund may be used to cover future pension cost (Norges Bank Investment Management 2017).

The current value of the fund is about 7.500bNOK which comes up to about 832b€, more than the double of the national GDP, as of today (January 22, 2017) and can be monitored in real time on trading days under https://www.nbim.no.

5.2.2.Facts, Investments

The fund invests in 78 countries worldwide and holds shares in 9.050 companies. This sums up to 1.3% of companies worldwide and 2.3% of companies in Europe. From the creation of NBIM in 1998 to the end of 2015, the Government Pension Fund Global generated an annual return of 5.6% in the fund's currency basket¹ (3.7% corrected for management costs and inflation), (All numbers courtesy of Norges Bank Investment Management, 2017).

Two decisive factors are taken into account by NBIM when it comes to investment strategy: its setup as a long-term support for the welfare of the people and its significant size, especially in relation to the country’s rather small size. Therefore the fund invests in many different countries and companies in order to “obtain the highest possible return with moderate risk as laid down by the Ministry of Finance” (Norges Bank Investment Management 2017). It is forbidden for the fund to invest in Norway.

Ethical factors are taken into account as well when decisions for new investments are made. Standing investments are constantly reviewed and divested when they no longer meet the standards of the fund. Currently this is discussed regarding the Dakota Access Pipeline project in the United States (Spear 2016).

5.2.3.Market Value and Inflow/ Withdrawal

After the 2016 presidential elections in the USA, global stock markets and especially the one in the US have risen significantly. In addition, the US Dollar has gained in strength, which leads to a depreciation of the Norwegian Krone. These two factors have led to an all-time high of the fund (Hovland 2016). Since the end of September 2016 the fund’s value has risen by 400bNOK, 6% of the fund’s value.

Until the end of 2015, the only real dips in the fund’s development can be seen around the Financial Crisis in 2009 and the Euro Crisis at the end of 2011 (Figure 3):

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Figure 3 - The fund's market value from 1998 to 2015 in bNOK, ©NBIM 2016

In March 2016, Norway's Finance Minister Siv Jensen and Prime Minister Erna Solberg announced that the first withdrawal in decades had been made from the fund. Details of the withdrawal were not confirmed at the time, but newspaper Dagens Naeringsliv said 6.7bNOK (780m$) had been withdrawn to use on public spending (Solsvik & Chopra 2016). We analyse these political decisions on the following theoretical basis.

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¹ “The fund invests in international securities. Returns are generally measured in international currency, a weighted combination of the currencies in the fund’s benchmark indices for equities and bonds.” (Norges Bank Investment Management 2017)