Future Norwegian Oil and Gas Policy

Norwegian Oil Policy: The Development and Maintenance of Efficient Fiscal and Regulatory Policies

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Management Summary

Oil and natural gas have helped run this world for the twentieth and twenty-first centuries. It is hard to imagine a world without oil and gas, yet the natural reserves we know of around the world are rapidly depleting. How will this decreasing resource size affect oil and gas policy in the nations of the world? One major nation that has profited immensely off of its oil reserves has been the northern country of Norway. After oil was discovered in the 1960s, the country went on a major oil profit spending spree, which then resulted in a recession in the 1980s and 1990s when global oil prices plummeted. To protect the nation from being so vulnerable in terms of oil prices and profits, Norway has since come up with a solution to help keep oil profits in line as part of the national budget without over-spending. With the national government enjoying much of the oil profits, they have set up an oil fund which aims to help keep money around for future generations in the form of a guaranteed pension fund. This strategy has begun to be adopted elsewhere in the world and has proven a way for Norway to keep control of its oil profits without spending overzealously.

Historical Review of Norwegian Oil

Until late into the twentieth century, Norwegians had relatively little idea what black gold awaited them under the North Sea. Oil was found in the North Sea in 1969, with production beginning in the middle of 1971 (Erikson 2006). This set off a wave of massive oil production profits in the region. However, “From the beginning, before the first drop of oil emerged the oil and gas reserves within Norwegian jurisdiction were defined by law as common property resources, thereby clearly establishing the legal rights of the Norwegian people to the resource rents,” (Gylfason 2008, p. 1). This guaranteed that most of the oil profits would stay within the Norwegian government, to be used by the people and for the people. It was a very ambitious strategy, one which later had a few bumps in the road, but later worked itself out. In terms of actual regulatory strategy, Norway proved tough on oil regulations. The model of the 1970’s Norwegian policy rested on “tight government control, a high degree of state participation and high taxes” (Noreng 2000, p. 1). Yet, even with tight regulations and high taxes, the country was in a top bargaining position. The strong political climate of the region gave it an advantage over other oil producing regions in the midst of internal and external struggles; “In the 1970’s and early 1980’s, political stability, rising oil process and promising geology gave Norway a strong bargaining position in relation to the international oil industry, especially as many OPEC countries nationalized their oil industries,” (Noreng 2000, p. 1). This then allowed the country to implement high taxes and tariffs combined with extremely strict licensing procedures and stiff regulations. Such a policy worked very well within the context of the Norwegian mainland, and the policy, although strict and disliked by many foreign oil powerhouses, was thought of as a success.

However, recent research has show that the massive oil fields in the region have reached their peak and have begun to deplete. Many within the field believe that “The resource base in the North Sea is mature, with finds getting smaller and more difficult and with a rising share of natural gas,” (Noreng 2000, p. 1). Some research has found that oil production out of Norway’s various fields reached a peak in 2001 and has since been declining, (Hook & Aleklett 2008). Out of all of the field types, large scale fields, small fields, natural gas liquids and condensate, large scale fields were the ones declining the fastest. According to research, the giant oil fields have been declining an average of -13% a year after their initial peak production year of 2001 (Hook & Aleklett 2008). Condensate fields have even been reported to have declines as much as -40% annually (Hook & Aleklett). This is a looming reality which will soon have a major effect on the nature of Norwegian oil policy as well as the Norwegian economy as a whole.

Yet, despite falling assets, Norway is still the third largest gas producer in the world. In fact, it supplies a large portion of the European Union with its gas and oil needs. Germany, France, the Netherlands, Belgium, Spain, Austria, the Czech Republic, Italy, Poland, and the United Kingdom all receive a massive percentage of their oil from Norway’s reserves, (Engebretsen 2007). The country has also been opening new building projects to implement new pipelines into the mainland of Europe, also attesting to Statoil’s desire to grow despite recent disappointing numbers (Engebretsen 2007). Even in the midst of a declining oil reserve, “Total oil production in 2004 was about 3.2 million barrels / day, and the net export of oil about 3.0 million barrels/day,” (Engebretsen 2007, p. 1). These results in massive profit numbers reserved for use by the Norwegian government. Even today, there are over 50 oil fields in production in and around the North Sea (Erikson 2006). This attests to the sheer magnitude of the fields discovered in the North Sea, and shows that despite a decline in oil production — Norway is not nearly finished with its production just yet.

Although oil production is decreasing, this is just one single aspect of Norway’s production within natural gasses as a whole. In fact, production of petroleum is expected to gradually increase until around 2011, when it is then expected to decrease slowly afterwards, (Erikson 2006). Research then forecasts a serious decline by 2030 (Hook & Aleklett 2008). This is following a similar pattern to the 2001 peak and decline of general oil production. However, gas production is expected to continue to expand until around 2013; “From representing approximately 35% of the Norwegian petroleum production in 2006, gas production is likely to represent a share of more than 50% by 2013,” (Erikson 2006, p. 4). This leaves many to have high hopes in the continuing success of Norwegian gas policy and its mission to help preserve its oil wealth for future generations to come. With the success of gas production, there are still much more profits to be made; “While Norwegian oil production has peaked and is declining, gas production is still increasing and this is important because there is particular concern within the EU about gas security,” (Stern 2006, p. 1). This then shows how Norway’s most valuable resource will continue to shape both foreign and domestic policy for years to come.

Review of Petroleum Policy

Once Norway had struck black gold, the country went through a long and painful learning process on how to control and manage its oil profits. In the beginning of the Norwegian oil boom, large petroleum profit spending in the early years of oil production was typical and a major staple within Norwegian oil policy within a fiscal context. Much of this money was spent on plumping up the economy and social programs, which much of industry itself could not have done; “Actually, [they] spent a large share of [their] expected petroleum wealth in the 1970s and 1980s. Welfare schemes were expanded significantly,” (Erikson 2006, p.5). Spending of oil profits was conducted as if the oil reserves would never dry up. This also led many Norwegians to attempt to use such large oil profits as a way to make up for the failures of other industries which would have normally contributed to the national budget before. There were temptations “to use oil policy as a balancing factor to offset failures in industrial policy and economic policy,” (Noreng 1980, p. 247). Together, these all lead to massive spending of oil profits within the first few decades of the initial oil boom in the North Sea.

Yet, in 1986 global oil prices per barrel dropped dramatically. This resulted in a severe recession in the 1980s leading into the 1990s in Norway (Erikson 2006). Norway had exhibited too great of a dependence on the profits of oil production within the construction of the national budget and overall financial health of the nation; “In 1985, the value of the petroleum production and its exports represented 18/7% and 37.6% respectively of the gross national product (GNP). Its share of the actual export of goods was about 50%,” (Austvik 1989, p. 1). When the price of oil fell in the mid 1980s, it fell drastically. In fact, “In 1986, when the oil prices fell from an average of 27.6 to 14.2 dollars a barrel and somewhat more in Norwegian kroner as a result in the fall in the exchange rate of the dollar, the value of the production fell by about 30 billion Norwegian kroner,” or about 11% of the GNP, “(Austvik 1989, p.1). Such a drastic fall put the Norwegian economy on the brink of disaster. It was from this lesson that legislators began to understand the need to put away large percentages of their oil profits and to not depend so much on spending that cash flow.

After the recession of the 1980s, Norway drastically re-examined its oil policy from both a fiscal and regulatory perspective. Up into the late 1980s, “foreign oil policy followed what was called a ‘purely commercial line.’ That is, it was not desirable to declare officially that political evaluation were included in its design,” (Austvik 1989, p.1). This lead Norway to be established as a “free rider” within the global oil market. According to research, “As a ‘free rider’ in the market, Norway was then also in the best possible position; she could increase her production and at the same time reap the price benefits deriving from other counties’ production reductions,” (Austvik 1989, p.1). The recession of the 1980s lead to complications which forced Norway to use this better bargaining position as a tool to help establish a more secure future — one not so vulnerable to recessions and oil price drops. In 1990, to ensure better fiscal health in future years, the Norwegian government established the Norwegian Government Petroleum Fund after the Act on the Government Petroleum Fund was adopted into legislation (Skancke 2009). In this fund “money will only be allocated to the Fund when there is a budget surplus,” (Skancke 2009, p. 318). It has since been adopted for use as a pension fund which ensures pensions for Norwegian citizens thanks to massive oil profits. Many also state that “The Petroleum Fund can also be seen as a fiscal management tool to ensure the transparency in the use of petroleum revenues,” (Skancke 2009, p. 320). The establishment of the Fund shows a new direction for Norwegian oil policy and its devotion to saving oil wealth for future generations and not recklessly spending it on the needs of just today’s generation.

Today, Norway is still not completely out of hot water. Although its policy has been changed to fit the needs of future generations, the current health of its oil production still proves vulnerable. Statoil, one of its top domestic oil companies, is beginning to show signs of a decline after years of massive profit increases. This has the potential to lead to its ultimate decline; “Statoil’s results are below industry average, these assets could make it a vulnerable target for an unfriendly takeover,” (Noreng 2000, p.1). As one of Norway’s top oil companies it is an example of the health of oil production within the country. Currently, it is not pulling in numbers like it used to and so “Statoil is the subject of criticism because its return on capitol is below industry average and because its foreign ventures, as a whole, have not been very successful,” (Noreng 2000, p.1). This is bound to also have future changes within Norwegian oil policy as developments continue to unfold.

Today, Norway’s strict regulatory policies are coming into question. With the vulnerability of major oil producers such as Statoil, “licensing policy is likely to change, giving easier access to independent and small oil companies,” (Noreng 2000, p. 2). This would help spur industry with smaller companies taking over what was once controlled by only a few elite powerhouses. In order to stimulate more activity within the oil sector, Norway must lower some of its regulatory practices. The nation has long been criticized over its exercise of strict regulations, but without the ability to follow up on them. Even with Norway’s much higher initial requirements and standards, “the most serious accident so far has taken place in Norwegian waters, revealing insufficient preparedness and control,” (Noreng 1980, p. 249). Thus, the country is looking towards more lax regulations, yet without sacrificing its true commitment to the safety of the environment.

In today’s market, the production of oil is still a major force within Norway’s economy. In fact, “In 2005, the petroleum sector accounted for 25% of the GDP in Norway. Through direct and indirect taxes and direct ownership, the state is ensured a high proportion of the vales created from petroleum activities,” (Erikson 2006, p. 3). Although not as impressive as in past decades, these are still impressive numbers. Oil profits represented 52% of all of Norway’s profits from exports in 2005 (Erikson 2006). Another major benefit Norway has in regards to its ability to benefit from large oil profit percentages, “oil and gas production exceeds domestic consumption many times over,” (Frognes et al. 1982, p. 46). This means that with little domestic need for the product, the nation can enjoy the benefits of exporting much of the oil produced within the country. This will continue to bring in large oil profits to be used in the Fund to provide pensions for Norwegians.

The Competitive Position of Norway

Norway has always held a great competitive advantage above other major oil producing nations. For one, it has enjoyed a great level of political stability, which has allowed for better management and handling of oil production profits. It has also made other purchasing nations more secure with their investments in Norwegian oil production. On top of this, Norwegian oil policy has also been strong too provide for domestic business and not let foreign capitol take over its most valuable resource. This has definitely proven successful; “The Norwegian policy of promoting the local supply industry, especially early in its oil history, made it possible or Norwegian firms to compete with multinational energy suppliers, even on specialized task,” (Davis 2006, p.72). Thus, smaller and domestic firms have the ability to compete with major global powerhouses like Mobile.

Another major step into a different direction for the oil policy of Norway is its attention geared towards future generations. Many Norwegians believe that they “have an obligation to ensure that also future generations will benefit from the oil wealth,” (Erikson 2006, p.6). It is an ambitious and selfless objective, one which will ensure greater and more stable economic health even within the midst of declining oil reserves. Since this mission was set in place, the Norwegian Ministry of Finance has” introduced budget policy guidelines that recognize the special nature of petroleum revenues: Central government’s net cash flow from petroleum operations is transferred in its entirety to the Government Pension Fund — Global via the state budget, whereas the guidelines stipulates that only the expected real return on the Fund should be returned to the budget for general spending purposes,” (Erikson 2006, p., p. 6). The Fund regulates oil profits into a manageable resource for pensions through long-term regulation of petroleum profits by the government (Velculescu 2008). It helps ensure a better future, both for current working Norwegians, as well as future generations who will definitely not see great future profits from oil production in the region of the North Sea. The Fund is now one of the largest retirement funds in the world, with an estimated worth around 160 billion Euros, (Norway: The Official Site in Australia 2009). It is an impressive example of how a nation can turn oil profits into a viable and long lasting way to boost the domestic economy without overzealous spending, which almost always leads to some sort of crash base on the extreme dependence on oil profits. Yet, even a fund built on the massive wealth of oil profits is vulnerable in today’s declining financial markets. The return of the Fund fell by 23% in 2008, loosing around 633 billion kroner, or 89 billion dollars, (Joshi 2009). However, all domestic markets are suffering in the wake of a global financial crisis. This slight decline does not signal the death of the Fund, and many future generations of Norwegians will still continue to enjoy the benefits of oil production and profits seen within their nation’s borders through the Pension Fund.

Today, the resources in the Fund are being used to help diversify the nation of Norway’s wealth. Recent budgets show heavy investing with the resources in the Fund; “The Fund’s benchmark portfolio for equities compromises more than 7,000 equities across 47 countries, whilst the benchmark portfolio for bonds compromises about 10,000 bonds from about 1,600 issuers in 21 countries,” (Ministry of Finance 2009, p. 1). Investing in foreign markets will help diversify the nation’s economic and fiscal resources. This will lead towards a further stance on its previous dependence on oil profits alone to boost the economy. The assets of such investment are located exclusively abroad; “This strategy ensures risk diversification and good financial returns,” (Velculescu 2008, p. 1). Currently the half of the Fund’s assets resides in Europe, with the other half split between the U.S., Asia, Australia, and South Africa (Norway: The Official Site in Australia 2009). So far, this strategy of heavy foreign investment has paid off for the Norwegian mainland. According to recent research, “The investment strategy has produced a healthy 4.3% average annual return during the past decade,” (Velculescu 2008, p. 1). Even more impressive, “Morgan Stanley calculates that such funds may control $12 trillion within a decade as Russia, China, and smaller economies like Iraq and Bolivia invest earnings from energy and other exports,” (Wigglesworth & Kennedy 2007). This has made Norway a leader in setting successful precedents for the dealings of large oil profits. Today, Norway has been known to actually provide experienced advice to developing countries dealing with learning how to manage major oil resources (Norway: The Official Site in Australia 2006). Thus, the country has come a long way since its overzealous spending of the past. It now has a bright future, despite declining oil reserves.

Recommendations for Changes to Norwegian Fiscal and Regulatory Policies

In alignment with this research, there are several recommendations which can be made to the state of Norway to increase the efficiency of its fiscal and regulatory policies. It is well-known that “Advocating fiscal restraint is not easy when the general government budget surplus is around 15% of GDP,” (Skancke 2009, p. 316). However, with the lessons of damaging overspending seen in Norway’s past handling o oil profits, it is clear that the country must continue to manage and cub its oil profit spending as much as possible. This then gives it more financial clout for internal projects such as the Pension Fund and also more ammunition for the nation’s foreign investment strategies.

Yet, there are several things Norway should make sure not to do when examining potential changes within its fiscal oil production policies. First off, raising taxes would definitely be a major mistake. According to research, the “Norwegian economic policy should probably not be based on further tax increases. Tax levels are generally high by international standards, and there seems to be an agreement — at least in principle — that some of the room to maneuver coming from an increased use of petroleum revenues should be used over time to reduce taxes and excise duties to increase the efficiency of the mainland economy,” (Skancke 2009, p. 326). Thus changes within fiscal policy should avoid tax increases. The already high tax standards set would make this a disastrous move that might threaten foreign buyers, leading to a decrease in market share.

Another recommendation to proceed cautiously is the dealings with foreign oil o capitalize the market. Today, Norway has been reaching out to underdeveloped countries like Iraq to do business, “On 30 June 2009, StatoilHydro participated in the first licensing round for the Iraqi oil sector. No contract materialized after the bidding but StatoilHydro has expressed a continued interest in doing business in Iraq,” (Visser 2009, p.1). This represents a moving interest from appealing to the Kurds as was done earlier, to appealing to the more centralized Iraqi government. However, Norway must be careful with its dealing in Iraq, and not move to align itself with the central Iraqi government too soon. The nation is still in major turmoil, and the fighting fractions may not look highly on a nation who had devoted itself towards doing business with the centralized government. For the moment, it might be a smarter business move to avoid business with Iraq until the nation moves towards more solid political ground. This would help Norway avoid backpedaling and reworking tainted alliances, as seen in the recent move to abandon dealings with the Kurds for the centralized government.

Lastly, there are recommendations to best deal with the dwindling oil resources known to exist in the North Sea. The giant oil reserves prove to be the ones most rapidly declining. Therefore, it would be smart policy to invest more capitol and resources into maintaining and finding dwarf field, which are much smaller but more productive. In fact, “A number are expected to come into production with eight new dwarf fields expected to come on stream in the coming years,” (Karasu 2006). Thus, moving towards placing dwarf fields at the center of Norwegian gas policy over the giant fields is an intelligent move. Finally, in regards to Norway’s hunt for more reserves, the country must proceed cautiously. It is true that if Norway is to maintain its income “from oil and gas [they] must begin activity in new regions,” (Solholm 2009, p. 1). However, potential fields are located to the north in the Norwegian Arctic. In order to maintain the nation’s commitment towards strict protection of the environment, Norway must proceed cautiously into the Norwegian Arctic, focusing on smaller scale productions in order to not break up the delicate balance of the Arctic environment. It is important not to just burst in to major development in the region, for it would have drastic environmental ramifications.

Conclusion

Norway has learned a lot from its previous endeavors with its oil policy in the past. The country has moved and progressed immensely from its time in the 1970s where oil money was overspent in short durations of time. Today, the country is a stellar example for what proper oil management can produce in terms of log-term success and financial health. With its success, Norway can teach other developing oil producers how to manage large and tempting oil profits efficiently to provide wealth for future generations to come.

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