It is time to change how Norway's Oil Wealth is managed
Norway has reached a critical point in how its oil wealth is managed. There is now an active debate not just on the investment strategy of the Oil Fund, but also on the governance mechanisms by which this oil wealth is managed.
The first debate has been driven in part by the launch of a 2013 Re-Define report that was critical of the Fund’s investment strategy. The second debate is driven by a secretive investment in Formula 1 that went wrong and has been recently exposed by Dagens Naeringsliv (DN)
Solutions to the first debate include selling out of fossil fuels, investing in the green economy, seeking out illiquid assets such as infrastructure and investing half the portfolio outside OECD economies. The solution to the second is to set up a Parliamentary Council for the Oil Fund “Stortingets Råd for Oljefondet” (SRO).
While the debates have originated independent of each other, they are intimately related. The Oil Fund is owned by Norway’s Parliament on behalf of Norwegian citizens. The Parliament defines the investment objective of the Fund as “maximising the purchasing power of the fund capital, given a moderate level of risk.” Under the present governance arrangements, this objective is translated into investment guidelines by the Ministry of Finance that are then followed by Norges Bank Investment Management, which actually invests the funds.
Once the reasonable sounding investment objective was defined by the Parliament, it has had little effective oversight of whether this investment objective was interpreted appropriately by the Finance Ministry or indeed into whether NBIM’s actions are in accordance with the spirit of this objective.
In its 2010 report, the Strategy Council for the Oil Fund, an advisory body, criticized the manner in which the objective set by the Parliament was interpreted into investment guidelines by the Ministry, but was largely ignored. The Formula 1 debacle can also be attributed to insufficient democratic oversight. Without proper accountability to the Norwegian people through adequate parliamentary oversight, the Fund will lose its legitimacy. A powerful SRO “Stortingets Råd for Oljefondet” that provides independent financial expertise to the Parliament will enable it to hold NBIM and the Finance Ministry to account effectively.
Following the adoption by Norway’s new government of the main recommendations of Re-Define’s report in its coalition agreement, it has demonstrated a deep understanding of the issues at stake and a seriousness of purpose. It is still too early to say whether the government will go as far as Re-Define suggests in changing the investment strategy of the Fund to make it more consistent with the Investment Objective set by the Parliament, but it is at least moving in the right direction.
Re-Define’s headline recommendations, as laid out in an Aftenposten Op-Ed, were 1) that the Fund sell out of all stakes in fossil fuel companies 2) that it apply a positive green filter to diversify away some of the residual carbon risk arising from the dependence of future inflows into the fund on oil and gas prices 3) that it have a much greater focus on illiquid assets such as infrastructure and growth equity to harvest the liquidity premium and 4) that it invest almost half the fund outside of OECD economies to provide structural diversification, generate higher returns and reduce risk.
The announcement by the government last week of the setting up of an expert panel to consider fossil fuel divestment goes towards fulfilling the first recommendation. The announcement, yesterday, by the Prime Minister that the Oil Fund would expand renewable energy investments is in line with our second recommendation.
NBIM itself, as well as the Finance Ministry, are looking into allowing the Fund to make infrastructure investments and there is a chance these will get a green light in the forthcoming white paper on the Oil Fund in April. That would be a big step in the right direction. Last, but not least, the Finance Minister, speaking at Klimadugnad yesterday, announced that the government will announce steps towards increasing Oil Fund investments in developing countries in the forthcoming budget in September. This is in line with our fourth recommendation.
These recommendations derived from work I had originally done in 2007 when I first looked at the Oil Fund for the then Finance Minister Kristin Halvorsen. An additional suggestion I had put forward then, but that did not feature in Re-Define’s report with the NCA, was that there was an urgent need to set up an independent “Oil Fund Watch” that would allow the parliament and citizens to effectively understand and oversee how their Oil Wealth was being managed.
Starting September 2013, I have met with most political parties in Storinget, the Norwegian parliament, to gauge what they think of an Oil Fund Watch in the form of a “Stortingets Råd for Oljefondet” (SRO). Most responded positively and that was before the debate surrounding the F1 broke out. I hope that fence sitters will now throw their weight behind the proposal, so it will have majority support in the Parliament.
Given this new government’s promising track record on moving in the right direction on the investment strategy of the Fund, I strongly hope that they will take the initiative and introduce legislation setting up the “Stortingets Råd for Oljefondet” (SRO) in 2014 itself.
Setting up a Stortingets Råd for Oljefondet – SRO would give the parliament the necessary financial expertise to understand how Norway’s oil wealth is managed and oversee the process effectively.
Is this really necessary? What powers will it have? Can it be effective?
Few countries have as big a gap between exposure to the international financial system and expertise on it, as Norway does. Most experts work for banks or insurers in the private sector or at Norges bank and the Finance ministry. Independent experts, such as Steinar Holden, are very rare. Norway abounds in independent think tanks on peace and foreign affairs, but has none on finance. Lacking in-house knowledge, the Parliament has few other places to turn to for advice and insights.
In private, Norwegian bankers admit they fear criticizing the Oil Fund too loudly. Nor can anyone at the NBIM or Finance Ministry can express dissent, at least in public. Most other experts also fear being ostracized if they challenge the consensus too loudly. Even Norges Bank board members are discouraged from criticizing the Oil Fund or the mandate handed down by the finance ministry. Much of this is common to other small countries, but nowhere else are the stakes so high as in Norway.
Martin Skancke, Asset Management chief at the Finance Ministry until recently, wrote in DN saying the Parliament had no expertise to opine on investment strategy. I agree. But the implication of this is not that the parliament ‘shut up’ but that an expert SRO is needed.
The Council should be created by a statute of the parliament with the objective of providing parliamentarians and possibly other stakeholders the independent expertise necessary to understand and opine on the running of the oil fund and the investment guidelines set by the ministry of finance. Manned by independent Norwegian and international professionals, the SRO should have privileged access to NBIM and the Ministry of Finance and seek to make what they do accessible to the parliament and public. Equally, the Council will allow the Parliament to translate widely held beliefs about issues such as “sustainability” amongst Norwegian citizens into actionable ideas that can be applied to the management of the Fund. Such a two-way flow of information between citizens and the Fund is critical to its legitimacy.
Unlike launching rockets where the science is clear and unambiguous and the task is best left to experts, investment is not a science. Finance is rife with fundamental disagreements about the nature of markets and appropriate investment strategies. The Parliament has no way of knowing if the present approach is appropriate. With little scope for dissent, groupthink is a serious risk. An SRO, by facilitating an informed debate about the trade-offs, risks and returns of different approaches, will improve outcomes and oversight.
An SRO, for example, would have helped challenge the Finance Ministry’s present interpretation of the Parliaments guideline to “maximize purchasing power for moderate risk” is actually appropriate. As I have argued, the present strategy is highly inappropriate and “locks in low returns for high risk”.
DN’s Mathiassen suggests the correct response to the Formula 1 scandal is that the Fund should be restricted to investing only in listed securities. That would be cutting off your nose to spite your face. It will lead to low returns and the Fund would fail to exploit the biggest strength it has, that it does not need liquidity. What is needed instead is that the governance and oversight of the Fund match the size and scope of its investments.
But more expertise in the board of Norges Bank, as suggested by Norges Bank Watch, is not the answer to better accountability. Norges Bank itself is too far removed from citizens to provide credible oversight and its track record of discouraging open disagreement about the Oil Fund in its board hardly inspires confidence. A powerful parliamentary watchdog in the form of the SRO is the only sensible way forward.
The gap between the present size and investment universe of the Fund on the one hand, and the ability of the parliament to exercise effective oversight on the other is already so big that only a powerful SRO can plug it. As the size of the Fund becomes bigger and invests in illiquid assets, only a strong parliament drawing on specialist expertise can oversee the Fund in a manner that is necessary to maintain legitimacy.
Sony Kapoor, is Managing Director of the International Think Tank Re-Define and a Senior Visiting Fellow at the London School of Economics. He is also the author of “Investing for the Future – Why Norway’s SWF needs to Change