Øystein Olsen: Managing Norway's oil wealth
Speech by Mr Øystein Olsen, Governor of Norges Bank (Central Bank of Norway), at the
"Desemberkonferansen" oil and gas conference, Kristiansund, 3 December 2015.
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Accompanying charts can be found on the Norges Bank's website: Charts (PDF).
Please note that the text below may differ slightly from the actual presentation.
In 1969, on the day before Christmas Eve, Norway as a nation received the gift of the century:
we struck oil! The Ekofisk oil field was the largest subsea oil field ever discovered. The
discovery of oil was the start of an extraordinary era for the Norwegian economy.
Chart: OECD countries' per capita GDP in 1971
When the first oil was brought to the surface in 1971, income levels in Norway were low
compared with other western countries.
Chart: OECD countries' per capita GDP in 2014
The picture has reversed since then. We have gradually caught up with the wealthiest nations.
Measured by GDP per capita, Norway now ranks at the very top.
It was established at an early stage that Norway's oil and gas resources belong to the
Norwegian people. The tax system and framework conditions for the petroleum industry were
designed so that the large revenues from this sector would accrue to the state. The stage was
set for greater prosperity, with prospects for growth in both public and private consumption.
The discovery of oil in the North Sea generated a wealth of opportunity for Norwegian business
and industry. The extraction of oil at great sea depths would require the development of new
technologies. This entailed the building up of expertise in our own country, which would secure
a full order book for many years ahead - and not only off our own shore. The activities on the
Norwegian continental shelf would also provide a boost to other industries in Norway.
Chart: A new market for the shipbuilding industry
And the timing was perfect: economic stagnation and competition from Asian countries had
brought the Norwegian shipping industry to the brink of a crisis. With the discovery of oil, an
adaptable shipbuilding industry and the oil companies were soon on good terms.
Building up a new industry and spending the revenues generated also brought a new set of
challenges, and in 1974 these challenges were the subject of a government white paper,
Report no. 25 to the Storting, entitled "The role of the petroleum industry in Norwegian society".
To provide room for the oil sector and higher consumption of goods and services, other
industries had to give way. The mechanisms described in the white paper are familiar:
"A transfer of production and jobs between firms and industries can occur via
increased domestic cost pressures."
So, the nation was prepared for restructuring and for the costs this would involve. But the white
paper also made it clear that, in order to reap the benefits of economic growth, restructuring
would be necessary.
We now know, more than 40 years later, that structural changes were indeed made. The
industry structure of our economy has changed. A growing number of firms, and not only in the
engineering industry, have targeted the oil industry. Labour shedding in some sectors has
freed up labour for other uses.
Chart: High wages in the oil industry
Oil companies have had the capacity and the willingness to pay. Tax rules have favoured
investment spending and earnings have been solid. Oil company employees have been wage
winners here in Norway.
A state-of-the-art oil service industry has emerged. New products and technological solutions
have been developed. For many firms, the contracts on the Norwegian continental shelf have
been a springboard to new export markets.
Chart: Growth in oil investment
High oil prices and a profitable petroleum production industry have led to record-high oil
investment in recent years. The level of investment in 2014 was equivalent to that of all the
domestic non-oil industries combined. The positive spillovers to the oil service industry and
other firms have been substantial. Employment has remained high and unemployment low,
even when the financial crisis hit in 2008.
A large share of the business sector and the labour market is now linked to the oil industry. A
relatively small number of jobs are directly involved in oil and gas production. But if account is
taken of all the suppliers to the petroleum sector, about 1 in 9 jobs in Norway, a total of about
300 000, were linked to the oil industry in 20141. A growing number of these jobs are related
to exports of oil extraction equipment.
The oil and gas industry has played a decisive role in the strong growth of the Norwegian
economy over the past 40 years. The past 15 years stand out in particular. But this dependence
on oil has also made the Norwegian economy vulnerable to changes in oil prices or a decline
in petroleum revenues.
Chart: High wage growth (not incl. the krone depreciation over the past two years)
High domestic labour costs have also increased the Norwegian economy's vulnerability. The
cost level in the Norwegian business sector has increased sharply in comparison with our
trading partners.
A rise is followed by a fall, and oil prices have fallen by more than half since last summer. As
activity and earnings from the petroleum sector decline, oil service companies must seek entry
into other markets. With a high domestic cost level, that task may prove demanding.
Chart: Fall in petroleum investment
A decline in activity on the Norwegian continental shelf has long been anticipated. The fall in
oil prices has accelerated and amplified an announced decline in activity. Norwegian exports
to other oil-producing nations are also in decline.
This does not mean that the oil age is now nearing an end. Nearly half of known oil and gas
reserves on the Norwegian continental shelf have not yet been extracted2. Large new
discoveries have been made over the past few years and the Norwegian oil service industry is
still receiving new orders. Nevertheless, the Norwegian economy must now adapt to
considerably lower demand from the oil sector.
After many years of relatively high wage growth in Norway, the domestic cost level must again
be brought more closely into line with that of our trading partners. A necessary adjustment of
the cost level can occur in two ways: through lower wage growth than in other countries or
through a depreciation of the krone exchange rate.
Over time, monetary policy can only influence inflation. Monetary policy cannot assume a
primary responsibility for delivering the necessary structural changes in the Norwegian
economy. But via the exchange rate channel, monetary policy can help facilitate the necessary
restructuring process.
Chart: High wage growth (incl. the depreciation of the krone)
Without our own national currency the situation would have been more challenging. The social
partners would have had to go it alone. The experience of some European countries shows
that this can be demanding. With a floating exchange rate, the necessary adjustment of the
cost level can take place faster and be less painful. The krone exchange rate functions as a
stabiliser. The depreciation of the krone through the past year indicates that this mechanism
is functioning.
As long as there is confidence that inflation will remain low and stable over time, the krone can
depreciate markedly even if the key policy rate is low. The benefit of a national currency is lost
if the temporary rise in inflation due to the depreciation is countered by higher pay increases.
The result could then be a higher key policy rate and a stronger exchange rate than would
otherwise be the case, and higher unemployment. The social partners have a particular
responsibility in this regard.
Oil companies had already given notice of lower investment, workforce reductions and cost
cuts in winter 2014. This tendency has been reinforced by the sharp fall in oil prices, resulting
in spillover effects on the mainland economy and rising unemployment.
Chart: Key policy rate reduced
As long as inflation expectations are firmly anchored, monetary policy can serve as a first line
of defence when the economy turns down. Since December 2014, Norges Bank has reduced
the key policy rate by a total of 0.75 percentage point, to 0.75 percent. The weaker outlook for
the Norwegian economy has been given weight in our assessments.
From the end of the 1990s, the price of North Sea oil rose from about USD 10 per barrel to
over USD 100 per barrel. Large shares of the sizeable revenues from the petroleum sector
over the past 20 years have been transferred to the oil fund. Norway's sound public finances
have been a great advantage to the economy, particularly through the financial crisis. But the
management of the government's large petroleum revenues through our 40 year-long oil
history has not always been equally well planned. In the mid-1970s, the budget deficit -
including petroleum revenues - reached a high level. And we could not know then that oil
prices would more than double a few years later - with the second oil shock in 1979, known
as OPEC II.
But we learned from our mistakes. The oil fund mechanism in 1990 and the fiscal rule in 2001
were introduced to discipline fiscal policy in such a way that Norway's petroleum wealth would
also benefit future generations. Oil fund assets are now equivalent to more than twice the GDP
of Norway's mainland economy, and the oil fund, or the Government Pension Fund Global
(GPFG), is today one of the world's largest sovereign wealth funds.
The GPFG represents the nation's savings, to be managed for the benefit of both current and
future generations. As an investor, the GPFG makes capital available to other countries for
economic activity, and the return on that capital will depend on the economic performance of
those countries.
The GPFG is a long-term, responsible investor. The objective of investment management is to
achieve the highest possible return at an acceptable level of risk.
Chart: Change in market value since January 1998
So far, our nation has earned a solid return on its financial assets. The cumulative return on
the GPFG since its inception amounts to over NOK 2 600 billion, equivalent to about a third of
total GPFG capital at the end of 2014.
Chart: Lower yields
Over a third of the GPFG is invested in bonds. Real yields on high-grade government bonds
provide a basis for the rate of return that can be expected ahead. In recent years, those yields
have been close to zero.
Low bond yields reflect global economic conditions: Governments, businesses and households
are seeking to save more, while demand for safe investments has increased. Central banks'
substantial asset purchases are pushing in the same direction. However, low yields may also
reflect modest expectations of economic growth further ahead.
There is no return without risk. The GPFG features a very long investment horizon and a
sizeable capacity to bear short-term risk. This is why the chosen allocation to equities is
relatively high. It is also the reason why the GPFG has moved into real estate. The authorities
have asked Norges Bank to assess whether the allocation to real assets should be increased.
Any increase in the allocation to real assets will probably be at the expense of bonds.
Chart: Spending of petroleum revenues almost level with revenues
Petroleum revenue spending over the fiscal budget has increased since the turn of the
millennium. The revenue stream from the continental shelf is now declining. We are
approaching the point where government spending of petroleum revenues will exceed the
revenues deriving from the petroleum sector.
Chart: Transfers to GPFG at an end
At today's oil prices, transfers to the GPFG will soon fall towards zero. We will then be in a
situation where the GPFG's current income is limited to interest and dividend income.
According to the 2016 government budget, some of the return on the GPFG will be used to
cover the non-oil budget deficit.
Oil prices have fallen sharply over the past six months. Even if prices edge up again, we have
been reminded of the uncertainty associated with future revenues. The oil fund mechanism
shields fiscal policy from such revenue fluctuations in the short term.
We have the fiscal space to stimulate overall demand if this should prove necessary again. But
we must also remember that, with lower oil prices, the government will over time have less
money to spend. Fiscal tightening may become necessary further ahead. Refraining from
increasing petroleum revenue spending further from today's level is a sensible risk adjustment.
The era of rising petroleum revenue spending should for the most part be behind us.
The more than 40-year old white paper about the role of the petroleum industry in Norwegian
society was both far-sighted and accurate. The restructuring it described has occurred,
although the growth in prosperity that followed in its wake was more difficult to predict. The
emergence of an advanced oil service industry is an industrial success story. We have
extracted large quantities of oil and gas in a period of very high prices. And we have set aside
a large proportion of the revenues - for the benefit of future generations. In spite of some
mistakes and a fair share of luck along the way, we would have to say that Norway's petroleum
wealth has so far been managed well.
Norway's oil age is far from over. But activity in the petroleum sector has passed the peak. We
must also be prepared for lower returns in the oil industry. In the period ahead, we should keep
an important insight in mind: the key to economic progress is the ability to restructure.
Thank you for your attention.