Sovereign Wealth Funds Useful Buffer Against Low Oil Prices

Norway is a unique example among the short list of the world’s most energy-rich states. As the world’s fifth-largest oil exporter—putting $40 billion into the state’s coffers every year—the Nordic country also boasts a vibrant and diversified economy. It spends heavily on social programs and boasts salaries that are 50 percent higher than those of its European Union peers. It also has the narrowest income gap among developed nations, and as a result of generous government subsidies, the highest per-capita rate of electric vehicle ownership in the world. Norway’s state-owned oil company, Statoil, is the eleventh-largest oil and gas company and the twenty-sixth-largest company by revenue. Though the company slashed capital expenditures by a quarter this year, recent discoveries, like the enormous Johan Sverdrup oilfield in the North Sea, hold great promise for future profitability. Oil production has clearly been a tremendous boon for the nation’s economy, but that is not all. Its national oil fund, the Government Pension Fund (GPF), is the largest oil investment fund in the world, currently valued at $850 billion and fast-approaching $1 trillion (Table 1, below). Norway’s oil fund owns one percent of all stocks in the world and has helped cushion the economy from the adverse effects of the recent oil price slide. This year, the Norwegian government was even able to increase spending without running a deficit. Sovereign wealth funds (SWFs) became prominent global investors during the 2008 Financial Crisis. During that period, Norway’s oil fund purchased $175 billion in stocks at a remarkable 25 percent return on investment the following year. The United Arab Emirates’ fund did the same, and in short time hit investment targets. SWFs can help countries weather fiscal uncertainty and survive short-term budget shortfalls. Such is not the case for Norway, where thirty percent of government revenues are generated from petroleum, yet the country’s economy does not fluctuate with the vicissitudes of the global oil market. In the year following the global financial crisis, for example, the country’s unemployment rate peaked at 3.3 percent, the lowest in Europe. By late 2009, it was well on the road to recovery. “[The fund] was a tool to stabilize the economy and introduce a buffer between very volatile oil revenues and the non-oil economy,” said Martin Skancke, one of the civil servants tasked with creating the oil investment fund, in a recent podcast interview. Data from the Sovereign Wealth Fund Institute, a U.S.-based consulting firm, shows that 45 countries currently invest in oil-linked accounts, collectively worth $3.7 trillion in assets (Chart, below). Most of the assets are held in Asia (39 percent) or the Middle East (37 percent), making Norway an important exception to the general rule. The countries with the largest oil funds are major producers, like the United Arab Emirates, Saudi Arabia, and Kuwait, which maintain 21.2 percent of global oil production between them. The U.A.E. uses excess revenues from that production to fill its oil fund, the Abu Dhabi Investment Authority, which has played a particularly prominent role in real estate in recent years. Its holdings include $773 billion in assets, slightly more than Saudi Arabia, which holds $757 billion (Chart, below). In an emergency, SWFs can act as a national rainy day fund. Countries with large energy reserves invest excess revenues that they can then draw upon when their government experiences an unpredicted budget shortfall. Successful funds can weather this fiscal uncertainty. Saudi Arabia—the global swing producer with 16 percent of the world’s proved oil reserves—is expecting a $39 billion budget deficit this year, based on crude at $65 or $70 per barrel. Its SWF, 19 times the size of its project shortfall, easily covers the disjunction between government revenues and expenditures, and is one factor that allows the OPEC member to endure low oil prices longer than other oil-producing states. Others have been less vigilant. Venezuela—bankrupted by the recent oil price decline—depleted its SWF and instead instituted onerous price controls. The heavily oil-dependent economy loses $700 million for every dollar drop in the price oil. In 1998, the government established the Macroeconomic Stabilization Fund, or “Fondo para la Estabilización Macroeconómica” (FEM) to prepare the country for economic emergencies like these. But when Hugo Chavez took power in 1999, his government raided the fund to support Latin American energy subsidies and expensive domestic programs. Had Chavez’s government put away 10 percent of its oil revenues every year, it would have been worth $26 billion in 2012 and $210.5 billion by 2030 at a nominal five percent rate of return, The Economist estimates. Brazil created a SWF in 2008, only to give in to similar temptations and secretly withdraw 80 percent of its value three years later. The success of these funds often depends on the political and economic stability of energy-rich nations. The most stable Middle Eastern OPEC producers also have the largest funds, and as a result, the highest per capita value of funds. Kuwait, with a population of 3.3 million, produces 3.1 percent of the world’s oil supply, and its fund of $548 billion equates to about $162,000 per capita. The African OPEC state of Angola, meanwhile, has a larger population, but a smaller oil fund of $5 billion, or $233 per capita. Successful funds avoid withdrawing cash when the going gets tough. Oil funds frequently look like politically and fiscally expedient tools to fix short-term budget deficits—and they often are. Sustainable oil funds, however, require fiscal vigilance: informed asset management choices, strong institutions, and long-term thinking. Without these, entire economies are tied to the whims of a global oil market that these countries’ governments depend on for critical revenues. Norway can credit its success to such vigilance, as well as a powerful understanding that the healthiest economies promote diversity and avoid the temptation of relying on one single resource.