with Kristin Halvorsen, Minister of Finance, Norwegian Ministry of Finance
Over the last 40 years, the oil and gas industry has propelled Norway from among the poorest to among the richest countries in Europe. At the same time, it currently provides a relatively large and homogeneous source of governmental revenue. How does this particular financial economic reality impact your governance imperatives, and which considerations come to the forefront as Minister?
Since oil and gas are exhaustible resources, it follows that a significant part of the current cash flows should not be regarded as income in the usual sense. It has to a large extent a counterpart in reduced resource wealth. I believe we have an obligation to ensure that future generations receive their fair share of the oil wealth. The government adheres to budget policy guidelines that recognise the special nature of petroleum revenues and seek to ensure that these revenues also benefit future generations.
There are many examples of countries where high revenues from natural resources have not made a positive contribution to the prosperity for the country’s population. The reasons behind this might be numerous and complex; among others the lack of fiscal discipline, rent-seeking activities, bad investments and no pressure for structural reforms. Norway has so far escaped many of these pitfalls when handling its resource wealth, but this is not a guarantee for the future. Large petroleum revenues may increasingly affect people’s expectations and their willingness to undertake necessary reforms.
The fiscal framework – the fiscal guidelines and the Fund mechanism – contributes to a stable development in the Norwegian economy both in the short and long run. Government revenues from the petroleum sector are volatile, largely due to swings in oil prices. The fiscal framework is designed to dampen the impact of oil price volatility on the Norwegian non-oil economy. The government’s current revenues from the petroleum sector are added to the Government Pension Fund – Global. The capital in the Fund is invested abroad, to shelter the real exchange rate from oil price fluctuations. Spending of oil revenues – measured by the structural, non-oil budget deficit – shall correspond to the real return on the Fund, estimated at 4 per cent.
However, discretionary fiscal policy may also be warranted to further stabilise the economic development. During periods of increasing unemployment, as we now experience, we can spend more than the expected real return on the Fund capital to stimulate production and employment. Correspondingly, there will be a need to curb fiscal spending during periods of high activity in the economy.
The real value of the capital in the Fund will stabilise in the long term, assuming that budget policy follows the fiscal policy guidelines. This enables a lasting contribu¬tion of the return on the Fund towards financing public welfare schemes. However, this contribution is relatively modest compared to taxes and excise duties from the mainland economy and will in due course also diminish as a share of both public spending and GDP.
Thus, I want to underline that although Norway’s oil revenue from the North Sea is considerable, it is of limited importance in the long run. Norway’s high standard of living is primarily due to an efficient and modern mainland non-oil economy. The overall labour input is by far the biggest contributor to future welfare, as pointed out in estimations of national wealth. High labour force participation rates and productivity growth are key factors to maintain future growth and the sustainability of our welfare system.
Moreover, I hope that we will be able to transform our knowledge and technologies from the petroleum sector to renewable energy sources for the future. There are rapid developments in this field and we need to be adaptable in order to meet future environmental and economical challenges.
I would also like to emphasise our responsibility as owners to have in place ethical guidelines for the investment activity. These shall help us avoid investments in companies that constitute an unacceptable risk that the Fund may contribute to unethical acts. The Ethical Guidelines of the Fund are transparent and predictable, and are based on internationally recognized standards.
In 2004, the government’s decision to amend taxation laws regarding the reimbursement of exploration costs saw an influx of smaller companies eager to produce the next generation of Norway’s hydrocarbon resources. To what degree has the program succeeded in its initial aims?
The aim of the amendments to the petroleum tax act in 2001 and 2004 was to make the petroleum tax system more neutral with respect to investment incentives and to increase fiscal certainty for new companies. Rules regarding carry forward of deficits and reimbursement of the tax value of deficits were therefore introduced. Deficits incurred from the year 2002 and onwards may be carried forward with an interest. From 2005 a company which, due to deficits, is not in a tax position, may each year claim refund of the tax value of the exploration costs from the state.
The changes in the petroleum tax act have been important for new companies, but also other changes in the regulation of the petroleum sector have contributed to the influx of smaller companies. In order to facilitate the entry of new players, a system of prequalification of new operators and licensees was established in 2000. In addition a system for award of production licenses in predefined areas in mature areas was established in 2003. The system entails a permanent annual cycle for licensing rounds in mature areas. Since 2000 to January 2009 approximately 55 new companies had been prequalified, or had become licensees on the Norwegian continental shelf.
I think it is fair to say that the tax changes and the changes in the regulation policy have succeeded to a large extent in attracting new companies to the Norwegian continental shelf.
Some smaller independent E&P companies operating in Norway are keen on the idea of extending a similar change to tax rules as seen in 2004 to include the development phase of the hydrocarbon lifecycle. In the context of a tight credit market, what is your view on the potential of such an extension?
We are familiar with the proposals of such an extension. The proposals raise some broader petroleum political issues. Such a change may for instance allow financially weak companies to engage also in development of oil and gas fields. It is questionable whether this is a development that is positive for the Norwegian continental shelf.
Norwegian companies are well-known for innovation, with the NCS oft-called a “breeding ground” for new technologies perfected here and exported around the world. This is due in no small part to an encouraging tax regime – how much of a consideration is the long-term development and fostering of technological innovation a deliberate concern in policymaking?
The most important considerations behind the design of the petroleum tax system are that it should raise revenue to the state and be as neutral as possible. The petroleum tax system in Norway allows for deductions of costs for research and development against the 78 percent tax rate. The research and development expenses must however be attached to the petroleum activity on the Norwegian continental shelf. General R&D expenses can not be deducted against the 78 percent tax rate.
Development of new technology and increased competence in the oil and gas sector are important to ensure that the sector will continue to contribute to economic growth and general welfare in Norway. The Government therefore contributes to several petroleum research programs such as Petromaks and Demo 2000. An important objective of Petromaks is to contribute to better exploitation of fields in production and increased access to new reserves. The objective of Demo 2000 is to contribute to reduced costs and risk for the industry and commercialisation of new technology by supporting pilot and demonstration projects.
Consideration for the environment has always been an integral part of the Norwegian petroleum activities. Norway introduced an offshore CO2-tax in 1991. This tax has led to development of technology and triggered initiatives that led to considerable emission reductions. Emissions per produced unit of Norwegian petroleum are about one third world average.
At the World Economic Forum in Davos, you stated climate change as the most pressing issue affecting the future economy, and expressed the importance to act not only as individuals, but as those responsible for financial policy. What do you think is the Ministry’s greatest contribution towards addressing this critical issue?
Climate Change is one of the most important environmental challenges for the world. In theory the solution is quite simple. We know what causes the problem, and we know how to deal with it. In 2008 more than 50 per cent of emissions came from developing countries, and nearly all growth over the next decades will come from these countries. Therefore it far from enough that mitigation is limited to the developed countries. All polluters around the globe must be given sufficient incentives to reduce their emissions. However, rich countries must take a large share of the costs.
In Norway we recognise that it is in our own best interest to fight climate change even if our income from petroleum exports could be hit. Long run sustainability cannot be traded against short run profits.
Even more than we rely on petroleum exports, do we rely on the prosperity of countries all over the world.
Norway has accumulated foreign assets corresponding to about 100 per cent of our GDP. Our investments have a long term perspective. Fighting climate change also means protecting these investments.
So, in our minds, for Norway to encourage and contribute to a forceful global response to climate change makes sense. It is not a contradiction, but a precondition for our country’s development.
To achieve this, the world must agree upon an ambitious international agreement in which all countries and all sectors are included. In order to be fair, the agreement must include mechanisms that compensate the poor countries for their costs of mitigation and adaptation. In practice this is, unfortunately, far from simple. All countries may, by only focusing on their own interests, have incentives to do little and hope that other countries take action – and the costs of mitigation. Norway has argued for ambitious international targets and strong action. We have proposed mechanisms for compensating the poorest and most vulnerable countries. In addition we have decided to take on several extra measures:
– We have decided to over-fulfill the Kyoto target by 10 percent.
– We have decided to use up to 3 billion NOK per year in 2009-2013 on measures against deforestation in developing countries.
– We are using substantial resources on developing technology in order to capture CO2 from power plants driven by natural gas. The aim is also to develop a technology that can be used for capturing CO2 from coal driven power plants.
In April of this year, the Ministry via the Pension Fund dedicated 20bn NOK over the next five years to environmental-related investments. In the past you’ve stressed that the fund is not a strategic investor, but a financial investor. What shift, if any, does this represent in the fund’s aims, and in which other ways can we expect to see the fund supporting the world’s transition from carbon-based energy?
This government takes climate change seriously – also in the management of the Government Pension Fund. As a broadly diversified and long-term investor, the fund has an interest in avoiding negative economic and financial repercussions of climate change.
On the 3rd of April we presented our annual report to the Storting on the management of the fund. In this year’s report we detailed plans to establish a new environmental investment programme, and to initiate a broad study of the possible effects of climate change on global capital markets. We also want to strengthen the focus on issues related to climate change in Norges Bank’s work on engaging with companies. Together, it is my hope that these measures will position the fund among the leading funds internationally in this area, and that we will inspire other investors to address the issue of climate change.
3 June, we were the first institutional investor to commit our self to a comprehensive research project in this area managed by the consulting firm Mercer. The project is aimed at assessing the impact of climate change on financial markets, as well as implications for strategic asset allocation. More specifically, the project aims to develop a methodology for conducting scenario analyses, and to identify risks to long-term financial investments, across asset classes and geographical locations.
Traditional strategic asset allocation modelling approaches have not taken climate risks, or opportunities, sufficiently into account. This project seeks to address that gap. This is an ambitious and complex task, which is more efficiently undertaken in collaboration with others. I will therefore encourage large institutional investors and industry thought leaders worldwide to join forces in this project. Together we need to develop the tools and critical thinking that is required to understand the financial implications of climate change.
The environmental programme will be aimed at investments that can be expected to yield indisputable environmental benefits, such as climate-friendly energy, improving energy efficiency, carbon capture and storage, water technology and management of waste and pollution.
Environmental investments will also serve to help develop expertise in the refinement of the Fund’s investment strategy. It is expected that these sub-markets will have high growth in the years to come. The Government wants to set aside a sum of money that can make a difference, but bearing in mind that there are clear capacity restrictions on investments in these markets.
We are planning that the entire amount for the environmental programme and a possible investment programme aimed at sustainable growth in emerging markets will be around NOK 20 billion, invested over a five-year period. This will entail substantial investments in terms of both the size of the markets and investments in other comparable funds internationally. However, before the investments can start, a number of matters must be clarified.
The Government Pension Fund – Global shall remain a financial investor. The environmental investment program does not change that.