– Divestment of the energy stocks in the Government Pension Fund Global (GPFG) is not an effective insurance against a permanent decline in oil prices. The energy stocks only contribute marginally to Norway’s oil price risk, says Commission chair Øystein Thøgersen.
The commission has taken a number of considerations into account, and based on an overall assessment, recommends that the GFPG should still be invested in energy stocks.
The Commission delivers its report to the Minister of Finance Siv Jensen today. The Commission’s main task has been to assess whether the energy stocks in the GPFG should be divested as insurance against a permanent decline in the value of Norway’s remaining petroleum resources.
– Insurance is costly and the need for such an insurance is historically low, says Øystein Thøgersen.
Composition and mandate
The Commission was appointed by the Ministry of Finance on 13 February 2018.
The Commission has been chaired by Øystein Thøgersen. Other members have been Harald Magnus Andreassen and Olaug Svarva.
The Commission was mandated to assess whether the GPFG should be invested in energy stocks, i.e. stocks included in the energy sector as classified by the index provider FTSE Russell. Energy stocks amounted to about 4 per cent of the total value of the Fund, or about 315 bn. Norwegian kroner at the end of 2017.
The commission was appointed against the background of advice from Norges Bank, stating that the vulnerability of the Norwegian state's assets for a permanent reduction in oil and gas prices would be reduced if the GPFG were not invested in energy stocks. The Bank emphasized that the advice was based solely on financial arguments and did not reflect any particular view of future movements in the oil price or the profitability or sustainability of the sector. In the terms of reference, it was emphasized that also the commission’s assessments should solely be based on financial risk and return.
The Commission’s recommendations
The Commission agrees with Norges Bank that the value of energy stocks is linked to the oil price, especially in the short term. In isolation, this would suggest a reduction of the Fund’s investments in energy stocks. At the same time, the Commission has been asked to take a number of considerations into account, including the need for, and the benefit of, an insurance against a permanent decline in the value of Norway’s oil and gas resources.
Divestment of the energy stocks in the Fund is not an effective insurance against lower oil revenues in the future. In a scenario with sustained lower oil prices, the loss in the government’s net cash flow from petroleum activities will be substantial. However, only around 1 per cent of such a loss will be covered if the GPFG is not invested in energy stocks. The estimate is uncertain, but the contribution will in any event be insubstantial.
A sale of energy stocks would challenge the current investment strategy of the Fund, with broad diversification of the investments and a high threshold for exclusion. This investment strategy is simple, well founded and has served the Fund well. If energy stocks are excluded from the Fund, the composition of the investments will differ from market weights, and the Fund will be expected to either achieve lower return or higher risk. A consistent adaption of the GPFG’s investments to other assets of the nation, may have major consequences for the investments - and represent a substantial change of the current investment strategy.
The need to insure Norway’s wealth against a permanent reduction in the oil price, is historically low. Norway has a high capacity to take on oil price risk, not least because we have a fiscal policy framework whereby current oil revenues are placed in the GPFG rather than being spent. Moreover, the risk in the remaining petroleum resources is historically low and declining - the largest petroleum values have already been converted to financial wealth in the GPFG.
Should the owner seek any additional reduction in oil price risk, it is likely to be more effective to reduce the Norwegian state’s direct ownership in Equinor or the State’s Direct Financial Interest (SDFI). These holdings constitute a part of the oil price risk on the Norwegian continental shelf, whereas the energy stocks in the GPFG are well diversified investments in international companies. The owner should assess the need for insurance and the potential costs before proceeding with such sales. Finally, if the owner also wants to reduce the climate risk in the GPFG, one could consider further work directed at the individual companies with largest exposure to climate risk.