Norway: Selected Issues

Abstract

Norway: Selected Issues

Norway’s Economy With a Maturing Oil and Gas Industry1

Norway’s half century of good fortune from its oil and gas wealth may have peaked. Oil and gas production will continue for many decades on current projections, but output and investment have flattened out, and the spillovers from the offshore oil and gas production to the mainland economy may have turned from positive to negative. Thus far, economic policy has needed to focus on managing the windfall, and Norway’s institutions have been a model for other countries. Going forward, the challenges will become more complex. The problems of managing “Dutch disease” are not gone, but they will abate, particularly if the recent drop in oil prices is sustained. However, they will be replaced by the difficulties of managing a transition away from what has been an increasingly oil- and gas-dependent mainland economy.

A. The Direct Contribution of Oil and Gas to the Norwegian Economy

1. The oil and gas industry has provided only modest direct employment in Norway. Employment in oil and gas extraction has only recently risen above 1 percent of total employment, although the high pay levels in the industry have pushed its share of total wages above 1 percent for some time.

2. The balance of payments impact has been much larger than the employment effect. Oil and gas as a share of exports of goods has risen from an average of 45 percent in 1981–90 to 63 percent in 1995–2014 and from 31 to 48 percent as a share of exports of goods and services. As a share of total Norwegian GDP (mainland and offshore), oil and gas exports have risen from a trough of 8 percent in 1988 to a peak of 24 percent in 2008. With the decline in oil prices in the latter part of 2014, this had fallen to 17 percent in 2014 and will likely be as low or lower in 2015. The effect on the international investment position is more speculative prior to the first transfer to the sovereign wealth fund (the Government Pension Fund Global, GPFG) in 1996, but the balance in that Fund had risen to more than 250 percent of mainland GDP by end-2014.

A01ufig1

Oil and Gas Exports

(Percent)

Citation: IMF Staff Country Reports 2015, 250; 10.5089/9781513503165.002.A001

Sources: Statistics Norway and Fund staff calculations.

3. Government income from oil and gas has also been much larger than the employment impact. Revenue started off much lower than production and exports because of the tax regime, which generates significant revenue only after investment and other costs have been recovered. Also, the revenue streams are multiple and complex. Government revenue from oil and gas generated less than 7 percent of total revenue and less than 4 percent of GDP on average from 1971 to 1995. Petroleum-related revenue was not treated differently from other revenue sources. By the late 1990s, the government began to receive much more substantial revenues from oil and gas. This roughly coincided with the creation of the GPFG and the fiscal rule. By 2000, petroleum-related revenue had risen above 10 percent of GDP and 25 percent of total revenue and has remained above those levels since.

4. The fiscal rule has provided considerable insulation against “Dutch disease.” The segregation of the proceeds of oil and gas (including ownership income from the government’s two-thirds stake in the Norwegian oil company Statoil), has largely avoided Dutch disease through the exchange rate appreciation or a crowding out of the private sector by government domination of the real economy. However, the insulation against Dutch disease has not been complete. This has been undercut both by the large size and steady growth of the GPFG and by the increasing share of the mainland economy devoted to providing goods and services to the mainland economy. These two channels are considered in turn in the next two sections.

5. However, production has peaked and begun what is projected to be a gradual, multi-decade decline. Roughly half of all of the oil and gas likely to be produced on the Norwegian continental shelf has already been extracted. As a result, the mainland economy needs to diversify away from oil and gas supply and service in the medium- and long-term. However, not all of the challenges from having too much income will persist even as the decline of oil and gas and the attendant investment demand creates a drag on the economy in other ways.

A01ufig2

Oil and Gas Production, 1970-2019

(Barrels of oil equivalent)

Citation: IMF Staff Country Reports 2015, 250; 10.5089/9781513503165.002.A001

Sources: Norwegian Petroleum Directorate: “The Shelf in 2014” and Fund staff calculations.

B. The Fiscal Contribution of Oil and Gas to the Mainland Economy: The Fiscal Rule and the Sovereign Wealth Fund

The Fiscal Rule

6. The fiscal rule very effectively insulates Norway’s budget from oil price fluctuations except in the long term. There are various official characterizations of the fiscal rule in English, but one recent, concise one explains that:

“Fiscal policy is guided by the fiscal rule, stipulating a gradual phasing-in of oil revenues in the Norwegian economy in line with the expected real returns on the Government Pension Fund Global estimated at 4 percent. The fiscal rule permits spending more than the expected return on the Fund in a cyclical downturn while the use of oil revenues should lie below the expected return when capacity utilization in the economy is high.” 2

The implication of the fiscal rule is that government spending should disregard direct current oil and gas revenues, and instead transfer 4 percent of GPFG assets to the budget each year as the estimated income from this endowment and that this should be the sole source of non-oil deficit financing.3

7. The fiscal rule buffers the economy in three main ways.

  • Because government non-oil deficits are a function of not just current oil and gas revenues but of the entire history of oil and gas revenues going back to the GPFG’s establishment, it automatically averages oil and gas revenue fluctuations over the history of the GPFG.

  • The fiscal rule provides explicitly for counter-cyclical fiscal policy.

  • The rule provides for an indefinitely sustainable income source. To the extent that the 4 percent real return assumption is borne out, the income stream should be constant in real terms. If it is higher or lower, the income stream would trend upward or downward in real terms over the very long term, but the GPFG would not be exhausted.

The Government Pension Fund Global

8. The GPFG was created to turn the various streams of government oil revenue into an endowment. The GPFG (originally and more accurately referred to as the Oil Fund) started receiving transfers in 1996. However, it was still small relative to the economy (51 percent of mainland GDP) when the fiscal rule was put in practice after end-2001.

9. The GPFG is managed by the Norges Bank according to relatively strict guidelines set by the government. In its earliest years, investments were concentrated in fixed-income assets, but it quickly evolved into a majority equity-based fund with a widening array of advanced, emerging market, and frontier countries. Currently, the fund guidelines are to invest 65 percent in equities, 30 percent in fixed income, and 5 percent in real estate. The fund operates mostly on a buy-and-hold basis and distributes investments very widely across companies and assets, with the result that its investment strategy, operating costs, and investment outcomes resemble those of a set of very large index funds. As a result of its size, it owns more than one percent of the world’s traded equity shares.

10. Market returns gain have replaced oil and gas income as both the main sources of annual growth in the GPFG and the main contributors to its volatility. Oil prices and changes in production volumes were originally the main factors driving year-to-year changes in the value of the GPFG. In the last several years, changes in financial market returns have generally had a bigger effect on the value of the GPFG than changes in the oil income. Volatility in investment income (including capital gains) also have a bigger effect on year-to-year changes in the GPFG value than volatility in oil income in recent years.

A01ufig3

GPFG: Starting Assets and Contributions to Growth

(Billions of NOK)

Citation: IMF Staff Country Reports 2015, 250; 10.5089/9781513503165.002.A001

Sources: Norges Bank Investment Management Annual Reports and Fund staff calculations.
A01ufig4

Annual Change in NBIM Assets by Source

(Billions of NOK)

Citation: IMF Staff Country Reports 2015, 250; 10.5089/9781513503165.002.A001

Sources: Norges Bank Investment Management Annual Reports and Fund staff calculations.
A01ufig5

GPFG: Volatility of Components of Annual Net Assets

(Billions of NOK)

Citation: IMF Staff Country Reports 2015, 250; 10.5089/9781513503165.002.A001

Sources: Norges Bank Investment Management Annual Reports and Fund staff calculations.

The complications for fiscal policy

11. Higher-than expected production and prices for Norway’s oil and gas have implied a steady fiscal stimulus. This complicates the operation of the fiscal rule. At about 250 percent of mainland GDP, a mechanistic application of the fiscal rule would imply a non-oil deficit of 10 percent of mainland GDP. With about half of the oil and gas yet to be produced, the steady state non-oil deficit would be much larger.4 When the GPFG and the fiscal rule were established, price expectations and expected output were much both much lower than what has been realized and what is currently projected.

12. The fiscal rule continues to insulate the economy from commodity cycles. That insulation has been improving over time as the fluctuations in oil and gas income have a steadily smaller effect on the size of the GPFG (in proportionate terms, if not in absolute value).

13. However, the fiscal rule has become less successful in insulating the budget from excessive fiscal stimulus. In the early years of the fiscal rule, the government tended to overspend relative to the four percent targets. More recently, government policies have been conservative relative to the fiscal rule. Nevertheless, there has been a mostly steady increase in the structural non-oil deficit even as the share of GPFG resources used each year is on a downward trend. In light of this trend, a commission was appointed by the government to consider possible supplements to the fiscal rule, and its recommendations—released in a report in June 2015—are currently being discussed.

A01ufig6

Structural Non-Oil Deficit

(Percent)

Citation: IMF Staff Country Reports 2015, 250; 10.5089/9781513503165.002.A001

Sources: Ministry of Finance and Fund staff calculations.

C. Real Sector Links Between the Offshore and Mainland Economies

14. There are multiple real-sector linkages between the oil and gas sector and the real economy on the mainland and abroad. The value of the income flows through these linkages is considerably larger than the fiscal transfer from the GPFG to the budget, but they are more complicated and harder to measure. Available data tend to capture either a subset of the various flows, also include flows unrelated to oil and gas, or both.

Measuring the Links between the offshore and mainland economies

15. Total expenditure by the oil and gas sector on goods and service far exceeds the value of the transfer to the budget. 2014 wages, intermediate consumption (non wage, non-investment inputs), and investment were equal to 1.7, 2.6, and 8.7 percent of mainland GDP respectively for a total of 13 percent of GDP. The balance of payments data have entries for exports and imports of oil- and gas-related goods and services. However, these are widely regarded as greatly understating the full amounts of both imports and exports. Goods and services supplied to the oil and gas industry do not map neatly into standard industrial classification schemes. Instead, firms within individual industries have evolved to produce goods and services for the offshore sector while remaining in the same industrial classification as other firms that produce goods and services for other sectors. Consequently, some more ad hoc adjustment needs to be made to estimate the import content of Norwegian investment, wages, and supply of goods and services to the offshore sector.

A01ufig7

Production Inputs in Extraction and Pipelines

(Percent of mainland GDP)

Citation: IMF Staff Country Reports 2015, 250; 10.5089/9781513503165.002.A001

Sources: Statistics Norway and Fund staff calculations.

16. The import content of demand from the Norwegian continental shelf appears to be on the order of roughly 40 percent. A couple of approaches support this. A recent study from Statistics Norway attempted to estimate both the direct and indirect aspects of demand from the Norwegian continental shelf for the mainland economy using an input-output model approach (see Box 1). This study concluded that offshore demand accounts for roughly 9 percent of Norwegian employment. Similarly assuming that wages on the Norwegian continental shelf are overwhelmingly income to the Norwegian mainland, but that intermediate consumption and investment has about 40 percent direct imported content (suggested by industry sources) gives an approximation of the net income flows for supply and service from the offshore sector to the mainland of about 8.5 percent of GDP in 2014. However, there is large uncertainty around these estimates.5 Exports of oil-related goods and services probably amount to something on the order of another 4 percent on some estimates.

Measuring Oil and Gas Sector Demand in Mainland Economy

A Statistics Norway study—Prestmo and others (2015)—estimates the ‘direct’ and ‘indirect’ deliveries from various Norwegian industries to the oil and gas sector using an input-output model. Direct deliveries refer to the part of an industry’s production that is supplied directly to the oil and gas sector in the form of, for example, capital goods and intermediate consumption. However, this industry may in turn uses inputs from other industries across the whole economy. The use of input-output tables can therefore trace along the production chains and identify the various inputs that are indirectly linked to oil and gas activity. This approach thus gives a more complete picture of the scale of mainland activities that are dedicated to supplying the oil and gas industry.

Results show that a wide range of Norwegian industries have links to oil and gas. These range from ship building and engineering, manufacturing, to a variety of services industries (e.g., banking and insurance, ICT services, retail). The service industry as a whole supplies about 41 percent of total investment products to the oil and gas sector, and about 43 percent of its intermediate consumption. Manufacturing plays a less prominent role, with 12.7 and 9.5 percent respectively.

Direct and Indirect Deliveries to Oil Industry

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Source: Prestmo and others (2015)

The study also provides estimates of total oil- and gas-related employment and the direct and indirect import content of service and supply to the offshore economy. In terms of employment, it is estimated that in 2014, about 240,000 workers—or 8.7 percent of the labor force—may be directly or indirectly linked to oil and gas activity. The estimated import share of inputs to the oil and gas sector (excluding direct labor) is about 40 percent: 20 percent direct, with the remainder indirect.

17. Measuring exports of goods and services to oil- and gas-production elsewhere is still more challenging. Here, the main sources are survey data on revenues collected by private sources. Rystad, a major supplier of global oil and gas industry data is based in Oslo, and the Norwegian Petroleum Directorate reports its revenue estimates for Norwegian firms on its website. A second source, also based in Norway, provides estimates of total revenues based on surveys that roughly match the Rystad data on total revenues, but also attempts to break this down into revenue to the Norwegian mainland versus revenue to these Norwegian companies that represents payments to foreign employees and suppliers and therefore represents foreign rather than Norwegian value added (Mellbye et al., 2012). Combining these sources suggests that something on the order of 4 percent of mainland GDP finds its way back to mainland Norway as income to Norwegian individuals and local parts of Norwegian firms.

18. These various income flows are shown in Figure 1 together with the many more directly measurable, oil- and gas-related flows as shares of 2014 mainland GDP.

Figure 1.
Figure 1.

Oil and Gas Related Incomes, 2014

(Percent of mainland GDP)

Citation: IMF Staff Country Reports 2015, 250; 10.5089/9781513503165.002.A001

Source: Fund staff calculations.

Growth in mainland value-added

19. Investment and supply for the oil and gas industry have grown relative to the mainland economy and provide a source of stimulus to the mainland. Total production inputs to the oil and gas sector rose from 8.4 to 13 percent of mainland GDP between 2004 and 2014. Some of this was supplied from foreign sources, but the trade balance of oil- and gas-related goods and services worsened by only 0.6 percent of mainland GDP over the same period. The net increase of 4 percent of GDP in oil and gas inputs from the mainland could be interpreted as an average annual stimulus of about 0.4 percent of GDP per year.

20. This stimulus will likely reverse regardless of oil and gas price developments. The relationship between oil and gas investment is not straightforward. Geology and changing technology imply different investment patterns over time that also differ across fields (see Box 2). Nevertheless, the best estimates of output from the Norwegian continental shelf suggest that about half of all of the oil and gas that will be produced has already been produced. Even if oil and gas prices return to early 2014 levels, the offshore demand for investment and supply will decline. Because investment tends to take place in advance of production, the decline in investment is likely to take place somewhat earlier than the gradual decline in oil and gas production.

Investment and Production in Norwegian Fields

The generally rising trend of aggregate oil investment masks diverse patterns across fields. At the end of 2014, there were 78 producing fields, and 11 fields being developed on the Norwegian shelf. While the general pattern is for output to peak a few years after investment in a given field, there are large differences across fields in the timing and scale of investment and output. A number of fields are close to having exhausted most of the recoverable reserves, whereas others are just coming on stream or being developed.

A01ufig8

Patterns of Investment and Production in Selected Major Fields

Citation: IMF Staff Country Reports 2015, 250; 10.5089/9781513503165.002.A001

Implications of sustained lower oil prices

21. The mainland economy is likely to be more negatively affected by sustained changes in oil prices than the budget. While changes in oil prices and production feed through directly into inflows into the GPFG, the very large size of existing assets in the GPFG and the influence of other factors (e.g., investment returns), and the fiscal rule would prevent these from significantly affecting transfers to the budget. However, the mainland economy would be significantly affected by cost reductions or cancelled/delayed investment over a much shorter time horizon.

22. The near-term effects on the mainland economy of low oil prices are likely to be more modest than the medium- and long-term effects if lower oil prices are sustained. However, there will be near term effects as oil and gas producers cut marginal investments and increase pressure for cost containment. Cost reductions are already being forced on suppliers and the authorities expect this to continue.

23. Expectations of a more protracted period of low oil prices will have a significant effect on investment. Oil investment is persistent given the multi-year nature of many investment projects, and fluctuations in prices that are not expected to persist would have little effect. However, it is significantly affected by expected future oil prices over the medium term. Expectations of a sustained lower price would reduce investment over the medium term (see Box 3).

A01ufig9

Investment Expense by Type

(Billions of NOK)

Citation: IMF Staff Country Reports 2015, 250; 10.5089/9781513503165.002.A001

Sources: Norwegian Petroleum Directorate: “The Shelf in 2014” and Fund staff calculations.

What Determines Oil Investment and Output?

An empirical exercise aims to understand the key drivers of oil investment and output. In particular, the recent decline in oil prices, if sustained, is expected to reduce the profitability of oil companies and prompt them to cut back on new investment or delay planned investment projects. Lower investment would in turn reduce future output. In light of the complex differences in the investment and production patterns across Norwegian fields (see Box 2), it is necessary to look beyond aggregate data. We thus estimate the empirical models using investment and output data for about 70 individual producing fields over 1970–2014.

Results suggest that real oil investment positively depends on expected future oil prices. Our empirical specification follows Hvozdyk and Mercer-Blackman (2010) and uses the (inverse of) OPEC spare capacity as a proxy for expected future oil prices. Although spare capacity is highly correlated with spot and futures prices, it has been shown that spare capacity ‘Granger’ causes the other two variables. Oil investment is also estimated to be rather persistent, reflecting the typically multi-year nature of oil projects, as well as driven by the estimated remaining reserves of a given field.

In addition, the level of oil investment has significant implications for future output. We estimate that oil production is positively related to field investment that goes as far back as six years on average. This is to be expected, as deep-water offshore drilling often involves complex and lengthy exploration phase, increasing the amount it takes for investment to translate into output.

Model of Norwegian Oil Investment

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Source: Fund staff estimates.Note: Dependent variable is log of real oil investment. Estimated with dynamic panel regression with field FE, for 68 oil fields over 2001-2014. Expected oil price is proxied by the inverse of OPEC spare capacity. Significance at *** 1%, ** 5%, * 10%. Alternative GMM estimation shows effect of oil price is robust.

Model of Norwegian Oil Production

article image
Source: Fund staff estimates.Note: Dependent variable is log of oil production. Estimated with panel fixed effects, for 63 oil fields over 1970-2014. Nominal oil investment deflated with PPI index for oil and gas sector. Significance at *** 1%, ** 5%, * 10%.

24. Lower investment would ultimately lead to lower production in subsequent years. While the budget would be insulated to a very large degree through the GPFG and the fiscal rule, inflows to the GPFG would be reduced. For example, we estimate that a reduction of 10 percent in real investment would lead to a cumulative reduction of about 2.2 percent in oil output over the next 6 years (Box 3).

D. Policies for Norway’s Future

25. New sources of volatility may call for amendments to the fiscal rule. A commission was recently appointed by the government to consider supplements to the fiscal rule. The commission issued its report in June 2015 with recommendations for smoothing spending and the fiscal impulse both on a year-to-year basis (e.g., limiting the change in the fiscal stance to 0.1 to 0.2 percent of trend mainland GDP per year) and over the medium and longer term. The Norwegian government is currently considering the recommendations of the commission along with other options to more explicitly smoothing over asset price and exchange rate cycles in addition to smoothing over the business cycle. Also, consideration could be given to a more explicit approach to limiting the non-oil deficit below the estimated real return in times when the economy is at or near potential. The recommendations of the commission have the advantage of simplicity, but they might not be as effective in circumstances where one particular source of stimulus or drag from the fiscal rule required a more aggressive response than smoothing.

26. Labor market policies could help to free up workers and facilitate their move to other sectors. Given the gradual and long-foreseen nature of the decline in investment, it may not be necessary to adopt special policies to redeploy workers and other resources from oil-related business to other businesses. However, greater wage differentiation across sectors could attract workers to new sectors rather than waiting until layoffs make such a move necessary. In the absence of wage differentiation, policies to discourage labor hoarding, improve information about economic prospects in different industries, and active labor market policies such as retraining could help ease the transition.

References

1

Prepared by Tom Dorsey and Giang Ho.

3

The measurement of plans versus outcomes in this regard is true to a first approximation, but there are various qualifications to this statement when measuring outcomes due to accounting differences between the government and the GPFG, the need to base budgets on forecasts of revenues, etc.

4

The fiscal rule is intended to preserve the real value of the oil and gas income in the GPFG in perpetuity, if the rate-of-return assumptions are borne out. However, a doubling of the cumulative income would not necessarily double the non-oil deficit as population growth and real per capita income growth would also raise the real value of mainland GDP.

5

Further complicating such calculations, not all direct import content is necessarily foreign content. A major export for Norwegian suppliers of oil and gas-related goods and services is South Korea, which in turn is a major exporter of oil platforms, some of which may find their way back to Norway containing Norwegian-sourced components.

Norway: Selected Issues
Author: International Monetary Fund. European Dept.