Oil revenues—their implications for an industrial economy: How Norway is coping with the flow of North Sea oil money

This paper highlights that the World Bank and its affiliate, the International Development Association (IDA), will support three projects in Kenya—one for rural access roads, an additional for integrated rural development, and a third for wildlife and tourism. A US$4 million loan and a US$4 million IDA credit will assist the government of Kenya in implementing the first phase of the rural access roads program. The program aims at the construction of 15,000 km of rural access roads in eight years.

Abstract

This paper highlights that the World Bank and its affiliate, the International Development Association (IDA), will support three projects in Kenya—one for rural access roads, an additional for integrated rural development, and a third for wildlife and tourism. A US$4 million loan and a US$4 million IDA credit will assist the government of Kenya in implementing the first phase of the rural access roads program. The program aims at the construction of 15,000 km of rural access roads in eight years.

This article takes Norway as an example an industrial economy adjusting to an increasing volume of oil and natural gas revenues.

Heinz Handler

The term “oil producing countries” has emerged in the wake of the oil crisis of 1973. It has been used to cover the oil exporters in the Middle East, Asia, Africa, and South America. Although these countries are heterogeneous as regards their standards of living, they have in common an economic structure that is still in a preindustrial stage. In general, they lack a production structure that would enable them to spend substantial amounts of their oil revenues domestically. The situation is completely different when an industrial country is an oil producer. In this article the example of Norway is taken to discuss the problems created by the development of a crude oil and natural gas sector in a highly developed economy.

With the emergence of an offshore oil sector at the beginning of this decade, Norway has entered a new development stage. Its industrial development came at the turn of the century when its economy, previously based largely on the production of fish, timber, and iron ore, started to utilize its huge hydropower resources for the establishment of a highly capital-intensive metallurgical and chemical industry. At the same time the merchant fleet was expanded and modernized. The last two decades have been characterized by diversification of production and increasing integration into the world economy. The next decade and beyond is likely to be greatly influenced by the developments in Norway’s new offshore oil sector.

Unless technical difficulties cause delays, the volume of oil and gas production in Norway is expected to rise to some 78 million tons of crude oil equivalent in 1980, from about 9.3 million tons in 1975. By 1982, when the oil and gas fields so far explored will be producing at full capacity, total oil and gas output is expected to reach some 90 million tons of oil equivalent a year, of which about one third would be contributed by natural gas. The recoverable reserves of oil and gas’ south of the 62nd parallel (latitude 62 degrees north) are estimated at 2 to 3 billion tons of oil equivalent and’ would last until the turn of the century. If reserves north of the 62nd parallel prove to be recoverable, the production period could last much longer.

Even at its peak in the early 1980s, production is unlikely to exceed 2 per cent of estimated world petroleum output, or about 7 per cent of European oil consumption. Norway will therefore not be able to exert a significant influence on the international price of oil. The margin of oil prices over production costs is an important determinant of the duration of the Norwegian “oil era” apart from the size of the recoverable oil reserves. At present, production costs of US$5-6 a barrel in the less “expensive” oilfields in the Norwegian North Sea sector leave a comfortable margin at current market prices. Average production costs in the North Sea would, however, increase if exploitation was to extend to oilfields located in deeper waters.

The investment required to develop the new petroleum sector rose sharply from NKr 0.3 billion in 1970 to NKr 5.5 billion in 1975. Owing to its high international credit standing, the prospective large income from oil production, and the involvement of foreign oil companies, Norway was able to finance the investment fully through medium-term and long-term foreign loans. As much of the investment consisted of imported equipment, Norway’s current account deficit in this period averaged over 4 per cent of gross domestic product (GDP), well above the 1½ per cent recorded in the 1960s. About one third of the oil equipment required was produced in Norway, particularly drilling platforms, and this activity was an important expansionary force in the economy.

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North Sea: oil and gas sectors

Citation: Finance & Development 0013, 004; 10.5089/9781616353278.022.A006

With the attainment of full-scale production of oil and the shift to being a net oil exporter from the latter part of 1975, Norway will substantially increase its per capita income and transform its traditional current account deficit into a large surplus during the second half of the 1970s. This surplus will be maintained even though oil revenue is likely to be used for raising the level of domestic consumption and investment; it will enable Norway to reduce its foreign indebtedness and to increase its investment abroad and its foreign aid. The oil revenue will accrue to a large extent to the Government via tax and royalty receipts as well as through government ownership of the Statoil company, thus enabling the Government to maintain control over the impact of the oil sector on the economy.

Oil policy

An important aim of Norway’s long-term oil policy is to integrate the oil sector into the traditional structure of the economy. Disturbances are inevitable insofar as cost and price increases are part of the process of establishing the oil sector, while contracting parts of the economy (releasing labor to the oil sector) are hardly likely to be able to reduce wages and prices. The impact of these disturbances is likely to affect almost every sector of the economy but it will be most pronounced in a few branches and markets, particularly in industries exposed to foreign competition.

Oil policy has been based largely on an assessment of Norway’s petroleum reserves in the North Sea and the expected long-term development in the international price of oil. The authorities’ decision to adopt a “go-slow” policy in oil exploitation has been determined by the desire to prevent rapid structural change and undesirable environmental damage. In this way, the initial adverse impact on other sectors of the economy can be softened, and the Norwegian “oil age” stretched. However, the policy also increases the period of risk of a future decline’ in the price of oil relative to the general price level.

Norway: some basic data

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Another element in Norway’s oil policy is the extensive government control of all activities connected with the new oil sector. The taxation of oil companies will assure the large government revenues needed to increase the intended public sector investment, to enable the Government to finance regional and labor market projects and to reduce direct taxation in the lower-income brackets.

The division of public sector oil revenue—the largest part of the revenue from oil operations—between foreign and domestic uses will influence the degree of pressure on domestic resources (as reflected in domestic costs and prices), which may result in conditions of full employment from spending the increasing oil revenue. An essential aim of short-term and medium-term policies is to moderate these pressures; but this will become more difficult to achieve as Norway’s current surplus rises. The growing surplus will increase the income expectations of the private sector, which will be expressed in higher wage claims, and this in turn will add to the pressure for a policy of spending public revenue in Norway rather than abroad.

The Government (in its report Petroleum Industry in Norwegian Society) has indicated that about half the public revenue from the petroleum sector may be used domestically, but only a part of this will be spent on goods and services. Part will be used to ease personal taxation—cuts in personal income tax rates were introduced in the budgets for 1975 and 1976—and to increase transfer payments to the private sector. The Government also plans to support certain investment projects in the private sector, most prominently in residential construction.

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Norway: past and projected petroleum production

(In millions of tons of oil equivalent)

Citation: Finance & Development 0013, 004; 10.5089/9781616353278.022.A006

Sources: Ministry ol Finance, Parliamentary Reports Nos. 2511973 74).50 (1974 75); 81 [1974 75), and 1 11975 761, and IMF stall estimates.

There are various options that could govern the use of public oil revenue spent abroad. The choices will not become urgent until about 1978. For a number of years after that, oil income will be largely earmarked to repay the foreign debt accumulated for offshore investments. Subsequently, it may be used to buy out foreign interests in companies operating in Norway, which is a form of capital export. Capital exports could also include lending to international organizations dealing with multilateral development aid. The Norwegian Parliament has declared its aim to expand official development assistance to 1 per cent of GDP by 1978. Thereafter, official aid is likely to rise faster than GDP.

The Norwegian Government also plans to acquire production facilities abroad as investments that could provide a return similar to that of domestic export enterprises without, however, absorbing domestic resources. In addition, foreign investments can be considered as a safeguard for the years after the end of the oil period.

Demand for labor

With the development of offshore oil, the demand for labor in Norway will increase both directly and indirectly. The direct increase will be in the oil sector, and those sectors providing it with goods and services. The indirect increase will occur as a result of the higher overall economic activity in the regions with oil-related industries. Moreover, in the economy as a whole, the demand for labor is likely to rise via the domestic spending of public oil revenue.

The direct effect of petroleum activities on the demand for labor has been small to date. In August 1975, a total of 20,700 persons (including some 2,500 foreigners) was employed in all petroleum-related operations; this accounts for not much more than 1 per cent of the Norwegian labor force. Up to 1980, an increase to about 25,000 employees is envisaged. Between 1974 and 1980 Norway’s total supply of labor is expected to increase by 75,000 persons; over the same period, the sectors protected against foreign competition plus the oil sector will require about 95,000 to 110,000 additional persons (disregarding the indirect effects of the use of oil revenues). The loss of labor in the industries “exposed” to foreign competition will thus be some 20,000 to 35,000 persons (Table 1). Furthermore, the domestic spending of oil revenue is expected to create 7,000 to 8,000 additional jobs in the protected sectors for each NKr 1 billion spent. Although these figures can only be approximate, they indicate the pressures that are likely to be felt in the labor market and the strength of the incentive to substitute capital for labor and to import labor-intensive goods from abroad.

Table 1.

Estimated cumulative change in employment 1974-80 1

(In thousands of man-years)

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Source: Ministry of Finance, Stortingsmelding Nr. 25 (1973-74).

Excluding the effects of oil revenues on non-oil sectors of the economy.

Sectors protected against foreign competition, e.g., construction, power, domestic transport and trade, banking, education, health care, etc.

Employment will increase also in the more dynamic industries exposed to international competition. The “necessary decrease in other sectors” is therefore net of such increases.

Supply and demand

The gradual development of the petroleum sector is changing the relative importance of production factors for the Norwegian economy. Certain basic input goods (oil, oil-based energy) are becoming relatively more abundant, and labor scarcer. Changes in the structure of production will inevitably follow, and friction will be unavoidable.

A major concern of long-term policy is to hold down the share of oil-dependent activities in overall production. Although the oil reserves in the Norwegian part of the North Sea seem large enough to assure a yield at least until the turn of the century, an economy based on the extraction and refinement of a single commodity is vulnerable—the international oil market in particular cannot be regarded as stable—and considerable uncertainty attaches to predictions of demand and price developments for crude oil over a longer period.

Some of the oil-related structural changes in the economy have already taken place. Most notably, Norwegian industry has developed new devices for large-scale exploration and production of oil in deep water that are already being exported to other countries. Norwegian shipyards have switched mainly to the production of mobile drilling rigs, and the construction sector supplies the newly developed concrete platforms. With the production of oil and its landing in Norway on a large scale, the development of additional refining capacity and of petrochemical plants will follow.

Petroleum development will change the production and export structure in favor of raw materials, thus reversing the pronounced postwar trend toward a rising share of manufactured goods, from 54.9 per cent of the value of total exports excluding ships, in the period 1955–57, to 68.7 per cent in the period 1972-74. The establishment of additional refining capacity and of petrochemical plants will retard the rise in the share of crude oil in total exports. In the second half of the 1970s, exports are expected to become the demand component with the fastest growth, and their share in total demand (measured in 1974 prices) is expected to rise from about 31 per cent in 1974 to about 38.5 per cent in 1980. With a projected average growth in the volume of exports between 1974 and 1980 of about 10 per cent a year, the contribution of the real foreign balance to aggregate demand would rise from—2.3 per cent in 1974 to almost 9 per cent in 1980. This will be entirely due to the contribution of the oil sector, while the deficit on the balance of non-oil goods and services is expected to increase, largely because of the increase in imports induced by the use of oil revenue. Compared with the increase in the relative importance of foreign demand, changes in the structure of domestic demand are expected to be minor (see Table 2).

Table 2.

Demand and supply growth, 1950-80

(Annual percentage changes)1

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Sources: Ministry of Finance, Stortingsmelding Nr. 50 (1974-75); Stortingsmelding Nr. 1 (1975-76); Central Bureau of Statistics, Statistisk Ukehefte; Nasjonalregnskap 1950-66, 1954-70; and IMF staff calculations.

Growth rates for the period 1950-70 are calculated from the old Norwegian system of national accounts. … indicates data not available.

Incomes, costs and prices

The shifts in demand and supply on the goods and labor markets, induced by the oil operations, are giving rise to changes in the structure of incomes, production costs, and prices. The ability of non-oil industries to adjust wage rates to the higher level paid in the oil sector will depend on the price elasticity of demand for their product. Norwegian industries exposed to foreign competition are, as a rule, price takers—they are not in a position to affect world prices. Consequently, they will not be able to mark up prices and, as a result, will tend to lose employees. There is greater freedom in the pricing behavior of sheltered industries, which usually find it easier to pass on higher costs to consumers.

Public income from offshore oil operations will vary primarily with the market price of oil, the volume of production, the degree of government participation in extraction, and the structure of taxes. Taking account only of the Ekofisk production (see map), where exploitation started in 1971, the cumulative public oil revenue over the period 1975 to 1980 could amount to about NKr 60-65 billion (in 1974 prices).

Imports of capital goods for the offshore oil sector, which rose steadily from about NKr 1.1 billion in 1972 to NKr 6.4 billion in 1975, contributed significantly to a persistent sharp increase in the current account deficit, from NKr 0.4 billion in 1972 to NKr 13.3 billion in 1975 (see Table 3). The expected leveling out of oil sector investment after 1976 and the sharp stepping up of oil production over the next few years will result in a gradual reduction in the current deficit and its possible replacement by a surplus as early as 1978. Subject to the great uncertainties of future export prices, petroleum exports are estimated to account for about 40 per cent of total nominal merchandise exports by 1980 (compared with 1½ per cent in 1974); by contrast, the share of capital goods imported by the oil sector in total merchandise imports is expected to drop from 9 per cent in 1974 to 3 per cent in 1980. Exports of offshore services, such as technology of oil and gas transportation and drilling, will also increase sharply. Offsetting factors will be the still rising interest payments for investment in the oil sector financed by foreign credit, and the envisaged increase in official development aid. Developments in the oil sector will also influence the balance of payments indirectly via the rise in imports induced by higher incomes, which will also serve as an equilibrating force on the domestic markets for goods and money.

Table 3.

Current account development

(In millions of Norwegian kroner)

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Sources: Central Bureau of Statistics, Statistisk Ukehefte; Ministry of Finance, Revised National Budgets 1974, 1975, and 1976, and National Budget 1976; and Stortingsmelding Nr. 50 (1974-75).

Exports of used ships minus imports of all ships.

Petroleum exports, exports of oil sector services, and imports of oil sector equipment.

After 1978, the current account surplus is projected to increase rapidly, to about NKr 20 billion by 1980. The value of oil and gas exports in current prices for that year may amount to some NKr 37 billion. Future current account surpluses are likely to be used largely for capital exports, first in the form of external debt repayments, and in due course in the form of investment abroad. A close official control of such investment is necessary to ensure that investment income can replace income from oil operations if and when the latter declines.

Outlook and policy issues

The development of the Norwegian economy beyond the early 1980s will depend on two factors: the successful management of the transitional period until the new petroleum sector is fully integrated into the economy; and the duration of the Norwegian oil age. How long the oil age lasts will depend on the economic exploitability of oil and gas, which turns on the interaction of the international price of energy relative to the cost of exploration and exploitation of the continental shelf. The existing “go slow” policy is in part an expression of the uncertainties involved in the petroleum project and in part the result of a judgment that the impact of the oil sector on the rest of the economy will be easier to manage the longer the period over which it is spread.

For the longer term, the authorities are evaluating the implications of three sets of alternative assumptions. A “high-growth” alternative assumes a gradual increase in petroleum output from 90 million tons of oil equivalent annually at the beginning of the 1980s to 180 million tons in the year 2000, and a strong increase in aggregate demand (compared with that under the other alternatives), resulting in an annual growth rate of real GDP of 4.3 per cent. A “medium-growth” alternative assumes unchanged production of petroleum between the early 1980s and the end of the century and a more moderate growth in aggregate demand, with an average annual GDP growth of 3.7 per cent. Under a “low-growth” alternative a reduction of oil and gas production by 1990 to about 50 million tons of oil equivalent and a comparatively slow growth in total demand is assumed; this results in an estimated annual average GDP growth of only 2.6 per cent. All three projections have in common that the growth in GDP in the 1980s and 1990s will be considerably lower than in the second half of the 1970s, largely owing to the projected slower expansion of exports that are expected to decelerate to a rate below that of imports. Assuming no drastic change in the terms of trade, the Norwegian current account surplus is thus projected to diminish and eventually disappear under all three projections by the turn of the century.

In the interim period, a policy mix will emerge that retains the merits of a highly diversified economy while allowing domestic living standards to rise and to be maintained on a high level beyond the passing of the oil age. The pace at which the real income expectations of the population rise and the manner in which they are met are critical elements in the transition. Should present controls of immigration from outside the Nordic labor market be maintained, the increase in wage costs can be contained if an increase in real disposable income is achieved through lowering taxes. To the extent that a large current account surplus remains, it will have to be offset by capital exports if domestic demand management is to be successful within a framework of a relatively stable exchange rate policy.

Other North Sea oil and gas producers

Besides Norway, four other countries (Denmark, the Federal Republic of Germany, the Netherlands, and the United Kingdom) have jurisdiction over sectors of the North Sea (see map).

The U.K. sector is the largest (Norway controls the second largest). Production in this sector started in 1975 with a total of 1.1 million tons of oil and about 31 million tons of oil equivalent of natural gas. Production of oil is expected to rise to some 15-20 million tons in 1976, about one fifth of domestic oil consumption. By 1980 oil production is predicted to reach 95-115 million tonsprobably more than domestic oil use in the United Kingdom. Total recoverable reserves of oil and gas from currently designated areas are estimated at some 4,200 million to 5,700 million tons of oil equivalent (of which 3,000-4,500 million tons constitute oil). At the envisaged rate of extraction in 1980, the oil reserves would last until about the first or second decade of the next century.

In 1975 the North Sea activities of the United Kingdom had a considerable impact on the balance of payments. Export earnings and import savings together amounted to some £1.9 billion or 1.8 per cent of gross national product. As in Norway, the direct effect of the offshore sector on employment has been small: in 1975 somewhat more than 6,000 persons (out of a labor force of roughly 23 million) were employed in offshore activities. Government influence over the U.K. oil and gas sector was ensured by several laws adopted in 1975. These provide for the control of exploration and production of petroleum and natural gas, the taxation of oil companies and the establishment of the British National Oil Corporation, which will be a major instrument of direct government participation in oilfields.

In the Netherlands the major natural gas finds were made on the continent. In the late 1960s and early 1970s the energy policy of the Netherlands aimed at a rapid depletion of the gas resources, so as to avoid the risk that alternative forms of energy would make natural gas obsolete. Most of the gas finds, including future finds, were contracted under the influence of the Government for export at prices that turned out to be low compared with the energy price level after the oil crisis. The Netherlands subsequently reappraised its energy policy. Because of lack of major new gas or oil discoveries, a “go-slow” policy was adopted to conserve existing reserves. In addition, most new contracts for the delivery of natural gas now include some sort of a price-cost indexation clause. The new policy attempts to ensure that production from the gas reserves, presently estimated at some 2,100 million tons of oil equivalent, would last until the turn of the century. Annual production is seen to rise from about 82 million tons of oil equivalent in 1975 to a peak of 93 million tons in 1978 and to decline gradually thereafter. Exports are also expected to reach a peak of some 49 million tons of oil equivalent in 1978.

Since 1974 the Netherlands has been a net exporter of gas and oil in volume terms, while the energy balance in value terms remained negative as a consequence of the relatively low export prices of gas. Since 1975 the Government is entitled to collect 90 per cent of the profit resulting from increases in the price of natural gas. In 1976 the nontax revenue of the Government from gas sales is estimated at some 5.5 billion guilders or 7% per cent of estimated total government revenue.

Finance & Development, December 1976
Author: International Monetary Fund. External Relations Dept.