Oil and gas in the capitals

Norway faces some important dilemmas and awkward policy trade-offs concerning the petroleum industry. Even if the country has a robust economy, it is sailing into more risky waters. Lower oil prices change the macroeconomic framework. In 2014, Norway had a trade surplus equal to 30% of GDP. Oil and gas, as well as refined products, accounted for 45% of total exports. Without petroleum exports, the trade deficit would have been 9% of GDP. Even at prices at one-half of the 2014 level, Norway would still have a comfortable trade surplus, but critical issues appear on the political agenda.

The key question concerns Norway’s economic strategy and the trade-off between continued petroleum investment and diversification. Over the past 10 years, exploration and development have boomed, thanks to tax breaks and high oil prices, driving costs up. As a rule, the government takes 78% of net income, but companies can deduct 90% of capital investment. The service/supply sector has benefited greatly, due partly to bottlenecks and imperfect competition. In Norway, industry factors have driven costs, not geology.

The oil industry’s cost escalation has spread to other sectors, as it has been able to pay high prices for goods and services, and high remunerations for labor. Thus, the oil industry expansion has weakened the competitiveness of other industries in a small, very open economy, even if it also has spread technology. For that reason—the crowding-out effect—Norway’s oil wealth is not an unmitigated blessing. 

Future direction. In Norway, a recurrent question is what the country should live on after oil, implicitly that it should prepare for a different export structure and deliberately scale down the petroleum industry. The issue is exaggerated, as Norway has a resource base able to sustain a petroleum industry for decades. Indeed, the question is rather what Norway should live on, together with the petroleum industry. Leaving aside the issue of business development based on the country’s natural and human resources, the question is how to treat the oil industry. Should it be promoted further or should it be downsized? Opinions differ.

In current money, Norway’s petroleum investment quadrupled from 2002 to 2014, while other business investment only rose 76%. Thus, the boom years made Norway more exposed to oil market risk. The outlook for petroleum investment is for a 34% decline, affecting new projects as well as enhanced recovery on producing fields. Already, the service/supply companies feel the squeeze, cutting jobs and shedding sub-contractors. Unemployment is beginning to affect local communities along the coast. The good news is that with lower activity, costs will decline. The bad news is the risk of losing industrial competence.

So far, the government seems unwilling to take any measures to stimulate exploration and development. The prime minister seems to think that through low oil prices, market forces will drive the structural changes needed to diversify the economy.

Bountiful wealth. Norway’s sovereign wealth fund, by spring 2015, is almost $900 billion, two and a half times the country’s GDP, or about $170,000 per capita. This year, for the first time, transfers out of the fund to the budget will exceed the inflow of petroleum revenues into it.

In 2014, transfer out of the fund was about $24 billion, about 2.3% of the capital, and about 15% of the total budget. That was about one half of the inflow into the fund—$47 billion. In addition, the fund earned $88 billion on its investment portfolio. For several years, the fund has grown more by investment activities than by petroleum revenues. Consequently, the fund’s intention has been realized, decoupling the domestic economy from oil price movements. 

Nevertheless, oil and gas represent the country’s major industry, essential to economic activity, especially along the coast. The risk is that oil prices, in the short term, will fall further and cause additional decline in exploration and development, before eventually stabilizing, perhaps at current levels. The government’s hands-off attitude seems to ignore the special capital-intensive and knowledge-intensive character of the industry. So far, demand from the industry has given stronger growth impulses to the Norwegian economy than has the use of petroleum revenues. The risk is that reduced oil and gas activity will cause a stronger cooling-off of the economy than anticipated, with regional and sectorial depressions. Therefore, requests for measures to stimulate petroleum activity are likely to mount, in so far as low prices persist and investment drops. In Parliament, a majority would probably be in favor, but the government might have to seek new partners.

Continental considerations. Norway is the second natural gas supplier to the European Union, after Russia. EU concerns about import dependency discredit the choice of gas as a source of power generation, with a preference for costly renewable energy or cheap imported coal. In 2013, EU demand was 15.5 Tcf of natural gas, of which domestic output was 5.2 Tcf and imports were 10.3 Tcf, including 4.4 Tcf from Russia and 3.8 Tcf from Norway. Import dependency was 66%.

Declining output in the Netherlands and the United Kingdom points to rising import dependency. This prospect is seen as benefiting Russia, harming supply security. Norwegian gas could make a difference. Counting Norwegian gas as “European” would raise domestic output to 9.0 Tcf and self-sufficiency to 57%. Consequently, the supply risk would appear as less ominous, politically facilitating the choice of natural gas in power generation. This would make sense, provided Norway shows a willingness to remain a key gas exporter. The matter is pertinent to the project of a European energy union.  

About the Authors

Dr. Øystein Noreng

Contributing Editor

Dr. Øystein Noreng is a professor emeritus at BI Norwegian Business School. He has been an advisor or consultant to the International Monetary Fund; The World Bank; the governments of Canada, Denmark, Norway, Sweden and the U.S.; and energy companies, including Equinor, PDVSA and Saudi Aramco.