Norway, Alaska, and Alberta have been operating petroleum revenue funds which are considered among the successful nonrenewable resource funds. Rules governing the three funds are quite different, from deposit and withdrawal rules to investment strategies and how the funds withdrawn are to be spent .This briefing note, third in a series of four, gives a brief description of each.

Financing non-oil budget deficit, paying out “oil dividends” every year to qualified residents, and funding capital projects for economic diversification are some of the ways in which the petroleum revenue funds in Norway, Alaska, and Alberta, respectively, have made use of petroleum income. The previous two briefing notes explained why petroleum revenue funds may be considered and how they may be run [1, 2]. This and the next notes provide information on how governments from around the world have been managing petroleum funds.

Norway

Norway’s aging population and associated rising pension expenditures—against the backdrop of declining oil revenues in the coming decades—were the main driver for establishing a petroleum fund. The Norwegian parliament adopted the Act on the Government Petroleum Fund in 1990. The fund has since been continued as the Government Pension Fund Global: the Norwegian parliament adopted the Act on the Government Pension Fund in 2005 and established the Government Pension Fund in 2006.

The Norwegian fund mechanism is markedly different from those of other funds, and has a parallel only with the fund in Timor-Leste. Money is allocated to the fund only when there is a budget surplus. This highlights an important fact: accumulating assets in the fund is possible only if the government runs a budget surplus. In this way, the fund balance reflects actual (that is, net) savings. The first half of the 1990s saw a strong recession and the government ran a deficit budget, as a result of which there was no net transfer to the fund. The budget went into surplus for the first time in 1995.

The fund income consists of net petroleum revenues and interests and dividends earned on the fund’s holding. The parliament determines the deficit on the government’s non-oil budget and that amount is paid out of the fund. More specifically, there is an annual transfer from the fund to the treasury corresponding to petroleum revenues used in the budget, which cover the nonoil deficit. The mechanism is illustrated in Figure 1.The fund invested only in fixed income assets until 1997. New estimates of the fund’s future growth indicated that it would be a long time before the government would start drawing on the fund. Given that stocks are appropriate for a longer time horizon; new guidelines permitting an investment of 30–50 percent of the fund in stocks were adopted in 1998. Emerging markets were added to the investment portfolio in 2000.

Today, the capital is invested in non-Norwegian bonds, stocks, money market instruments, and derivatives—in 42 stock markets and 31 currencies for fixed income investments. The finance ministry is tasked with managing the fund. It lays down the fund management strategy including the long-term investment strategy. The latter includes choices on geographical, currency, and asset class distribution. The ministry selects a benchmark portfolio, which serves two purposes:

• The actual portfolio is not permitted to have a variation (in standard error) exceeding 1.5 percent from the benchmark portfolio.

• Actual returns are compared with the benchmark portfolio returns.

Ethical guidelines were established in 2004 and the Advisory Council on Ethics has been appointed.

The finance ministry has delegated responsibility for the fund’s operational management to the Norges Bank Investment Management (NBIM). NBIM is a separate part of Norges Bank (Norwegian central bank) and is responsible for investing the international assets of the Norwegian Government Pension Fund. NBIM uses a mix of internal and external managers. External managers are used for those assets with which the central Bank has little prior experience. Norges Bank reports results on a quarterly basis. Performance differences between the benchmark and actual portfolios are reported and explained. The auditing of the fund has been assigned to the Office of the Auditor General, which bases its audit on the work performed by the Central Bank Audit [3–5].

How the fund is used in the 2008 budget (January to December 2008) is shown in Figure 2. The budget was approved by mid-2007. The government assumed an oil price of 369 Norwegian kroners (NOK), or about US$69, per barrel. The government estimated that net deposits into the fund would consist of 301.8 billion NOK of net petroleum revenues and 78.7 billion NOK of returns on the fund’s holdings.

Alaska, United States

In 1969, the state of Alaska received $900 million in bonuses from the Prudhoe Bay oil lease sale. This amount was as much as all previous state budgets combined. The question was what to do with this windfall, and after some debate the government decided to spend it on education, health, and infrastructure projects. When the $900 million was spent within a few years, concerns were raised that some of the money might have been wasted and that future revenues might not last long. By 1975, there was enough negative reaction to the spending of the $900 million and a proposal for a permanent fund had gained a following in the Alaska legislature.

Because the state constitution at the time prohibited dedicated funds, a proposal to establish a permanent fund was put forward to Alaskan voters in the form of a constitutional amendment. In 1976, as the Trans-Alaska Pipeline construction neared completion, Alaskan voters approved a constitutional amendment to establish the Alaska Permanent Fund. The amendment reads.

At least twenty-five percent of all mineral lease rentals, royalties, royalty sale proceeds, federal mineral revenue sharing payments and bonuses received by the State shall be placed in a permanent fund, the principal of which shall be used only for those income producing investments specifically designated by law as eligible for permanent fund investments. All income from the permanent fund shall be deposited in the general fund unless otherwise provided by law.

An important feature of this amendment is that the fund’s principal (or capital, to be distinguished from earnings on capital) cannot be touched. Spending a portion of the capital would require another constitutional amendment. The legislature may spend realized earnings. Unrealized earnings—those resulting from the change in the market value of the fund’s holdings— cannot be spent. Earnings have been “inflation-proofed” almost since inception—the amount corresponding to inflation is subtracted from nominal earnings to arrive at earnings in real terms. Inflation proofing is designed to prevent the situation whereby the capital, after adjusting for inflation, declines in real value over time.

After four years of debate in the legislature and press about the use of the fund, a bill was passed in 1980 creating the Alaska Permanent Fund Corporation. The law provides for independent management by a board of trustees and requires the board to publish a report on the fund by September 30 each year. The report must include financial statements audited by independent external auditors, the amount of money received by the fund from each investment and a description of fund investment activity during the period covered, a statement of the fund’s investments including an appraisal at market value, and a comparison of the fund’s performance against various benchmarks. Initially the fund was invested in high-grade fixed income securities. Today, the fund is invested in stocks, bonds, real estate, and alternatives.

Beginning in 1982, out of its realized earnings, the fund has paid annual dividends to all residents of Alaska, including minors, who had resided for at least the previous 12 months in the state (numbering about 600,000 in 2007). The dividends are not necessarily correlated with world oil prices because the fund’s income is not determined by the price of oil but by overall returns on the fund’s investments (that is, the performance of the stock and bond markets, and so on). The historical dividends are shown in Figure 3. The highest dividend was paid in 2000, when oil prices were not particularly high; the lowest dividend in recent years was handed out in 2005, despite surging oil prices [5, 6].

Alberta, Canada

The Canadian province of Alberta has benefited from healthy petroleum revenues for decades. By 1975, royalties accounted for 41 percent of total government receipts. A savings fund was proposed in 1974 and, following vigorous debate during the 1975 election, the Alberta Heritage Savings Trust Fund Act was passed by parliament in 1976. The act set out three objectives: (1) save for the future, (2) strengthen or diversify the economy, and (3) improve the quality of life of Albertans. The finance minister is responsible for the operation of the fund.

The fund was set up with a special contribution of C$1.5 billion from the General Revenue Fund—which is the province’s main operating fund—and 30 percent of petroleum revenue received by the government of Alberta amounting to C$620 million. This percentage was not fixed in the law for future fiscal years, and the transfer of petroleum royalty revenues to the fund was stopped in 1987. In the 1980s, some money from the fund was used for capital projects intended to help diversify the economy (such as medical and renewable energy research) and improve the quality of life (developing parks, preserving forests). The fund provided loans to Alberta corporations, mostly to Crown corporations (state-owned enterprises). These loans performed poorly, returning about 2 percent, against the 10 percent achieved by the commercial division of the fund [5].

In 1995, the government asked Albertans about the future of the Heritage Fund in a survey called “Can we interest you in an $11 billion decision?” The respondents wanted to keep the fund for future generations and focus on generating higher returns on long-term investments. In response, the Heritage Act was amended and the fund was restructured. The fund could no longer be used for economic development or social investment purposes. A new business plan, which included a plan to increase long-term investments, was implemented in 1997. The fund’s business plan is published as part of the provincial budget and the fund’s income is consolidated into the provincial revenue. The amendment created a new Standing Committee (of the legislative assembly) tasked with the following responsibilities:

• Review and approve the business plan annually
• Receive and review quarterly reports on the operation and results of the fund
• Approve the fund’s annual report
• Review annually the performance of the fund and report to the legislation whether the mission of the fund is being fulfilled
• Hold public meetings with Albertans on the investment activities and results of the fund.

Performance measures include timeliness of reports and public accountability meetings, knowledge of Albertans about the fund, and whether half of Albertans can estimate the fund’s value. In 1998, the government surveyed Albertans about their fiscal priorities. Albertans ranked increasing savings in the Heritage Fund high, fourth in overall priority. This was echoed in another survey in 2000, again on fiscal priorities, where Albertans indicated support for a savings plan, including saving an unexpected petroleum windfall for the future. A survey conducted in 2002 specifically on the Heritage Fund showed that 61 percent of Albertans wanted the fund to continue to operate primarily as an endowment fund. After a transition period, the fund is now an endowment fund.

The Alberta Heritage Savings Trust Fund Act requires the fund to be inflation-proofed once the accumulated debt of the province is eliminated. Debt retirement was achieved by 2005, and the government began inflation-proofing the fund in fiscal 2005/06. Today, the income earned by the fund, less the amount retained for inflation proofing, is transferred to the General Revenue Fund to help pay for priority programs. Although there were no new transfers into the fund for many years, the budget for fiscal 2006/07 included a C$1 billion transfer to the fund from the budget surplus. Another C$0.9 billion was transferred to the fund in fiscal 2007/08.

The fund’s investment managed by the Alberta Investment Management Corporation (AIMCo), which is the investment operations group of the provincial ministry of finance. AIMCo makes use of external managers for certain investments with the potential to generate high returns but that require specialized resources. The fund’s auditor is the Auditor General. The fund’s portfolio consists of stocks, bonds, real estate, and absolute return strategies (designed to achieve positive returns in both up and down markets). About half of the fund is invested in stocks (Canadian, U.S., and non-north American). As with the Norwegian and Alaskan funds, the Heritage Fund has benchmarks against which its performance is measured. Through its 32-year history, the Heritage Fund has generated C$30 billion in investment income [5, 7, 8].

Observations

The three funds discussed in this note are all characterized by transparency of operations. Accessible reports are published in the public domain. Audit results are made regularly available on the Internet and in print. There are vertical and horizontal checks and balances, and fund managers, board members, and others involved in fund management and oversight are selected on merit. All three funds have been operating as savings funds— in practice in the case of the Norwegian fund, although the saving function is not legislated.

There are important differences. The Alaska Permanent Fund operates under legal rigidity, requiring a constitutional amendment to change spending rules. The Alberta Heritage Savings Trust Fund Act provides much more flexibility to fund management. In the 1980s, with falling oil prices and gradual elimination of transfers into the fund, the failure to even inflation-proof the fund led to a decline in the fund’s real value. The Norwegian fund has no set accumulation or withdrawal rules, and it is thanks to the strong fiscal discipline of the Norwegian parliament that fund use has not been manipulated by election cycles and other political considerations aimed at short-term gains.

The government of Alberta has conducted a number of surveys to ask its residents how they would like to see the petroleum revenues used. Albertans have given overwhelming support for channeling petroleum revenues to a savings fund for future generations. There is little evidence that the initial strategy of using the fund for economic diversification and improving social infrastructure was particularly successful. Yet it is precisely this type of use that a developing country government might be tempted to follow—large prestige projects that would not normally be accommodated in the budget or chosen through rational project selection.

The loans made by the Alberta fund had weak constraints on financial performance. The survey response and support for an endowment fund might be an indication that there was no strong public perception that the earlier spending programs had achieved their goals well, and this offers an important lesson for governments considering use of new petroleum income.

References

[1] World Bank. 2008. “Petroleum Revenue Funds –Part 1.” Petroleum Sector Briefing Note No. 12, June–July.

[2] World Bank. 2008. “Petroleum Revenue Funds –Part 2.” Petroleum Sector Briefing Note No. 3, October.

[3] www.norges-bank.no/[4] IMF. 2003. “Stabilization and Savings Funds for Nonrenewable Resources” in Fiscal Policy Formulation and Implementation in Oil-Producing Countries.

[5] ESMAP. 2006. “Experiences with Oil Funds: Institutional and Financial Aspects.” Report 321/06.

[6] www.apfc.org/

[7] www.finance.gov.ab.ca/business/ahstf/index.html

[8]www.finance.alberta.ca/business/ahstf/publications.html#annual

(Source: The World Bank Newsletter, Petroleum Sector Briefing Note, No.4, January 2009)

Related posts:

• Country Experience with EITI – Part 1 (1)
• Avoiding the Resource Curse (0)
• Extractive Industries Transparency Initiative (0)
• Oil and Gas: A Blessing or A Curse? (1)
• Introduction to Oil and Gas (1)
• Oil Resource Holds Hope for Cambodia’s Future Wealth (2)
• Refining Crude Oil – Part 1 (0)
• Contracts for Petroleum Development – Part 3 (0)
• Country Experience with EITI – Part 2 (1)
• Oil contracts remain a “mystery” (0)

This entry was posted on Friday, January 30th, 2009 at 4:40 pm and is filed under Oil and gas. You can follow any responses to this entry through the RSS 2.0 feed. You can leave a response, or trackback from your own site.