The Mistake that Cost Norway Huge in Oil Wealth

Spooked by '80s recession, it sped up extraction of crude worth way more today. Eighth in a series.

There was a time when it made good sense to convert hard assets like pork bellies or iron ore into convenient and liquid cash. But with today's global currency crises quietly draining value from millions of people's savings, the commodity tide is now flowing rapidly the other way. Many financial advisors now promote an "end times" investment strategy focused on raw resources that, among other things, is leading to a gold-rush on fertile farmland around the globe.

This has serious implications for Canada as a nation rich in non-renewable resources. Our nation's business plan since confederation has largely been to liquidate these resources as cheaply and quickly as possible. A focus on volume-based extraction with minimal value-added processing plays out most recently in the Alberta oil sands, where pell-mell development is preoccupied with piping unrefined bitumen to outside markets. If globally scarce and strategic resources are rising in value compared to paper money, what's the rush to convert it to cash? Would Canadians benefit more from a go-slow approach to resource development?

This series has so far focused on seeking lessons from Norway regarding Canada's petroleum policies (or lack thereof). Norway's $600-billion oil fund is often seen as symbol of disciplined success managing their petroleum resources. However, this vast investment fund is in fact the result of a fundamental shift away from some of the fiercely independent policies instituted in the 1970s. These choices around the pace of Norwegian oil development hold important and cautionary lessons for us here in Canada.

One of the founding documents of Norwegian oil policy from 1974 stated, "...After a comprehensive evaluation of its social aspects, the Government has concluded that Norway should take a moderate pace in the extraction of petroleum resources."

These words represented a bold ambition on the part of the small Nordic country: to intentionally go slow with oil development to protect the non-oil aspects of their economy, and their society as a whole.

This "moderate pace" of extraction was defined as 90 million tonnes of oil equivalent per year -- a level that was not reached until the late 1980s. In 1988, the Norwegian parliament also agreed that annual oil investments should be limited to 25 billion Norwegian kroner (about $4.2 billion).

But in politics as in life, nothing is permanent. Norway experienced a stinging recession in the late 1980s when oil prices collapsed and the jobless rate reached six per cent -- mild by North American standards but a shock for a country accustomed to full employment. These political pressures led to a quiet but dramatic increase in Norwegian oil production in the 1990s with wide-ranging consequences now being felt by the Nordic nation.

Race to bank wealth

A detailed history of Norway's oil industry by Dr. Helge Ryggvik at the University of Oslo showed that by 1993, oil investments had blown past the ceiling set by parliament, reaching 53 billion kroner. Oil production doubled over 1988 levels, reaching 2.3 million barrels per day.

A government white paper at the time seemed to abandon any attempt to maintain a moderate pace of production, stating "Activity levels in the petroleum industry are to a considerable extent dependent on conditions we cannot control" -- a major departure from the steely determination of 20 years earlier.

This decision to open the oil production floodgates also led directly to the formation of the Norwegian oil fund. The rationale was that oil wealth could be converted into cash and stored in the bank instead of underground. Economists argued that revenues invested in securities would yield interest immediately and dilute the risk of fluctuating oil prices. Between 1986 and 2001, oil production increased almost four-fold and has been declining ever since.

But economists are not always right. Compared to today, oil prices in the 1990s were in the toilet -- not rising above $45 per barrel until 2004. So what would have happened had Norway stuck to their guiding principles and maintained a moderate pace of petroleum development?

In 1986, Norway was producing 841,000 barrels per day. If they recovered 70 per cent of these revenues through taxation of oil sales based on yearly prices to present day, they would still have about $229 billion in the bank in 2011. They would also have an additional 14.2 billion barrels of reserves more than they do now, worth about $1.5 trillion at today's price of $110 per barrel for Brent crude.

Assuming that 70 per cent of that wealth was converted to revenues for the benefit of the Norwegian taxpayer, this would amount to about $1.1 trillion. In addition to the $229 billion in the bank, Norway would therefore have approximately $1.3 trillion in investments and extractable reserves -- about $700 billion ahead of where they are now.

Bubble tendencies

This rush to production has also created many of the same problems faced in Alberta by ballooning costs and labour shortages. A strike by oil workers this year cut production by 15 per cent, and another looming strike by oil service workers is heading to arbitration next month.

Oil professionals in Norway make more than $180,000 per year – double the global average. Drilling costs are 40 per cent higher than in the U.K. Statoil is considering cutting 1,000 jobs or 30 per cent of their workforce in an effort to reduce costs.

Annual oil investments will reach a record 204 billion kroner next year, almost 10 times the ceiling proclaimed by Norwegian parliament in 1988. Norway's Oil Minister Ola Borten Moe defends rising industry wages but acknowledges, "We have a responsibility, together, to make sure we don't build bubble tendencies in this part of the economy."

The oil fund has become so large that even minor withdrawals into general revenue are overheating the Norwegian economy. By law, the government is allowed to utilize four per cent of the fund annually but observers predict the budget this year will only access 2.5 per cent of this mountain of money for fear of further driving up domestic wages.

Norwegian industry leaders are predictably cool on calls to slow petroleum production. "In other countries, a discussion about how we should restrict the (oil and gas) activity would sound like a joke," said Statoil CEO Helge Lund. "If the critics get what they want, the Norwegian shelf will lose its competitiveness and the entire development of Norway's oil industry, with hundreds of thousands of jobs at stake, would be put at risk."

Meanwhile Norway's remaining oil reserves have dwindled under the vastly ramped-up extraction that peaked in 2001. Production is less than half of what it was 10 years ago. While a major new discovery was made recently on the Norwegian shelf, questions remain about how much longer Norway will remain a major oil exporter. The 2012 Statistical Review of World Energy by BP showed that in 2011 Norway had less than 10 years of reserves left at current levels of production.

Cut the boom and bust

What does this mean for Canada? The mantra here seems to be to maximize investment and production at all costs. Investments in the Alberta oil sands have topped $10 billion every year since 2006. The Alberta government predicts that production will double by 2020 to 3.5 million barrels per day.

Yet this frantic pace of development has created numerous boom/bust cycles, and calls from both the Alberta Federation of Labour and the late premier Peter Lougheed to slow the pace of oil sands growth.

Even with the massive distortion created by the oil sands in the Alberta workforce, the province has been unable to balance the books since 2007. In that time the province has so far spent $17.1 billion of past oil wealth, with another $3 billion deficit forecast for the coming budget. Clearly the legacy of Peter Lougheed to "think like an owner" has been forgotten.

Sitting on such a massive investment fund, Norway has obviously fared much better. However, they are also dealing with their own challenges resulting from their rush to development and declining oil reserves. If there is a lesson and advantage for Canada from the Norwegian oil experience, it is the importance (and profitability) of going slow.

Next Wednesday, the final instalment of this series: What if Canada had a national petroleum policy?, Wedn Sep 26, 2012
Byline: Mitchell Anderson

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