Posted on: July 11th, 2017
By R. Bruce Striegler
In its simplest terms, a sovereign wealth fund (SWF) is a government-owned investment fund established for the purpose of protecting or boosting the national economy. Its funding is derived from resource-related revenues, other government sources such as surplus in balance of payments, proceeds from privatization of one or more public sector entities, receipts from exports, governmental transfers and other sources. These funds invest in real and financial assets such as stocks, bonds, real estate, precious metals, or in alternative investments such as private equity fund or hedge funds.
Every sovereign wealth fund has its own unique purpose and objective, but the general aim is to do something that will benefit the country as a whole. Some objectives include the funding of social or economic projects to boost growth and employment, to provide long-term capital growth opportunities for the domestic market while protecting the economy from excess volatility due to “lumpy” sources of revenues, to provide stability against fluctuating commodity prices, or to diversify the portfolio with an aim to create savings for future generations. The largest SWF in the world is the Norwegian “Government Pension Fund – Global” with about one trillion (US) dollars of assets under management. The words on the website of the Government Pension Fund Global are plain, but direct. “The Government Pension Fund Global is saving for future generations in Norway. One day the oil will run out, but the return on the fund will continue to benefit the Norwegian population.”
How does one judge the success of a sovereign fund?
Norway’s sovereign wealth fund, now valued at $1 trillion and built from offshore oil reserves, is often held up as a prime example of how such funds can succeed. In recent years, much has been written and discussed comparing the Norwegian fund to the Alberta Heritage Savings Trust Fund, with much criticism that the Alberta fund has not been managed particularly well. Now, with a new anti-oil government in British Columbia, and fears that the latest attempt to get Alberta oil to tidewater via the Kinder Morgan TransMountain Pipeline to Vancouver will be stymied, Canadian Sailings felt it time to re-visit the debate. At the same time, we decided to include a look at the Saudi Arabian Public Investment Fund (PIF) which was established in 1971 by Royal Decree.
Norway’s Fund is only one of an estimated 80 or so sovereign wealth funds worldwide that collectively hold about US$7 trillion in assets. These others probably also hold lessons for how governments can save wisely for future generations. Lessons that might apply to Alberta’s Heritage Savings Trust Fund, which began in 1976 with the best of intentions, but seems to have stalled out at roughly $17.2 billion.
In a report published by CBC, several experts were quoted. “How do you define success?” asks Michael Maduell, President of U.S.-based Sovereign Wealth Fund Institute, a research organization. “Is it investment returns? Is it their goals?” By most measures, Norway’s 25-year-old fund — easily the largest in the world and considered very well-run — comes out a top performer.
“For sure, it’s the most successful,” says Greg Poelzer, a University of Saskatchewan professor who has delved into the “global lessons from Norway” in a recent report published by the Macdonald-Laurier Institute. One of the keys, he says, was Norway’s decision to move all its oil revenues out of general revenues, a strategy that set the stage for greater economic stability.
“You don’t have this overheating,” says Poelzer. “You don’t have a super-high inflation and you also avoid, especially with government budgets, the roller-coasters which we have been seeing in Alberta.”
Alberta, Norway and Saudi Arabia, a 2017 first quarter review of each country’s fund
The (Norwegian) Government Pension Fund Global is a fund into which the surplus wealth produced by Norwegian petroleum income is deposited, and with a name change in 2006, it is now commonly referred to as The Oil Fund. The Alberta Heritage Savings Trust Fund (HSTF), established in 1976 by former Alberta Premier Peter Lougheed, had three objectives: “to save for the future, to strengthen or diversify the economy, and to improve the quality of life of Albertans.” The Heritage Savings Trust Fund used oil revenues to invest for the long term in such areas as healthcare, education and research and as a way of ensuring that the exploitation of non-renewable resources would be of long-term benefit to Alberta.
For decades, the Saudi Public Investment Fund (PIF) was a little known and largely inactive holding fund. But a sudden burst of deal-making and the central role it is being given in the kingdom’s reform plans have put it on course to become one of the world’s most powerful sovereign wealth funds. When Saudi Arabia completes the initial public offering of Saudi Aramco, scheduled for 2018, it is its PIF that is expected to reap the rewards — the expectation is that it will be the depository for a potential $100 billion from the sale of a five per cent minority share in the state oil company.
Operating under the Alberta Heritage Savings Trust Fund Act, the Alberta fund provides “prudent stewardship of the savings from Alberta’s non-renewable resources by providing the greatest financial returns on those savings for current and future generations of Albertans.” Between 1980 and 2014 government revenues derived from non-renewable resources in Alberta generated almost $190 billion in value – however, as at the end of 2014 the value of the Heritage Fund was only $17.3 billion. For the first nine months of the fiscal year 2016-17, the Heritage Fund earned a 7.4 per cent return and $1.5 billion in net income. As of December 31, 2016, the fund’s assets were worth $19.1 billion on a fair value basis. Over the past five years, the Heritage fund earned an average annual rate of return of 11.7 per cent.
First quarter 2017 results for the Norwegian Fund were reported in mid-June, showing a return of 3.8 per cent, equivalent to 298 billion kroner (US$34.6 billion). During the quarter, the Fund’s total return since inception surpassed the total inflow of principal into the Fund. Overall returns from investments were 3,421 billion kroner, against total gross contributions of 3,375 billion kroner.
The CEO of Norges Bank Investment Management, which invests the proceeds of Norway’s vast offshore oil and gas production, said that, “Measured in Norwegian kroner, this was the third best quarter in the history of the fund, driven by strong returns on the equity investments. During the last month, the total return exceeded the total inflow of the fund,”
The purpose of the Oil Fund is to invest parts of the large surplus generated by the Norwegian petroleum sector, generated mainly from taxes paid by Norwegian oil companies, and payments for exploration licences, as well as the State’s Direct Financial Interest and dividends from the partly state-owned Statoil. The current revenue from the petroleum sector is estimated to be at its peak period and to decline in the future decades. The Petroleum Fund was established in 1990 after a decision by the country’s legislature to counter the effects of the forthcoming decline in income and to smoothe out the disruptive effects of highly fluctuating oil prices.
In early May, the Saudi PIF, following a transformation, is showing signs of a newfound boldness. Last year, it announced it was investing $3.5 billion in Uber, the car-hailing app, a deal that bankers say put it on the global map. It followed up with an agreement to co-invest $45 billion in a partnership with Japan’s SoftBank to launch a new $100 billion technology fund. In November, Riyadh increased PIF’s firepower by allocating SR100 billion (US$27 billion) to the Fund from the central bank’s assets, even as the government slashed spending elsewhere as it a grapples with a fiscal crisis triggered by low oil prices. Bankers close to the Fund say that more assets will be allocated to PIF over time, including land and projects such as the King Abdullah Financial District, the 73 towers on the outskirts of Riyadh owned by the Saudi Public Pension Agency. One banker estimates that PIF’s assets could rise from about $190 billion to $500 billion even before the Saudi Aramco’s IPO.
Expert conclusions recommend change; others disagree
From a 2015 Macdonald-Laurier Institute commentary titled, “What Crisis? Global Lessons from Norway for Managing Energy-Based Economies”, Greg Poelzer, Founding Director and Executive Chair of the University of Saskatchewan International Centre for Northern Governance and Development writes about Norway, “The drop in oil prices is cause for prudent concern, not panic, even though oil counts for 25 per cent of the Norwegian economy, the same as in Alberta. Norway has no plans to radically change its forecasted budget and it even has a budgetary buffer of $8.5 billion should things get worse, which is roughly the same as the $7 to $10 billion deficit that Alberta is expected to see the next fiscal year.”
The report notes the difference between Norway and most other oil-producing jurisdictions is around policy choices determining the role of resource wealth in the economy in general and in government budgets in particular. Twenty-five years ago, Norway established a sovereign wealth fund to capture its oil revenues and remove them from government general revenues. Alberta chose not to do this; neither has Saskatchewan nor Newfoundland. Premier Peter Lougheed had the vision to create the Alberta Heritage Trust Fund almost four decades ago; yet, scarcely a decade later his successors abandoned the commitment to build the fund, and today critics say Alberta is paying the price. In contrast, Norway shows that governments blessed with petroleum resources can build modern, stable, and prosperous economies on the bedrock of oil and gas, without causing the rest of the economy to suffer as a result of rising labour costs and higher inflation, or taking tumultuous rides on the boom and bust cycles of energy commodities.
With oil prices down sharply, Norway’s massive fund clearly puts the Scandinavian nation of five million people in an enviable position. Although its oil output has dropped by half over the past dozen years and thousands of oil workers have lost their jobs, Norwegians aren’t losing much sleep over it. Since Norway’s Oil Fund invests in roughly 9,000 companies globally, generating billions of dollars in diversified investment revenues each year, Norway is far less dependent on volatile energy revenues than Alberta.
It’s ironic that it was Alberta which inspired Norway to establish its sovereign wealth fund in 1990, a full 14 years after the Heritage Saving Trust Fund was founded. But when it comes to applying those lessons to Alberta, there are some significant differences between jurisdictions that make such comparisons difficult. Norway is a country, not a province. So while Alberta’s energy producers pay a 10-per cent corporate tax to the province, the federal government take an even bigger slice, at 15 per cent. That means that billions of tax dollars generated in Alberta’s oilpatch flow to Ottawa, helping to fund a variety of federal programs across the country. Similarly, well-paid Albertans who work in the oilpatch ship billions of their tax dollars to Ottawa each year, monies that have been sprinkled nationwide under the federal equalization program.
Critics acknowledge that Norway deserves full marks for its fiscal discipline, and the long-term approach it has taken to managing its resource wealth, but they also point out Norway’s corporate tax rate is a staggering 78 per cent. They ask, “Can you imagine Suncor, Canadian Natural Resources or any of Alberta’s big oil producers investing in the oilsands if they had to fork over nearly four-fifths of their profits to the government? The reason such a lofty tax rate is accepted in Norway is that Statoil, the industry’s major player in Norway, which accounts for more than three-quarters of the country’s oil production, is controlled by the Norwegian government. So most of Statoil’s profits flow directly into Norway’s sovereign wealth fund.
The structure of Alberta’s energy industry is fundamentally different. It is tightly integrated with the U.S. energy sector. Dozens of domestic and foreign players operate here. Most are widely held, publicly traded companies that trade on the major stock exchanges. As such, they are expected to generate a decent return for their shareholders. In return, they have invested billions of dollars of private capital to develop Alberta’s resources. It’s called capitalism. Norway embraces a very different socialist model. If managed properly, the oilsands could double output over the next 20 years, generating wealth and jobs for future generations. Meanwhile, Norway’s North Sea production is falling steadily, making it a sunset industry.
Despite all the economic differences between Norway and Canada, and notwithstanding arguments over the cost implications of exploring for and processing oil from different geological and geographic locations, it is disappointing to see that after 40 years of production averaging about 1.9 million barrels/day, Alberta’s sovereign wealth fund represents a value of only $19 billion. Think about it: assuming an average price per barrel of $40 during the period, corporations sold roughly 28 billion barrels of oil valued at $1.1 trillion, but the present value of Alberta’s Heritage Savings Trust Fund, after cumulative contributions, withdrawals and investment returns is only $19 billion, roughly equivalent to 68 cents per barrel of production. By contrast, as described above, Norway managed to build a fund with a value some 50 times greater than Alberta’s which, even at today’s low investment returns, produces a return that is roughly equivalent to 40 per cent of Norway’s GDP, and growing. Saving for a rainy day, or saving to have the necessary funds to transform an economy when a country’s non-renewable resource will no longer be able to sustain it, is not such a bad idea after all. Perhaps Canada’s reliance on maximizing current consumption to keep the economy going needs a rethink. With everything being paid for out of current revenues, we have no rainy day fund to fall back on. Moreover, the emphasis on current consumption has left governments and private citizens heavily indebted.