In light of Norway’s central bank’s proposal to reduce the exposure of the Government Pension Fund Global (GPFG) to quoted oil and gas equities, we reviewed some of the logic behind the proposal, other sovereign wealth funds’ (SWFs) performance in the 2017 AODP Global Climate Index and some of the expert commentary on the proposal in order to find out – what are the Norwegians up to? Are there lessons for other SWFs? And what does this say about the current investor appetite for the oil and gas sector?
One of the key basis for this Norwegian proposal is that the removal of oil and gas stocks from the GPFG’s financial portfolio reduces the country’s vulnerability to oil price changes. Like many of the oil-producing nations where national SWF’s equity holdings in integrated oil companies (IOCs) may sit alongside country’s significant holdings in the national oil company (NOC), Norway’s petroleum wealth comprises of GPFG’s equity holdings in IOCs and Norwegian Government’s majority stake in Statoil (Norway’s NOC) in effect doubling up on the oil exposure. Counting in cash flow from petroleum activities, this exposure is increased seven-fold, putting Norway’s wealth at risk. We would expect other oil-producing nations to have similar oil exposure in multiple areas, carrying similar risks to ‘national wealth’.
With this backdrop, reducing exposure to the integrated oil and gas equities is a rational risk reduction exercise. Like the Norwegian SWF, SWFs of oil-producing nations are unusual asset owners whose fiduciary interest may not be in line with using traditional market cap indices. Use of market cap indices potentially results in an aggregate portfolio with a high level of exposure to the domestic petro-economy and the oil price. This exposure might come through equity holdings but also domestic GDP, real estate prices or domestic employment. In the words of Avery Shenfeld of CIBC Capital Markets, “This is really nothing more than Finance 101… If you’ve already got a large exposure in your economy to the oil sector and you’re putting aside money for a safe haven for when oil turns soft or when you run out of oil, you don’t invest in oil and gas equities. You are already heavily invested.” Jan Erik Saugestad of Storebrand Asset Management expressed a similar sentiment, “From a financial point of view this makes perfect sense, and we have been arguing for this for many years. This is a rational move given the overall exposure the Norwegian economy has towards oil.” From this viewpoint, Norway’s central bank’s proposal seems eminently sensible and needs to be considered by a range of other SWFs.
Some of this risk is connected to changing technology and regulation related to climate change so we might expect SWFs in oil economies to be sensitive to climate-related risks in their aggregate SWF portfolios – something that might come through in AODP ratings. Disappointingly this is not the case and many of them fall in the ‘laggard’ category of the 2017 AODP Global Climate Index, including funds from the top oil-producing countries: Iran, Kuwait, Russia, Saudi Arabia, United Arab Emirates, United States.
So, although Paul Fisher of the Bank of England in reference to Norway’s central bank’s proposal reflected that “it is not surprising that we see the world’s largest sovereign wealth fund managers no longer prepared to take the increasing risk associated with oil and gas assets, which do not have a long-term future”, we see little action from GPFG’s peers – other large SWFs, which is both surprising and concerning.
Currently, SWFs of oil-producing nations might not feel in the position to change asset allocation in response to these challenges. However, they should be more on the front foot when engaging investee companies and their asset managers – if the results of the AODP 2017 are correct this is something that is clearly not happening and needs to change.
Are the Norwegians trendsetters and is this likely to light the fire under fund managers at other SWFs? One thing is clear: financially material climate-related risks are creeping up the agenda at a range of blue-chip institutions. Recent decisions by Vanguard and Blackrock to support, for the first time, climate-related resolutions against the wishes of executive management of oil and gas companies shows that institutions are increasingly confident about making high-profile decisions. Decisions that would have been largely dismissed several years ago. AODP’s 2018 asset owner survey will hopefully track some changes at SWFs of oil-producing countries – but don’t hold your breath.