1 Background

When the Bratteli Government submitted the first comprehensive report to the Storting concerning the inclusion of the petroleum activities in the Norwegian economy, Report No. 25 (1973–74) to the Storting, The role of the petroleum activities in Norwegian society , the defined ambition was for the oil revenues to be used primarily in the development of “a qualitatively better society”. Weight was attached to “avoiding an outcome characterised only by fast and uncontrolled growth in the use of material resources, without any other changes to society”. Our large current petroleum revenues offer us considerable room for manoeuvre in terms of economic policy, compared to most other countries. However, high wealth is accompanied by large management responsibility.

Long-term management of petroleum wealth reflects a fundamental social perspective, and is an overarching priority for the Government. Such management implies that this wealth can benefit all generations. At the same time, it makes an important contribution to stability in output and employment. These are necessary prerequisites for realising the vision of a qualitatively better society, characterised by security for individuals and inter-generational solidarity.

If we had planned to consume all oil wealth within a generation or two, it would have given rise to major changes in the industrial structure, and in particular for those employed in the sector exposed to international competition. In the short run, these transitional problems could to a large extent have been compensated through government financial contributions to those affected. Such an arrangement for the spending of oil revenues would have given Norwegians even more scope for consumer spending in coming decades, although we already have one of the highest consumption levels in the world. However, after a couple of decades we would have had to reduce the high consumption level again, in line with falling proceeds from oil activities. Without considerable assets accumulated abroad, declining oil revenues would have occasioned an increasing need for internationally competitive business activities in order to fund imports from abroad. This would have resulted in additional restructuring, now by way of manpower having to be withdrawn from businesses in the sector sheltered from international competition, and without high oil revenues to smoothen the transition. Consequently, saving a major part of such oil wealth as it is transformed into a cash flow every year, is based on the best traditions of solidarity within Norwegian politics.

The Government Pension Fund was established with effect from 1 January 2006, encompassing the former Government Petroleum Fund and National Insurance Scheme Fund. The purpose of the Government Pension Fund is to support government savings to finance the pension expenditure of the National Insurance Scheme and long-term considerations in the application of government petroleum revenues. To ensure that the petroleum revenues are contributing to the stable development of the Norwegian economy, the revenues shall be phased into the economy gradually, whilst the savings shall be invested outside Norway. The Government Pension Fund – Global contributes, by investing a significant part of the petroleum revenues abroad, to a capital outflow that offsets the impact on the Norwegian krone exchange rate of large and varying foreign exchange inflows from the petroleum sector.

The savings of the Pension Fund take the form of general fund accumulation. The Fund is fully integrated with the Fiscal Budget, in order to facilitate growth in the fund being a reflection of the State’s actual accumulation of financial assets, cf. Box 1.1. The Government Pension Fund does not have its own Executive Board or administrative staff.

Under the Pension Fund Act, the Ministry of Finance has been charged with managing the Fund. The Ministry determines the general investment strategy of the Pension Fund, as well as its ethical and corporate governance principles, and follows up on its operational management. The Government Pension Fund adopts a long investment horizon. Our management responsibility includes responsibility for ensuring that the Fund is managed with a view to maximizing return, given a moderate level of risk. This enables future generations to draw the maximum possible benefit from our savings as well. At the same time, we share responsibility, as investors, for the conduct of the companies in which the Fund invests. The Government therefore emphasises that ownership interests in the companies in which the Fund invests is exercised with a view to promoting good and responsible conduct, showing respect for human rights and the environment.

The Pension Fund is invested in securities issued by many different states and by companies in many different countries. Consequently, the risks facing the Fund are well diversified. The expected return and risk of the Pension Fund is in large part determined by the Ministry’s guidelines on how the funds shall be invested. Norges Bank and Folketrygdfondet (also known as the National Insurance Scheme Fund) have been charged with the operational management of the Government Pension Fund – Global and the Government Pension Fund – Norway, respectively, within the guidelines laid down by the Ministry.

The management of the Government Pension Fund is subject to a high degree of openness. The Storting is apprised of the investment framework and the Ministry’s follow-up of the Pension Fund on a regular basis. Operational management performance is also reported by Norges Bank and Folketrygdfondet on a regular basis. This is emphasised by the Ministry for purposes of strengthening the credibility of, and confidence in, the Fund and the fund structure.

The main aspects of the distribution of responsibility between the Storting, the Ministry of Finance, Norges Bank and Folketrygdfondet are described in Figure 1.1.

The Government aims for the Government Pension Fund to be the best managed fund in the world. This implies that one shall seek to adopt best practise within international asset management in efforts relating to the Fund. Material deviances from recognised international practise should be justified specifically. Efforts relating to the Government Pension Fund require specialised qualifications. Demands are imposed on both the resources of the Ministry and the external assistance used.

Textbox 1.1 The fund structure

The Government Pension Fund comprises the Government Pension Fund – Global and the Government Pension Fund – Norway. The accumulation of capital in the Government Pension Fund – Global does in large part reflect the conversion of oil and gas resources in the North Sea to financial assets abroad. Consequently, the ongoing proceeds from the petroleum activities are of a different nature than the other revenues of the State, since they partly correspond to a reduction in the petroleum wealth of the State. The proceeds also vary considerably in line with, inter alia , fluctuations in the oil price.

Figure 1.2 shows the relationship between the Government Pension Fund – Global and the Fiscal Budget. The revenues of the Government Pension Fund – Global comprise the cash flow from the petroleum activities, which are transferred from the Fiscal Budget, net financial transactions relating to the petroleum activities and the return on the Fund’s assets. The assets of the Fund may only be allocated to transfers to the Fiscal Budget pursuant to a resolution passed by the Storting. The transfer covers the oil-adjusted budget deficit. Consequently, the net allocation to the fund forms part of an integrated budgetary process, and renders visible the State’s use of petroleum revenues. The fund accumulation thereby reflects the actual surplus of the Fiscal Budget.

The budget policy guidelines (the fiscal rule) imply that the structural, oil-adjusted budget deficit shall over time correspond to the expected real return on the capital of the Government Pension Fund – Global. This facilitates predictable spending of the petroleum revenues, which is uncoupled from ongoing revenue flows. This results in the Fiscal Budget and the mainland economy being sheltered from effects of fluctuations in oil revenues. At the same time, the fiscal rule supports preservation of the wealth over time, in order that it may contribute to maintaining the welfare of coming generations as well. Whilst the capital of the Fund can only be spent once, the real return may finance a permanently higher level of government expenditure.

The basic capital of the Government Pension Fund – Norway originates primarily from surpluses in the national insurance accounts from the introduction of the National Insurance Scheme in 1967 and until the late 1970s. The return on the assets of the Government Pension Fund – Norway is not transferred to the treasury, but is added to this part of the Fund on an ongoing basis. There are no transfers of capital between the two parts of the Government Pension Fund.

When the accounts pertaining to central government’s net cash flow from the petroleum activities are available, these will normally differ from what has been resolved by the Storting in the newly balanced Budget. The difference is classified as a balancing item between the Government Pension Fund – Global and the treasury. One will, in line with regular practise, offset this balancing item in connection with the transfers for the subsequent year, cf. the more detailed description hereof in the Central Government Accounts. The present Report refers to the value of the Government Pension Fund – Global as set out in Norges Bank’s annual report for the management of the Government Pension Fund – Global in 2006. The Central Government Accounts for 2006 will be presented in late April 2007.

Norway’s handling of its petroleum revenues is often invoked as a benchmark internationally. This pertains, in particular, to the role of the Government Pension Fund as part of the framework for a long-term, sustainable fiscal policy, which facilitates stable economic development. The Ministry assists, through the rendering of advice in this area, several other countries in the organisation of their natural resource management. This effort takes place through bilateral cooperation, the “Oil for Development” programme under the auspices of Norad, as well as international organisations like, inter alia , the IMF, the World Bank and the UN.

The Government Pension Fund is one of the largest funds in the world, and its assets are growing rapidly. The Fund is large relative to the size of the Norwegian economy, and the return on the Fund will make considerable contributions to the funding of State expenditure in coming years. Focus on the management of the Fund has increased in line with the growth in its size. This underscores the importance of ensuring that the investment strategy of the Pension Fund, and its ethical and corporate governance guidelines, have the firm backing of the Storting, and that the Ministry reports thoroughly on its follow-up of operational management. From now on, the Ministry of Finance will be able to report in a more comprehensive manner to the Storting, by way of an annual report, on the management of the Government Pension Fund. In addition, important matters relating to the management of the Pension Fund may be presented to the Storting in the National Budgets in the autumn. The present Report primarily addresses matters relating to the management of the capital of the Government Pension Fund. More general issues relating to the management of the petroleum revenues, the position of the Fund within overall economic policy, as well as how much of the oil revenues we should spend are discussed in the National Budget documents.

The Report is structured as follows: An overview of the management performance is provided in Chapter 2. A separate Appendix to this Chapter presents more detailed analyses of the Fund’s return and risk.

Chapter 3 outlines the investment strategy of the Pension Fund, and explains that the Government intends to increase the equity portion of the Government Pension Fund – Global from the current 40 pct. to 60 pct. At the same time, one intends to increase the number of companies in the Pension Fund – Global by including the segment comprising small listed companies in the benchmark portfolio. One also intends to change the regulation of recognised markets and currencies. This Chapter also includes a discussion of the status of the Ministry’s effort to evaluate the possible inclusion of real estate and infrastructure as a new asset class under the Pension Fund – Global.

Chapter 4 addresses ethics and corporate governance, and contains, inter alia , a more detailed discussion of the corporate governance policies pursued by Norges Bank and Folketrygdfondet. This Chapter explains that in future the Government will be applying any decisions to exclude Nordic companies from the portfolio of the Government Pension Fund – Global to the Government Pension Fund – Norway as well. Chapter 4 also contains a discussion of the impending evaluation of the Ethical Guidelines of the Government Pension Fund – Global, which the Government intends to complete during the course of the present Storting period.

Chapter 5 refers to the effort to develop and follow up the general framework governing asset management. The Ministry is also submitting, in connection with the present Report, a proposal to the effect that Folketrygdfondet be organised as a separate legal entity pursuant to a designated special act, cf. Proposition No. 49 (2006–2007) to the Odelsting.

The Act relating to the Government Pension Fund and the Regulations relating to the management of the Fund, with supplementary provisions, are appended to the present Report. The recommendations and assessments of Norges Bank, the Strategy Council and the Council on Ethics regarding the proposed changes to the investment strategy of the Government Pension Fund – Global are also appended. The annual reports of Norges Bank and Folketrygdfondet concerning the management of the Government Pension Fund in 2006 are appended by reference.