How to manage oil revenues

African governments are adopting an increasingly mature attitude towards the management of oil and gas revenues, with sovereign wealth funds (SWFs) emerging as by far the most popular option.

The total assets of all SWFs around the world reached $5.16 trillion in 2012, up from $3.98 trillion in 2011, growing far more quickly than global share indices. About 58% of the 2012 figure came from assets that had been bought with oil and gas revenues. The world’s best known SWFs are located in Norway, the Middle East, China and elsewhere in the Far East.

It is the Norwegian model that has proved most attractive to new oil and gas producers, as it has proved the most successful, helping to turn one of the poorest countries in Western Europe into one of the richest.

Norway’s Government Pension Fund is split into two halves focusing on domestic and global assets respectively. It was set up in 1990 and at the end of June this year it held $889bn in assets, making it the biggest SWF in the world, just ahead of the Abu Dhabi Investment Authority.

It receives dividends from the state’s stake in oil firm Statoil, licence payments and oil and gas company taxes. At present, the fund is allowed to invest up to 60% of its resources in stocks, with 5% in real estate and the balance in bonds.

The government of Norway estimates that national hydrocarbon revenues have already peaked and will begin to decline in the near future in line with the more general fall in North Sea oil and gas production.

There are some ethical constraints on which companies the fund can invest in. These are high compared to most other SWFs and pension funds but low compared to most ethical investment funds. It cannot invest in companies that manufacture land mines, nuclear weapons or tobacco. In Africa, it has ruled out investment in companies that are involved in oil exploration in Western Sahara.

Benefits
The income from oil, gas and other commodities can easily become subsumed within ordinary government spending but many countries around the world have shown the benefits of investing this money for the long term.

This ensures that the people of that country will continue to benefit long after the natural resource in question has run aground; it generates more money for the long term through prudent investment; encourages sound financial management by taking away immediate demands on the money; and helps to rein in the inflation that can result from a sudden influx of money. SWFs can provide a source of funding for domestic infrastructure projects, along the line of the Norwegian model.

Finally, they can also be used to smooth out fluctuations in revenues from year to year, which is particularly useful in countries that rely heavily on the export of a single commodity.

This final factor appears to be the key motivation behind the succession of African SWFs that have been set up recently, or are in the process of being set up. African oil producers without SWFs have suffered enormously through fluctuations in oil prices. Although prices have remained high over the past five years, they had previously doubled or halved over the course of a single year. The terms of joint ventures or concessions can help mitigate the impact to some extent but such radical changes play havoc with state finances.