The petroleum sector in Norway: Resource management and policy

Per Heum

MBA Summer Cource NHH

June 24, 2008

Outline

• Brief history of petroleum activities in Norway – overall policy issues

• Licensing system• Depletion policy• Industrial development – local content

• Cfr. FACTS 2008 – The Norwegian Petroleum Sector. Is available as pdf to be downloaded from www.petrofacts.no

Petroleum activities in Norway- the beginning

• 1963: Sovereignity proclaimed over the continental shelf by the government of Norway

• 1965: Norwegian sovereignity internationally accepted, except for the border with Russia

• 1965: First liscenses; drilling starts• 1969: First commercial discovery• 1971: First oil extracted

Petroleum activities in Norway in an international perspective, 2007

• Oil production: No. 11 in the world (2,37 mill. b/d)

• Oil exports: No. 5 in the world

• Gas production: No. 6 in the world

• Gas exports: No. 3 in the world

Petroleum activities - share of the Norwegian economy, 2007

• 24 % of GDP

• 31 % of state revues

• 23% of total investments

• 48 % of exports

The petroleum sector in the economy of Norway

Overall policy issues

• Pre-oil: How to attract the necessary competence to explore for petroleum, and to develop and extract petroleum that is discovered?

• Post-oil: How to make the society benefit from the oil activities?- cost efficiency- government take- industrial spill-overs/local content

• Post-oil: How to deal with huge (and fluctuating) cash flows from a non-renewable natural resource?- separation of revenue generation and consumption

Oil revenues to the state,Billion 2008-NOK

Norwegian production of oil (green) and natural gas (red)

Licensing system

• Concerns the allocation of property rights

• Important as the state as the property holder does not hold the industrial competence to explore for and exploit the natural resources

• Based on principles applied on water falls and the generation of hydro power (early 20th century)- transfering the right to exploit the water fall resources from the government to the private sector, limited in space and time

• At work since 1965

Licensing system (2)

• 1963: Sovereignity proclaimed over the continental shelf by the government of Norway

• 1965: Norwegian sovereignity internationally accepted, except for the border with Russia

• Dividing the continental shelf into blocks (geographical areas) defined by longitudes and latitudes

• Forms the basis for allocating rights to resources in geograhically limited areas from the government to oil companies

Licensing system (3)

• The overall challenge: To have oil companies to employ and develop their industrial skills for the benefit of society- to improve knowledge of the resources

- to act according to economic efficiency

- to contribute to economic and industrial development

• Have chosen a concessionary system rather than an auction system

Licensing system (4)

• Concessionary system- open geographic areas for petroleum activities (Storting)

- oil companies apply for the right to blocks they want in each licensing round to the Ministry of Oil and Energy

- the government considers the applications, the ideas and plans of the applicants (oil companies)

- the government composes a group of companies to form a license group, and appoints an operator

- the license group agrees to a work plan

Licensing system (5)

• Framework for the license group’s consession- has the owner ship right to petroleum resources that are discovered in the block- has agreed to a work plan for exploration- the area has to be returned within a period agreed upon if petroleum resources are not discovered/proven- has the right to develop and extract the petroleum resources, when a development plan has been presented to the government and approved by the Storting

Licensing system (6)

• Based on a division of labour between- government: regulator and government take- oil companies: business and technical operations

• Challenge: Predictable and transparent regulation enhancing the engagement of ideas and creativity of oil companies- temporary, but predictable property rights- group of companies in the license- mutual interest in profitable operations (owner ship, tax system)

Licencing system (7)

• Puts the government in a crucial position when negotiating with the oil companies in connection with- awarding of licenses- approval of development plans

• Allows for incremental considerations and improvements- knowledge of reservoirs/resources, experience, technological improvements, mature vs. immature regions

• But may also easily pervert

Depletion policy

• In accordance with the rights attached to the license, commercial considerations shall determine the exploitation of resources

• Approval of development plans was considered to be a means for deciding the volume of oil and gas to be extracted

• Was discussing volume targets in the 1980s (50 vs. 70 vs. 90 million ton oil equivalents)

Norwegian production of oil (green) and natural gas (red)

Depletion policy (2)

• Never succeeded in reaching volume targets- distort company insentives - why continue to explore, or to come up with new technology, if you are not allowed to develop what is discovered and commercial to exploit

- meaningless in economic terms, as revenues depend on the oil price and volumes of petroleum

• Needed to reconsider the focus

Planned production (blue) and achieved production (red)

Depletion policy (3)

• Ensure that the oil companies act according to commercial considerations

• Establish a policy that separates revenue generation from the oil sector and the spending of these revenues in society- idea of permanent income and positive or negative savings on an annual basis (Pension Fund)

• Some attention was paid to activity levels, but never really decisive for the rate of depletion

Industrial development

• Activities connected to exploration, development and extraction of oil and gas form a basis for industrial development

• Local content is an issue in most petroleum regions

• Overall issue: How to avoid that the ”infant industry policy” becomes a subsidy to poor performance, when you want to enhance competitive business development?

Industrial development (2)

• Norway has been quite successful- significant share of supplies of goods and services to the offshore petroleum activities in Norway- Domestic providers of petro-related equipment and services are increasingly serving international markets; foreign sales as share of the turn-over for petro-related companies with industrial base in Norway has increased from 29% in 1995 to 46% in 2006

• This development has been achieved through deliberate policy and because Norway hosted relevant industrial competence and fortunate (lucky) timing

Industrial development (3)

• Policy to enhance industrial development- Ambition: Increasingly aware that the purpose is ”competitive industrial development” and not supplies because of ”nationality” - Be open to international competition, but used consessionary system to assure

* that domestic firms were allowed to compete* that supplier is chosen according to fair competition

- Reward programs for local industry development when negotiating licenses

• Statoil as an instrument, but always foreign oil companies, and two other Norwegian owned (Hydro and Saga). Reorganizing state participation saved Norway from suffering from monopolization of the activities

Industrial development (4)

• The fortune of hosting relevant and international competitive industrial competence- shipping and fisheries; for offshore operations- manufacturers of ship equipment and yards- large process facilities in energy-intensive industries- geological competence in mining

• The wisdom of not using non-competitive relevant competence (cfr. steel)

Industrial development (5)

• Lucky timing (1970s and early 1980s)- the oil industry was in search of new technology to deal with the challenges of offshore petroleum activities – a window of opportunity for newcomers- the major players, oil companies and global service providers, was increasingly attracted to the Norwegian shelf (proved increasingly richer in reservoirs, oil prices high, and excluded from many major petroleum regions)- the relevant domestic industrial competence was seeking new market opportunities

Industrial development (6)Lucky timing (continued)

• How to avoid the pitfall of permanent protection?

• ”Norwegianization” was about to pervert- extremely high local content, local activity distorted commercial considerations (taxes, investments, Statoil)

• External factors saved Norway from making severe mistakes- the collapse of the oil price in the mid-1980s- the EEA-agreement assured international competition

Challenges

• Activities moving north (discoveries and infrastructure, markets, environment, fisheries)

• Sovereignity issues (Russia, Arctic)• StatoilHydro: total dominance on the

domestic scene (dynamics, policy formulation)

• Internationalization and foreign policy