Sovereign Wealth Funds: Norway's Example

Larry Elliot of the Guardian writes in his blog  decrying Britain's squandering of its North Sea oil resource.  This once vast and rich production area reached peak output in 1999 and continues its decline.  The offshore oil industry really honed its technological, logistical and geophysical capabilities in this hostile exploration and production environment.  It has been a remarkable testament to the industry's ability to extract oil safely in such large quantities from such a nonconventional source.

When I teach my MBA Investments class, I like to break up the dry but necessary mathematical development of the capital asset pricing model and the efficient frontier, by using incorporating some practical material. For this, I incorporated a lecture Professor Robert Shiller gave to his financial economics class at Yale as additional reading material. The link above is to a YouTube video of the class and to a transcript of the lecture.

The subject of the lecture is portfolio diversification, the introduction of the riskless asset, and the optimum portfolio's location at the tangency point to the efficient frontier.  Shiller and his colleague Ronit Walny went to the Norwegian government in 2006 to encourage them to change their portfolio mix dramatically.  Shiller notes that the State pension fund was about 2 trillion Krone at that time, and the national endowment of North Sea oil was worth about 3.5 trillion krone, so 64% of the wealth that could be used to support the State pension fund was "black gold," or depleting oil.  Shiller's argument for changing the portfolio mix was heard by the State pension fund, by the government and the central bank.  Although they moved slowly, the Norwegian achievement has been remarkable, especially when compared to the British experience. 

Professor Shiller's introduction of the CAPM paradigm, the adoption of a different political approach to national involvement in oil production, together with a significant portfolio realignment has led to a $550 billion State pension fund, one of the largest in the world to support a small population of 5 million Norwegians.  In USD, the State pension fund grew from about $300 billion in 2006 to the current level of $550 billion. On top of this, the diversification has served to extend the life of Norway's North Sea oil resources to an additional 60 years, despite intensive production for the past forty years.

Shiller tells this story in a low key manner, but it's a dramatic example of how a fresh application of a rational, financial economics theory can really benefit all citizens.  Were our government only so politically and economically astute.  Alas...