Norway's Fund Jolts Energy and FX Markets?
Norway’s trillion-dollar sovereign wealth fund is proposing to drop oil and gas companies from its benchmark index, which would mean cutting its investments in those companies, the deputy central bank chief supervising the fund told Reuters, sending energy stocks lower.
If adopted by parliament, the fund would over time divest billions of dollars from oil and gas stocks, which now represent 6 percent - or around $37 billion - of the fund’s benchmark equity index.
The aim is to make the Norwegian government’s wealth less vulnerable to a permanent drop in oil prices, at a time when the fund is increasing its exposure to equities to 70 percent of the fund’s value from 60 percent earlier.
Europe’s index of oil and gas shares hit its lowest level since mid-October on the news and was trading down 0.39 percent at 16.41 GMT .
The proposal came in a letter sent by the central bank to the finance ministry and signed by its governor, Oeystein Olsen, and the chief executive of the fund, Yngve Slyngstad, Deputy Central Bank Governor Egil Matsen said in an interview.
“Our advice is to simply remove the oil and gas sector, as it is defined in the FTSE reference index, from the fund’s reference index,” Matsen said.
“That would mean all companies that the FTSE has classified with the sector, should be removed from our reference index.”
The fund is the world’s largest sovereign wealth fund. It invests Norway’s revenues from oil and gas production for future generations in stocks, bonds and real estate abroad.
It is among the largest investors in a wide range of oil companies, holding stakes at the end of 2016 of 2.3 percent in Royal Dutch Shell, 1.7 percent of BP, 0.9 percent of Chevron and 0.8 percent of Exxon Mobil.
“The risk for the oil sector is how many investment funds will downsize their exposure to extractive industries,” said Jason Kenney, oil analyst at bank Santander.
The fund also held 1.7 percent of Italy’s Eni, 1.6 percent of France’s Total and 0.9 percent of Sweden’s Lundin Petroleum, among others.
At the end of the third quarter, Royal Dutch Shell was the fund’s third-biggest equity investment overall, worth around $5.34 billion and exceeded only by its ownership in Apple and Nestle.
“This news will be scrutinized very closely by funds around the world who are already looking closely at the climate risks in their portfolios and which sectors and companies will fare best in the low-carbon transition,” said Stephanie Pfeifer, head of the Institutional Investors Group of Climate Change, which groups 140 investors that work on global warming and represent assets of more than 20 trillion euros.
“Investors will look even more carefully at which companies are aligning their business strategies to the transition to a low-carbon energy system and which ones are not. Investors then have a range of options for managing the risks they perceive,” she told Reuters.
Others were less sanguine.
“My guess is that after the initial market adjustment – which would have been difficult to anticipate – the move may not damage the sector’s long-term performance significantly,” Kevin Gardiner, global investment strategist at Rothschild Wealth Management, told Reuters.
BP and Shell declined to comment.
PROTECTING NORWAY‘S WEALTH
The aim of the proposal is to make Norway’s wealth less vulnerable to a permanent drop in oil prices, especially at a time when the fund is increasing the proportion of its portfolio it invests in equities to 70 percent from 60 percent previously.
“That would mean buying more stocks in the oil and gas sector,” said Matsen.
The fund has grown so large that even though the Norwegian state is taking less than 3 percent of the fund’s value every year for its fiscal budget in recent years, oil spending now accounts for one in five crowns spent by the state.
In addition to its holdings via the fund, Norway has its own exposure to oil and gas through untapped offshore hydrocarbon reserves, as well as its 67 percent stake in the national oil company, Statoil.
“Oil price exposure of the government’s wealth position can be reduced by not having the fund invested in oil and gas stocks,” said Matsen.
The fund could still invest in the sector if other parts of the fund’s mandate are fulfilled by having some investments in some of the companies, he said.
“But clearly the direction is that ... if the ministry and the politicians think it is good advice and they say yes to it, clearly the investments in the oil and gas sector will decrease over time,” he added.
Initial reactions from Norwegian politicians were positive, with two key centrist opposition parties backing the proposal. Green campaigners also welcomed the news.
“Bravo Norway, and let’s hope it gets through because the future of fossil fuel investment is looking shaky indeed,” said Rachel Kennerley, climate campaigner at Friends of the Earth.
“This is astonishing — as astonishing as the moment when the Rockefellers divested the world’s oldest oil fortune,” said Bill McKibben, founder of the 350.org campaign group.
“This is the biggest pile of money on the planet, most of it derived from oil — but that hasn’t blinded its owners to the realities of the world we now inhabit.”
COAL FIRST, OIL AND GAS NEXTIt certainly is great to have the luxury that Norway‘s giant pension fund has and let me state from the outset, I concur with this proposal and it should have been done a few years ago.
Since 2015, the fund no longer invests in companies that derive more than 30 percent of their revenues or activities from coal - one of an early group of investors to do so, which has made the coal sector less attractive to some investors.
Oil and gas stocks would be replaced by investments in other companies, Matsen said. “The straight answer is that all other sectors would be weighted up in proportion ... (under) our current mandate,” he said.
At the end of 2016, the fund’s equity investments were split between investments in the financial sector (23.3 percent), industrial companies (14.1 percent), consumer goods (13.7 percent), consumer services (10.3 percent), healthcare (10.2 percent), technology (9,5 percent), oil and gas (6.4 percent), basic materials (5.6 percent), telecoms (3.2 percent) and utilities (3.1 percent).
The proposal has to be reviewed by the Finance Ministry, which in turn needs to decide whether to propose it to parliament. The Finance Ministry said it would conclude with its own view in the autumn of 2018.
If it backs the central bank’s proposal, Parliament could vote on it in June 2019 at the earliest.
“It’s great to have that luxury, isn’t it?” Peter Fitzgerald, Aviva Investors head of multi-assets, told Reuters. “You make all your money from one asset class and then you sell your holdings.”
Why? Because Norway is already exposed to oil and gas, that's how the country derives its revenues, so it makes sense to diversify away from this sector.
You can say the exact same thing of Saudi Arabia and other oil producers. Why invest in oil and energy if you derive most of your revenues from that sector and need to diversify away from it?
Now, we can debate whether all pensions should follow Norway's lead but I think it's important to stress this proposal has nothing to do with climate change and reducing its carbon footprint, it's all about smart diversification over the very long run.
In other words, this isn't a divestment based on responsible investing principles like OPTrust's recent decision to butt out for good (will speak with Hugh O'Reilly on Friday and update that comment). Norway's pension has divested from coal and certain weapons manufacturers in the past based on such principles but this decision is purely based on smart long-term diversification.
Will this decision weigh on oil and gas shares over the next few years? I don't think so since many other institutional investors will continue buying these shares. However, I'm on record stating I'm short energy (XLE) and metal and mining (XME) shares because I fear global deflation is around the corner and we're headed toward a prolonged economic slump which will last a lot longer than anyone anticipates.
That's the main reason why I think Norway should have dropped this sector by now.
However, I am surprised that the Fund is increasing its stake in equities. Earlier this week, I explained why CalPERS is considering more than doubling its bond allocation (updated that comment to include most recent clips on the Investment Committee) and I agreed with this decision.
Norway's trillion-dollar pension has decided to increase its allocation to equities from 60 percent to 70 percent, which makes sense for them since they're not managing assets and liabilities closely, they are trying to maximize returns to keep up with expenditures.
The big problem with this approach, however, is that Norway's giant beta problem is only going to get worse and if these markets on the edge of a cliff reverse and we end up experiencing the worst bear market ever, Norway's Fund will get clobbered just like it did in 2008 and maybe far worse.
Maybe that's a risk Norway's Fund is willing to take but other pensions that manage assets and liabilities very closely can't afford to take such risks.
You know my thoughts, I fear it's as good as it gets for stocks but with euphoria creeping back into markets, no thanks to global central banks, maybe we have a lot more to go before it's game over for a long, long time. Or maybe not, depending on what happens in credit markets.
Let me end by commending Norway's Fund for demanding more transparency in the FX market:
Norway’s $1 trillion sovereign wealth fund is advocating for change in the way currency markets function to ensure both sides of trades have equal access to the information they need.You can read the Fund's paper here. I can't comment on these proposals but I know that FX markets are still the Wild West of finance and purposefully so. Big banks derive enormous profits skimming their retail, commercial and institutional clients in FX and there is no way they're going to sit idly by and allow anyone to regulate this away.
“FX markets are now the most liquid in the world, which is a significant achievement,” the Norwegian wealth fund said in a paper published on Friday. “However, the solutions have also tended to exacerbate the informational advantages enjoyed by dealers in bilateral, over-the-counter markets.”
The world’s currency markets generate more than $5 trillion in daily turnover, with spot transactions alone making up almost $1.7 trillion of that, according to the Bank for International Settlement’s triennial report.
The fund, based in Oslo, says the recent release of a global code of conduct for currency markets provides an opportunity to revisit assumptions on how trades are carried out. The investor warned of the risk of “significant informational asymmetries between dealers and clients” it says ought to be addressed. While existing practices help dealers avoid price risks and contribute to liquidity, “they can also lead to excess intermediation profits and inefficient price discovery,” the fund said.
Currency markets are less shaped by regulation than areas such as fixed income. Instead, participants are guided by the FX Global Code of Conduct. Norway’s wealth fund says the practices that currently steer currency trading need greater transparency and verifiability, which it sees as “key to mitigating the impact” of a lack of symmetry in information.
The fund identified three practices it says “particularly stand to gain from greater transparency and verifiability.”
The fund said it wasn’t calling for any of the three categories to be abandoned, just improved.
- Last Look
- The implementation of electronic algorithms
- The linkages between Request For Quote feeds and interdealer market prices
“We believe that governance standards are a natural extension for the FX Global Code,” it said. “These would serve to further strengthen the well-functioning of this important market.”
Actually, let me be fair here. Following the conviction of a former HSBC currency trader for front-running, I said there's no way his superiors didn't know about this and that HSBC isn't the only bank doing shady things in FX markets.
But I also said that banks often eat losses too for their big institutional clients, especially big hedge funds, so it's not only a win-win for banks in currency trading. Sometimes they need to take losses to manage their big relationships. It's a give and take.
I asked a friend who trades currencies what he thought of Norway's proposals in FX markets and he shared this:
Unfortunately, there are enough large institutional clients and hedge funds that have an advantage in the current setup. Particularly in information and execution that will side with the banks and continue to oppose more regulations.Ah those banksters, they sure love their easy spreads!! (we need Amazon in finance to level the playing field in many areas, I'm serious!).
Last look is fundamentally wrong. The model should be no spread no last look just a commission. The banks would never go for that they will argue we have a credit risk to the client and clients like to hedge cash flows and hence use forwards. The answer to that is collateral, central clearing and an organized exchange which is regulated.
Think of it the banks have gone to a model of best efforts (for them), they won't honor a stop loss price but rather fill you at the next best price (which is according to the bank) no recourse available to the client, on top orders they won't necessarily fill you on your order (they will say it didn't trade for your full amount or we did not credit or it was a bad print) again client left with all the risk. And then they will say use or electronic platform which embeds the last look which means they will fill your trade if they can get at profit (spread).... So banks don't want any risk, they want guaranteed profits.
Hardly an efficient and fair market!!!
Those are my comments. As always, feel free to email me at LKolivakis@gmail.com if you want to add anything.
Below, Bloomberg reports the word's biggest wealth fund wants out of oil and gas. Good move for this fund, now if only it can really shake things up in the currency markets.
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