SWF-ing your problems away – Israel’s offshore gas

Israel is experiencing something of an offshore resource gold-rush. Last month Noble Energy announced the discovery of 16 trillion cubic feet of natural gas at the Leviathan 1 offshore site. A second site, Tamar, is expected to start commercial production of 8.4 trillion cubic feet of natural gas in 2013. Since mid 2008 the Oil & Gas Exploration Index of the Tel-Aviv Stock Exchange (TASE) rose by more than 500% (see chart).

Oil & Gas Exploration Index 2008-2011

Oil & Gas Exploration Sector Index TASE, Source: TSAE

Revenues spurts and sputters

The long term demand prospects for natural gas are looking positive. BP’s latest Energy Outlook predicts that, “Natural gas is projected to be the fastest growing fossil fuel globally to 2030”.

But natural gas revenues are notoriously unstable. Global demand, supply side shocks, and geopolitical conditions make prices as volatile as the gas itself. In the past ten years the Henry Hub Natural Gas Front Month Futures price has fluctuated between $2.15 to $14.75 per million MMBTU (see chart).

Chart: Henry Hub Natural Gas Front Month Futures 1990 - 2010

Henry Hub Natural Gas Front Month Futures 1990 - 2010, Source: Financial Times

Controlling the flow SWF-tly

Norway has come up with a solution to manage the volatility of oil revenues from its North Sea oil fields. In 1990 it created a national oil fund which acts as a buffer between unstable oil revenues and government spending.

Each year, all the oil revenues are channeled into the fund. If there is a budget deficit for the year without the oil revenues (a non-oil deficit), then the money from the fund is used to balance the budget. Surplus revenues remaining in the fund, only after the budget is balanced, are then invested in overseas securities. As there is no gain in saving if the government needs to borrow, the first priority is to balance the budget.

It took Norway five years to start saving in this way. Over time a surplus was accumulated and the Government Pension Fund Global (GPFG), as it was renamed in 2006, is one of the world’s largest Sovereign Wealth Funds (SWF). Currently the fund  $512 billon assets under management.

Chart: Norwegian Petroleum Fund Global Returns 1998-2010

Norwegian Petroleum Fund Global Returns 1998-2011, Source: Norges Bank

As Norway’s economy generally runs a budget surplus a fiscal rule was introduced in 2001 to determine how much the GPFG’s profits should contribute to the national budget. The ‘4% rule’ stipulates that these transfers should not exceed 4%, the fund’s projected annual return (see Annualised cumulative returns in the chart below). In so doing Norway has provided a stable revenue source regardless of market and output fluctuations thus ensuring future generations can enjoy the spoils.


About Gideon Benari
Solvency II Wire a site dedicated to informing professionals in financial services industry about Solvency II, the new regulation for the European insurance industry.

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