Tired of having its economy whipsawed by big swings in oil prices, Norway in 1996 opened a rainy-day fund to save oil earnings for future generations and cushion the government’s budget from volatility in crude prices. Today the Government Pension Fund Global, as it’s called, is the world’s largest sovereign wealth fund, with $870 billion in assets. Its massive size can easily offset the fiscal hit from the recent drop in global oil prices or help prevent “Dutch disease” — the tendency of natural-resource revenues to strengthen local currencies and weaken economic competitiveness — should oil prices rebound.
“A lot of natural-resource-dependent countries came to the right conclusion that to avoid Dutch disease or boom-bust economies, it was necessary to save money or stockpile assets,” says Terrence Keeley, global head of BlackRock’s official institutions group. Government taxes on oil and gas production finance more than half of the world’s $5.3 trillion in sovereign funds, according to Institutional Investor’s Sovereign Wealth Center.
These funds are more important than ever following the sharp decline in global oil prices in recent months, to about $60 a barrel from its peak of $115 last summer.
According to estimates by the International Monetary Fund and Fitch Ratings, Norway, Kuwait, Qatar and the United Arab Emirates all need relatively low oil prices — of $40, $54, $60 and $77 a barrel, respectively — to balance their budgets. In contrast, Saudi Arabia, Venezuela, Libya and numerous other oil producers have break-even points that top $100 a barrel.
Norway and the UAE shouldn’t have much trouble weathering the oil shock, Keeley says. The UAE rivals the Scandinavian country with its oil savings, having an estimated $850 billion — more than twice its gross domestic product — spread across five sovereign funds: the Abu Dhabi Investment Authority, the Abu Dhabi Investment Council, the Emirates Investment Authority, International Petroleum Investment Co. and Mubadala Development Co. Venezuela and Angola, with its small wealth fund equal to 4 percent of the nation’s GDP, are among the more vulnerable countries, with lower savings and break-even oil prices of $117 and $110, respectively, according to Deutsche Bank and Standard Chartered.
Oil exporters have four basic ways of responding to oil price shocks: cutting spending, issuing debt, tapping their sovereign wealth funds and, in the longer term, diversifying their economies. In today’s circumstances, Keeley sees debt issuance as the first recourse for hard-pressed exporters.
Celeste Lo Turco, a sovereign wealth fund expert for the Italian Ministry of Foreign Affairs, says countries with high break-even prices may be forced to tap their sovereign funds if prices stay low. “This is the moment for sovereign wealth funds to show they are important tools for stabilizing their domestic economies,” she says. “But it is in their governments’ hands to use them effectively.”
Russia, grappling with Western sanctions over its incursion into Ukraine and a break-even oil price of $98, began drawing on its sovereign wealth funds — the National Wealth Fund and the National Reserve Fund — last August, when two of the country’s sanctioned banks, VTB Bank and Rosselkhozbank, split $6 billion from the Wealth Fund. More recently, Moscow withdrew $7.5 billion from the Reserve Fund in January to prop up the ruble. It also proposed a $35 billion “anticrisis” plan that includes taking about $9 billion from the Wealth Fund to recapitalize Russia’s banks, with more than half earmarked for state development bank Vnesheconombank. According to Alexei Ulyukayev, Russia’s minister for Economic Development, the government will spend an additional $7.9 billion from the Wealth Fund on infrastructure projects. The two funds have combined assets of about $170 billion, but those reserves could run out in less than three years unless the government restructures its budget to reflect lower oil revenue, Finance Minister Anton Siluanov warned recently. Russia came close to doing just that during the global financial crisis in 2009, but the quick rebound in oil prices enabled it to replenish those funds.
The prospect of drawdowns may encourage some sovereign wealth fund managers to rethink allocations to illiquid asset classes such as infrastructure or real estate, says Lo Turco. “This is a time when they will be sure to hold more-liquid assets, in case the government needs to withdraw funds,” she says. So far, however, there’s little sign that sovereign funds are altering allocations, says BlackRock’s Keeley, whose division manages about $300 billion in assets for official institutions, including sovereign wealth funds, central banks and public pensions. “There really is no linear relationship between a country’s break-even oil price and its appetite for risky assets,” he says.
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