Arctic Oil and Public Finance: Norway's Lofoten Region and Beyond.

AuthorMohn, Klaus

    The Arctic holds a substantial potential in terms of petroleum resources. According to the USGS (2008), more than 400 billion oe of oil and natural gas are yet to be discovered in this part of the world. Managed properly, these resources can be converted to reserves, revenues, and financial wealth for the host countries. And if governments are successful in the capture of resource rents, significant gains could arise for the general public of resource-rich countries, via government spending and/or tax relief.

    At the same time, Arctic oil and gas resources involve substantial challenges and dilemmas, and development so far has been sluggish (Henderson and Loe, 2014). Poorly mapped offshore resources in a demanding climate, technology requirements, infrastructure investment, and stakeholder management are elements that contribute to the cost and risk of Arctic oil and gas exploration. Late developments for energy and climate policies are also not in favour of large-scale oil and gas operations in the Arctic, adding skepticism and controversy to the issue.

    Norway's Lofoten region is an appropriate example. (1) With a significant resource potential, the waters off the coast of the Lofoten region are viewed as highly attractive by the oil companies. Although the underground uncertainty is high, resource values are most likely substantial, judged not only by estimates from the Norwegian Petroleum Directorate (NPD; 2010), but also by the interest from the oil industry.

    Awards of virgin exploration acreage to oil companies who are short on exploration acreage and investment opportunities can provide activity and employment, and stem the expected stagnation on the Norwegian Continental Shelf (NCS). Industry interests also argue that Lofoten oil and gas activities could add large revenues to government budgets, and leave a potential for more government spending, and/or future tax relief.

    An opening of the Lofoten region for oil and gas activities will require a full public impact assessment. The decision to start this process is still pending. At the same time, skepticism and resistance against further oil industry expansion is gaining strength in the Norwegian public. The Lofoten region has significant symbolic value for its regional fisheries, tourism activity, and recreational services (e.g., Navrud et al., 2016). Questions are also raised if Arctic oil exploration can possibly be combined with a forward-leaning attitude to climate policies. A recent national opinion poll indicates a 58 per cent majority in the Norwegian electorate against opening, (2) and to many the fate of the Lofoten region is currently seen as a watershed for Norway's future role in the world of energy and climate policies (e.g. Milne, 2017). (3)

    Estimates of economic values involved by oil and gas exploration form an important part of the information set of policy-makers. This study proposes a methodology to assess the net present values implied by direct revenues and costs relating to oil and gas activities in the Lofoten region, which also can be applied for other oil and gas provinces. I consider value drivers that normally enter decisions among oil companies who plan for exploration and extraction activity in the area. Indirect economic effects and external effects are therefore not part of this study. A full economic impact assessment would have to consider net present values reflecting ripple effects and external costs and benefits both on the regional and the national level (Fjose et al., 2012, Cappelen et al., 2012), including net impact on other industries (e.g., fisheries and tourism), potential local pollution and catastrophic risks for nature, ecosystems, recreational service provision (Loureiro and Loomis, 2012; Navrud et al, 2016), as well as costs of C[O.sub.2] emissions and climate policies (e.g., Fashn et al., 2017).

    A full investigation of indirect and external costs and benefits go beyond the scope of this study, which is limited to direct economic effects, and in particular the implications for public finance. Even so, my approach may still prove useful point of departure for the evaluation of indirect and external effects both in Norway and elsewhere in the world. Specifically, if the sum of indirect and external costs falls short of the net present value of direct effects, the policy signal is that new oil and provinces in the Arctic could be opened. And conversely, if the net present value of indirect and external costs exceed net direct benefits, one should think twice before oil companies are let into the area.

    A contribution of this study is the integration of resource valuation in a framework of resource revenue management and public finance, enabling an assessment of the financial contribution to public finance and fiscal capacity from a specific expansion of oil and gas exploration acreage. Building on previous theoretical work on resource revenue management (e.g., van der Ploeg and Venables, 2011; Venables, 2016), the impact on government budget capacity is assessed under a benchmark Permanent Income Hypothesis (PIH) approach and under a Bird-in-Hand (BIH) approach, the latter of which is a resemblance of the Norwegian model of resource revenue management.

    I combine resource estimates from the Norwegian Petroleum Directorate (NPD; 2010) with economic theory and industry data to calibrate a cash flow model for oil extraction in Norway's Lofoten region. A generic model is calibrated to establish a Reference scenario for revenues and expenditures, which are then discounted to form net present value estimates for companies and for the government. The Reference scenario serves as a benchmark for subsequent sensitivity analyses and alternative scenarios. Under the Norwegian resource management model, valuation results are linked to public finance via the oil fund mechanism and the fiscal policy rule, to investigate the implications for fiscal capacity, i.e. government spending and/or tax relief. Tentative implications for other resource-rich countries with territorial interests in the Arctic circle are then discussed in light of resource assessments by USGS (2008).

    In terms of key results, this study suggests that the net present value of Lofoten oil and gas activities for the government could range from USD 4 bn to USD 40 bn (USD 15 bn in the Reference scenario), (4) which again represents 0.4-3.7 per cent (1.4 per cent) of the current value of the Norwegian oil fund (Government Pension Fund; GPF). Under the Norwegian fiscal policy rule, oil and gas extraction in the Lofoten region would allow the government to increase annual fiscal spending by NOK 3.6 bn (USD 450 M) in the Reference scenario, or to offer a corresponding amount in tax relief. In other words, the Reference scenario of this study suggests that the willingness to pay for protection of the Lofoten region at least will have to exceed NOK 521 (USD 65) per capita per year.

    The assessment of direct economic resource values is laid out through the establishment of the Reference scenario in section two, with a calibrated model of revenues, expenditures, discounting procedures and senstivity analyses. Section three presents the implications for resource revenue management policies, public finance, and fiscal capacity, with an approximate extension to other resource-rich countries within the Arctic circle. Section four offers a discussion of indirect and external effects, whereas a summary and concluding remarks are offered in section five.


    2.1 Resources and production

    The NPD's (2010) assessment of the resource potential of the Lofoten region is illustrated in Figure 2, with an estimate for expected resources accompanied by a P95 and a P05 estimate to reflect uncertainty. The expectation by Norwegian authorities is for a total volume of 1.3 bn boe, with oil (64 per cent) representing roughly twice the volume of expected gas resources. Note also that NPD's assessment is for resources to exceed 480 M boe with a 95 per cent likelihood, and that the likelhood of a resource potential higher than 2.3 bn boe is limited to 5 per cent.

    Building on the historical gradualism of exploration policies in Norway (Mohn and Osmundsen, 2008), an impact assessment in 2022/2023 could be followed by license awards in 2024, with exploration drilling commencing from 2025 and onwards. With idle capacity in supplier markets, lead times might be slightly lower than the historical average, and extraction is therefore assumed to start in 2031. With higher requirements for planning, investment and value-chain development, lead times of gas field discoveries are typically than for oil fields. Consequently, gas discoveries are expected to come into production in 2036, which is largely in line with lead times of previous discoveries of natural gas on the Norwegian Continental Shelf (NCS). These developments are approached through the modelling of two generic sample fields for oil and natural gas, establishing a reasonable benchmark for an extraction path which is consistent with NPD (2010) resource estimates. The model of this study is deterministic. The distribution over time of exploration activity, field development, and extraction is characterized by:

    [mathematical expression not reproducible] (1)

    where a is the realisation of the exploration/development/extraction, whereas [micro] and [sigma] represent parameters of the time distribution. As the time resolution of this study is annual, discrete groups of outcomes are formed for each year of the sampling period. Consider extraction from a stylised oil field as an example. Startup in 2031 and closedown in 2070 gives rise to 40 categories with successive ranking. Consequently, the share of total recoverable oil resources which is extracted in year t (a,) is approached via the following relationship:

    [mathematical expression not reproducible] (2)

    For each year in...

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