Effects of reducing Norwegian extraction of oil and natural gas

How can Norway reach targets relating to climate emissions and what are the economic consequences of measures introduced in order to reach these targets? One measure that has been suggested by leading Norwegian environmental economists is to reduce Norwegian exploration of its petroleum resources. One objection to this policy is that it may entail large macroeconomic costs because Norway is so oil dependent. Among possible policy measures to reach emission targets one should choose those with low economic costs. Is reducing petroleum exploration a possible candidate? This report attempts to estimate the macroeconomic costs of two alternative reductions in Norwegian production of petroleum.

The first alternative consists of ending the possibility of explorations in areas that have not been granted already and the oil companies have been given licenses. On existing licenses there are no restrictions neither on producing from existing fields nor for exploring further on blocks already granted. We think that in this case the oil companies will turn their attention from exploring new fields to intensify the production and exploration on existing blocks. Therefore, we estimate that it is only from 2030 and onwards that such a policy will lead to lower investments in explorations and oil platforms and later production of petroleum. Because the Norwegian petroleum industry has already begun its long run decline by 2030 due to lack of available resources, the additional decline that follows from this policy is moderate. In macroeconomic terms the reduction in mainland GDP is estimated to be only half a percent compared to our baseline scenario. Even industries closely linked to the oil industry due to deliveries of inputs to petroleum extraction, will fare quite well. One reason for this result is an expected lowering of interest rates and a depreciation of the currency that will lead to an increase in non-oil exports. A depreciated currency will increase the domestic value of capital incomes from the state pension fund abroad that will support fiscal policy so that cuts in spending or higher taxes will not be necessary to obey the fiscal policy rule.

The second policy alternative combines restrictions on new licenses with a number of tax changes for oil companies that not only will lead to lower explorations on new fields but also related to existing licenses. In this case we estimate that effects on petroleum investments and production will be noticeable from 2025 and onwards. Following a large drop in petroleum investments during the latter half of the 2020s, output is nearly halved compared to the baseline scenario by 2050. In this case macroeconomic effects are much larger than in the first alternative and mainland GDP is reduced by roughly 2 percent compared to baseline in 2030. The unemployment rate is increased by close to one percentage points and the real wage falls by roughly one and a half percent. Cuts in the interest rate and a currency depreciation the economy will lead to some recovery in non-oil activities during the 2030s. Lower state revenues from petroleum will reduce the size of the state pension fund and in order to meet the benchmark of the fiscal policy rule fiscal policy has to become more restrictive. Thus, even by 2050 the unemployment rate has increased by half a percentage point, the real wage drops by one percent and mainland GDP is nearly one and a half percent lower compared to the baseline scenario.

Why are the macroeconomic effects quite moderate according to our estimates? First, petroleum activities in Norway will fall significantly from around 2024 to 2050 also in our baseline scenario which is also in line with official forecasts. The absolute changes in petroleum investment and production relative to the size of Norwegian economy will therefore fall and the impact of the alternatives will moderate even if the effects on the petroleum industry itself are large. Second, in line with the Dutch Disease literature, there are economic mechanisms in the economy that will boost non-oil exporting industries as well as import competing industries that will absorb some of the resources that have become underutilized due to policies that cut the petroleum industry. Finally, again referring to the Dutch Disease hypothesis most of the effects in our study are due to the “resource movement effect” and not the “spending effect” because the fiscal policy rule is related to accumulated petroleum rents and not current rents. The state pension fund is not much affected by these alternatives simply because most of the rent has been invested in the fund irrespective of the two alternatives we study.