For North Dakota SWF, Future $230 Billion Bonanza Spurs Spending Debate

February 19, 2015 by Nicholas Lansing

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Solid unit train of bakken crude oil heads east through upstate New York

A regional advocacy group forecasts a giant payday from Bakken hydrocarbons some day. Now the Midwestern state’s citizens are pondering what to spend it on.

The U.S. state of North Dakota took a cue from Norway 30 months ago. Eighteen business, academic and political leaders from the state flew to Oslo. Their goal: assess how Norges Bank Investment Management runs Norway’s $860.8 billion Government Pension Fund Global — the world’s largest sovereign wealth fund.

Since then, North Dakota has ramped up its own sovereign vehicle, the Legacy Fund, which had some $2.8 billion in assets at the end of last year. A November 2014 report predicts the fund will double assets by 2017, when it will first be allowed to disburse money. The big news: The fund could have $230 billion in assets by 2060 according to a forecast by the Legacy Fund Initiative (LFI), a group convened by the Minneapolis-based Great Plains Institute (GPI), a non-profit focused on energy-related issues that has operations in North Dakota.

North Dakota and Norway may seem an odd couple. One is a landlocked Midwestern state, the other a nation of fjords and mountains. Yet the kinship between the two runs deep. More than 30 percent of North Dakota’s population is Norwegian-American. And like its Nordic cousin, North Dakota is awash in oil, pumped out of the Bakken shale formation, with an estimated 7.4 billion barrels of oil available for extraction with today’s technology.

In 2012, North Dakota overtook Alaska to become the U.S.’s second-biggest oil producer. Its population: 740,000. Even if that figure grew to 1 million by 2060, the fund would amount to $230,000 per person, versus the $170,000 for each Norwegian citizen provided by the GPFG.


"We felt that, given the cultural connection between North Dakota and Norway, it would be tremendously valuable to have leaders from industry and government spend some time seeing how the Norwegians have done a tremendous job developing their oil and gas resources," says Brad Crabtree, vice president of fossil energy at GPI, who visited the NBIM in 2012.

The two funds are grappling with oil’s epic sell-off; despite a recent uptick, Bakken crude and Brent are still down some 50 percent from last year’s peaks. Norway has had two and a half decades to build up GPFG’s assets while North Dakota has had just a couple of years. Last December, North Dakota budget forecasters predicted oil and gas tax revenues of $8 billion. A legislative committee in January pegged the amount at half that over the next two years.

Since executive director David Hunter took the reigns of the North Dakota fund in December 2013 after a career at HSBC Holdings, he has helped steer its portfolio out of short-term treasuries into a broad collection of asset classes overseen by professional managers. Consultant R.V. Kuhns & Associates of Portland, Oregon, now RVK, helped develop the plan, which bears some similarities to GPFG’s asset allocation.

As of April, 2014, LSV Asset Management, Los Angeles Capital, and Parametric Clifton were overseeing large-capitalization domestic stocks for the Legacy Fund, comprising 15.7 percent of the portfolio. Research Affiliates and Parametric ran small-cap U.S. equities (5.4 percent of the portfolio), while Capital Group, LSV, Dimensional Fund Advisors, and Vanguard Group managed international stock (14.8 percent).

Ten other money managers ran fixed-income portions of the fund — a total of 25.9 percent of the portfolio, in addition to inflation—protected assets like Treasury Inflation—Protected Securities (TIPS), timber and infrastructure (0.9 percent), and real estate (5.3 percent). The balance was in cash and short-term fixed-income (32 percent).

"Sophisticated Discussions"

The target allocation, Hunter says via email, is 50 percent stocks, 35 percent bonds and 15 percent real estate. "There is no exposure to hedge funds or private equity," Hunter adds. That too follows NBIM’s lead.

Meanwhile the state is pumping 1.23 million barrels of oil a day. And it is salting away $110 million each month into the Legacy Fund.

The big question for North Dakota is what it will do with the money. That, says Hunter, is not the focus of his department. "The Retirement and Investment Office is clearly more focused on the investment of the assets in the Legacy Fund," he says.

Paul Rose, a professor of business law at Ohio State University, who writes about sovereign wealth funds, thinks dialogue is necessary. "You see North Dakota’s assets increasing tremendously," he says, "I wonder if they had sophisticated discussions about how much to set aside and what to do with it."

The LFI is trying to spark such a conversation. Voters approved the fund in 2010 to safeguard assets and employ oil and gas revenue for economic growth. To quote its mission statement, the fund will "preserve the real, inflation—adjusted purchasing power of the monies collected."

Political Football

North Dakota directs 30 percent of taxes from oil and gas into the fund. According the state’s constitution, earnings from the fund cannot begin to be spent until July 1, 2017, at a rate capped at 15 percent of the fund’s principal balance every two years. Two-thirds of each house of the legislature must agree. That fails to establish a purpose for the fund — a classic stumbling block.

"The Norwegians said that it’s really important to get consensus on the management purpose of the fund before it accumulates billions more," says Crabtree. "One of the major takeaways was to put into place a project to come up with recommendations for the fund’s use." He adds that the state needs to decide what the money should be spent on.

Rose agrees. "I know that North Dakota is trying to be as careful and thoughtful as they can, and consulting with Norway can’t hurt," he says. "The biggest concern I have with North Dakota’s Legacy Fund is — and I hope this proves to be unfounded — the danger that it will become a political football, and that politicians will be continually lobbied about how to spend the earnings."

Avoiding pitfalls is just as important, says Rod Backman, a former director of the state’s Office of Management and Budget and an LFI member. "One thing we learned from Norway is not to follow the Alaska pattern, where you take the money and write a check to citizens," he says. "It wouldn’t be productive in terms of generating wealth."

The LFI’s report, "North Dakota’s Legacy Fund: Building a Bridge to the Future," harnesses data about the fund’s recent and historical revenue and balances. It recommends focusing on a 25-year scenario that it says "offers state policy-makers a pragmatic middle ground between spending everything and spending nothing."

The Spoiler

LFI emphasizes a "reinvest, replace and spend" policy — disbursing 25 percent of annual earnings from 2017 to 2039 and reinvesting the remaining 75 percent back into the fund until oil production peaks. That will generate $100 billion by 2050 and $230 billion ten years later. "The proposal recommends using fund earnings to replace declining state revenue once oil production peaks and and starts to fall," says Crabtree. "I think that kind of framework can endure."

Spending options for the 25 percent are plentiful. Among LFI’s ideas: building a world-class educational system, funding 'bold, visionary and transformative’ infrastructure projects, without specifying what those might be. Another suggestion is to create a so-called genius initiative to promote the development of private and public innovation, such as game-changing technology ventures.

"Part of the 25 percent should be utilized for key goals to move the North Dakota economy forward — and part of that is diversification away from oil," says Backman. "The genius initiative is about how we can be a part of finding the next Google or Facebook," he says, referring to two California—based internet giants.

Crude prices are the spoiler. LFI assumes $80 a barrel. Crabtree says that oil prices will affect the accumulation rate of the fund but not LFI’s goals.

Most oil forecasts are for prices above current levels. "If the long—term fundamental projection changes, then I suppose it might influence how people think about managing a fund like this," says Crabtree. Backman says the framework of replacement and spending still applies, regardless of crude prices. "You would just be dealing with smaller amounts of earnings."

"Cultural Understanding"

The damage from the crude sell—off is already apparent. The number of drilling rigs fell to 156 in January, down from 200 three years ago. Production of one million-barrels-a-day last April may be winding down.

But the state has danced this dance before. It’s waiting out the deep freeze in prices. Today, however, some question the feasibility of profitable shale oil production at $50 per barrel. "We’re trying to respond prudently but not with any sense of panic," says Crabtree. "The state has gone through significant price swings before."

Crabtree points out that the boom — and the fund itself — are both young. "The vacuum where there is no conversation was understandable, but it’s important not to let that go on too long," he says. "What protects the fund in Norway is a shared cultural understanding. There is no profound constitutional protection — any sitting parliament could change what happens to the fund — but it’s a shared sense of purpose that protects it."

So far, it seems, Crabtree and the rest of the LFI may be talking to themselves. Senate Bill 2344, which recommended setting up a foundation to oversee the direction of the fund and enact many of the group’s recommendations, was scuttled on February 9 in a 5-to-2 "do not pass" senate committee vote. The bill goes to a full vote by the state’s senate within a week from today. Typically, says Backman, a thumbs-down recommendation by a committee means the end of a bill. "But who knows," he says, "someone could give a passionate speech on the floor and convince the senate to pass it."

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