Scottish independence: Fjords flowing with funds

Norway's oil fund has continued to show strong growth

The most tantalising prospect for the nationalist cause is that an independent Scotland could turn itself into Norway.

It would quite like to add some of Sweden's economic vitality, Finland's approach to innovation and, among other things, Denmark's classy TV drama.

But the Norwegian comparison is based on having Europe's other big deposit of subsea oil and gas.

This week, the calculation of Scotland's public finances has renewed the vigorous debate about the role of oil in Britain's past and Scotland's future.

Scotland's deficit has been smaller than that of the UK's in recent years, if you include its share of oil and gas revenue.

Taxes and services

The difference, of course, is that British oil revenues have been used to fund current spending. You could argue they've either allowed for higher levels of public services than we'd otherwise have had, or that they've allowed the Treasury to keep taxes lower than would have otherwise been necessary.

The Norwegians, by contrast, paid off their debts and started putting their oil revenues into its oil fund, formally known as the Norway Pension Global Fund.

In an act of sacrifice and long-term planning which looks rather foreign to those of us on this side of the North Sea, they pledged to limit the amount of earnings from the fund that they funnel into current spending. They also pledged not to invest in unethical companies, or in Norwegian assets, as that would inflate domestic prices unhelpfully.

Norway's oil exports also lead to a currency strength, which is no help to the rest of the economy. And being willing to put the oil revenues aside means that Norway has high taxes to fund its services.

Meanwhile, the oil fund has grown. And how.

On Friday, in Oslo, the managers of the fund revealed how it performed in 2012. The numbers are mind-boggling.

By the end of January, it had grown in one year by 13%, or 504 billion kroner to reach 3,816 billion kroner.

Converted using Friday's exchange rate, that means £447bn. Let's repeat that: four hundred and forty seven billion pounds.

The £59bn increase in value had three components. Returns on existing investments delivered £52bn. Inflows from Norway's oil revenues last year came to £32bn (three-times those attributed to Scotland).

But there was a catch. The strengthening value of the kroner required a heavy price, reducing the domestic value of investments in only one year by £26bn.

The growth rate was the second strongest year on record, after a big slump and bigger rebound in 2008 and 2009. The average growth rate since 1998 has been 5% per year.

Gilt complex

Dig a bit deeper into the report, and you find some interesting nuggets about what you can do with that much money, when you've become one of the biggest investors in the world.

For instance, the fund has sharply cut its exposure to UK Treasury bonds, and this was before the downgrade in Britain's triple-A rating.

The UK share of sovereign bond exposure fell from 12% of the total to 6%, leaving £7bn invested in UK gilts.

That's as the Norwegians shift their investment strategy away from Europe, and towards emerging markets. They've started buying, for instance, bonds issued in Mexico, South Korea, Russia and Brazil.

The oil fund's equity portfolio rose by 18% in value. Of that, 16% is held in UK stock, compared with 28% in the US. Less than 2% is held in China's stock market, but that may grow.

While its biggest single stake is in Swiss-based Nestle, the top returns on its equity portfolio was HSBC bank. Among the worst was UK-based energy firm BG.

And it started investing last year in real estate, buying sizeable chunks of Sheffield's Meadowhall shopping centre and London's Regent Street.

There are other benefits to Britain, as London is the hub for managing much of this asset. Of the five biggest earners, on more than 5m kroner or £600,000 last year, three were in London and two in Norway.

There are those in Scotland who are rather hoping to attract that kind of sovereign fund asset management to Edinburgh.

Kroner envy

So, two questions: could an independent Scotland have done the same, and could an independent Scotland do so now?

The answer to the first question is to learn from the Norwegians that the fund required sacrifice when it was set up, and it still does. Quality public services in Norway are funded by taxes with a strictly limited use of oil wealth.

You can make your own judgement as to whether Scottish politicians were ever likely to do that.

As for the current position, Scotland's fiscal balance still requires all its oil and gas revenues to keep its deficit to 5% of gross domestic product. That's lower than the UK, but it's still too high.

That's in a good year. There has been much heated debate this week about how much more oil there is to come - probably a lot, but not necessarily offering up quite such generous tax revenue once the industry has been incentivised to drill and develop in deep water and hard-to-reach reserves.

And, as acknowledged in the leaked paper from the finance ministry this week, an oil fund would require sacrifices in future spending on public services.

Aggreko: plugged into power gaps

While on the energy watch, here's one end-of-week observation about one of Scotland's better-performing corporates, Aggreko.

Based in Glasgow and assembling its generator units in Dumbarton (it now has a fleet of 6,000 of them operating or available around the world) its full-year figures for 2012 were very healthy, helped by powering the Olympic Games.

Chief executive Rupert Soames sent a gently negative message at the end of last year about future prospects, for which investors punished the stock price.

But this week's full year figures sent it sharply up.

That might be because of the longer-term strategy, published alongside the 2012 figures.

It started by reflecting on growth since 2003 that's seen revenues up by a compound 19%, and trading profits up by a compound 28%.

Not everything has worked, it notes. The intention of expanding refrigeration (the roots of Aggreko's business were in refrigerating food for Christian Salvesen) has come to nothing much.

Likewise, trying to build a link with wind generation, supplying power for turbines' down times, has not sparked much activity.

But the prospects are good, claims Aggreko, because the power gap in emerging economies is so big. "We believe the shortfall between supply and demand will grow at about 13% (compound annual rate) over the next five years. We think this will translate into an increase in market demand for temporary power in the range of 10 to 15% per annum."

With a market leading position, that points to Aggreko having growth in return on capital of between 25% and 30% over the next five years.

Helped by product innovation: "Longer term, we believe that the key to expanding the market for power projects is to be able to deliver a cost per kilowatt hour which makes temporary power competitive with permanent power."

In other words, instead of building big new gas power stations to back up renewable turbines, even Britain could be looking to Aggreko to plug in its generators.

This is a company that does quite simple things. But it's doing them in very interesting ways.

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