Cuts in oil output may imperil Norway’s financial sector – Norges Bank

A reduction in oil production may imperil Norway’s financial sector, warns Norges Bank’s annual financial stability report, published on November 5.

In addition, on November 4, governor Øystein Olsen said changed public opinion and the prospect of harsher environmental regulations may be contributing to the krone’s depreciation. The currency is trading at its lowest level on record against the US dollar.

“For Norwegian banks and financial markets, transition risks, particularly related to the oil and gas industry, may be important in the years ahead,” says the financial stability report. This is especially the case for sectors exposed to climate regulation, emissions pricing, or competition from new climate-friendly technology, it adds.

The report points out “changes in customer preferences and investor demands can lead to unexpected shifts that have implications for existing projects.” Such a phenomenon could directly impact banks providing funding for the industry. “Expectations of a change may nevertheless cause a shift already today, partly because Norwegian oil and gas fields have a long life with substantial initial investments.”

Since late June, the krone’s depreciation has accelerated. Over the past four months, the currency has fallen by 7.5% against the US dollar, hitting 9.17 earlier today.

This depreciation has surprised observers, because Norges Bank has implemented a tighter monetary policy over the past year. The central bank has made four 25 basis point rate hikes since September 2018, which have taken the policy rate to 1.5%.

“We perceive some voices in the currency market among market participants, who confirm that there is some focus on what’s happening in politics and in general in relation to the prospects for the Norwegian oil industry,” said Olsen in a press conference. “It’s a topic that may have gotten increased attention.”

The governor had already warned against the negative financial impact a hasty implementation of environmental regulations may have on the Scandinavian economy.

“There is still global demand for oil and gas. If we reduce production on the Norwegian shelf earlier than planned, other suppliers are ready to take over,” said the governor in its annual address on February 14. “The climate impact of an earlier reduction would therefore be marginal, while the costs to Norway would be substantial.”

Wider risks

The financial stability report acknowledges Norwegian banks have reduced their exposure to the sector over the last few years. Their oil-related exposure at default declined from over 8% in 2015 to hover around 5% in 2019, with data available up until June 30.

Nonetheless, the oil sector remains important for the banking sector. “Large losses for the banks as a whole will likely occur if a structural decline in oil-related activities have large spillovers on other sectors of the economy,” says the report.

Norges Bank points out how the 2014 oil price decline showed that oil services companies were just as vulnerable to lower prices as operators extracting crude oil in the shelf.

The report says risks may be higher in more segments of the economy in a structural, climate-related downturn than in a cyclical downturn. “In a structural downturn, investors are less likely to inject fresh capital into an enterprise,” it says. “The result may be lower collateral values, higher probability of default rates and thereby higher bank losses.”