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An Oil Fund for Scotland: Taking forward our National Conversation


5 Policy Issues for a Scottish Oil Fund

Chapter Summary

  • There are a number of important policy choices which must be made when establishing an oil fund. These include:
    • the management structure of the fund;
    • the proportion of tax revenue transferred to the fund;
    • how the revenue transferred to the fund should be invested; and
    • managing withdrawals from the fund and what the fund income should be used for.
  • Successful oil funds tend to share key characteristics: they are transparent and make a commitment to invest on a regular basis; they focus on long-term investments and wealth creation; and, all those involved in the operation of the fund, from managers to policy makers, are accountable to the relevant legislature and the general public.

5.1. Having established the basic motivation behind the creation of an oil fund for Scotland and the potential value of such a fund, this chapter reviews in more detail the structure of the Norwegian, Alaskan and Albertan oil funds and sets out various options for how a Scottish oil fund might operate.

5.2. Successful oil funds tend to share key characteristics: the rules for the funds are generally simple and transparent; there is a commitment to invest in the fund on a regular basis; the fund managers operate a diverse investment strategy with a focus on long-term wealth creation; and, all those involved in the operation of the fund, from managers to policy makers, are accountable to the relevant legislature and the general public. Public support for the fund is viewed as critical to its success.

5.3. This chapter discusses seven important policy choices for a Scottish oil fund:

  • establishing the fund;
  • aims and objectives;
  • basic framework and management;
  • investment strategy;
  • investment portfolio;
  • transfers from the fund; and
  • using the fund income.

5.4. The Scottish Government welcomes ongoing discussions on the policy choices set out in this chapter, and all other aspects of this report. A series of questions have been included in the chapter to facilitate discussion of the issues that are central to establishing an oil fund for Scotland. Details on how to respond to the questions posed are provided at the end of the report.

Establishing the Fund

5.5. The creation of an oil fund for Scotland would require appropriate legislative and legal authority. Currently, a significant proportion of fiscal, economic and monetary policy, including oil and gas taxation, is reserved to Westminster. Creation of an oil fund for Scotland would, under the current devolution settlement, require legislation by the UK Parliament. Independence would enable the Scottish Parliament to set up an oil fund for Scotland. This would also be possible under some forms of greater fiscal autonomy. As oil and gas revenues contribute to the total pot of UK fiscal resources, which in turn fund public services in Scotland both directly and via the block grant to the Scottish Government, it is likely that establishing an oil fund would require a change in the fiscal framework for Scotland. For example, in order for an oil fund to provide net additionality funding, an agreement would need to be reached with HM Treasury that expenditure financed from the fund would not lead to an equivalent reduction to the Scottish block.

5.6. The experience of other countries suggests that full financial and/or political independence is not a necessary pre-requisite for the creation of an oil fund. In the USA and Canada, responsibility for natural resource taxation is devolved to the states and provinces, enabling Alaska and Alberta to establish their own oil funds within the context of a larger political and fiscal entity. The final report by the Calman Commission on Scottish Devolution did not recommend the devolution of oil and gas taxation to the Scottish Parliament. However the report prepared by the Commission's Independent Expert Group on natural resource taxation argued that, in principle, the Scottish Government could be given control over the proportion of the UKCS deemed to be within its jurisdiction. An alternative arrangement suggested by the Expert Group is for the Scottish Government to be assigned the tax revenue generated from oil and gas exploration in Scottish waters. The report suggests that whilst work would have to be undertaken to identify the share of revenue generated in Scottish waters such an allocation would be possible.

Aims and Objectives

5.7. Once agreement has been taken in principle to establish an oil fund for Scotland, basic parameters would be required setting out the overall aims and objectives of the fund. For example, should the fund be used as a long-term investment fund to provide a permanent income stream, or as a short to medium term funding source to assist economic development?

5.8. The Norwegian and Alaskan funds are good examples of the primary focus being on the establishment of long-term investment funds so as to maximise the stock of financial wealth held in the fund. The constitution in Alaska explicitly prevents the running down of the Permanent Fund's asset base (i.e. the principal), while in Norway the long-term motivation of the fund is to create a pot of sustainable wealth that can be used to finance the country's future social security obligations. In both cases, growing the underlying asset value of the fund and ensuring that it continues to exist on a permanent basis are widely seen as the central objectives.

5.9. In contrast, the Province of Alberta initially put a greater emphasis on using the fund to assist economic development. Over the past thirty years, nearly $30 billion CAD has been transferred from the fund to the government's general purpose budget for spending on government programmes and in particular to pay for investment in infrastructure and in human and physical capital formation 65. No restrictions were placed on withdrawals from the fund, and in fact the opportunity to take revenues directly from the fund's asset base was a clear objective of the fund from the outset. Following a major restructuring in 1997, the fund has adopted a strategy more comparable with that of Norway and Alaska. The objective of the fund is now "to provide prudent stewardship of the savings from Alberta's non-renewable resources by providing the greatest financial returns for current and future generations of Albertans" 66.

5.10. Using oil funds as development mechanisms remains popular in emerging countries where the goal of short-term economic growth and development lies above, for the moment, that of creating long-term financial wealth.


5.11. International experience offers two main alternatives for the aims and objectives for a Scottish oil fund. The approaches are not mutually exclusive and indeed a hybrid approach, combining short and long-term priorities, could be adopted.

Should control of North Sea Oil revenue be devolved to the Scottish Parliament?

If established, what should be the principal aims and objectives of a Scottish Oil Fund?

Basic Framework and Management

5.12. Having set out the broad aims and objectives of the fund, a basic framework setting out the fund's operation and governance would need to be established. The IMF have concluded that the "quality of institutions in the creation of an oil fund are important determinants of successful outcomes" 67.

5.13. One option would be for the government of the day to set out the fund's objectives and overall investment strategy, but to delegate operational management to an institution independent or quasi-independent of government. A key challenge with this approach would be to maintain a balance between independence and accountability. A system of checks and balances, including independent audit and detailed reports could be created to maintain transparency and political accountability.

5.14. The Alaskan Permanent Fund is managed by a quasi-independent state entity, the Alaska Permanent Fund Corporation ( APFC). A six-member, governor-appointed Board of Trustees oversees and is ultimately responsible for the performance of the APFC. While two of the Board's members are incumbent Government Ministers, the remainder are appointees from the private sector selected for their competence and expertise in finance and investment management 68. To maintain independence, appointments are staggered over four year terms.

5.15. Figure 21 outlines the structure of the Alaskan Permanent Fund and highlights the key elements of separation between the State Government and the operation of the fund.

Figure 21: Structure of Alaskan Permanent Fund

Figure 21: Structure of Alaskan Permanent Fund

Source: Warrack & Keddie (2000) - Alberta Heritage Fund vs. Alaska Permanent Fund: A Comparative Analysis and Alaska Permanent Fund (2005) - An Alaskan's Guide to the Permanent Fund

5.16. The balance of independence and accountability is maintained through a number of channels including the requirement that the APFC report to various audit and financial committees of the Alaskan legislature and the fact that the entire State Legislature is required to approve the APFC's budget each year. Furthermore, as the APFC is effectively an investment company operating on behalf of all Alaskans, it is a legal requirement that the fund present detailed reports setting out its operations, costs and performances in a manner that is readily accessible to the general public.

5.17. A slightly different structure exists in Norway. The basic framework for the Fund's operation is set by the Norwegian Parliament. The Fund's auditors also report directly to the Parliament, ensuring Parliamentary oversight of the Fund's operations. The Fund's guidelines, benchmark performance and risk limits are set by the Finance Ministry with operational management devolved to Norges Bank Investment Management ( NBIM), a division of the Norwegian Central Bank. 69 The degree of independence of the fund is however, less than that in Alaska as the fund is fully integrated into the government budget. Accountability is achieved through a combination of transparency and formal rules of monitoring. Under the general rules setting out the operation of the fund, Norges Bank is required to submit quarterly reports on the fund's performance to the Ministry of Finance, and reports to a private sector company hired by the Ministry which monitors in detail the financial transactions of the fund's managers.

5.18. The structure of the Norwegian oil fund is outlined in Figure 22 below.

Figure 22: Structure of Norwegian Oil Fund

Figure 22: Structure of Norwegian Oil Fund

Source: Norwegian Ministry of Finance (2008) - Sovereign Wealth Funds and Norway's Government Pension Fund

5.19. It is generally accepted that the establishment of near independent institutions to manage the oil funds of Norway and Alaska has been a success - see Hannesson (2001) 70.

5.20. An alternative option would be for the fund to be managed and operated by officials and Ministers within the Scottish Government. Such funds are known as informal funds.

5.21. This management approach has been adopted in Alberta. The Alberta Heritage Savings Fund is run by the Ministry of Finance and at the discretion of the Provincial Government. While the investment portfolio of the fund is managed by professionals in the Investment Management Division ( IMD) and external managers are employed to manage specific investment mandates, the Ministry of Finance has ultimate management responsibility for the operation of the fund including its investment policies and overall structure.

5.22. In this model, accountability is more directly linked to the political process and the various checks and balances of the Parliamentary system.

5.23. Transparency can be achieved through a number of avenues. Both the Norges Bank and the APFC publish detailed reports on the management of their respective funds. The reports provide details of investment dealings, annual returns and detailed breakdowns of running costs. In this regard, both funds operate as normal private sector investment funds reporting to shareholders.

5.24. The Alberta Heritage Savings Fund differs from the other two funds and transparency, like accountability, is maintained primarily through the political process. For example, the Albertan Minister of Finance is required to report on the performance of the Fund on a quarterly basis and to provide a detailed annual report at the end of each fiscal year. The Standing Committee on the Alberta Heritage Savings Trust Fund conducts public meetings to inform the general public of the operation of the fund.


5.25. The key advantage in setting up an oil fund as an independent institution is that it can help insulate the fund from short-term political pressure and allow the day to day management of the fund to be conducted by experts in the field.

5.26. Furthermore, creating a separate institution challenged to meet specific long-term goals can provide a clear focus for the operation of the fund and facilitate maximum public support. The key advantage of an internal management model is the direct element of accountability in the operation of the fund via the political process.

5.27. The degree of transparency in the operation of oil funds is thought to play a vital role in their long-term success and it is claimed that one of the main reasons for the success of the Norwegian oil fund is its high level of transparency 71. The fund scored 100 per cent for governance, accountability and transparency in a recent study by the Peterson Institute for International Economics 72 .

What do you believe would be the most appropriate institutional and managerial framework for a Scottish Oil Fund?

Investment Strategy

5.28. Once established, a key decision in the operation of an oil fund for Scotland would concern when and how transfers would be made into the fund. Once again, the experiences of Norway, Alaska and Alberta offer some important insights.

Ad hoc transfers

5.29. Under this approach, payments would be made to the fund on an informal basis. For example, if there was an unexpected 'windfall' in any given year, perhaps due to an unexpected increase in the price of oil and gas, this money could be transferred into the fund.

5.30. This approach is currently adopted in Alberta. Initially the Alberta Heritage Savings Fund was allocated 30 per cent of the non-renewable resource revenue received by the Government of Alberta. This continued until 1982-83, when this figure was reduced to 15 per cent. From 1986-87 onwards a formal annual transfer was stopped and the government committed to make payments to the fund whenever possible. However, for a number of years, no payments were made. It is only since 2006 that additional money has been transferred to the fund.

Invest when budget is in surplus

5.31. An alternative would be to commit to invest any proceeds from a budget surplus directly into the fund.

5.32. This is the model adopted in Norway. This ensures that revenues are not invested into a fund at the expense of reduced spending on other government programmes or the creation of government debt. It also means that investment in the fund responds to changes in the business cycle, with greater revenues invested when the economy is performing strongly and less being invested during periods of economic downturn.

5.33. By setting up a fund, a country has an explicit choice as to whether to use its oil revenue to fund current services or invest in the fund. Such a choice does not exist or is not offered to the public in a country without an oil fund.

5.34. A possible downside with this investment strategy is that through time, the level of oil and gas reserves may themselves become a driver of the overall size of the public sector budget, which may well be undesirable.

5.35. The UK fiscal position, including North Sea revenues, is currently in deficit. On only six occasions since 1980-81 has the UK fiscal position, including North Sea revenues, been in surplus 73. This suggests that under this model, in most years the UK Government could only have transferred revenues to an oil fund if it was accompanied by increased borrowing and/or higher taxation/lower expenditure.

Invest a fixed proportion of oil revenue

5.36. Another approach would be to allocate a fixed proportion of oil and gas revenues to the oil fund each year, irrespective of the government's wider fiscal position.

5.37. In Alaska, 25 per cent of revenues from the auction of new leases and state mineral royalties are automatically transferred into the Alaska Permanent Fund. The automatic transfers exclude severance taxes, so the transfer as a share of total oil revenues is approximately 10-15 per cent. In addition, while the mandatory amount must be transferred each year, in practice the government has elected to make additional extraordinary payments into the fund on a number of occasions.


5.38. These options each have their advantages and disadvantages. Committing to invest a certain proportion of natural resource revenues each year guarantees a consistent transfer of resources to the fund. However, this rigidity can be a disadvantage in that it does not account for short-term fluctuations in oil and gas prices and/or the economic cycle.

5.39. In contrast, undertaking ad hoc payments and/or only investing when in surplus ensures that payments are made only when it is economically and financially prudent to do so. However, short-term pressures may result in less money being allocated to the fund than is optimal, while the level of oil and gas reserves may themselves become a driver of the overall size of the public sector budget.

5.40. A possible variant on these approaches would be to combine a rigorous medium to long-term commitment to investing a certain share of oil and gas revenues while allowing for short-term flexibility in the amount actually transferred each year. For example, a framework could be adopted whereby the government was required to invest a fixed proportion of oil and gas revenue over the economic cycle (or a specified fixed time period) but annual payments could vary depending upon the economic and fiscal climate (a form of 'oil fund golden rule').

What form of investment strategy should be adopted for transferring revenue into a Scottish Oil Fund?

Investment Portfolio

5.41. Having decided upon how much to invest in the fund in any given year, the fund's managers would be required to set out a strategy for investing the fund's wealth.

5.42. The over-arching investment strategy of the Norwegian, Alaskan and Albertan oil funds is to achieve high financial returns subject to moderate risk. Clearly there are a number of ways that this can be achieved.

5.43. The pie charts below highlight the investment portfolios of the three funds.

Figure 23: Portfolio Allocations of Selected Oil Fund

Figure 23: Portfolio Allocations of Selected Oil Fund

Sources: Norges Bank Investment Management (2009) - Annual Report 2008
Alaska Permanent Fund (2009) - Investment Portfolio 2008
Alberta Heritage Savings Trust Fund (2009) - 2008-09 Annual Report

5.44. The Norwegian model is relatively unique in that the fund is invested only in financial assets outside Norway. The aim of this strategy is to ensure that the fund's operations do not feed through to the Norwegian economy and create fluctuations in the exchange rate and interest rate. As the Albertan and Alaskan Funds operate within wider currency unions, this issue is of less importance.

Ethical investments

5.45. An interesting feature of the Norwegian model is the establishment of 'ethical guidelines'. Under this commitment, all investments made by the Norwegian oil fund are subject to strict guidelines governing the companies into which the fund can invest 74.

5.46. The guidelines stipulate that the fund should be used to encourage companies to reduce ethical infringements. The Norwegian Parliament generally aims to achieve this through normal shareholder practices such as the application of voting rights. However, the Parliament also reserves the right to exclude certain companies from the fund's available investment portfolio if they deem them to be in significant breach of their guidelines. The 2008 NBIM Annual Report lists 29 companies which have been excluded from the fund since 2002 75.


5.47. Ultimate responsibility for the investment portfolio of a Scottish oil fund would lie with the fund's managers. However, from the experience of other countries it is likely that the government/parliament would determine the benchmark performance and target asset allocation of the fund. As with any investment strategy, a balance would have to be struck between risk and return. All three of the funds studied adopt similar approaches with the relative weight of investment balanced in favour of reducing risk to the underlying asset base. The operation of ethical guidelines offers an additional policy choice.

What investment strategy and portfolio allocation should be implemented by a Scottish Oil Fund?

Should a Scottish Oil Fund adopt ethical guidelines to govern the types of investment undertaken?

Transfers from the Fund

5.48. Once a fund has been established and investments made, a decision would be required on how much to withdraw from the fund each year.

No withdrawals

5.49. One option would be to prevent any withdrawals from the fund unless under exceptional circumstances. This would allow the value of the fund to increase significantly.

Variable transfers

5.50. An alternative would simply be to allow the transfer of money from the fund as and when the fund's trustees, government or parliament deem appropriate. In Alberta, revenue can be withdrawn from either the fund's income or from the underlying principal.

Nominal returns

5.51. In most years, the fund would be expected to make returns on its investments. These returns could be transferred from the fund for spending on government programmes. Until 1997, the Alberta Heritage Savings Fund automatically transferred all income, including income from capital gains, to the government budget 76.

Real returns

5.52. A downside with transferring the nominal returns is that without 'inflation proofing' the real value of the fund would decline. Indeed this has been the case in Alberta where the real value of the fund has fallen - see Figure 20.

5.53. To maintain the real value of the fund, one option would be to draw down no more than the real returns from the fund each year and reinvest the remaining returns in the fund to ensure the purchasing power of the fund remains constant.

5.54. This is the approach adopted in Alaska. The Constitutional Amendment establishing the Alaska Permanent Fund separates the fund into two elements: the principal (i.e. the underlying asset value of the fund) and income (i.e. the wealth generated from the fund's investments). The Constitutional Amendment requires that the principal of the fund is protected. Additional legislation ensures that a share of the fund's income is re-invested into the fund for 'inflation proofing', while a further amount is kept in a reserve account to cover periods when the fund's returns are smaller than anticipated. The remainder is then left to be transferred from the fund 77.

5.55. Since 1997, the Albertan Fund has placed increased importance on inflation proofing and provision has been made to re-invest a share of the nominal returns from the fund's investments each year.

Expected real returns

5.56. Transferring only the real returns from the fund can lead to fluctuations in the annual payments out of the fund each year with higher revenues being transferred during successful years and lower revenues during economic downturns. Unfortunately, this mechanism tends to work in exactly the opposite direction to when the income could be used most effectively.

5.57. To ensure a degree of predictability, one option would be to transfer the annual expected real returns from the fund - i.e. a fixed proportion each year.

5.58. This is the approach adopted by the Norwegian oil fund. The NBIM estimate an expected real return of 4 per cent on the fund's investments and in theory, withdrawals from the fund are not meant to exceed this level 77. However the government has flexibility in the revenue which can be withdrawn from the fund and the funds guidelines allow "fiscal policy to be used actively to counter fluctuations in economic activity" 79. As such there have been a number of years where withdrawals have exceeded the expected real return in response to budgetary pressures 8081.


5.59. There may be an advantage in limiting transfers from the fund in the period immediately following the establishment of the fund, to ensure maximum growth in its value prior to oil and gas reserves being exhausted.

5.60. In practice withdrawals are made from all funds. Given this, there are clear advantages in transferring out from the fund no more than the real returns, whether this is conducted on an ad hoc basis or part of a formal commitment. This would ensure that the underlying asset value of the fund is maintained. As the real return will vary year to year depending on the performance of the fund's investment portfolio, both the Alaskan Permanent Fund and the Norwegian Pension Fund have attempted to ensure stability by focussing either on the expected real return or the average return over a number of years. The potential risk is that if the actual returns are persistently below the expected return then the real value of the fund could be diminished.

How should withdrawals from a Scottish Oil Fund be managed?

Using the Fund Income

5.61. Finally, having decided how much income to transfer from the fund an obvious question would concern how best to spend the income generated.

General expenditure

5.62. One option would be to transfer the income from the fund to the general government budget for non-ring fenced expenditures. This is the approach taken in Norway.

Ring-fenced expenditure

5.63. An alternative would be to ring fence the revenues for particular expenditures, such as the development of infrastructure or the expansion of human and physical capital stocks.

5.64. This is the approach adopted in Alberta. Revenue from the fund is used to help pay for priority programmes in areas such as health care, education and public infrastructure. The fund also provided the initial capital for a number of specific endowment funds 82.

Endowment Fund

5.65. In addition to ring fencing expenditure from its oil fund, Alberta has created a number of subsidiary funds for specific purposes. These include the Alberta Heritage Scholarship Fund and Alberta Heritage Foundation for Medical Research Endowment Fund.

5.66. The Alberta Heritage Scholarship Fund was created using income from the Alberta Heritage Savings Trust Fund and other sources. The income generated by the fund is used to sponsor a range of academic scholarships and bursaries. Alberta Heritage Foundation for Medical Research was created in 1980 using revenue from the Heritage Trust Fund. The fund is used specifically to support biomedical and health research at Alberta universities and related institutions. The fund is now worth $1.5 billion and supported 250 researchers in the Province during 2008 83.


5.67. A completely different approach would be to follow that taken by Alaska. Income from the Alaskan Permanent Fund is paid directly to qualified Alaskan residents in the form of an annual dividend payment.

5.68. Between 2000 and 2008 the dividend averaged $1,700 a year in real terms. Since its inception, over $17 billion (in nominal terms) has been dispersed through the programme as illustrated in Figure 24 84.

Figure 24: Alaska Permanent Fund Dividend Per Resident (1982 to 2008) (2008 Prices)

Figure 24: Alaska Permanent Fund Dividend Per Resident (1982 to 2008) (2008 Prices)

Source: Alaska Permanent Fund Corporation
Note: 2008 figure includes an additional $1,200 Alaska Resource Rebate
Figures were deflated using OECDGDP Deflators, OECD Economic Outlook

5.69. In 2005, the Albertan Government paid out a $400 CAD dividend to everyone in the Province. Whilst an apparent windfall from the oil and gas sector, the money did not come directly from the Alberta Heritage Savings Fund but was paid out of the general government surplus which has been bolstered by high commodity prices.


5.70. The experiences of Norway, Alberta and Alaska offer clear philosophical differences regarding how the wealth generated from an oil fund should be spent. In Norway and Alberta, the returns from the fund are transferred to the general government budget and the government of the day decides how best to spend the money. In contrast, through its public dividend policy, individual citizens in Alaska decide how best to spend the fund's returns.

5.71. The operation of oil funds in Norway, Alaska and Alberta offer a number of different options for the potential operation of an oil fund for Scotland. The most important decisions to be undertaken would include the fund's management structure, financing programme and transfers of resources.

How could the income generated by a Scottish Oil Fund be used most effectively?

Should a proportion of the income accruing from the Fund be used to create a specific endowment fund to provide support for areas such as education or the voluntary sector?