The Government Petroleum Fund Annual Report 2003

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Management mandate

Act relating to the Government Petroleum Fund

Adopted on 22 June 1990. Amended by Act no. 2 of 16 January 2004

§ 1. The Act shall regulate the deployment and investment of a fund intended to safeguard long-term interests through the use of petroleum revenues.

§ 2. The Fund’s income consists of the cash flow from petroleum activities, which is transferred from the central government budget, the return on the Fund’s capital and net financial transactions associated with petroleum activities.

The cash flow is the sum of

• total tax revenues and royalty deriving from petroleum activities collected pursuant to Act no. 35 of 13 June 1975 relating to Taxation of Offshore Petroleum Resources and Act no. 11 of 22 March 1985 relating to Petroleum Activities
• revenues deriving from tax on CO2 emissions due to petroleum activities on the continental shelf
• revenues deriving from the State’s direct financial interest in petroleum activities, defined as operating income and other income less operating expenses and other direct expenses
• central government revenues from net surplus agreements associated with certain production licenses
• dividends from Statoil ASA
• transfers from the Petroleum Insurance Fund
• central government revenues deriving from the removal or alternative use of installations on the continental shelf
• any government sale of stakes representing the State’s direct financial interest in petroleum activities

less

• central government direct investment in petroleum activities
• central government expenses in connection with the Petroleum Insurance Fund
• central government expenses in connection with the removal or alternative use of installations on the continental shelf
• any government purchase of stakes as part of the State’s direct financial interest in petroleum activities

Net financial transactions associated with petroleum activities are the sum of:

• gross revenues from government sale of shares in Statoil ASA

less

• government capital contributions to Statoil ASA and the company/companies promoting the State’s interests in petroleum activities

§ 3. The Fund’s capital may only be used for transfers to the central government budget pursuant to a resolution by the Storting (Norwegian Parliament). The Fund’s capital may not be used in any other way, nor may it be used to provide credit to the central government or to private sector entities.

§ 4. The Fund’s capital shall be invested in the same manner as the central government’s other assets.

§ 5. The Fund may not raise loans. The Fund itself has no rights or obligations vis-à-vis private sector entities or public authorities. The Fund cannot be subjected to legal proceedings and may not institute legal proceedings.

§ 6. The Ministry of Finance shall manage the Fund.

§ 7. The King may issue provisions to supplement this Act and concerning its implementation, including provisions relating to the establishment of the Fund, its management, etc.

§ 8. This Act comes into force on the date decided by the King.

Regulation relating to the Management of the Government Petroleum Fund

Laid down by the Ministry of Finance on 3 October 1997 and last amended on 18 December 2003

§ 1. Management of the Government Petroleum Fund

Norges Bank manages the Government Petroleum Fund on behalf of the Ministry of Finance. The Bank may use other managers. Such managers must have adequate internal ethical guidelines for their own activities.

Norges Bank shall submit reports on the management of the Government Petroleum Fund in accordance with the guidelines set out by the Ministry of Finance.

§ 2. Placement of the Fund

The Government Petroleum Fund shall be placed in a separate account in the form of NOK deposits in Norges Bank. Norges Bank shall invest this capital separately in its own name in financial instruments and cash deposits denominated in foreign currency.

A specific amount of the investments in foreign currency, stipulated by the Ministry of Finance, shall be invested separately in equity instruments pursuant to detailed guidelines set out by the Ministry (the Environmental Portfolio). The other capital (the ordinary portfolio) shall be invested in accordance with Sections 5 to 8 of this Regulation.

Norges Bank shall seek to achieve the highest possible return on investments denominated in foreign currency within the limits set out in the regulation and the guidelines issued pursuant to this regulation.

§ 3. Accounting return on the Government Petroleum Fund

The value of the Petroleum Fund’s krone account is set at the combined value of the environmental portfolio and the ordinary portfolio. Norges Bank’s book return on the environmental portfolio plus the ordinary portfolio, less remuneration to Norges Bank, shall be added to the Petroleum Fund’s krone account on 31 December every year.

§ 4. Benchmark and relative risk

Following consultation with Norges Bank, the Ministry of Finance shall establish benchmark portfolios for the environmental portfolio and the ordinary portfolio. The Ministry shall set maximum limits for the expected return differentials between investments in the environmental portfolio and the ordinary portfolio and their respective benchmark portfolios, measured in the form of tracking error.

§ 5. Asset mix

The ordinary portfolio shall be invested in accordance with the following asset distribution:

When calculating the asset distribution in accordance with the first paragraph, investments in derivatives shall be calculated as if they were invested directly in the underlying instruments. In accordance with the first paragraph, the asset distribution must be calculated on the basis of the entire ordinary portfolio excluding derivatives.

§ 6. Currency and market distribution

The ordinary equity portfolio shall be invested according to the following currency and market distribution:

The ordinary portfolio may be invested in equity instruments listed on stock exchanges in the following countries and regions:

Total investments in equity instruments in Turkey, Brazil, Chile, China, the Czech Republic, Hungary, India, Indonesia, Israel, Malaysia, Mexico, the Philippines, Poland, South Africa, South Korea, Taiwan and Thailand shall not exceed 5 per cent of the combined investments in equity instruments, measured by currency or market share.

The ordinary fixed income portfolio shall be invested according to the following currency and market distribution:

The ordinary portfolio may also be invested in fixed income instruments issued in the currency of one of the following countries or regions:

§ 7. Interest rate risk

Modified duration on the total portfolio of fixed income instruments and related derivatives shall be between 3 and 7.

§ 8. Credit risk

Finansdepartementet fastlegger rammer for kredittrisikoen i den ordinære porteføljen.

§ 9.

The Ministry of Finance shall nominate a commission which, at the request of the Ministry of Finance, shall provide an evaluation of whether the Fund’s potential investments in financial instruments issued by specified issuers may be in conflict with Norway’s commitments under international law. When requested by the Ministry or the commission, Norges Bank shall secure factual information from the specified enterprises.

The Ministry of Finance may change the Fund’s investment options by excluding financial instruments issued by specified issuers if investment in such instruments may be in conflict with Norway’s commitments under international law.

The commission shall consist of three members and shall be highly qualified in international law.

The commission shall organise secretariat functions. The Ministry of Finance may issue detailed rules for the commission, its activities and its organisation.

§ 10. Risk systems and risk management

Norges Bank shall ensure that satisfactory risk systems and control routines exist for the instruments to be used in the management of the Fund. Derivatives may be used provided that the financial exposure does not exceed the exposure that would have resulted from investing directly in the underlying instruments.

§ 11. Equity ownership

Investments may not be made in such a way that the environmental portfolio and ordinary portfolio combined exceed 3 per cent of the equity capital in a single company or 3 per cent of the voting shares in a single company. Norges Bank shall not exercise ownership rights linked to shares unless this is necessary in order to protect the financial interests of the Fund.

Guidelines for the Government Petroleum Fund’s environmental portfolio

Laid down by the Ministry of Finance on 21 August 2003 with effect from 19 September 2003 pursuant to section 2 of the Regulation of 3 October 1997 relating to the Management of the Government Petroleum Fund.

1. The environmental portfolio is to be established on 31 January 2001, with capital of NOK 1 billion. Changes in the amount invested may be made pursuant to specific decisions. The portfolio forms part of the Government Petroleum Fund and is to be managed by Norges Bank.

2. The environmental portfolio is to be invested exclusively in equity instruments listed on stock exchanges in the following countries and regions:

3. The benchmark portfolio for the Environmental Portfolio consists of those companies in the FTSE indices for the countries listed above which fulfil specific requirements regarding environmental reporting or environmental management systems. Companies that are considered to have little negative impact on the environment are also included, even if they do not comply with the reporting and certification requirements. The British consulting company Ethical Investment Research Service (EIRIS) has been commissioned by the Ministry of Finance to identify these companies.

4. At the time of establishment, the regional distribution of the benchmark portfolio for the environmental portfolio is set at 50 per cent in Europe, 30 per cent in North America and 20 per cent in Asia/Oceania. The country weights within each region are determined by the market value of the companies that fulfil the criteria. Within each country, the approved companies are weighted in proportion to their market value. The regional weights in the environmental portfolio will not be rebalanced, but will vary with developments in market value in the regions.

5. The environmental portfolio’s investment universe and the benchmark portfolio are identical with two exceptions: First, companies that are removed from the benchmark portfolio may remain in the environmental portfolio for a further three months. Second, investments may be made in companies that EIRIS or FTSE has decided to include before the companies are actually added to the benchmark portfolio.

6. The upper limit for the expected tracking error for the environmental portfolio in relation to its benchmark portfolio is 1 percentage point.

7. Norges Bank is to report on the management of the environmental portfolio at the same time as it reports on the management of the Petroleum Fund in general. The Bank shall assist in gathering and processing data for use in evaluating the environmental portfolio after three years of operations.

8. The benchmark portfolio is to be constructed on the basis of the FTSE GEIS (Global Equity Index Series) with sub-indices for large and medium-sized companies, but excluding sub-indices for small companies, and a list from EIRIS of companies that fulfil the environmental criteria. On behalf of the Ministry of Finance, EIRIS is responsible for sending the list of companies that fulfil the environmental criteria to Norges Bank and the index providers simultaneously.

Management Agreement between the Ministry of Finance and Norges Bank

The Ministry of Finance and Norges Bank entered into the following Management Agreement on 12 February 2002

1. The contents of the agreement, etc.

The State, represented by the Ministry of Finance, has delegated to Norges Bank the responsibility for the operational management of the Government Petroleum Fund. The management of the Fund is subject to Act no. 36 of 22 June 1990 on the Government Petroleum Fund with the appurtenant regulations, as well as other decisions and guidelines that have been or may be adopted by the Ministry of Finance. This agreement, together with the regulations and decisions mentioned, governs the relationship between the Ministry of Finance and Norges Bank in connection with the management of the Fund.

All notifications that affect this agreement shall be in writing and signed. Such notifications shall be communicated to Norges Bank Investment Management and to the Economic Policy Department of the Ministry of Finance.

2. Obligations of Norges Bank

2.1 Norges Bank’s responsibilities

Norges Bank shall manage the Fund in accordance with the law, the financial management regulation for the central government, regulations and other decisions and guidelines that apply to the Fund (cf Clauses 1 and 3.1). Matters of special importance shall be submitted to the Ministry of Finance.

Quarterly and annual reports on the management of the Fund, to be drawn up by Norges Bank in accordance with guidelines laid down by the Ministry (cf Section1 of the regulation), shall be approved by Central Bank Audit. Norges Bank shall without undue delay notify the Ministry of significant changes or expected significant changes in the Fund’s assets. Norges Bank shall provide the Ministry of Finance with information as requested by the Ministry, including information in machine-readable form to companies that assist the Ministry in evaluating Norges Bank’s management of the Government Petroleum Fund.

Norges Bank is liable for paying damages to the State for losses arising as a result of negligence or intent on the part of the Bank, external managers or external service providers operating under an agreement with the Bank (cf Clause 2.2, first paragraph of the agreement).

2.2 Management of the Fund

Norges Bank may use external managers and external service providers in the management of the Fund. Norges Bank is party to agreements with such service providers, and shall supervise their activity on behalf of the Fund.

The Ministry of Finance shall be informed of the choice of external service providers of major importance to management and the basis for the selection. The Ministry shall receive copies of the annexes relating to remuneration in new management agreements entered into by Norges Bank with external managers in connection with the management of the Fund. Remuneration to external managers shall be such that the Petroleum Fund retains the major part of increases in the excess return. The Ministry of Finance may require Norges Bank to submit to the Ministry all contracts entered into in connection with the management of the Fund.

2.3 Amendments to regulations, guidelines etc

At the request of the Ministry of Finance, Norges Bank shall provide the Ministry with advice regarding amendments to the framework conditions for management, including regulations, decisions and guidelines laid down by the Ministry. Norges Bank may also submit its own proposals for such changes in the framework conditions as the Bank considers advisable.

2.4 Withdrawal of financial instruments

At the request of the Ministry of Finance or the commission, as specified in Section 9 of Regulation no. 1078 of 3 October 1997, Norges Bank shall secure information about specified issuers, and supply the commission with this information.

If the Ministry of Finance makes decisions to exclude particular financial instruments from the Government Petroleum Fund’s investment universe, Norges Bank shall be given a period of at least four weeks in which to unwind any such positions the Fund might have.

Norges Bank shall notify the Ministry of Finance when a position has been unwound. The Ministry of Finance shall consider whether to announce the assessments of the commission and the Ministry of Finance on a case-to-case basis (cf. the Royal Decree of 30 November 2001). If management considerations indicate the necessity, the Ministry shall endeavour to postpone announcement until it has been notified that a position has been unwound.

2.5 Information

Norges Bank shall provide information concerning the Fund’s management to the public, in accordance with the Public Information Act and the Public Administration Act and detailed guidelines issued by the Ministry of Finance.

3. The obligations of the Ministry of Finance

3.1 Regulations, guidelines, etc

Norges Bank shall have the opportunity to express its view before any changes are made to regulations, decisions or guidelines on management, and shall be notified in due time for changes to be made in the portfolio.

3.2 Remuneration

Remuneration shall be subject to Annex 1 to this agreement. Changes in the method for calculating remuneration for the following calendar year may be requested by either party before 1 December of each year.

Remuneration is drawn from the Fund’s gross return before the net return is transferred to the Fund’s krone account on 31 December of each year. Norges Bank shall submit its remuneration calculations to the Ministry of Finance as early as possible and no later than one week before finalising the accounts.

3.3 Crediting

If relevant, the Ministry of Finance transfers capital from the Treasury to the Fund’s krone account in Norges Bank. The deadline for notifying Norges Bank and the final amount credited in NOK shall be in accordance with the prevailing “Guidelines for rebalancing the Petroleum Fund”.

3.4 Amounts debited

The Ministry of Finance shall inform Norges Bank of any drawings on the Fund in due time for the Bank to make any portfolio adjustments. The Ministry of Finance will inform Norges Bank of the account to which the transfer is to be credited.

3.5 Taxation

The Ministry of Finance shall contribute to providing the documentation necessary to clarify the tax position of capital from the Fund that has been invested abroad.

4. Amendments and entry into force, etc.

4.1 Amendments

The agreement shall be revised when changes to laws or regulations, decision or guidelines so require. This agreement and the annex thereto may not otherwise be amended without the written approval of both parties.

4.2 Entry into force and termination, etc

This agreement enters into force on 1 January 2002. If neither of the parties has given written notification by 31 December in a given year that the agreement is to be terminated as from 31 December of the following year, the agreement will continue to apply one year at a time until such notification is given.

The Ministry of Finance issues further specified rules and instructions in connection with the termination of the management assignment, including severance pay and other remuneration to Norges Bank in connection with the termination. Clause 3.1 applies accordingly.

Annex 1: Remuneration for management of the Government Petroleum Fund in 2003

The remuneration shall cover the costs incurred by Norges Bank in connection with the management of the Fund. However, costs in excess of 10.0 basis points of the Fund’s average market value shall not be covered. Calculation of the average amount shall be based on the market value of the Petroleum Fund’s portfolio measured in NOK at the beginning of each month in 2003. In addition to recovering costs up to the upper limit, Norges Bank shall receive remuneration for the portion of the fee to external managers that is due to the excess returns achieved.