Hard Natural gas Lessons

Jan Dwarshuis, Senior Asset Manager at Thirteen Asset Management AG

Jan Dwarshuis, Senior Asset Manager at Thirteen Asset Management AG, gives us insight in the Dutch natural gas industry. He highlights several developments and options we have within this sector.

Hard Natural gas lessons
Pfäffikon SZ, Switzerland – Over the course of the years Dutch natural gas has been a hot topic. The wealth the Netherlands has obtained is, amongst others, due to its fifty years of natural gas revenues. In sum, the Netherlands has earned over € 265 billion in natural gas revenues. However, the Netherlands decided to not save these proceeds but spend them immediately. In particular in the beginning years it leaned heavily on these revenues. Up to 1994 these revenues flowed into the resources of the State without a specific destination. I have a bad feeling that a lot of that money, at that time, drained to expensive left hobbies.

Between 1995 and 2010 the policy became more careful and a quarter of the proceeds flew to the Fonds Economische Structuurversterking (FES). The money in this fund was mainly spent on infrastructure, knowledge and innovation. The FES served as a sort of key fund. According to the Rekenkamer, 33 billion in total has flowed to the FES, of which 26 billion originated from the natural gas revenues. Approximately 80 percent of these resources have been spent on projects regarding infrastructure, for example the Betuwelijn and the Hogesnelheidslijn.

From 2011 onwards the natural gas resources were thrown on a large pile. In 2015 a futures fund will be created where only 100 million of the natural gas proceeds will end up in. Recently, the Rekenkamer sketched three interesting future scenarios involving the destination of the natural gas revenues. The first option being a familiar one, namely to add them to the general resources pile. The second option is creating a share fund based on the model of FES that was reasonably successful. The third option is creating an equity fund of which part of the proceeds would flow to the treasury yearly. Of course it is also possible to mix these options.

Rich pension fund
The Netherlands has a rich and successful history with regard to the saving of pension money. The Dutch pension funds are still considered one of the richest in the world. This is one of the reasons that the Dutch pension industry has a couple of excellent managers and investors at its disposal that manage its money. The Netherlands was one of the founders of the current pension system that, at that time, was seamlessly adopted by Norway. According to the Rekenkamer, the Netherlands, at the moment, should have approximately 350 billion in their register if the natural gas proceeds would have kept flowing to a comparable state fund. Next to that, 4 percent of the funds capital would have flown to the general resources yearly. This would have led to approximately 13 billion in revenues over the year 2013.

I would like to note that, in that time, Norway adapted a more rigorous approach. The proceeds from all natural energy sources there have flown to a state fund. Whether this is a coincidence or not, but from this year on theoretically each Norwegian is a millionaire measured in their own currency. The Norwegian state fund owns approximately 1 percent of all possessions in the world, which has been built carefully throughout the years. Whether it concerns shares, obligations or property, you will definitely find the Norwegian state fund as a co-owner. The expectation is that in 2020 the fund will pass the magical number of 1 trillion in invested capital. Yearly 4% of the state fund flows into the Norwegian treasury. Whereas significantly high state debts are in the news daily, Norway forms a remarkable exception.

The Dutch culture has changed a lot over the years. Undoubtedly, this change is related to the changed composition of Dutch society. Whereas in the past the Netherlands was best known for her frugality, right now the country is mortgage debt world champion. More than a third of the Dutch houses have a mortgage that is higher than the fair value of the underlying dwelling. Even a student in the Netherlands is raised directly with debt. I have been living in Switzerland for a while and I see big differences with the extremely cautious and conservative Swiss in this area. The Netherlands, therefore, are faced with a mindset that is completely driven off financial reality. Politicians contribute to this on a daily basis by encouraging debt fiscally in many ways. Slowly, generation to generation has created an image that debts would be good for you. The reality is unfortunately more obstinate.

Sustainable solution
When asked what the Netherlands should do with the natural gas revenues from today, my answer is simple. First of all, I believe that the gas bubble should be very carefully dealt with. A good option is to simply sell no more gas. The advantage of such a scenario is that the value of the gas reserves will increase over the course of the years, as natural gas becomes scarcer. Politically, however, this will very likely be infeasible, since politicians generally have a fairly short horizon. Next to that, the Netherlands has made agreements to supply gas to several countries. The only other option that remains is to apply the knowledge gained in the management of pension money to the natural gas revenues. An attractive and sustainable solution for the Dutch government is to seek substitution for the natural gas revenues, even though they are a smaller part of the total budget of the Dutch government as a percentage than was previously the case.
Factor Compounding
The success of APG (including the previous ABP) is mainly due to a careful investment policy in which the factor ‘compounding’ has done its job well. I do note that Mr Lubbers and Mr Balkenende had substantial amounts transferred from the pension funds. The factor ‘compounding’ has grossly been interrupted by the two men, which still leaves its traces in terms of coverage ratio. Recently, Lubbers freely admitted that it had been a big mistake to grab money from the pension funds. It painfully shows that the knees of seemingly respectable politicians are very weak when it concerns large sums of money. Precisely from someone like Lubbers I had never expected such a thing. Especially with his Rotterdam background, he should have known better.

Dissipating no option
Anyway; apparently politicians do have mastered this discipline in Norway. The Norwegians understand better than anyone that the natural resources will be depleted one day. Dissipating is not an option for the Norwegians. In addition, the Norwegian is not selfish and thinks about the next generations. An additional advantage is that the Norwegians are less affected by fluctuations in global commodity markets. The Norwegians have laid a solid foundation which can last from generation to generation, if not infinitely.

The Netherlands are therefore facing an important choice. Sooner or later the global interest rates rise again. At this time, the Dutch government finances debts at virtually zero percent interest or sometimes even receives money. This is unprecedented and flawlessly shows that we are living in exceptional financial times. No one knows when interest rates will rise. However, when they are going to rise, the Netherlands will face a sharp rise in its interest bill. The highly increased government debt will be a heavy burden for the Dutch state budget.

Partly because of that, it is crucial that the Netherlands will build substantial financial buffers. With the proceeds from natural gas it is probably the last chance for the Netherlands to do so decently. Politicians should realize that, with prudent management, the Netherlands can benefit from the natural gas revenues for hundreds of years in the future and also find a solution to the dwindling revenues from the waning gas bubble. Let them especially learn from the hard natural gas lessons and use the natural gas revenues carefully and sustainably according to the Norwegian model.