The elephant in the ground: managing oil and sovereign wealth
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van den Bremer, Ton
van der Ploeg, Frederick
Wills, Samuel
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Crawford School of Public Policy, The Australian National University
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Oil exporters typically do not consider below-ground assets when allocating their sovereign wealth fund portfolios, and ignore above-ground assets when extracting oil. We present a unified framework for considering both. Subsoil oil should alter a fund's portfolio through additional leverage and hedging. First-best spending should be a share of total wealth, and any unhedged volatility must be managed by precautionary savings. If oil prices are pro-cyclical, oil should be extracted faster than the Hotelling rule to generate a risk premium on oil wealth. We then discuss how the management of Norway's fund can practically be improved with our analysis.
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Centre for Applied Macroeconomic Analysis Working Papers
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