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Focus on ESG has weakened the NOK

Focus on ESG has weakened the NOK

Has the oil price become a less important determinant for the NOK? Many think so due to developments especially during 2017-2018 when the NOK depreciated despite higher oil prices. We suggest that the NOK was adversely impacted by the growing awareness around ESG but that the link has come back to life as the ESG factors may have been baked into today’s stock prices.

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The oil price is a well-known key determinant for the NOK. A higher oil price contributes to a stronger NOK at least through two channels: 1) A positive shock for the economy, which improves Norway’s terms of trade and wealth; 2) Increased attractiveness and value of oil-related stocks. Foreign investors are then more likely to purchase Norwegian oil stocks and in the process buy NOK.

However, our long-trusted empirical model for EUR/NOK, with the oil price and interest rate differentials as explanatory factors, broke down in 2017, see chart A. That something happened is clearly visible also from chart B, which shows the correlation between oil prices and EUR/NOK. Prior to 2017 and from 2019 onwards, there is a clear negative correlation; a higher oil price goes hand in hand with a lower EUR/NOK. For a brief period, however, from late 2017 to late 2018, this correlation became positive.

In our search for an answer to this puzzle, we think that the ESG wave has likely had an impact on the NOK.

Find out more about the Norwegian economic outlook in this article from the Nordea Economic Outlook: Unrestricted Growth.

ESG focus has led to a permanently weaker NOK.

Kjetil Olsen, Nordea Chief Economist, Norway

Charts showing the link between ESG and NOK

In recent years ESG factors have become more important for investors. For many, oil-related companies have become unattractive. The growing importance of ESG investing has resulted in a decline in the market value of oil stocks relative to the market value of other (cyclical) stocks  beyond what can be explained by the oil price itself, see chart C. This decoupling between the market value of oil stocks and the oil price started around the same time as the link between the NOK and the oil price broke down. This could partly explain why a regression model with only interest rate differentials and oil prices does a poor job of explaining the EUR/NOK development after late 2017. When including the market value of oil-related companies relative to the market value of other companies, we see a clear improvement where our new regression model explains most of the movements in EUR/NOK, see chart A. As ESG factors may have been baked into today’s stock prices, the relationship between oil prices and the NOK seems to have been re-established, but at a possible permanently weaker level.

 

This article originally appeared in the Nordea Economic Outlook: Unrestricted Growth, published on 11 May 2021.

Authors:

Kjetil Olsen, Nordea Chief Economist, Noway
Kjetil Olsen, Nordea Chief Economist, Norway

Dane Cekov, Nordea Analyst
Dane Cekov, Nordea Analyst

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