By Balazs Koranyi and Joachim Dagenborg
OSLO (Reuters) - Norway's Conservative leader Erna Solberg said she would form a minority cabinet with the populist Progress Party after talks with two centrist parties broke down on Monday, giving ground on oil exploration and immigration.
Solberg agreed to give up plans to drill for oil in several promising Arctic areas and also agreed to tighten asylum policies to win the support of her eventual coalition partner and the outside backing of the centrist Liberals and Christian Democrats.
"We were very close to finding good solutions... This is the second best option," said Solberg, who is set to become Norway's second female premier after winning elections earlier this month. "This is not the end of cooperation between the four parties."
She now faces a difficult alliance with the right wing, anti-immigration Progress Party, which will enter government for the first time. Since it was founded in 1973, and until now, mainstream parties had considered it too radical for power.
"We can't hide the fact that we are very pleased with the immigration issues here. We have got a fairly strong tightening," said Progress leader Siv Jensen, who is likely to become finance minister when the government takes office Oct 18.
Progress, whose members once included mass killer Anders Behring Breivik, has toned down its policies in recent years and moved closer to the centre, but still faces criticism over its radical spending and tax proposals and warnings about a "creeping Islamification" of Norway.
New immigration rules agreed on Monday could increasingly differentiate among asylum seekers, making it easier for the government to forcibly return people. However, the changes will not affect immigration from the European Union, which accounts for the vast majority of migration to Norway.
Progress has also won concessions on pensions and road building but agreed to back the current budget rule that sharply limits how much of the lucrative oil revenues the state can spend.
"When you have a majority in parliament, and still end up forming a minority government, then that's a defeat," Frank Aarebrot, a political science professor at the University of Bergen said. "This government will be considerably less stable than if they got all four parties in there."
The oil industry, which accounts for a fifth of the country's economy, quickly denounced the deal, with the Norwegian Oil and Gas Association, an industry lobby, calling the decision to prevent drilling in some new areas "disappointing and undemocratic".
Waters off the Lofoten islands are thought to hold around 1.3 billion barrels of oil equivalents while Jan Mayen, a speck of uninhabited land north of Iceland could contain some 566 million barrels of oil equivalents.
With fields maturing in the North Sea, the industry needs new areas to explore and oil firms argue that these areas are vital to maintaining the sector, Norway's lifeblood for decades.
Still, a minority government does not mean automatic instability as Norway, like neighbours Sweden and Denmark, has a long tradition of well functioning minority governments.
Laws do not allow for early elections and parties have developed a culture of cooperation even in case of major policy differences.
In the case of minority governments, negotiations over policy are moved into Parliament and deals are often made in the public eye instead of cabinet rooms.
(Additional reporting by Terje Solsvik and Alister Doyle; editing by Ralph Boulton)