The new company will be 62.5 percent state-owned, though the state is expected to eventually raise its stake to 67 percent.
"The industry faces an increasingly challenging international landscape. To merge now makes perfect sense," said Jan Reinaas and Jannik Lindbaek, the respective chairmen of Norsk Hydro and Statoil, in a joint statement.
Norsk Hydro's share price jumped 23 per cent to $40.47 on the Norwegian stock exchange following the merger announcement. Statoil shares rose nearly 7 per cent.
Statoil's shareholders will own 67.3 percent of the merged group and Norsk Hydro's shareholders 32.7 percent.
Helge Lund, Statoil’s chief executive officer (CEO), is expected to continue in that post for the new group, with Eivind Reiten, Norsk Hydro's CEO, becoming chairman of the board.
"This is the start of a new era. We are creating a global energy company and strengthening Norway's oil and gas industry," Jens Stoltenberg, Norway’s prime minister, said in a statement.
"The government sees the recommended merger as industrially and strategically well founded," he said.
Norway is the world's third largest oil exporter, behind Russia and Saudi Arabia.
But as oil resources deplete on the Norwegian continental shelf, Statoil and Norsk Hydro have turned looked further afield to maintain their independence.
Furthermore, a recent decision by Gazprom, a Russian gas company, to shut out foreign oil companies from the development of the Shtokman gas field in the Barents Sea was a severe blow to the Norwegian companies.
The new entity will be present in close to 40 countries and will have proven oil and gas reserves of 6.3 billion barrels of oil equivalents.
Statoil is based in the western port of Stavanger and employs about 24,000 people in 31 countries.
Norsk Hydro, based on the outskirts of Oslo, employs about 33,000 people in 40 countries. It is the world’s third-largest aluminium producer.