Category: Infrastructure

 

I very much welcome the final regulations for the NEPA rules governing environmental approvals for infrastructure projects.  Now the environmental review process will no longer take 15 years, and will be approved or denied within two years. With 500 shovel ready projects we now need to ASAP get moving. An impediment is that we don’t have a nation wide consensus on project risk sharing between federal, state and local governments and the private sector. Simple issues such as deciding between contracting out, PPP or just outright privatization result in mind numbing debates and drag on. The Trump administration should tackle this heads on.

 

#ActiveAllocator Opinion – We strongly advocate that where possible the private sector works hand in hand with the public sector to deliver infrastructure projects. Significant policy work still remains to be done in most countries to expand private sector involvement in infrastructure, although many governments are increasingly focused on advancing such policies.

Governments have historically used bond financing, custom lease structures, special tax districts, tax incentives and credits, as well as usage fees, to facilitate funding of infrastructure projects. They are now increasingly turning to private capital to supplement or replace public financing. This trend began in Australia and the U.K. and carried over to Canada and continental Europe. It is now becoming increasingly important in the U.S. Significant policy work still remains to be done in most countries to expand private sector involvement in infrastructure, although many governments are increasingly focused on advancing such policies. For example, in the U.S. a number of drivers are catalyzing increased private sector involvement. They include, among others, (i) funding shortfalls at each level of government caused by limits on tax increases and available debt; (ii) divestitures of existing infrastructure assets to raise capital for new investments; (iii) initiatives to obtain private sector management and technical expertise to improve service efficiency; (iv) enactments of favorable PPP legislation by federal and state governments; and (v) availability of debt and equity financing from private investment sources.

 

With few exceptions, under investment in infrastructure has been a global secular trend. In some instances the true economic cost is not passed on to consumers. In these situations, under-pricing tends to be subsidized by the government, which results in pressure on government finances. The cumulative adverse impact is under investment, lagged maintenance and inadequate infrastructure replacement. This in turn slows development, erodes productivity, and in some cases results in shifts of populations and industries to more infrastructure efficient geographic areas. Estimations and methodologies to determine infrastructure funding needs differ due to varying definitions of infrastructure as well as the level of subjectivity involved in assessing the need to renew, maintain or to add to existing assets. The market for private investment in public infrastructure is expected to continue to grow in size, sophistication and opportunity. Private investors recognize this trend and have begun to raise dedicated infrastructure funds to address these opportunities. These infrastructure funds bring together capital from a variety of investors and allow for efficient deployment of equity capital.

We strongly advocate appropriate sharing and retention of risk between the private and public sectors in infrastructure projects. PPPs can take a wide variety of forms with varying involvement of the private sector and with varying degree of risk transfer from government to the private sector. Properly implemented, PPPs and PFIs transfer risk from the public sector to entities that may be better qualified to bear it as well as be better qualified to reduce costs and create better service delivery outcomes. It also frees government resources and public funds to address pressing social problems or to develop projects that are less attractive to private investors. Issues that inevitably feature in policy discussions relate to economic transfers and distributional effects, e.g., who benefits and at what costs to others, rents, accountability, regional development, jobs, prices and tariffs.

WSJ June 24, 2020 article “AbuDhabi Gets $10 Billion Deal”

We see this infrastructure deal as midstream transportation and hydrocarbon handling and transportation. It is a typical gas  pipeline deal that uses a “toll-road” or “fee-for-service” business model to handle, process, and trans-port oil, gas, gas liquids, and refined products.

#ActiveAllocator Opinion – We strongly advocate  both greater upfront as well as ongoing risk analysis to catalyze infrastructure development. The fundamental drivers of infrastructure revenues are changes in macroeconomic factors such as GDP and demographic trends. Growth in these factors increases usage-based revenue and positive cash flows for these assets. Infrastructure assets typically feature a set of common attributes which provide for defensive investment characteristics.

There are three key criteria that dictate the risk/return characteristics of infrastructure to a large extent:

Stage of Maturity

Investment in assets under construction is riskier than completed assets; investment in newly completed assets with no operating history (including usage) is riskier than investment in mature assets with established operations and usage history.

Geography

Political risk in developing countries is a key consideration given the essential nature of the assets to the local economy, the long life of the assets and the fact that they cannot be moved, making them vulnerable to expropriation. To mitigate this risk, many investors target only developed countries or developing countries with robust legal frameworks, particularly with respect to property protection and contract enforcement. The long payback period also increases the probability that an investment may be adversely affected by a period of severe economic instability (e.g., government default, hyperinflation). In compensation, many emerging markets are enjoying significant economic growth, which has strong direct benefits for infrastructure businesses.

Sector Scope

All else being the same, infrastructure businesses whose revenues are not subject to price and/or volume variations are less risky than those that are. Some social infrastructure PPP companies (e.g., for hospital facilities) may be paid by the government on an “availability basis,” e.g., revenue is independent of usage and the service is compensated at a fixed price, with deductions only for poor service. Where there is volume risk, this may be mitigated by the nature of the service (e.g., provision of water to a given area) and/or by the monopolistic nature of the asset (e.g., being the only airport for a major city). Price risk may be mitigated by regulation that periodically determines price to provide a certain return on capital (e.g., for utilities) and/or by fundamental demand (e.g., for a toll road for a major corridor). To the extent that price and volume risk is not significantly mitigated, the asset may not be considered to be “infrastructure” for investment purposes. For example, power generators that sell electricity into a market at spot prices (e.g., it is “merchant” generation with no long-term power purchase agreements) is considered ineligible by many infrastructure investors.

We strongly advocate that government needs to develop a complete portfolio level picture of infrastructure needs rather than one off projects driven by political interests. It needs to figure out financing sources and funding. It also needs to bring in granular project management expertise and put in place appropriate structures, practices , systems, accountability and controls to ensure prioritized execution.

 

Governments have historically used bond financings, custom lease structures, special tax districts, tax incentives and credits, as well as usage fees, to facilitate funding of infrastructure projects. They have also increasingly turning to private capital to supplement or replace public financing.  Multiple drivers are catalyzing increased private sector involvement. They include, among others, (i) funding shortfalls at each level of government caused by limits on tax increases and available debt; (ii) divestitures of existing infrastructure assets to raise capital for new investments; (iii) initiatives to obtain private sector management and technical expertise to improve service efficiency; (iv) enactments of favorable PPP legislation by federal and state governments; and (v) availability of debt and equity financing from private investment sources. Government has a huge role to catalyze infrastructure development that goes far beyond traditional projects and financing.

 

 

 

Infrastructure has traditionally been under the purview of governmental bodies. Its importance from a public interest perspective cannot be overstated. For several reasons, there has been globally widespread historical under-investment, resulting in degradation of existing assets with simultaneous failure to add new capacity. As this issue is unlikely to reverse course any time soon, forward thinking countries and government entities have sought to encourage convergence of public and private sector activity. Their aim is to help the creation of economically viable new infrastructure assets and upgrade, properly maintain, manage and operate existing ones.

Formal contracting structures through active PPPs supported by recent government initiatives have made progress in encouraging private capital investment in infrastructure. A lot still remains to be done. Despite where they stand in the different stages of the privatization process, the collective market opportunity in developed countries remains substantial. These opportunities are in civil aviation, bridges, roads, mass transit, railways, greenfield and brownfield projects, dams, water, waste management and energy.

#ActiveAllocator Research – WSJ Wed, June 17, 2020, B11  today has a piece “Construction Shares Leap Amid Optimism On Infrastructure Bill”. While President Trump has long called on Congress to allocate big to infrastructure in coronavirus aid relief packages we remain pessimistic that such a bill will be passed in 2020. Infrastructure as a sector can absorb huge amounts of capital, can  facilitate the growth of businesses, promote trade and enhances economic welfare by improving access to vital resources.