Darryl Murphy looks across the global market to assess the likely drivers of infrastructure debt activity over the coming year.
6 minute read
The infrastructure sector was never far from the headlines in 2018. From Brexit to the collapse of Carillion, the story was an uncertain one – despite relatively healthy transaction activity. The uncertainty is unlikely to disappear in 2019.
Heading into last year, we forecasted strong deal flow in the infrastructure debt market; albeit against an unclear political backdrop. This prediction was borne out with global infra debt transactions totalling $510 billion in 2018, versus $599 billion in 2017.1 What we did not predict, however, were the events that led to a fierce debate over the role of private finance in public infrastructure.
On January 15, 2018, UK contractor Carillion entered into compulsory liquidation. The focus quickly moved beyond the company’s performance and business practices into a wider spotlight on the loss of public trust in the private sector’s delivery of essential public services. This has been particularly focused in the UK on the water utility and rail sector and, more widely, the use of Public Private Partnership (PPP)/ Private Finance Initiative (PFI).
It subsequently came as no surprise in the November Budget to see Chancellor Philip Hammond retire the current model for delivery of PPP in the UK, PF2. What we don’t yet know is what this will mean over the long term, with the Chancellor seemingly open to the PPP concept so long as it addresses the perceived failures of the previous model.
As we enter 2019, the UK and Europe face a defining moment as the Brexit process enters a critical period, with a variety of outcomes still possible. Looking across the global infra debt market, the big question is whether it can continue to perform strongly against increased economic and political headwinds.
The market is showing signs that a correction may be upon us. Public bond credit spreads widened steadily over 2018 and more acutely at the end of the year; conversely, private infrastructure debt pricing tightened over the same period, primarily driven by commercial banks. It is unlikely this inherently negative illiquidity premium will be sustainable in 2019.
It promises to be a challenging year for investors. A combination of abundant demand, limited supply and increased economic volatility is a dangerous cocktail, requiring investors to focus on long-term credit risk and stability to deliver value.
UK: More than just the ‘B’ word
The UK market performed strongly in 2018, primarily due to large financings in the offshore wind sector that accounted for around 40 per cent of the £36 billion of completed deals. However, beyond corporate transactions in public markets, acquisition financings and refinancings of legacy PPP projects, there was a low level of greenfield financing activity. This may explain why the collapse of Carillion was mostly felt in terms of the debate over private finance rather than damaging investor appetite.
July 2018 saw the publication of the National Infrastructure Assessment (NIA), an important piece of work undertaken by the National Infrastructure Commission (NIC) on the infrastructure investment requirements over the next 30 years.2 This assessment received a low-key reception, highlighting the tension between the role of the Infrastructure and Projects Authority in supporting delivery of infrastructure during the current Parliament and the longer-term objectives of the NIC.
The government’s response to the NIA is expected in mid 2019 through a National Infrastructure Strategy, and market practitioners are keen to understand the commitment to infrastructure investment in the short term. The political debate over the delivery of major infrastructure projects remains active given the lengthy delay to Crossrail and the cost overruns facing Transport for London on this publicly-funded project.
TfL is likely to remain in the spotlight through two key infrastructure transactions; the sale and leaseback of Crossrail rolling stock and the £1 billion Silvertown Tunnel. This is effectively a PPP project which, after a lengthy procurement process, is scheduled to close this summer. Two bidding consortia remain, testing both appetite for complex construction risk and the health of the credit market.
Somewhat ironically given the government’s announcement on PPP, the Welsh mutual investment model commences in 2019 with the procurement of the A465 road project, although that is not likely to reach financial close until next year.
Acquisition activity is harder to forecast with no major transactions on the horizon, although the depressed value of sterling may generate interest from international investors for key assets - subject to their confidence in the post-Brexit economy.
In energy, offshore wind deal activity will likely be lower than 2018 but should remain in the spotlight with the third Contracts for Difference auction taking place in May. This is likely to see strike prices below £56 MWh for delivery in 2023-2024, putting pressure on developers to continue cutting supply chain costs and risk allowances while trying to predict interest rates, inflation, currency and the cost of credit in what is set to be a volatile economic period.
A theme developing across Europe is the delivery of zero subsidy onshore wind and solar renewable projects, with the use of long-term corporate PPAs becoming more established or investors taking a view on merchant power price risk. It is clear financiers need to wean themselves off subsidy-based regimes if they are to remain active in these sectors.
Last year also saw the challenge of the capacity market in relation to European State Aid; another development that did not receive much press attention but is significant to many conventional energy projects. While the UK government is expected to reapprove the scheme, it highlights the outstanding challenge to the country’s energy sector in terms of baseload generation and the role of gas. Energy storage remains in development and we do not expect to see any long-term debt opportunities in this market anytime soon.
Another emerging trend is the role of nuclear. The government is due to announce if it will consider the financing of Sizewell C, a proposed nuclear power station in Suffolk, via the regulated asset base model, as used on the Thames Tideway Tunnel project. This could present a major opportunity for infrastructure investors for a project of this magnitude, with financial close targeted for 2021.
The UK offshore transmission market remains the only true pipeline of projects in procurement. This year should see the close of the Galloper and Walney projects and the procurement of Rampion, followed by the commencement of Round 6. This will be watched closely as the licence period is extended by five years to 25 years and the financing requirement increases, which may require a revised approach to the current procurement of financing. Last year saw the public bond transaction for the Dudgeon offshore wind project in Norfolk, albeit at a cost above commercial bank market pricing. As a result, the requirement by the UK regulator Ofgem to hold pricing for procurement periods of over nine months may need to be reconsidered.
Rail faces an important year with the publication of the Williams Review, which should provide clarity on the sector’s future. However, is it unclear whether the impact to the franchising model and Network Rail will be immediate. Consequently, the main source of activity will likely remain in rolling stock with the Southeastern, East Midland and West Coast franchises in competition. While market-led proposals for infrastructure development should progress, direct financing opportunities are not apparent. The recent report on the consultation of the Western Rail Link to Heathrow project concluded a PPP approach should be taken forward, albeit for a scheme not scheduled to close until 2021.
PPP in its broadest form will remain an option, although activity is likely to be more focused on refinancings. The government’s Comprehensive Spending Review due later this year could be a watershed for departments facing a lack of capital; driving a need for a new version of PPP. This is likely to be relevant for social infrastructure investment in prisons, roads, education and health, which could stimulate activity in 2020-2021.
The use of a PPP-type structure is also likely to feature in the regulated utility sector. Examples include the Direct Procurement for Customer model in the water and onshore transmission sectors to replace Ofgem’s Competitively-Awarded Transmission Operator model. These concepts are likely to result in limited opportunities for investors, however.
The coming year is also likely to see a continued focus on emerging technologies. Electric vehicle charging networks, broadband, smart meters, data centres and energy storage facilities will remain important themes. While these areas are unlikely to provide immediate opportunities in the infra debt market, they should have a larger influence in the long run.
Europe: a focus on renewables
Deal activity declined in Europe last year with just over €100 billion of deals compared to €122 billion in 2017; albeit the values were inflated by large corporate acquisition financings, such as the Spanish toll-road operator Abertis.
Activity was evenly spread across the region, a trend set to continue with limited PPP programmes. Road projects will continue in Holland, Germany and Norway, but the main focus will continue to be on renewables, including offshore wind schemes in North West Europe.
Spain firmly re-emerged in 2018 with healthy acquisition and refinancing flows, although the promise of a major new road PPP programme did not emerge due to the change in government.
Primary financings represented only 15 per cent of the overall market last year, with Turkey the main contributor. The lack of greenfield opportunities is likely to continue, with a greater focus on acquisition opportunities, including Orsted’s regulated business in Denmark and the sale of part of Aeroports de Paris. Investors are therefore likely to continue to push into the core plus area with associated debt opportunities in the investment grade crossover market.
North America: fuelled by energy
Canada saw deal activity of around C$47 billion, with PPP representing 14 per cent of the total. The remainder was heavily influenced by oil and gas/pipeline activity.
The Canadian market looks set to generate similar volumes in 2019, with the use of P3 focused in Ontario and selectively in other provinces. The emergence of the Canadian Infrastructure Bank is a potentially significant development, with its focus on financing projects through the private sector rather than taxpayers. The coming year will be important for this new entity now it is fully operational, although the Federal election may impact activity given it has enjoyed direct support from the Trudeau administration.
The US remains the largest infrastructure debt market globally at $150 billion, with the bulk of activity coming from liquefied natural gas, oil and gas and corporate energy financings. P3 accounted for less than four per cent of deals last year, with the one major transaction being the $1.6bn LAX People Mover in Los Angeles.
Rest of the World: Aussie rules
Australia remains at the forefront of activity in the Rest of the World, accounting for USD $41billion of the $139 billion total. The level of activity looks set to continue due to the breadth of investment activity in energy, mining, LNG, PPP and privatisations. There continues to be interest from long-term institutional investors in what has been historically been driven by shorter-term, commercial bank loans.
Elsewhere, Latin America has generated consistent activity – around $40 billion in 2018 – aided by appetite among domestic investors in Chile, Colombia and Peru. This has offset lower investment in the Middle East and North America, which saw $12 billion of deals in 2018. That was almost matched by the $11 billion of transactions in Sub-Saharan Africa, albeit this is a region driven by sizeable investments by multilateral development banks.
1 IJOnline – incorporating all infrastructure debt transactions including corporate facilities