Aviva Investors’ Darryl Murphy dissects the key trends keeping infrastructure managers occupied as we move into the new year.
Covid-19 has fundamentally altered many aspects of our society, and indications from the government are that private sector funding will be needed to build a new green economy.
The National Infrastructure Strategy sets out an ambitious vision. The devil will be in the detail on how the strategy is delivered — a strategy is worthless unless it can be executed
But with the nation’s recovery from the pandemic anything but certain, along with other market threats still lingering, certainty is a hard thing to come by in any asset class.
It is too early to predict how 2020 will shape the UK infrastructure sector in the long term. But we see five key themes that are likely to shape the market in 2021.
Recovery from Covid-19
The government sees infrastructure as a key part of the post-Covid recovery. The prime minister made several speeches in 2020 supporting infrastructure investment, along with the announcement of a 10-point plan for a green industrial revolution.
The National Infrastructure Strategy sets out an ambitious vision. The devil will be in the detail on how the strategy is delivered — a strategy is worthless unless it can be executed.
The NIS signposts a long list of sector strategies, as well as the imminent release of an energy white paper, which will set out the government’s energy policy. One key theme is the support for private investment to meet the vision — this is welcome after the negative feeling towards private infrastructure investment prior to the 2019 election.
The transport sector will continue to present challenges, although the rollout of vaccines will hopefully lead to a resumption of business and leisure travel. The forecast for airports suggests a long path to recovery.
At that point, companies may look closely at their assets’ balance sheets, which may result in refinancings and even opportunistic sales for investors willing to take a longer-term view.
Birth of the NIB
The NIS included the long-awaited announcement of the National Infrastructure Bank. More detail is expected in the spring, including how it will be resourced.
It will be important for the government to demonstrate the NIB is truly aligned to the crowding-in of private sector capital.
The NIB may serve an important role in encouraging new technologies by providing early-stage development capital.
Post-Brexit, the most important challenge for the NIB will be to navigate the state aid rules that historically stifled similar investments from the Green Investment Bank and wider use of the UK Guarantee Scheme.
Net-zero gets real
The vast investment required to meet the UK’s target of net-zero carbon emissions by 2050 begins in earnest in 2021. The energy white paper will be accompanied by other strategies, including initiatives focused on hydrogen, heat and buildings, and electric vehicle charging. These will be important milestones as we head towards COP 26 international climate talks.
Nascent technologies will continue to attract attention, but investment opportunities will remain limited. We may see nuclear re-emerge with a regulatory asset base model, which will require private investment. The key for many projects will be how the NIB combines with government policy to encourage private capital.
Mainstream renewables will also return to the spotlight through the fourth ‘contracts for difference’ auction. The target of 12GW of generation could lead to a large amount of investment opportunities, albeit in 2022.
Fibre 2.0
The hottest sector of 2020 was fibre-to-the-home, with several corporate sale processes taking place along with debt raising. Appetite for the sector remains high.
Substantive activity could emerge via consolidation and larger-scale financings for mature businesses. The government target of 85 per cent gigabit-capable coverage by 2025 should help to stimulate greater investment.
Regulation to change competitive landscape
The NIS promises an overarching policy paper on regulation in 2021, which will look at whether regulatory models need adjustments to meet the changing needs of the regulated utility sector — not least their role in the pathway to net-zero.
We are also seeing the emergence of the first direct procurement for customers regime in the water sector, with the first scheme, Haweswater Aqueduct for United Utilities, entering the bidding phase in 2021. It will be interesting to see how this model develops as a hybrid between a corporate public-private partnership with a water company and an extension of financing for a water company outside of the Regulated Asset Base model.
More work needed to make ESG meaningful
Scarcely a week passes without an announcement of a new environmental, social and governance-oriented venture. But experts warn more needs to be done if onlookers are to be confident that words have meaning.
The Early Competition Plan for onshore transmission has entered its Phase 3 consultation. The model proposes a move to competitively procured models for discrete parts of the network, although the first transactions may not emerge until 2023. These examples illustrate regulators’ desire for greater contestability within existing models.
More mature Offshore Transmission Owner processes will continue, with the expected financial close of Hornsea, the selection of a preferred bidder on East Anglia, and the commencement of the next round of bidding for two more assets. We are also likely to see the first project-financed interconnector project, supported by the Ofgem cap and floor mechanism.
Infrastructure will play a key role in the recovery from Covid-19. But while the sector enjoys government support, investors need to remain agile to find opportunities that meet their risk and return profiles.
Darryl Murphy is managing director of infrastructure at Aviva Investors
