Let’s call this Musing a discussion of what happens when an already-struggling infrastructure funding model meets a global pandemic and the myriad uncertainties roiling our rapidly changing world.
There are countless casualties of this past year’s epidemic, but one of these should be the dismantling of our illusions about the risks associated with privatized infrastructure, especially toll roads and airports. Highway traffic worldwide has been severely curtailed by government ordered shutdowns, and airline traffic has been decimated. Indeed, the entire transportation sector (airports, car parks, toll roads, rail and other public transport) has been devastated by the pandemic and much uncertainty surround when and how the sector’s eventual recovery will play out. This matters for a host of reasons, but we bring it up here because there is a big bucket of private sector investment money chasing infrastructure assets for their ‘steady-state’ returns and low risk profile, especially as the Biden Administration makes infrastructure a key priority. The characterization of transport infrastructure assets, which private investors have pursued through PPP (public private partnership) and concession structures, as “low risk” might have always been suspect – but the experience of 2020 calls it into stark question.
The traffic numbers for this transport sector asset class are grim. In a mid-year 2020 report on global toll roads, S&P estimated that traffic levels on global toll roads were down 40% - 85% during 2020 vs year earlier levels (depending on regional differences), and separately estimated that air traffic declined by 55% - 70% during 2020. Moreover, while road traffic is recovering faster than airline travel and could return to 2019 levels by 2022, S&P estimates that air traffic will still be down 40% - 60% in 2021, with recovery to pre-pandemic levels delayed until 2024. Additionally, unlike many other disasters, insurance carriers have thus far generally maintained that business interruption insurance coverage does not apply to the impacts of the pandemic, thereby cutting off a critical income recovery avenue for privatized transport infrastructure entities.
Clearly the pandemic lockdowns have hit these assets on an unprecedented scale. But we also need to be clear-eyed about what the past history has really been, and what the future might look like. Australia’s 4-D Infrastructure wrote in an April 2020 article titled “Global Listed Infrastructure – Buy Time Looming?” that infrastructure is a “defensive asset class” with “generally lower volatility of earnings and higher yields than broader equities”. They divide infrastructure into “essential services” which include regulated utilities in the power, gas and water space (which they assert are typically “immune to economic shifts”), and “user pay” assets which are positively correlated to GDP growth and include airports, toll roads, rail and port assets where consumers pay for use. What we have seen this past year is the dramatic impact of the pandemic on these “user pay” assets where, most often, returns are based on tolls which have largely evaporated and will very likely take years to recover.
In fact, there is a real chance that a return to the prior version of “normal” isn’t in the cards at all, as the world adjusts to the complexities of new lifestyle and technological disruptions that go far beyond the pandemic. These disruptions could dramatically impact assumptions about the value and utility of infrastructure assets. Consider what it means for traffic patterns and transit system utilization if we learn to work more from home, if ridesharing replaces car parks and private cars, if autonomous cars allow for much greater traffic density, if more meetings are virtual thereby decreasing business travel needs, if shopping increasingly goes on-line, if 3-D printing decreases the need for freight movements, and as air travel is less essential and even stigmatized for its carbon footprint. Even assuming we return to a pre-Covid “normal”, waiting another year or three is a long time for projects dependent on toll and traffic revenues, and these other disruptive trends will be lurking all the while.
A closer look at the issues facing transport-sector infrastructure projects during this pandemic indicates that while extreme, the challenges for private investment in this sector have been brewing for decades. A 2014 StreetsBlog article looking at “The Indiana Toll Road and the Dark Side of Privately Financed Highways”highlights the history of toll road failures in the United States, noting that the 2014 bankruptcy of the $3.8-billion Indiana Toll Road (ITR) was ”just the latest and largest in a crop of privately owned tollway failures that now litter the land…including other privately financed toll roads that have filed for bankruptcy protection” including San Diego’s South Bay Expressway, South Carolina’s Southern Connector, the Alabama and Detroit roads owned by American Roads the SH-130 outside Austin and the restructured Northwest Parkway between Denver and Boulder. Moreover “[b]ankruptcy or default won’t necessarily eliminate the risk of a public bailout. The 12-year-old Pocahontas Parkway outside Richmond failed twice” largely because “projected sprawl in its vicinity just never materialized”. Reasons for these failures are described by various observers, including by StreetsBlog, by the Congressional Budget Office (CBO) in a January 2020 report on Public Private Partnerships, and by the Organization for Economic Development’s International Transport Forum (OECD/ITF) in a 2019 report on the role of private investment in transport infrastructure. All generally conclude core problems with these projects include: 1) politics that frequently delays the development process; 2) opaque contract agreements; 3) poor execution performance and conflicting project objectives; 4) profit strategies on the part of the private investor based on fees unrelated to the actual performance of the infrastructure asset; and 5) faulty assumptions about traffic and the real performance expectations for the asset.
Yet this reckoning with the challenges of private investment in transport infrastructure comes just as the new U.S. Administration and governments around the world are promising a major new infrastructure boom. The Economist, in its current (January 2, 2021) edition, points out that the U.S. President-elect, Joe Biden, has a program to spend $2-trn on infrastructure, while the European Union has pledged €750-bn ($918-bn), China has pledged 10-trn yuan ($1.5-trn), and various Latin American and other Asian governments have also announced plans for new infrastructure projects.
In the US, this investment will take two forms: fast-tracking maintenance and upgrade programs that are shovel-ready and will therefore kick-start immediate jobs programs (e.g., tackling the backlog of bridge and highway repairs); and spending on new capabilities (likely to include a host of green/renewable energy projects, broadband expansions, data centers, electric transport and new transit programs). The article quotes the Global Infrastructure Hub, a unit of the G20, which assesses that the world will need $82-trn of investment in infrastructure, in 2015 prices, by 2040, but will likely fall far short of being able to muster that investment total.
Can private capital fill the investment gap? Here’s that The Economist says: “Some hoped institutional capital could plug the gap. Worldwide, over 16,500 private infrastructure transactions have closed since 2015, with a big chunk done through specialist funds. These have raised $710-bn since 2008, according to Infrastructure Investor, a trade publication. A record $220-bn is still unspent”. One of the problems with this strategy, though, is that most private investors prefer acquiring existing assets to building new ones, and thus “secondary deals have made up four-fifths of the total value of their infrastructure transactions in recent years”.
Private capital remains important, but clearly this limits private investment’s usefulness for new infrastructure project delivery. So, after a robust launch, The Economist comments, “PPPs have fizzled. When these took off in the 1990s, they were seen as offering the best of the public and private worlds. As investors put up the cash, governments did not need to fork out capital upfront, yet could still regulate the service and gain control of the assets at the end of the contract. Outside expertise, it was hoped, would lead to speedier execution. Investors, for their part, would gain from the state’s ability to bear big risks, through subsidised insurance…Yet in Britain, the birthplace of the idea, the value of new PPPs fell to next to nothing in 2017. Even India, the world’s top recipient of private investment in PPPs in 2008-12, has hit the brakes... Worldwide, private investment in new PPPs fell to $30-bn in 2019, from $55-bn in 2010.”
There will continue to be a big and important appetite for private investment in telecoms, data centers, green energy, water and many other infrastructure asset classes. But it is highly likely that the 2020 Covid experience, with its cratering transport traffic numbers, as well as the dubious recovery trajectory, will cast further doubt on the already struggling PPP formula for transit – causing further erosion of private investment in roads, airports and the like.
And the challenge isn’t just around the transport sector and the pandemic. The kinds of technological, economic and even regulatory disruption or obsolescence we mentioned earlier can impact all sectors. The fossil fuel industry has been massively impacted by regulatory change and CO2 emissions restrictions. Electric power producers and utilities have been disrupted by new renewable technology, distributed power networks, deregulation and grid management changes. Customer preference can change rapidly. Gas utilities are under pressure in cities which are prohibiting new gas line extensions. We have mentioned airport and highway disruptions, but city transit systems are also being impacted by ridesharing and altered commuter patterns. Malign actors are impacting systems as well, with “hackers” disrupting internet and industrial control systems in ways that threaten the viability and continued operation of vast networks. And then there is climate change and the environmental issues that projects will face, from flooding to wildfires, community relocation, increased weathering and the host of other impacts.
This level of risk and uncertainty around what we have regarded as “safe” long term investments needs to be considered carefully. There is tremendous value that the private sector can bring to infrastructure funding, design and project execution, and efficiencies are badly, even desperately needed. But how can private investors balance this more volatile future where it no longer feels comfortable to just “sit on an asset” and assume that the future will mirror the past. We suggest that investors in projects:
Need to be ever more alert and implement methodologies and systems to track and constantly evaluate this in all aspects – technological, competitive, economical, customer preferences, political and regulatory etc.
Consider and understand all insurance and financial implications. Fund managers (who have been masters at financial engineering) need to become masters of a broader skill set dealing with the unknowns and volatility of these businesses in the future – and they need to think much more about a broad range of changes that could impact their assets going forward, and how these can be insured and mitigated. The world will be much more complicated. Post pandemic is one of the issues – but there are others, including system hacking, natural disasters and climate change
Where possible, invest in things that are perhaps smaller to start, more modular, adaptable to changing circumstances
Always be on the lookout for mergers, acquisitions, project adaptations and enhancements, financial restructurings, competitive strategic moves and profitable exit or partnership opportunities. Should you plan to not stay in an asset for as long as previously expected? How can you position yourself to be ready to address these considerations? What can you do to combine or merge with other businesses to prepare for future risks and change? All of this should be on the table
2020 and the global pandemic may have brought the challenge for private infrastructure into stark relief, but it likely only did what Richard Haas talked about in his article “The Pandemic Will Accelerate History Rather Than Reshape It”. Assumptions about planning, volatility, and long-term trends for infrastructure were due for significant rethink anyway. How we build, where we build, the life of these assets, technology disruption risks, and how they can be financed all needed serious reconsideration. The pandemic has accelerated this conversation, but it was due regardless.
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