UK Infrastructure - assets recycling, pricing and deal flow

The Treasury’s latest National Infrastructure Plan (NIP) report, published in December 2014, puffed the Government’s ‘long term economic plan.’  Big numbers and a long list of big projects in transport, utilities and housing were the order of the day.

According to the report, the refreshed infrastructure pipeline ‘sets out over £460bn of planned public and private investment to the end of the decade and beyond, with £55bn of investment (including £12bn oil and gas) is planned for 2015-16 alone and over £320bn (including £53bn oil and gas) up to 2020-21.’

After being accused of being too slow to press the infrastructure button in the early years of the Coalition administration, the Treasury is keen to make up for lost time, noting that average annual infrastructure investment is 15% higher in this Parliament than it was in the previous Parliament, and that since 2010, over 2,500 different infrastructure projects or schemes have been completed.

At face value this is all good news, but there remains a political overhang. However, three policy changes – asset recycling, adjustable pricing and dealflow – could remove that overhang and deliver a significant enhancement to the UK’s infrastructure programme.

Western Governments, including the UK, have the financial firepower to take risks, for example the construction of HS2, that private investors simply cannot, but once these projects are built the Government hands off operational responsibility by selling the management of the completed asset to private investors, taking money out to be re-cycled for further investment. This model has proved very successful in Australia, where by and large “asset recycling” has resonated with politicians and the electorate. Asset recycling uses proceeds from the privatisation of an infrastructure asset to fund the development of new infrastructure assets, often benefiting the communities that might be affected by the privatisation.

Secondly, and in the UK, despite the Government’s long menu of projects, critics argue that the kind of assets appropriate to pension funds and similar institutional investors are not readily available. Pension funds need secure, long-term, contractual, inflation-linked income flows, avoiding construction risk, and while there are some opportunities in the secondary market, that is a crowded field. There is certainly a dearth of new deals coming on stream but what about pricing?

Take the privatisation of the Post Office, for example. A high profile transaction, the risk of reputational damage was high for both Government and the investment community, and so it proved, thanks to the tricky task of setting the right price. Sell too cheap, and the Government (as was the case) receives a bloody nose, but too high a price creates a struggle to get the sale away. Moreover, in the case of the Post Office, the investors were hammered for using a much loved public institution to line their pockets at the expense of the taxpayer. Bad PR for all parties.

So pricing models must avoid the industry cutting its own [reputational] throat, and give politicians adequate air cover. Would it be possible to use self-adjusting pricing as a solution? If an asset is sold at, say, £3 per share, yet climbs in value to £5 per share and stays there, adjustable pricing would enable the Government to claw back a proportion of the excess value. And if the worm turned, and the asset value dropped from £5 to £3 per share, the investors would receive appropriate compensation.

There are problems with this approach: You can’t buck the market, natch. An asset is worth what it is worth, and furthermore it would be hideously complicated to concoct adjustable pricing formulas to cover issues like force majeure, for example.

The Post Office illustrates that pricing needs attention, maybe. But pricing doesn’t matter if there are no deals to be done. Developers and financiers want certainty of pipeline. A pipeline that is sporadic or uncertain (for example as a result of policy changes), will encourage investors to go to other parts of the world where there is certainty that projects will get off the ground during the next five-ten years.

In the so-called ‘noughties,’ PPP emerged in the UK as a model that encouraged investment, not least because the Government was firmly committed to the concept and gave it full support. More recently, the PPP tap has been turned off, and the financiers and developers we need in the UK have moved to deploy their capital elsewhere, for example to Brazil, India, parts of Africa and other emerging markets where Governments have woken up to the infrastructure and privatisation opportunity. Once that money has gone, it is hard to bring back, so the Government must be prepared to turn the tap back on and keep it on if it wants its infrastructure programme to succeed.

De-risking political and reputational risk from asset sales is manifestly a ‘good thing,’ and would obviate a significant barrier to further asset sales. In Australia, enlightened market-oriented policy reforms that kicked off in 1983 and continue to the present day have transformed Australian infrastructure, spurring significant and innovative private sector involvement in tollroads, airports, ports and energy assets, including construction, operation, financing and privatisation.

Like Australia, the UK enjoys a stable regulatory regime and legal framework. Imaginative pricing reform to negate political and investment risk will give the UK’s own infrastructure programme a timely and significant boost. But we do need deals too