This article is sponsored by AMP Capital
Certain areas within transport infrastructure have obviously been hit hard by covid-19. But how would you say the sector has fared overall?
From an infrastructure standpoint, 2020 was the year when the market changed the way it viewed entire segments of the investment landscape. On the one hand, covid-19 resulted in a surge in demand for data, which has underpinned strong performance in areas such as telecoms, but equally the pandemic has highlighted demand risk in other areas, and in particular, for transportation infrastructure. Certainly, pockets within the transportation space have experienced genuine distress, with airports, globally, seeing year-on-year declines in passenger volumes and revenues of around 65 percent as a result of restrictions on movement. But elsewhere the effects have been more nuanced.
In fact, some transportation assets have shown remarkable resilience. Owners of public transportation assets backed by availability-style contracts with government counterparties have, in general, experienced no real negative impacts to cashflows during the past 12 months. Meanwhile, other areas, such as electric mobility, have experienced explosive growth even as the pandemic has run a disruptive course across the globe. The picture for transportation assets has been mixed.
Despite that mixed picture, is there going to be a fundamental shift in perceptions of risk around transportation infrastructure?
Transportation has been a key component of infrastructure investment portfolios since the dawn of the asset class more than 30 years ago. That is not going to change any time soon. But I do think the pandemic will recalibrate the way investors think about the risk profiles of their transportation assets. In fact, that has already happened. Covid has emphasised the importance of robust stress testing for extraneous demand shocks, such as those seen over the past 12 months, on assets such as airports and toll roads. But I also think the pandemic has reaffirmed the value of long-term contracts with counterparties that can withstand severe demand shocks. Finally, covid has further highlighted ESG risks and opportunities across all asset classes, and transportation infrastructure is no exception.
How has that increased focus on ESG created opportunities within the transport sector?
When the pandemic started spreading rapidly throughout the West in the first quarter of 2020, the expectation was that the energy transition would suffer major setbacks due to shelter-in-place orders and supply chain bottlenecks. But what has actually played out has been almost entirely the opposite. Those shelter-in-place orders resulted in a steep decline in emissions and drastic improvement in air quality in many major cities as millions of conventional internal combustion engine vehicles were taken off the road and people got a glimpse of what a clean energy future might actually look like. That has created some powerful tailwinds for the clean energy transition and for clean transportation in particular.
As we know, electricity production is the economy’s highest emitter of greenhouse gases. In recent years, that industry has reached a critical mass on its path to decarbonisation. The economy’s second-largest contributor is transportation, which produces around a quarter of the world’s carbon dioxide emissions. There is therefore an urgent need to decarbonise the transportation sector, which is why I believe that e-mobility is the next frontier of the clean energy revolution. From an investment standpoint, I would say that the e-mobility space today looks not at all dissimilar to solar generation 10 or 15 years ago.
So far, you’ve chosen to focus attention on Latin America. Why is that?
There are a number of reasons. First, the regulatory framework in Latin America is actually quite advanced and often based on a European model. Latin America also has the highest per capita use of bus services globally and many of the major cities in South America have some of the worst air quality in the western hemisphere. We’re also keeping a watchful eye on opportunities in North America, however. The US will become a market of enormous potential and scale once it fully embraces electrification.
That process, which is still in the earliest stages, is currently being led by California. But one of President Joe Biden’s policy goals is that all new American-built buses will be zero-emission vehicles by 2030 and that all 500,000 school buses, which is a huge market segment, will become zero-emission vehicles in the coming years. Those strong policy tailwinds at a federal level, coupled with continued progress already taking place at a state level, should generate very healthy investment opportunities in the medium term.
What are the technology risks associated with e-mobility and how do you overcome them?
E-mobility is obviously a rapidly evolving sector but the lithium-ion battery technology that powers most electric vehicles has been around since the early 1990s. The technology itself is not new. What is changing, however, is the cost of that technology. The cost of lithium-ion batteries has fallen by almost 90 percent over the past decade. That rapidly declining cost is set to continue and is one of the key drivers in the electric vehicle space generally.
Meanwhile, lithium-ion batteries in adjacent applications such as
utility-scale energy storage have already proven to be both investable from an equity standpoint and, more importantly, bankable. A significant number of successful project financings have taken place in the utility sector in recent years.
What’s crucial in these situations, indeed in any infrastructure investment, irrespective of sector, is effective structuring to ensure the party best able to manage a given risk is, in fact, the party that bears it. In the context of
e-mobility, what that typically means is that technology risk – for example, excessive battery degradation – should be borne by the original equipment manufacturers. That’s how we structure all our investments in this space. With a thoughtful approach to structuring and risk allocation, like utility-scale energy storage, e-mobility can be both investable from an equity perspective and bankable in terms of financing. Indeed, AMP Capital closed the financing of a Chilean electric bus fleet in August last year. That represented one of the earliest infrastructure-style project financing deals of scale in the e-mobility market globally.
Are there any other particular challenges associated with investment in e-mobility?
We need to build more awareness around e-mobility and the benefits it can offer.
That’s really a function of the nascency of the industry. For example, procurement frameworks in less-established markets often simply seek out the lowest cost option from an upfront capex standpoint, rather than considering the total lifecycle cost. That means that although electric buses already offer a real advantage over traditional diesel buses from a total-cost-of-ownership perspective, antiquated procurement processes can actually slow the transition from internal combustion fleets to battery.
However, as awareness grows among governments and municipalities, not just regarding the lifecycle cost benefits of electric public transportation but also the potential to neutralise the upfront capex requirements through procurement methods such as PPPs or structured lease deals, I think a huge opportunity will be unleashed for the asset class.
We also need to build awareness regarding the nature of the investment opportunity that e-mobility can offer. Investment in e-mobility is not just limited to making technology bets on Silicon Valley EV companies in the latest SPAC deal, of which we have obviously seen plenty of late.
This is a fast-growing investment class where, with the right contractual framework, the right counterparties and the right structuring, capital can be deployed at scale into assets with an attractive risk/return profile.
Once the infrastructure investment community fully wraps its head around that e-mobility opportunity set, we should see very significant sums of private capital flying into the space over the coming years.
AMP Capital has specifically been investing in the electrified bus sector. Why has that been an area of focus?
Our belief is that we’re at the start of a major structural shift in transportation that will ultimately result in a large-scale switch from internal combustion engines to low- and zero-emission mobility options. The bus vehicle segment is actually the most advanced of all vehicle segments when it comes to electrification today. Around a fifth of the global bus fleet is already electric, compared with less than one percent of passenger cars. Electric bus numbers have grown at a compound annual growth rate of over 100 percent since 2013 and around half of all new bus vehicle sales are now electric. That proportion is expected to continue to increase.
Another appeal of the electric bus segment for infrastructure investors is the fact that there is a clear role for private capital. Governments and municipalities often look to procure transportation assets, such as public buses, off balance sheet. Working with private investors can also reduce their capex burden through structures such as financial leases. The final important trend underpinning e-mobility generally is continued urbanisation. Governments and municipalities are becoming increasingly conscious about deteriorating air quality in major cities. Covid, for example, has been shown to spread more rapidly and to have greater health implications in cities with poor air quality. Switching buses from diesel to electricity can be an important tool in the fight to improve the quality of air in urban environments.