Infrastructure tends to be seen as a stable and predictable asset class, but that’s not to say it doesn’t evolve. As technology developments and societal concerns emerge, such as the current drive to reduce emissions, infrastructure adapts. The changes under way in the market currently are creating investment opportunities.
Looking at the infrastructure market broadly, McKinsey has forecast that $57 trillion of global infrastructure investment is needed by 2030, while Preqin reported that 88 per cent of institutional investors expected to commit the same amount or more to infrastructure in 2017. The demand for infrastructure from society – including road, rail, water, power generation and distribution – is set to continue to expand significantly. In addition to these traditional infrastructure assets, new technologies are being adapted and rolled out to meet new demand – such as fibre optics and district heating.
The opportunities in the infrastructure lending space are being eagerly embraced by institutional investors, as we saw over the course of 2017, with a number of successful fundraisings achieved in the infrastructure debt sector. That included our own AMP Capital Infrastructure Debt Fund III, which surpassed its fundraising target, securing $2.5 billion for the fund and an additional $1.6 billion in co-investment and partner commitments. In deploying this capital, we are focussing on creating a well-diversified, robust portfolio of junior and mezzanine loans in the core infrastructure space, keeping a keen eye out for attractive emerging sectors that meet our stringent definition of infrastructure.
District heating is one such sector; we have recently made two investments in the sector and anticipate increasing our exposure across Europe.
As core as core gets
District heating is a proven technology that is increasingly viewed as a smart solution to the challenges facing the European energy market. We have found certain assets in this sector that represent excellent investment opportunities as they possess attractive characteristics typical of core infrastructure assets. They tend to operate in markets with supportive and stable regulatory environments; as a utility, they come under the definition of essential infrastructure, demonstrate monopolistic characteristics, and benefit from stable revenue streams. There is typically only one effective network in any one location, so, although revenues are not contracted as customers are free to cancel their contracts at any time, their need for the service remains and alternative options are minimal.
The vast majority of networks also boast pleasingly low counterparty risk, as many of the parties most reliant on the networks consist of social infrastructure assets backed by the local authority. Further, barriers to entry are high: the build cost of a network of subterranean pipes is expensive and, once built, the network must offer a sufficiently reduced price for heat to attract customers away from the incumbent provider. We therefore view the sector as being defensive and stable in nature, with promising opportunities for growth and consolidation.
The EU’s 20 percent by 2020 renewable energy target has focussed the minds and pockets of investors not only on generation but also on efficient distribution. Alongside policy backing, drivers supporting the roll-out of district heating include the decarbonisation trend, as district heating can harness a range of renewable or low-carbon energy sources such as biomass and geothermal; energy security, as district heating can improve the reliability of access to energy at both the user and national levels by reducing reliance on central energy networks; and energy efficiency, which is higher with district heating than traditional boilers. The increasing digitalisation of energy networks – e.g. smart meters and temperature monitoring – has the potential to improve this further.
Historic district heating deployment has varied significantly by country. In Sweden, Finland, Denmark, Germany and Iceland, district heating thrives; the UK and France have traditionally experienced low uptake but both countries’ governments are actively supporting its adoption, with France aiming to increase district heating volumes by five times between 2012 and 2030, and the UK aiming to stimulate £2 billion ($2.8 billion; €2.3 billion) of investment in the sector by 2020.
The fact that district heating is providing solutions to environmental concerns in these countries means it is a utility story that rates highly on its environmental, social and governance attributes. The technology was developed with energy efficiency in mind as it was initially conceived to recycle heat generated in industrial processes. Networks are now frequently powered by sustainable energy sources such as biomass, and the scalable networks can incorporate energy from a variety of different sources; an environmental advantage over gas heating networks. ESG is a key consideration for AMP Capital and we believe infrastructure that supports the growing trend for greener energy has great long-term investment potential.
Our infrastructure debt investment strategy is focused on extending subordinated loans to defensive, non-cyclical infrastructure businesses headquartered in Western Europe, North America and other developed economies. We plan to extend exposure to district heating within IDF III – building on our already strong investment history in the emerging sector, with investments in Solor Bioenergi in Sweden and Coriance in France.
In May 2017, AMP Capital completed a SKr1.47 billion ($163 million; €149 million) mezzanine debt investment in a portfolio of 43 operational district heating assets owned by Solor Bioenergi, a leading district heating business providing sustainable heating solutions across Sweden. With one of the coldest climates in Europe, Sweden relies on district heating year-round to meet its residential and industrial heating requirements. Swedish energy consumption has remained relatively flat at around 400TWh over the past 30 years which, on a per capita basis, represents close to double the EU average.
“Barriers to entry are high: the build cost of a network of subterranean pipes is expensive and, once built, the network must offer a sufficiently reduced price for heat to attract customers away from the incumbent provider.”
Here, district heating assets are particularly attractive as competing technologies, such as heat pumps and electric boilers, suffer from high upfront investment costs, punitive taxation treatment for non-renewable fuels, higher maintenance requirements and correspondingly elevated costs.
Also capitalising on the opportunities in Scandinavian district heating, in late 2015 AMP Capital’s infrastructure equity team agreed to acquire a 50 percent stake in Adven, a pan-Nordic energy infrastructure company with assets including district heating networks in Finland, Sweden and Estonia. The Swedish district heating market is currently highly fragmented and, as a result, is expected to yield opportunities for consolidation, and for established players such as Solor Bioenergi and Adven to enhance their existing portfolio through both the addition of new connections and the acquisition of new assets.
In 2015, IDF III bought into the French district heating story, investing €45.8 million in Coriance, which manages and operates a portfolio of 28 concessions across France. The district heating networks are operated under long-term, concession-style contracts – so-called Délégation de Service Public contracts – granted by French local authorities, which give the provider exclusivity over a geographical area. The 28 networks encompass 226km of pipelines and more than 1,000 substations.
Coriance also operates a number of co-generation plants from which electricity is sold under long-term power-purchase agreements, providing revenue stability. Its stability is also supported by its credible and diversified counterparties, which include state-owned and private housing, schools and hospitals, for which an uninterrupted heat supply is critical. Both Solor Bioenergi and Coriance are essential infrastructure businesses, in core jurisdictions with a supportive regulatory environment.
With its strong environmental attributes and scalability, we anticipate that district heating as a promising infrastructure asset class will continue to grow in Europe, creating new opportunities to invest in established businesses with material growth potential. District heating is an emerging sector to watch.