This article is sponsored by InfraRed Capital Partners
The world currently faces a $15 trillion infrastructure financing gap by 2040, according to the Global Infrastructure Hub, driven by ageing infrastructure, the social imperative to decarbonise resulting from climate change and the democratisation of digital infrastructure. The sourcing and deployment of capital for this purpose represents a significant global challenge, and a huge investment opportunity, creating a pivotal moment for the global infrastructure sector.
Addressing a funding hole of this magnitude is a significant challenge, particularly given the recent steep increase in the cost of capital, stretched fiscal budgets and heightened geopolitical tensions that have had a deglobalising effect. As a result, addressing these issues requires significant investment of scale, and governments alone cannot provide what is required.
To successfully deliver what societies need, governments and providers of capital will need to work in partnership, within a supportive policy environment. This will allow infrastructure asset managers to harness their experience and skills to do what they do best for all stakeholders: providing effective project selection and design, timely buildout, with higher productive use and cost efficiency.
The context for investment decisions feels like it has fundamentally changed, and investors are facing unprecedented challenges. Following supply-chain challenges resulting from lockdowns and the gas supply crises in Europe, the easy monetary policy we have enjoyed in the past is gone, and rampant, persistent inflation is eroding real investment returns.
The rising cost of capital is also a factor investors need to contend with, as central banks aggressively intervened with successive rate increases to manage inflation. In just two years, these adjustments have shifted interest rates from near zero to 4-5 percent, leading to sharp asset price “corrections”. A general higher cost of capital environment seems likely to persist over the next few years. These factors paired with ongoing geopolitical crises and investor uncertainty, create a challenging environment in which to operate.
Despite this, infrastructure as an asset class has inherent defensive features that mean it is ideally positioned to address these investor challenges.
The effects of inflation are often mitigated within infrastructure investment due to inelastic demand and strong pricing protection. For example, toll roads often have the contractual right to increase tolls, and consequently revenues, in line with inflation; while in European renewables, the electricity price can be indexed to inflation via mechanisms such as Contracts for Difference.
Geopolitical concerns are balanced by both strategic risk mitigation, such as having a geographically well-diversified portfolio, and external support, such as strong domestic policy support for infrastructure investment. Legislative initiatives such as the Inflation Reduction Act in the US or Green Deal in the EU will drive infrastructure investment over the next decade and beyond. In Europe, energy security now drives support for the transition to renewables as much as
Capital also continues to be available for infrastructure, as its robust features appeal to lenders as well as equity investors. Banks continue to be very constructive in financing renewable energy projects and energy transition opportunities, favouring their sustainability characteristics.
Maturation of macro themes
Coupled with this defensive positioning, the infrastructure sector is enjoying tailwinds from long-term macro themes that are driving investment needs, particularly decarbonisation and digitisation. The ongoing maturation of these themes is creating a paradigm shift, with the most investable solutions crystalising as the ‘infrastructure’ of the future.
When it comes to future-proofing existing infrastructure, the pursuit of net-zero ambitions increases the obligations on existing asset owners to take a robust view on future-proofing essential assets. This requires the ability to work in partnership with key stakeholders, for example public sector clients, to ensure the interest of all parties are balanced. At InfraRed, for example, we are taking an agenda-setting role in industry groups in association with the Infrastructure Projects Authority in the UK on achieving Net Zero, and we are actively contributing to future policy via government consultations on the future of clean energy sources.
Digital fibre infrastructure networks are now increasingly mature. Many markets in Europe already have high penetration/roll out, and we see the beginnings of consolidation in certain markets – for example the merger of Virgin Media and O2.
However, we are still in the infancy of the digital transformation of society. Data is the currency of global digitisation and so the transfer and storage of data is essential to the functioning of a digitised society. There is a decades-long trend of data outsourcing, moving away from on-premises location of data, which gives data centres essential infrastructure characteristics. We increasingly view the basic infrastructure and environment of data centres as attractive opportunities given the balance of risk and return, the high level of greenfield investment required and a proven revenue model.
The decarbonisation of energy generation is also well advanced, driven through the exponential growth in renewables. The renewables sector is maturing, and with its cost, energy security and decarbonisation benefits, we are now seeing renewables overtaking fossil fuels as the primary generation source in Europe. Renewable energy is expected to account for almost 90 percent of global new capacity over the next five years, with important implications for energy affordability and accessibility according to the International Energy Agency. InfraRed committed $1.7 billion of capital to renewables and associated areas in 2022.
To facilitate a full shift away from fossil fuels, the creation and adoption of flexible capacity is key. To respond efficiently to price signals and smooth the intermittency of renewables generation and to stabilise supply frequency, electricity storage, including utility-scale batteries, is critical to the energy transition. These therefore represent an attractive and sizeable investment opportunity. Additionally, robust transmission networks are essential to efficiently use the clean power we generate, as the energy transition changes our generation locations.
Road transport globally accounts for around 40 percent of the world’s CO2 emissions according to the IEA and so the decarbonisation of transport is a crucial step in the energy transition. It will result in fundamental societal changes and is driving high growth in sectors such as electric vehicles (EV), the charging infrastructure these rely on, and the electrification of public transport infrastructure. In 2023, we committed capital to a new EV charging business in Germany, which will bring ultra-fast charging infrastructure to dense urban areas.
Decarbonising the built environment is currently more nascent, but nevertheless has seen strong progress with the further development of solutions such as district heating networks. However, given 30 percent of global final energy consumption comes from operating buildings – equating to 27 percent of total energy sector emissions, according to data from the IEA – there is much more to be done. My view is that smart homes and offices will become the new frontiers in this shift.
The future of clean energy sources to power these developments must also be considered. Alternative fuel carriers, such as biogas, green hydrogen and sustainable aviation fuels, have a material contribution to the future decarbonisation of hard-to-abate sectors and are being proactively supported by public policy.
We are also tracking wider ‘circular economy’ themes, such as biomethane lifecycles, which are also important for the decarbonisation agenda. Within this, we view the European biomethane sector as an attractive sector, with near-term investable opportunities. It is an immediately available technical and commercial solution as an alternative fuel source, with a highly supportive EU regulatory environment that is driving market growth.
Creating long-lasting value
I believe that future success across these opportunities for mid-market, nimble players will require the ability to scale three key success factors to create long-lasting value for both investors and society.
First, strong industry relationships are crucial to success in this market; for example, InfraRed has developed a network of partners throughout the supply chain built over 25 years in the business, which means we are taking an aligned and long-term view with our stakeholders and can work through issues together.
Second, ‘build to core’ expertise is hard to achieve or replicate. Developing opportunities successfully through every stage of the infrastructure life cycle requires a complex combination of close partnership with management teams, business partners and communities.
Finally, a disciplined investment approach is key to mitigating risk and consistently delivering for investors. Our process means the relentless pursuit of profit, from carefully selected investments selected from opportunity sets that also meet our sustainability criteria. Once invested, we drive operational excellence to maximise investment returns through truly active management of the assets, with little reliance on leverage to generate or enhance returns.
We have gained these insights by being pioneers in investing in critical infrastructure, with a track record of innovation. We listed the first infrastructure investment trust in London in 2006; we were an early investor in renewables, having made our first investment nearly 15 years ago; we also listed the first multi-sector and multi-geography renewables investment trust in London in 2013.
Now, we are continuing to innovate by pursuing investments at the forefront of the digital and energy infrastructure sectors. Standing still is not an option for successful infrastructure investors – we consciously track macro trends; we adopt technological advancements; and we keep challenging ourselves to optimise our business model and ways of working.
The infrastructure landscape is, and will continue to be, shaped by the winds of macroeconomic uncertainty and societal change. These represent significant opportunities for the most agile and innovative market participants, those who can scale key success factors and create value for investors and societies alike. The prize is significant: a prosperous, sustainable future.
We are invested in making that a reality, and we are committed to working with our partners, our supply chains and governments to get there. Together, we are creating the infrastructure the world needs to thrive.
Jack Paris is chief executive of InfraRed Capital Partners