A painful adjustment

“Is the rush to core infrastructure making it unsustainable from a returns perspective?” This is one of the questions being posed as part of a panel entitled “Where the money is going” at Infrastructure Investor’s Berlin Summit 2013 – key highlights of which will be reported in our April issue.

One thing is for sure: the panellists will have had no shortage of talking points, give the regular shocks that infrastructure investors in Europe have been subjected to in recent months.    

After all, it was less than two months ago that Norway’s Ministry of Petroleum and Energy rocked investors in gas network Gassled with the announcement that tariffs on future contracts (the now-famous ‘k’ factor) would be cut by 90 percent (if you’re going to cut something, you may as well do it properly). 

It was also within the last couple of months that Germany’s Environment Minister Peter Altmaier revealed he was thinking about a temporary suspension of feed-in tariffs for new renewable energy plants in the country – an uncomfortable reminder of the Spanish solar debacle which began at the tail end of 2010 and continues to this day.    

And, although there has been some relatively good news in the apparent compromise between regulator Ofwat and investors in the UK’s water companies, at least some of these investors were left in a state of shock that removing up to 40 percent of revenues from the established price control framework was contemplated in the first place. (“We’d always thought of UK water regulation as gold standard” said one bemused observer, whose assumption was now dangling by a thread). 

To cast your mind back a little further than two months is to be reminded of other political and regulatory horrors. Just a couple: the spectre of re-nationalisation being raised in France as part of the government’s dispute with steel company ArcelorMittal over proposed job cuts at the firm’s French operations; and the Spanish government following its retroactive action against solar tariffs with the double whammy of a 6 percent energy tax on producers. 

Potent combination

To revisit the question in the opening paragraph, you can look at asset valuations in core infrastructure and make a case for unsustainability based on that alone. Cheap capital + desperation for yield = a potent combination. Thus, core infrastructure finds itself caught up in the “asset price inflation” trend identified by Swiss private markets firm Partners Group in a recent study.

Partners Group co-founder and executive chairman Alfred Gantner described the phenomenon thus: “With the currently still elevated risk aversion, investors are piling into perceived safety, pushing the risk premium of supposedly safe assets to historically low levels. As a result, the flow of ‘safe-haven-but-yield-chasing’ liquidity has broken the link between perceived versus actual risk and has resulted in large valuation gaps. In this value divide, perceived and actual risks diverge sharply and investors will have to thoroughly search for real value to separate the wheat from the chaff.”

Some say this has pushed expected returns from core infrastructure down to around 8 or 9 percent compared with 12 to 14 percent pre-Crisis. 

But there are returns…and then there are risk-adjusted returns. Add risk adjustment to the equation and you can see why investors are getting nervous about core infrastructure in Europe. We can say with some certainty that the discussion in Berlin will have been an interesting one.