“Asset recycling” is fast becoming a very efficient approach that enables governments to fund desperately needed infrastructure development in those OECD economies where levels of current borrowings make debt-funded or tax revenue-funded development difficult.
Asset recycling involves solely utilising the proceeds from the sale of publicly-owned energy and transport infrastructure assets (“old assets”) in the development and operation of new infrastructure assets (“new assets”), a concept that has recently been expanded upon – and in fact actively incentivised – in Australia. It has helped Australia become what Riddell describes as “the current global focus for financial investors, including infrastructure fund managers, sovereign wealth funds and pension funds to deploy significant amounts of capital in a highly sought-after sector”.
With its originally touted A$80 billion (€57 billion; $62 billion) privatisation wave, and notwithstanding aborted processes for the sale of poles and wires and port assets in Queensland and new-build toll road projects in Victoria – both due to political opposition – Australia is still expected to stay on investors’ radars for a while yet.
And, as more and more high-profile transactions come to fruition, so the significant capital allocation set aside grows ever higher. Riddell points to the establishment of “Restart NSW”, a fund established in 2011 by the current New South Wales government which has been set up solely for the purpose of funding new infrastructure development, and has seen more than $A7.5 billion in proceeds pour into its coffers so far.
Moreover, Riddell believes that the asset recycling model is transportable to other markets, particularly some OECD economies that remain asset rich, but funding poor. He thinks it could even possibly displace the public-private partnership (PPP) model which – while still having a big future in emerging markets, he believes – is falling out of favour in many mature markets due to a perceived lack of effective risk transfer to the private sector, which means higher leverage structures. It is also often the case, says Riddell, that “the private sector capital at risk is a very small quantum of the overall project cost”.
‘BANG FOR BUCK’
He also believes that, compared with PPPs, large asset recycling deals offer much more ‘bang for your buck’. “The majority of financial investors that have large capital allocations to infrastructure tend to have minimal exposure to PPPs because you simply can’t deploy enough capital for the project size based on the usual capital structures utilised. By contrast, with something like major GDP-linked assets like ports and airports, or regulated assets like electricity, gas or water utilities, you may be able to deploy multiple billions of dollars in one transaction.”
This all sounds good in theory, but anyone familiar with recent political developments in Australia will be aware that nothing should ever be taken for granted. The new state government in Queensland ran a very vocal anti-privatisation campaign in respect of the planned sale of regional port assets and their poles and wires assets as their major policy platform, so much so that nearly A$40 billion of proposed infrastructure asset sales have now been taken off the table. Moreover, these fears remain in relation to the planned privatisation via long-term leases of similar poles and wires assets elsewhere.
“In Queensland, the opposition party ran a very successful anti-privatisation campaign arguing against the merits of asset sales to fund infrastructure development and this proved successful with the electorate,” Riddell reflects. “As a result, capital set aside by financial investors for the planned A$40 billion of infrastructure asset sales will now have to find a new home. This outcome has left a sour taste in the mouths of many financial investors which had allocated significant resources, relocated teams and made a very significant decision to invest in Australia.”
Riddell worries that the Queensland precedent – especially if followed by further negative developments – could see the tide begin to turn in Australia. “One of the things I have learned over the last 15 years is that the capital allocated by financial investors in infrastructure is very mobile and indiscriminate, and will not hesitate to move to other markets as new opportunities present themselves,” he says. “Queensland was a body blow, but not the death knell. However, if this trend continues, that would be problematic.”
Having said this, he thinks that – even as some large privatisation deals have ended up being shelved – other investment opportunities may present themselves for long-term capital deployment in the Australian market. “Capital optimisation via divestments of non-core assets by strategic investors, particularly in the energy and resources sector, were previously expected to be delayed as financial investors focused on government asset sales. But now some of these other private sector investment opportunities may be brought forward as financial investors look to fill the gap.”
As an example, he cites the liquefied natural gas (LNG) pipeline sector. In December last year, BG Group sold an LNG pipeline to APA Group, Australia’s largest gas pipeline owner, in a $5 billion deal. This LNG pipeline was the first of three LNG pipelines being built in Queensland to reach financial close. The remaining pipelines are sponsored by consortia led by Origin Energy and Santos Limited and it is possible that these assets will come to market to fill the void left by the Queensland election outcome. These pipelines are likely to also sell to financial investors for multiple billions of dollars.
“With depressed commodities prices, it opens up opportunities for energy businesses to sell off non-core infrastructure assets to investors with lower costs of capital,” Riddell points out.
ASIA: ‘SLOW BURN’
He also suspects that financial investors that have relocated to Australia may well begin looking at other investment opportunities in the region, including New Zealand as well as Asian markets such as China, Japan, India and Southeast Asia. “Financial investment into Asia will be a slow burn but more people will be looking at opportunities there as and when they arise,” says Riddell.
This prompts further consideration of how investment into Asian markets is likely to develop. In many of these markets there is a history of government funding infrastructure needs without any private sector help. Riddell explains: “You have governments that are not debt constrained, run low debt-to-GDP ratios, and are well financed due to historically strong economic growth.”
In this environment, governments have had sufficient capital to develop new infrastructure on their own without the need to tap the private sector. However, Riddell expects funding in the future will likely consist of a combination of public and private sector financing, particularly if economic growth slows.
“In the future, not all new infrastructure development will be financed by governments simply writing cheques. In some emerging markets, we are seeing the green shoots of PPP markets develop and this is what you would expect because PPPs, particularly in Asia, tend to have more balanced capital structures reflecting an appropriate level of risk and return.”
However, Riddell points out that infrastructure development via PPPs has slowed in developed markets like Australia and the UK due to a shift towards lower private sector risk, more availability-type structures and as a result, increased leverage and lower capital deployment. This still works for the smaller social infrastructure projects, such as schools and hospitals. But big-ticket investments via PPPs, particularly in the transport sector, are becoming increasingly rare as projects are de-risked by governments (effectively resulting in a relatively expensive form of borrowing).
In Asia, an added complexity is the need to address the difficulties in some jurisdictions for foreign financial investors to extract yield. “It’s generally quite hard to take yield out in Asian projects,” Riddell reflects. “You have growing, wealthy governments and markets that are less experienced in dealing with the needs of foreign financial investors and their requirement to extract yield in a timely and efficient way.”
For the time being, he says, encouragement arises from the tentative steps being taken towards developing Asian PPP markets. The next logical step in his view would be for these markets to explore the role that investors could play in asset recycling. But that may be some way off yet.
At the end of the day, the important thing for governments to understand is that financial investors, while having a healthy appetite for infrastructure investment, need to ensure their key investment criteria of investing in capital intensive, transport and energy infrastructure assets requires:
Manageable sovereign risk;
Access to long-term predictable yield either via contractual, regulatory or market protections;
Alongside governance rights that enable financial investors to protect and direct their investment capital.
This is true no matter in which markets investment opportunities are being assessed.