A world of uncertainty

When it comes to infrastructure investment, much boils down to how much risk is involved, and whether that risk is worth taking when weighed against returns.

Risk takes many forms, manifesting itself across the spectrum of geographies, cultures, sectors and project stages. It takes years of hard knowledge mixed with just the right balance of objective cynicism and visionary optimism to inform the long-term investment decisions that typify the infrastructure asset class. But while the very nature of risk is in itself unpredictable, the expert infrastructure analysts at BMI Research helped us identify common risk scenarios in each of six geographical regions globally.

Below are some of the key conclusions reached.

EUROPE: LEANING TO THE LEFT

From the infrastructure investment perspective, BMI infrastructure analyst Richard Marshall says Europe is a “destination” market in terms of political risk, but is not without problems.

A trend underway is a general shift toward more left-leaning policies, and this could be problematic for infrastructure, he says. In Greece, the previous government was planning power, railway and other logistics infrastructure development, but the new left-leaning government scrapped that – in the process “really damaging what [BMI] thought was going to be a good story”. In Spain, he notes left-leaning groups are polling very well at the moment.

Looking to UK elections, the Conservative party plans to put European Union (EU) membership to a referendum, while the Labour Party is vowing to freeze energy prices. While Marshall says these proposals give reasons for pause, the relatively stable policy framework in place in the UK is still a strong draw.

EU green energy targets are causing disruption in markets such as Germany, which saw several coal power plants taken offline to attain compliance. This presents an opportunity for those looking to grow their renewable asset base in the region.

Looking to the east, the Russian annexation of Crimea and the residual Ukrainian conflict has incentivised Europe to bolster energy security, Marshall says. “Threats from Russia to cut off gas supplies to Europe has been a long-term issue,” he says, “but now it seems Europe is really pushing to increase its gas distribution infrastructure so the more vulnerable countries – those reliant on Russian gas – are better insulated against such threats.”

“So actually, in terms of infrastructure investment, the higher risk in Eastern Europe is creating opportunities elsewhere in the region,” he adds.

Another conflict by-product, Marshall says, is that “investor caution surrounding assets exposed to the economic performance of the Eurozone has spiked”.

“With many exporting economies in Eastern Europe reliant on demand from Russia, the sanctions on the Russian economy have dampened optimism for those economies,” he says. “That could be a major threat to areas like toll roads and demand for electricity.”

In general, Marshall says European investors are most exposed to risk in the initial planning and pre-construction phase. Getting projects off the ground in some nations can be a costly, time-consuming process. He contrasts China’s ability to build high-speed rail in relatively short order to the construction of the Koralmbahn in Austria, which has been under construction since 2006 and won’t enter the first operational phase until 2024.

MIDDLE EAST: INSURGENCE, BUT STILL SOME INVITING OPPORTUNITIES

The first thing to know about the Middle East, Marshall says, is that a distinction should be made between Gulf Cooperation Council (GCC) countries and other nations, as the former present a “safe haven” of sorts in an otherwise risky region.

“Outside the GCC you’ve got the more high-risk markets [of] Iraq, Iran, Syria, Israel…these are much more high-risk markets than within the GCC,” he says.

The momentum of the Arab Spring has slowed, Marshall notes, but that form of unrest has been more than replaced by the rise of Islamic State (IS) and deterioration of the situation in Yemen. Over the past year and especially the last couple of months, this has significantly increased the risk premium across the whole of the Middle East. Even Saudi Arabia – where there are several high-profile infrastructure projects underway including mass transit and port projects – has increased its risk profile in Marshall’s view by taking part in anti-insurgency military campaigns.

“The more assertive foreign policies that GCC countries have engaged in have exposed them to risks that normally they wouldn’t be involved in. Now, you can’t rule out that Saudi Arabia [might] see some kind of attack on infrastructure for [its] involvement in bombing in Yemen and Syria,” Marshall says. “The IS organisation is really proliferating [and] these countries can’t insulate themselves anymore against something like that.”

While these risks are quite intimidating, Marshall says it is important not to overstate the security risk in the Middle East, and investors should bear in mind that some countries, such as the United Arab Emirates (UAE), Qatar, and to a lesser extent, Oman, with its strong public-private partnership (PPP) framework for water and power projects, are working very hard to increase their attractiveness to private partners by orienting their market framework to be more inviting to foreign investors. The structuring of green bonds and other recent regulatory developments are indicators that the UAE is trying to establish a strong project financing environment, Marshall says.

In contrast, Kuwait has a poor business environment overall and should be approached with extreme caution if at all, Marshall says, noting the government’s history of interference, withdrawal of tenders, and cancellation of projects.
“The UAE and Qatar are keen to keep their hands off, they don’t want to appear to be a state that will intervene,” Marshall says. “They realise how beneficial it is to get international investors and construction companies in the door.”

AFRICA: PRONE TO INSTABILITY, BUT INCREASING ATTRACTIVENESS

Africa’s story is one of diversity, which in many ways is both its greatest resource and its greatest weakness. The North African nations of Algeria, Libya, Tunisia and Egypt face similar security risks to their Middle Eastern neighbours and Marshall believes that, even within the Middle East, there are more attractive markets to engage in; Libya in particular shares many market characteristics with Iraq and Iran, he says, “with its reliance on oil revenues and poor governance not translating into a lot of action on the ground in terms of infrastructure development”.

Even in two of BMI’s favourite markets, Nigeria and Kenya, security issues tied to Islamic militant groups Boko Haram and Al-Shabaab are causing risk premiums to rise.

“Like in the Middle East, the perception of the increased security premiums is probably going to be the overriding issue in the coming years,” says Marshall. One of the issues is that instability is quite easily spread in the region. “In Nigeria, construction workers are regularly targeted for kidnappings, you can never rule out bandits in most countries – it’s really still quite a lawless place to do business outside of major urban areas,” says Marshall.

Nationalism is another strong risk driver in African nations, and can have drastic consequences. For example, Marshall points to Zambia’s decision to hike taxes for copper miners, and the withdrawal of foreign aid from Uganda following the passage of anti-gay legislation, drastically reducing its public sector capacity.

“Any number of sub-Saharan African markets have similar dynamics,” says Marshall. “There are very diverse populations in these countries and politics play a very divisive role.”

Along with the overarching issues of poor governance and lack of security, lack of contract enforceability and arbitration ability are other common themes.

CENTRAL AND LATIN AMERICA: CORRUPTION COMMONPLACE, POLICIES SHIFT DRAMATICALLY AND OFTEN

Looking at 2015, BMI infrastructure analyst Juliana Correa notes that “it’s a particularly exciting year in terms of elections for some countries,” referencing Guatemala’s upcoming election in September, Argentina’s in November and Venezuela’s in December. Typically, she says, investors can expect to see spending increases in the year leading up to elections, followed by a period of instability until the dust settles.

Corruption and lack of transparency plague the tendering process, and there’s not a lot of protection for investors, particularly in Central America, says Correa. “It’s a bit complex in the sense in that it’s not just corruption at the local level, but also at the national level,” involving all levels of stakeholders, from banks to government officials to permitting agencies.

In Peru, for example, a developer is likely to need to apply for environmental permits two or three times before work can begin, and each time payment is required.

Populist movements are quite influential in countries such as Bolivia, Ecuador, Peru, and southern Chile, where protests by the indigenous Mapuche community, which has been at odds with the colonial government for hundreds of years, delayed construction on the Ralco hydroelectric energy project by four years from 1995 to 1999, and where rural land is often sold by these communities to multiple parties – a serious problem for developers.

Unions are another driving force in many locales, including Chile and Argentina, where Correa tells us that on a recent visit she personally witnessed the entire country being effectively shut down as one union’s strike led to a domino effect of solidarity strikes across all sectors.

In Brazil, BMI head of infrastructure research Michelle Karavias says “infrastructure is extremely politicised”. Widespread corruption surrounding the state-run oil and gas company, Petrobras, has brought the public-private infrastructure development marketplace to a grinding halt. Development of politically important assets and environmentally sensitive projects tend to carry the most reputational risk, Karavias says, pointing to a handful of massive hydro power projects with implications for indigenous populations which have garnered international attention with the help of celebrities like Sting and Bono.

A standout marketplace in the region is Colombia, which, though not without security risks, is showing promise with its $25 billion 4G road and rail development programme and a peace agreement with FARC, the country’s oldest and largest guerrilla group, possible in the near future.

NORTH AMERICA: TO EACH THEIR OWN ISSUES

The three nations of North America are very much their own markets, and in many ways, the only thing tying them together is their geography, though some similarities exist across borders.

Canada, says Karavias, is “a safer environment with a couple of quirks”. Corruption isn’t unheard of, especially in Quebec, she points out. And while there are five separate procurement agencies nationally, which have collectively cleared about $70 billion in projects since inception, there are some projects that are extremely difficult to execute, among them oil and gas pipeline projects. As there is little likelihood of force majeure in Canada, much like Europe, most of the political risk occurs during the pre-construction phase.

In the US, underinvestment in infrastructure is the most pressing risk issue, Karavias says. Infrastructure is highly politicised and differs completely on a state-by-state (and city-by-city) basis. “Everybody wants the infrastructure but no one can tell you how to do it without hitting a political hot button,” she says.

Developers commonly face pushback from sceptical local populations because “people don’t want the private sector to come in and pay for their assets,” says Karavias, even if it is clear that the public sector doesn’t have the capacity to tackle the growing infrastructure problem on its own. Additionally, developers face reputational risks when associating their brand with bad infrastructure deals, or with a poor transport framework, which has contributed to highly-publicised recent oil and gas train wrecks.

Mexico faces insufficient institutional capacity. Underinvestment and criminality are especially prevalent in the southern states where there is less infrastructure demand (which should be differentiated from need), which is why Karavias says the bulk of risk occurs in the operational stage here. News of oil and gas pipelines being tapped, of extortion in ports, and of workers being abducted are not uncommon, she says. The underinvestment that is characteristic of southern Mexico is likely to continue due to recent budget cuts, but a recent policy shift in the energy ministry to allow foreign investors to participate in the energy market show that it’s not all bad news south of (what’s left of) the Rio Grande.

AUSTRALASIA: STARTING TO SEE POSITIVE POLICY FORMATION

As in Latin America and Europe, expected upcoming elections in Myanmar, the Philippines, and Thailand are likely to cause disruption in the infrastructure marketplace, according to BMI infrastructure analyst ShuiYong Lim.

“Any change in government will usually lead to a review of various infrastructure plans and also cause some uncertainty in policy continuity,” says Lim. “Even with greater political stability in countries such as India and Indonesia since the 2014 elections, we still expect political headwinds in pushing through various reforms.”

Lim says the construction phase carries the most risk for infrastructure projects in the region, with operational and financial planning stages following closely behind.

“Various business environment issues, such as land disputes, remain a challenge to construction and we recently highlighted that in Indonesia, for example, even with Joko Widodo personally overseeing the land disputes for the Batang power plant project, there is still significant opposition from Batang residents and environmental activists,” he says.

Despite reforms in recent years that have led India to become increasingly alluring, it still remains among the least attractive of the 13 markets in the Asia-Pacific region along with Pakistan and Cambodia, according to BMI analysis, which Lim says is a reflection of “deep-rooted and wide ranging risks of financing, building and operating projects in these markets”.

But Lim says there is good news too. “We do see positive policy formation that will help spur reform momentum, which could start to gain traction over the coming years,” he says, noting that “better PPP frameworks, easier land acquisition processes, and a stronger legal and regulatory environment” could be on the way.

Looking south to Australia on the other hand, increased regulatory risk is the word of the day. Recently aborted poles and wires, ports and highway projects in Queensland and Victoria have some saying it’s time to price additional risk into this market. Still, it remains the centre of global attention says James Riddell, infrastructure M&A leader for Deloitte Touche Tohmatsu.