European infrastructure is an exciting space today for investors. Mega trends, such as digitalisation, decarbonisation, and changing city demographics (in terms of transportation and mobility) are pushing countries to re-think their infrastructure systems and re-engineer them to cope with 21st century living.
Within the energy space alone, this means reducing reliance on coal fired power stations, decommissioning nuclear power stations, and a continued commitment to investing in renewable energy sources. According to the International Energy Agency’s World Energy Outlook 2017, the proportion of total global electricity generated by renewables will increase from 24 per cent in 2016 to 40 per cent by 2040.
This will be vital if the developed world is able to support the expected rise in adoption of electric vehicles – those used by households as well as corporates as they overhaul their transport fleets – which will place significant demands on energy grids and require substantial increases in electricity production.
Renewable energy investing
As BlackRock highlights in its latest report, The global energy and power transition: implications for infrastructure investors*, energy and power (including renewable power) accounted for 62 per cent of global infrastructure investment activity in 2017, equivalent to USD177 billion. Total energy investment worldwide in 2016 was more than USD1.7 trillion, or 2.2 per cent of global GDP, according to the IEA, with energy infrastructure accounting for a significant percentage.
“If you are an infrastructure investor and looking to deploy capital, then fish where the fish are,” says Alan Synnott, Global Head of Research & Product Strategy for BlackRock Real Assets. “That is why you are seeing increased investor interest in global power and energy. At the same time, the sector itself is going through significant fundamental change. There is massive technological innovation taking place, which has completely changed the cost picture for renewables and for the production and distribution of natural gas.
“That is replacing incumbent energy infrastructure, which in Europe is nuclear and coal.”
Over the last decade, infrastructure has emerged as one of the fastest growing allocations for institutional investors.
At the beginning of each year, BlackRock produces the BlackRock Rebalancing survey where it surveys 200 or so of its top global relationships representing over USD7 trillion in investable assets and asks what they intend to weight up and weight down across alternatives for the forthcoming 12 months. This year, 58 per cent said they planned on increasing their allocations to real assets, which includes infrastructure; a figure that was some way ahead of Private Equity (33 per cent) and Real Estate (32 per cent).
“Within the infrastructure space there are lots of positives; it is a transparent asset class, it has lower correlation to traditional markets (equities and fixed income). The negatives, however, are access to deal flow and compressed returns. Against that backdrop we explain to investors about what is happening in four key sectors of infrastructure – power, energy, transport and social,” explains Synnott, one of the co-authors of the global energy and power transition report, along with Jim Barry, Global Head of BlackRock Real Assets and Mark Florian, Global Head of BlackRock’s Energy & Power Infrastructure team.
In the European market, he says there has been a growth of buy and hold strategies for operating renewable power projects, while some investors preferring a higher return for more risk are looking at greenfield opportunities, such as offshore projects (i.e. wind farms).
“The investment structures used in Europe are changing and many European investors are looking not just at European investments, but global investments. The scale of projects in Europe can be smaller than they are globally, which is why using capital on an unlevered basis can be more efficient for institutional investors; it means they can deploy more capital in a single diligence exercise, to a single investment vehicle.
“As a result, we have innovated and introduced 20-year funds that use unlevered equity. These funds do not rely on any project finance. We invest on an all-cash basis in European renewable power projects. The investment goal for investors in these funds is to accept a more moderate return but to buy and hold assets on a long-term basis for income generation,” explains Synnott, confirming that BlackRock currently manages approximately USD5 billion in equity assets within renewable energy.
Martin Lennon is co-founder of Infracapital, one of the UK’s leading infrastructure investment managers. He says the IEA’s 2040 forecast figure for renewable energy growth is well understood in the marketplace. But he notes that the increase of intermittent power generation capacity has consequences on the broader market as we shift more towards renewables.
“What is the back-up solution when the wind isn’t blowing or the sun isn’t shining?” asks Lennon. “We are still just at the early stages of energy storage using batteries. It’s an industry we think will go from strength to strength although we’ve not invested in the storage space yet as we’ve yet to see a business model that works for us; but that will no doubt change as it is an important aspect of the shift towards renewable energy.
“One also needs to think about the wider implications of what renewable energy is replacing. In certain parts of the European landscape there is still a very high dependency on hydrocarbon fuel sources. There will be some real challenges in terms of shifting from those to more environmentally friendly fuel sources but I do think it represents a large, long-term macro trend for European energy infrastructure.”
Governments, regulators, corporate stakeholders are all driving the trend towards cleaner, sustainable energy. Infracapital is well aware of this trend. One of its investments, for example, is Eteck, which uses deep wells and various carbon friendly solutions to provide sustainable central heating and cooling systems to residential and commercial customers.
“Not only is Eteck responding to government incentives, it is also creating a valuable long term investment which has the potential to significantly reduce the carbon footprint of the Netherlands. It is a good example of a whole new industry that has come about as a result of the significant trend towards increased reliance on renewable energy,” says Lennon.
LNG import facilities
One important infrastructure opportunity that will likely emerge in Europe over the coming years, in response to a burgeoning natural gas market in the United States – thanks to the fracking of US shale reserves – is the development of liquefied natural gas import facilities.
BlackRock’s report shows that world liquefied natural gas (LNG) imports are projected by IHS Markit to more than double by 2040, with Asia showing the biggest growth. Some USD80 billion of investment in East Asia will be needed by 2030 to keep pace with the expected level of demand for LNG imports.
There is only one LNG export facility in the US, currently, although five more are being built and are expected to become operational by 2019.
Within a European context, like Asia, as it transitions away from coal and nuclear towards natural gas, it will need to build import infrastructure just as the US is now starting to build its export infrastructure.
“We just financed a power generation facility called the Lackawanna Energy Centre in Pennsylvania, which sits on some of the cheapest natural gas in the US,” says Synnott. “We are also seeing an evolution in natural gas pipelines across the US – where once they took gas and imported into the country and distributed it, you now have pipelines being built in the opposite direction from the shale reserves to the export facilities.
“There is a new technology called ‘liquefaction’ which allows you to super cool the gas and transport it by ship, which is also an investment opportunity (as each liquefaction facility costs up to USD2 billion). From a European perspective, the import facility, the re-gassification facility, the pipelines and the distribution systems are all future energy infrastructure investment opportunities.”
In natural gas and renewables, therefore, one can point to technology-driven positive fundamentals, a supportive policy environment and a significant pipeline of investable opportunities in midstream and downstream markets. With asset owners increasingly looking for capital partners and some looking to recycle assets, it is opening up the door for European infrastructure investors.
Not everyone, however, necessarily sees investment opportunities in all areas of renewable energy because they do not offer the right return profile.
“I often hear about solar projects being constructed on a zero subsidy basis because the cost of solar panel production has gone through the floor as technology has improved,” comments Matt Evans, Partner, Global Origination (Infrastructure Equity) at AMP Capital. “You therefore have to be quite careful about how governments might evolve their views on technology over the next decade and what that could mean for future asset prices.
“More broadly, there has been an explosion in renewable energy in Europe in the last 15 years with numerous businesses supporting industrial infrastructure in terms of grid reliability. We have a business in Finland called Adven, for example, which provides off-grid industrial energy solutions to medium and large businesses. To overcome grid reliability issues, Adven might install a co-generation plant, for example, to provide energy, cooling and heating needs or large scale ground source heat pumps (geothermal pumps), which are a sustainable energy technology.”
Infracapital has also invested in Adven and is a form of platform investment, where new acquisitions are bolted on the primary business to bolster the size of its operations. “Platform investments for us means growing the asset organically, or inorganically, and creating greater efficiencies. It is a powerful source of investment opportunity,” says Lennon.
He refers to another platform company, held in the Infracapital Greenfield Partners Fund, called Bioenergy Infrastructure Group (‘BIG’), a UK biomass and Energy from Waste (‘EfW’) aggregation platform. “We are growing and diversifying the business by bolting on new business streams and projects to the holding company structure,” adds Lennon.
Transportation & mobility
Tomorrow’s world is going to look unrecognisable, with respect to the way our cities function and how we move. Smart cities, where every device and object will be connected to the Internet of Things, will see us living in buildings that are operated with the highest of green energy credentials, electric vehicles will run on electrified roads, and what we regard as commonplace features of today’s cities, such as car parks, will likely not exist in a generation or two’s time.
This is having real implications as to how infrastructure investors think about the future, and how they can ensure that the assets they invest in today will still be relevant in 20 or 30 years’ time.
Transport and mobility, as a trend, offers up potentially huge opportunities as society re-imagines what it means to get from A to B, without polluting the air we breath.
“Corporates understand the need to reduce their carbon footprint and to change the way they’ve been operating for the last 20 or 30 years,” comments Philippe Taillardat, Director at Conquest, a European infrastructure asset management business. “If corporates switch to thinking about how to deliver the same services, but in a way that reduces their carbon footprint, then managers who invest with these companies are going to appeal to end investors.
“One good example is the Allianz Group, which announced recently that it had stopped doing business altogether with any companies involved with coal-based energy production. No insurance services offered to these companies, no nothing. That’s a major statement. It underscores the growing level of global awareness for sustainable investing.”
As part of its global investment strategy, AMP Capital looks at how globalisation and urbanisation are impacting areas of infrastructure such as transport assets. Airports are one piece of infrastructure where AMP Capital has made a number of investments, in part to respond to changes in mobility and improved living standards.
“That applies to our UK airport investments. Inevitably, over time we believe you will see increased demand from the Indian traveller, the Chinese traveller, coming to visit the UK and that will give an opportunity for regional airports. We’ve looked in a number of European markets, and today we’ve made three investments in UK airports – Newcastle, Leeds Bradford and Luton. We’ve spent a lot of time looking at other European opportunities in particular, and we continue to look at airport opportunities globally,” explains Evans.
He also refers to centralisation of working patterns and the way people commute as another trend.
“The ongoing demand for more trains was a big part of the investment decision in increasing the stake we manage in Angel Trains from 25 per cent to 65 per cent,” adds Evans.
Ian Harding is a Co-Managing Partner at London-based Arcus Infrastructure Partners, which focuses on energy, transport and telecoms in the European mid-market. “The three things we see impacting European infrastructure are what we call the ‘Three Ds’: decarbonisation, demographic change and data explosion,” says Harding. As infrastructure changes and moves towards a decentralised model, it naturally means there is a greater requirement for localised infrastructure.
With decarbonisation, this is being achieved by moving towards renewable energy. However, there is a lot more intermittency created on the grid and that requires localised solutions; this could be battery storage or demand management systems to ensure the grid is properly balanced during periods of no wind or no sun.
Electric trains – a live wire investment
“In transport, there is a huge desire to take carbon-emitting vehicles off the road. This will lead to more rail or intermodal transport systems and will require fresh investment.
“With respect to data explosion, people are demanding faster Internet connections to stream live TV on their mobile devices. Investment will be needed in wifi communication towers, telecoms infrastructure, data centres, fibre-to-the-home and so on.
“These general trends are like a wave impacting the infrastructure market and from our perspective we want to ride that wave, rather than swim against it,” says Harding.
Like AMP Capital, Arcus invested in Angel Trains, one of the UK’s largest rolling stock leasing companies. Arcus realised this investment in 2015, having held it since 2008. During its period of ownership, Arcus helped Angel Trains achieve 12 per cent EBITDA growth.
“That was a stunning exit for us,” comments Harding. “We exited the UK Rosco space at the right moment as since then there has been an increased level of competition. People like Rock Rail have come in and bid down the returns you can achieve from new build passenger fleets.
“We have a current investment in Alpha Trains. The fourth railway package in Europe is creating an increased amount of liberalisation, so incumbents like the SNCF in France will face increased competition from the private sector. Alpha Trains is an independent private sector owner of rolling stock and gaining market share. This is allowing us to grow in continental European markets, which we feel provide better opportunities than the UK.”
Investing in electric trains such as Alpha Trains, fits well with the long-term sustainability trend that European governments are promoting. Since Arcus invested, Alpha Trains has more than tripled the size of its fleet and EBITDA, helping take passengers off the roads and reduce city congestion.
“The quality of transport infrastructure is improving and this is encouraging people to use the rail network rather than the road network. Alpha Trains has won a number of awards for its sustainability initiatives. With more people moving into urban areas there is a need for better passenger services. The provision of high quality rolling stock is helping with the urban needs faced by our cities as the demographics change,” opines Harding.
Electric cars still in first gear
As we become increasingly reliant on renewable energy, local grids will steadily modernise into smart grids, or microgrids, using data analytics to accurately gauge consumer demand and provide the necessary energy. In some respects, technology will play a vital role in linking transport and energy infrastructure; e.g. meeting energy demand at electric car charging points across the city.
This sounds obvious enough. But our cities and grids were not designed to accommodate electric vehicles. As such, it will require new infrastructure. Charging points is a demand story but there is also a supply story that could emerge, whereby the roads themselves become electrified. Cars will simply self-charge, and potentially provide excess battery storage to the local grid during periods of peak demand; think of Scalextric that proved popular with kids in the 1980s. If that were to happen, electric vehicles could eventually be used for grid balancing.
“Electric highways could be part of the infrastructure transformation story,” states Frederic Palanque, Director at Conquest. “A number of players who are looking at this are those in the train industry because the concept will be similar to train lines, where the roads have electrified strips. We are working with, and advising corporates to identify opportunities and to try to see if this could become a live solution; if it does, we will be positioned to provide private capital.
“Within the cities and the suburbs, however, it will require a lot more charging points. The current electrical network cannot sustain multiple charging vehicles, which means that the existing electrical network will require significant investment to upgrade medium voltage substations.”
The electric vehicle revolution is years, if not decades ahead, so there is plenty of time to get the infrastructure in place. There are 31 million cars in the UK out of 38 million registered vehicles. The number of cars sold per annum is currently c.2.5 million “so you’re looking at an overall fleet replacement timeline, on average, of 12 years or more and that assumes that every car being sold is electric (versus around 5 per cent today). This is a trend that may still be 20 years away from being realised,” says Evans.
European governments are committed to removing diesel cars from the roads and supportive of bringing on stream more electric vehicles.
Harding points out that Scandinavia now has some roads which have charging infrastructure built in.
“It is possible that certain stretches of roads in Europe will use this charging infrastructure. It comes down to cost benefit analysis and whether a particular country can incorporate it within the road infrastructure, but it may well happen in certain places,” he says.
Digital infrastructure & data management opportunities
Digital infrastructure will be a vital cog in the European infrastructure wheel over the coming years as businesses and consumers alike step up their demands for ever-faster Internet connectivity.
Conquest’s Palanque says that digital infrastructure has various meanings. Firstly, it relates to the additional flow of data that will be needed to manage and upgrade existing infrastructure.
“Instead of having a constant flow of energy down the grid, the only way to use distributed power generation is to know who wants what, and when, and what price they are willing to pay.
“Now that the data is here, we are finally in a position to provide local generation to match local demand. People call it ‘smart grid’ or ‘microgrid’; regardless, it means having more regional power generation and regional consumption,” says Palanque.
Italy is already doing net metering (‘Scambio Sul Posto’) where regional plant operators pay the energy supplier for the electricity consumed and receive compensation for any excess electricity they export to the grid from renewable sources as PV installations.
“This is going to happen across other parts of Europe, perhaps using a combination of wind and solar, where digitalisation of infrastructure will connect users and producers at the right time, at the right cost. Before you had one price, one cost, and nobody knew who was consuming what.
“This same digitisation trend applies to transport. When using a charger for your electric car, you need to know whether the capacity of the charger is appropriate for your car, you need to be able to book it so you’re not waiting. To do this, the energy network needs to be aware that someone is going to be using it – multiply that by hundreds, or thousands of people, all charging their cars in future years, and you see why digitisation of the power grid will be necessary,” adds Palanque.
The second meaning of digital infrastructure applies to data; the infrastructure needed to handle the flow of data referred to above.
There is a huge need to deploy fibre optic cable in Europe and develop local networks that are linked to cities and regions.
“The need for corporates to be involved and lead this transformation will bring the industrial and technical expertise needed to make this happen,” states Taillardat.
At AMP Capital, Evans remarks that Europe is still in the early stages of a 20- or 30-year cycle in respect to fibre being ubiquitous for our homes and businesses.
“There is no doubt you will need fibre-to-the-cabinet but whether fibre-to-the-home is achieved in most markets remains unclear,” says Evans.
The cabinet is the local junction box at the end of a residential street. Fibre goes to the cabinet and then DSL, which is a copper wire technology, delivers, theoretically, up to 70MB connection to the Internet. DSL degrades over distance, however. Copper lines weren’t laid with the expectations there would be high speed Internet.
“The question is, when does DSL get replaced and what does it get replaced with? Will it be a fibre-to-the-home product or will it be a fixed wireless product using 5G? The latter is a technology path that isn’t fully explored yet and could compete with fibre-to-the-home, particularly in suburban and more rural environments,” adds Evans.
Data and digital infrastructure also encompasses communication towers and data centres, which are needed to store and manage the vast volumes of data flowing across our cities.
“We currently have three fibre optic platform investments in Ireland, the US and Spain,” confirms Evans. “With respect to data centres, we spend a lot of time looking at potential investments. We also look at ancillary wireless; all of the new parts of wireless networks emerging as a result of 5G – they won’t replace towers but there will be much more complex wireless networks.”
Firms like Infracapital have invested in fibre infrastructure businesses, the most recent example being a majority acquisition in CCNST, a leading provider of broadband services in Germany. Germany is currently one of Europe’s most underserved fibre markets, with Fibre to the Building penetration of just 7 per cent. Likewise, AMP Capital has invested in E-Fiber, a growing fibreoptic network platform providing 68,000 fibre-to-the-home across parts of the Netherlands.
Sourcing and executing deals
No matter what the investment opportunities might be that lie ahead, sourcing and originating the most compelling is a key skill of any infrastructure manager. At Infracapital, its transaction team go out into the field across Europe where they meet different asset owners, accountants, lawyers, advisers. This is to make sure Infracapital knows what’s out there and “they know who we are, what we do, and what we can bring to the table”, says Lennon.
“That’s really the genesis of deals in both our brownfield and greenfield strategies and how we feed the pipeline. It takes a lot of time and effort. On top of that, you need to have significant credibility in certain situations because on occasion we are finding companies that have done well but are at a point where they have the opportunity to take the business to the next level. They want a trusted partner to come in and help make that happen.”
Calvin Capital, a UK owner and supplier of gas and electricity meters to electricity utilities across England, is a good example of a successful investment where Infracapital helped it to achieve 17 per cent EBITDA growth over the period of ownership.
“We acquired 50 per cent of the Calvin Capital business alongside United Utilities and it had a small management team in place. We were then able a couple of years later to acquire the remaining 50 per cent from United Utilities, which enabled us to take full control of the business. We supplemented the management team with a new CEO, and strengthened the management team on top of an already experienced and respected workforce.
“What we find works well for us is that, at the point when we wish to sell any asset we want to have a really high quality management team that will speak well about the business and be able to easily transition with the new owners. That means whoever is buying it will have the confidence to let the management team continue to run the business. At the point of sale, we don’t want any business to still be overly reliant on us as an owner.
“That’s why having our own in-house asset management team is really important. Whatever the circumstance, we take comfort from the fact that we can work with a solid, continuous management team or if needs be we can go in and make necessary changes with the confidence we have the proven ability to do so,” outlines Lennon.
In his view, the ability to source interesting opportunities in limited or non-competing situations, with an active asset management overlay, should lead to interesting returns.
Right now, there is a revolution taking place equivalent to the Industrial Revolution, as infrastructure evolves to support a digital age.
“These are investments for the benefit of society and for future generations. It is necessary for institutional investors to support this effort. However, it requires significant industrial insight. That means partnering with dedicated asset managers who have the experience and who can help bring an alignment of interests between themselves and corporates,” concludes Palanque. n
