22 Jul 2020
Building infrastructure's future
In my last post, I suggested that our endowment of infrastructure in the UK is far from perfect, but it is not as bad as is sometimes suggested. We can learn from our rich history.
There is no ‘one size fits all’ in terms of infrastructure development, and we need to open our minds to various ownership and operating models in different circumstances, as we look to the future.
Right now, our basic infrastructure is entering a disruptive period that will involve growth of new assets and destruction of some existing ones, as we confront the immediate challenge of the pandemic crisis and the long-term demands of environmental sustainability.
Future investment needs to be delivered efficiently and financed reliably. How can we hope to encourage large pools of capital to invest in new infrastructure assets at the same time as we are seeing major extinctions of existing ones, driven principally by our move away from a fossil-fuel system in power generation, transport and heat? The danger signs for investors are obvious already with recently-announced multi-billion-pound impairments by Shell and BP.
With large sunk costs and multi-decade asset lives, the dominant issue for private investors in infrastructure assets is the danger of capital loss, driven by political opportunism, technological progress, or societal shifts as we now address climate change.
The investment that has gone into our electricity and water networks since privatisation, delivered on a RAB methodology, has transformed those industries over the last thirty years.
There are two main ways for a society to mitigate these risks. One is to legally protect investors, in terms of their investments, to ensure they are not stranded before capital costs have been repaid. This boils down to a credible regulatory framework enjoying broad public legitimacy. The other is for government to directly finance infrastructure, but to do it in an efficient way (this implies credible over-sight of political mandarins). The clue in each case lies in the word ‘credible’.
We should not rule out the nationalisation route, when based on a clear political mandate. The post-World War Two UK government used fiscal policy (high tax rates) to channel savings directly into a successful economic reconstruction. At least some of the infrastructure we need now can be financed by government, through tax revenues (in effect society’s project equity) and debt, especially given low-interest rates. It can also be delivered efficiently, if independent scrutiny of government departments is allowed to flourish and to have sharp teeth.
However, we are all aware of some potential pitfalls with nationalised endeavour. On the grounds of diversification, if nothing else, it also makes sense to attract private investment directly into core infrastructure. Can we envisage a regulatory architecture to ensure the private sector will provide us with the infrastructure we need to sustain our economic future, at acceptable costs of capital relative to direct government investment?
I think we can. One of the better aspects of our existing infrastructure is the part financed privately via a Regulated Asset Base (RAB). Regulators have a duty to ensure that RAB-accounted assets are fairly remunerated. The RAB is, in essence, a log of investments – a protected number designed to give private investors, including you and me through our pension funds, the confidence to invest.
For example, the investment that has gone into our electricity and water networks since privatisation, delivered on a RAB methodology, has transformed those industries over the last thirty years. In some cases, there is no good reason why this regulatory innovation cannot be extended to other areas of infrastructure.
Indeed, the real question is why we have not extended the RAB concept before now. With the environmental clock ticking, time is running out to get on with it.
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The blog does not aim to give investment advice, but is designed to afford relevant longer-term context to investors, encouraging a broad perspective where uncertainty is high and a spirit of learning is important. The views expressed are those of the author, not those of Investec.