Filling the infrastructure funding hole

Private equity investment in infrastructure will clearly need to take a quantum leap over the next decade, if governments across the globe are to have any chance of expanding their energy, transportation, communications, and water networks to meet forecast demand.

The scale of the required investment is staggering. The Organisation for Economic Co-operation and Development (OECD) has forecast that its member countries will need to spend US$50,000bn on such projects by 2030, while the American Society of Civil Engineers maintains the US alone needs to invest US$2,200bn over the next five years to renew “crumbling infrastructure”.

The ability of governments to meet even a fraction of this expenditure will be more impaired than ever, as the cost of rescuing the global financial system puts unprecedented stress on public-sector budgets in the years ahead.

The banking crisis has also put huge strain on the traditional source of private-sector funding for infrastructure development – project finance. As banks contend with tighter capital adequacy requirements, reduced liquidity and higher funding costs, global capacity for what has historically been highly leveraged, long-term debt has predictably shrunk.

The recent failure of the planned US$2.52bn privatisation of Chicago’s Midway Airport brought this message home. The deal collapsed in April because the winning consortium was unable to secure the necessary finance.

While investment infrastructure funds have increased at an exponential rate over the past five years – climbing from US$6.6bn in 2005 to over US$90bn in 2008 – bank-sponsored funds have accounted for the majority of the money raised to-date, and there is obviously a shadow over the future of this model.

This year has seen encouraging signs that private equity is ready to fill the funding void, as two of the largest US players – Kohlberg Kravis & Roberts and Blackstone – have launched maiden infrastructure funds that between them could ultimately raise over US$10bn. If such investment vehicles can galvanise the pensions industry to allocate a meaningful proportion of their assets into the sector, there is a realistic chance of raising the volume of funding that will be required.

For while a handful of pension funds have made significant investments in infrastructure (usually directly), the vast majority have largely steered clear of assets that are in many respects well-suited to meet their liabilities (long-term investments, paying stable – and in many cases index-linked – returns).

The scope for pension funds to make a real difference is certainly there. A recent OECD report concluded that an across-the-board allocation of just 3% of their total assets could release US$500bn for infrastructure investment.

There are, of course, real hurdles to overcome before this can happen. Not least among them will be the need for private equity to lower its historical expectations on returns and the fees it charges limited partners (there are already signs of this occurring), and to exercise an unfamiliar degree of patience when dealing with the bureaucratic procedures and political opposition that often characterise private-sector involvement in infrastructure.

The state legislature’s rejection last year of a US$12.8bn plan to privatise the 855km of toll road in the Pennsylvania Turnpike system was a sharp reminder of how politics can frustrate projects.

But without the will on all sides to overcome such obstacles to large-scale private equity involvement, most of the roads, energy transmission systems and water networks, which the world needs over the next two decades, will simply not get built.