Aus & NZ: 2018 Infrastructure outlook: Australia & NZ

06 December 2017 - 12:00 am UTC

In the minds of many top-tier infrastructure investors and advisers Australia for the next six months is one project – the AUD 16.8bn (USD 12.7bn) WestConnex. Beyond that the amount of infrastructure assets in play is limited. Across the Tasman Sea, New Zealand remains a mystery as a new left-wing government settles in.

As well as the split between the beginning and end of the year, there is a divide between large and small funds. How busy you’ll be depends on how much you need to invest, what risks you are prepared to take and whether you are a brownfield or greenfield investor.

Smaller funds, construction firms, commercial banks, lawyers and engineers say they see the promise of a host of greenfield projects, which are beginning to dominate the pipeline. It includes money from “asset recycling” sales in New South Wales and Victoria being used to build public transport, renewable energy development continues and governments look for ways to fill big shortfalls in housing, schools and health. Even WestConnex is “khaki”, with a large third stage greenfield component in the M4-M5 tunnel and a fiendishly complex Rozelle interchange testing the mettle of many funds.

QIC’s head of global infrastructure, Ross Israel, says they have to really earn their keep once again. “In Australia, the pipeline is going to need to be more actively developed. It is not as easy as a privatisation, it does not come wrapped with a bow and a card. You have got to be talking to people within the different sectors.”

Julian Peck, co-head of investment banking and head of infrastructure at Morgan Stanley Australia echoes many of his counterparts. “I am not a pessimist on infrastructure activity levels, I just think going forward over the next two or three years the visibility on the pipeline is going to be a little bit lower and the lead time on deals is going to be a little bit shorter than we have seen in the last two or three years,” he says.

Outside WestConnex, the size of brownfield asset sales take a big step down in size. They include a “commercialisation” of Victoria’s land titles unit, and a possible AUD 1bn sale of the Basslink, electricity interconnector between Tasmania and Victoria. Western Australia may return to a few small privatisations, despite the new Labor government ending the Western Power and Fremantle Port sell-offs. A year ago, some big funds would have steered clear of land titles and Basslink, but most in the market will now consider any sales that come up. “They have to. There’s just not much else going on,” says another investment banker.

There is also action within infrastructure funds themselves, including a possible listing or sale by parent Commonwealth Bank of Colonial First State Global Asset Management, and moves by Utilities Trust of Australia to oust Hastings Funds Management.

 

Managing what you’ve got

Michael Hanna, head of Australian infrastructure at IFM Investors, says in Australia the fund manager is focusing more on investments in assets it owns. There are also more opportunities for investments offshore at the moment.

Israel at QIC says something similar. “Markets are pretty fully priced,” he says. “It may make more sense to look inside the assets you own and focus on improving the assets with small bolt-ons. The flipside of that is it is a good time to sell assets.”

Both IFM and QIC have been contenders for WestConnex. But at the time of writing all those interested were still awaiting further details on the transaction before deciding whether to bid.

They are owners of large, monopoly assets that are important to the Australian economy and have a lot of customers, including Ausgrid, Melbourne Airport and Port of Melbourne. Both are keeping close tabs on their political impact.

“The political environment remains unpredictable which impacts investment certainty,” says Hanna. “The need for all infrastructure investors to advocate strongly and act responsibly is even more important today. When politicians are looking for quick wins, unfortunately everyone is in the cross hairs.”

IFM is making big investments in Ausgrid to overhaul what was “the least efficient utility in the NEM”. That will help meet the clamour to reduce the hikes in electricity bills and prepare Ausgrid for the rise in renewable energy in the NEM. It is also making good use of market led, or unsolicited proposals, including building a cruise ship terminal at Port of Brisbane and negotiating an AUD 300m investment to further develop Southern Cross Station in Melbourne. 

 

PPP comeback

In line with the greenfield resurgence, the pipeline of public private partnerships is building again. “I think it will be a very busy year,” says Plenary’s head of origination, Paul Crowe. “The short-term pipeline is almost all transport projects and in general they are mega projects.”

These include Brisbane’s Cross River Rail – which looks likely to go ahead as the Queensland government was close to returning to power at the time of writing – the Regional Rail trains PPP in NSW and the Inland Rail PPP. The AUD 16bn North-East Link tollway in Melbourne could hold opportunities, as well as plans for at least one more arterial roads PPP in Melbourne. A process for Western Harbour Tunnel in Sydney is also underway.
Another project could even return from the dead. Victoria goes to the polls in November and if the Opposition Liberal-National Party wins, it has pledged to reinstate the East-West Link, which the present government scrapped in 2014. 

“In the longer term we would see a move back into social infrastructure projects. Whether that happens in 2018 or not we will see how the political landscape plays out,” Crowe adds.

South Australia may kick off two schools PPPs early next year and Victoria is understood to be considering seeking private investment for another big program of school building.  

All states as well as the federal government are looking for ways to get private operators and investors into social housing. 

 

Cloudy future for renewables

There are dire predictions of a severe curtailment of large scale renewables projects from 2020 onwards under the federal governments’ planned National Energy Guarantee. But developers, investors, advisers and bankers Inframation spoke to in the sector remained upbeat about 2018 and the next few years.

More than 500MW of the 6GW of extra renewable power plants that was estimated in 2016 would be needed by the end of 2018 to meet the 23.5%, 2020 renewable energy target still need to be commissioned. Lots of solar farms scheduled to be built in 2018 will also seek equity investors.

Power purchase agreements are harder to find, but the Victorian and Queensland governments are now helping out with reverse auctions and corporate PPAs are on the rise.

Infrastructure Capital Group managing director Tom Laidlaw says there about 20 energy projects they are considering for investment in 2018. 
“The pipeline in mid-market is very strong,” he says. “You could easily identify dozens of deals to be done in the next 12 to 24 months. That will be heavily skewed to energy, and of that heavily renewables. Up until 2020 I think there will be a real flurry of deals that will likely need to be done in the next 12 months.”

ICG will still be seeking long-term PPAs before they invest. Many more will go ahead on the strength of wholesale power prices rather than with a power purchase agreement, he says. But the PPAs are getting shorter and shorter – even as low as three years.

“There is a big question for us as to whether or not three-year contracts, rolling or not, are infrastructure,” he adds. “There will still be a number of long-term PPAs with governments and corporates. But you need to be a little wary there. Even though you may have a corporate with a decent credit rating, they may not be prepared to take on things like ‘change in law’ risk.”

 

Auction aversion

Despite the number of deals in the offing in renewables, the returns are getting squeezed because fewer viable projects can get long-term contracts that investors covet, meaning there are fewer low-risk projects to choose from. 

All funds are exploring ways to get an edge, often by taking a risk with small bets at earlier stages of development, via non-core investments or behind the scenes negotiations with private or government owners of assets.

In ICG’s case, it has returned to very early stage investments in renewable developers, even before they have acquired land in some cases. This had not been necessary until recently, Laidlaw says, as there were enough deals with 10 to 15 year PPAs. “In the last few years it has been getting too competitive on some of them. So we’re going slightly up the risk spectrum and originating more of the pipeline ourselves.”

“We’re happy to fund deals along the development stage on the assumption they will get a PPA and if they don’t we will sell our interest in it,” he explains. “So it might be AUD 100,000 to AUD 1m. We may not end up wanting to fund the construction because it doesn’t have an offtake agreement, but someone else will. The project will be de-risked and so we should at least get our money back and get a return on some.”

Paul Newfield, chief investment officer at HRL Morrison, says it will continue to face more competition from larger funds that are now prepared to invest in non-core infrastructure, which his fund has focused on. The high prices paid for land titles offices this year is one example of that trend. Data centres, social infrastructure, and renewable energy are others. 

Along with this, he says local infrastructure funds and LPs themselves are becoming much more active investors – shifting closer to their private equity brethren, some of which are also beginning to compete in Australia with their own infrastructure funds.

“As large institutions increase direct investments and infrastructure managers take on more operationally complex assets, people are realising that asset management is a thing,” he says. “That’s going to become a lot more obvious in the next 12 months. Managers who are too passive and lack hands-on operational skills will be shown up and some will get fired.”

He will continue to look for poorly understood areas with fewer competitors.

One area he is looking at is “land based emissions”. “For example, we have a research focus on understanding how to manage the carbon footprint of farms. If you can translate that into infrastructure-like cashflows, this could be an attractive investment space and a way to deal with one of the largest sources of carbon emissions in our region” he says.

 

New Zealand

The end of nine years of rule by the pro-private finance National Party is forcing investors there back to the drawing board – particularly on social infrastructure, where the new Labour-led coalition has an aversion to private money.

“The change in government in New Zealand will bring into question private sector involvement in infrastructure,” says Crowe at Plenary.
Newfield argues Labour will be open to private money in transport and in some more limited forms of social infrastructure. But in general he sees a return to 2008 when HRL Morrison launched the first PPP fund there.

“There was a period post the 2008 election when there was a lot of groundwork to be done with procuring agencies, understanding the new government’s priorities and educating them about how to bring projects to market. The NZ market may go through another phase like that,” he says.

Regulation in 2018

As well as elections in South Australia, Victoria and potentially federally in 2018 or early 2019, rule changes on several fronts will affect deals next year.

  • Energy policy is the most obvious. The federal and state governments and the new Energy Security Board will start to put some meat on the bones of the National Energy Guarantee from April. But some investors don’t expect any real clarity on the policy for at least another two years.
  • Less obvious is the impact of the new critical infrastructure regime and changes in the works to the taxation of stapled trust structures and tax exemptions for some offshore investors. Some Australian funds say the tax office and Australian Competition and Consumer Commission, among other agencies, are more intimately involved in assessing infrastructure acquisitions. They says this gives them an advantage on some assets.
  • The federal Treasury put out a discussion paper in March that could have seen almost all stapled structures unwound. It has since been watered down after a big protest from investors. However, Treasurer Scott Morrison is understood to have told advisers in private briefings he does not want “the Australian taxpayer subsidising foreign buyers”. In this vein, the government is also understood to be looking at ending the tax exemption for foreign state owned enterprises and sovereign wealth funds.
 
Infrastructure