“As set out in NIP 2013, the UK has been at the forefront of developing a model of infrastructure investment whereby
Since publication of the fourth version of the National Infrastructure Plan (NIP) in December 2013, the development of infrastructure across the UK continues to be a much discussed topic.
responsibility for funding, financing and delivery is split between the public and private sectors.”
National Infrastructure Plan: finance update, 19 March 2014
Providing insight into the government’s most urgent infrastructure investment, the announcement of the budget in March 2014 highlighted support for building more than 200,000 new homes, a GBP 270 million guarantee for the Mersey Gateway bridge, an additional GBP 140 million for flood defence repairs/maintenance and a pledge towards funding improvements in Welsh road infrastructure.
The Queen’s Speech last week also highlighted a new Infrastructure Bill to further reform change of use rules to make it easier for empty and redundant buildings to be converted into productive use, and support for exploration of shale gas reserves under private land without consent. Indeed, it has been estimated that the GBP 36 billion of planned investment into UK infrastructure over 2014/15
could lead to more than 150,000 construction jobs1 and add up to 5% to GDP2. The impact of the Autumn Statement and upcoming General Election will be closely watched by the industry.
With this continued focus and topical political and market developments (such as rising costs and skills shortages) on the horizon, it is an interesting time for infrastructure
stakeholders both nationally and internationally. As the NIP and UK infrastructure market further evolve, Clyde & Co will continue to be active across sector developments with legal and market insights as they arise.
In this paper, we explore:
The challenge of energy infrastructure: energy security, decarbonisation, and affordability Rhetoric, relaxing restrictions and the future for fracking The “A-2015” Highways Agency roadmap The Queen’s Speech Network Rail to join the public sector Institutional investment: a sector by sector review
We hope that you find these insights informative. If you have any questions regarding the UK infrastructure market, please don’t hesitate to contact us.
The UK energy system faces a number of challenges as existing infrastructure closes, domestic fossil fuel reserves decline, and the system increasingly requires adaptation in order to meet low carbon objectives.
The challenge of energy infrastructure: energy security, decarbonisation, and affordability
Changes are required to ensure that the UK has a secure energy supply in years to come and, already, the threat to supply security has been brought to the top of the agenda this year due to the political troubles in the Ukraine.
The UK government has recognised that changes are critical to maintain security of supply and deliver the energy people need, where they need it. In its own words “Large-scale investment is required in order to achieve security of supply as the UK makes the transition to a lower – carbon economy”3.
This is reflected in the fact that GBP 147 billion of the total GBP 375 billion required investment in the National Infrastructure Plan (NIP) is earmarked for electricity generation. In fact there is a view that this may not be enough. A joint report by the London School of Economics (LSE) and nPower suggests that the energy sector needs record levels of investment of up to GBP 330 billion by 2030 if security of supply is to be achieved while carbon emissions are reduced. This in turn would enable the
UK to achieve the EU’s long term 2030 emissions reduction target.
Where is the energy investment required?
HM Treasury’s “National Infrastructure Plan: finance update March 2014” (Treasury Update) accepts that the historical model of large utilities financing electricity generation on balance sheet is unlikely to deliver the scale of investment required. This is particularly the case when the traditional utilities are seeking to reinforce their balance sheets through asset sales and cuts in capital expenditure4. As
a result, the way forward must include project specific investment in the electricity sector with finance through separate vehicles where the return is directly related to the performance of specific electricity assets.
The Treasury Update gives a useful summary of where investment is required and the total value of projects (by technology type) which are in the pipeline for the period up to 2020 (excluding those in construction or already part of an active programme).
‘Top 40’ project pipeline
Central to the National Infrastructure Plan (NIP) is the infrastructure pipeline which includes the government’s ‘Top 40’ priority investments which are considered crucial to meeting the UK’s needs in each infrastructure sub-sector.
Valued at over GBP 375 billion, the ‘Top 40’ includes large For industry participants, this prioritisation is a welcome infrastructure projects with a capital value of GBP 50 step however critics are quick to highlight that for million such as the Northern Line extension to Battersea, contractors and investors particularly, the greatest
the nuclear generation project at Hinkley Point C, and opportunities may not lay within the ‘Top 40’, as 27 of these Crossrail. Additionally, capital programmes worth the same projects are already under construction and many others amount but comprising of many smaller projects grouped are already procuring project partners. Thames Tideway is together are also included. Examples of these projects an example whereby eight ventures were shortlisted in late include road works/upgrades and flood prevention schemes. 2013 with construction expected to commence in 2016.
There are seven categories of infrastructure asset covered While future projects and elements such as the 2015 UK within the plan: transport, energy, communications, water, General Election will undoubtly influence project planning, flood, waste and intellectual capital. Based upon the below it is clear that funders and contractors must be on the however (which details the ‘Top 40’ priority investments), front foot to take advantage of opportunities. Moreover, the transport and energy sectors are the big winners in securing long term, guaranteed funding in order to
terms of capital value investment and prioritisation. maintain an active pipeline will be crucial.
HM Treasury and Infrastructure UK: National Infrastructure Plan: Finance Update, 19 March 2014. 4 Industry Outlook, EMEA Electric and Gas Utilities. Moody’s Investors Service, 20 November 2013.
It is no surprise that a sizeable chunk of funds are required for Hinkley Point C, which is the first nuclear plant in the nuclear renewal programme regarded as essential to ensuring that the UK has a secure and low carbon electricity supply. In order to give investors the confidence to commit the billions necessary,
the UK government has provided price certainty through contracts for difference for the power off-take at what is generally regarded as a very generous strike price. It also intends to provide support through the UK Guarantees Scheme.
Off-shore and on-shore wind The off-shore wind sector potentially offers the largest investment opportunity pre-2020 with an estimated value of GBP 18.3 billion.
On-shore wind, which is thought
to have an existing established investment model using debt markets, is expected to generate projects with a value of up to GBP 10.4 billion. There is also help for developing offshore marine renewable energy (both tidal and wave) through demonstration projects such as the publicly owned Wave Hub in Cornwall.
While large scale renewable projects may provide suitable investment opportunities for project specific finance, small scale renewable projects (including solar, wind and anaerobic digestion), are generally considered too small individually
to be suitable for a project finance solution unless bundled up into
a portfolio sale. The government intends to continue the support for smaller scale projects through measures such as feed-in-tariffs. However large scale renewables (including solar) which have
historically been supported through the Renewables Obligation regime, will continue to receive support as part of the government’s Electricity Market Regime (EMR) policy through ‘contracts for difference’.
There is a GBP 900 million potential opportunity for investment in biomass where the government has supported conversion of one engine at Drax, the UK’s largest coal power station, to biomass by providing a GBP 75 million UK Guarantee.
One of the key issues facing the UK energy market is the extent to which gas-fired capacity will be developed and a “dash for gas” will slow down the need for structural changes which are required to reduce carbon emissions. Although the construction of combined cycle gas turbines (CCGT) could result in short term price gains by switching from coal to
competitively priced gas (while initially achieving moderate reductions in greenhouse gas emissions), this delays the long term investment required in low carbon plant if required emissions reductions are to be achieved.
It is interesting in this context to see that the government regards investment in CCGT as part of the energy mix. The Department of Energy & Climate Change’s (DECC) EMR policy is to create a capacity market with 15 year capacity agreements available which should
provide sufficient certainty to unlock investment in new gas plant. The government’s recognition of the continued importance of fossil fuels as an important source of the electricity generation mix is also implicit in the allocation of GBP 1 billion of public funding to help develop Carbon
Will investment be made?
The reality is that the government’s energy and climate change policy has three competing objectives: energy security; decarbonisation; and affordability. These are enshrined in the Energy Act 2013 (Energy Act) which contains the legal framework for the government’s EMR policy for long term support for low carbon electricity generation.
The conflict is reflected in the factors the government must take into account under the Energy Act when setting its decarbonisation target range. While the impact of climate change is relevant it must also consider the need for economic growth and the cost to consumers. There is no easy way to reconcile the fact that it costs more at the
moment to provide power from low carbon technology than from traditional fossil fuel sources. The Labour opposition has politicised energy prices making it difficult to retain the current green levies which add a substantial amount to the cost of household bills. However some sting has been taken out of this debate by Ofgem’s referral of the energy market to the Competition Markets Authority (CMA) who are unlikely to report until after the next election.
Given that the CMA’s main focus will be to assess whether the “big 6” suppliers should be broken up, there are significant concerns that this will put a halt to the investment needed in UK power generation.
Despite this, there are a number of hopeful signs that investment to create green growth has started. A recent EY Renewable Energy Country Attractiveness Index5 indicates that the UK is now the fifth most attractive place in the
world for renewables, the second for biomass and the first for off-shore wind. Further, according to Bloomberg, Britain saw record levels of investment in renewable energy in 2012 to 2013 which rose 59% to GBP 7.3 billion; placing the UK third in the world behind China and the US.
Finally, in late April, the DECC announced the first tranche of support under the new legislative framework for eight major new renewable projects ranging from off-shore wind to the conversion of a unit at Drax to biomass which will attract around GBP 12 billion in private investment. This will be followed by auctions for ‘contracts for difference’
to assist the low carbon transition. The UK is also now benefitting from some foreign direct investment in its renewable supply chain with ABP and Siemens making a GBP 310 million investment in Hull in two new factories to make turbine blades and assemble off-shore wind turbines.
The future of UK energy depends on continued investment. This in turn depends on ensuring the investment environment is favourable and one of the key conditions that must be satisfied to enable development is regulatory certainty. With more clarity emerging on the detail of EMR and the announcement of the first awards for support, there may now be a base on which investors can rely to unlock their funds.
T: +44 (0)20 7876 4863
Capture and Storage through a commercialisation competition.
5 Ernst & Young: Renewable energy country attractiveness index, February 2014
In early 2014, David Cameron boldly announced that the government supported the exploitation of onshore oil and gas through hydraulic fracturing (fracking) and that the UK should fully embrace exploration, stating: “I want us to get on board this change that is doing so much good and bringing so much benefit to North America”1. Since then, the government has announced further tentative steps towards its ambition to realise shale gas exploration such that it is now one of the governments ‘Top 40’ priority UK infrastructure projects under the most recent iteration of the National Infrastructure Plan (NIP).
Rhetoric, relaxing restrictions and the future for fracking
Latest studies have indicated that supplies of natural gas which are economically recoverable from shale in the United States can accommodate the country’s domestic demand for natural gas (at current levels of consumption) for more than a hundred years. This is an economic and strategic boon home and abroad, and at least in the near term, a potentially important stepping-stone toward lower- carbon, greener energy. However, as things stand in the UK currently, unconventional oil and gas exploration is hampered by a powerful anti-fracking movement and a cumbersome planning and environmental permit process.
The government is seeking to address both of these hurdles by a combination of rhetoric and (at least the beginnings of) relaxation of restrictions. It has also introduced the most competitive tax regime in Europe for shale gas and in the Queen’s Speech, the government announced plans to allow developers to drill under homes without the owner’s permission. Nevertheless, it remains the case that any developer wishing to exploit (what is estimated to be) 1,300 trillion cubic feet of shale gas lying underneath British soil still has a challenge ahead. On 8 May 2014, the House Of
Lords Economic Affairs Committee released a report stating that development of shale gas resources should be an “urgent national priority”, blaming the “dauntingly complex” regulatory framework for the snail’s pace of exploration.
What fracking will mean if given the green light Work is carried out in three distinct phases: exploration, appraisal and production. The exploration phase can last anything from two to six months and involves drilling wells to identify whether oil or gas can be produced profitably. All UK shale gas development is currently in this phase.
The appraisal phase is next, and typically lasts from six months to two years. It requires testing of the deposits to establish the strength of the resource and its potential productive life. Finally, the production stage can begin, when developers can begin profiting from their efforts. This phase is expected to last a minimum of 20 years. However, preparing the apparatus and finding a suitable drilling site is only half the battle. Before the government will grant the developer a drill consent, numerous other consents and permissions must first be obtained.
1 BBC: “Cameron urges fracking opponents to ‘get on board’, 13 January 2014.
Rights to drill from landowners
Firstly, landowners must agree to drilling underneath their property. Fracking for shale gas is performed in both vertical and horizontal wells, and horizontal wells can be
over a mile long. Therefore, a single fracking operation may require rights to drill under multiple landholdings. As the law currently stands, drilling without landowner consent will amount to trespass and opens extraction companies to the risk of landowners obtaining injunctions to halt the drilling process. Unlike in the United States, landowners have little incentive to cooperate with developers as underground oil and gas belongs to the Crown.
Reports in the press have suggested that opponents of fracking could obstruct drilling by buying up strips of land, known as “ransom strips” in a fracking area, giving them the right to mount legal challenges to drilling. Licensed developers have the right to seek compulsory purchase
of land required for drilling: however, to date no such order has ever been implemented. Such proceedings are likely to be drawn out: the developer must show that the need to acquire the right is in the national interest, and that the landowner has been unreasonable in refusing to grant the right by private arrangement. It is unlikely that landowners who have refused access to developers will go down without a fight.
The government is seeking to clarify the position for developers post Queen’s speech following a public consultation. Ministers want to establish that energy companies have the right to run shale gas pipelines
under private land, without breaking trespass laws. This is likely to be accompanied by a right to compensation
for local communities.
Petroleum exploration development licences Secondly, the developer will require a petroleum exploration development licence (PEDL). There are
currently 176 PEDLs for onshore oil and gas in the UK and
the Department of Energy and Climate Change is planning to conduct a new round of licensing in 2014. These licences confer on the developer an exclusive right to search, bore for and extract hydrocarbons in the licence area. However, this licence alone is not enough to start drilling.
Planning permission and Environmental Impact Assessments
Planning permission is also required from the Minerals Planning Authority (which is usually the County Council). When applying for planning permission, the developer must complete an ownership certificate which provides details about the ownership of the application site and confirms that appropriate notices have been served on landowners. The government has recently signalled its intention to simplify this process by allowing developers to apply for planning permission without notifying the owners of land where only underground operations will
take place. This should be welcome news to developers and shows recognition by government of the impracticalities
of identifying interests in land over large areas in the early stages of seeking the various consents needed. As yet, planning permission has only been granted for exploratory wells at a small number of sites, with no site being close
The Minerals Planning Authority must also decide whether an Environmental Impact Assessment (EIA) is required,
on a case-by-case basis. It is unlikely that an EIA will be required for exploratory drilling operations which do not involve hydraulic fracturing.
Environmental and health & safety go ahead Fourthly, permits from the Environment Agency will be issued to ensure fracking is not harmful to the surrounding environment. This will be a step heavily
scrutinised by environmental campaigners, who advocate
that the techniques used in fracking could cause small earth tremors, water contamination and environmental damage. However, the government claims that if there is any risk to the environment, the authority will find this risk unacceptable and not permit activity.
No developer has managed to reach this stage in the process as of yet: the House of Lords Economic Affairs Committee’s report pointed out that the Environment Agency has not received or approved any applications for the necessary permits since the moratorium on hydraulic fracturing was lifted in 2012.
Finally, the Health and Safety Executive must be notified of the well design and operation plan. If satisfied, a well consent will be granted.
Only when all of these consents have been obtained will the government grant a drill consent to the developer.
The future for UK fracking – the good and the bad It’s not all negative news for UK onshore energy operators. As above, in the government’s bid to go “all out for shale,” the most competitive tax regime in Europe for shale gas has been introduced; saving companies an extra 24p in tax for every GBP 1 they spend on the project. The new tax breaks are structured so that when a developer starts making taxable profits from selling gas, it will be taxed at 30 per cent rather than the usual 62 per cent. In fact, new developers will now have an effective tax rate lower than the US.
The government is also allowing councils to keep all of the business rates raised from fracking sites, a deal
which is expected to generate millions of pounds for local authorities. It is claimed this could be worth up to
GBP 1.7 million a year for a typical site, funded directly from central government. This has been vilified by critics, with Greenpeace accusing ministers of trying to “bribe councils.”
Whatever your stance, fracking continues to be a topic for debate, sparking lobbying and protests from
campaigners. However, the government has firmly marked its position; the production of onshore oil and gas is ‘full steam ahead’. There is no doubt that post Queen’s Speech and in the lead up to the Autumn Statement (December 2014), fracking will be a key industry topic. Based upon
the government’s statements so far this year however, industry leaders will certainly be monitoring these announcements to see if they signal the end to rhetoric and political positioning and instead, the start of developer application approvals and progress.
T: +44 (0)20 7876 4245
With the Highways Agency transforming into a government owned yet
“independent” company, the road ahead looks clearer.
In line with the Government’s “Action for Roads” Command Paper issued last July, and its subsequent consultation process (which concluded in April), the draft Infrastructure Bill proposes to transform the Highways Agency by April 2015 from an entity run directly by the Department for Transport into a government owned – but “independent” – company.
As a consequence, it will have much greater freedom to make decisions affecting the strategic road network, without the need for ministerial scrutiny in every case.
The Bill provides for a “Road Investment Strategy” to be produced to determine the levels of performance and investment that are to be delivered (probably over a five year period, similar to the model already in use on the railways), and a committed revenue stream will provide enhanced certainty for contractors (replacing the previous “brake/accelerate” approach to funding). The government has estimated that these changes to the Agency could save the taxpayer GBP 2.6 billion over ten years.
These structural reforms should constitute at least a first step on the journey to a more dynamic road network for the 21st century – but how will the new company operate in practice?
The Bill itself sets out the overall strategic parameters of the relationship between the government and the company, in a way that seeks to protect the public interest, without the need for daily intervention in its
activities. The detail of the governance regime, however, will be set out in three additional key documents:
A formal Licence will be issued by the Secretary of State, setting out key conditions for the company’s operation of the network A Framework Agreement will be entered into between the Government and the company, setting out the procedural interface between the two, defining roles and responsibilities, and laying down policies as to financial independence, reporting, monitoring, audits etc Finally, Articles of Association will set out the company’s constitution and internal rules and procedures, in line with normal principles of corporate law
The (backseat) drivers
As sole shareholder, the Secretary of State will appoint the Chair of the company who, in turn, will nominate the CEO, and the majority of the board – subject to approval by the Secretary of State. The latter will also have the right directly to appoint a non-executive director to provide support and advice to the Chair.
In addition to its other normal rights as sole shareholder (such as calling an EGM or dismissing board members), the Secretary of State is also likely to retain a number
of sanctions to deal with poor performance by the company. These may include financial penalties (for example, the Bill provides for fines in the event of
a failure by the company to comply with the Road Investment Strategy, or with directions or guidance issued by the Secretary of State). They may also include
the withholding of incentives for management, and/or the loss of operational independence, whilst remedial measures are implemented.
It shouldn’t be thought however that oversight will only be exercised by the Secretary of State. The company’s CEO will be formally answerable to parliament for the expenditure of taxpayers’ money, whilst the Bill provides for two external bodies to hold the company to account
– one within Passenger Focus to represent the interests of road users, and the other within the Office of Rail Regulation to oversee cost and efficiency.
In addition, the company will, of course, ultimately face action in the courts, if it fails to comply with its legal duty as a highway authority to maintain its road network in a safe and serviceable condition.
Whilst there will almost certainly be delays, with the odd pothole and traffic jam looming (the run-up to a General Election, for example….), we now know a lot more about the route ahead. Directions will become clearer still, when promised first drafts of the Licence, Framework Agreement and Articles are published over the course
of the summer. We will continue to provide journey updates in later editions of this briefing on these drafts and progress.
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Infrastructure in numbers
The Queen’s Speech
On 4 June 2014, the Queen’s Speech announced a number of changes across investment and infrastructure in addition to the previously discussed Highways Agency changes. Below our Clyde & Co infrastructure partners provide their comments on the announcements:
growth in the infrastructure sector for
The proposal to give energy companies the right to exploit shale gas
reserves under private land without landowner consent is an important step in addressing existing practical difficulties, albeit I suspect that there is still some way to go before fracking becomes a serious proposition in the UK. Potential investors will still need to be persuaded that the intricate procedural hurdles and local politics can be overcome...
The pension reforms are further evidence of the government’s commitment to encouraging pension saving. This is likely to provide a welcome
boost to saving, supplying much needed capital for investment in infrastructure projects.
A significant reason for the current housing bubble, particularly in London, is the shortage of supply of suitable housing. While the pending secondary legislation to allow the development of a Garden City around Ebbsfleet, which has excellent transport links to central London, is to be welcomed
– as is further reform to ‘change of use’ rules – it’s doubtful whether this alone will be sufficient to achieve the additional numbers of new homes required in the short term.
T: +44 (0)20 7876 4229
T: +44 (0)20 7876 6892
T: +44 (0)20 7876 4248
industry’s contribution as a percentage of total UK GDP
due to get under
way over the next two years
Network Rail to join the public sector
From September 2014, Network Rail will become a government
controlled body. Is this merely a case of “statistical change”, or something more significant?
Changed basis of analysis
Network Rail Ltd was incorporated in 2002 as a company limited by guarantee and is often referred to as a not-for- profit institution. It was set up to replace Railtrack plc which was put into Railway Administration on 7 October 2001 following a number of railway accidents, including the Hatfield crash in 2000.
The UK’s Office for National Statisitics (ONS) had previously decided, based on its interpretation of the European accounting rules which applied at the time, that Network Rail is a private corporation. New rules come into force on 1 September 2014 and the ONS has now decided that Network Rail will, from this date, be within the public sector.
In reviewing the position of Network Rail the ONS reviewed the degree of the government’s risk exposure and concluded that this is highly relevant for three reasons. First, Network Rail’s debt is guaranteed explicitly by the Department for Transport (DfT). Second, under the Railways Act 1993, the government has a statutory obligation to protect the interests of rail users so if Network Rail was not able to operate the rail network
the government would be required to do so. Finally, as Network Rail has no shareholders, only government bears any significant financial risk in relation to the company.
Network Rail has downplayed the change stating in its press release: “This reclassification of Network Rail as a central government body is a statistical decision that does not alter the
company’s structure as a not-for-dividend company, limited by guarantee, with members rather than shareholders. The business acts and operates today as it did yesterday, and our job of delivering a safe, reliable and improving railway for four million daily users continues”12.
Reaction of DfT
Publicly, DfT have supported this view. In his statement on the topic, Patrick McLoughlin, the Secretary of State for Transport, said: “I am committed to ensuring that Network Rail maintains the operational flexibility to continue to deliver a safe, punctual rail network and increased capacity for our busy railways and that it is able to attract a high calibre of staff, while still providing value for money and being accountable to Parliament13.”
Notwithstanding these words, it appears that DfT has established a group of people which is referred to as the Network Rail Sponsorship Group. Little is known about this group but an implication may be that DfT is assessing what the change means and how to respond. A flexing of departmental muscle could be on the horizon.
Memorandum of understanding
DfT and Network Rail have entered into a Memorandum of Understanding which sets out the implications of the “statistical reclassification for the relationship between Network Rail and Her Majesty’s Government”. It also explains where further work will be needed to determine the way this relationship will function and the conclusion of this
will be set out in a Framework Agreement between the Department for Transport and Network Rail. One could draw the conclusion from this that DfT do not yet fully understand the implications of the change which could take some time to understand.
There is a clear desire to continue some business as usual. The Memorandum states that the change in approach will not affect “the Government’s commitment to the railways
or its plans for investment, including both its existing rail investment strategy for 2014-19 and HS2”. The rail franchising programme should be unaffected too.
More cryptically, the Memorandum states that the “Framework Agreement will aim to preserve Network Rail’s ability to continue managing its business with appropriate commercial freedom, within a proper regulatory and control framework to maintain effective accountability”.
The Memorandum goes on to state that the “Government’s general approach to this reclassification is therefore only to make changes where they are: required to satisfy Government and Parliamentary budgeting and accountability requirements; or justified to deliver value for money”. Delivering value for money is a theme which runs through the Memorandum and it will be interesting to see what this means in practice but it is clear that DfT will want more rather than less oversight.
Network Rail’s senior management will also be interested to see what the change means for them as the framework for executive director pay and incentives is to be reviewed “in light of Government’s new accountability to Parliament for Network Rail”. Capping pay at the level of the Prime Minister’s would be an unpalatable prospect for some at Kings Place.
The role of the Office of Rail Regulation (ORR)
The Memorandum states that the ORR will continue to act as the independent economic, competition and safety regulator for Network Rail’s activities. If DfT is to exert
greater control over Network Rail some may query whether the ORR needs to retain all of these functions.
T: +44 (0)20 7876 4955
12 Network Rail: “The Office for National Statistics announces a change to its classification of Network Rail”, 17 December 2013
14 13 Department for Transport (The Rt Hon Patrick McLoughlin MP): “ONS decision on the classification of Network Rail”, 17 December 2013 15
Institutional investment: a sector by sector review
Institutional investment is increasingly seen as a new method of funding infrastructure projects. Below, we consider a few sectors available for investment by institutional investors and assess the extent to which the National Infrastructure Plan (NIP) offers the right opportunities in these areas.
The National Association of Pension Funds (NAPF) supports social housing investments by pension funds stating that “it has liability-matching properties and the potential for investment returns much higher than those currently available on inflation linked gilts.14”
The opportunities offered by the sector are greatly shaped by the financial crisis and the Basel 3 capital requirements where banks have become very reluctant to hold long term illiquid assets such as housing investments on their balance sheet. The government in turn has cut almost 50% in grants to the social housing sector following the post crisis austerity measures. It is now estimated that housing associations will need to borrow around GBP 15 billion
to fund planned regeneration and maintenance projects between now and 2015. All this combined with the government led rent increases for housing associations to be RPI plus 0.5% created just the right combination
of factors to encourage pension funds and insurance companies to take advantage of the opportunities offered by the social housing sector.
Surprisingly, however, the NIP does not mention social housing or investments in schools or hospitals as an area of focus in its policy framework for UK infrastructure. Given the social impact implications of this sector and the marked interest of pension funds and insurance companies, this oversight is regrettable.
Some other areas of great social concern that will likely become more and more pertinent in the future given the events in recent years are water supply and sewage. The government issued a strategy policy statement to Ofwat, the water sector regulator, encouraging a greater attention to:
The impact of regulation in the field upon future investment prospects in the sector The long term challenges faced by the sector, and The sustainable development objectives
As a reinforcement of this trend, Ofwat’s provisional price determinations for 2010-2015 provided for a major capital investment program of more than GBP 25 billion in water infrastructure (including GBP 13 billion of expenditure for capital maintenance), leaving water companies to prepare their business plans for meeting these infrastructure commitment targets. All this seems to promote a more investor friendly approach to the regulation of the water sector.
An increasing number of investors have begun to factor environmental, social and governance issues into their decision-making process and recognise their unique position to play a role in driving the transition to a more sustainable global financial system. Investment in water supply and sewage could be a great opportunity for institutional investors looking to diversify their portfolio and make
Contrasting with NIP’s complete lack of oversight of socially responsible investment in social housing, renewable energy has been an area which received much more attention. Several factors can be found in the NIP to support institutional investment in this sector including:
The liberalised market The Electricity Market Reform package of measures being implemented by the government in order to meet the renewable energy target set for 2020 The government’s legally binding carbon commitments The government’s plan to implement the Contracts for Difference (CfDs) in the low carbon generation technologies, and The government’s plan to implement a favourable tax regime for shale gas
All these factors should support institutional investors in renewable energy by decreasing some of the risks associated with investing in this sector.
The CfDs will protect investors from fluctuations in the wholesale electricity price, will provide increased certainty about future revenues and help reduce the initial cost
of capital. The government also intends to include other contract terms such as the providers’ flexibility to reduce capacity, protection against unexpected events and protection against change of circumstances.
Renewable energy therefore provides a clear option
A project focused approach
Given that 40% of the government’s pipeline of projects is already under construction, it is also important for institutional investors to focus on sectors where the government has not yet identified key projects within the NIP policy framework and where it adopts a more flexible approach as to the type of projects available for consideration.
The government encourages projects in gas and unconventional gas production, wind energy, biomass, solar PV, wave and tidal energy and states that it will monitor investments in these sectors at a program level despite not identifying specific projects.
There is significant scope for government led financing in these sectors if a suitable project is put forward by the investors and institutional investors should consider these opportunities.
T: +44 (0)20 7876 6892
T: +44 (0)20 7876 6395
14 NAPF: “Investment insight: Social Housing”, March 2013
for institutional investors both by favourable market
conditions as well as by undoubted government support.
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