ICAEW.com works better with JavaScript enabled.

long read

The big infra challenge

Author: Andy Thomson

Published: 06 Dec 2023

construction site city skyscrapers train tracks cranes forklifts trucks machinery infrastructure AI

The sheer scale of energy transition projects means there will be no lack of demand for private capital to be deployed in infrastructure. In the UK, however, rising costs are creating a deliverability issue. Andy Thomson reports.

From large global projects to the small and local, infrastructure developments are still coming thick and fast. In a world where headlines are dominated by macro-economic pressures and geopolitical volatility, infrastructure has not been marginalised. 

“The scale of the opportunity and need in infrastructure is gigantically bigger than it was even 20 years ago, when we were getting very excited about it,” says Richard Threlfall, global head of infrastructure, government and healthcare at KPMG. “We’ve come to understand that infrastructure is not only the main driver of economic growth for countries and the most significant way of achieving the UN’s Sustainable Development Goals, but also essential to addressing the climate emergency.”

A quick browse through my inbox on one random morning last month shows the different types of infrastructure investment, and where it’s happening across the globe. KKR announced a $400m (£328m) investment in Singapore’s OMS Group for the development of digital infrastructure in South-East Asia; the Emerging Africa Infrastructure Fund has put $48m towards the Côte d’Ivoire government’s plan to give its people universal access to electricity; on the home front and on a decidedly humbler level, Manor House Golf Club in Wiltshire announced the installation and electrification of EV chargers for its players.

Singapore OMS Group city skyscrapers buildings bridge water skyline infrastructure
Singapore’s OMS Group has just received £328m to develop digital infrastructure

Everywhere, it seems, there is huge demand for infrastructure investment – and the UK is no different. The big theme is energy transition, but it’s far from being the only one. In a low-growth world, new infrastructure is being used to deliver economic growth – including in less affluent areas as part of the government’s ‘levelling up’ agenda. At the time of writing, the focus in the UK was on flood defences in a long period of almost constant rain, but pressures on the health service and schools also continue to be talking points. HS2 has been a long-drawn-out debacle, but upgrading rail infrastructure for long-suffering commuters remains another priority. 

The funding question

In November 2020, the UK government published the National Infrastructure Strategy, which set out a roadmap for the sector in the UK, and paved the way for the launch of the UK Infrastructure Bank. But, as has been the case with infrastructure for a while now, the challenge is less one of demand and more one of supply of finance. In some areas, the UK is seeing much less of that finance coming from the private sector sources that were once courted with a passion. 

“I think the big question, from an infrastructure investor’s point of view, is how much of the opportunity is investible,” says Tim Jones, a partner in the financial advisory practice and transport sector lead for Deloitte. “The trend with large-scale transport schemes – such as HS2 and Crossrail – and social infrastructure since the demise of the Private Finance Initiative (PFI) has been towards more public-sector funding and financing of infrastructure programmes.”

The UK Infrastructure Bank

In October, the UK Infrastructure Bank published its annual report and accounts for the year ended March 2023. The bank, which was set up by the government in June 2021 and whose CEO is Corporate Finance Faculty board member John Flint (above), completed eight transactions during that fiscal year, investing £1.1bn in the clean energy, digital and water sectors.

Cumulatively, the bank has made investments of nearly £2bn in energy transition and levelling-up infra projects.

Flint said: “Since the financial year closed our deal pipeline has continued to grow and we have invested in a range of projects that will help the transition to net zero, including a lithium mine in Cornwall, and one of the largest standalone battery storage facilities in the UK.

“As we continue to ramp up the deployment of our capital, it’s critical that we have the right expertise in place. To this end, we very deliberately prioritised recruitment to our Banking and Investments team and our goal is to be fully staffed across the entire Bank by Spring 2024.

“Achieving net zero will mean a complete overhaul of UK infrastructure, requiring billions of pounds of investment. We are currently mobilising private finance at five times the rate at which we are investing, helping to overcome barriers to investment that the market cannot solve alone, and supporting the growth of businesses and creation of jobs across the UK.”

Perhaps the area where the biggest current demand for private capital is found – not just in the UK, but around the world – is energy transition and decarbonisation. The government did launch the Transition Plan Task Force in November, which is a consultation sector-specific transition plan guidance for investors and operators. The outcome will be published next spring. The required investment amount could hardly be described as small change. In March this year, the International Renewable Energy Agency said it estimated that, for a successful global energy transition, $35trn of investment was needed by 2030. And, unlike in certain areas of infrastructure, private capital is the dominant force. 

“There is a fundamental need for more energy infrastructure to hit net-zero targets, and the appetite and skill sets to deliver on that infrastructure are there in abundance,” says Gavin Quantock, head of KPMG’s clean energy M&A team. A clear example of the potential for private capital to assist energy transition came in early October when the Australian competition regulator cleared a consortium led by Brookfield to acquire Origin Energy, the country’s second-largest power generator, for $10.2bn. The deal is seen as a way to help speed up the country’s renewable energy ambitions.

Rising costs

While the need for finance is clear and the sources of finance are willing, even the fashionable area of energy transition is not immune to macro-economic pressures. Once-hyped supply chain issues may have been pushed out of the headlines by rising interest rates, but they have had a damaging effect on the cost of building energy infrastructure. Higher costs have the potential to put a real dampener on market activity. 

Inflation challenge

While inflation has been falling since hitting peaks last year – 11.1% in the UK, 10.6% in the European Union and 9.1% in the US – it has remained “sticky” and is still at significantly elevated levels compared with historic averages. For those involved in infrastructure projects, it has been an unwelcome headache. 

“It clearly creates challenges from a project control and business planning point of view,” says Deloitte’s Tim Jones. “Inflation is a key aspect of construction cost and it’s made it much more difficult to get the market to commit to fixed-price turnkey contracts – which then cascades through into overall project costs, and we’ve seen some major programmes be directly impacted by it.” 

James Pincus, a partner and head of the infrastructure M&A advisory team at PwC, makes the point that investor returns are bound to come under pressure in an environment of higher inflation and interest rates. “We’ve seen regulated and subsidised areas, such as solar and offshore wind, bid down by some investors to single-digit equity IRRs when interest rates were at 0.5% and had been for a significant length of time. It will be interesting to see what happens to transaction valuations in a macro-economic environment where inflation remains persistently high and long term interest rates are around 5%.” 

However, there’s one feature of private market deals in general where infrastructure may have avoided falling into a trap. Infrastructure hasn’t suffered too much from overleverage, which would have been a problem with interest rates so much higher.

In the UK, the classic example was the latest offshore wind auction, where no bids were submitted and allegations arose that the government had not taken seriously claims that such schemes were no longer economically viable. The government did move swiftly to increase the maximum price available for offshore wind projects by 66% to encourage investors. 

“There are some estimates that the cost of delivering an offshore wind farm has gone up by about 40% due to supply chain issues, and that’s really hurting the offshore sector right now,” says Quantock. “Only time will tell how long that this will go on for.”

Threlfall says it’s important that industry is believed when it says there are issues around cost, as building trust between the parties is vital given the scale of investment that’s needed. He points to the creation of ‘energy islands’ in the North Sea as one example of the huge scaling up that’s taking place: Germany, France, the Netherlands, the UK and Norway committed in April to connect offshore green generation sites, aiming to quadruple offshore wind energy capacity by the end of the decade. 

Offshore Structures wind farm facility in Birmingham transition piece yellow blue sky
A transition piece for a wind farm at the Offshore Structures (Britain) wind farm facility in Billingham

But while the UK – which built a strong reputation for offshore wind delivery with previous auctions – has suffered some embarrassment, Jones thinks it’s important not to get the issue out of proportion. “I don’t think you should necessarily extrapolate from an individual auction that there is a wider malaise in renewable or energy transition investment in the UK,” he says. “I’m sure the lessons will be learned, but the CfD structure has been a highly successful instrument in driving renewables investment in the UK, so I don’t think you can say it’s symptomatic of a wider issue.”

However, while that may be true of energy transition, when it comes to other aspects of infrastructure, there’s no shortage of observers saying they see symptoms of a serious issue in the UK. In some sectors, there is simply a lack of projects, such as airports and ports.

When looking at social infrastructure, past prime minister Boris Johnson’s pledge three years ago to build 40 new hospitals by the end of this decade now appears very unlikely to materialise. The first of the 40 is scheduled for completion soon, but work on others is well behind schedule. Moreover, it has become clear that much of the promise related to upgrades to existing sites rather than completely new sites. 

Part of the problem with social infrastructure schemes today is that the PFI – launched in 1992 by the Conservatives and accelerated by Labour under the then prime minister Tony Blair as a way of efficiently channelling private capital into infrastructure projects – fell out of favour some years ago. PF2 replaced it, but a perceived lack of value for money, and perhaps less backing from government and the general public, resulted in its downfall. 

“Sentiment in the UK has swung quite firmly against PFI and it seems increasingly impossible to bring it back to the table after it became political anathema a few years ago,” says Threlfall. “There is zero interest at the heart of government to reopen the conversation.”

It’s worth noting that some public-private partnership projects are still ongoing – such as the £1.2bn Lower Thames Crossing, a new road connection under the River Thames. But by and large, they are considered to have had their day as a delivery mechanism for new infrastructure.

New era

“The decarbonisation of an entire continent” is how one market source grandly described the attempted take-private of listed Australian energy giant Origin Energy by a Brookfield Asset Management-led consortium. The mega-deal, implying an enterprise value of $18.7bn, is an example of private finance assisting energy transition. 

Origin’s largest shareholder AustralianSuper was holding out for a higher offer at time of writing. Whether the deal eventually transpires or not, it was “a great example of a big, bold move by a large pool of capital”, according to KPMG’s Gavin Quantock. 

In the UK chancellor’s Autumn Statement in November, £600bn of public sector investment over the next five years was announced to support energy security and net zero. It is not clear how much of that is ‘new’ money. The government also said it would amend the National Planning Policy Framework to to speed up the rollout of EV charging hubs.

One area attracting attention is battery storage. In September, London-based Zenobe, a firm providing battery solutions, received an investment of around £600m from KKR – having been formed just five years ago with half a dozen employees. PwC advised on Zenobe’s various equity rounds.

“There’s a lot of activity in the battery storage space,” says James Pincus at PwC, “and there will be some big winners and market leaders as this market continues to grow and consolidate.”

New broom

The demise of PFI means that a greater proportion of infrastructure funding now comes from the public purse, with all the potential controversy that can bring in its wake. This was most recently evident in the government’s decision to cancel the northern leg of HS2, the high-speed rail line now set to run only from London to the West Midlands rather than to Manchester; the Leeds extension having already been shelved in 2021. The government said it believed the £36bn cost of the northern leg could be more usefully deployed on other projects. 

A cutter head for HS2 construction site work men high vis orange
A cutter head for HS2 is moved into place

Understandably those in the market are reluctant to comment in detail on government decisions, but they acknowledge the gravity of pulling back from such a landmark project. “I would say that HS2 has put the delivery of infrastructure into really sharp focus,” says Quantock. “Has it undermined confidence? I’m sure there are investors out there who would say yes. It’s a difficult decision that elicits an emotive response from almost anyone you speak to about it.” 

Threlfall makes the point that, due to their long-term nature, infrastructure projects are subject to changes in the economic and political cycle. “In a democracy, where governments are subject to five-yearly elections, there’s always nervousness about exactly how committed things can be,” he says. 

Since the announcement of the HS2 decision, a lot of attention has now been focused on whether the money saved from that will be allocated to other infrastructure projects – something strongly hinted at when Prime Minister Rishi Sunak made the cancellation announcement. 

Jones makes the point that there is unlikely to be £36bn of savings made available for new projects in the near term: “Cancelling phase two does potentially release funding that could be deployed in the north or elsewhere, but that cost would probably not have been incurred until 2028-30 or beyond. So is there money to be deployed right now? Probably not.”

What could potentially shake up the UK infrastructure is a general election, which is expected to take place some time next year – and which in any case must happen by the end of January 2025 at the latest. “There is no doubt that if there’s a change in government there will be a review of current policies around the delivery of infrastructure, so it does feel like we’re in a holding pattern at the moment,” says Quantock. “One thing that can be said with confidence is that, if there’s a change in government, there’ll be a change in policy.”

Turning a corner

There is a view that a Labour government would want to not only continue backing energy transition projects, but also to revive social infrastructure in areas such as health and education. There is still also hope that they might row back on the government’s recent announcement that it was slowing certain green targets – in relation to making electric vehicles compulsory and phasing out gas boilers, for example. 

Regardless of who actually wins the election, Threlfall expresses optimism that it may mean a turning of the corner for a UK infrastructure market that has had its challenges. “I’m quite optimistic that we should find ourselves in a position where we have fresh thinking, fresh programmes and hopefully, therefore, a landscape that will be more attractive to private investors than the past couple of years have been,” he says. 

US leaps forward

Last year, the US put in place what apologists have argued is a major step towards addressing climate change: the Inflation Reduction Act, complete with $369bn of green subsidies and tax credits designed to give a rocket boost to areas such as electric vehicles, batteries and renewable energy. Many countries are still working out how to respond to the trailblazing initiative and those without a coherent plan of action could end up marginalised. “In the UK there is the potential for us to be left behind and fall out of the green race,” says KPMG’s Gavin Quantock. 

Richard Threlfall at KPMG believes responses shouldn’t be about trying to match the US’s move. “The one thing the UK has to do is stabilise the attractiveness of the country to the private investor. That’s not just about throwing subsidies around in the way the US has; it’s also about confronting the dilemma that has been placed on regulators around how to balance investibility with net-zero investment obligations – and I don’t think the government can duck that.”

But while some think the UK has been dropping down the global infrastructure league table, some insist it’s still well above the relegation zone. “The UK is seen as pretty stable from a political, economic and regulatory perspective and if you’re investing in infrastructure then that long-term stability is really important because you might have a project that’s modelled the cash flows out for 25 or 30 years,” says James Pincus, a partner and head of the infrastructure M&A advisory team at PwC. 

“Many of our large infrastructure projects, energy assets and utilities are owned by long-term investors, both domestic and overseas, and if you’re investing in these types of assets, you really want that long-term stability. And I still think the UK is broadly seen from an investor perspective as an attractive destination.”

Open AddCPD icon

Add Verified CPD Activity

Introducing AddCPD, a new way to record your CPD activities!

Log in to start using the AddCPD tool. Available only to ICAEW members.

Add this page to your CPD activity

Step 1 of 3
Download recorded
Download not recorded

Please download the related document if you wish to add this activity to your record

What time are you claiming for this activity?
Mandatory fields

Add this page to your CPD activity

Step 2 of 3
Mandatory field

Add activity to my record

Step 3 of 3
Mandatory field

Activity added

An error has occurred
Please try again

If the problem persists please contact our helpline on +44 (0)1908 248 250