May 1st, 2014
Investing Daily Article of the Week
by Richard Stavros, Investing Daily
Whether it’s power plants, bridges or roads, the developed world’s aging infrastructure is in dire need of replacement. Meanwhile, the infrastructure build-out taking place in the emerging markets has been unable to keep pace with surging economic growth and rapid urbanization.
But all that’s about to change. The world’s political leaders and financiers are starting to explore new ways to finance capital-intensive projects through public-private partnerships between government, private industry, institutional and private investors. And the world’s top energy companies have also begun indentifying tomorrow’s growth markets.
These new public-private partnership structures are certain to offer various ways for both public and private investors to participate, and to benefit from each other’s involvement. Private investors will earn sizable returns by helping to finance these projects directly, while public investors will benefit from the greater earnings that flow through to their investments in various energy firms and developers.
Furthermore, new mutual funds or exchange-traded funds (ETF) may be created to invest in these energy utility assets solely, or as part of a more general infrastructure fund that includes roads and bridges. Future investment products may even be segmented by growth, region and risk profile. And it’s very possible that the government’s involvement may allow for the securitization of these public-private partnerships, with special tax incentives and other protections or guarantees to induce investment.
In fact, your correspondent has been privy to many discussions of these possibilities, most recently at an invitation-only dinner hosted by Standard & Poor’s last month that brought together infrastructure industry experts and players, including analysts, as well as company and private-equity executives. And the one theme throughout all the talks was the substantial growth evident in global energy infrastructure.
According to a report by consultants Bain & Company,
“The simultaneous crumbling of aging infrastructure in advanced economies and surge of development in developing economies will drive a steady 4 percent annual growth on infrastructure investment well into the second half of this decade, pushing total investment to a figure of $4 trillion.”
Further, the consultants believe that utilities, oil and gas infrastructure will account for 40 percent of this investment, which is consistent with population and income figures we also highlight below.
So far at least, Wall Street is largely ignoring the investment potential of this massive spending. The vast majority–roughly 75 percent–of institutional investors allocate less than 5 percent of assets under management (AUM) to infrastructure.
But target allocations are quickly shifting. Bain expects the majority of investors to allocate 5 percent or more of assets under management (AUM) to infrastructure in the coming years. And the total number of infrastructure funds has already nearly tripled in the past five years.
Why now? Global economic growth, though still moderate, is improving, and that’s created the economic rationale for infrastructure investment. Furthermore, countries that would have tried to defer these necessary upgrades in the past can no longer do so without severely hindering future economic growth.
According to a recent report from the International Monetary Fund (IMF), global growth is projected to strengthen from 3 percent in 2013 to 3.6 percent in 2014 and 3.9 percent in 2015. In advanced economies, growth is expected to increase to about 2.25 percent in the 2014–15 period, an improvement of about 1 percentage point compared with 2013.
Among the key drivers are a reduction in fiscal tightening, except in Japan, and still highly accommodative monetary conditions. Growth will be strongest in the US, at about 2.75 percent, but varied in the eurozone, according to the IMF.
In developing economies, the IMF forecasts growth will rise more gradually, though from a much higher base, from 4.7 percent in 2013 to about 5 percent in 2014 and 5.25 percent in 2015. Growth will be spurred by stronger external demand from advanced economies, but tighter financial conditions will dampen growth in domestic demand in some countries.
Start with Power Demand
There are a number of ways to identify which infrastructure investments are poised to benefit the most from these trends. Some like to look at growth figures in the various energy segments, such as growth in oil, coal, natural gas, and renewable energy, which do offer insights. But I’ve always found that power demand, population growth, and gross domestic product (GDP) are the best measures to use as a starting point.
And when comparing power demand between emerging markets and the developed world, the numbers are appreciably higher in developing economies. While power demand grows around 1 percent annually in developed economies such as the US, faster-growing countries and regions such as China, India, Latin America and Africa show double-digit power-demand growth.
Chart B: Projected Increases in Power Generation Through 2050
Source: International Energy Agency, Chadbourne & Parke
According to a recent project finance report from the international law firm Chadbourne & Parke
“There is an overwhelming urbanization trend in most of the world, but especially in Asia. The developing markets are starting to become reasonably large, but unless it is China or India, the market will take a while to reach scale. We are going to see a lot more cities of 10 million to 20 million people in the developing world”.
In fact, global energy use is projected to grow by 56 percent between 2010 and 2040. The US Department of Energy’s Energy Information Administration attributes half of the increase to China and India.
Population and income growth are the main drivers behind growing demand for energy. By 2030, the world population is projected to reach 8.3 billion, which means an additional 1.3 billion people will need energy. And world income in 2030 is expected to be roughly double the 2011 level in real terms, according to various government and economist estimates.
Low- and medium-income economies outside the developed world will account for over 90 percent of population growth to 2030. “Due to their rapid industrialization, urbanization and motorization, [emerging markets will] also contribute 70 percent of global GDP growth and over 90 percent of global energy demand growth,” according to one European energy company’s forecast.
The Big Power Plant Build-Out
Power generation is going to be the fastest-growing major demand sector. As noted earlier, worldwide electricity use is projected to increase by 90 percent from 2010 to 2040, with developing countries accounting for the overwhelming majority of that increase.
And given the high output from the prolific US shale plays, natural gas is going to be a big player in that future as a fuel for power plants as well as other uses. Nuclear power and renewables will also make significant contributions toward fulfilling future energy demand.
In fact, in a recent report entitled “The Outlook for Energy 2014: A View to 2040,” ExxonMobil predicts that by 2040 the world will consume 40 percent more energy from natural gas than coal. However, it should be noted that this forecast differs sharply with the International Energy Agency’s prediction that global coal consumption will outstrip both oil and natural gas as early as 2017, owing to growing coal consumption in the developing world.
By contrast, Exxon expects demand for coal, which is currently the second-most consumed fuel after oil, will level off and fall to third place by 2025, as countries opt to use less carbon-intensive natural gas instead.
Half of the growth in demand for natural gas is being driven by the need for electricity around the world, according to the report. Though demand for nuclear power and renewable energy sources, such as wind, solar and biofuels, will actually grow at an even faster rate, they will contribute only a small share to the energy mix during this period because of their cost.
Incidentally, all these new power-generation options will also lead to billions upon billions of dollars of power and gas transmission investment.
What’s remarkable is that while the projected rise in energy demand over this 30-year period is substantial, it is only about 80 percent of the growth seen from 1980 to 2010. This is all the more extraordinary because the growth in economic output from 2010 to 2040 will be more than double the growth from 1980 to 2010. This means that the world is continuing to become more efficient as prosperity advances, and efficiency as an area of investment is likely to increase as more countries around the world adopt smart-grid technologies, for example.