Future spend: Moody’s views
Transatlantic Elite 2011
27 August 2013
12 December 2013
9 May 2014
23 June 2014
16 June 2014
Credit rating agency Moody’s Investors Service provides credit ratings for more than $1.5tr of debt securities associated with utilities and project financings.
The long-term credit fundamentals behind these borrowings remains intact, for now, as companies and countries continue to produce relatively stable and predictable sources of cashflow and repay their debt service obligations in a timely manner.
But as the world’s population expands, it will continue to spur demand for increased investment in infrastructure. Prospectively, Moody’s sees strong evidence that global infrastructure investment will continue to increase, owing largely to major maintenance requirements in the industrialised regions and new growth projects for emerging economies. A well-defined legal framework and political stability represent two critical ingredients to attract private capital to invest alongside governments.
We believe the starting point for investment is a reliable source of electricity, which is currently a mature, albeit more polluting, infrastructure. The overall business model for electric utilities is entering a long-term state of transition, whereby electricity supplies are coming increasingly from relatively clean and renewable sources, such as sun and wind, rather than from carbon-emitting and finite sources. This transition is likely to be accompanied by a more efficient system for moving power over long-distance transmission lines. Moody’s estimates the cost of such a transition at roughly $1tr over the next 20 years.
Transitioning the world’s electric generation supplies away from fossil-fired assets will take many years. Today, it is still more expensive to build renewable generation than traditional electric generation, and most sources require some form of government subsidy. But the economic equation is poised to change, especially when the benefits of economics of scale and technological advancements (with respect to capacity factors and efficiency) take hold. We see the economic change being driven by many emerging markets, such as China and India, which are incorporating the transition directly into their infrastructure plans.
In many respects, this trend is best exemplified by the State Grid Corporation of China, which has around a billion customers across 26 provinces covering almost 90 per cent of China. State Grid says it is deploying 250 million smart meters, which should provide better intelligence regarding demand, demand response and outage management. But it is also looking to attain a more balanced supply by increasing its hydro-generation (to 340GW), nuclear (to 80GW), wind (to 150GW) and solar (to 24GW) by 2020.
Likewise, in Japan the government is looking to transition away from its reliance on nuclear generation in favour of renewable energy sources and efficiency programmes, owing in part to the political reaction stemming from the 11 March disasters. We believe all global nuclear operators will be hurt by Japan’s experiences, and note several high-profile government announcements to abandon nuclear generation over time, such as in Germany and Switzerland. Conceptually, with decreased demand for new nuclear generation, the already high costs of construction should rise. This creates a potential risk for nuclear generation given its long construction cycle and high fixed costs. As these plants come online, in the 2016-20 period they will be competing against renewable alternatives, which are likely to enjoy more competitive economics.
Nevertheless, we see the regulated utility sector as one of the better positioned to attract private capital. In fact, we observed that during the 2007-09 financial crisis, regulated utilities benefitted from the ’flight to quality’ by investors and were some of the first companies to re-emerge into the capital markets with both secured and unsecured debt offerings.
With an established, reliable source of electricity, governments can turn their attention to complementary infrastructure requirements, namely transportation. We see a clear desire on the part of many industrialised nations to refurbish and rebuild their ageing roads and ports. In the US we observe that the average infrastructure investment as a percentage of GDP has not been rising over the past few years, raising concerns that major maintenance programmes are necessary. This is most notable with US roads, bridges and some ports, especially airports. In several emerging markets, such as Brazil, Russia, China and India, there are concerns that investment has not kept pace with growth.
For these infrastructure needs we see clear differences between countries with stable political environments and well-established legal frameworks, which can attract private capital more easily, from those characterized as less politically stable. Brazil, for example, stands out as an attractive market for investment in South America.
Political stability also raises a key consideration for all infrastructure investment: how much can a government contribute to specific development plans? In light of the interrelated global financial markets and sovereign debt issues, we see the percentage of government sponsorship declining. Private investors will have to make up the difference. But private capital, through PPPs and concession arrangements, often demands higher returns than governments, which will ultimately raise costs for consumers. Nevertheless, we see strong evidence that PPP arrangements will continue to develop as a method to meet infrastructure investment plans. This is most notable in Europe.
Another consideration is the cost of capital, which we believe will rise over the longer-term horizon (three to five years), due primarily to an expectation for rising interest rates in the US and Europe. Funding infrastructure projects with 100 per cent government-backed debt is likely to result in a lower cost of capital than private equity-financed projects. Higher capital costs will raise the costs for end-use consumers in the form of higher electric bills, higher transportation fees and a higher cost of goods sold. A struggling and sputtering economic recovery can create a volatile political cocktail across all sectors, despite today’s relative political stability.
Our global economy could benefit from increased coordination with respect to allocating the capital required to maximise the infrastructure demands. In the meantime, we expect countries will continue pursuing their own economic interests, so some duplication of effort (in building competing infrastructure projects) is inevitable. But with strong legal frameworks, stable political environments, conservative capital structures, manageable construction risks and realistic cashflow projections, we see no end to the private markets’ willingness to finance these critical assets.
Jim Hempstead is senior vice-president at Moody’s Investors Service