Private investment in American infrastructure is more attractive, but it is not enough — and it doesn’t have to be.
By Wassim Selman, Ph.D., P.E.
The recent Arcadis Global Infrastructure Investment Index report ranked the United States as the eighth most attractive market for private investment (https://www.arcadis.com/en/united-states/our-perspectives/2016/which-countries-are-the-most-attractive-for-infrastructure-investment-/). This is a boost from eleventh place in world rankings just two years ago. The ranking is based on an index that compares the attractiveness of countries for infrastructure investment.
The global infrastructure investment report identifies the most attractive markets as those with strong growth potential, secure business environments, well-established legislative and regulatory systems, and stable political environments (see Figure 1). Held to these standards, the U.S. has risen above many of the world’s top economies known for being receptive to private funding, such as the UK, the Netherlands, Japan, and Germany. The main reasons for this jump are because the U.S.:
- has a critical need and an increasing project backlog,
- offers investors the economic stability and business strength they require, and
- has a good pipeline of contractors.
In the U.S., the American Society of Civil Engineers (ASCE) estimated that more than $1 trillion will be needed between 2016 and 2025 to bridge the surface transportation investment gap. While private investment can provide much needed help, it is obviously not enough. But here’s the good news: It does not have to be. A variety of creative methods are available to bridge the gap.
Redefining the gap
To start, we should be more realistic in our expectations related to infrastructure level of service. Without compromising safety, we can take a hard look at how we define infrastructure adequacy, especially when we know affordability is a major challenge. We can also do a better job in developing more effective solutions.
Considering the big impact our designs have on cost, we should think of creative ways to modernize our designs and design standards. We can do that by taking into account current technological advancements related to both infrastructure and vehicles. We also have opportunities to optimize system designs to manage incidents and reduce clearance. Consequently, the gap will become more manageable right from the start.
Bridging the gap
Realizing that federal sources have their limits, government agencies are becoming increasingly adept at structuring their own state and local funding. The pain of inadequate infrastructure is felt most at the local level. It is felt by private citizens and their families that utilize roads and bridges every day, by business owners who depend on surface transportation to move their products, and by elected officials who want to improve the quality of life in their communities.
Consequently, voters in many counties have been presented with opportunities to raise taxes in support of infrastructure investment and they have approved them. These voter-approved sales tax measures have taken several forms and range from self-help counties in California to Special Purpose Local Option Sales Tax (SPLOST) programs in Georgia. In addition, many states have increased their transportation funding, while others are seriously considering doing the same.
Elsewhere, planners simply eliminate the gap for new construction and instead pull more value from existing infrastructure with better asset management. In fact, the role and promise of asset management are expanding, putting us in the middle of an asset management revolution. No longer solely a technical discipline primarily driven by the need to forecast capital investment, there is now a business-driven mindset looking at the full asset life-cycle cost, inherently transforming the way agencies operate. This transformation and its outcome will provide much-needed benefits in the form of reducing total expenditures.
Finally and most notably, tighter government spending in core markets means that project sponsors are increasingly turning to private finance to bridge the investment gap. This shift in attitude is partly driven by necessity. While it’s obvious that infrastructure improvements deliver tangible, long-term benefits, economic prosperity, jobs, and quality of life, the hefty price tags for highways and other transportation projects are persistent deal-breakers. When public funding loses out to sticker shock and politics, infrastructure projects fail to launch. But more importantly, community and economic growth suffer too. This is where private investment can play a critical role.
From the investors’ point of view, infrastructure is gaining popularity as an asset class. In times of trouble and uncertainty, the desire to invest in infrastructure increases. It is long term, stable, and will be around in 30 years.
Generating long-term income through the range of public-private partnerships (P3) structures, which require a significant early capital investment from contracting teams, is a highly attractive proposition for firms. Therefore, it is not surprising that contractors today are using a number of strategies to enter into emerging high potential markets, deemed to have a big future in P3/private finance initiative (PFI)/design, build, finance, operate, and maintain (DBFOM) projects and major project investment. There is also growing awareness that private investment in infrastructure can deliver much-needed projects faster and more cost effectively.
Canada has historically been an international leader in P3 arrangements and offered high returns to investors. A recent Reuters article explained that Canadian pension funds look for the long-term, low-risk opportunities that infrastructure offers (www.reuters.com/article/us-canada-pensions-infrastructure-exclus-idUSKCN0ZM23B). A McKinsey & Company interview with Mark Wiseman, president and CEO of the Canada Pension Plan Investment Board, pointed out that fund managers seek very long time horizons — 25 to 75 years (www.mckinsey.com/industries/infrastructure/our-insights/mark-wiseman).
This experience is now being transferred to the U.S., Latin America, Eastern Europe, Australia, and the Middle East and aligns well with the desired life cycle of many infrastructure assets. Add in the operations and maintenance over the entire asset life cycle, and infrastructure fits investors’ time horizon sweet spot. With the usual investment option of long-term government bonds now flirting with negative returns, these investors seriously need alternatives.
Better opportunity through packaging
Sometimes, projects need to be packaged differently. The limited scale of some infrastructure projects doesn’t align with investor requirements. In those cases, authorities, states, and program managers can bundle their projects into a cohesive unit and create scale and efficiencies that benefit all.
It also helps to have in place policies that encourage private investment. Canada again serves as a model with federal funding policies that require 25 percent of financing from private sources. On top of that, Canada lets it be known that its projects are wide open to private investors.
State and government agencies that are used to the control they enjoy under public funding models haven’t always been able to structure deals with investors, but are now finding creative ways to do so. For example, in Atlanta, a new major interstate interchange is being funded up front by a contractor. In return, the government agency guarantees regular payments over a 10-year period of time to the contractor. The government maintains responsibility for maintaining and operating the facility. This is but one example of how a public-private financing model can ease the risk on the investor.
Getting the risk right
While infrastructure owners are thinking about private investment more than before, it is essential that concessionaires and contractors remember that for these owners, some of which are new to private finance, local involvement must be retained. Understanding and utilizing the local market is essential, especially if firms are to be successful beyond qualification stage when concessionaires and contractors inevitably find themselves in a price war.
But — and there’s always a but — to get the best price, asset owners must be prepared to share some of the risk aspects of the scheme. Holding on too tightly to risk in such projects prevents concessionaires and contractors from employing innovative construction and financing methods that will ensure infrastructure is delivered at the best possible value. It also means more cost to government agencies that have to ensure that resources are in place to manage these risks. This is not to say that agencies can’t retain some control. The most effective contracting arrangements are those where project owners and concessionaires can strike a risk distribution balance, creating true P3s.
While opportunities abound like never before, policy and human biases will take time to overcome. The status quo in the U.S. is indeed entrenched, but with ample investment opportunities, eager investors, complementary regulatory environment, balanced risk distribution, and creative deal structuring, the doors to private money can open wide.
We see signs that change has already started. The first success stories may be the snowball starting down the hill.
Wassim Selman, Ph.D., P.E., is Arcadis North America leader for infrastructure. He has vast expertise in infrastructure planning, development, and management.