How Governments Can Harness Private Equity’s Billions for Infrastructure Renewal
Public debt is rising and infrastructure is aging. Governments around the world can turn to private equity to fund modern, sustainable infrastructure systems.
• Governments are struggling to fund upgrades to creaking public infrastructure due to rising debt.
Governments around the world are struggling to maintain and modernize their infrastructure. Roads, bridges, power networks and public transit systems are aging faster than they are being replaced. At the same time, demand for public infrastructure to support new technologies is soaring. Rolling out high-speed internet requires the installation of expensive fiber-optic cables, and distributing renewable energy at scale will need huge networks of new transmission lines and smart grids.
Tackling this problem comes with a price tag that governments are increasingly unable to afford. Levels of public debt continue to grow; inflation remains stubbornly high, and economic growth is sluggish. Governments around the world find themselves without enough fiscal headroom even to maintain existing public infrastructure, let alone fund new projects. The result is a gap in global public infrastructure funding that will only continue to widen if it isn’t addressed. At the same time, private equity and institutional investors hold hundreds of billions of dollars earmarked for infrastructure. Private investors are, therefore, ready to play an increasingly important role in plugging the public infrastructure investment gap.
Unlocking private capital
Private infrastructure didn’t exist as an asset class until the 1980s. Since then, it’s been one of the fastest-growing areas for institutional investors. Assets under management have risen by more than 15 percent a year over the last decade, according to the data provider, Preqin, and the amount of private capital available for infrastructure investment more than quadrupled in a decade to $129bn in 2021, most of which was raised in North America and Europe.
Many governments have turned to so-called asset recycling as a way to unlock some of this capital for public projects. Asset recycling involves private sector investors acquiring or leasing existing public infrastructure assets such as toll roads, bridges and energy grids. If the asset has been leased, it can be “recycled” back into public ownership after the lease has expired. Asset recycling programs have become increasingly popular with governments around the world in recent years, including in Europe, Japan, India and Canada. This model allows governments to reinvest the new capital into other projects and avoid adding to public debt. For investors — as with investment into privately owned core infrastructure — backing existing public infrastructure assets offers potential opportunities for stable long-term returns. Government-guaranteed payment structures and subsidies, and revenues that are often inflation-linked, can also make public infrastructure investment more appealing and lower risk.
The Australian government has been one of the most successful pioneers of this model through its Asset Recycling Initiative, which was introduced in 2014 to encourage state and territory governments to sell or lease existing infrastructure assets. In states where the take-up has been strongest, it has contributed significantly to new infrastructure funding. In New South Wales, asset recycling generated A$25.9bn ($16bn) in funding as of 2018 for infrastructure projects, including the Sydney Metro.
“Attracting private capital for new infrastructure will require governments to focus closely on structuring deals that balance risk and return”
Something old, something new
While asset recycling focuses on investing in existing assets, private equity is also playing an increasingly important role in financing new public infrastructure projects at an earlier stage, which typically bring higher risks but potentially higher returns.
Some public infrastructure sub-sectors in particular will require huge investment in the coming years. Building low-carbon energy infrastructure, for example — as well as making existing energy assets fit-for-purpose — will require huge investment, which governments alone will be unable to meet. The International Energy Agency estimates that more than 80 million kilometers of grid infrastructure will need to be built or updated by 2040 to meet current climate commitments — double the existing total.
Public-private partnership models (PPPs), which allow private equity firms to invest in critical infrastructure and share risks with the public sector, remain the primary model through which private capital can be allocated to public infrastructure development. One recent example is the $9.5bn New Terminal One at John F. Kennedy Airport in New York. The upgraded building is scheduled to open in 2026, funded by a PPP model. By using private capital, the project has allowed for the development of a major new piece of critical infrastructure without placing a significant burden on public finances, while the investment consortium financing the project will benefit from a lease that runs until 2060.
Attracting private capital for new infrastructure will require governments to focus closely on structuring deals that balance risk and return. Investors are unlikely to commit capital unless they have clarity on risk allocation.
The UK government’s new National Wealth Fund provides one such model. It will provide £7.3bn ($9.5bn) in funding for new public infrastructure development and aims to lever about £20 billion in private sector investment. The UK Infrastructure Bank, which will manage the fund, also works to reduce private investors’ exposure to early-stage project risks by offering co-financing, credit guarantees and other risk-sharing mechanisms.
Creating the right conditions for private capital investment will be critical. As the infrastructure funding gap grows, opportunities for investors to help build modern, efficient and sustainable public infrastructure systems are only likely to increase.
ThinQ is the must-bookmark publication for the thinking investor.
