The Chancellor's Autumn Statement and the concurrent launch of the 2011 Infrastructure Plan present great opportunities for investment in the UK's infrastructure. But in addition to economic considerations, cautious fund managers will need to rely on the security and risk advisory community to help with investment decisions.
By Kyle Johnston, Research Analyst, RUSI
5 December 2011 - The recently announced programme of investment will undoubtedly change the face of the UK's infrastructure over the next half-century. However, as a new range of private sector investors look to enter the infrastructure market - a veritable safe-haven during the current financial uncertainty - the prospects of a deeper, and perhaps more profound change are at hand.
For with new investors come new opportunities; new opportunities for Government to work with the private sector in building a secure and resilient infrastructure capable of servicing the needs of the nation. But before this new relationship can bear fruit, both sides of the public-private divide will have to come to terms with the evolving nature of infrastructure threats, and in turn, take responsibility for mitigating and managing the risks. In this sense, the decades to come will not only be witness to a new infrastructure landscape, but also to a range of new infrastructure actors, each of whom will be critical to securing the UK's essential services and networks.
The Economic and Infrastructure Challenge
With downgraded growth forecasts for 2011-2012, rising unemployment, falling incomes and increased government borrowing, the UK economic outlook has deteriorated rapidly since the Chancellor George Osborne announced the so-called 'Budget for Growth' in March of this year. The independent Office for Budgetary Responsibility (OBR) this week predicted that the economy will grow by a piecemeal 0.9 per cent going into 2012; the OECD suggested that the figure is more likely to be contraction of 0.03per cent. Either way, it is manifestly clear to many that the Government's 'Plan A' of aggressive public spending cuts and rising taxes, when combined with the crisis in the Euro zone and the rise in commodity prices, has failed to deliver much-needed growth to the UK, and that new thinking is required to jumpstart the economy.
In plans announced as part of the Chancellor's Autumn Statement, the Government will look to boost infrastructure investment - a scheme seen by many as one of the few glimmers of hope in the UK's ailing economy. However, already in October 2010, a Treasury Infrastructure plan outlined that by upgrading the UK's ageing economic infrastructure - its networks and systems in energy, transport, communications water and waste management - the Government hopes to inject money into the economy and realise the wider benefits that such investment can bring: increased private and public sector productivity, reduced business costs, diversified means of production and job creation.
Despite the announcement that an extra £5 billion for capital spending has been found for infrastructure projects over the next three years, the combination of shrinking public finances and the growing difficulty of raising traditional forms of private capital (e.g., the bank loans with long maturities) will mean that the Government must look for new sources of finance to pay the infrastructure bill.
And what a bill. The new National Infrastructure Plan, also published this week, approximates that up to £250 billion worth of infrastructure projects require investment between now and 2015, but as the example of energy infrastructure shows, even this figure is likely to be a conservative estimate.
To be sure, at present the total electricity generation capacity in the UK stands at 90.2 GW and peak demand is at around 60 GW. However, environmental legislation will lead to the closure of 12 GW of coal and oil-fired generation by 2015 and the EU's Industrial Emissions Directive could lead to further closures by 2023. Additionally, up to 7.1 GW of existing nuclear generation capacity is reaching the end of its operational life and will close by 2020, meaning that at least 19.1 GW of generation will be taken off the grid by 2020.
The need for investment in new, low-carbon generation capacity will be particularly pressing, since there are strong indications that peak demand, rather than remaining at its current level of 60GW, will rise to around 65GW by 2020 - a consequence of population growth and the increased use of electricity for transport and heating.
Correspondingly, it is estimated that £110 billion is needed by 2020 to finance new power stations and grid connections - almost double the rate of investment between 2000-2010 - and official estimates suggest that across the board, energy infrastructure alone will require £200 billion of investment by the mid-2020s. This is not to mention the investment that will be required for transport, digital communications and other forms of economic infrastructure.
Emphasis on New Investment
The real hope for infrastructure investment is the private capital of institutional investors such as sovereign wealth funds and UK pension funds - the latter of which hold over a trillion pounds in assets but has only 2 per cent invested in infrastructure. With this in mind, the Government this week signed a Memorandum of Understanding (MoU) with The National Association of Pension Funds (NAPF) and the Pension Protection Fund (PPF), in the hope of developing better vehicles and advice to encourage UK pension funds to invest in domestic infrastructure projects - something which larger Canadian and Australian pension funds have already sought to do. As the Chancellor's statement and the new infrastructure plan confirm, the Government will target up to £20 billion of investment from these initiatives before 2015.
Institutional investors, however, have limited experience of infrastructure investment, and with the exception of real estate, they have traditionally built their portfolios around liquid assets such as equities and bonds. However, as global economic uncertainty has spread, fund managers - and in particular pension fund managers - have shown a growing appetite for investment in illiquid assets such as infrastructure; 'real' projects whereby underlying value is easier recognise.
Indeed, pension funds are particularly drawn to infrastructure investment because of the long duration of pension liabilities and increasing uncertainty within other asset classes. Put simply, infrastructure projects have the potential to offer secure, sustainable and strong returns, something which suits pension funds and their need for predictable and long-term cash flow streams. As Joanne Segars, the Chief Executive of the NAPF commented on the signing of their MoU with the Government, '[i]nfrastructure is a good fit with the needs of pension funds because projects like ports and power stations can offer a reliable return over a long timeframe'.
But optimism about the funding of the UK's infrastructure should be tempered. A significant body of research has shown that a series of barriers have historically prevented the ever-cautious pension funds from investing in these new projects; barriers which will need to be overcome before George Osborne's infrastructure plan can even get off the ground.
How the Security and Risk Investment Community can Assist
The main barrier comes down to the inexperience of pension funds in the infrastructure market. As a September 2011 report from the OECD made clear, 'infrastructure investment [for pension funds] involves a steep learning curve given the unique nature of each investment', and most pension fund managers simply lack the skills and expertise to assess the wide array of risks and opportunities which exist. On account of this knowledge-gap many pension plan trustees feel ill-equipped to invest in infrastructure, meaning that their recognition of the potential benefits has not always translated into actual investment.
Of course, discussions of risk in investment circles usually centre on economic and financial risks rather than physical risks. In the case of infrastructure, for example, pension-fund managers will take a keener interest in barriers to market entry and the monopoly-like characteristics which are typical infrastructure assets, as opposed to their physical characteristics. However, if pension funds are ever going to invest in the vast array of infrastructure projects available in the UK, they will similarly have to get to grips with a range of other risks - from security, construction, operational and environmental risks - all of which have the potential to disrupt the stable and long-term cash flows they ultimately require.
The economic and infrastructure challenges of the coming decades will therefore present an opportunity to the security and risk-advisory community, where the services of those experienced in infrastructure protection and resilience will be in demand from a growing range of potential investors and clients. From highlighting well-established risks to mapping emerging threats, the ability to a) predict and b) mitigate physical disruptions to otherwise profitable infrastructure will be a valuable commodity to institutional investors across the UK - and indeed, across the globe - as the worlds' 'cautious capital' will require a full understanding of the potential risks which are tied to infrastructure projects and systems.
The views expressed here are the author's alone and do not necessarily reflect those of RUSI.
 In real terms.
 BBC News, 'Autumn Statement: At-a-glance summary of key points', 29 November 2011. Available here: http://www.bbc.co.uk/news/uk-politics-15937446.
 BBC News, 'Autumn Statement: Osborne to unveil bid to boost growth', 29 November 2011. Available here: http://www.bbc.co.uk/news/uk-politics-15931086.
 HM Treasury (November 2011) Autumn Statement 2011. Available here: http://cdn.hm-treasury.gov.uk/autumn_statement.pdf.
 Allegra Stratton, 'Pension fund investment sought by ministers to stimulate economy', The Guardian, 13 November 2011; Reuters, 'UK seeking £50 billion infrastructure boost', 13 November 2011; Kitty Ussher, 'A pep talk for Osborne: there is one way left to boost growth', Financial Times, 29 November 2011.
 HM Treasury (November 2011) Autumn Statement 2011, p. 7
 HM Treasury, (November 2011), National Infrastructure Plan 2011, p.5. Available here: http://cdn.hm-treasury.gov.uk/national_infrastructure_plan291111.pdf
 DECC, Statutory Security of Supply Report: A report produced jointly by DECC and Ofgem, November 2011. Available here: http://www.decc.gov.uk/assets/decc/11/meeting-energy-demand/energy-security/3425-statutory-security-of-supply-report-2011.pdf.
 DECC Press Release, 'Electricity Market Reform: Keeping the Lights on in the Cheapest, Cleanest Way, 12 July 2011. Available here: http://www.decc.gov.uk/en/content/cms/news/pn11_061/pn11_061.aspx
 Fiona Harvey, 'Chris Huhne: UK must invest in energy infrastructure to keep the lights on', The Guardian, 12 July 2011.
 NAPF Press Release, 'Pension funds and PPF sign landmark agreement with government to help boost investment in UK infrastructure', 27 November 2011. Available here: http://www.napf.co.uk/PressCentre/Press_releases/0146_Funds_and_PPF_sign_landmark_agreement_with_gov_to_boost_investment_in_UK_infrastructure.aspx
 HM Treasury (November 2011) Autumn Statement 2011, p. 7.
 Sovereign wealth funds are less risk adverse because they have excess capital.
 Ibid., p. 16.
 Mark Huamani, 'Infrastructure Investing: An Attractive Alternative for Pension Funds', Investment Analytics and Consulting, December 2007, p. 5. Available here: http://www.jpmorgan.com/cm/BlobServer/Investment_Analytics_Consulting_Newsletter?blobkey=id&blobnocache=true&blobwhere=1158468327998&blobheader=application%2Fpdf&blobcol=urldata&blobtable=MungoBlobs
 NAPF Press Release (infra fn. 7).
 Georg Inderst (2009), 'Pension Fund Investment in Infrastructure', OECD Working Papers on Insurance and Private Pensions, No. 32, pp.20-22. Available here: http://www.oecd.org/dataoecd/59/33/48634596.pdf; George Inderst (2010), 'Infrastructure as an Asset Class', EIB Papers , 15(1), pp. 70-106. Available here: http://www.eib.org/attachments/efs/eibpapers/eibpapers_2010_v15_n01_en.pdf; Raffaele D. Croce, Pension Funds Investment in Infrastructure: A Survey, International Futures Programme, OECD Project on Strategic Transport Infrastructure to 2030, September 2011. Available here: http://www.oecd.org/dataoecd/59/33/48634596.pdf
 Croce (2011), p. 19.
 Inderst (2009), pp.20-22.
 Inderst (2010), p.80.