Infrastructure projects: The potential and the risks

Certainly, the public sector can only pay for so much. The private sector, therefore, can play a major role in meeting this demand for investment, especially with the backing of public initiatives – such as the European Commission’s ‘Juncker Plan’, the European Investment Advisory Hub, and the UK’s National Infrastructure Commission – to help address the deficit.

The challenge is to recognise why projects have failed in the past and learn from these lessons to identify the key risk factors for future projects.

Tapping infrastructure’s potential

Taking advantage of a ‘multiplier effect’ – by which infrastructure investment generates greater returns as a proportion of GDP – economies could boost employment and stimulate long-term economic growth.

Encouragingly, the Juncker Plan, approved in July 2015, intends to identify 2,000 potential new projects that would bring €315bn (£242.5bn) of investment to European infrastructure.

Yet the public sector will only contribute €21bn. Private investors and national development banks must foot the rest of the bill.

With a current financing surplus in the private sector, and infrastructure able to offer resilient returns, projects stand to offer great potential for investors seeking high yields.

Key to instilling private sector confidence will be initiatives such as the European Investment Advisory Hub and the UK’s National Infrastructure Commission, both of which are designed to provide advice and long-term strategic planning to potential investors.

Considering key risk factors

As well as having the right guidance, increased transparency on project risk is especially vital.

The first such risk can be the design of a project’s construction. Technology-related issues or cost-overruns can affect both development and eventual operational performance. 

For example, a malfunctioning power station drains project liquidity into maintenance costs, as power outages hurt revenues. Proven technologies and experienced construction firms can help to mitigate these risks.

A second major risk is market exposure. Groupe Eurotunnel, which runs the underwater connection between the UK and Europe, obtained temporary judicial protection in 2006 due to several stresses that included weak traffic volumes.

Additionally, raw materials and energy prices fluctuate, which can in turn have an impact on costs. The amount of cash flow from electricity generated by a power station can change according to the price of fuel. Therefore, accounting for market prices is key.

Meanwhile, resource availability can be a concern. Renewable energy plants are particularly at risk of such variations: water, sunshine or wind levels inevitably vary.

Another concern is poor creditworthiness among parent companies. S&P has seen several projects face difficulties when the parent company goes bankrupt. 

Large exposures to important counterparties – such as concession-providing local governments or key clients – may bring risks of their own. In 2002, for instance, North Yorkshire’s Drax power station faced problems when its largest customer, TXU Europe, went bankrupt.

Finally, changes to tariffs or regulations can prove problematic. Coal-fired power stations can default if low energy prices coincide with the need to install expensive pollution-control equipment due to new regulatory requirements.

Infrastructure projects can form a resilient addition to an investor’s portfolio, as well as benefiting society as a whole by boosting economic growth and creating more job opportunities.

Michael Wilkins is managing director of infrastructure finance at index provider and credit rating agency Standard & Poor's