Traps for the Unwary in Green Infrastructure

Although acknowledging need for low carbon solutions and the energy transition, Frontier Advisors’ Manish Rastogi cautions investors to be wary of the sustainability of business models of some new-generation infrastructure assets because they have yet to be fully proven.

Infrastructure, whether listed or unlisted, is an asset class that has a front and centre role in the Frontier Advisors’ playbook when it comes to portfolio allocation or construction.

The consistent message from the firm over 25 years’ of advice, covering around $600 billion of assets across the superannuation, charity, public, insurance and university sectors has been to allocate to infrastructure.

This is a reason that to stay ahead of the curve Manish Rastogi, Head of Real Assets at Frontier Advisors, and his team scour the globe to stay ahead of emerging and evolving trends in infrastructure.

Rastogi offers advice on the pitfalls in rushing headlong into renewable energy and energy transition, and tips on how to defend a traditional asset from becoming stranded in the rush to net zero.

He sees energy transition along with electrification as a long-term thematic and the move into renewables as irreversible.

While he understands the general thematic that dictates allocations to decarbonisation and digitalisation, he cautions investors to be wary of the sustainability of business models of some new-generation infrastructure assets because they have yet to be fully proven.

Rastogi has reservations, for instance, about the strategy to set up charging stations for electric vehicles (EVs) in urban centres.

“In Europe, the initial business model was to open charging stations with the expectation that people would come on the premise that electric vehicles need to charge. So they offered the plug-and-pay model, with many companies offering charging stations in major cities.

“I am not convinced that some of these business models are working,” says Rastogi. Charging stations are finding that their usage rate is low.

The model is faltering, not because people are not converting to EVs, but because the frequency of charging has not kept up with forecasts. The main reason is that, unlike cars running on petrol (or diesel), EV owners have the option of charging those batteries from their home garage.

“It is not like service stations which are the only places where cars can fill up their tanks. Instead of sitting around for half an hour waiting to charge at a charging station, EV owners can charge their cars when not in use.

“Often time when they will need to charge consistently away from home is when they are on a long trip, Then, they will need to charge halfway through the trip.”

The EV charging models that are getting traction in Europe and elsewhere are the ones offering availability-based revenue, there is predictability and certainty of revenue based on uptime of chargers and regardless of usage volume. “This is much more akin to infrastructure characteristics”.

Going it Alone or Platforms?

Investors need to be mindful of the ramifications of going it alone in acquiring single assets, whether it is in solar or wind farms, Rastogi says. There is a tendency to go for direct investment, but he believes investors will get a better outcome from investing in platforms.

“They get the benefits of economy of scale and the diversity of energy sources”, he says. “Platforms can incorporate battery energy storage systems (BESS) and other firming technologies to offer firm power to off-takers.

“Our view is to invest through platforms that are technology-agnostic. Whether it is solar, offshore or onshore wind, or BESS, investors can have more benefits from having a portfolio of assets – and that usually comes from being part of a platform.”

Solar and onshore wind farms are now commercially viable and there is a free market for these assets. Offshore wind projects, however, require subsidies because they are expensive projects to bring to fruition.

In time, says Rastogi, it will become apparent that the way to achieve the best returns from investing in energy transition is to invest through platforms. It may even be possible that large Australian super funds get together to create a renewable energy platform.

He sees as a “smart” approach the formation of a partnership with an established renewable energy platform or to invest in a portfolio of assets in a platform.

It is an alternative to a portfolio of assets that are under construction and which may suffer from teething issues such as procurement, planning, construction and time frames. It can typically take anything from three to five years to commence (from development) and complete (operational state) a new renewables project in Australia and in many other developed markets, he says.

Rastogi observes that the focus is on clean energy generation, and that here not enough attention is paid to transmission networks required to transmit the energy generated. With secure long-term contracts, investments in transmission assets will provide stable cashflows, he says.

Traditional Infrastructure

As institutional investors shift their focus to decarbonisation and digitalisation, are they walking away from traditional infrastructure assets?

Not at all, says Rastogi. “There have been a lot of headlines and noise about digitalisation and decarbonisation but this does not mean investors have lost interest in traditional assets.”

Today, stakes in Brisbane, Perth and the Queensland Airport Ltd, which owns airports at Gold Coast, Townsville, Mount Isa and Longreach, are being marketed partly as their owners (such as super funds) seek to rebalance their portfolios as a result of mergers or participating in the privatisation of Sydney Airport.

In the UK, a stake in Heathrow is also on the market.

But airports have not fallen out of favour with institutional investors, he says, because people will always use air travel.

Investors and operators of airports, especially, are looking to protect their assets from being stranded when the world goes net zero. He says airports also are doing much to decarbonise. Melbourne Airport, for instance, has an onsite solar farm that provides green energy through its GreenPower Network to retailers, tenants, and partners.

Rastogi says the future lies in commercialisation of sustainable aviation fuel which will help reduce but not totally irradicate the carbon footprint from aviation and airports.

He understands airports well. Before he joined Frontiers in 2017, he was an executive with IFM investors. where he undertook direct investments and asset management with a specialisation in airports.

Similarly, there will always be a place for toll roads in a portfolio because the people will not give up driving.

One asset that has an increasing risk of becoming stranded is the long-distance gas or oil pipeline. These midstream assets will be caught in the push to end the use of fossil fuels. Oil and gas is increasingly seen as transitionary fuels, Rastogi says, but that trend has multi decades to play out.

This does not necessarily mean that investors should not invest in these assets if the opportunity arises. But rather than looking at midstream businesses as a long-term asset, investors should underwrite such investments with an annuity mindset. That means, he says, setting a short-term horizon of, say, 20-25 years, and assuming the asset as having no economic life beyond that.

Frontier Advisors regards infrastructure as a critical component of a balanced portfolio for good reason.

“If you look over the last decade, infrastructure has had a good run with a loose monetary environment and low interest rates helping drive allocations into the sector. Investors were rewarded with strong returns.”

The macro-economic environment changed with the disruptions of COVID-19. Monetary policies have tightened in the wake of rising inflation which has pushed the cost of funding up to its highest level in more than a decade, says Rastogi. “But despite the macro-economic volatility, returns from traditional infrastructure assets are still positive.”

Whether unlisted, which delivered returns in mid to high single digits or listed, offering returns of 1 and 3 per cent for the year ending December, 2023, Rastogi says infrastructure has repeatedly demonstrated resilience. There is enough evidence here through the global financial crisis, the global COVID-19 pandemic and the current higher interest rate environment.

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