Australia’s newly elected premier, Tony Abbott, has declared he wants to be an ‘infrastructure prime minister’. And his treasurer, Joe Hockey, has called for infrastructure funding to be a key topic at next year’s G20 summit, to be hosted in Brisbane, the capital city of Queensland.
Most economists agree that Australia n eeds a fresh round of infrastructure spending to boost efficiency and stimulate the economy as the mining boom turns down. But state and federal governments, battling deficits and debts, are reluctant to spend.
The government wants the private sector to step up and help fund infrastructure. It is particularly keen for the nation’s superannuation funds to use some of the AUD1.6 trillion (US$1.52 trillion) of Australian retirement savings they manage to invest in infrastructure.
But a string of high-profile toll-road collapses has burnt private investors, and the conservatively run superannuation funds are reluctant to take risks on new projects.
That has led to calls for a radical change in how Australia’s infrastructure is built and funded, with both industry players and investors arguing that the government needs to shoulder more of the risk.
“If we’re going to turn to private investment, there has to be a return available,” says Brendan Lyon, chief executive of Infrastructure Partnerships Australia, the nation’s leading infrastructure body. “It’s not as simple as saying Australia has a big gap, and because there is a lot of superannuation, super can fill it.”
Even if the government does seek to attract more private funding for infrastructure, it is uncertain whether super funds will take on the risk of ‘greenfield’ projects. That could force Sydney to turn to infrastructure bonds instead.
It could also trigger a raft of privatisations, where cash-strapped governments sell off infrastructure assets such as ports, electricity and water to super funds and other investors and ‘recycle’ the capital to reinvest in new projects.
Infrastructure era
Infrastructure projects have long been part of Australia’s folklore. The Snowy Mountain Scheme, a post-war hydroelectric power project completed in 1974, became an icon of a new, optimistic, multicultural country.
In recent years, public infrastructure spending has been on the rise, surging from around 1% of gross domestic product (GDP) in 2003 to more than 2% in 2011. The mining boom also triggered an increase in private-sector spending.
Yet despite this increase, there is a general consensus among politicians and experts that Australia needs to further accelerate its infrastructure spending. This includes building greenfield projects such as roads, public transport, freight networks, ports and water infrastructure, encompassing water capture and storage.
Engineers at Infrastructure Partnerships Australia estimate the country has an AUD700 billion shortfall in spending.
The belief that more needs to be spent is partly down to demographics. The nation’s population is set to double over the next 50 years, reducing productivity and efficiency, and causing more wear and tear on existing infrastructure. From a shorter-term perspective, there is a need to stimulate the economy as the mining boom on which Australia has relied so heavily over the past 10 years winds down.
Not everyone subscribes to this belief. John Daley, chief executive at The Grattan Institute, an independent public-policy think-tank, says in a report entitled ‘Game-Changers: Economic Reform Priorities for Australia’ that spending more on infrastructure is unlikely to boost the size of the economy over the next decade.
But he’s in the distinct minority. “Clearly there is a big infrastructure gap in Australia,” says Julian Vella, Asia-Pacific regional leader of global infrastructure at KPMG. “There’s no doubt there’s a big, big need for infrastructure. Just look at what’s happening in ports, and in roads between cities.”
The new government agrees. A spokesperson for treasurer Hockey says infrastructure is a top priority. “All growth is driven around infrastructure at all sorts of levels,” he says.
Projects ready to proceed include the Brisbane Cross River Rail project and upgrades of the Pacific Highway Corridor in New South Wales.
The problem is paying for them. Since the global financial crisis and the downturn in the mining boom, both Australia’s state and federal governments have been hit by falling revenue. That has triggered budget deficits and increased borrowing. A number of state governments, including Western Australia and Queensland, have lost their cherished triple-‘A’ credit ratings.
That has limited the ability of state governments to pay for big new projects. “They don’t want to risk credit ratings or put budgets into deficit as a result of funding infrastructure,” Vella says.
The Grattan Institute says there is a serious risk of Australian government budgets running deficits at around 4% of GDP – or AUD60 billion a year – over the next decade due to rising costs, big political promises, tax shortfalls and falling mineral prices.
Exploring PPPs
The inability of state governments to fund infrastructure schemes would appear to offer an opportunity for the private sector to play a role.
The trouble is that the private sector has already been involved – and has been punished for doing so. Several companies had their fingers burned after the public-private partnerships (PPPs) in which they participated alongside state governments spectacularly imploded.
The M7 Clem Jones Tunnel, an underground inner-city toll road that cuts across Brisbane, was built by privately owned group Rivercity Motorway. It collapsed under AUD1.3 billion of debt in 2011 when toll revenues proved to be just one-third of the volume forecast. BrisConnections, the builder and operater of the AUD4.8 billion Airport Link, which links Brisbane’s northern suburbs to the airport and its central business district, was also placed under voluntary administration in February this year.
There were similar, earlier failures in Sydney, including the Cross Sydney Tunnel, a two-kilometre tunnel that links the western and eastern fringes of the city’s central business district. The first tunnel owner collapsed in 2007 when usage forecasts proved overoptimistic. Now the second owner, Cross City Motorway, which is owned by the Royal Bank of Scotland, EISER Infrastructure and Leighton Contractors, has been placed under voluntary administration.
These failures have left the private sector leery of participating in infrastructure projects. “The private sector doesn’t have a big appetite to take demand risk,” says Vella. “Lenders, in particular, are increasingly reluctant to [do so].”
If state governments want private-sector companies to participate, they need to offer much more appealing funding models, and take on more project risk.
“Unless they do that, the private sector is not going to play the game,” Vella says.
One of the main problems with the PPP model used for the troubled toll-road sector was that state governments sought to shift too much risk to the private sector. Private companies had to take on construction risk and also demand risk – the chance that traffic and toll revenue would not be enough to pay off the capital invested.
David Hartley, chief investment officer of industry super fund Sunsuper, says that infrastructure, particularly underground toll roads, has a social benefit. “If you’re asking the private sector to come in, it’s not really appropriate to ask [them] to pay for the social benefit,” he says.
Some governments are now looking to assume some of the demand risk to make projects more palatable to private-sector investment. In Melbourne, East West Link is a AUD6 billion-AUD8 billion 18-kilometre road connecting the central business district with the city’s north. It will be a PPP with funding from the Victoria state government, the federal government and private sectors. Construction begins in late 2014.
Victoria state government is using an ‘availability’ model for East West Link: there will be full risk transfer for construction to the private sector, but the state will initially retain tolling and traffic risk. They have effectively split the PPP in two. “The government itself will take demand risk,” Vella says.
Another problem with the model is revenue. Australians seem averse to paying tolls. But many argue there needs to be more direct charging for those who use the infrastructure.
“Someone has to pay for this infrastructure,” Vella says. “It seems very valid to me and just about everybody else in the infrastructure industry that the people who use the infrastructure should pay for it.”
Super-cautious funds
State governments are often fond of discussing how the nation’s pool of AUD1.6 trillion of superannuation retirement savings could help fund new infrastructure projects.
Industry Super Australia, which represents not-for-profit industry superannuation funds, estimates that those funds could provide AUD15 billion for infrastructure investment over the next five years.
But the PPP model is particularly unappealing to super funds, especially at the development stage. Owen Hayford, a partner at law firm Clayton Utz who specialises in infrastructure projects, says in a report entitled ‘Linking Superannuation Funds to Australian Infrastructure Projects’ that PPPs are too risky for the funds.
He notes that PPPs often carry demand risk; concerns often exist over construction and financing risk; they are typically too highly geared because governments want to minimise their financial contribution; the ‘ticket size’ of equity investment into the PPPs is often too small; and PPP bidding costs are high.
It’s an unappetising combination of factors that makes them unappealing in the eyes of many super funds.
“There is risk associated with greenfield [projects],” says Hartley of super fund Sunsuper, which manages AUD24 billion. “Governments want to get them done, but they need to work out a way to make risk acceptable.”
Sunsuper owns a 7% stake in Brisbane Airport and a stake in the Gold Coast airport. Hartley says that it continues to look at other infrastructure investment options, including greenfield projects.
For example, Brisbane Airport is building a new runway by 2020, which will need investment. “Some of those assets are quite attractive,” he says.
But most agree that greenfield PPPs will always struggle to get superannuation investments. Clayton Utz’s Hayford says experiences in Canada bear this out.
“Canada has a well-functioning PPP model, and yet its pension funds are not major investors in it, despite Canadian pension funds being recognised as among the most significant and expert investors in infrastructure in the world,” he says.
Revenue restraints
One way to get superfunds to reach into their deep pockets to fund existing public infrastructure could be through ‘recycling’ capital. That sees government privatise assets and specifically redirect the funds to new projects.
The New South Wales government, for example, recently sold the 99-year lease of Port Botany and Port Kembla for US$5 billion to a consortium led by Industry Funds Management. IFM is a fund manager owned by 30 not-for-profit super funds, which has AUD48 billion under management invested in infrastructure, debt, equities and private capital.
Matthew Linden, the chief policy adviser at Industry Funds Australia, notes the New South Wales government made it clear that it would reinvest the sale proceeds into urban transport infrastructure, including WestConnex, the US$11.5 billion, 33-kilometre motorway that is planned to link Sydney’s central business district, west, south-west, airport and port areas, and is due to commence construction in 2015.
Linden says privatisations are politically sensitive, but the community is more likely to be positive if they are linked to greenfields infrastructure investments. “That is a great example of a model we think can gain community acceptance and support, which is quite critical,” he says.
KPMG’s Vella agrees that recycling is a good option. “Looking at assets and trying to monetise equity in those assets is a valid thing to do,” he says. He adds that this model could lead to large privatisations in coming years, including further port sales in Victoria and Western Australia, and electricity assets in the likes of Queensland, Western Australia and New South Wales.
Government body Infrastructure Australia estimates that AUD100 million of commercially suitable infrastructure sits within Australian government portfolios, including airports, roads, water services, ports, freight rail and electricity generation, transmission and distribution. It says offloading them could fund much of Australia’s infrastructure needs.
Seeking more funds
But even recycling cannot fully meet the estimated cost of bridging Australia’s infrastructure gap. Many say the federal government will have to step up and commit more funds to infrastructure.
“It does have some balance-sheet capacity,” Vella says. “The government should borrow to fund priority infrastructure and it should still be able to maintain its triple-‘A’ credit rating.”
Infrastructure Partnerships Australia’s Lyon says estimates suggest the federal government has capacity to borrow AUD140 billion before it begins to approach its triple-‘A’ trigger. And, to be fair, the new Coalition government has committed to spending AUD11 billion on transport infrastructure, including AUD1.5 billion to East West Link and Sydney’s WestConnex.
The spokesperson for Treasurer Hockey concedes, however, that “nothing really concrete” has yet been done to attract more private-sector infrastructure funding. He says that Jamie Briggs, the assistant infrastructure minister, is finalising the terms of reference for a Productivity Commission report into the issue.
A focus is expected to be the possibility of infrastructure bonds. While the Hockey spokesman says such bonds are “still part of the thinking” he admits that nothing has been put on paper, although they are likely to be looked at as part of the Productivity Commission inquiry.
Hartley says that borrowing to finance infrastructure is different to borrowing to finance current spending. “If the issue of infrastructure bonds helps to make this clear distinction, then they could be quite good,” he says.
But he also notes that if the federal government were to guarantee such bonds, investors would be unlikely to distinguish much between infrastructure bonds and more regular government bond issues.
An interesting twist on such funding would be if infrastructure bonds were to offer inflation-linked payments.
“Such bonds are not attractive for super funds because of the tax treatment [under current rules, tax is payable on amounts that have not been paid to investors] but [they] would be better for the retirement phase,” says Hartley.
Australia has a sizeable infrastructure funding gap, and there genuinely seems to be political will for a new round of infrastructure spending. But with state and federal government spending constrained, governments will have to be clever in formulating new PPP models to attract private-sector interest.
The Productivity Commission should provide a roadmap for funding, but the government needs to act on a number of fronts, including spending more of its own money.
As treasurer Hockey’s spokesperson said of the infrastructure funding issue: “There is a lot of talk.”
That’s all well and good, but it needs to be followed by action.