Chancellor George Osborne has announced plans for a National Infrastructure Commission headed by Lord Adonis. The UK’s pension funds are prime targets as investors, but it’s not that simple, says Mike Weston, chief executive of the Pensions Infrastructure Platform, spoke to New Power editor Janet Wood
Two years after it came into operation, the Pensions Infrastructure Platform (PIP) has helped raise £1 billion in infrastructure funds. “Some will say that’s way off the chancellor’s £20 billion target, but £1 billion is pretty good going,” says chief executive Mike Weston.
After the chancellor called for UK funds to invest, pension schemes agreed that core infrastructure was a good investment, but it was difficult to achieve because separate schemes had different aims and different investment allocations in their portfolios. That was when the National Association of Pensions Funds (NAPF) and the Pension Protection Fund (PPF) said they would facilitate working together.
It took two years for some of the country’s largest pension funds to agree principles on which to collaborate. They are: UK-only investments; no economic sensitivity; inflation-linked cash flows and a return of RPI plus 2-5%; and low fees. The group sought a manager on that basis and the PPP equity fund managed by Dalmore Capital was launched.
Weston says that after kicking off that initial investment, “the founding investors decided to start a building phase. I was appointed with four priorities: to work with Dalmore to increase investors in that fund; to spread PIP’s message – there were lots of people that knew we are here but did not know what we are doing; to find more investment opportunities – that’s when we started with Aviva investors to do rooftop solar; and to get PIP authorised as an asset manager so that instead of getting other asset managers to invest for us, we could do it ourselves.”
Weston says when PIP is authorised, “Pension schemes will invest be able to invest in the PIP multi-strategy infrastructure fund and we will make decisions on what to invest in. It makes decision-making much quicker, much more efficient, and it will enable us to compete with other asset managers out there.” PIP is “quite early in the process. We are in active dialogue with the FCA and that’s [typically] a three- to four-month process”.
Weston says: “As soon as that comes through we can launch the fund, and as soon as we have launched the fund and we have investment, we can go out and buy assets directly.
“We’ll market the fund to all pension funds in the UK and all will be treated equally. Regardless of size, they will pay the same fees and get the same benefits. It’s a way of allowing all pension funds, whatever their size, to invest in infrastructure. In the meantime we are still working with our founding investors to invest on a bilateral basis.”
How important is energy in PIP’s portfolio? Weston says: “We deliberately have a very broad infrastructure remit. We are geographically limited to the UK, and we cover energy and utilities, transportation, communications, social infrastructure – pretty much everything.” The funds do not take on economic sensitivity, or unrewarded construction risk, but PIP can invest in equity or debt, “so we are trying to build up a multi-strategy infrastructure portfolio – a spread of sectors, a spread of asset types”.
Avoiding economic risk – focusing on stable revenue streams that depend on availability – chimes well with energy investments such as renewables or network assets. And Weston says: “If you look across all those sectors, undeniably there is more going on in the energy space than in the others. The PPP and PFI activity has reduced, as government is re-evaluating whether it’s something they should be doing.” Energy, in contrast, is a very active sector.
I ask Weston whether PIP finds political risk more acceptable than economic risk. He says: “Our view is that if you are looking 20 or 25 years ahead… there is political risk over that time. The really important thing is that government doesn’t decide to change the rules retrospectively.
“I am confident they won’t do that. It is such a big can of worms, not just in renewables and energy, but no-one will ever trust the government to invest [if it does that]. It doesn’t stop government doing it, but it would be such a major about-face. Short of a completely new government coming on board with more radical views – but you would get a feel of that in an election campaign.”
The long view on FIT changes
I ask whether recent changes, such as the withdrawal of Levy Exemption Certificates, are close to being retrospective. Weston admits the change was very sudden, but makes two points about predictability: “You now have a single party government rather than a coalition, so some policies coming out are ones that would have been implemented by a single party government had we had one previously, but were diluted or changed by the coalition.
The second is that “industry is moving faster than the government can keep up with, so instead of being able to make several small changes, they are a bit behind the curve and have to make one big step.
“Clever entrepreneurs have been able to make more money before the step than they would have been able to [if the steps had been more frequent]. The changes would have come – no-one would have argued for never-ending subsidy. These things have to be economic in their own right. Some of these technologies are at parity and don’t need subsidy.”
If there are excess profits to be made because people are exploiting a subsidy scheme that has not kept pace with reality, that is clearly going to be unsustainable.
So people should have expected change? “Absolutely. If there are excess profits to be made because people are exploiting a subsidy scheme that has not kept pace with reality, that is clearly going to be unsustainable. So you know it’s going to change at some point. Lots of small steps would be better than fewer, bigger steps, but that’s inertia.”
I ask Weston what the recent announcements on reducing feed-in tariff (FIT) levels have had on PIP’s solar fund, managed by Aviva. He says, “Most of that capital has not been deployed yet. It has been committed to the fund, but it hasn’t bought many assets. To a certain extent we are caught up in the uncertainty surrounding what happens next.” Since PIP’s fund is not intended to put panels on the roof, but to buy them from developers who want to recycle capital, the question may be over developers’ strategies: “If [as a developer] you aren’t sure you can do more installations because the subsidy regime has changed, do you sell the ones you have already put up?”
In fact, he says, developers tend to be entrepreneurial, so they like to recycle capital. The difference may be that when they do so, they recycle elsewhere than the renewable energy business. He doesn’t anticipate problems in deploying PIP’s capital, but there will be a period of uncertainty – not least because: “There is a window when the developers are just going to throw up as many panels as they can and get them connected. They are more interested in getting that done then spending time talking about selling ones they already have.”
In fact, he says, Aviva is in active discussions with developers over installations and has a pipeline of deals. In the end, the fund will have a variety of assets operating at different FIT levels, depending on when they came into operation.
But what if the fund had to rely entirely on projects with returns at a level planned in the current FIT consultation? Weston admits: “It would be less attractive. It would depend on the price of the panels – it’s the fact that the price has come down so much that is the reason the returns have been exaggerated, which has allowed the government to reduce tariffs. In the consultation, the government is still targeting a 5-8% rate of return so in their view they haven’t changed the return people can get because panel prices have come down.
“We have an RPI plus 2-5% target, so it might be difficult to do that under the new regime starting from scratch.”
But he thinks there will be innovation: “Those people who just saw it as a way to make a quick buck will do that, sell their portfolios on, and go off and do something else. The established, quality, bigger players will stay put, and try to find a new way to increase returns.”
That’s the case across the renewables industry, he says, but he is positive about the outcome: “Business models will evolve and we are in one of those change cycles at the moment. One thing that doesn’t change is the need for more renewable power and carbon reduction. The macro trends are there: it’s how they develop in practice.”
Weston can see lots of attractive assets that have reached the stage where PIP and other pension funds can invest. In onshore wind, for example, “Lots of utilities are looking at their balance sheets now, wanting to recycle capital. There are potentially lots of operating windfarms – that’s great, they are pretty de-risked projects. If you have some historical operating data, you know what the yield is going to be. You know what the subsidy regime is and that stays put, then you have to take a view on the operation and maintenance risk… it’s a classic for institutional investors to look at.”
CfDs’ attraction for pension funds Looking across the changing landscape, Weston sees distinct possibilities in the Contracts for Difference (CfD) regime, which he says could open different funding options – if investors can take the leap.
He explains: “Where you have an inflation link to revenues with a project – as with CfDs – you can fund them with inflation-linked debt. There is a natural hedge within the project and inflation-linked debt is a great asset for PIP. In a sense the government has created a mechanism to facilitate inflation-linked debt. But it’s a bit of a change in structure.
“Most big energy projects tend to be funded with fixed or floating rate debt plus inflation swaps, because that’s good business for banks. There’s a lot of fixed and floating rate capital out there and banks will do what they have been doing for years, instead of saying we’ll do something different and use inflation-linked debt.
“A bit of that is because there is no track record, so there is a bit of uncertainty.” Banks can’t be sure at this stage that the pension funds will take that debt, and they are afraid the project will not close.
He adds: “There are institutional barriers to moving to CfD and inflation-linked debt. Banks make lots of profit on inflation swaps. But the government has put the CfD mechanism in place… It might have been an unintended consequence but once it was realised it was quite favourable – they said, we’ll run with it.”
There are institutional barriers to moving to CfD and inflation-linked debt. Banks make lots of profit on inflation swaps.
That makes some big, long-term projects very attractive for pension funds: “If you fund a £20 billion nuclear project with lots of inflation-linked debt, you can use lots of inflation-linked revenue to pay the bill.” So is nuclear a potential home for PIP’s funds?
Weston says yes: “If the government were to provide the sorts of guarantees talked about for the project. You can get to the stage where the risk is taken out and it would become an attractive asset. Certainly once that plant is operating with CfD inflation-linked revenues, that will be a perfect scheme.” As for construction risk, “Like the Thames Tideway Tunnel, you can structure it in a way to mitigate the risk – absolutely.”
In general, PIP’s approach will be providing debt during construction and equity in operation. And Weston is not ruling out any type of energy asset. “It depends on the security of revenue. We would not want to take merchant power risk, but if there is a power purchase agreement in place that de-risks the revenue stream. It’s all about understanding the risk and where it is.”
The new capacity market means there is a similar predictable revenue stream for conventional assets, so they are also potential investments for PIP – but two caveats apply. The pensions industry as a whole has long-term stewardship and sustainability in mind, and it is cautious of high-carbon projects that could become stranded assets. And the low price that came out of the first capacity market auction does not make it a high priority.
Weston hopes PIP will have opened its new fund early next year, but his message to energy asset owners is not to wait. The fund will invest in around 20 assets over the next five years, but alongside PIP he expects other pension schemes will co-invest, as has been the case with the Thames Tideway Tunnel. “That would have been too big to go in the fund. But with fund participation and co-investors it’s an indication of the size of the ticket,” Weston says.
“in the past, the [pensions management] industry has been a bit slow at making decisions and coming in”
He admits that “in the past, the [pensions management] industry has been a bit slow at making decisions and coming in”. Once the PIP receives FCA approval he wants to do things differently. “It’s a small industry – everybody knows everybody – and you can’t afford to start doing projects and then drop out at the last minute.” But he needs projects coming through the door now so the fund can move quickly once it opens: “The message is that pension schemes are ready and willing and we can move fast. Come and talk to us.”