More of the Same for Less. In energy, 2017 saw the same as 2016, and 2015 before that. Falling energy prices, especially for wind and solar generation. The effects of continued technology improvements in both areas were joined by the effects of smarter procurement – more and more countries adopting competitive auctions, and the design of those auctions continually learning from experience and improving. In 2018, expect more of the same – further falls in auctions prices. Look in 2018 for the “world record” price in solar generation auctions to fall below two US cents a kilowatt hour — $0.02/KwH. For those making comparisons, that’s about 1/3-1/4 of the cost of new greenfield coal-fired generation capacity.
Less for Longer. Of course, falling wind and solar prices are not a new thing. And the main issue they pose to grids – their intermittency – is also not new. What is increasingly new is the ability to use solar and wind power for longer periods, and with less intermittency. Not new in the technical sense – energy storage has been around for decades – but new in the cost-effective sense. Battery prices are falling as fast, if not faster, than the prices of wind and solar farms. In 2018, look for the first auctions for solar PV generating capacity with associated energy storage to drop below $0.08/KwH — eight cents per kilowatt hour. About the electricity cost of a greenfield coal-fired plant (Ok, not an apples to apples comparison, but a big marker, with storage costs continuing to decline in the 20% per annum range). And alongside this, look for the volumes of capital going into utility solar/wind generation plus storage to become noticeable.
But some for less long. Expect “re-powering” to gain steam in 2018. We’ve been seeing a fair amount of re-powering (retiring existing generation capacity, as opposed to adding incremental capacity) in the US, with old coal-fired plants being taken out of service and replaced mainly by gas-fired plants. China has also seen a fair amount, driven in part by air quality considerations. Now pressure is building up for many countries, especially those who were at the forefront of early renewable generation, to replace “older” (as in 6-10 year-old) wind or solar farms with their newer, much cheaper successors. For countries which signed up to buy wind or solar power at 15 cents or more (>$0.15/KwH), the attractiveness of switching to new capacity, which can be expected to be at 5 or 6 cents or less, is becoming way too strong to resist. Tearing up old contracts, as Spain and Germany had already done, will make sense to more and more governments. The big question will become one of process – an orderly process, or a disorderly one?
China will be even bigger… in Electric Vehicles. China had dominated solar cell production and generation – the country accounts for about half of all new solar generation capacity additions annually. As the global market for EVs grows, China will grab an even bigger share of it. Production of EVs in OECD countries is growing, but slowly, and deployment is happening with minimal public policy support, other than places like the Netherlands, or some cities. By contrast, the government in China has made production and deployment of EVs a national priority, and is moving further and further ahead of the rest of the world on both count. Look for China to have a 60% global share in EVs in 2018.
… but the only thing bigger in the US will be noise. Addressing US infrastructure deficits has been a priority in policy debates for years, including in the new administration. Word of a new “trillion dollar infrastructure plan” being imminent are growing louder. But the fundamentals are moving the other way. Public spending on infrastructure will clearly be more constrained after passage of the new US tax bill, TCJA. Cuts in taxes will mean much less money for the federal government to spend, while changes in tax rates and in deductibility of state and local taxes means that cost of financing will go up for states and municipalities. Normally this might lead to opening up more space for private infrastructure and PPPs. But the universal lesson of experience is that infrastructure reform, and the creation of any large-scale PPP programs, require above all else policy predictability and some degree of underlying policy consensus. This does not seem part of the present policy direction in the US. Surely some states and cities will make progress, but expect 2018 to end with as much displeasure about the state of US infrastructure as it begins.
EM reformers won’t budge the numbers. Emerging Markets account for anywhere from ½ to ¾ of future global infrastructure investment needs. By and large EM governments are fiscally constrained, with negative trends, so one would expect large markets for private infrastructure. Yet private infrastructure investment in EMs is tiny (around $300B p.a.), and has fallen significantly since 2013, according to World Bank Group data. Hopes have risen in recent years with the advent of reforming governments, or announcements of planned major sector reforms, in several large emerging markets – notably Brazil, Nigeria, Argentina, Indonesia, India, Vietnam. Each of these has the potential to be itself by a $100B a year PPI market – reforms across all six could more than double current EM numbers for private infrastructure investment. But don’t expect this to show up in the 2018 numbers. At current stages of reform, only Argentina has a strong chance of becoming a major new PPI recipient this year. Maybe 2019?
Maximizing Finance for Development won’t budge the numbers either. The development finance community has its strategy exactly right. Help countries find ways to crowd in more private capital to deliver infrastructure services, and to help governments meet rising aspirations. This is Maximizing Finance for Development, or MfD, also often spoken of as “Billions to Trillions.” MfD is a clear and visible top priority in the World Bank Group, and many more in the development finance community. But don’t look for big results just yet. The nuts and bolts of policy reform are not simple, vested interests are not getting out of anyone’s way, and it will take a while for reforms to translate into large increases in crowding in. MfD is a long game, not a short one.
Cities are where it’s at. Municipal investments have been gaining share, as a % of total infrastructure spending, for years. Expect this trend to accelerate in 2018. The long-term driver has been growing urbanization, and increased fiscal decentralization around the world. Those trends are not going to reverse. What is new is the role of technology. Over the last few years, technology has enabled countries to get energy cheaper, with broader access and fewer environmental costs. This has fueled a huge boom in investment in wind and solar generation. Now technology has come to transport, especially urban transport. Electric vehicles and driverless vehicles, combined with shared-use models, promise significantly cheaper transportation options. This will fuel a similar investment boom, concentrated in cities. Expect the reform spotlight to shift from sovereigns to cities, as Buenos Aires, Jakarta, Mumbai, Istanbul and Lagos drive big jumps in infrastructure investment.
Investing in infrastructure – the rules keep changing. Investing in infrastructure has long been synonymous with long-term stable returns, exactly the kind of returns which many investors (especially pension funds and insurance companies) want. The primary issue for most investors has been finding assets in which to invest. To some extent, policy efforts – around project development support, or sector reform – have helped create a somewhat greater flow of investable assets than would have otherwise been the case. But the big driver of new investable assets in recent years has been technology: wind and solar generation, and natural gas midstream and gas-to-power, have seen huge jumps in investment made possible by technology development. That has been good for investors, whether of equity or debt, searching for assets in which to invest. However those assets look, “different”, than traditional infrastructure investments. While very attractive from a public policy, or corporate image, perspective, these investments increasingly have a different risk-return profile than traditional infrastructure. The first waves of renewables depended heavily on public subsidies, which in many places turned out to be not so stable. The current wave depends much less, if at all, on subsidy, but the prices are being bid down so low that associated returns are very compressed. Utilities buying this power are themselves finding their cash flows and stability changing radically, as we are seeing most clearly in the US. There are good reasons to expect this dynamic to be repeated as investment opportunities scale up for energy storage, for electric vehicles, and for driver-less cars. As an investor, expect asset opportunities to increase, but stability to decrease. That is the new infrastructure world.
Climate adaptation climbs the priority list. As reported this week by the US NOAA (National Oceanic and Atmospheric Administration), the costs associated with extreme weather-related events affecting the United States in 2017 set a new record – one that was more than 50% above the previous one-year record: $306B, compared to $200B the year of Hurricane Sandy. This is getting to be serious money. As shown by an excellent series of reports by the Houston Chronicle, infrastructure shortcomings and policy choices were critical elements in the costs of the biggest of the 2017 events – Hurricane Harvey’s landfall at Houston. This is a high visibility, big numbers version of a lesson being learned repeatedly in recent years, that infrastructure choices are key to adapting to the increase in extreme weather events associated with climate change. Expect growing attention across the world in 2018 to how the costs, and other effects, of such extreme weather events can be best managed.