Not Your Father’s Infrastructure – Part I
Infrastructure has traditionally been associated with stability. One thinks of long-term assets, sometimes long, long, long term (think Roman roads or aqueducts), and — for investors — related unchanging, low-volatility, low-risk cash flows. Regulation and contracts have been the key aspects of most infrastructure investments, with most infrastructure either delivered by governments, or backed contractually by governments. Granted, some types of infrastructure — with mainly commercial users, like ports and airports – have exhibited marginally higher volatility and risk, as has the electricity business in countries that deregulated and created merchant markets — such as the US in the last two decades. But compared to the risks, and the pace of change, in other sectors of the economy – manufacturing, communications – infrastructure has been and been seen as a low-risk, stable business. Rating Agency analysis, and expected returns to investors, have been aligned with this profile. Your grandfather easily understood your father’s infrastructure.
Underpinning this low-risk, high stability profile has been the relative insulation of infrastructure from rapid technological change. Infrastructure assets gained some efficiencies at the margin over time, as for example in the efficiencies of thermal generation plants. The important word here is some, as in some efficiencies, as in maybe a percentage point gain in efficiency a year. A few changes in business models – super-critical coal technology, co-generation – led to faster efficiency gains when introduced, perhaps low single digits on average over a decade. But these type of gains from better thermal plant efficiencies were generally swamped by relative movements in the cost of feedstock, especially for oil and gas-fired generation. These were not efficiency gains which fundamentally changed businesses or sectors. Infrastructure costs as a whole were generally driven more by construction costs than anything else (think of hydropower dams, roads, railways), and construction as a sector has shown the least productivity gains over decades than almost any other part of the global economy.
No more. Over the past decade, the tectonic plates under infrastructure have started to move. Not in gentle, smooth moves, but in earthquakes. Technology has arrived. The Opening Act of the new infrastructure world – and this really is A New Infrastructure World — has been in energy markets. Since the beginning of the decade, two big technology-driven changes have fundamentally altered the profile of the energy business. These changes – the development and plunging costs of wind and solar energy generation, and the (permanently, in my view) lower cost and far-wider accessibility of natural gas – have been widely covered, but are still playing their way through global energy markets, and their implications are far from fully understood. What is clear is that technological change in these sub-sectors is making energy available at much lower costs, with easier access, and with fewer negative externalities, than ever before. And that the pace at which they are changing energy markets is unlike anything we’ve ever seen.
Now two quick sidebars on the preceding assertions. First on natural gas. In speaking of the radical effect of technology change on natural gas, I do not refer to what is most contentious and most-widely referred to in terms of the current low costs and much higher availability of natural gas in the United States – “fracking.” What I refer to is the greatly improved imaging technologies, which enable companies to “see” far more easily and more cheaply underground reserves, increasing significantly known reserves and decreasing significantly the financial costs and risks associated with developing those reserves, and the evolving gas transportation models – which enables natural gas to be transported and consumed in far more markets than previously. These changes, in my opinion, are permanent. Second, one could argue that OPEC and the oil crises of the 1970s and 1980s were bigger changes in energy markets – but in my view these have proved to be temporary changes, now largely overwhelmed by the effects of technology.
The changes we have seen so far in energy markets have had a major impact on many fronts – on countries, on consumers, on energy companies, and on investors. I see these changes as more fundamental than any others over the past century. And they have come fast – the bulk of these changes only really hitting home in the past five years, and in many countries just beginning to be felt. But even more importantly, the Genie of technology is not back in the bottle.
Habits die hard. All of us tend to think the future will look a lot like the past, or the present. The more something has been stable, the less likely we are to think about it changing in the future, and a couple thousand years is a long time. And so it is with infrastructure. Infrastructure is stable. We tend to see change as unlikely, and if it comes, we see it as likely to be a one-off. In your father’s time, that kind of thinking worked. It doesn’t any more.
First on energy: for all the change and disruption we’ve seen, we can see a lot more change coming, all of it with major repercussions, and all of it coming faster than anticipated. Far from being back in the bottle, the Genie has just begun to wreak havoc. The technologies of wind turbines and solar panels have not ceased improving – there are further cost reductions coming, which will continue to expand the cost differences between these technology-driven energy sources and alternatives. The costs of storing that intermittent energy are declining at the same pace – 20% or more per annum – as were the costs of wind and solar generation. Combining energy storage with intermittent low-cost generation will have widespread impacts, and will do so quickly. Distributed generation is already transforming the landscape of energy in the United States, and associated costs will continue to drop, with deployment broadening across geographies and uses. And energy-efficiency is being affected in major ways by the host of technologies variously lumped under the heading of “smart grids” or the “Internet of Things.”
All of this means one thing: good-bye to stability.
Secondly on mobility, or “transport” as it is more commonly referred to in the infrastructure space. The Genie is out of the bottle here as well. Technology is already having a major impact on the nature of car engines, with the rapid fall in the cost of electric vehicles, and the corresponding rapid rise in their deployment. Today the numbers of EVs, while rising rapidly, look like a drop in the bucket of overall vehicle sales. The same was true of wind and solar generation only five years ago. And now wind and solar account for over 50% of all new electricity generation capacity addition worldwide – that’s the magic of exponential growth rates. The same underlying driver holds for EVs as held for wind and solar: technology delivered an infrastructure service so much more cheaply, with easier accessibility and more convenience (in the sense of less pollution, local and GHGs), that demand grew exponentially. EVs, though by definition consuming electricity, because of their greater efficiency use far less energy than their combustion-engine peers – by a factor of five or more. They will be far cheaper for consumers to maintain, with far fewer moving parts – by a factor of close to a hundred (expect most EV auto-makers to offer unlimited maintenance and service guarantees). And soon they will be cheaper to buy than comparable combustion-engine models, as battery prices continue to drop by 20% a year. Charging infrastructure, while an issue today, will be an easily solvable problem in the bigger scheme of things.
Cars of course are not infrastructure per se. EVs affect in the first instance only energy markets. But combined with two other developments, they will have a major impact on transport more widely. Those two other developments are the technology of AVs, autonomous or driverless vehicles, and the communications technology-enabled rise of Transport as a Service models, such as Uber. These three together will radically change how people and goods move. Drones may also come to have a big impact on the movement of goods. Together these will create major changes in the usage of roads, especially urban roads, in the usage of public transport systems, in the usage of parking facilities, in the locations businesses and people choose, and more. And through this we will major changes in the patterns of demand for transport infrastructure. It’s well behind energy markets, but it’s coming, and coming soon.
And it means the same thing as change in energy markets: good-bye to stability. It’s not your father’s infrastructure any more.
In the rest of this series, we’ll explore some of the implications of this New World of Infrastructure: implications for policy-makers, for infrastructure companies, and for financiers.