Speaker 1is infrastructure climbing up the risk curve that's something we often hear but what does that actually mean together with infrastructure investor america's editor zach bentley and ann louise peterson senior reporter for the energy transition we debate what asset class characteristics are falling by the wayside which risks are perhaps not entirely evident to investors and whether some higher risk assets are still infrastructure or if their risk profile moves them beyond the confines of the asset class i'm bruno alves infrastructure investors editor-in-chief and this is the infrastructure investor podcast hi i'm louise zach good to see you and welcome to the podcast thank you so you know we as a team i feel been on and off talking quite a lot over the years about whether infrastructure as an asset class is you know becoming riskier or climbing up the risk curve and to me i i feel like that the recent acquisition of london listed fund bbgi global infrastructure by canada's british columbia investment management fund it's almost like a triggering event a bit because you look at that 56 asset portfolio made up of you know availability style cash flows you know it's just a reminder of a bygone era something that used to be pretty common across the asset class and now it's almost like you're looking a little bit at an endangered species and it's you know it's in a way it's a great great hook for us to hang on as we have this discussion so let's try and frame this for our audience let's analyze whether we feel infrastructure is becoming riskier and to help kind of really contextualize it which traditional asset class characteristics do you feel are most important to you and what are some of the most important things that you feel are now becoming harder to come by or falling by the wayside entirely zach maybe you could you could start natalie's then we'll get your thoughts also i think one
Speaker 2thing to say from the outset is we used to have a conversation in the industry dominated by brownfield or greenfield and that conversation hardly exists anymore because i think to sort of get any meaningful alpha you have to be doing some kind of greenfield and naturally that does send you a lot of questions and i think that's a really good point and i think that's a really good point and i think that's a really good point and i think that's a really good point and i think that's a really good point and i think that's a really good point and i think that's a really good point a little further up the risk
Speaker 1curve yeah that's definitely happening and louise what's on your mind in terms of higher risk for for this asset class well i'm
Speaker 3always turning the discussion to energy transition so in this case it would be about i really do wonder a lot of these energy generating assets how protected they really are they would always say that oh you can't just add another solar farm or another wind farm to this area but many times you can and to some extent you can't just add another solar farm or another wind farm to this area but many times you it doesn't always matter so much because the grid is connected so in a way you're competing with so many other wind farms so many other locations all the time so you're not that protected and that matters particularly when we talk about merchant revenue being part of the revenue stack that you are really dependent on something other than just something regulated and contracted to come in and save you or at least save that extra cherry on the top to provide you your value at risk return
Speaker 2and i think that's a really good point and i think that's a really good point and i think that's actually maybe an always related to what you're saying is part of the greater risk in that because we keep adding and adding we're perhaps affecting without even some of the knowledge of doing so we're really affecting some of the power prices that are happening out there uh you get a lot more volatility and sometimes negative power pricing because of so many generation assets
Speaker 3at one moment yes absolutely cannibalization is out there it's very real but everybody knows about it the problem is or the thing that may be harder to know about is we've got an enormous pipeline of renewables coming online just how is that going to affect that merchant price five years down the line who can actually forecast that and so when you have a revenue stack where a merchant makes up a significant portion maybe up to 30 percent sometimes even more if you're even more pe like that really isn't guaranteed in any way it is just hopeful and hopefully you will go through and hopefully be there but you just don't know and i thought it was interesting researching this a little bit six years ago i noticed that frederick blank brood from edhec was already arguing that we really should let go of the whole value add core and core plus categories and say is this contracted regulated or merchant and start using different terminology about how to categorize the risk
Speaker 1return yeah well i think the merchant example is very pertinent because i think we'll all remember a time when investors would just refuse to take that risk or would not to take merchant risk because they could by the way things were subsidized they could do that but there was a time when this was firmly considered not an infrastructure type risk to take on and then circumstances changed people's hands got forced etc and of course merchant risk is something you have to live with now so i suppose another way of putting it is how much can you protect against it how many assets can you get these days that have enough contractual protections in the context of this transition to minimize that merchant risk because that is what we're talking about isn't it we're talking about minimizing it not eliminating exposure to it altogether i
Speaker 2feel yeah i mean i think there's a balance to be had but i think that there may be some people argue there may be certain assets that have to be merchant i think i think something like battery storage and the picture of battery storage depends on which regulated market you're talking about but i go back to something aaron zubati ceo of the gip portfolio company earlier and he said a couple years ago after they secured financing for i think at the time the largest merchant battery storage asset ever built and he was commenting on the merchant risk and battery storage and he said that the storage is not and should not be lumped with contracted renewables and he said that that's not what the storage play is it has to be volatile because of what it's doing for the grid i'd
Speaker 3absolutely agree with that it's the way i see people approach battery storage it's not at all that they want to cut out the merchant risk they are really going for it and and that's why we're seeing more pe like companies or strategies going in there and trying to get themselves some some batteries the question is whether there's an infrastructure so how many of these battery projects are really infrastructure and how much of it is pe light if you will and i feel
Speaker 1the energy transition is fertile here so what else are you seeing where you are bumping up against this question you know this risk profile it doesn't look very infrastructure where else in the energy transition would you say people should be paying attention to put it that way you could
Speaker 3argue that maybe offshore wind has turned into a place that definitely for those who don't know exactly what they're doing has a lot more risk a lot more development risk a lot more greenfield risk than you would usually be comfortable with as an infrastructure investor i think this is being recognized across the board at the moment so so maybe that's a little bit of an old-fashioned example but green hydrogen is another place it's been very up there i think few and fewer proper infrastructure funds are going there but you do have funds calling themselves infrastructure that are invested in green hydrogen and the risk there is just simply too high it seems
Speaker 2yeah i'm i would add to that that again uh something that may have been an excitable asset a few years ago but people have turned away from a little bit something like ev charging infrastructure again kind of like which market you're talking about but there is a lot of merchant or hope as we were talking about before there's a lot of hope involved in that people are plugging into your assets yeah i think
Speaker 1that's valid with the exception sometimes in europe i think you can find some concession-like structures around ev charging when some governments get involved and that immediately turns it into infrastructure because it gets through the merchant risk so so to speak and the volatility but it's probably not the majority here so okay so we're coming across a few risks zach you mentioned at the very beginning that we used to talk a lot about greenfield brownfield and you know this time when you could just invest mostly in operational assets without doing much is over so you always have to take a bit of that development risk these days and then we got to talking about merchant and the lack of downside protection i feel another risk as platforms have shot up the agenda as a way of of doing things and also now with some of the newer strategies again on the energy transition is also scalar up risk which is another risk is another way of talking about growth infrastructure equity and that seems to be becoming more popular and you wrote about platforms not that long ago zach so maybe it's worth recalling some of the you know of the risks that you identified
Speaker 2then yeah i think the risk for platforms is you build up a vast pipeline of projects that perhaps never see the light of day and then we can get into all the risks associated with renewables projects in terms of connection to the grid but you end up with large development pipelines that are maybe aren't going to be developed i guess the benefit of platforms in this respect and you're starting to see is in the data center world as well is that actually you can build up a portfolio half of which is what people are calling stabilized assets operational stabilized has become the new word for operational and then there's the greenfield development side of businesses and so you're getting the revenue in from the stabilized assets and at the same time you can build out the
Speaker 1platform and there's also what And Anneliese, we've discussed this, Venus, there's also the type of the part of the scale up risk that is essentially where infra and PE meld, isn't there? And in the energy transition, you see this in some of the newer businesses where you're also just trying to grow something as in the contracts are there. KKR, what they're doing with Zenobis is an obvious example. They bought something, it has contracts, et cetera, but they want to grow that business by 10x or whatever it is. And that is kind of a private equity risk in a way, or certainly a growth equity risk. And I feel the transition is a place where you see a lot of that.
Speaker 3On the other hand, you do have to platform to get anywhere. So it's a risk I think they've got to take. And it's also a risk that you could argue it's well managed within the infrastructure sector. It's been seen before. It's nothing new, really. Maybe the scale is new, but then so the scale is new in everything these days. I don't know. The scale up risk is not. Not so much my concern. I think where I'm mostly concerned is that when people go out and present these strategies to the LPs, that they have a language to describe what they're selling that is perhaps a little more accurate than what they are showing up with. So as long as everybody knows that this is a scale up risk, that's not a concern. But if what's being scaled is stacked rather than infrastructure assets, so has a revenue stack that consists of a lot of merchant risk. That's a different proposition that just scaling up a contracted asset class.
Speaker 1Yeah, that's right. And that brings us back to downside. Well, I guess you're hinting at that, you know, the revenue stack isn't maybe being made as clear in some of these assets as maybe it should be. Is that a fair way of putting it?
Speaker 3I think so. I've seen, you know, there's a very cute way of talking about a merchant nose or a merchant tail and, you know, oh, it's a little bit of extra. And people keep talking about the merchant. Slice of the revenue stack is a little bit of an extra, but really it is becoming quite prominent. And it's sometimes the lines are sometimes a little bit blurred on just how much of this merchant can you trust and can you rely on in five, seven, 10 years, 12 years, even for some of the infrastructure funds. It's a long time to rely on something where you have no control at all.
Speaker 2Even when you're not on merchant risk and you have a PPA, I was reminded about something that was said. I was at the InfoCast Clean Energy Investment Summit in Houston last year, and there's a representative from the US subsidiary of the Japanese group, Jera. So not an infrastructure fund, but investing in similar assets. And he was saying sort of if you take a solar asset, which has a 30, 35 year life and you have a 15 year PPA, he was saying that you're naturally taking speculation on what prices are going to be from year 16 through to 35. And so, yeah, you might be able to sign it. You might have a PPA after that, but really you don't know. And that's also quite, quite a risk that's being taken. And he was saying mostly our IRR is going to be driven in those 15 years. You don't know what's coming after that.
Speaker 3Yes. And of course, most assets would have a PPA in there too. And then they would have the merchant slice on top of that. So even those solar projects for 15 years might still have a merchant bit added to them, which would, of course, help a little bit, hopefully, with the IRR over the 15 years.
Speaker 1But I think what we're also saying is this isn't just about, in case somebody is listening and thinking, well, you know, this is maybe about some of the newer energy transition assets. And what's coming clear is, yes, you have some of the newer assets like batteries, and they arguably are something else that falls entirely off the spectrum. But we're also talking that this is present, this higher risk with merchant, et cetera, in the common stuff or the more common stuff that people were used to, wind, solar, et cetera, right? That is a fact. That's effectively what we're saying.
Speaker 2Yeah. And we've been talking about this for a number of years, but PPA contracts, the terms of them, the length in which they are usually signed for, I think 15 is a luxury. And often these days, you're looking at more like seven or eight, and maybe 60% of that is actually under contract.
Speaker 1And that raises a very important question, which is, you know, is this infrastructure enough as a, you know, a risk return profile, because it is a short tenure in many of these cases. So let me flip the question. Nowadays, what can you do and where should you go if you still want to buy into some of those more traditional infrastructure characteristics, ensure you have downside protection, et cetera?
Speaker 2I think coming from the U.S. space, I think there's a great opportunity in the utility sector, which is highly fragmented, but is regulated and maybe in some of the larger opportunities, regulation is forcing. Some of these returns down, but it's still a sort of high single, low double digit opportunity, which would be the ability to sort of generate further returns from delving further into the energy transition space while having a traditional regulated utility.
Speaker 1Yeah, that's fair. And Annelies, what are you, you know, what's catching your eye?
Speaker 3Where you have barriers to entry, better barriers to entry in something like coal logistics and in waste management, you don't suddenly just pop out of nowhere and have trucks ready to collect the goods. The garbage that people throw out. So these things are where I think we might see some development and where people go in and it's fully contracted all the way through and has very strong infrastructure characteristics. You may have ports as well. There'll be some various things with the ports that you, you know, you cannot just put up another port. Even airports might be something that people might return to. But definitely, I think the whole energy transition space, that the energy generation space and the storage space may not be where people go if they want core and core plus structures.
Speaker 1Are we saying a bit also that if you look at the context of the megatrends, broadly speaking, so the transition and digital, and because you have a lot of people piling in and also a lot of assets being, you know, developed, we can go outside of the transition. We see some problems in fiber if you want to get these downside kind of protections or barriers to entry, forget about it. So is it something to consider? It's something to be watchful for because these are the megatrends, but actually, you know, the upside is deal flow and lots of tailwind and the downside is maybe letting go or having to look very hard to implement some of those infrastructure characteristics.
Speaker 2I think if you're a fund and wanting to tap into these megatrends, you kind of have to accept that there is an increased risk. There is way more development that's needed, whether you're talking about transition or day centers or the like. There's going to need to be some more development risk and with that comes the contracted risk
Speaker 1as well. Is it just development though? Because when I was hearing Anne Louise talk about some of her examples, it's also about barriers to entry, right? It's just, I feel the barriers to entry are just not there to the same extent. To go, you know, to go to your trucks example, Anne Louise, that you just don't pop up with a fleet of trucks, but you pop up with a solar farm or even, you know, a farm. You know, a fiber line as we've spoken. I think there is an element of that also at play here, isn't it?
Speaker 3I would say so. I think that's the biggest difference. Absolutely. And I don't necessarily think it's something bad. It's just be careful what we're talking about. And if it's slightly more PE, if it's slightly less traditional infrastructure, just be honest about it. Say what it is. And I'm sure that there are people out there who can still see a value in investing in renewable assets. Of what we call them or what the revenue stack looks like. They just need to know.
Speaker 1It's funny because this line resonated with me when I interviewed recently Pasha Nikolova, who heads up infrastructure for five of New York City's retirement systems. And there's a couple of things that caught my ear and one that she kind of stressed looking at deals on a deal by deal basis or characteristics and things like downside protection, so on and so forth. But she seemed relatively open about, you know, this, this shift up the ridge. The risk curve in the sense that she said, this is the way the assets are changing and it's what society needs. And we're, we're going there following, but also she felt there was enough. And of course this is relative enough downside, enough protection to still anchor it in the infrastructure round for her, obviously for her and her portfolio. And I thought that was quite interesting and maybe a way for us to wrap up is when we're discussing going up the risk curve, okay, are we still saying most of these investments, most of these investments are in the infrastructure spectrum up here, or are we actually saying some of them are out there? And I think we're kind of saying that batteries are maybe in a place that is beyond, beyond the higher end of the infrastructure spectrum, at least in some cases, right?
Speaker 3I think that is a case that can be argued. Also the duration of those projects are sometimes quite short, five to seven years in some cases. So yes, arguably they are looking a lot like PE, but on the other hand, it's worth noting that. It's not as if private equity has been busy trying to come and say, oh, we'll take this over. So it may still belong in the infrastructure realm for a while.
Speaker 2Uncontested. Yeah, I think it's more just that the realm is widened. I think people will, as Anna will say, are coming to eat this lunch. It is still in for, I think you're accepting it upon yourself that when you're going into some of these assets or some of these funds that there is going to be a greater risk. And if you don't want that, there's other more core like opportunities for you.
Speaker 1Yeah. And also, could PE come and eat our lunch? so to speak, because we haven't been talking about skill set much. We're focusing solely on risk. But just because you're PE and you're used to taking on higher risk doesn't necessarily mean you could come and take this kind of higher risk and have the right skill set to get it to a good place. I think that's something I would say.
Speaker 2Yeah, I think where we've seen more PE-like investments in the transition space, at least, is more towards maybe climate tech is the best description for it. More just before those assets really get to an energy transition asset, never mind an infrastructure asset.
Speaker 3And I don't know if it's a valid point, but the skill set that infrastructure investors have had to acquire in the past five years has also changed enormously. If you look at how to get a battery project going and get that stack sorted, this is not easy. The whole PPA thing is not trivial. So the skill set, I think, of everybody is changing. And of course, there can be PEP, coming to infrastructure too, and they are there. And there will be some infrastructure people going more and more PE as they find that they can make that work. Why wouldn't they?
Speaker 1Yeah, I think that's a good point to end on. Anne-Louise, Zach, thanks very much for coming on and sharing your insights. Good to see you. Thank you. You too. That, again, was infrastructure investor America's editor Zach Bentley and Anne-Louise Peterson, senior reporter. For the Energy Transition. To hear more of our episodes, head over to infrastructureinvestor.com forward slash podcast, or you can search and subscribe to the Infrastructure Investor Podcast wherever you like to listen.
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