UK Infrastructure: Investment Opportunities or Risk?

Investors in UK infrastructure will be able to tap into new opportunities to create the sustainable, resilient water supply needed to support economic growth. Taking account of financial risk from resource use and future environmental liabilities upfront could help secure future returns. Including carbon costs in business planning is already paying off for some water companies.

The UK Treasury updated its National Infrastructure Plan last month, setting out a substantial pipeline of over £200 billion worth of planned investment in UK infrastructure. The majority of this will be funded with private money. The coalition Government aims to help investors raise spending on UK infrastructure through a Memorandum of Understanding with UK pension funds (including the National Association of Pension Funds and the Pension Protection Fund) and an Insurers’ Infrastructure Investment Forum.

The plan includes a £22 billion program of investment in water infrastructure by 2015. Projects will need to take account of a Water White Paper published by the UK Department for Environment, Food & Rural Affairs last week. This outlines plans to reform the water industry to address challenges including demand pressures, supply constraints, and overuse of some water resources. Measures will include changing abstraction charges that “do not send the right price signals” as they do not reflect the relative scarcity and abundance of water, or competing water demands. Reforming the water abstraction regime aims to facilitate investment to meet water needs while protecting ecosystems. This reflects the Government’s plans to ensure that prices and markets increasingly reflect the value of natural capital, so that investors look for opportunities to make a financial return from investing in activities that improve natural services.

Infrastructure that locks in high levels of resource dependence and pollutants could face higher than forecast costs, lowering future cash flows and return on investment. Costs have already increased for infrastructure projects including road building, water and sewerage and energy since 2005. The UK water industry expects greater energy efficiency and more renewable power generation will help insulate against energy price volatility. The water industry is energy intensive and contributes around 1% of UK GHG emissions. The sector has an important part to play in helping to meet the UK target to cut emissions by at least 34% from 1990 levels by 2020.

Water companies will need to pay for carbon dioxide emissions from energy use under the CRC Energy Efficiency Scheme from April 2012. UK water companies include carbon in business planning, taking account of whole-life carbon impacts and costs. Carbon pricing can be applied to expected emissions to calculate potential exposure to carbon costs. This can be factored into financial modelling to adjust the net present value of future cash flows. The same approach can be used to take account of external environmental costs from impacts such as water abstraction and air pollution. In addition to monitoring current and future operational risk, investors and companies can calculate likely energy use and greenhouse gas (GHG) emissions from construction on greenfield sites, and maintenance and expansion of brownfield infrastructure projects. Capital expenditure in different sectors can be used to calculate likely environmental impacts and related costs.

The Government measures infrastructure on indicators including reducing carbon intensity. Trucost data show that two of the largest listed water utilities in the UK have already reduced their carbon intensity, measured as GHG emission from operations and direct (first-tier) suppliers relative to revenue, between 2009 and 2010 (see Chart 1). Northumbrian Water Group has reduced its carbon intensity by 20% to 236 tonnes of carbon dioxide equivalents (tCO₂e) per US$ million, while Severn Trent has reduced its carbon intensity by 22%. This is in contrast to a 4% increase in the average carbon intensity of listed water utilities globally.

Chart 1:   UK water Utilities and sector average carbon footprints 2009-2010

Northumbrian Water has a target to reduce operational GHG emissions by 35% by 2020, from a 2008 base. The company has invested £33 million in thermal hydrolysis advanced anaerobic digestion, enabling waste water sludge to generate methane to fuel gas engines and produce green electricity. Severn Trent has cut emissions by measures including improving efficiency, minimising transport fuel use and reducing the volume of sludge processed. The firm has a long-term target to meet 30% of its energy demand by generating renewable energy from sources including crops, hydro turbines and sewage gas combined heat and power (CHP). In 2010, 22% of the company’s energy demand was met by renewables.

The next five-year cycle of investment will be subject to Ofwat’s price review from 2015-16. Ofwat, the economic regulator of the water and sewerage sector in England and Wales, is currently consulting on proposals to change the way it sets price limits to take account of factors such as population growth, climate change, and growing water scarcity. It is moving towards a whole-life costing, total expenditure (‘totex’) approach to assessing efficiency to help address any real or perceived capex bias towards capital- and carbon-intensive projects. Incentives to encourage more efficient water use are likely to raise water prices more for business than residential water users.

Managing exposure to resource-intensive infrastructure – and suppliers – from the outset can help address financial risk from resource use as well as liabilities for emissions and other pollutants under environmental taxes, emissions trading programmes, regulatory regimes, changes in licensing conditions and business or supply chain disruption.

Rebecca Maclean works on investor projects and covers the technology sector. Prior to joining Trucost in October 2010, Rebecca worked at UN PRI (United Nations Principles for Responsible Investment) as an Assessment and Reporting intern. Rebecca holds an MA in International Relations from King’s College London and a BA in Experimental Psychology from Oxford University.