Private debt funds in the US have for years now made their case to potential investors with some version of the following narrative: “This fund relies upon strategy X. Strategy X is solid, but for various reasons (practical and/or regulatory) banks have largely withdrawn from the field of X lending. This has created an opportunity for private debt funds, which can step in and do the work the banks used to do.”
There is nothing inherently implausible about this narrative, and it is surely true for many specific strategies. Infrastructure lending, though, is not X. Banks have neither been pushed nor have they jumped away from infrastructure: or, at least, they have not leapt with the same alacrity with which they have done so in other areas.
Some recent regulatory developments have helped keep banks in the mix. For example, regulations intended to spread broadband internet across rural areas in the US (the Broadband Equity, Access and Deployment programme) presumes bank involvement.
Brent Canada, a partner in the infrastructure debt strategy of Los Angeles-based Ares Management, says: “Historically banks have been active senior lenders to core infrastructure projects, in particular greenfield construction financing, whereas our strategy [at Ares] typically provides junior or mezzanine financing. So, we often lend to the same projects where senior bank debt is in the capital structure.”
On the other hand, banks to some degree have pulled back. There, “we have seen an opportunity for us to attach higher in the capital structure and seek a similar return”. In this space, as Canada suggests, the reigning narrative is not: ‘the banks have left’ but ‘there is room for everyone, and the banks can be helpful partners’.
Infrastructure debt means…?
The defining characteristics of infrastructure investing are “an essential service, barriers to entry, a predictable cashflow, and large physical assets”, as Canada puts it.
Debt funds operating in this space typically invest in debt linked directly to projects, rather than to the corporate entities involved in those projects. The corporate sponsors benefit from the project focus, which entails the creation of a new entity that services the debt, which keeps the debt off the sponsor’s own balance sheet. This can leave the creditor with no access to any other sponsor assets. For this reason, the project finance world, and infrastructure in general, entail more protective covenants than ordinary corporate debt.
Infrastructure debt is often broken down into “brownfield” or “greenfield”. Brownfield assets are mature and may already be operating; greenfield assets may still be a title deed to the land and an apple in a developers’ eye. In simple terms, the “greener” the field, the higher the risk, and the more that investment may be considered the pursuit of alpha. The more brown the field, the more the investment looks like capital protection.
Canada says: “The US is seeing a tremendous amount of greenfield opportunities, especially in energy transition on the one hand – including the new market technologies it requires – and the high-speed fibre networks on the other.”
Much the same risk spectrum is sometimes described as a distinction between “core” infrastructure and “non-core” or “core plus”. As Lisa Bacon, of the private markets team at Meketa Investment Group, says: “Core includes low-risk assets that are operational and have predictable cashflows. Examples of non-core assets with higher risk-return profiles include those in the development, permitting, construction and early operations stages.”
The maritime energy transition
A major impetus for infrastructure change here is the ongoing energy transition as it applies to seagoing vessels. Seagoing engines that run on liquified natural gas emit approximately 25 percent less carbon than conventional marine fuels for the same amount of propulsive power.
That may not be a sufficiently impressive advance toward a net-zero emissions world for some. The general adoption of renewable natural gas, made from biomethane, produced from the fermentation of organic matter, offers hope of greater advance.
An industry coalition, SEA-LNG, was formed in 2016 to advance the use of liquified natural gas (and, of late, its renewable form in particular) as a sustainable maritime fuel. In a new market analysis, the coalition says annual production of biomethane is around 30 million tonnes, which is 10 percent of shipping’s total annual energy demand.
Of course the fuels themselves are not infrastructure. Neither, arguably, are the ships, though they certainly are expensive structures. A new container ship can cost hundreds of millions of dollars. Retrofitting a ship to allow it to use LNG can cost anything from $6 million to $22 million, according to trade publication Ship & Bunker.
But cost and size do not alone make for “infrastructure”. In the words of Ares’ Canada: “We don’t typically consider the ships themselves to be part of the infrastructure asset class, just as we don’t consider airplanes to be infrastructure. Ports and terminals, like airports, are infrastructure.”
SEA-LNG reports that bio-LNG, made from biomethane, is available via the existing infrastructure at 70 ports worldwide, notably in Singapore, Rotterdam and much of the east coast of the US, as well as the ports of New Orleans and Long Beach.
Lending for the maintenance and expansion of those facilities, then, would no longer be a greenfield project, or (for those who prefer) a non-core project. It would be brownfield and core. One says “would be” because, as yet, there seems to have been little lending for this purpose.
But at the release of the SEA-LNG report on biomethane, Adi Aggarwal, general manager of SEA-LNG, said: “Climate change is a stock and flow problem. The longer our industry waits to start using low-carbon fuels, the tougher the decarbonisation challenge will be.”
This may prove a promising and profitable new challenge for lenders, and the subject for conversations in elevators.