Understandable and deliverable revenue streams are the key to tapping into the huge amounts of private money ready and willing to underpin the UK's infrastructure needs. Beth West explains the challenge.

The recent commitments by the Government to infrastructure spending is a great recognition that growing economies need good, modern infrastructure in order to keep growing. But we still are not out of the woods with regard to our overall economic health, and austerity still remains a key fact of life in the public sector. 

Like buying a house, building infrastructure requires major capital outlays but with the benefits being spread across decades.  But unlike a mortgage for your house, financing for infrastructure construction is constrained by many factors:  size of project, duration of construction, or lack of a clear revenue stream.  However, there is a huge supply of financing that is seeking ‘regulated returns’ of the kind that can be achieved through regulated utilities. 

"Things start to get trickier as you move away from individual utility assets.  Although elements of railways – such as well travelled franchises – can make an operating profit, the totality of railway infrastructure has typically relied on government subsidy to fund its capital costs."

So how do we make supply and demand match so that we can finance more infrastructure through the private sector?

The first thing to look at is types of asset, if they have a revenue stream that is financeable and if there are ways to mitigate the construction risks that currently are turning off investors.   

Assets such as traditional sources of power generation are relatively easy to finance as are only developed if they have clear operating profits that can pay down debt and make a return on equity.  More complex projects have developed some innovative support structures which can attract financing that would otherwise not accept the risks. 

Thames Tideway Tunnel raised £2.8 billion in financing despite its seven year construction duration because it was provided with a government guarantee structure which protected investors from material construction risks.  This structure was ultimately successful due to the stable revenue stream that was provided by Thames Water customers.

Things start to get trickier as you move away from individual utility assets.  Although elements of railways – such as well travelled franchises – can make an operating profit, the totality of railway infrastructure has typically relied on government subsidy to fund its capital costs.   

Railways are also integrated systems and therefore financing distinct elements of the infrastructure can create difficulties in optimising the system because the owner loses control of total decision-making.  This type of asset may be an area where only discrete elements are able to be financed, such as HS1, which is a closed system.  Provided the revenue stream for these discrete assets can be easily identified and captured and construction periods are not too long, these assets should be able to attract reasonable private financing.

"There is a huge amount of money available looking for stable, infrastructure assets into which to invest."

The final category of assets are those that do not have a clear revenue stream that could be used to pay back financing, such as hospitals and schools.  The Private Finance Initiative schemes for hospitals and schools left many with crippling debts because they were not making sufficient operating profits to pay down the financing.  Although devolution is now slowly becoming a reality, for the most part in the UK, local authorities must bid for funding or seek special privileges to capture increases in taxes that come from central government.  

This financing technique remains challenging outside of London because the revenue to be raised in this way is relatively small compared to the investment needs in many local authorities.  

An alternative could be the municipal bond approach that is very common in the United States.  I particularly like this method when linked to a referendum at which voters can decide if they want to finance a new asset through an increase in their taxes.  I like it because it places the decisions about investment in the hands of the likely users. 

It doesn’t stop people acting in their own self-interest -- pensioners from voting against new school investment, for example – but it does result in outcomes that are appropriate for the local area.  And good infrastructure leads to higher property prices which should ultimately be to the benefit of the residents who have paid for the investment.

There is a huge amount of money available looking for stable, infrastructure assets into which to invest.  The key to tapping into this money is to ensure an understandable revenue stream that doesn’t burden the infrastructure with unrealistic operating cost forecasts to make a return on the investment.

Beth West is commercial director at HS2 Ltd