The Middle East, with its gleaming sky cities, remains a world leader in super-scale infrastructure. In the shadow of the towering Burj, two great trends are on meteoric collision within institutional fund investing: the exponential rise of Environmental Social Governance (ESG) investing and the drive towards Sustainable Development Goals (SGDs), versus the search for esoteric long dated cash flow assets, infrastructure projects. The aims of institutional investors are at risk of becoming counter-productive without a change in approach.
Why is infrastructure challenging for SDGs?
There a number of issues facing infrastructure. The first is the emissions and carbon impact of the materials that go into many projects like concrete. The second is the carbon emissions of the construction process, and the third is the impact of the project once operational.
"When buying funds, understanding the difference between ESG, impact, and social investing is key to managing your own carbon footprint of your portfolios on behalf of clients."
Such projects often expose the difference between ESG, Impact, and Social investing. Impact investing may have a positive green impact through developing clean energy or may actually have a social impact through housing or education. When buying funds, understanding this difference is key to managing your own carbon footprint of your portfolios on behalf of clients. It’s a clear stewardship issue and of the 17 goals, a challenge to meet Sustainable Development Goal 13 (not to mention COP21 Co2 targets).
Goal 13: Take urgent action to combat climate change and its impacts:
“People are experiencing the significant impacts of climate change, which include changing weather patterns, rising sea level, and more extreme weather events. The greenhouse gas emissions from human activities are driving climate change and continue to rise. They are now at their highest levels in history. Without action, the world’s average surface temperature is projected to rise over the 21st century and is likely to surpass 3 degrees Celsius this century—with some areas of the world expected to warm even more. The poorest and most vulnerable people are being affected the most.”
However, infrastructure can be positive in terms of other sustainable development goals such as addressing poverty, hunger, health, education, clean water, economic growth, and innovation. Many of these goals are tied into the globalisation of the world economy and developing previously dubbed ‘third world economies’, as much as addressing issues closer to home like homelessness, poverty and illiteracy. When thinking about these goals it is not hard to see how projects that develop schools, hospitals, desalination plants, roads, rail, airports, and housing can all have a positive impact, just not necessarily in terms of the climate. Transitioning to sustainable cities has been a key agenda of my Long Finance think tank.
Infrastructure vs ESG: what's the problem?
Infrastructure uses intensive materials. The concrete industry is one of the two largest producers of carbon dioxide, creating up to 5% of worldwide man-made emissions of this gas, of which 50% is from the chemical process and 40% from burning fuel. Take the UK’s 900 million tonnes of Carbon Dioxide footprint; over half (53%) of that is from infrastructure. In HM Treasury’s 2013 Infrastructure Review it noted “the infrastructure sector does have control over almost one sixth of total emissions and therefore has a key role to play in contributing to the national reduction.” The report went onto note: “The impact of infrastructure is projected to increase from 53 per cent of UK emissions in 2010 to over 80 per cent of the carbon reduction target in 2025, and rising again to 90 per cent in 2050.”
"To an architect it may represent a pinnacle of vertical construction; to a climatic analyst the environmental cost is anything but elevating."
By comparison, the scale and acceleration of infrastructure in the likes of Asia and Middle East dwarves the UK. For example over 45,000 m3 of concrete, weighing more than 110,000 tonnes were used just to construct the foundations of the world’s tallest building, the Burj Khalifa, in Dubai. In total the Burj Khalifa's construction will have used 330,000 m3 of concrete and 39,000 tonnes of steel rebar, and construction will have taken 22 million man-hours. To an architect it may represent a pinnacle of vertical construction; to a climatic analyst the environmental cost is anything but elevating.
Why then infrastructure investing?
The attractiveness for institutional investors is actually quite easy to fathom. Insurance firms, defined benefit pension schemes, family offices, sovereign wealth funds, and banks, along with profit funds and annuity providers all carry long-term liabilities and need long-term cash flows to match. This is what we call Liability Driven Investing (LDI). Investors focus heavily on the long-term cash flows of infrastructure assets to match the future outflows of the business. The long-term environmental impact of projects are less widely recognised as risks, less known or modelled today.
The 2016 Prequin Infrastructure Report estimated that $349bn was the aggregate deal value of 661 deals completed globally in 2015. The 2016 Global Infrastructure Survey by Arcadia notes the growing infrastructure funding gap and “Our world is facing major challenges from rapid urbanization requiring better mobility for citizens, to climate change being taken evermore seriously, with COP21 seeing countries commit to lowering greenhouse emissions. As a result the urgency for new and improved sustainable infrastructure in countries around the world is increasing. However infrastructure projects are continually delayed through lack of investment, even though the appetite to invest is evident.” Infrastructure, then, is set to rise, but what sort?
Middle East Infrastructure
Much of the region’s past focus has been on the construction of gleaming cities and oil extraction/distribution. However, increasingly organisations in the Middle East are adopting the latest Internet of Things (IoT) technology infrastructure. The region’s market is now surpassing $8 billion according to global IoT enabler SAP. Beyond skyscrapers and IoT, in its report Arcadia also noted;
"Priorities for the (Qatar) emirate include new systems for transportation and improving the country’s connectivity. A new port has been developed, in part, to support the import of materials needed to deliver ambitious spending plans that both satisfy the 2030 national vision and the more immediate FIFA 2022 World Cup. Huge investments have been undertaken and major projects are underway in airports, the railway network, light rail, highways, water supply and power provision."
To date, Qatar’s infrastructure has been wholly government financed and there is no sign that the emirate will seek to harness private investment in the near future. Opportunities are more likely to be in the operation and maintenance of existing assets, particularly in healthcare and education as the government seeks to ensure that its infrastructure remains of a high standard.
"The very real dichotomy facing the institutional investor is that infrastructure funds may well bring a wide range of long-term benefits, but the immediate climatic impact of infrastructure may be too expensive."
Conversely the UAE, which was third in the index, maintaining its position from 2014 and rising from 4th in 2012, is expected to encourage private finance into its infrastructure investments in future. In September 2015 the Dubai government issued a new law designed to encourage its officials to entertain PPP and start formulating their approach toward PPP programs. Interestingly the law allows for Build, Operate and Transfer (BOT) as well as Build, Own, Operate and Transfer (BOOT) schemes, and encourages private companies to approach government agencies with proposals which do not have to be led by the public sector.”
Infrastructure is synonymous with the expansion of the great Middle East cities. How they become sustainable is a challenge, particularly for foreign investors. The Middle East’s transition from potentially stranded carbon assets into the fourth industrial revolution is underway. Will that transition be sustainable? The very real dichotomy facing the institutional investor is that infrastructure funds may well bring a wide range of long-term benefits, but the immediate climatic impact of infrastructure may be too expensive. Such investments may simply not meet the wider ESG policy of the investor. The trade-off between near-term and long-term impacts of infrastructure should be at the forefront of any decision for the sustainability-minded investor. A move towards Green Finance is well underway. The footprint, not just the cash flow profile, will impact tomorrow’s decision-makers.
JB Beckett, author of #NewFundOrder, will be presenting at FundForum Middle East & Africa, delivering a presentation 'ESG in the Middle East: How to establish ESG as a key investment criteria.'