RESEARCH REPORT. RREEF Infrastructure. European Infrastructure Market Update. First Quarter RREEF Infrastructure

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1 RESEARCH REPORT RREEF Infrastructure European Infrastructure Market Update First Quarter 2012 RREEF Infrastructure

2 Contacts: Table of Contents Irina Johnstone Director Head of Investor Relations + 44 (0) irina.johnstone@rreef.com Simon Durkin Director Head of European Research simon.durkin@rreef.com 1. Economy Inflation Interest rates Infrastructure investment trends Increasing fiscal pressure drives further privatisation Outlook Conclusion Important Notes... 9 RREEF Infrastructure European Infrastructure Market Update First Quarter

3 1. Economy An environment of economic uncertainty and volatility in the latter half of 2011 yielded to a more stable outlook for Europe in early Long-term refinancing operations ( LTROs ) introduced by the European Central Bank ( ECB ) temporarily relieved pressure faced by European banks, and reforms introduced in some sovereign markets brought a short-term respite after months of uncertainty. These stabilising trends in Europe were cited by the International Monetary Fund ( IMF ) in April 2012 when it released a new modestly upgraded global economic outlook. Yet despite recent optimism, the Eurozone crisis still carries substantial downside risks, and the region s current recession even if shallower than first thought will nonetheless pull global economic output down to 3.4% in 2012 from 3.9% in 2011, according to the IMF. 2 The ECB expects external demand and low interest rates to contribute to gradual economic improvement in the region over the course of the year. 3 But high unemployment, rising energy prices, and abrupt fiscal consolidation have also spurred tension across sovereign markets, from Spain and Italy to the Netherlands and the UK. The most impacted sovereign debt markets Greece, Portugal, Ireland, Spain, and Italy still face long struggles back to fiscal sustainability. 4 For now, IHS Global Insight forecasts the economy of the Eurozone to contract by 0.5% in 2012, an improvement from the 0.7% contraction expected just three months earlier. The recession will be relatively deep in Spain and Italy in 2012, with GDP in these markets expected to fall by more than 1.0% during the year. The Dutch economy will also shrink in 2012, and lacklustre conditions in Denmark and France will put these two markets near the edge of contraction. In contrast, IHS Global Insight forecasts marginal but positive economic growth in 2012 in Germany, Sweden, Austria, Ireland, and the UK. 5 IHS Global Insight s relatively positive forecast for the UK is notable, since the preliminary estimate for UK economic growth in Q showed a contraction of 0.2%. This firstquarter contraction reflected declines in production and construction activities which were partially offset by modest growth across much of the services sector. 6 Mixed signals were also observed among other economic indicators. For example, UK employment levels have risen slightly (though largely due to part-time work), and retail sales are up modestly, but this could also be a factor of rising fuel prices. 7 In February, the Bank of England ( BOE ) dubbed the country s economic outlook unusually uncertain due to the tenuous situation in the Eurozone. 8 Indeed, external demand, including demand from the Eurozone countries, will influence economic momentum in the year ahead, as will credit conditions and the ongoing realignment of household and government budgets. 9 As of April, IHS Global Insight forecasts the UK economy to expand by 0.8% in 2012, representing a modest upward revision from the 0.3% forecast released in January. Assuming the downside risks are avoided, the UK is expected to rebuild economic momentum at a faster pace than the overall Eurozone in Consensus Forecasts, Consensus Economics, 10 April World Economic Outlook, International Monetary Fund, 17 April Monthly Bulletin, European Central Bank, 3 April Consensus Forecasts, Consensus Economics, 10 April World Overview, IHS Global Insight, 13 April Gross Domestic Product: Preliminary Estimate, Q UK Office of National Statistics, 25 April Economic Review UK Office of National Statistics, 25 April Inflation Report, Bank of England, 15 February 2012, p Monthly Bulletin, European Central Bank, 3 April World Overview, IHS Global Insight, 13 April RREEF Infrastructure European Infrastructure Market Update First Quarter

4 Exhibit 1: GDP Growth Real GDP % growth F 2013F Spain Italy Netherlands Eurozone Denmark France Ireland Austria Germany United Kingdom Sweden World F = forecast Source: IHS Global Insight As of 13 April 2012 The countries of Central and Eastern Europe ( CEE ) have also experienced shifting economic conditions due to volatilities in the Eurozone. In the latter half of 2011, diminishing external demand pushed the Czech Republic into a shallow recession that undermined consumer confidence. In Hungary, tense relations with the IMF and EU continue to cloud the country s outlook. 11 According to IHS Global Insight, Poland will be one of the CEE s more buoyant economies in 2012, with 3.0% GDP growth forecast for the year. The Czech Republic should ease gradually out of recession with a modest growth rate of 0.4%. Meanwhile, Hungary is expected to contract by 0.6% in Emerging Markets Monthly, DB Global Markets, 12 January 2012 and 5 April World Overview, IHS Global Insight, 13 April RREEF Infrastructure European Infrastructure Market Update First Quarter

5 2. Inflation Prices rose in the Eurozone at an annual pace of 2.7% during Q Fuel costs and indirect taxes continue to put upward pressure on prices, and this should keep inflation in the region above 2% through the rest of The ECB expects this upward pressure to be short lived, with relatively weak economic conditions pulling the inflation rate back below 2% by Consumer prices in the UK continue to grow faster than in the Eurozone. In Q1 2012, the annual pace of inflation ranged between 3.4 and 3.6%. Still, this is a decline from the 4.2% annual pace at year-end Diminishing pressures from labour (wages), the value-added tax ( VAT ), energy, and import prices are all expected to pull the inflation rate down further in Spare capacity in the economy will also relieve pressure on prices in Increases in tobacco and alcohol taxes announced in March could provide modest inflationary pressure. 18 A bigger outlying risk, however, would be a significant disruption of oil and gas supplies. 19 Exhibit 2: Long-Term Government Bond Yields and Inflation Long-term government bond yields, % Inflation, % yoy F 2013F 2014F F 2013F 2014F F 2013F 2014F F 2013F 2014F Euro Area Germany Spain UK F = forecast Source: IHS Global Insight As of 13 April Euro area annual inflation stable at 2.7% Eurostat (press release), 17 April Monthly Bulletin, European Central Bank, 3 April Monthly Bulletin, European Central Bank, 3 April Consumer Price Indices, March 2012, UK Office of National Statistics, 17 April Inflation Report, Bank of England, 15 February Consensus Forecasts, Consensus Economics, 10 April Inflation Report, Bank of England, 15 February RREEF Infrastructure European Infrastructure Market Update First Quarter

6 3. Interest rates With economic conditions deteriorating in late 2011, the ECB lowered its refinancing ( refi ) rate by 25 basis points in November and then another 25 basis points in December, bringing the total re-fi rate to 1.0%, exactly where it had been at the start of the year. With economic conditions stabilising in early 2012, the Governing Council of the ECB made no further changes to the re-fi rate during its first four meetings of the year. 20 For the 37 th consecutive month, the BOE announced on April 5 that it would leave interest rates unchanged. 21 In February, the BOE s Monetary Policy Committee expanded its asset purchase programme by 50 billion, bringing the total operation to 325 billion. 22 The current round of purchasing will end in May, and given the recently mixed but positive-trending economic signals, analysts do not currently expect the quantitative easing to be extended further Infrastructure investment trends The European Investment Bank ( EIB ) projects a need for 3 trillion in new infrastructure investment in Europe over the coming decade and significant bank participation will be necessary for this to occur smoothly. 24 In the short-term, bank participation has been held back by higher capital ratios which have limited their lending operations. Funding has been a challenge for banks, though accommodative policies by the ECB have provided some recent relief. 25 A few observations and trends relating to infrastructure investments were noted in Q1 2012: Deals. With economic conditions stabilising in early 2012, a number of large, stalled infrastructure projects began moving forward, especially motorway programmes. The 1.3 billion A1/A6 motorway public-private partnership ( PPP ) in the Netherlands moved toward bidding, and two motorway PPPs in Italy the 2.4 billion BreBeMi and the 1.4 billion Milan Eastern Road also inched forward. 26 Policies. The UK recently called for more private sector involvement in the country s road sector. 27 Government reforms promoted in Spain and Italy include more widespread application of PPP. In contrast to these policies, Portugal s plans to minimize its exposure to existing PPPs have so far resulted in 1.2 billion in compensation claims from roadway concessionaires, and the recent cancellation of the 1.5 billion Poceirao-Caia high-speed rail PPP is expected to produce more compensation claims. 28 Sectors. Toll-road traffic, which is closely correlated with economic growth, showed signs of softening in some markets in late 2011, especially Spain and Portugal. 29 With Spain s economy now deep in recession in 2012, some of the country s motorway concessionaires have run into trouble. The situation has forced the Spanish 20 Monetary Policy Decisions (various press releases), European Central Bank, Bank of England Reduces Bank Rate by 0.5 Percentage Points to 0.5%, Bank of England, 5 March 2009; and Bank of England maintains Bank Rate at 0.5% and the size of the Asset Purchase Programme at 325 billion, Bank of England, 5 April Inflation Report, Bank of England, 15 February Global Economic Perspectives, DB Global Markets, 20 April European Infrastructure Finance Summit 2011: What Happened In Madrid? InfraNews, 12 October The Credit Outlook: Entrenched Eurozone Crisis Challenges Global Rating Stability, Fitch Ratings, 26 January Sector Spotlight Q Transport and Social Infrastructure Q InfraNews, 4 April Private cash needed to boost roads network, says David Cameron, BBC, 19 March Sector Spotlight Q Transport and Social Infrastructure Q InfraNews, 4 April Outlook: EMEA Transport Infrastructure, Fitch Ratings, 12 December 2011, pp. 1 & 3. RREEF Infrastructure European Infrastructure Market Update First Quarter

7 government to consider a number of options, including an extension of motorway concession terms, merging concessions, or directly providing funds. 30 According to Infrastructure Journal s transaction database, the preliminary total of closed transactions in Q was 3.2 billion. 31 This figure reflects both infrastructure project financing and non-project financing deals. The volume of closed deals represented a significantly lower level of activity than in recent quarters. This reflects at least two factors. First, weak economic conditions in late 2011 put fewer projects on the path toward financial close in Q And second, Infrastructure Journal s preliminary list of closed projects at the end of each quarter often rises as more information about recently completed deals becomes available. On a sector level, about two thirds of the preliminary deal volume that closed in Q was spread across three sectors in the energy supply chain: renewables (31%), oil & gas (31%), and power (8%). Transport projects accounted for an unusually small share (9%) of the closed transactions in Q From a regional perspective, France (30%) and the UK (25%) accounted for more than half of the preliminary deal volume in Q About one-third (31%) of the volume could be traced to the CEE region, with Germany (8%) and the Nordics (6%) making up the balance. Notably missing from the preliminary Q total were closed deals in Southern Europe. 32 Exhibit 3: Closed Infrastructure Transactions, 1Q 2012, by Region and Sector 1Q 2012 Closed by Regions 1Q 2012 Closed by Sectors UK 25% Germany 8% Social & Defense 21% Transport 9% Nordic 6% Power 8% France 30% CEE 31% Renewables 31% Oil & Gas 31% Note: Other Europe includes Andorra, Austria, Cyprus, Gibraltar, Ireland, Liechtenstein, Malta, Monaco, Switzerland, and deals that span multiple countries in Eastern and Western Europe Source: Infrastructure Journal As of 31 March Sector Spotlight Q Transport and Social Infrastructure Q InfraNews, 4 April Infrastructure Journal, 4Q 2011 download as of April Infrastructure Journal, 4Q 2011 download as of April RREEF Infrastructure European Infrastructure Market Update First Quarter

8 5. Increasing fiscal pressure drives further privatisation Fiscal constraint continues to pressure European countries to privatise assets, especially in southern and peripheral European countries. With sovereign debt ratings being downgraded or placed on watch lists in several countries in late 2011, Fitch expects subnational governments in those countries to come under further fiscal pressure, especially in Spain and Italy. 33 And indeed, there is already some evidence that this is occurring. Madrid s local government, for example, tentatively plans to privatise the metro system (with an estimated value of 2 billion) as well as Canal Isabel II, the local water utility (valued at billion). 34 The City of Rome is mulling whether to float a stake in Acea, its public utility. 35 The City of Milan plans to sell its majority stake in SEA, the airport group which includes Malpensa and Linate. 36 Ireland announced a privatisation programme in February that is expected to raise up to 3 billion by divesting of stakes in companies such as Firmus Energy (gas utility), Aer Lingus (airline), Coillte (forestry), and ESB (electricity). 37 In Greece, the privatisation programme announced in September 2011 was supposed to divest of 5 billion in stateowned assets by the end of the year. 38 Greece s programme, TAIPED, blamed delays on legal and market constraints 39 and pushed some of the asset sales into the first half of Sales of government stakes in two listed companies, OPAP (lotteries and gaming) and Hellenic Petroleum (refining) are now anticipated in May. The sale of Greek water firms EYDAP and EYATH is expected to follow in the second half of The EU, IMF, and the Greek government now expect the revised privatisation schedule to yield proceeds of about 3 billion in Exhibit 4: Increased Pressure to Privatise Norway Eurozone average long-term growth Fiscal Balance (average F) F = forecast. Source: IHS Global Insight. As of 13 April Sweden Switzerland Germany Italy Finland Austria Belgium Denmark Portugal Netherlands Spain France Greece United Kingdom Ireland Poland Hungary Czech Republic Long-term economic growth (average 2015F-2040F) 3% deficit limit 33 The Credit Outlook: Entrenched Eurozone Crisis Challenges Global Rating Stability, Fitch Ratings, 26 January Madrid prepares water and metro sell-off, Financial Times, 6 February Rome Municipality Mulls Stake Sale Of Public Utility, Infra News, 16 March Milan Municipality Plans Further Divestment In Italian Airport Operator, Infra News, 20 March Irish government's 3bn euros sale, BBC, 22 February Greek Government Accelerates Asset Sales to Counter International Criticism InfraNews, 8 September Greek privatization project running into obstacles, Kathimerini, 7 December Full speed ahead for privatizations, Kathimerini, 27 December Greece to sell major listed companies this year, Kathimerini, 21 March RREEF Infrastructure European Infrastructure Market Update First Quarter

9 6. Outlook Though economic conditions improved over the last quarter, the overall long-term outlook for the European infrastructure market remains largely unchanged: public budgets for infrastructure are expected to be constrained and the availability of debt financing is likely to be tight. 42 Europe s pipeline of potential deal flow will remain sizable but the number and speed of closed deals will be tempered by the availability of debt financing. 43 Preqin observes that recent infrastructure fundraising shows an appetite from institutional investors, but expectations are realistic as both investors and fund managers continue to adapt to life in the post-crisis marketplace. 44 Across individual sectors of the infrastructure asset class, the outlook varies to some degree. Core infrastructure assets have tended to be more resilient in the post-crisis environment than have peripheral infrastructure assets. 45 With much of Europe in recession, for example, any decline in air passenger traffic is likely to weigh more heavily on smaller airports than on major hubs. Energy sector projects with broad-based demand are expected to experience relatively stable performance. Toll roads in countries with less competition may be more stable performers than those in countries with more exposure to toll-free networks. 46 The overall pipeline of European deals stood at billion as of the close of the first quarter of 2011, according to Infrastructure Journal s transaction database. Most of the pending deals are in the UK (27%) followed by Southern Europe (16%). Another quarter of the deal flow lies in the former communist bloc; the countries within the Commonwealth of Independent States ( CIS ) account for 15% of Europe s pipeline and CEE countries add another 8% to the total. At a sector level, more than half of the deal flow lies in the transport sector (54%) followed by oil and gas (13%), mining and metals (12%), and power (8%). 47 Exhibit 5: Infrastructure Transaction Pipeline, Q1 2012, by Region and Sector Pipeline by regions Pipeline by sectors Nordic 1% Other Europe 22% UK 27% Oil & Gas 13% Mining & Metals 12% Power 7% Social & Defense 6% Germany 3% Benelux 3% France 5% CEE 8% CIS 15% Southern Europe 16% Transport 54% Other crosssector 2% Renewables 3% Telecoms 2% Water & Wastewater 1% *Other Europe includes Andorra, Austria, Cyprus, Gibraltar, Ireland, Liechtenstein, Malta, Monaco, Switzerland, and deals that span multiple countries in Eastern and Western Europe Source: IHS Global Insight As of 31 March Global Transport Outlook 2011: Examining the deal flow, Infrastructure Journal, 15 June Global PPP/PFI Outlook H2 2011: Volumes up despite low activity, Infrastructure Journal, 21 September 2011; and Refinancing Wall for European Transport Infrastructure, Fitch Ratings, 27 March Infrastructure Spotlight, Preqin, January Refinancing Wall for European Transport Infrastructure, Fitch Ratings, 27 March The Credit Outlook: Entrenched Eurozone Crisis Challenges Global Rating Stability, Fitch Ratings, 26 January 2012, p Infrastructure Journal, 4Q 2011 download as of April RREEF Infrastructure European Infrastructure Market Update First Quarter

10 7. Conclusion The atmosphere of uncertainty and market fragility in late 2011 stabilised in the first quarter of 2012, but a long-term resolution of Europe s sovereign debt crisis still eludes policymakers. EU and IMF officials continue to follow a stop-and-go approach as they weigh fiscal solutions that financial markets and rating agencies will accept against complex political realities in domestic markets. Inevitably, fiscal consolidation will need to incorporate some aspects of privatisation and private sector participation. Over the medium term, this will keep Europe s deal flow active. In the short term, however, limited credit availability is a key risk on the buyer side. As Europe s infrastructure market evolves, investors in search of the best risk-adjusted returns should bear in mind that considerable variations persist across countries, regions, and sectors, as well as in the terms and conditions of individual funds. RREEF Infrastructure European Infrastructure Market Update First Quarter

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