Tokio Marine AM: Opportunities in Japan’s Energy Infrastructure

Unlisted infrastructure in institutional investor portfolio

The recent market environment has not been particularly helpful to investors looking for medium-to-long term investment opportunities. Equities have been characterised by decelerating momentum and a less certain outlook, while fixed income has come under pressure from rising interest rates in the US and the ECB making it clear that QE will be wound down.

It may therefore be no coincidence that interest in less volatile asset classes has been strong. A good example is unlisted infrastructure, which attracted USD 37.6bn of investor capital globally in the first half of 2018, according to Preqin. In Europe, Danish pension giant ATP has recently invested into an offshore fibre optics company, and Dutch fiduciary manager PGGM bought a stake in a US water business, IPE reported.

 

Chart 1 Unlisted Infrastructure Fundraising by Region in Q2 2018

Source: Preqin Quarterly Update: Infrastructure, Q2 2018

Investors in the asset class are attracted by the stable inflation-linked cash flows, as well as the protection associated with the tangible asset ownership. Also, while the appraisal-based valuation presents some challenges in assessing the up-to-date financial position, it coincidentally shields the portfolio from the short-term volatility to which public markets are prone,  due to the day-to-day news flow.

North America and Europe dominate the asset class, with Asia lagging behind both in terms of capital raised and number of deals, standing at approximately 10 and 15 percent of the global total. In Japan, deals have been scarce, but currently there are some interesting trends, which are set to significantly increase investment options in unlisted infrastructure.

 

Chart 2 Infrastructure Deals by Region in Q2 2018

Source: Preqin Quarterly Update: Infrastructure, Q2 2018

Japan’s electric power supply reform

At 1000 TWh (terawatt-hour), Japan’s total electricity generated in 2016 exceeded that of Germany and the UK combined (987 TWh) and was not far behind that of Russia (1087 TWh), a country with a territory 45 times larger. The power grid is complicated by the split into 50 and 60 kHz frequencies between West and East Japan, as well as mountainous terrain, making interconnectivity between different parts of the network a challenge.

 

Chart 3 Electric Power Generation in Selected European and Asian Countries

Source: BP Statistical Review of World Energy 2017

Historically, power generation, transmission and distribution were organised by region, with ten vertically integrated General Electric Utilities controlling the entire value chain. However, the reforms, which go back as far as 1995, are scheduled to culminate in legal unbundling of these functions in 2020.

 

Chart 4 Selected Milestones in Japan’s Electricity Market Reform

Source: Japan Electricity and Gas Market Surveillance Commission

The deregulation is good news for consumers, who can now choose their distributors, but it presents challenges for the power utilities. The ability to raise funds is important in this capital-intensive industry, but the credit rating of power generation assets will come under pressure after deregulation, so refinancing the interest-bearing debt for power plants will become increasingly difficult.

Another unrelated factor is the increasing safety requirements for nuclear power plants and the need to replace the suspended nuclear generators with alternative sources of power. CAPEX requirements are rising, while the ability to raise capital is under threat.

Investment opportunities in Japan’s energy infrastructure

This set of trends makes power utilities receptive to the idea of offloading their power generating assets from their balance sheets. Similar pressures could encourage divestment of power distribution assets.

Getting exposure directly to the offloaded assets can produce  stable returns for a sophisticated long-term investor, and higher electric power prices during the peak consumption periods offer a potential upside. This however requires significant operational and structuring expertise. Outsourcing to an experienced local investment manager should help maximise the upside, while keeping the risks under control.

For more information about the issues raised in this article, please contact Business Development at Tokio Marine Asset Management (London) Ltd.

Email: tmal@tokiomarine.co.uk

Tel.: +44 (0)20 7280 8580

Website: www.tokiomarineam.co.uk

Disclaimer

This document is intended for informational purposes only and no claims can be made based on the content provided therein. It does not constitute an offer or an investment recommendation to purchase or sell investment funds/products or to execute any other types of transactions. It makes no guarantee for the accuracy, reliability, currency and completeness of the information provided herein. The content of this document is subject to change without notice. Tokio Marine Asset Management (London) Limited is authorised and regulated by the Financial Conduct Authority (FRN 487699) and accepts no liability for any damages whatsoever arising from action taken on the basis of the contents of this document. Any simulated performance data and/or past performance data is not a reliable indicator of future performance.

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