Infrastructure trends to expect as part of a Canadian economic recovery

Torys Quarterly: Strategy for accelerated change

Infrastructure has long been a source of opportunity for governments making the pivot from an economic crisis management mode to an investment mode.

It is unsurprising that, as the world works to recover from the economic shock of the pandemic, many countries are looking to infrastructure spending as a key priority.

In Canada, well before the crisis, infrastructure had become an imperative endorsed by political parties across the spectrum as significant aspects of Canadian infrastructure were in need of refurbishment and expansion. The disruption of COVID-19 will be an agent of change for the infrastructure sector, as well as sharpen the focus on policy issues that already existed before the pandemic.

In this article, we look at five trends we expect will influence the infrastructure landscape in post-pandemic Canada.

User-pay and revenue-generating projects will be considered

User-pay or revenue risk projects (whether P3 or full concessions) are common globally across all the economic infrastructure sectors including power, water, telecom and transport. Compared to the United States, which has long made use of tolled roads and managed lanes, user-pay projects have been only infrequently seen in Canada beyond the regulated public utility context.

But with the impact of COVID-19 straining government fiscal capacity at all levels, some speculate a further shift towards user pay seems inevitable. Governments are becoming more open to user-pay, while lenders and developers with activities in both Canada and internationally (including the U.S.) have been comfortable accepting some revenue risk in the past for core economic infrastructure with historically stable demand. The pandemic has challenged this thinking though as some tolled roads, for example, recently saw unprecedented drops in demand and revenue. While government enthusiasm for user pay projects is likely to rise, in the near term we may see private investors with reduced enthusiasm or possibly taking a more conservative view of demand forecasts.

Getting revenue modelling right is empirically a tricky task. As user-pay projects are increasingly considered, those projects that will be piloted in a post-pandemic Canada will benefit from the experience of user-pay projects in other sectors and regions on how to best structure, procure, develop, finance and maintain or operate such projects.

Dynamics will shift among levels of government

Most Canadian infrastructure stock is at the municipal level, followed by provincial and then federal levels—but financial capacity is in the inverse order. COVID-19 has materially challenged provincial and municipal fiscal capacity, but the federal capacity is still (relatively) healthy. As a result, we expect to see not just more federal financial support, but also more federal influence over project selection and prioritization by lower order of government to suit federal policy goals. The Canada Infrastructure Bank is likely to play an increasing role in delivery of federal projects and federally funded projects.

All levels of government in Canada appear to recognize the main infrastructure weaknesses revealed during COVID-19, including seniors’ health care and ex-urban broadband. These are likely to become high-priority sectors for stimulus programs. Green initiatives that were priorities before the crisis, such as clean transit and clean energy (including transmission of clean energy), are also likely to remain priorities.

New models will emerge

As the priority of infrastructure rises, we expect governments will increasingly look to public-private partnerships (P3s) and other modern approaches that consider whole-life cost and also supplement government capital with private capital.

The P3 model has had a good run in Canada, delivering almost 300 major projects valued at almost $150 billion, and consistently demonstrating good value for money. But as the procurement approaches and contract terms have been progressively tightened, it is becoming more challenging to procure and deliver P3 projects in as timely a way as governments are likely to require of their stimulus programs, while also incentivizing innovation and allowing for efficient transfer of risk.

For post-pandemic infrastructure projects, we expect to see an evolution of today’s P3 approach to introduce procurement approaches and contractual models which are nimble and collaborative, such as co-development, alliances, integrated project delivery and joint ventures.

Private investors will call more of the shots

With finite opportunities to invest in core infrastructure assets, private investors in the past would often capitulate to government expectations for procurement approach, risk transfer and deal structure. As that dynamic now shifts to a more collaborative procurement, revenue risk and higher private capital proportions, private investors will be tempted to flex their negotiating power.

What will private investors be looking for when selecting infrastructure projects? The world is not short of capital, but in choosing where to deploy it, private investors will be looking for projects with reasonable risk-adjusted return profiles. Private capital will continue to be attracted to “core” projects with monopoly or essential service features, and stable, predictable cash flows. And with rising prices and declining yields for infrastructure assets in the secondary market, we expect to see some funds looking to embrace more greenfield development risk to boost their returns and avoid auction processes for mature assets.

Relationships with Indigenous peoples will be crucial to project success

With infrastructure seen as a mechanism for economic recovery, “shovel-ready” projects with near-term job opportunities and efficient deployment of capital will be attractive to both governments and project proponents. Even with “shovel-ready” projects, there will be a need to ensure that consultation with any Indigenous peoples involved has been properly carried out.

The principles of consultation remain the same. Know the communities with which you are engaging and the realities that they currently face post-COVID-19. Take the time to understand their objectives and how they can be met, including, for example, through Mutual Benefit Agreements and/or equity participation which can also address economic reconciliation—ensuring that a substantial share of the benefits of economic recovery flow to Indigenous groups. Meaningful two-way dialogue is key to building relationships genuinely based on respect and trust.

There is a real opportunity for developers who are committed to meaningfully engaging affected Indigenous communities in their projects to capitalize on the economic recovery incentives in a COVID-19 context and to bring projects to successful completion in a timely and cost-effective manner.

Conclusion

Choosing the right infrastructure projects and delivering on them in improved ways will be of paramount importance to investors and the Canadian economy at large. While timely stimulus will be desirable for many, it is important to invest wisely for the long term by focusing on “shovel-worthy” projects rather than over-weighting “shovel-ready” projects. This aligns well with the overall policy objective to rebuild the economy in the years ahead in a way that drives enduring value and economic benefits.

Tags:

The Authors

Read More From This Issue
Q3 | Summer 2020: Strategy for accelerated change
Companies have had to move fast to survive. They are now adjusting longer-term strategies to seize upon emerging trends and position themselves for success. Here are the latest insights from Torys.