Brexit: energy, resources and infrastructure industry insight

Following the vote by the UK to leave the European Union, the outlook for different sectors and asset classes is mixed. In this insight, we examine the consequences for the energy, resources, transport and infrastructure industries.

Built Environment

We foresee a general slowdown of activity across the real estate industry. With the pound’s depreciation against the dollar, yen and other safe haven currencies this will delay decision making whilst also opening up short term opportunities for investors keen to take advantage of the fall. However the key difference between now and the 2008 financial crisis is that the proportion of distressed sellers is modest and the investment market is dominated by equity rich ownership.

London will remain a significant global city for investment and development but some businesses will look to move parts of their operations to Europe. To ensure the UK’s second tier market doesn’t suffer, the UK Government will need to commit to infrastructure projects such as Crossrail 2, HS2 and the expansion of Heathrow which will stimulate large scale residential projects and provide wider economic benefits.

Brexit may accelerate the re-pricing of residential property which some commentators were saying was inevitable, particularly at the top end of the London market which many investors considered to have reached its peak even before the Leave vote.

The return to longer term confidence for investors and developers needs to be underpinned by political stability, commitment to infrastructure and the preservation of the UK’s status as an open and transparent society in which to live and work.

As regards social infrastructure, even before the Brexit vote there was reference to the Infrastructure and Projects Authority working with H M Treasury and other departments to identify a pipeline of public sector projects which could be delivered via PF2. With the likely fiscal constraints resulting from the Brexit vote, we would anticipate that there will be a new impetus to use private finance where it can present a value for money option in areas such as schools and hospitals. The batching of smaller facilities has provided a mechanism for creating the scale of investment opportunity needed for private finance in the schools sector, together with umbrella financing arrangements such as the PSBP aggregator finance structure to create additional financing efficiency.

Following the Brexit vote, pressing on with proposals for encouraging housing development outlined in the National Infrastructure Delivery Plan 2016 would also seem to be an even more urgent policy response, in terms of addressing both the shortage of housing and the need to stimulate growth and employment in the economy.

There has been an increasing pipeline of university student accommodation deals coming to market, driven by the need to attract UK students who now have to pay for their university places and to increase revenues from foreign students. The Brexit vote has created some uncertainties around this market, given its potential impact on EU funding of new university facilities, on the free movement of foreign students from other EU member countries and on research and development in the wider UK markets. We foresee some temporary disruption in this market.

Mining

The mining industry is a highly international sector. Whilst the industry is heavily financed out of London there is very limited UK/EU trade in the sector, the industry is not exposed to the political uncertainty consuming the UK and Europe and is unlikely to be effected by any crisis in consumer confidence.

Mining companies listed in London tend to quote their share prices in sterling, but report their earnings in US dollars, so the significant fall in sterling since Brexit has relatively made mining stocks cheaper resulting in rises in stock prices. This has been particularly pronounced for gold mining companies and gold itself as a commodity, which are seen as safe havens in times of uncertainty. The gold price itself is back to its August 2014 levels, and the share prices of some gold companies have seen fairly dramatic increases. The increases have been further driven by the expectation that interest rates both in the UK and the US are now less likely to rise due to the uncertainties surrounding Brexit which makes gold more attractive as an asset class.

The fundamentals for base commodities have not really changed as a result of Brexit; the focus remains on China, the oversupply in the market, depressed prices and where interest rates will go.

In the longer term Brexit is likely to be neutral for the mining industry – it has much bigger issues to worry about.

Oil & Gas

Brexit should affect oil and gas significantly less than other industries for two key reasons. Firstly, its revenue stream is in dollars, so the fall in sterling will have a limited effect (and if anything favour companies whose shares are quoted in in sterling). Secondly the regulatory regime applicable to the UK oil and gas sector is largely a domestic UK matter.

Having said that, if the Brexit vote causes Scotland to leave the United Kingdom, this would have a significant impact because much of UK oil and gas reserves lie in Scottish waters. Effectively the UK’s oil and gas industry would be divided between two independent countries.

Depending on what form the UK’s new relationship with Europe takes, there will obviously be an impact on various areas of the law which are relevant to the oil and gas industry – such as competition law, state aid and third party access – although it is too early to predict in any detail what that impact will be.

Ultimately, Brexit does not pose the same level of challenge for either the UK or global oil and gas industry as that represented by the low oil prices of the last 18 months.

Roads

As an unregulated industry the impact of Brexit on the UK roads building, operation and maintenance industries is likely to be slight. EU legislation in areas such as tunnel safety and electronic tolling inter-operability are generally already directly transcribed into UK law and are unlikely to change following Brexit.

The European Union has been a significant funder of road infrastructure, particularly through the Trans-European road network (TERN) and subsequently Trans European Transport Networks (TEN-T) programs. This specific road funding is now likely to cease.

In the short term, the most visible impact on the road system is likely to be a significant increase in the retail cost of petrol and diesel (both internationally priced in US dollars) arising from the fall in value of sterling. The impact of fuel increases are currently softened by the low oil price, but will be susceptible to future changes.

Rail

In the rail industry, the EU has promoted a trend of liberalising passenger markets and greater levels of technical harmonisation and interoperability between member states. A large body of direct and indirect EU legislation relating to rail has been developed, much of it specifying detailed technical standards. Many of these are now fundamental to the UK’s flagship rail proposals, such as the central role of the European Rail Traffic Management System (ERTMS) and the European Train Control System (ETCS) in the Digital Railway programme.

In our view, neither the UK Government nor the rail industry is likely to benefit from a divergence of technical standards, and retaining the vast majority of rail related EU legislation is likely to be preferable, at least in the short to medium term.

Any economic downturn arising from Brexit could lead to lower passenger demand/increased ticket prices, and franchises where premium/support payments are linked to variations in GDP or CLE (Central London Employment) could become more expensive for DfT. On the upside, the UK Government is likely to focus on investment in infrastructure to boost the UK economy, a decline in sterling could make it more attractive for international investors to purchase equipment such as rolling stock manufactured in the UK, and the freedom to relax the separation between infrastructure management and operations could aid divestment by Network Rail of some of its assets as mooted in the Shaw Report.

Given the UK Government’s commitment to the rail franchising programme and the benefits of continued alignment with EU developed rail standards, it seems unlikely that there will be any significant changes on the horizon. There may be some financial challenges to the rail franchising programme but in our view the Government will be wishing to show that it is very much business as usual.

Airports and Aviation

Any prolonged period of uncertainty is likely to have an economic impact on UK air transport due to lower economic activity and the fall in the sterling exchange rate. Weaker sterling will tend to encourage inbound trips by visitors and discourage outbound travel by residents. The first effect may outweigh the second because, although the UK air market is dominated by outbound traffic, inbound traffic is more sensitive to price changes. The longer term impact on air freight will depend on the nature and timing of trade agreements and relationships negotiated by the UK which is expected to take many years.

As regards the regulatory implications of Brexit, European legislation affects aviation business in a range of areas including safety and security rules, consumer protection, environmental regulation and economic regulation. A key issue is whether the UK can negotiate continued access to the Single Aviation Market which provides UK airlines with certain freedoms in particular the right to fly between EU countries; and the right to fly within an EU country (known as ‘cabotage’). One option would be for the UK to join the European Common Aviation Area (ECAA) but this would require the UK to accept EU aviation laws and would depend on the agreement of existing members. Alternatively, the UK might seek to negotiate a bespoke comprehensive agreement with the EU while preserving some policy freedom by limiting the exposure of the UK to the full raft of EU aviation law.

The UK benefits also from the air traffic rights negotiated at the EU level (as a single trading bloc) with third party countries. The most significant of these is the EU-US Open Skies Agreement, which allows any airline of the EU and any airline of the US to fly between any point in the EU and any point in the US. This agreement (and others like it) would potentially cease to apply to the UK, possibly requiring the UK to negotiate its own bilateral agreements. ECAA membership could also be a solution in this area.

Airlines can be expected strongly to refer that the UK continues to enjoy access to the EU’s internal market for air transport by joining the ECAA. This outcome will depend on whether the UK government sees merit in gaining greater flexibility as regards the application of EU aviation law. Given that the UK has been a strong proponent of many elements of the EU regime, in our view the Government is likely to take the view that ensuring the continued application of this regime and the avoidance of disruption to aviation markets is the priority.

Ports and Shipping

The ports and shipping industry is predominantly an international marketplace, with carriers crossing global borders under the rules of international maritime shipping regulations and trade agreements, such as those overseen by the World Trade Organisation.

A period of uncertainty post-Brexit vote will prevail as it is anticipated that exporting goods and services may become more complex, and more importantly, potentially reliant on the outcome of future negotiations of trade agreements with EU and non-EU countries (replacing the current network of EU bilateral and multilateral external trade agreements). The key question is whether the UK retains a role as a member of the European Economic Area (EEA). The alternative would be the potential
complexity of the industry having to comply with both UK and EU trade laws, rather than the current integrated system.

In the meantime, any economic downturn in Europe is more likely to have the greater impact on the ports and shipping industry, given the fluctuating global currency market and faltering confidence.

Looking at related areas of economic activity, there may be some effect on passporting rights for ship financiers and insurers, which may result in the secondary businesses’ shifting their focus away from London. Conversely, Brexit may open the door to lobbying for a more favourable taxation regime and positioning for alternative passporting and market access rights. There is also the question of whether the UK will continue with the recently ratified EU Ports Regulation, which introduces rules intended to improve efficiency and cut costs across the EU with free market access as the overriding theme.

As a crucial trading partner and an efficient largely privatised port system, the UK is hopefully well placed to negotiate strong terms with the EU community to maintain an even keel for all involved.

Utilities

In our view, the Utilities sector in the UK will be largely unaffected by Brexit. The sentiment of many of the key players in this appears to be that this is exactly the right asset class to invest in post-Brexit. There may well continue to be changes in the regulatory and fiscal regimes but these were in the pipeline irrespective of Brexit.

The biggest threat to the Utilities sector is the current general market uncertainty which may impact deal flow in the short to medium term because of increased cost of funding or a general reduction in foreign investment. However, investment in the UK power and renewables market is driven by the on-going trilemma of:

• the need for security of supply;
• the need to drive down costs; and
• the need to decarbonise the power sector

and Brexit does not materially change those three factors. 

From a regulatory perspective, the UK’s 2020 targets were driven by the EU targets and the UK would have been subject to EU penalties for failing to achieve these targets. However, the UK is on schedule to meet the 2020 targets in any event and due to the long lead time for project developments, Brexit is unlikely to materially impact the build out of projects to 2020. The bigger question is what the future holds beyond 2020 for renewables in particular. No EU or UK targets have been set for beyond 2020 and investors have been crying out for more certainty. Now the UK can shape its own low carbon future and energy mix beyond 2020.

The Government has indicated that, despite the Brexit vote, it remains committed to new nuclear power in the UK, including the development of small modular nuclear reactor technology. There are increasingly positive signs that EDF will shortly take a final investment decision on the Hinkley Point C project. However, it remains unclear what impact the Brexit vote will have on the appetite of foreign investors who are sizing up opportunities to invest in other large scale new-build plants that are in the pipeline.