Infrastructure investment is an optimal asset class in this turbulent political and economic time

The upcoming November election has dominated the US media headlines, with the contest expected to be tight. Anecdotal conversations with management teams at the time indicated domestic concerns mirror international concerns – whether either President Joe Biden or Donald Trump were fit for office, and the impact their policies could have on economic progress, as well as the clean energy transition. President Biden has since announced he will not run for a second term, and the Democrats have nominated Kamala Harris as the party primary to run against Donald Trump.

While the Democrats are focused on supporting the energy transition and supporting working class jobs through the continued onshoring of select industries back to the US, Donald Trump is focused on supporting the exploration and production of traditional fossil fuels, reducing regulation and red tape, and extending tax cuts he implemented in his first term. Tax rate reductions are scheduled to expire in 2025, but it is widely expected that Trump will fully extend the tax cuts he previously implemented, while his election opponent in Kamala Harris will also extend components of the reductions, both putting upward pressure on budget deficits and inflation.

In terms of trade restrictions, the Democrats are likely to maintain tariffs on select Chinese goods and support the onshoring of manufacturing back to the US. Trump has communicated the more aggressive position for a universal tariff of 10 per cent on all imports, and 60 per cent on Chinese goods. The economic impacts of this could cause stagflation for the US economy, a real fear among economists.

Turbo charged load demand to favour infrastructure

For the first time in decades, many electric utility companies expect rising power needs, driven by several factors including population growth, on-shored manufacturing, especially from technology companies supported by the US Chips Act, and electrification in the transport, space heating and the oil/gas industries. Data centre demands and the rising energy needs of artificial intelligence (AI) is also a recurring theme.

Questions centre around whether utilities maintain their guidance of growing earnings at 4 to 8 per cent a year, or whether increased load demand will push this higher. The resounding feedback we hear from utility management teams is that increased load demand growth is expected to support the investment proposition of utilities, not change it. Companies are more likely to hit the higher end (or just above) their earnings growth guidance ranges but are unlikely to significantly change their long term guidance to the market.

Management teams are cautious about data centre energy demand. It is felt that some communicated demand from big tech companies developing data centres such as Amazon, Meta, Microsoft and Google may not eventuate. If utilities make investments to facilitate that expected load, and it doesn’t eventuate, the cost of that investment would be spread over the remaining customer base, negatively impacting affordability of regular residential customers. This is a major concern for both regulators and utility companies.

The impact of environmental policy on utilities led energy transition

Donald Trump has also communicated that he intends to repeal Biden’s Inflation Reduction Act (IRA) which supports renewable energy sources, and electric vehicles (EVs) through tax credits. Commentators suggest he may only repeal components of the bill such as support for EVs.

Trump has instead communicated the intention to support drilling for traditional fossil fuels in oil and gas, potentially through streamlining the permitting process for drilling and pipeline development. This would be supportive of investment in midstream infrastructure companies which transport oil/gas from production wells to demand centres. Gas pipelines are perceived as central to supporting the intermittency of renewables in the energy transition process.

This policy changes by Trump could be detrimental to companies investing in the clean energy generation, as well as the electric utility sector. Most electric utility management teams have communicated a desire and ability to deliver their generation plans under either the Democrats or Republicans in government. This is based on focusing on the economic benefits of renewable generation for customers, and delivering in line with state based legislative mandates.

The need for asset replacement and hardening to support reliability and safety

Reliability is potentially the key focus of legislators and regulators across the US. Ensuring electricity and gas supply is not only essential for business operations, and therefore economic growth, its demanded by all customers and therefore a sensitive political issue. Regulators demand reliability performance of electric and gas utilities, and are supportive of investment to facilitate it. Companies are replacing aging infrastructure, as well as adopting modern technology to support maintaining/improving reliability in ever increasingly difficult environmental conditions.

Reliability and safety investment for utilities is focused on replacing ageing assets, but also hardening the network against the increasing frequency and ferocity of natural disasters, such as wildfires and tropical storms. This is to ensure that electricity networks don’t ignite fires, causing massive legal liabilities for companies, and to reduce damage and network interruptions in the case of tropical storms. Over recent years wildfire liabilities have forced at least one utility into bankruptcy, causing significant disruption in the delivery of service to their customers, and wiping out shareholder value.

With increasing demand for baseload power generation through gas, and increasing concerns around energy reliability, the environmental focus on reducing gas utilisation has subsided. Gas utility management teams have outlined anecdotal evidence from discussions with regulators that they understood that gas networks would be around for decades, and the investment in them will be maintained for the foreseeable future. Importantly, regulators across US states still largely support the replacement and modernisation of gas networks, to ensure safety and reliability for customers.

Allocating to assets in the region

As the markets wrestle with the timing and magnitude of interest rate cuts, this will no doubt feed into US infrastructure valuations over the second half of 2024 and into 2025. The fear that politically motivated fiscal policy could ignite inflation and put upward pressure on interest rates again is a risk to valuations. In addition, markets currently believe there is roughly a 50 per cent probability that the US economy encounters a recession. The earnings resiliency of infrastructure stocks would be appreciated by investors as compared to other sectors if a recessionary scenario plays out.

Despite some challenges, infrastructure investment is essential across the US. This investment should support consistent, predictable earnings growth for investors over the long term, with the defensive qualities of infrastructure likely being favoured by investors.

By Peter Aquilina, portfolio manager – sustainability