Friday, June 21, 2024

How deglobalisation is shaping infrastructure’s future

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Covid-19 had barely ended when the Russian invasion of Ukraine began. Both were reminders that relying too heavily on a small number of partners can ultimately end with shortages of supply for key industries and infrastructure.

Those were two significant events in the evolution of reshoring and deglobalisation, although for many, they were accelerators of trends already happening, with a number of countries and companies developing “China-plus-one” strategies – or similar – since the late 2010s as geopolitical tensions took hold.

Brookfield Asset Management has been touting deglobalisation as one of its key investment themes – alongside digitalisation and decarbonisation – publicly since 2022, although Sam Pollock, chief executive of its infrastructure business, charts this back several years beforehand.

“The trend towards deglobalisation probably accelerated during the previous US administration, when we saw protectionism starting to build up a bit more, and governments focused even more on where they sourced their goods. That really precipitated with the tensions between the two major economies – the US and China. I think we’re now in a 10- to 20-year period where countries will reshore or realign critical manufacturing and critical energy infrastructure,” Pollock told Infrastructure Investor in our September issue.

“If you have raw materials but no people available to turn them into the final product or actually build it, lay it, construct it, then you have a problem”

Tim Mawhood
GHD Advisory

European Commission President Ursula von der Leyen presented an example of this last month, declaring: “From wind to steel, from batteries to electric vehicles, our ambition is crystal clear: the future of our cleantech industry has to be made in Europe.”

Notably, this statement came alongside the announcement that there was to be an investigation into Chinese subsidies for electric vehicles, which underlines the geopolitical reality behind the renewed focus on supply chains.

Also, the day after von der Leyen’s speech, a coming low-carbon battery giga-factory in France was announced with a Macquarie-owned company in charge and featuring the support of the European Investment Bank and €650 million in French subsidies. This was one small step towards keeping Europe’s sustainable mobility on a self-sufficient track, and one giant leap away from Adam Smith and the global free market.

This news comes after a détente was reached earlier this year between the European Commission and the US, after the duo traded barbs as Europe responded to the US Inflation Reduction Act, which sought to onshore critical energy infrastructure, particularly with regards to the supply chain supporting it. That was after November 2021’s passing of the Infrastructure Investment and Jobs Act, requiring all iron, steel, manufactured products and construction materials used in federally supported infrastructure projects to be produced in the US.

Australian manager QIC is another GP publicly highlighting deglobalisation as a key investment theme, alongside decarbonisation and decentralisation. QIC has only been vocal about the trend since last year, although its New York-based senior principal Arash Shojaie tracks the theme back to 2008.

“When there was a steep rise in lithium prices around a year ago, this market power allowed the supplier who controlled the bottleneck to not only pass on those costs but [reclaim] some money for projects they had previously lost money on”

David Russell
Equis

“Our own reading and analysis suggested globalisation as a theme had been slowing down,” he says, stating that QIC treats the three themes as very interdependent. “It was amplified by the covid-19 experience, where we now have tangible experiences of the vulnerabilities of hyper-globalisation and a reliance on complicated supply chains. It was also amplified by the Russia-Ukraine war. It has magnified our microscopic analysis of this trend and we’re now doubling down on it.”

Shojaie says QIC is looking through the deglobalisation lens as a primary trend, rather than necessarily a direct driver of deals, noting the potential for friendshoring, in addition to reshoring.

“We are seeing increased connectiveness in some regions. Look at the US and Australia, for example. In the IRA there are various incentives for trade with countries the US has trade agreements with,” Shojaie explains, pointing to Australia’s wealth in minerals as one potential example.

Domestic transition

The energy transition has become a particular flashpoint in this trend, in part because of the respective measures of the US and Europe but also because of the basic need for clean electricity: if countries are to diversify away from China, the energy transition is an imperative consideration.

China’s share in all the manufacturing stages of solar panels shipped to projects globally exceeds 80 percent, according to the International Energy Agency. The IEA also states that about 75 percent of all lithium-ion batteries are produced by China.

In the US, the Department of Commerce has been investigating the dodging of tariffs placed on solar panels coming from Chinese manufacturers through Southeast Asia. Come June 2024, many of those imports will be banned, requiring a massive ramp-up of domestic capacity.

“Onerous local content requirements might lead to diversification of supply chains in the long term, but in the short term it’s raising costs and distorting the market even more”

Alan Rai
Baringa Partners

In 2022, the US imported 29GW of solar module capacity from China. It produced 5GW domestically, according to the National Renewable Energy Laboratory, leaving the clean energy-associated industry potentially facing short-falls.

“The US government is trying to serve multiple objectives, and the objectives are not all perfectly aligned with each other,” observes Todd Alexander, partner at law firm Norton Rose Fulbright.

“It is quickly and extensively expanding tools available to reduce emissions and create well-paid jobs and lessen dependence on imports. A lot of that is trying to serve different constituencies. To maximise one, you have to sacrifice somewhere else.”

The offshore wind industry is another space where supply-chain issues are paramount. Wood Mackenzie suggests that $27 billion is needed to build out the wind supply chain through 2030 to add 30GW of yearly non-Chinese capacity, and one thing will be in short supply in most places: skilled labour.

“People is another part of the supply chain. If you have raw materials but no people available to turn them into the final product or actually build it, lay it, construct it, then you have a problem. There are skills challenges in certain areas and a global dynamic around how people move around the world in pursuit of money,” says Tim Mawhood, EMEA executive director at GHD Advisory.

Bottlenecked batteries

David Russell, managing director, investments, Australia and New Zealand, at APAC-focused renewables developer Equis, illustrates how limited numbers of original equipment manufacturers for certain products can lead to bottlenecks that hold up entire projects.

“We had a huge constraint in the supply of batteries for the Australian market, as there were only three providers approved by the Australian Energy Market Operator: Tesla, Fluence and Wartsila. Every single one of those three, up to a year ago, sourced all their batteries for Asia from one supplier: CATL in China,” he says.

“We’ve definitely seen over the past few years activity from West Coast ports move to East and Gulf Coast ports, primarily due to labour unrest, service issues, inventory cuts and congestion”

James Wyper
Stonepeak

“That all meant we were focused on the supply constraint in batteries – then when there was a steep rise in lithium prices around a year ago, this market power allowed the supplier who controlled the bottleneck to not only pass on those costs but [reclaim] some money for projects they had previously lost money on.

“Prices went through the roof, and what was a six-month timeframe from purchase order to delivery blew out to 18 months, with a reduction in price certainty as well. In the last nine months that’s changed because Tesla has opened a new gigafactory in Shanghai – but that’s still in China.”

Governments: Solution or problem?

Governments are trying to address some of these issues in the long term by introducing local content requirements for new projects. But this is having a perverse short-term impact, as Alan Rai, director at consultancy Baringa Partners, explains.

“Governments are amplifying the problem as opposed to soothing it. Onerous local content requirements might lead to diversification of supply chains in the long term, but in the short term it’s raising costs and distorting the market even more.

“The result is it makes it more expensive and harder to build things. So there is a disconnect there between the challenges on the ground and policymakers’ response to it.”

Rai says that clients suggest it is possible to source many components for projects from outside China, but that the cost of doing so can be prohibitive.

“It’s not about reducing the reliance on China to zero – it’s more about taking it from a vast majority percentage of value-add to perhaps a slim majority, through relying on other countries in Asia, or parts of Eastern Europe, or maybe parts of the US in time.”

This is an example of how the IRA could lead to benefits for Asian countries allied to the US in the long run, Rai says, as free trade agreements could allow companies access to support that will help to build scale.

Conversely, with the IRA added to the mix, Europe’s ability to attract and retain people could be further diminished, according to Mawhood, but the pace of this shift has been slow so far.

Europe is also hampered by the lack of good nearshoring locations as the lower-cost regions are affected by war. In North Africa and Turkey, governments may not always see eye-to-eye with European wants and wishes; nearshoring but perhaps not quite friendshoring.

Russell is clear in his view that “the APAC region is absolutely competing with North America and Europe”, but agrees with Rai that the region should be able to compete effectively in certain areas, thanks to favourable government regimes for new project development in places like South Korea and because of the scale that markets like Australia can offer.

Xylia Sim, counsel at Linklaters, says APAC may be able to compete when supply chains are tight and capital has a choice of where to go, citing higher returns in developing Asia, although she cautions that developers would still need to take more construction risk.

But capacity could be the biggest constraint on delivery. Rai points out that the biggest concern among investors in renewables in APAC for a long time was a lack of policy certainty. As governments commit to net zero, this has been replaced by other issues.

“The larger source of concern is that supply-chain and capacity concerns cut across sectors and geographies, and that is harder for a policymaker in one country to solve,” he says. “This really needs co-ordination at a regional or perhaps even global level.”

However, presuming that the war in Ukraine will end, Mawhood sees a bright future for Europe.

“There is a potential for nearshoring capability in Eastern Europe. There are raw materials there, there are people, good transport and good education, so all the raw ingredients for a strong economic engine for Europe.

“Right now, geopolitics are playing out, but I hope that will change and when it does, the future there could be very bright to the benefit of that region and to Europe as a whole.”

No sea change, but change of seas

A diversification of supply chains away from China will, naturally, change where goods are coming from and arriving to, which will have implications for port capacity. This was another theme that Brookfield’s Pollock highlighted.

“We are witnessing manufacturing moving to India, where we’re now seeing a lot more components of iPhones being built,” he said. “Vietnam is another big area where you’ll see a lot of manufacturing move to. All those countries are going to need new ports to deal with the additional capacity, and it will change the flow of goods and where they enter countries. In the US, there may be more investments into expanding the capacity in ports on the East Coast as well as Canada, where historically it’s primarily been on the West Coast.”

This is also a trend noted by Stonepeak, which, through its 2020 investment in TRAC Intermodal, provides marine chassis at port and inland terminals across the US.

“We’ve definitely seen over the past few years activity from West Coast ports move to East and Gulf Coast ports, primarily due to labour unrest, service issues, inventory cuts and congestion,” says James Wyper, Stonepeak’s senior managing director and head of transportation and logistics. “The West Coast ports used to be the most efficient point of entry. Looking at the largest ports in the US, in 2022, the East and Gulf Coast ports together surpassed West Coast ones in terms of volume for the first time in a very long time.

“We’re spending a lot of time on chips manufacturing and battery manufacturing, but they are not slam dunk infrastructure exposures to the deglobalisation thematic”

Arash Shojaie
QIC

“The movement of manufacturing and cargo production from Asia to India or other countries are goods that typically come into the East Coast of the US and we do think that’s another market dynamic that could support the shift of cargo from west to east over the longer term.”

The longer-term aspect is an important one to consider in this respect. Despite everything, 2022 saw the largest volume of US imports from China since 2018 – the last pre-pandemic year – importing $537 billion of goods from the country, with $538 billion in 2018, according to the US Census Bureau. That is now down by about 25 percent in the first half of 2023, although labour issues on the US West Coast have had a damaging effect.

A source at a global marine terminal operator acknowledges that it is expanding into countries such as India, Vietnam and Mexico, although the source thinks this is more a recognition that these are simply good places to invest in. “I think that the trading partner shifts are slow,” the source says. “Is it really a trading partner shifting or is it shippers and logistics companies temporarily diverted? I think what we haven’t seen is our customers massively changing their routes yet.”

This is where the China-plus-one strategy comes back. There may not be a sea change away from China, but rather a diversification of global trading partners.

“The shutdown of key manufacturing facilities, in particular on the east coast of China during the pandemic, made it very clear to various supply-chain counterparties and also producers and manufacturers of goods that single source supply-chain points of failure were a big risk, and so we’ve seen folks push for increased diversification of supply,” says Wyper, adding that TRAC has been repositioning some of its chassis assets as it observes shifts taking place.

Chipping away

Brookfield made its biggest splash with the deglobalisation trend and a push for greater diversification of supply in its August 2022 announcement of up to $15 billion in funding for Intel to build a $30 billion semiconductor manufacturing facility in Arizona. With 60 percent of the world’s semiconductors produced in Taiwan and the growing risk of Chinese military action there, that critical infrastructure supply is under threat.

Stonepeak is another GP which has leaned in here. In January 2022, the firm acquired Rinchem, a provider of chemicals and gases essential to the production of semiconductor chips to leading manufacturers in the US.

“When we invested in Rinchem, we thought we were investing behind a very good market, and frankly, the expansion outlook for the sector is now better than we even thought it would be,” says Wyper.

US manufacturing of semiconductors commands just 12 percent of global market share today, down from 37 percent in 1990, according to the Semiconductor Industry Association. China’s growing threat and the US government’s decision to support onshoring with the CHIPS and Science Act, releasing $280 billion in funding to boost manufacturing, was a boon for the likes of Brookfield and Stonepeak.

“Frankly, [the CHIPS Act is] a sea change in investment in redomiciling and developing local and regional manufacturing capability to diversify as well as reinforce the US’s domestic capability to avoid supply-chain disruptions and eliminate supply-chain gaps from a national security perspective,” believes Wyper, noting the Department of Commerce has earmarked $50 billion in funding for value-chain players such as Rinchem.

Investing directly in the factories – as Brookfield did and the aforementioned Macquarie-backed battery investment – is not the favoured approach for some.

“We’re spending a lot of time on chips manufacturing and battery manufacturing, but they are not slam dunk infrastructure exposures to the deglobalisation thematic. As we delve into the details of the types of risks they present, the infrastructure definition needs to be stretched,” says QIC’s Shojaie.

Infrastructure asset managers that put cash directly behind this trend of deglobalisation, rather than adjacent to it, have no guarantee that this will pay off. The US and EU’s relationship with China has been unpredictable over the past decade and there is a risk that this is another transitory stage.

“The timeframes are still long enough to have immediate implications but long-term risks,” believes Shojaie. “The onshoring effects will be inflationary in the short term as you’re not competing with cheap imports, but in the long term as globalisation themes come back, all of this will be excess capacity and these effects become deflationary in nature. That’s a very specific element of risk that infrastructure investors need to watch out for.”

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