VX2014: New Tools & Markets For Financing & Insuring Water, Energy, and Resilient Infrastructure Projects

Issue: 

Kathleen Brown: This panel is about how we finance water, energy, and resilient infrastructure. We certainly heard today about the need. Communities and utilities across the nation are facing challenges of aging infrastructure, climate change, increased costs, and limited funding. With some of these challenges there are opportunities—opportunities to be innovative, and for our utilities and communities to become more efficient, more sustainable, and more resilient. 

Solutions such as green infrastructure and renewable energy projects are addressing these issues while enhancing the quality of life in our communities. Funding for them is a major challenge with creative financing—note that I am emphasizing funding and financing since they frequently get confused. Funding is a key part of the challenge that we don’t always talk about. Investment bankers—I used to be one—have many financing solutions, but we have to solve where the money will come from to pay the bonds back. With creative financing ideas being tried across the nation to help utilities and communities meet these challenges, what are some of the innovative solutions and projects that we are seeing across the country? What are some of our best ideas? 

Ian Parker, a former colleague of mine at Goldman Sachs, has been involved in infrastructure finance for well over 20 years. He focuses not only on transportation infrastructure but also on water and energy infrastructure as well as the general government space. 

Dan Adler is the managing director of the California Green Energy Fund—a non-profit evergreen investment fund created to advance the green energy economy. Mr. Adler is responsible for investments across six funds in venture capital and project finance and leads the firm’s efforts to identify catalytic new investment theses. 

Adel Hagekhalil—my co-moderator—and I were at the Board of Public Works with the City of Los Angeles back in the 1980s, where the topics we’ve been discussing today were dark secrets. I remember during my term at the board we created the first water use committee that had the DWP and the Board of Public Works working together. That was in 1989. Adel is a registered civil engineer with the State of California and a national board-certified environmental engineer. He’s currently an assistant director with the City of Los Angeles’ Bureau of Sanitation where he is responsible for the bureau’s wastewater collection system management, stormwater, watershed protection programs, water quality compliance, facilities, and advanced planning. Under his direction the city has prepared an award-winning One Water Integrated Resource Plan. 

Ian Parker: I’m not going to talk about financing resilient infrastructure. Instead, I’m going to talk about how you deal with the risk mitigation of an event. 

You can’t stop an event. That’s for sure. Whether you are focused on global warming or the timeline of weather patterns, weather is a really volatile force that we have to just interact with—as are earthquakes, which I’m also going to talk about. 

You can do the best possible job in terms of setting up resilient infrastructure, but to the extent that you do have an event, if you don’t have the resources to deal with it, it becomes very challenging. I’m going to talk about the potential ways to finance that outcome, specifically with catastrophe bonds. 

To put some numbers out there, Superstorm Sandy was estimated to have cost $68 billion for the New York area. Of course, FEMA came in, but they are capped at 80 percent of that loss, so there’s still about 20 percent of $68 billion for the New York area. To look at that same year from a global perspective, it is estimated that there was $160 billion in losses in global catastrophe events. That’s a huge number, and that will most likely continue if we have the global warming trends that folks are predicting. 

What is a Cat Bond? The catastrophe bond is kind of a fancy name for an insurance-backed product. It is a security, so you can trade it back and forth. But it is buying insurance: you pay a certain premium, and if the event happens, you will receive cash very quickly. To put some perspective on the different types of Cat Bonds you have: in Florida you have a lot of hurricane-funding vehicles. You have the reinsurance element, and sometimes you just have the liquidity element, meaning prefunding an event. In Florida, chances are you will have another hurricane in the future. We haven’t had a major one in seven years, but the clock is ticking on that. Or you can try to find the more efficient risk-taker, and that’s the reinsurance companies or hedge funds, folks that have the scientists who have done all the calculations to manage that. 

This market started in the mid-’90s. There’s been about $57 billion of issuance to date in securities format. There’s probably $20 billion outstanding, so it’s a very robust market.   

Now to the New York MTA. The MTA, like a lot of New Yorkers, was very surprised at what happened with Superstorm Sandy. They estimate to have about $5 billion of exposure to that in terms of rebuilding infrastructure. Using that 80 percent FEMA number earlier, that puts them at about $1 billion short. Now, there are a lot of different ways that they can go about funding that, but the risk transfer was something that they woke up to. Yes, there is the insurance market that is very robust, but this is a cost-effective strategy. 

So what did the MTA do? They came to us, and we worked with them to structure a transaction where we raised $200 million in capital that sits in escrow. That is reinvested in treasuries—very safe investments. Over the next three years, if there is a named storm and if there are storm surges above 8.5 feet in three areas and above 11 feet in two other areas, then the trigger is met, and MTA will receive $200 million to help them deal with storm recovery. 

There is a cost associated with that. For The New York MTA is paying about 4.5 percent per year on that $200 million, but you need to view it as an insurance policy. 

It’s not just the transit issuers. Historically we have seen insurance companies managing their risk, but you’ve also seen corporates. Universal Studios last decade went out and sold $175 million in catastrophe bonds linked to earthquakes. Disney Tokyo did a similar thing to mitigate the earthquake risk. 

There are plenty of examples out there, and it’s a deep market. To draw a connection to potential infrastructure sponsors going forward, there is a message that you do need to view this from a risk management perspective. It’s not a question of “if” this catastrophe will happen, but a question of when. Hopefully it’s going to be very far in the future. But as you look at all the parameters that need to be factored into infrastructure investment, that is a very small cost component. I would end by saying that these risks are out there and need to be mitigated. I think to the extent that those building infrastructure can think of user fees or trying to provide cash flows to pay for the prevention or to effectively insure against this risk, should it happen, that would be money well served.  

Dan Adler: My perspective is in the energy sector, traditionally at an orientation towards venture capital. We as an organization were formed out of the electricity crisis—a very non-resilient period in our state’s infrastructure—more as a form of market design than of underlying technology and natural disasters. 

A point I’d like to emphasize when it comes to resiliency is the resiliency of cash flows of the project in question. We realized as an organization, as we were laboring in venture capital in the middle of the last decade and trying to get tradition financial providers to take the clean energy technology opportunity seriously, that the success we were having was running up against the real scale finance marketplaces and the ways that bulk infrastructure gets funded. We were trying to use a venture capital model to build the first-generation power plant solar thermal facility. Not very cost effective and not scalable, but we found that clean energy technologies, despite their proven nature technologically, did not have access to capital markets to the degree that they needed.  

We started focusing on a few areas. The master limited partnership, which is the financing technique that has built the bulk of this nation’s transmission and storage gas infrastructure, is not accessible to clean energy technologies. There was a bipartisan push in Congress led by Senator Chris Coons of Delaware called the MLP Parody Act that simply by creating a new legislative phrase would have opened up what is a multi-hundred billion dollar financial mechanism for clean energy infrastructure. Wall Street wants it; the MLP professionals want it; Washington DC’s dysfunction kept it from happening. It may yet happen, but I’m not going to hold my breath.

Another perhaps even more lucrative opportunity is in the real estate investment trust model. This is a proven financing technique, $500 billion globally, very liquid, and constantly accretes new infrastructure types into the marketplace. It started out as the traditional built environment and now includes datacenters, railroad, and people are petitioning the IRS to retrievement, initially for solar photovoltaic panels. 

A group that we have invested in, Renewable Energy Trust, is trying to get a PLR for its solar assets. They did a case study analysis of what the IRS has said is real property, and they found that they had ruled that digital billboards are real property, and the income that’s associated with digital billboards, which changes as a function of light coming out, is readable, and therefore the income streams can be distributed to reach shareholders. Why not light coming in? The IRS thought about that and said it was a great example, but nothing they do is precedential. I do think you’ll see action on that front through an executive order or legislative action. It may even happen on its own accord in the treasury service.

Meanwhile, the industry is not waiting, and you’ve seen companies like Pattern Energy and NRG coming out as yield companies, providing resilient income streams based on a combination of proven technology and these durable markets that have been created in 30-plus states. 

These offerings are oversubscribed. Once they are traded in the public market they accelerate dramatically. Meanwhile, while the stories of venture capital’s demise are told in 60 Minutes or elsewhere, in the cleantech space the WilderHill Clean Energy Index was up 60 percent last year, beating the overall markets by a good mile. 

The private capital markets understand where the energy business is heading, and they understand these technologies are proven. There are a few regulatory and legislative impediments in the way, but when we get over them we’ll be in good shape. 

I’ll close my comments on where California is with its green bank. We have a transformational opportunity in our greenhouse gas action revenues, maybe $20 billion by the end of this decade. How do we use that money alongside private money? Let private investors lead, let private investors bring as much capital as they can behind energy, infrastructure, and water, and then top it off with a smart public investment. This could be the trigger for a whole new wave of meaningful infrastructure investments against this clean energy alternative. 

Warehouse those offerings. Take them back out. Refinance them in the public bond markets, and I think you’ll see California in the lead on those forms of financial innovation as we support our technologies at the same time. 

Adel Hagekhalil: In my view one of the biggest challenges and opportunities for the City of Los Angeles is stormwater management compliance with water quality. But I think one of the areas for increasing funding is leveraging resources, providing multiple benefits. 

When we are building a water quality project, we can also bring in money for augmented water supply, for greening communities, addressing contaminated properties, and flood control so that you can leverage funding to build a pot of money to build a project that can provide multiple funding resources. That’s one opportunity for creative funding of a project. And this is what the community is asking of us—to be smart about how we protect resources. 

People want complete project; people want to be able to see things put together. We did a project in South Los Angeles, a stormwater project funded by Proposition O, which is water quality funding. However, money also came in from the MTA—there was a property of theirs, which we bought with help from their funding. We had money from the state bonds for water quality. We had money from the EPA for the cleanup of brownfields. We had other sources of money that came together to build a project that now is a community asset. 

It’s still a big challenge to raise rates, and you’ve heard that the biggest challenge in California was Prop 218 for stormwater. It’s still the only utility that needs two-thirds support of the people by vote. We were lucky back in 2004 in Los Angeles to have put together a water quality bond measure, Proposition O, a water quality bond measure, that allowed us to raise half a billion dollars to build these multi-benefits projects, which I call a down payment. We were successful in building about 80 projects that are multi-benefit, and about 78 percent of the voters voted for this. 

Prop 218 is a challenge, but we’re trying to also find new sources of funding for this in LA. One of the areas we are considering is an environmental car rental fee. We are proposing for the Los Angeles City Council and for Mayor Garcetti to look at this through the budget process. In this, for every car rental per day there would be a couple dollars going to an environmental fee to address pollution—water pollution, stormwater pollution, and our waterways. Many people use our city and our streets who are not taxpayers here, and this is a smart way to give taxpayers a break. We project that we could raise $24 million in revenue, which would be great.

VX2021 Speakers: