Politics and economics constrain UK infrastructure finance options

The appointment, late last year, of Geoffrey Spence as an adviser to the Treasury on project finance sparked speculation that the government is considering a return to some form of private finance initiative (PFI) model as a means of attracting private investment in UK infrastructure. Spence, a specialist in infrastructure financing, previously served as special adviser to then chancellor Alistair Darling under the last Labour government in the late 2000s. His new tasks included advising the Treasury on financing structures for public and private investment to support the government’s priorities.  

PFI harnessed the private sector to obtain finance to design, build and operate infrastructure assets for the benefit of the public via a 'special purpose vehicle'. In return, the public sector awarded its private sector partner a long-term contract to run the facility and paid a monthly fee over the life of the project to repay the initial loan, meet the operating costs, and generate a financial return as recompense for the risks associated with the whole venture. 

In political terms, most of the PFI projects in the UK were initiated by the Labour governments led by Tony Blair and Gordon Brown between 1997 and 2010. The use of PFI solutions, and its short-lived successor, PF2, solutions for the delivery of infrastructure dwindled under the coalition and Conservative governments, before being scrapped by then chancellor Philip Hammond in 2018. Variants to PFI and PF2 have lingered on through the activities of the devolved governments – the so-called non-profit distributing model in Scotland and mutual investment model in Wales.

The environment in which the Labour government elected last year is exploring its options for financing infrastructure has changed considerably since the heyday of the Blair/Brown years.

Indeed, PFI remains politically sensitive, due to criticisms over the way public assets have been operated by investors, deficiencies in the way the contracts have been managed by public sector bodies and concern that the projects have not delivered value for money for the state and taxpayers. This is going to be brought into sharp focus, with hundreds of legacy PFI contracts set to expire between now and 2050 –many during the lifetime of the current UK parliament.

For the government, this poses a question of what should happen to public assets – schools, hospitals, prisons, for example – when the contracts expire; whether they should return into public control to be operated by the public sector, or whether they should continue to be operated by the private sector under new contractual arrangements – and, if so, what those contractual arrangements should provide.

Amidst heavily constrained public sector budgets, it seems likely that the private sector will have a role in operating and maintaining these assets over the coming years, but the high volume of disputes and negative press over the PFI brand means many would-be participants will look for clarity on any model that they are being asked to back. The return of full control of assets to the public sector will also highlight the difficulties of long-term infrastructure planning in the context of changing demographics and societal needs.

A way of financing the new infrastructure that the government envisages being built also needs to be found. Among other things, it has committed to: deliver 1.5 million new homes before the next general election, due in 2029; improve school buildings and build new, and modernise existing, hospitals; make the UK a clean energy superpower, by scaling up renewable energy generation capacity and supporting carbon capture usage and storage (CCUS) and green hydrogen projects; support road and rail network improvements and investment in electric vehicle charging infrastructure; and facilitate data centre development to underpin investment in AI and other new technologies that can support business innovation and efficiencies.

The government has updated planning rules to support development and has further set in motion plans to ensure there is a reliable, long-term pipeline of infrastructure projects, which it hopes will give developers and contractors the confidence to invest in skills and technologies needed to deliver those projects. That pipeline and the government’s long-term infrastructure strategy is expected to be published next week. However, funding solutions in many cases are still unclear.

While the government has already committed some public funds to certain infrastructure development, like housing and transport, the fiscal constraints it is operating under mean it will need the private sector to invest substantially in many of the envisaged projects. Finding some other way to describe an initiative that will involve the private sector and its ability to procure finance is one way to keep the consultant industry busy, but it won’t disguise the fundamental acceptance that PFI, for all its weaknesses, was not all that bad.

The government could decide to lean more heavily into funding models that are already in operation.

For example, the regulated asset base (RAB) model and its variants has been used in the energy and water industries for years as a means of financing major new projects. The model forms the basis for the financing of, among other things, the Sizewell C nuclear power plant project and the Thames Tideway Tunnel, London’s new 25km ‘super sewer’. There is current speculation as to whether something similar to this is going to be applied to the development of the Lower Thames Crossing and operation of existing infrastructure at Dartford – although there is a high likelihood that this may necessitate primary legislation not to mention consideration of the impact that such an approach might have on the contracts already awarded.

Under the RAB model, infrastructure is effectively funded by money gathered from end user consumers and/or businesses, with licensed private sector investors subject to regulatory oversight over what charges are added to end user bills and how that money is spent. The model is designed to ensure the capital needed to finance investment can be secured at low-cost, while enabling investors to obtain a fair return for the share of the risks they take on in building and operating the assets that is comparable to alternative similar investments.

The ’end user pays’ principle is already embedded in other financing models – the utilities sector and toll roads are clear examples, to which fuel duty on petrol and diesel could also be added.

However, selling an extension of the “end user pays” principle as a solution to a UK public already under financial strain following a period of higher inflation and sustained higher interest rates is likely to be difficult, politically, for any government. There is evidence for this already in how some sections of society and media have reacted to the ongoing imposition of what has become known as the green levy – the proportion of people’s energy bills that goes towards government schemes that support the development of new renewables projects – as energy bills have risen in recent years, notwithstanding evidence that suggests other factors, such as wholesale gas prices and how they affect how UK energy bills are calculated, have been bigger contributors to those rises.

Across the different sectors, the challenge is the same: how can the government make it sufficiently attractive to the private sector to participate in infrastructure projects that the UK needs in a way that is fair and affordable, both in the short and long-term? And who will pay for them?

The reality is that the UK government must either borrow more to pay for investment or ask the private sector to take on the cost of doing so. Neither will be a free or comfortable ride and will require clear, honest and realistic assessments on how the much-promised infrastructure investment will be delivered.

If the investment can deliver growth, then it will pay for itself – but not all of the UK’s infrastructure needs will deliver wider growth. These assets need renewal to face the next 50 years – using RAB models or other structures that can spread the full costs over a longer period, with the hope that future economic conditions, driven by investment in new infrastructure now, will improve to the point that there is greater capacity for future governments and the next generations to pay for those projects, would be the ultimate goal. If there is consensus on what is needed for growth, then this will make this difficult judgement call an easier one to make.

It is hoped that the upcoming infrastructure strategy will provide the details of the government’s intentions, which can then support the approach to infrastructure investment that will be set out in the spending review.