Two potential scenarios set out very different paths for global infrastructure investment and the impact on UK construction, according to new research from PwC.
Even before the UK’s recent EU referendum vote, capital project and infrastructure (CP&I) spending across the world was in for a bumpy ride, especially in the near term.
“Global investment in transport projects will likely have a rocky few years ahead, no matter how global conditions turn out”
During the past 18 months, an unprecedented combination of largely unanticipated events have put CP&I expenditure on the back burner for many companies and governments.
These include plunging oil and commodity prices, the slowdown in China’s growth, the strong US dollar and uncertain forecasts for multinationals to mention but a few.
Now, the vote to leave the EU inevitably adds a further layer of concern, with the Bank of England warning that the resulting “risks have begun to crystallise”.
What’s clear – at least in the short term – is that the additional uncertainty and volatility are likely to impact the UK CP&I market directly and have knock-on effects at a Western European and global level.
Upside vs downside
So, against this background, what’s the outlook for CP&I spending across the world – and, within that, for Western Europe?
In our newly published Capital Project and Infrastructure Spending Outlook 2016, PwC has teamed up with Oxford Economics to examine the global CP&I environment for the next five years through the lens of two opposite scenarios: a hard landing in China, and a global upturn.
These two projections underline the fine balance of risks and opportunities in today’s marketplace, and provide all stakeholders in CP&I with options for making the right decisions about capital expenditures.
It’s more important than ever for companies affected by CP&I volatility to understand the potential range of possibilities they could face and be sufficiently agile to respond to conditions as they change.
To develop this understanding, we’ve benchmarked our two scenarios against a ‘baseline projection’ that’s likely to come about if conditions stay as they are.
Under this baseline, global CP&I spending growth will remain low, hovering at about 2 per cent over the coming year before inching up in 2017 and reaching about 5 per cent in 2020, driven mainly by higher oil prices. However, even this 5 per cent growth would be well below the double-digit levels seen before the global financial crisis.
And compared with the baseline, the growth outlooks that emerge under the two opposing scenarios are dramatically different – with total global infrastructure spending by 2020 varying by US$1.7tn between the two outcomes.
China’s hard landing
A detailed look at the downside scenario of a Chinese hard landing underlines its profound impacts on CP&I spending.
CREDIT PwC_China downside scenario vs baseline 2015-20
This downside outcome assumes a significant decline in Chinese GDP growth, with the yuan depreciating by as much as 10 per cent, housing sales falling sharply and wage growth plummeting.
Under this outcome, global infrastructure investment between 2015 and 2020 would fall by 4 per cent, and total CP&I spending growth would hit almost zero in 2016 before picking up slightly in 2017.
To put this in hard dollar terms, a China hard landing would reduce CP&I expenditures by US$1.1tn between 2015 and 2020 compared with the baseline – from US$28.2tn to US$27.1tn.
How would this global picture play out in different regions? Cumulative infrastructure spending for 2015-20 would – perhaps unsurprisingly – be hardest hit in Asia Pacific by a hard landing in China, with Western Europe – including the UK – getting off relatively lightly.
The impacts on different sectors would also show dramatic variations.
Extraction would take the worst hit because weakness in Chinese infrastructure and manufacturing development would hit demand for oil, steel and other commodities. Even without further economic instability in China, capital investment in extraction efforts would be diminished – a victim of depressed prices.
Similarly, global investment in transport projects will likely have a rocky few years ahead, no matter how global conditions turn out.
In contrast, our global upturn scenario assumes that recent market gloom fades, confidence increases and growth picks up in several economies.
As a result, US and Western European investment rises and global infrastructure investment between 2015 and 2020 hits US$28.8tn – US$1.7tn more than the outcome of a Chinese hard landing and US$600bn more than the baseline.
Just as Asia Pacific would be hardest hit in the downside scenario, so it would benefit most from the upturn.
Western Europe would also gain a disproportionate share of global growth. Meanwhile, all sectors except the extraction industries – where investment will decline in both scenarios – would see cumulative investment rise by between 1.5 per cent and 3 per cent during 2015-20.
Implications for UK construction
In light of these scenarios, what issues and approaches should contractors, investors and other stakeholders in Western Europe and the UK consider to capitalise on – or mitigate – the effects of either outcome?
“Engineering and construction firms should look to exert tighter control on schedules, deadlines and costs to remove excess expenses”
The first thing to stress is that regardless of which of the scenarios – upside, baseline or downside – pans out, the overall need for infrastructure will not diminish, as rapid urbanisation, the growth of emerging economies and technology innovation continue to drive spending.
But within this overall environment, there are steps that each participant in the CP&I ecosystem can take to prepare for whatever comes about. For example:
- Project owners should aim to streamline their current operations, renegotiate to reduce costs where possible, and shift resources to their most essential and valuable operations.
- Engineering and construction firms should look to improve project delivery efficiency while exerting tighter control on schedules, deadlines and costs to remove excess expenses.
- Project investors should conduct a risk review to assess potential exposures. This may result in a rationalisation exercise to reposition some projects, improve efficiency on others, and possibly increase exposure where other investors are anxious to exit.
- Governments should focus on prioritising, streamlining and renegotiating projects – but remain prepared to invest if conditions deteriorate.
These actions will help to position each stakeholder for anything the next few years throw at them.
And under any scenario, we see a bright future for public-private partnerships (PPPs) as a way to help boost infrastructure investment.
While levels of investment in infrastructure may vary, the need for essential services is constant. PPP helps to ensure every participant has a shared interest in meeting it – whatever the environment.
Neil Broadhead is a partner at PwC