Five Key Trends in the Transport Sector

The last few years have been a challenging period for transport and the difficult fundraising situation means the sector is not yet fully recovered.

Just before the COVID-19 pandemic, transportation infrastructure funding was at its highest level in the past 10 years in terms of fundraising, according to data Infrastructure Investor data, attracting more than $6 billion in 2019. Nine sector funds closed this year.

The next two years were, of course, a different story. Covid took out much of the transportation sector as lockdowns and international travel restrictions wiped out almost all consumer demand—and investor appetite. Those transportation funds in the market during that time struggled to raise a combined $700 million, with five funds closing in 2020 and 2021.

On the bright side, the outlook seemed to be improving through 2022. Fundraising for transportation vehicles rebounded to $3.6 billion as two funds closed and cumulative consumer demand for road and air travel surged.

2023 seems to indicate a lack of fundraising, despite passenger numbers in most transport categories remaining similar to 2022. What does the transport sector look like in 2024 and where should investors look?

1Fundraisers are drying up – but all is not lost

If you were to look at the numbers alone, the current fundraising situation for the transport sector would make particularly grim reading. The reasons for this are fairly easy to discern. Transport assets are often considered a staple play, whose appeal has waned significantly over the past 18 months, in part due to inflation and higher interest rates for longer periods forcing investors to move further up the risk curve in search of significant rewards.

In some ways, this mirrors the situation experienced by the transport sector between 2013 and 2016. Back then, a combination of cheap money and a relative lack of economic volatility meant that more exciting profits were readily available elsewhere, and in transport, the secular tailwinds of decarbonisation and electrification were yet to develop.

Of course, we are currently dealing with a different situation, as these megatrends are deeply entrenched and show no signs of abating, facilitated by interventions such as the US Inflation Reduction Act.

Elevated interest rates are now likely to prove to be a medium-term concern, with rate cuts predicted for the second half of this year and into 2025.

There is evidence to suggest that freight could also return on the road, as more deal-making activity takes place – even if fundraising remains at a standstill. Indeed, anecdotally and in terms of the types of deals they have been doing over the past 12 months, infrastructure GPs now believe they have reason to be optimistic, on a number of different fronts.

2Traffic data shows the way

One reason for optimism is the upward trend evident in various forms of traffic data. After all, user behavior – as evidenced by passenger and freight volumes – is a relatively strong leading indicator of the future performance of the transport sector (barring another unforeseen disruption on the scale of the covid pandemic).

In air travel, for example, global passenger numbers are currently rising rapidly, reaching 94.1 percent of their pre-pandemic (2019) levels in 2023. That’s up from 72.6 percent the previous year, according to Airports Council International.

The tipping point, where global passenger numbers finally exceed pre-pandemic levels, is expected to come this year, after being held back over the past few years by a slower recovery in the Asia-Pacific region.

Similar increases can also be observed on roads, railways, the entire public transport network, and in some sectors of the transport industry.

For Oleg Shamovsky, managing partner at Arjun Infrastructure, this growth trend across the board makes it relatively easy for investors to find attractive opportunities in transportation. “We’re seeing a lot of activity around toll roads,” he says. “There was a period of uncertainty about the post-COVID traffic recovery, but now that traffic is back, deals are back.”

Traffic data also serves as a valuable means of identifying where infrastructure megatrends—including decarbonization and digitalization—intersect with the transportation sector’s statistical rebound. For example, Shamovsky says his company invested in a U.K. motorway service area operator “that has proven to be incredibly resilient and outperforming the benchmarks.”

The appeal is twofold: first, according to Department for Transport data, UK motorway traffic is now just 0.9 per cent lower than it was in 2019 (as of 2023); second, motorway service areas offer energy transition opportunities in the “neighbourhood, including electric vehicle charging,” Shamovsky notes.

3Greater technological transparency

However, to capitalize on these megatrends, investors need to understand which technologies are proving to be the best solutions to the various sustainability and usability challenges facing the transportation sector.

Fortunately, the last few years have brought some useful additional clarification on this issue.

In aviation, it is becoming increasingly clear that hydrogen and battery-electric solutions are losing out in the race to reduce the sector’s 2.5 percent share of annual global CO2 emissions. Instead, sustainable aviation fuels (SAFs), derived from things like cooking oil, animal fats and municipal waste that would otherwise end up in landfill, are securing their place as the mainstream solution.

The International Air Transport Association estimates that by mid-century, increased production and deployment of SAFs could reduce aviation-related greenhouse gas emissions by 65 percent.

“SAF is the only viable near-term solution to reducing aviation emissions fast enough to keep up with global regulatory requirements and decarbonization goals,” said Jason Cheng, CEO and co-founder of private equity firm Kerogen Capital and energy transition firm CelerateX.

By contrast, “hydrogen is great in concept but incredibly expensive,” says Danny Elia, global head of asset management at Australian asset manager IFM Investors. To make it work at scale, “you’d have to completely rebuild the infrastructure.”

But in other parts of the transport mix, there still seems to be room for future technological disruption. Most Western European countries have already achieved electrification of 50 percent or more of their rail networks, for example, but huge markets like the US and Australia have yet to make significant progress on this front.

Allard Ruijs, partner and chief investment officer at DIF Capital Partners, explains that “railway electrification is not expected to expand significantly in Europe, as it will be overtaken by further developments in technologies such as batteries and hydrogen power.” If batteries or hydrogen were to become widespread in Europe or another major market, it is quite possible that electrification would take a back seat. Investors will have to remain cautious for some time yet.

4Brownfield’s Enduring Appeal

Given the challenges of selecting viable technologies in the face of a lack of funding opportunities, it is no surprise that investors favor investments they know are safe, often in the form of degraded transportation assets.

One study by the G20 Global Infrastructure Hub found that infrastructure funds that focused exclusively on greenfield projects raised less private capital than brownfield-focused strategies over time and had a larger share of dry capital, with 43 percent of capital uninvested compared with 19 percent for brownfield. Greenfield-focused funds were also found to have more volatile returns than brownfield-focused ones, with an average 17 percent standard deviation in net IRR compared with 11 percent standard deviation for brownfield-focused funds.

Francisco Del Pozo, head of infrastructure funds at Bestinver, is one investor who is currently hesitant to back greenfield transport projects. He explains that his firm is now very reluctant to invest in new projects or even in expanding existing assets such as airports. “We would prefer brownfield airports with strong monopoly characteristics and where there is solid data on how the asset has performed during the COVID-19 pandemic,” he says.

5Connecting the public and private sectors

Part of the challenge of modernizing existing transport infrastructure – and securing the funding to do so – lies in the mismatch between attitudes between the public and private sectors. This is something that is gradually improving, but still has a long way to go.

First, the private sector’s focus on identifying reliable revenue streams for transportation assets often conflicts with the perception of their status as a public good. As Morgan Richmond of the US finance and policy think tank Climate Policy Initiative puts it in relation to efforts to improve the climate readiness of transportation assets: “The cash flows for adaptation and resilience projects are variable. The project is often initially a net cost, and the benefit is future resilience. That means there is a potentially monetizable benefit. But it is an avoided cost that is typically not calculated.”

The established models for assessing transportation investments may not necessarily be sufficient to satisfy all parties. Anne Chataigné, senior program manager at the Institutional Investor Group on Climate Change, believes that inconsistencies in existing modeling approaches will need to be ironed out. “These investments often have high upfront costs and uncertain financial returns, making them difficult to justify without a standard approach,” she says.

Much greater cooperation with the public sector—and compromise on both sides—may therefore be required if more infrastructure PPPs are to be realized. For example, between 1999 and 2023, transportation accounted for just 24.5 percent of all such arrangements that reached financial close, according to the World Bank’s PPP database. That’s significantly lower than the 51.4 percent for the energy sector during the same period.