As more people across the globe are immunized against COVID-19, economic prospects are looking brighter, offering a clear exit path from pandemic restrictions. S&P Global Ratings still foresees a K-shaped recovery that would ultimately expose widening gaps between certain sectors and countries. Here's what we anticipate for infrastructure and energy in 2021.

U.S. Transportation: Economic Growth Plan Signals Recovery

The past quarter has seen an overall recovery for many roadway transportation assets across North America. As lockdown restrictions continue to ease, domestic toll road travel has demonstrated recovery for many operators across the sector. Commercial trucks performed particularly well after an initial shock in Spring 2020, also given a sizeable shift in consumer behavior toward e-commerce.

That said, there are still laggards. For instance, congestion-relieving toll roads, such as the 95 Express Lanes and the 407 International, are still seeing reduced traffic. Among the most affected infrastructure niches, however, remain conference center hotels, which continue to struggle as business travel remains subdued, while a return to normal for stadiums is equally uncertain.

As for the U.S. airport sector, domestic travel--which accounts for an important 80% share of total--has seen an uptick in activity. The slow recovery of international travel, however, still means that some airports will continue underperforming.

Overall, strong progress on vaccination roll-outs and improved economic outlook have resulted in more stable prospects for the not-for-profit transportation infrastructure. This also takes into account the more than $38 billion in additional direct federal grants authorized for transit and airport operators under the $1.9 trillion American Rescue Plan stimulus package.

The American Jobs Plan will inject more than $1 trillion into U.S. infrastructure.   The first part of President Biden's "Build Back Better" program for economic recovery will look to reinvest in infrastructure and improve employment levels weakened by the pandemic. About half of the $2.3 trillion American Jobs Plan, combined with $0.4 billion in estimated clean energy tax credits, is targeted for traditional infrastructure. This includes roadways and bridges, airports and ports, transit and rail, water, power grids, renewables, and new infrastructure assets to encourage the expansion of both the still-nascent electric vehicle segment and broadband internet into underserved regions (see chart). The plan also extends beyond traditional infrastructure assets, and includes $400 billion to increase in-home care for older and disabled citizens by improving pay and benefits for caregivers, with another $213 billion to be spent on affordable housing.

U.S. Utilities: ESG Risks And Minimal Financial Cushions Are Squeezing Credit Quality

Environmental, social, and governance (ESG) related risks have had a significant impact on credit quality in the U.S. power and utilities sector the past quarter. February's Texas winter storm, for instance, exposed the industry's vulnerability to extreme weather events, leading to multiple downgrades. We also downgraded Duke Energy Corp. because it agreed to a significant disallowance related to the recovery of coal ash costs.

In our view, many utility companies are currently managing their financial positions with little to no cushion from our downgrade threshold. For example, we recently revised our rating outlook on American Electric Power Co. Inc. to negative from stable because we expect its financial measures to consistently reflect the lower end of the range for its financial risk profile category (see "American Electric Power Co. Inc. Outlook Revised To Negative On High Capital Spending And Limited Financial Cushion," published April 28, 2021). The lack of a sufficient financial cushion increases the industry's vulnerability should an unexpected event that has not been built into their base-case scenario occur. Given the potential for further extreme weather events, we continue to monitor the industry's financial and hedging practices.

A corporate tax rate increase could benefit metrics.  As we move toward the summer months, we will continue to monitor how utilities position themselves to withstand the sometimes tight alignment between power generation and demand, which could lead to a recurrence of scarcity pricing. The coming three to six months could be pivotal for the sector should we see some consolidation of President Biden's tax plan.

Notably, the proposed 7% hike in the corporate tax rate--taking it to 28%--would increase cash-flow-to-debt metrics by about 100 basis points. This seems counterintuitive; however, utilities fully recover the statutory income tax expense from customers, while actual tax payments depend on prevailing fiscal depreciation, deferred taxes, and holding company interest.

The plan also promulgates the Energy Efficiency and Clean Electricity Standards, which seek to foster the development of renewables in the pursuit of a carbon-free power sector. Key to this plan is a 10-year extension of investment and production tax credits for renewables and storage, as well as a boost to research and development.

That said, many in Congress oppose the overall size and social components of the plan. As such, we believe the final package, which is expected before the end of summer, will look different to its current form.

Global Oil And Gas Markets Find A Better Balance As Demand Recovers

In the first quarter of this year, we saw a rebound in demand for both oil and gas after dramatic lows in second-quarter 2020. For the oil sector, the recovery remains on track, even though jet fuel demand is unlikely to return to prepandemic levels before 2022. Similarly, gas prices have settled into a pattern of relative stability, although they remain subdued across Europe and Asia.

Supply cuts are supporting oil prices.   We anticipate U.S. oil production will decline this year, given investors' calls for oil producers to moderate investments and increase profitability. This, together with major supply cuts from OPEC and Russia, have underpinned the strong upswing in prices this year.

We believe that OPEC will continue to aim for a trading range of $60-$70 per barrel. If prices go beyond that level, perhaps due to a stronger-than-expected increase in demand, it is plausible that U.S. shale oil producers could ramp up production again.

Nonetheless, a number of developments on the horizon could prompt downside to prices, or at least keep a lid on them. For instance, OPEC has an overhang of 7 million barrels per day (bpd)--of which 2.1 million bpd could come back by July--that it could eventually bring to the market in a bid to increase its market share. And, if the Biden administration loosens sanctions on oil-producing Iran and Venezuela, the market could end up with additional supply. There are demand-side risks too, since the economic recovery could subside later this year should there be a strong resurgence in COVID-19 cases.

M&A Continues Apace For Europe's Utilities

During the past quarter, the ongoing acceleration of the energy transition has seen European utilities fortify efforts to align with the EU commitment to achieve a net-zero carbon economy by 2050. Alongside this, after hitting a three-year high at the end of 2020, mergers and acquisitions (M&A) have remained on the same trajectory as macroeconomic trends for the sector remain favorable.

Noteworthy transactions include National Grid's acquisition of PPL's Western Power Distribution operations, Veolia Environnement's acquisition of waste group Suez, and accelerated strategy execution in the Fortum Uniper transaction in the form of adjustments to senior management.

Stable ratings against an unclear regulatory backdrop.  Generally speaking, we expect utility companies' creditworthiness to remain steady. However, we see pockets of risk relating to jurisdictions where regulation is currently under review, including the U.K., Netherlands, and Sweden.

We also expect to see updates on the status of nuclear power within the energy transition, following calls from a number of countries to include it in the EU taxonomy for sustainable investments. The outcome would provide greater visibility on the direction of the sector, with potential consequences for Électricité de France and wider-reaching implications for the European energy market.

Europe's Aviation And Toll Roads Won't Bounce Back Just Yet

Although Europe is ramping up vaccinations, a meaningful rebound of air travel across the continent doesn't appear to be on the cards this summer. Even assuming most of the population is immunized by the end of the third quarter, we expect air traffic in Europe will be only 30%-50% of the 2019 levels this year versus our November 2020 forecast of a 40%-60% shortfall. In the U.K., the gradual unwinding of mobility restrictions could come in the form of a traffic light system, with a list of "green" countries considered safe. As such, passenger numbers could recover quickly as tourists visit green countries. But if this does not happen, air traffic levels could be even worse this year.

Our ratings on European airports remain, on average, one notch lower than before the pandemic (see "Another Stretch Year For Europe's Airports," published March 22, 2021). European governments have been cautious about reopening cross-border travel, even in the U.K. where 60% of the population has been vaccinated, owing to the risk of exposure to new variants of the coronavirus. An exception to this could be U.K.-U.S. traffic, which could potentially reopen by June or July.

The latest lockdowns have not restricted travel on European toll roads as much as they did last year.   But the situation differs from one country to another, with Spanish toll roads generally underperforming those in Italy and France. There are strong indications that, as in 2020, traffic on toll roads will pick up quickly in the summer once restrictions are eased.

M&A activity has continued as road operators seek to diversify or replace cash flows from expiring concessions. For instance, Vinci has announced its €4.9 billion acquisition of an asset portfolio owned by Spain-based ACS Industries, which has an attractive pipeline of renewable generation projects. This could trigger a domino effect, since the ACS Group has expressed an interest in buying Italian motorway Autostrade per l'Italia (ASPI). The sale of ASPI isn't yet final; however a series of bids were put in by a consortium of Cassa Depositi e Prestiti and infrastructure funds.

Mexico And Brazil Take Contrasting Approaches To Infrastructure

The Latin American infrastructure sector has witnessed a number of significant government actions in recent months, particularly in two of the region's largest markets: Mexico and Brazil. Since the election of President López Obrador in 2018, the Mexican government has played a larger role in the sector, with one of its main objectives being the strengthening of state-owned utility company Comisión Federal de Electricidad (CFE), as well state petroleum company Petróleos Mexicanos (Pemex). Under the recent energy sector reform, approved in March 2021, the dispatch order of the Mexican electricity system was adjusted to prioritize all existing CFE power plants, rather than prioritizing dispatch by cost.

By contrast, in Brazil, the government is looking to foster greater private-sector involvement, launching an infrastructure concession auction for airports, ports, and roads to attract investment. Infrastructure investment in Brazil has traditionally been relatively low, especially for an emerging economy. Public infrastructure spending is currently around 0.5% of GDP, a far cry from the 2%-4% in most countries. This has been holding back productivity, providing opportunities for private investors to step in.

Changes could be significant.  In the months to come, we anticipate that Mexico's proposed reform will affect the stability of the Mexican regulatory framework. Although the legality of the reform is still being processed in the Mexican judicial system, the new regulations would affect some contracts signed since 2014.

Meanwhile, we expect Brazil may face some difficulties attracting international investment, given the long-term impact of the pandemic; although its stable regulatory framework will likely prove attractive to overseas investors. What's more, there is still space for local players to participate, especially because they have the financial flexibility to do so and benefit from their status as incumbents in the market.

China Energy And Infrastructure: Economic Rebound Comes With A Funding Squeeze For Some

China's Two Sessions--the country's most important annual parliamentary meeting--took place in early March 2021, laying out the country's economic roadmap for the next five years. It didn't set an explicit GDP target, leaving room for China to achieve other objectives pertaining to social warfare, deleveraging, and its energy transition.

Alongside this, China's announced new-energy targets were less ambitious than we expected, with annual renewable capacity additions of at least 66GW on average in 2021-2030. This undershoots the record 120GW added in 2020. The only 2030 target officials raised was the share of nonfossil fuel in the nation's primary energy mix, namely, to 25% from a previous threshold of 20% and up from the current 16%. It is worth noting that China tends to underpromise and overdeliver, so we can likely expect more in this area.

The various levels of Chinese government largely fuel infrastructure investment. At the Two Sessions, China announced that it would issue Chinese renminbi (RMB) 3.65 trillion (about $570 billion) in local government special purpose bonds in 2021. This marks a small decline from last year. While a significant portion of the bonds will be deployed to finance infrastructure projects under construction, the government is placing less emphasis on infrastructure for economic recovery. In general, we expect infrastructure growth for this year will likely be in the low single digits, in line with the subdued growth seen in the previous two years.

In the coming months, China will likely continue its strong recovery from the pandemic.   We forecast real GDP growth of 8% for 2021. Energy consumption will remain high alongside demand, and the national emission trading system should start trading carbon credits in the middle of the year. China's power sector is still contending with high coal prices and, as a result, we expect the margins of coal-fired power companies to be squeezed.

Additionally, local government financing vehicles (LGFVs) face a RMB2.7 trillion maturity wall in the onshore bond market in 2021, with tougher funding conditions for weaker issuers. This follows high-profile defaults by state-run corporations, including Henan-based Yongcheng Coal and Electricity Holding Group Co. Ltd. (not rated) in November 2020. As deleveraging returns to the government agenda and officials tighten rules on bond issuance, LGFVs will be under increasing refinancing pressure in 2021.

A Mixed Outlook For South And Southeast Asian Infrastructure

South and Southeast Asia has seen a varied recovery from the pandemic. India's economic performance has bounced back significantly, but the recent variant outbreak may prompt us to revise down our base-case assumption of 11% growth over fiscal years 2021-2022, particularly if the government is forced to reimpose broad containment measures. Other countries in the region, including Indonesia and Thailand, have experienced a more muted recovery due to a stronger dependence on tourism.

Overall, the region has seen funding availability improve markedly in the past quarter, thanks to increased access to capital markets. Although this has favored companies across the board, credit differentiation is notably sharper, coming at a significant cost for companies with weaker financial metrics.

Uncertainties lie ahead.  Along with tracking the speed of the economic recovery and each country's success in containing the virus, investors will be scrutinizing issuers' access to funding in the coming quarter. From investors' perspective, the market remains volatile. This could affect corporate growth plans if the cost of capital increases or capital funding sources start to dry up.

The pandemic is also straining sovereign and provincial governments' balance sheets. This has raised investor concerns about the continuity of regulations in those provinces, and the robustness of government support for state-owned entities. For instance, in late 2020 we took rating actions on some Indonesian government-related entities that reflected a lower likelihood of timely extraordinary government support.

Project Finance Forges Ahead After A Disruptive Year

The bulk of project finance ratings have proven largely resilient to the fallout of the pandemic, on the back of supportive contracts and liquidity. Among those still under considerable pressure, we see social projects exposed to volume risk, such as stadiums and hotels. Many remain closed or are operating at severely reduced levels, and relying on liquidity reserves since revenue has not improved sufficiently to cover operating expenses and debt-service obligations.

Although prospects of traffic recovery for transportation projects remain uncertain, we expect to see a gradual resurgence in regions where vaccinations are well underway or expected to increase in the second quarter of 2021, such as in the EU and North America.

We will also continue to closely observe the strategy of universities in the context of student accommodation projects. We see an increasing risk of universities choosing to prebook fewer rooms than in the past. Alongside a more permanent move toward remote learning, this could have implications for student accommodation projects' metrics in the short and medium term.

We downgraded slightly less than 20% of project finance debt during this period of economic stress, equating to 58 of over 300 rated projects.   The largest impact has been felt by transportation and social infrastructure projects exposed to volume risk. Last year, we lowered our ratings on about 33% of transportation projects, followed by 17% for volume-based social infrastructure projects. By comparison, power projects were more stable in aggregate, with about 12% being affected in 2020. However, only one-third of the power projects we rate are fully merchant exposed, and those remain under stress due to continued slippage of pricing and demand.

Editors: Bernadette Stroeder, Maureen Cuddy, and Jasper Moiseiwitsch

Related Research

• The Hydrogen Economy: Hot Air Or Future Reality?, April 22, 2021
• Asia-Pacific's Energy Transition Will Be Long-Drawn-Out, April 20, 2021
• Energy Transition In Asia-Pacific: A Marathon, Not a Sprint, April 19, 2021
• Cross-Sector Outlook: India's Escape From COVID, Feb. 16, 2021
• India Infrastructure: Recovery Won’t Be Quick, Nov. 23, 2020