S&P Global Ratings has received many questions from investors about the possible credit consequences of the Russia-Ukraine conflict for rated European infrastructure companies. Although the situation is evolving rapidly, this article outlines our initial thoughts.

S&P Global Ratings acknowledges a high degree of uncertainty about the extent, outcome, and consequences of the military conflict between Russia and Ukraine. Irrespective of the duration of military hostilities, sanctions and related political risks are likely to remain in place for some time. Potential effects could include dislocated commodities markets--notably for oil and gas--supply chain disruptions, inflationary pressures, weaker growth, and capital market volatility. As the situation evolves, we will update our assumptions and estimates accordingly. See our macroeconomic and credit updates here: Russia-Ukraine Macro, Market, & Credit Risks. Note that the timing of publication for rating decisions on European issuers is subject to European regulatory requirements.

Frequently Asked Questions

Do you anticipate a weakening in the creditworthiness of rated infrastructure businesses over the short term?

The recent sovereign rating actions on Russia and Ukraine have prompted us to lower our issuer credit ratings on companies based in those countries directly affected by the conflict, by the Western sanctions imposed on Russia, or by the capital control measures introduced by Russian authorities (for further information see "Russian Corporates Downgraded To 'CCC-' After Similar Action On Sovereign; Ratings Placed On CreditWatch Negative," published March 8, 2022, and "Ukraine Long-Term Ratings Lowered To 'B-', Placed On CreditWatch Negative On Fallout From Russia's Military Attack," published Feb. 26, 2022, on RatingsDirect). We are also mindful that the conflict may have some direct and--probably more severe--secondary effects, which may hurt other infrastructure businesses in Europe, the Middle East, and Africa (EMEA). We anticipate that some infrastructure companies--most notably airports and seaports--have a degree of direct exposure to the region, for example, in terms of air traffic or sea freight volumes.

The secondary effects derive from the economic fallout of the conflict, such as inflationary pressures, soaring commodity and energy prices, and potentially weaker consumer confidence. Weaker growth and capital market volatility may have a more severe and generalized impact on infrastructure companies' credit quality, depending on the headroom and liquidity position of each company. Hence, we will analyze the exact impact on each rated company on an individual basis.

What is your view of the impact on airports?

We expect low operational impact on rated airports, mainly in the form of slower traffic recovery from the COVID-19 pandemic for some airports. That said, we have observed a strengthening of the recovery from the pandemic, underpinned by healthy bookings year-to-date for Easter and the summer season, which could partially compensate. However, the visibility for the full year remains low given the persisting short-term booking curve. We currently maintain our expectations for our rated airports that air passenger traffic numbers will be 45%-65% of 2019 levels in 2022 and 70%-85% in 2023. In our view, the current geopolitical tensions may adversely affect airports in various ways. The most notable include:

• Cancellation of flights between Russia and Western Europe following the mutual ban. Rated airports have low exposure to Russian and Ukrainian air traffic and passengers--less than 2% of direct flights, hence although our recovery forecasts will be slightly reduced, we expect limited fallout.
• For airports with significant exposure to the North Asian market, the loss of Siberian overflight will likely affect the number of flights to those destinations and as a result depress traffic recovery expectations. Air traffic between Europe and Asia was already at minimal levels prior to the conflict, and hence we expect a further delay in the recovery of this air corridor, previously expected in 2023.
• Potentially lower flight traffic toward countries in Central and Eastern Europe while the conflict lasts. This represented on average an exposure in the single digits as a percentage of flights for our rated airports back in 2019.

How will port operators be affected?

Depending on location and type of import/export handled, port operators may be directly affected as a result of exposure to trade with Russia or Ukraine. Given both countries are major grain exporters and Russia's crucial role in crude oil and industrial materials global trade, ports that are more commodity- or bulk-oriented may face a challenging period. Container transport will be affected by the rising cost of bunker fuel.

Depending on the sector, spill-over effects from increasing energy costs could also hurt the energy-intensive companies served by bulk port operators. Although port operators may have minimum revenue or volume agreements in place with some larger clients, these agreements are typically short term and do not entirely protect port operators' revenues. While high during the pandemic, volumes could be damaged by macroeconomic pressures on consumer demand.

Will regulated infrastructure companies be worried by the inflationary environment?

The consensus view is that the conflict will contribute to a higher inflationary environment, via higher energy, food, and commodity prices. We revised our 2022 inflation forecast for the Eurozone on March 8, 2022, to 5.1% from 2.0% previously (see "Global Macro Update: Preliminary Forecasts Reflecting The Russia-Ukraine Conflict," published March 8, 2022). We believe this will be a key risk to regulated infrastructure companies. These companies typically benefit from a unique ability to pass through inflation via their tariffs, since this is a key element of their regulatory framework. However, infrastructure companies usually provide a public service, and hence the affordability of their tariffs is a strong social factor beyond the purely regulatory consideration. When inflation is low, transferring costs is usually relatively straightforward if the regulatory framework is solid. However, the higher the inflation, the more controversial this becomes as users bear an ever-increasing burden. We believe regulatory frameworks will be tested in case of high inflationary environments, given the social mandate of these companies and the importance to affordability for the governments.

Some companies we rate have tariffs agreed on a nominal basis within their regulatory periods, which can last several years. In these cases, adjustments for deviations in inflation may happen in the following regulatory period, leading to a possible drop in operating revenue. Also, infrastructure companies generally remain exposed to at least a one-year time lag in tariff indexation, since annual tariffs are usually indexed to the previous year's actual inflation, while operating costs and capital expenditure (capex) are immediately affected by sharp changes in inflation.

Could an inflationary environment also reduce capex?

On top of general inflation, infrastructure companies are asset-intensive and have high capex on an ongoing basis. Capex--typically for major maintenance of assets or expansion--is a key assumption within our forecasts. We have noted in certain countries an increase in construction and raw materials costs, materially higher than overall inflation. Material increases in capex could weaken companies' return on investments or their ability to make new investments. In the absence of mitigating factors such as flexibility on amount or timing or government support, this could add further pressure on credit metrics, especially if capex was a factor driving growth.

During the pandemic, the postponement or reduction of capex was already one of the mitigants companies implemented to limit the impact on their credit metrics. Some of our rated airports for instance curbed capex to a mere 20%-50% in 2021 compared with 2019. Our expectation for 2022-2023 had been a rise in airport capex back or close to pre-pandemic levels, which may be adjusted as a result of the conflict and inflationary environment.

Will high electricity prices burden the profitability margins of infrastructure companies?

Electricity prices spiked in Western Europe to their highest level ever from the second half of 2021. The conflict has further increased oil and gas prices, which in turn has increased electricity prices to levels never considered before. For infrastructure assets, electricity needs are quite different depending on asset class. Railway companies are often one of the largest electricity consumers in their respective countries, with energy costs typically accounting for 4%-8% of their total operating costs. Pending visibility on any ability to include energy cost increases in tariffs or receive further state support, we anticipate profitability margins and cash flow generation will be reduced, particularly for companies with tighter headroom. Higher electricity prices could potentially put some pressure on individual credits or, in the worst-case scenario, lead to disruption of services (we do not factor this into our base case at the moment). For other transportation asset classes such as toll roads, airports, or seaports, we do not anticipate a material impact on creditworthiness, given the limited weight of electricity in their overall expenses.