Listed infrastructure: the sources of inflation protection
There are essentially three key mechanisms through which infrastructure assets of all kinds receive protection against rising inflation. In descending order of certainty and visibility, they are the following: automatic indexing, cost recovery guarantees, and pricing power.
Automatic indexing consists in directly linking the growth in the revenues and/or the regulated asset base of a company to an inflation index. Automatic indexing is typically regarded the “safest” form of inflation protection as it is enshrined in regulatory formulas and contracts. For regulated utilities, this typically takes the form of a real regulated asset base, where every year the value of the company’s assets recognised and remunerated by the regulator goes up by inflation (or, occasionally, is linked to inflation proxies like long-term interest rates). This is the case for regulated utilities in Italy and the UK, for example, where regulated asset bases are directly linked to inflation rates, and regulated utilities in Portugal and Illinois, where allowed rates of return on nominal asset bases are directly linked to long-term interest rates. For power generation companies with long-term contracts, this typically takes the form of price indexing, where a fixed real price is (in nominal terms) annually escalated by an agreed rate of inflation. This is the case for Renewables Obligation Certificates (ROCs) in the UK and renewable contracts for difference (CfDs) in the UK, Italy, and several other countries in Europe.