Infrastructure outlook: Federal aid drives growth, costs pose risk

Public infrastructure will glide into 2023 supported by massive federal aid, but the rising cost of projects could trip up the country’s national rebuilding plan.

Macroeconomic uncertainties like material prices, labor shortages, high interest rates and slowing economic growth may make capital financing more expensive. And that may prompt cautious local and state leaders, who fund 75% of the nation’s infrastructure, to delay, cancel or scale back projects.

Amid the headwinds, a trio of major new laws – the $1.2 trillion Infrastructure Investment and Jobs Act, the $740 billion Inflation Reduction Act and, to a lesser extent, the $280 billion CHIPS and Science Act – will flow into infrastructure sectors for the second year.

On top of that, voters in November approved around $60 billion of bond measures to support capital projects, including New York State’s $4.2 billion environmental bond. The ballot measures promise a fat pipeline of projects, some of which may be procured this year.

IIJA funds began to flow in the second quarter of 2022, and over the year the country saw more than 29,000 new highway and bridge projects. That marks a 9% increase over 2021, said Alison Premo Black, chief economist for the American Road & Transportation Builders Association.  

“We are expecting more market growth in 2023 and from what we’ve seen, the IIJA is definitely contributing to the growth,” Black said.

“There are very positive signs that the market is strong right now and we expect it to be strong next year, but overall, the wild card is really project costs,” she said.

ARTBA projects that public highway, pavement, and street construction will grow 13% next year – not accounting for material, labor or inflation increases – reaching $96 billion compared to $84.8 billion in 2022.

The total value of overall transportation construction work will grow to $172.3 billion in 2023, up from $155.4 billion in 2022, ARTBA predicts. That includes a 14% increase in bridge and tunnel work, a 13% increase in port and waterway construction and a 4% increase in public transit and rail construction.

Almost every sector will see more activity, said John Medina, an analyst in Moody’s Investors Service Global Project & Infrastructure Finance Group.

“Everybody got some kind of money: energy, transmission, water, wastewater, roads; there’s a lot of new funding coming through,” Medina said.

Medina said that inflation, which reached a 40-year high in June, has already taken a big bite out of the federal aid.

“There’s still going to be a lot of investment but it’s not going to go as far as we thought,” he said.

Construction costs traditionally track higher than consumer goods. The national average price for highway and street construction material is up 34% since January 2020, per the Bureau of Labor Statistics.

Meanwhile, the construction industry is experiencing record-high unemployment levels and demand will remain high as federal money is awarded.

The industry had 440,000 job openings as of April, according to McKinsey, which warned in an October report that the labor crunch could “derail” the nation’s infrastructure plans. McKinsey estimates the IIJA will create “hundreds of thousands” of new job openings a year, peaking at more than 300,000 in 2027 and 2028.

“We haven’t had a lot of positive labor policies in the last several years, so that will affect certain industries like construction,” Medina said, noting that some governments haven’t even gotten bids on projects. “Now we don’t even have enough for local labor and that’s only going to continue.”

The value of contract awards for highway and bridge projects by states and local governments rose by 25% in 2022 from 2021, Black said.

“An increase of 25% is very, very significant,” she said. “We know that part of that is higher project costs, but part of that is real growth as well,” she said. “It’s a leading indicator of work that’s going to be happening over the next few years.”

Mega projects that may see work begin next year include New York’s $12.7 billion Gateway Hudson Tunnel project; Maryland’s American Legion Bridge replacement and toll lanes project; California’s high-speed train; the Metropolitan Transportation Authority’s Second Avenue Subway Phase 2; and Ohio and Kentucky’s Brent Spence Bridge replacement.

On the P3 front, major projects like the SR-400 in Atlanta and the I-10 in Louisiana have been shortlisted and are expected to come to market in the first or second quarter of 2022, Medina said. There’s also the MTA’s first P3, which will be priced next year, along with an Oswego, Ore. wastewater treatment plant and several higher-education projects, including at the universities of Florida, Louisiana and Maryland.

The inflation script is flipped on the investor side, where infrastructure is considered a natural hedge to rising prices as many assets like toll roads have automatic inflation-linked rate increases.

“We’ve been talking to investors about the benefits from inflation protection for almost a decade, and you almost get rolling eyes because inflation has been so low,” said Julio Garcia, head of infrastructure-North America for infrastructure investment firm IFM Investors.

“But now there’s a renewed interest. Infrastructure is more suited to times that are more uncertain,” Garcia said. “Investors often look to infrastructure to provide some ballast in their portfolios.”

For those that keep their eyes on the so-called asset recycling or privatization space, 2023 might not be a big year, Garcia said. That’s because many cities and states remain flush with cash and “so there’s not that level of need for financial resources,” he said.

Energy is the sector with the most deal flow and opportunities, Garcia said.

The Inflation Reduction Act features a lengthy list of incentives for private and public entities to invest in renewable energy projects like solar, offshore wind and nuclear. The traditional energy sector, which also benefited from the IRA, is also getting a new look amid European scarcity stemming from the Russian-Ukrainian war.

“There’s a high level of participation from investors in this sector,” Garcia said. “We’re moving into a world where the market share for cleaner energy is only going to increase.”

On the 2023 legislative front, the action is likely to be more on the rulemaking and state side than from big federal actions. More states might start to authorize P3s, like Tennessee’s recent move. Meanwhile, conflicts over rules like the IIJA’s Buy America requirement, which many state departments of transportation are pushing against, will play out over the year.

As Republicans gain a narrow majority in the House, they will control key committees like Transportation & Infrastructure. They have also promised to launch investigations into the DOT’s use and oversight of the IIJA dollars. Under the IIJA statute however, the GOP cannot interrupt the flow of the federal infrastructure dollars, which are set to support the sector through 2026.