Market focus: Ukraine fights history with road PPP plan

Ukraine’s president Volodymyr Zelensky and the World Bank’s IFC are promoting six pilot road PPPs worth over USD 1.5 billion. Toll roads worth over USD 5 billion could follow. But the track record doesn’t look great, reports Sergei Kuznetsov

Ukraine has a long history of failing to bring private capital into its road infrastructure.

Each time the country’s authorities have attempted the launch of concessions over the past two decades, hesitation by politicians and the absence of proper legislation have turned out to be insurmountable obstacles. As a result, to date, the country has been unable to use private investment to build or rehabilitate a single road.

But things may be about to change.

Ukraine’s authorities and the World Bank’s private sector development arm – the International Financial Corporation (IFC) – are launching a long-term PPP program for roads, with significant support from the country’s leadership and a new law on concessions already in place, having been recently adopted.

According to the Kyiv office of global law Irm CMS, the country has also taken “a sensible step” towards transparency and cleared up much red tape in recent years.

The success of the two Irst port concession projects – Kherson seaport and the Olvia seaport at the Black sea – proves that improving the investment climate “is not just groundless statements”, CMS wrote in a report in December.

New life has been breathed into old concession plans, thanks largely to the launch last year of an ambitious infrastructure development program, initiated by president Volodymyr Zelensky, who was elected in 2019.

“I’d like to be a president who will be remembered by the people as someone who made roads appear in Ukraine,” he told journalists in 2020, referring to the fact that 95 per cent of the nation’s roads were in poor condition at the beginning of that year.

Indeed, according to Ukraine’s infrastructure ministry, Kyiv channeled around UAH 100 billion (USD 3.5 billion) to the reconstruction of roads at the national and local levels last year, which is twice more than in the previous year.

So how successful will the privately Inanced component of this plan be this time around?

Making roads appear

Ukraine is starting with six pilot PPP projects that mainly consist of existing roads; only 14 km of new stretches are due to be constructed. The projects – with estimated capital expenditures from USD 180 million to USD 370 million each and total coverage of 1,400 km – are to be implemented under the availability payment mechanism. “It is necessary to phase this process in overtime, so that as many actors as possible can take part,” Vladyslav Kryklii, the nation’s infrastructure minister, says in an exclusive interview with Inframation.

According to the minister, this will allow the same companies to participate in different tenders.

Three projects were recently selected as priority tenders that should be completed by the autumn, specifically:

The remaining three projects of the Irst phase should follow the priority projects with a time-lag of six to nine months, which ensure sufficient competition. The second batch includes:

All six roads from the Irst phase have similar legal status including Ukrainian parts of international highways and a national highway between Dnipro and Mykolaiv, says Roman Riabenko, senior associate at Kyiv-based law Irm Vasyl Kisil and Partners. “So, they will potentially be of similar attractiveness to the investors,” he adds.

But the interest of potential private investors in these projects will depend on qualification criteria (technical and initial) for the participants for each project, the conditions under which availability payments will be made to the investor by the government (size, scope, limitations), as well as any budgetary and legislative constraints, says Volodymyr Yaremko and Vladlena Lavrushyna at Kyiv-based law firm Sayenko Kharenko.

According to infrastructure minister, the Ukrainian authorities need to amend the country’s legislation this year, “so that [the scheme] works correctly and the state assumes its obligations” before investors, to successfully launch the Irst six pilot projects.

“The concessionaires should be confident that the state will take on long-term obligations, as well as making the availability payments in full based on their proposals” he adds.

Amending payments

Availability payments for the PPP projects should be made from the state road fund, which is funded by fuel and vehicle excises, import duties on petroleum products, and Ines and penalties. The fund’s revenues stood at slightly above USD 2 billion last year and should reach USD 2.4 billion in 2022. Around 95 per cent of the fund’s revenues are denominated in EUR, according to the Ukrainian government.

“Currently there is no legal framework in the budget legislation of Ukraine for the long-term financing of the road concession projects,” Yaremko and Lavrushyna wrote in their comment e-mailed to Inframation.

“A critical amendment” is therefore required, since currently the government is not ready to ensure regular payments to the concessionaire over a concession period that can be from 5 to 50 years, and if the PPP projects are launched sooner than this amendment is implemented, the public partners will Ind themselves in “a difficult situation” when trying to make availability payments to the investors, according to the lawyers.

They see no need for other “urgent and significant” amendments to the legislation in order to launch the Irst six pilot projects. However, the lawyers added, the PPP legal framework should be further reIned, specifically, by providing a detailed procedure for the submission of unsolicited proposals by private investors, as well as for their review and approval by public partners.

Turkish bidders

The Ukrainian authorities wish to see as many bidders as possible during expected concession tenders, says the minister.

Likely to be formed as consortia, they must have construction experience, adequate liquidity, and probably the support of multinational lenders and equity investors.

A senior source at one of the Western multinational lenders believes that some bidders will seek participation of the IFC, the European Investment Bank (EIB) or the European Bank for Reconstruction and Development (EBRD). The IFC declined to comment for this article.

This could also minimize any corruption risks during tenders, for which Ukraine has been notorious, the source adds: “If there is funding from international financial organisations, then tenders will be under their control.” A procurement watchdog agency could also be set-up to protect investors.

Kyiv-based consultants and sector lawyers name European players including Vinci, Bouygues and Strabag among expected participants of the Irst concession tenders. Vitaliy Rabchenko, a partner at the Kyiv office of CMS, also forecasts “a clear interest” from companies based in Turkey.

“There are very reputable Turkish companies that could make very competitive price offers,” says the multinational source. “It is difficult to compete with them.”

According to the Ukrainian office of London-headquartered Infrastructure Transparency Initiative (CoST), Turkey’s Onur group won 10 per cent of the road construction and rehabilitation tenders (in money terms) between January and November 2020.

Sensitive tolling

After the successful launch of the Irst six pilot projects, the Ukrainian authorities intend to embark on two more phases of the road PPP campaign, with projects working on a revenue-based mechanism.

Between 2023-2025, Kyiv will offer potential investors between seven and nine mainly greenfield projects, covering up to 1,600 km of roads and requiring total capital expenditures of between USD 2 billion and USD 3 billion (from USD 300 million to USD 400 million each).

During the Ive subsequent years, Kyiv could offer another nine to 10 projects, covering up to 1,800 km of roads and requiring potential investments between USD 4 billion and USD 5 billion (from USD 400 million to USD 500 million each).

According to the infrastructure minister, the toll roads program is “a sensitive issue” for Ukrainian public opinion, and the authorities need to “correctly communicate” its launch, [but] “we will integrate the toll roads system incrementally, starting with commercial transport. Passenger cars will follow that. People should get used to the idea that they have to pay not only for fuel but also for roads if they want to have roads of high quality.”

The minister is reluctant to name specific projects that could be offered to potential investors in the second and third phases of the scheme. However, he admitted that a new road between the city of Lviv and the Krakovets-Korczowa checkpoint on the border with Poland will be on the table.

A new 84.4 km highway should be built along the existing 65.2 km road, which, according to the nation’s state road agency Ukravtodor, has trafic intensity of 8,400 vehicles per day.

“The Lviv-Krakovets concession was attempted in 1999 and was planned again in 2015 and 2017. Ukravtodor was seeking advice from experts to make it work, including legal assistance from Vasil Kisil and Partners,” the Irm’s lawyer Riabenko says.

In 2015, two bidders Iled documents for a tender – a consortium of Ukrainian companies and France’s Bouygues Construction. However, the tender was canceled by the Ukrainian authorities, citing an alleged inability of both bidders to secure the necessary funding.

Bouygues did not respond to a request for comment on any possible interest in a potential new concession tender.

Major interest

According to lawyer Riabenko, “the new laws allow for toll road concessions, which removes one of the major reasons why loans could not be attracted to Inance the project in the past”.

He believes the Lviv-Krakovets road construction project will be of “major interest to investors”.

Among other possible options that could be offered to potential investors in toll roads, Ukraine’s road construction sector experts usually mention a new ring road around Kyiv. This highway would consist of six principal stretches (connecting existing international roads that head towards the capital), with a trafIc intensity of 25,000 to 75,000 cars per day, according to calculations published by Ukravtodor in August 2020.

According to the initial estimates of the Ukrainian authorities, the whole project would require investments of up to UAH85 billion (USD 3 billion). Last year, Ukravtodor signed a memorandum with China’s state-controlled Poly Changda Engineering Corporation over the construction of the Irst stage of the road.

Another option is a new 50km highway between Kyiv and the city of Bila Tserkva, part of the route from the capital city to the nation’s southern port city of Odesa.  According to initial estimates by Ukravtodor, this project requires investments totaling UAH 7.5 billion (USD 265 million). “According to Ukravtodor in 2019, the traffic on the Kyiv-Odesa road in Kyiv Oblast was between 10 000 and 48 500 cars per day,” Riabenko says.

While the existing road between Kyiv and Odesa would remain toll-free with recent and currently anticipated major repairs funded by the EBRD, a new toll road would “provide a faster way to pass traffic jams and end at the new bypass road around Kyiv,” he added.

The route also belongs to the Pan-European transport corridor Helsinki (Finland) – Kyiv – Dimitrovgrad (Bulgaria) – Alexandroupolis (Greece).

On December 23, the Ukrainian government adopted a set of maximum charges per kilometer for travel on the toll roads built under the concession:

The purpose of this resolution is to create the conditions “for starting a dialogue” with investors on the later implementation of concession projects, Ukravtodor said in a statement.

Understanding Ukravtodor

Yet unreformed government management of the road sector in Ukraine could pose a threat to the successful implementation of an ambitious concession program, says the Western multinational source.

“Unlike the maritime and railway sectors, the management of the road sector has been in a very strange form: via a state agency Ukravtodor, which is some sort of civil service, but not a company,” he says.

“While the nation’s railways have a supervisory board, audits, an investment program, Ukravtodor has almost nothing of the sort.” The source adds that frequent changes in the cabinet and other government officials make it difficult “even to Ind” a person who can “consciously and competently” carry out reforms of the agency.

Political risks also remain high in Ukraine.

The start of the second phase of the concession program will coincide with the 2024 presidential campaign. “Indeed, the change [of the political leadership] is a material risk,” says the lender source, adding that possible victory of populists could derail long-term concession plans. “We need political stability, but, unfortunately, there is none.”

However, CMS’s Radchenko remembers that international donors have been “motivators and pushers” for the Ukrainian authorities over the past years.

“We already saw as some projects were started under previous leadership, and Inished under the current one,” he says. “The port concessions were started under [president Petro] Poroshenko, but tenders took place and their winners were announced under Zelenskiy.”

Authorities hope they will be able to repeat the same success with the road PPPs.

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