The tender for the $3 billion St Petersburg Western High-Speed Diameter ring-road, the first concession in Russia's much anticipated roads PPP programme, is expected to kick off with roadshows in the coming weeks.

The project will likely be followed in early 2007 by the launch of the $2 billion sections 1-3 of the $15 billion Moscow-St Petersburg toll road – tender documents have been finished by advisor Ernst & Young and are awaiting government approval: The total project is a network of roads and motorway, split into 40 sections with 178 flyovers and 100 bridges.

A third project – the Moscow ring road – is still at the feasibility stage with Macquarie, PricewaterhouseCoopers and Cameron McKenna advising.

Although floating on a cushion of petrodollars, Russia is serious about PPP. High state spending would aggravate inflation, which is already at around 10%. Finance minister Alexei Kudrin wants to get inflation down to 3%-4% in the near future, while also increasing capital investment growth from around 9% to 15%-20%. A wide-ranging PPP programme could help achieve those seemingly incompatible aims if international private sector investors and lenders can be persuaded of the stability of long-term PPP income streams.

That seems likely given confidence in the Russian economy is high. Russia has become an investment grade-rated net creditor, and although its economy and currency is integrally linked to the sale and price of energy (which appears unlikely to drop significantly in the foreseeable future), finance minister Alexei Kudrin has stored away almost $20 billion of petrodollars in a stabilisation fund, the total of which is forecast to rise to $40 billion by 2007.

Some of those petrodollars have also been diverted – and will continue to be on an annual basis – into State Investment Funds for use on PPP projects, of which toll roads are going to be the flagship.

Forecast development needs

Only last week Russian transport minister Igor Levitin announced to the Duma: "As of 2006, only 37% of federal roads and 24% of regional roads meet operational standards. If the trend continues, less than 15% of all roads in Russia will remain in satisfactory condition by 2010." The target, according to Levitin, is to bring 90% of Russia's road network up to international standards by 2025. And according to Deputy Prime Minister Alexander Zhukov that means attracting around $75 billion of investment for the long-term development of Russia's road network.

A policy in the making

But if a Russian PPP programme looks set to become a reality – other major potential projects include port terminals at Novorossiysk, Murmansk and St Petersburg, a hydroelectric dam in Siberia and the Sheremetyevo, Koltsovo and Khrabrovo airports – it is still a process very much on the drawing board.

For example, next year Levitin says the government plans to allocate R25 billion from the State Investment Fund (SIF) on construction of new roads. But according to secondary sources the governments own forecasts for the Western Diameter are total cost Rb83.624 billion with Rb28 billion toward construction from SIF – in effect the whole SIF new roads budget, and more, for 2007.

The timescale also appears to be optimistic. The Western High-Speed Diameter is due to be completed in 2009 and comprises around 30 miles of road, half of which will cross the inner city area via two tunnels under the Neva River and 72 bridges and flyovers.

The forecast IRRs for some of the upcoming roads – if correct – may not excite sponsors given the major PPP opportunities in the US. The Western Diameter forecast is annual IRR of 8.5% based on 25 years. The connection road between Moscow and the M1 – total cost Rb70.257 billion with SIF injecting Rb10 billion – has an IRR of 8.9% based on 12 years.

However those IRRs may turn out to be much higher given the state has approved SIF money for the Western Diameter based on a per kilometre investment of $70 million, which seems very high despite the complexities of the project.

Furthermore, the Moscow-St Petersburg (15-58km section) has total forecast cost of Rb54.933 billion with SIF putting in RB25.798 billion and an IRR of 14.8% based on 18 years – better than the average western European or US toll road.

Security will be key to getting private investors into Russian PPP. Under Russian law the state owns and operates all key infrastructure and past PPPs – there have been a number in the waste and utilities sector (the Eu190 million St Petersburg Southwest Wastewater Treatment Plant for example) – were not concession based but used a lease agreement post construction that the existing law allowed for.

Concession laws

But the Russian government appears to becoming increasingly sophisticated in its appreciation of PPP process. In 2005 a PPP concession law was introduced to facilitate development which, although its still restricts sponsors to build-tranfer-operate (BTO) deals, has also created the potential for step-in rights based on the pledges of shares thus giving lenders and sponsors the ability to structure more security into future deals. Similarly, initial plans that the state would be reimbursed by winning bidders for feasibility and tender process costs have been scrapped.

Nevertheless, the concessions law is untested and because there is no overarching PPP governing body, different government ministries and regional governments are developing their own frameworks – the potential for a mass of contradictory legislation is therefore large if not a certainty.

As with most PPP markets it is the Ministry of Transport that is most advanced with its PPP programme. It is putting together a law for toll roads concessions that cross-references to the concession law. But the toll road legislation is only a framework law – 17 sections in all – and tends to throw up more questions than answers: For example there is one provision that states the concessionaire will be involved in the acquisition of land and the state will pay for it which would seem to contradict Russian land ownership legislation.

Similarly, on the tax side, sponsors will become liable for 18% VAT when a road is transferred to the state post construction as must happen under the BTO system. At the moment there is no provision in the tax code for resolving the situation.

A further issue is the model concession agreement – a mandatory form that has been approved by the Prime Minister's office. According to many in the market the form is far from ideal for the forthcoming roads deals, with a third of provisions duplicated and many that do not apply to the roads sector.

Guarantees

Confidence in Russia's PPP programme will hinge on armour-plated guarantees and the state has, quite sensibly, not come out with a definitive guarantee policy. The issue of guarantees will be decided on a deal-by-deal basis and for many sponsors any sticking points will likely be in the details rather than whether or not those guarantees are concrete – the Russian government has never reneged on repayment in the utility deals it has done to date and given the political backing for PPP, it is unlikely to ever do so.

In effect, sponsors and lenders are being asked to take a leap of faith in Putinist capitalism that is a step further than the model that has gone to date in the hydrocarbons sector where the government has a controlling stake in national corporations with foreign investors taking a minority stake. PPP concessions will be based on shares in special purpose operating vehicles rather than the assets themselves, which may prove difficult for lenders to swallow without a hefty margin on the debt.

Nevertheless, a number of high-profile European toll road contactors and operators are already looking intently at the market – particularly German and Spanish firms and, notably, Macquarie. So there is unlikely to be a shortage of interest from either sponsors or their relationship banks when the Western Diameter goes to prequalification in the coming months.

Furthermore, hydrocarbons money will be paying for any minimum revenue guarantees or availability payments made to PPP sponsors. Consequently the pace of Russian PPP development will be linked to the price of oil and gas. Most analysts concede that the price of crude will continue to waiver between $50 and $70 a barrel with the average next year predicted to be $64. For the moment it would take a very significant, and even more unlikely, fall in energy prices to hamper Finance Minister Kudrin' ability to service debt guarantees on a major infrastructure construction programme whilst keeping inflation in check.