In March this year, financial close was reached on the US$244 million South West Waste Water Treatment Plant (SWTP) in St Petersburg.

The project has been described as the first PPP in Russia: the Norvod project company, owned by Skanska, NCC construction companies, the Nordic Environment Finance Cooperation (NEFCO) and St Petersburg utility Vodokanal (the City-owned water and sewerage company) will be responsible for implementing the project in partnership with the local authorities.

Once completed, the project will reduce the discharge of untreated wastewater in the Gulf of Finland which is considered to be the greatest single environmental problem affecting the whole Baltic Sea. At present, raw wastewater from almost a million inhabitants is being discharged into the Gulf of Finland, affecting the water quality of the entire Baltic Sea. When the project is completed, the treatment rate will rise from 75 to 87 per cent.

The Project

The project covers the following main components:

The construction/rehabilitation of the wastewater treatment plant

The plant will be built by a consortium of contractors consisting of the Swedish companies Skanska and NCC, and Finnish YIT on behalf of a special purpose company, Nordvod.

Nordvod, which was established to build and organise the financing of the project and is owned by Russian and foreign investors, will thus take up financing and has a certain amount of equity capital.

When the SWT plant is completed, the project will be transferred to Vodokanal, the public water utility of St. Petersburg. The completed plant will be operated by a separate operating company with the same owners as those of Nordvod.

The project implementation started in spring 2003 and the plant is estimated to be completed during the latter part of 2005.

The Borrower

Nordvod, the SPV jointly owned by NEFCO, Skanska, NCC, YIT and Vodokanal, has the following shareholder structure:

The company is to run the plant for at least 12 years, by which time Nordvod will have paid back its loan.

Background

Before 1979 St Petersburg had no waste processing and all sewage was discharged into the rivers. Today a number of wastewater treatment plants are already operating in the central and northern parts of the city but additions such as SWTP are still urgently needed.

According to the EBRD, currently about 74 per cent of the city's sewage is treated, which means that the sewage of about 1.5 million people is dumped, untreated, into the River Neva and the Gulf of Finland. The Neva also gets large amounts of industrial waste. Beneath the city there are thousands of kilometres of sewers built at different times in history, which have never been repaired.

Construction work on the SWTP began during the Soviet era, in the 1980s but was discontinued in the 1990s owing to shortage of funds. By then about one fifth of the plant’s concrete structures had been completed.

Given that many of Russia’s environmental problems are of a transboundary nature (the narrow gulf between Finland and Estonia for example are particularly badly affected), those Nordic countries affected by the pollution have been keen to get involved.

The SWTP project is the forerunner of the Northern Dimension Environmental Partnership (NDEP) which was established in the spring of 2001, following a joint initiative by NIB and EBRD and the governments of Sweden and Finland.

NIB chaired the Partnership’s Steering Group for the first year of operations which led to a successful pledging conference in Brussels in July 2002. That conference resulted in pledges totalling EUR 110 million (US$140 million) for the NDEP support fund, enabling a start to be made of important environmental projects, requiring both grants and loan financing. The pledges to the fund are increasing and have by now reached some EUR 170 million (US218 million).

Financing

The total project cost is estimated at US$ 244 million and will be financed by a loan from European Bank of Reconstruction and Development (EBRD) of DEM 35 million (US$23 million), grants from the Nordic Environmental Finance Corporation (NEFCO) amounting to DEM 3.4 million (US$2.2 million) and bilateral grants of DEM 21 million (US$13.8 million), mainly from agencies such as Ministry of Environment of Finland, SIDA, EU TACIS. The Northern Dimension Environmental Programme (NDEP) also participates with a grant of US$7.5 million. The local contribution is DEM 17 million (US$11 million).

The NIB will provide a loan of DEM 15 million (US$98 million) with Vodokanal of St. Petersburg. The NIB loan which has a maturity of ten years including a grace period of three years, will be allocated to the rehabilitation of the wastewater treatment, and to raise the availability of water and operational efficiency in the Sestroretsk area located north west of the City.

The European Investment Bank will provide a loan of EUR 25 million (US$32 million) to the St Petersburg water company Vodokanal and for the execution of the necessary associated works. The project is the first project in Russia to benefit from EIB financing following a decision of the Stockholm EU Council to authorise activity by the bank in support of environmental projects in the Baltic Sea Rim of Russia.

Legal Issues

The core agreement, the Tripartite Agreement, between the project company Nordvod, Vodokanal and the City of St Petersburg was signed on November 30, 2002. Implementation of the project officially started on December 30, 2002.

The Financing Agreements including the loan agreements were signed during spring and summer 2003. The first disbursements under the loan agreements took place in September 2003.

First disbursements under the donor financing agreements (incl. NDEP) are expected before year end 2003. The tender for construction of the incineration plant is expected to be published in early 2004.

Commenting on the legal framework, Marc Polonsky of White and Case who represented the key lenders (the NIB, the EBRD, Swedfund International AB and the Finnish Fund for Industrial Cooperation Ltd) said: "It is a complex financing even more so as it is the first project of its kind. Russian law is still developing so one has to work around it. A large number of the contracts involved are Russian law agreements. Due to the fact that Russian law is still in a nascent stage, a complex web of English law agreements were needed to create a more certain legal structure".

Added to this, the law in relation to Russian state unitary enterprises such as Vodokanal of St Petersburg changed in relation to that type of entity during the project. Polonsky said: "The success of the project in spite of these issues is a good indication that projects of this complexity in the specific Russian environment can be done".

Risks

According to Jon Sigurosson, CEO of the NIB, one of the main challenges of structuring a wastewater project was trying not to place any direct burden on the finances of the City of St. Petersburg, neither its budget nor its borrowing or guarantee capacity.

Whereas in the Nordic countries, wastewater treatment plants generally are financed out of municipal budget funds, the restrictive guarantee policy of the Russian Federation and the limited guarantee capacity of the City of St. Petersburg meant a PPP-structure for the project needed to be developed which makes use of the basically strong financial situation of St. Petersburg without burdening the City with direct financial guarantee obligations.

Sigurosson said: "This was an absolute requirement of the Russian public utility partner, because of financial constraints, and it meant that some form of private sector financing was needed. However, private sector financing of a stand-alone wastewater treatment project is unusual to say the least. When private sector financing is used for waste water systems, it has generally been in connection with the fresh water supply utilities to ensure cash flow - tariffs and income – for the investments. This meant that the situation was very difficult to handle both legally and operationally".

Sigurosson added: "This kind of financial structure would also not have been possible without a significant grant element, as the costs for the financing otherwise would have been far too high considering the low municipal service fees and tariffs." As a major part of the financing package consists of long-term loans from IFIs, the financing costs can be maintained at a reasonable level. Another important element is the relatively large commitments from the sponsors, in terms of subordinated loans and equity capital, which reduce the risks for the external financiers.

It was thus of crucial importance for the financing that the project was supported by strong Nordic sponsors, who were able to bring technical and financial strength to the project.

The political risk involved in dealing with Russia was thus mitigated by this degree of federal support.

Conclusion

Public-private partnership (PPP) solutions, such as the SWT-plant, are clearly needed to attract funding to much needed municipal infrastructure investment in transition and developing countries.

Yet as Sigurosson said, "it is clear that PPPs are not a panacea for resolving the shortcomings in water sector performance". Changes in over-arching policies, incentives and institutional arrangements from the governments are central.

Private sector participation can be very helpful but public sector provision of water services will remain dominant also in the future. According to Sigurosson, "the task is basically to establish a healthy allocation of risk and reward as well as of resources. A partnership means that each party takes responsibility for the elements of any project it knows best and can best control: The public partners can best manage political risk including the setting of tariffs. The private partners, on the other hand, should bear the performance risk".

The SWTP can hopefully serve as an example of this kind of PPP. It is also a good example of how IFIs can join forces with their countries of operation and bilateral donors to fully finance waste water projects that are of great significance for the environment. To accomplish this, the IFIs must be willing to lend to sub-sovereign borrowers, i.e. in particular municipalities, as well as to PPP-companies in the infrastructure sector.