Road Construction in Ukraine — PPP vs EPC

Roads have been an old wound in the side of Ukrainian infrastructure for quite a long time. According to the EBA’s Infrastructure Index 2020^[1], the average mark on the state of roads is 2.6 (out of 5), which means that they are in a “less than average” condition to say the least. Besides, only 2% of respondents argued that our roads are in “good” shape.

Being aware of this issue, the government has made substantial attempts to improve the state of roads through various programs and initiatives. The most significant and widely known among them are the Road PPP program^[2] and the Big Construction program^[3]. Both programs aim to resolve the everlasting problem of bad roads, although by different means.

The Road PPP aims to attract private sector investment in the development of roads under the public-private partnership (PPP) framework. The scope of the Road PPP covers over 4,500 km of highways, which should be granted as separate segments in concession, and consists of 3 phases spread over 2021 — 2030. The pilot tenders for the first few segments of highways are expected to be held in late 2021.

On the other end, there is the Big Construction program, which envisages construction and repairs of several thousand kilometres of roads of state and municipal importance. Such works are performed by the winners of public procurement tenders held on the ProZorro platform by the State Agency of Automobile Roads of Ukraine (Ukravtodor) under short-term quasi-EPC contracts.

The key difference between the Road PPP and Big Construction lies in their approaches. Under the PPP framework, the investor receives assets in management with an obligation to carry out certain repairs or upgrades, maintain assets in the necessary condition, and provide designated services. The state receives the concession payments, and the investor covers its expenses from availability payments or tolls.

Under an EPC contract, the investor only performs the agreed scope of works within the required timeline and receives guaranteed compensation. While EPC contracts provide more flexibility and are simpler, the PPP has better risk allocation instruments and is viable for large-scale projects.

First Steps towards Road Concessions

The PPP, or rather the concession framework in Ukraine, has made a great leap over the last few years. Following the adoption of the new Law On Concession^[4], concession legislation became compliant with best EU practices, introduced a new transparent concessionaire selection procedure, and provided additional guarantees for investors and lenders (e.g., direct agreements with step-in rights, free choice of applicable law and dispute resolution mechanism).

The roads concession under the Concession Law contains certain key points that must be kept in mind:

•  only public roads may be granted in concession;
•  the concession term should be between 10 and 50 years (the “ordinary” concession term is 5+ years);
•  for toll road concession, an alternative toll-free road should be made available by the government throughout the lifetime of the concession; and
•  roadside facilities may be owned and used by the concessionaire in order to receive additional income.

Another important note is that the government limits the tolls. Still, they are mostly the same as in the EU (e.g., EUR 0.023 per km for cars weighing up to 3.5 tonnes).

As mentioned above, the Road PPP consists of 3 phases. Phase 1 of the Road PPP covers six segments of highways which are planned to be granted in concession by the end of 2023, namely:

1. M-29/M-04/M-18 — Kharkiv — Dnipro — Zaporizhzhya — total length of 276 km — initial CAPEX around USD 370 mln;

2. M-03 — Boryspil — Poltava — 292 km — USD 180 mln;

3. M-14 — Kherson — Mykolaiv — 64 km — USD 310 mln;

4. M-06 — Kyiv — Zhytomyr — Rivne — 308 km — USD 370 mln;

5. M-07/M-19 — Yagodyn — Kovel — Lutsk — 146 km — USD 240 mln; and

6. M-04/H-11 — Dnipro — Kryvyi Rih — Mykolaiv — 312 km — USD 290 mln.

These are brownfield projects — new construction takes only 14 km combined from all of them.

These six concessions will be based on availability payments instead of tolls. The sum of availability payments received by the concessionaire will depend on compliance with the performance requirements set out in the concession agreement. Such requirements may include road availability, its readiness for winter/summer seasons, etc.

The government’s choice to proceed with availability payments may be justified by successful examples: upgrading and O&M of BR116 highway in Brazil (633 km), construction and O&M of Ruta del Sol Motorway in Colombia (1,071 km), construction and O&M of Almaty Ring Road in Kazakhstan (66 km), etc.

Availability payments will be paid from the State Road Fund, which also finances construction and maintenance of roads, debt service payments related to the development and maintenance of highways, and investment in developing road safety measures. In its turn, the State Road Fund is funded by:

1. excise taxes and import duties on vehicles and petrol;

2. tolls for passage through toll roads;

3. certain administrative fines; and

4. concession payments from road concessions.^[5]

Taking into consideration the fact that the World Bank Group supports the Road PPP, upcoming tenders have every chance of being successful and becoming a new source of pride for the government.

Still, there are some gaps in the laws which prevent the start of the road concession, and the key issue is the absence of a legal framework for long-term budgetary obligations. Two alternative bills were registered in Parliament to resolve this issue.^[6] However, neither of them has been put to the vote in Parliament as of now.^[7]

Speaking of toll roads, in March 2021 Ukravtodor signed a memorandum with a private Ukrainian company for developing a feasibility study on the concession of the Krakovets-Brody-Rivne highway. Signing the memorandum is the first step towards constructing the first toll road in Ukraine, which is expected to be built in the next few years.

Size of Impact of Big Construction

The Big Construction is an extensive program сovering the maintenance of roads and repairs of schools, sports venues, and hospitals. However, roads are both the key marketing point and a major piece of the Big Construction.

Ukravtodor regularly holds its tenders for the reconstruction and repairs of roads on the ProZorro platform.

ProZorro is a state-owned platform that offers a transparent, competitive, and simple procedure for the public procurement of various goods and services. To participate and win the tender, the investor must meet the requirements of the tender documentation and give the best price offer during the auction stage.

The agreements signed with the winners of Ukravtodor’s tenders are short-term construction contracts (varying from several weeks to 10–12 months). The scope varies from the reconstruction of long sections of highways to minor repairs of several kilometres of regional roads.

The cost of road works per km has reportedly increased since the beginning of the Big Construction program. In 2020 average prices per 1 km were as follows^[8]:

1. new construction — USD 3.26 mln;

2. reconstruction — USD 1.38 mln;

3. capital repairs — USD 760,000; and

4. minor repairs — USD 391,000.^[9]

Besides, the number of tenders held by Ukravtodor increased significantly — rebuilding tenders have doubled alone in number since the start of the Big Construction program.

The intergovernmental agreements signed between Ukraine and other countries may make ProZorro tenders much easier for foreign investors from the relevant jurisdiction. Valid international treaties prevail over public procurement laws. Therefore, if an international treaty sets out different rules for procurement other than the law, the rules of the relevant international treaty apply.

For example, under the treaty between Ukraine and Poland^[10] only enterprises from Ukraine or Poland may develop the infrastructure near the border between the countries funded by a loan from the Polish government. Consequently, several Poland-based contractors won the ProZorro tenders for reconstruction of roads in Western Ukraine, mostly without any competition.

To Each His Own

The first phase of the Road PPP looks promising, although the fact that the concessionaire’s reward is based on availability payments makes these projects less attractive for investors.

At the same time, the priority for the government is to improve the state of existing roads without putting too much of a financial burden on road users. At the same time, the government works on the concession of the Krakovets-Brody-Rivne highway, which should occur within the next few years and will likely prove that toll roads are also a viable road PPP option in Ukraine.

The goal of the Big Construction program is slightly different. Its key goal is not only to improve the infrastructure of Ukrainian roads, but also the creation of a strong marketing effect in Ukrainian society. While the Road PPP applies a relatively new (for Ukraine) instrument of cooperation between the state and private investors, Big Construction is an extensive public procurement program with a larger scale and strong marketing.

^[1] The EBA presentation Infrastructure Index 2020 is available in Ukrainian at: https://eba.com.ua/wp-content/uploads/2020/12/Infrastructure_2020.pdf

^[2] The Road PPP program website is available at: https://roadppp.in.ua/en/

^[3] The Big Construction program website is available in Ukrainian at: https://bigbud.kmu.gov.ua/#about

^[4] Law of Ukraine On Concession, dated 3 October 2019, No. 155-IX.

^[5] Item 1 of Article 24²(2) of Budget Code of Ukraine, dated 8 July 2010, No. 2456-VI.

^[6] Bills Nos. 5090 and 5090-1 On Amendments to the Budget Code of Ukraine on Settlement of Budget Relations During Implementation of Agreements Concluded under Public-Private Partnership Framework, Including Concession Agreements.

^[7] The article was prepared on 21 May 2021.

^[8] USD equivalents here are calculated according to the exchange rate as of 21 May 2021, which was USD1 = UAH27.4665.

^[9] According to the research of CoST Ukraine available at: https://portal.costukraine.org/

^[10] Law of Ukraine On Ratification of a Treaty Between the Government of Ukraine and the Government of the Republic of Poland for Providing a Tied-Aid Loan, of 3 February 2016, No. 977-VIII.