One can drive free of charge on Ukraine’s 170,000 kilometers of roads. This means that the country is potentially losing out on millions of dollars per year that could be used to finance their construction and maintenance.
This is one of the many reasons why Ukraine scored a lamentable 130th place out of 137 countries on the most recent World Economic Forum survey of road quality in 2018.
Attempts to introduce toll roads have failed, including plans to build a new toll road between Lviv and the Polish border. Low traffic flows, among other problems, turned investors off.
Ukraine’s highways may, however, may still have their heyday.
The Ukrainian government is launching six public-private partnerships (PPPs) to rebuild and maintain around 1,400 kilometers of nationally important highways. Instead of building toll roads, the government is using a PPP model to attract private capital.
If these pilot projects work well, the idea is to expand PPPs to an additional several thousand kilometers of important international and national highways. Above all, says Oleksandra Azarkhina, head of the reform team at Ukravtodor, PPPs would “allow us to elevate the road sector to international levels.”
The right fit
As part of President Volodymyr Zelensky’s Big Construction program to repair 30,000 kilometers of state roads, the government has pledged a record $1 billion by 2024.
Even with record government spending, “the efficiency of that spending is under question,” says Volodymyr Shulmeister, former first deputy minister of infrastructure. Both a lack of effectiveness in the government and budget shortfalls necessitate private sector investment.
That’s why the government is turning to PPPs. When they are done correctly, the government and end-users of infrastructure gain from the expertise and efficiency of the private sector.
Typically, PPPs involve concession-style toll roads in which investors profit from a stream of revenue that comes from fees. This doesn’t work in Ukraine: traffic flows are well below the average 12,000–15,000 vehicles per day needed to justify the risk to an investor. Additionally, alternative free routes alongside toll roads are not always available. And, with no history of toll roads, there is low acceptance to paying for roads.
After years of trying and failing, decision makers in the government are finally getting the picture.
“Past failures had to happen and key decision makers had to get to the point where they could see how it could be done differently,” says Oleg Kudashov, investment officer at the International Finance Corporation.
The IFC, the European Bank of Reconstruction and Development and the World Bank helped Ukraine complete two successful port concessions last year. They will also play an active role in helping to ensure the success of PPP in the road sector.
Ukraine is going with a “government-paid” model in which a private partner puts up all the money upfront and the government pays 100% of investor fees from the State Road Fund over contracts of 20 to 30 years.
This model addresses a host of obstacles in upgrading Ukraine’s highway network: Private capital provides immediate financing, while long-term contracts and private expertise pick up the slack in maintenance; the government commitment to paying the investor avoids the unpopularity of toll roads.
According to Taras Boichuk, head of the SPILNO PPP management office in the Ministry of Infrastructure, this model is the only viable option for Ukraine right now.
An interchange in Poltava Oblast, part of the M-03 Kyiv-Kharkiv-Dovzhansky highway. The PPP model attracts private sector capital, expertise, and principles. In profit maximization mode, the private sector may be able to deliver the quality, modern highways Ukraine’s public sector has failed to do. (bigbud.kmu.gov.ua)
An evolving model
While PPPs are crucial to upgrading Ukraine’s highway network, the proposed 1,400 kilometers of PPPs represent under 1% of Ukraine’s more than 170,000 kilometers of roads.
According to IFC assessments, the nearly $3 billion currently in the State Road Fund is already a huge step forward: five years ago, there was no Road Fund at all. But it’s not enough to maintain the entire network and to build new roads.
The State Road Fund currently accumulates funds from excise taxes on fuel and vehicle sales. As electric vehicles become more prominent and less gasoline and diesel is consumed, that’s less money for the Road Fund in the future.
Toll roads will have to be introduced eventually to generate additional revenue. In the beginning, tolls will only be levied on heavy vehicles and trucks. Most countries in Europe have classification systems for charging heavy vehicles based on weight.
Considering overloaded trucks are largely responsible for tearing up the roads, experts agree that hardly anyone will argue with introducing a payment system for heavy vehicles. The Ministry of Infrastructure estimates that additional levies on trucks could add $3 billion annually to the road fund by 2025.
But according to Kudashov, there needs to be a national tolling strategy that determines the rates and technology that will be used. That will take time, but over the course of the next 5–10 years, “it’s a conversation that has to happen.”
“Once the highway system is properly rehabilitated, we don’t want to get back to the situation where most of the roads are destroyed, and so to avoid that, you have to properly operate and maintain these roads. That costs money,” Kudashov says.
In a PPP, the investor will also have an incentive to monitor overloaded trucks on their roads as they are the ones who pay to operate and maintain the highways.
Laying the groundwork
Before these projects are even implemented, further legislation and changes to the budget code are necessary to minimize risks for both the investors and the government.
While the 2019 law on concessions and PPP is widely considered to be sufficient to proceed with PPPs, changes to the budget code are necessary to allow for 20- to 30-year commitments as part of these PPP road construction contracts.
This law also guarantees that the traffic risk will not be transferred to the private partner. In other words, the investor will get paid regardless of the volume of traffic. To protect the government from overcommitting, the law will also place limits on how much money can go to the private investor from the Road Fund. The cap will most likely be 50% to ensure that there is money left over for other projects.
Nearly a decade ago, Ukraine increased green energy tariffs to spur investment in the renewable energy sector. But when the Energy Ministry turned around and slashed the guaranteed price in response to opposition in recent years, investors lost millions in investments. Investors in road projects will likely demand guarantees that the government will live up to its commitments, unlike in the green energy sector.
According to Boichuk, it is highly unlikely that any future government would destroy the State Road Fund, although “it’s a high-risk, high-reward situation.”
Public-private partnerships will allow Ukraine to rebuild the roads now and pay later in installments over the next 10-15 years, solving constraints in funds that it doesn’t have at the moment. (Kostyantyn Chernichkin)
A long road ahead
Planning, environmental studies and detailed risk assessments are needed before a private company can even bid on a project.
One way to ensure that PPP projects are implemented properly from start to finish is by having agencies dedicated to grooming and supervising projects. Countries like Canada and Australia have strong records in infrastructure in part due to separate agencies dedicated to PPPs.
With the recommendation of the IFC, Ukraine established the PPP Agency in 2018 under the Ministry of Economy. However, the agency only has eight people, capable of managing five or six projects at a time, and lacks money, according to Boichuk.
As part of the law on concessions and PPPs, which is still under review in parliament, 10% of all concession fees would go to the Special Project Preparation Fund, providing a sustainable source of funding that could be used by the PPP Agency.
In the meantime, the Ukrainian government still has to hire IFC consultants to lay the groundwork and to conduct feasibility studies for each pilot project, select which of these six will go to tender first and to prepare the bids. This process can take up to six months.
Once that’s done, the projects can go out for tender. The bidding process can take up to another six months. Realistically, construction won’t even begin until 2023–2024.
“We need to be frank and open that these projects aren’t simple, they take more time and preparation than simple public procurement, but it’s worth the effort,” says Jason Pellmar, head of the regional IFC office in Ukraine.
