INFRASTRUCTURE INVESTMENTS IN RUSSIA: CONCEPT AND OUTLOOK

Many investors still cling to the stereotype that in Russia the range of quality investments is limited to the oil and gas sector. The tide, however, has recently turned and investors are beginning to explore a variety of new options. One of the latest investment phenomena in Russia is infrastructure investment. Still in its formative stage, this business has the potential to develop into a rich investment field, thinks Oleg Pankratov, Head of Infrastructure Capital at VTB Capital.

Oleg Pankratov, Head of Infrastructure Capital at VTB Capital

How can the term ‘infrastructure investment’ be defined in a nutshell?

The main classes of infrastructure by target sectors are social (hospitals, schools, court houses, government facilities), transportation (roads, bridges / tunnels, rail, port facilities, airports), environmental services, energy (power transmission and distribution, gas distribution, contracted power generation). Infrastructure investment activities are typically divided into two main areas. Infrastructure acquisitions is when economic assets are acquired, and these are typically existing cash yielding assets. Pulkovo Airport is like this in some respects, however, there is also a major capital expenditure element to it, which makes it more like the next category: Greenfield Projects – these projects will typically have construction needs.

Are there any safe bets in infrastructure investments? What are investors looking for hen they make a decision?

There are never, by definition, any “safe” investments. But those that invest in infrastructure are looking for certain characteristics, essential qualities that the business must have. Firstly, it must provide essential services to the community. Secondly, it must have a predictable cash generation. Good infrastructure must also exhibit long-term and predictable cashflows due to high entry barriers, so that competition is minimized.

Government support is often a ake-or-break factor in ussian business. How crucial is the role of the state in nfrastructure financing?

In my experience, compared to Western schemes such as the UK PFI scheme, Russian PPPs (Public Private Partnerships) are typically organized or initiated by a government ''master plan''. Rather, businesses provide a steady deal flow, which the government accepts on a case by case basis. However, the exception to this is St. Petersburg where they have developed their own PPP legislation and have launched tenders for infrastructure PPP schemes, such as Pulkovo Airport, the Light Rail Transit PPP project, the Orlovsky Tunnel project, the Yanino Waste Treatment project and other large-scale projects. Since the global financial crisis only the Pulkovo Airport and Yanino Waste Treatment projects are continuing toward the procurement process.

Is it fair to say that Public Private Partnerships are key solutions to the severely underfinanced Russian infrastructure situation?

Back in 2007, it was said that infrastructure development in Russia will require investments of at least US$2 trillion in the next 20 years, according to government estimates. Part of the strategy envisaged by the government to meet this demand was to finance investments by attracting both internal and external funding. The issue was that Russian companies’ limited resources make it difficult to raise equity and obtain commercial debt from domestic lenders, who in turn may not be able to provide attractive long-term financing. The market therefore turned to infrastructure finance, which can ease the capital raising burden via allocating risk to all participants. An example of how this is working already is St. Petersburg’s PPP legislation.

The development of infrastructure in Russia is increasingly attracting private sector investment to form PPP partnerships with the government – particularly in the transport industry.

What are the possible drawbacks of Public Private Partnerships?

In general, PPP schemes entail construction, maintenance, political, and environmental risks. Infrastructure projects where the Public Private Partnership mechanism is used are typically low-yield in nature. Examples of this in Russia are toll roads, such as the new Moscow-St. Petersburg freeway, the M1 Odintsovo Bypass and the Western High-Speed Diameter. Project development does not necessarily lead to project implementation. Healthcare and education PPP projects in the Central Region have not proceeded to investment stage despite considerable effort. Long-term investment in these sectors may start developing with the involvement of the Russian government.

What steps has the Russian government taken in upporting infrastructure development?

The Russian government has made a commitment to developing a number of national infrastructure projects. Although the downturn made a number of international banks and sponsors exit the market, a recent tender that we are running for the St. etersburg government shows renewed interest.

What is the general outlook for Russian infrastructure?

Despite the economic crisis, Russia presents great opportunities to investors, developers and construction companies. The market is largely untapped. As far as I am aware, to date no proper PPP project has reached financial closure: many projects across all sectors are in the pipeline. There is potential for small-scale as well as large-scale projects.

In this context we are proud that VTB Capital is already a part of a successful PPP project in the reconstruction of Pulkovo Airport in St. Petersburg. In the two years since its engagement, VTB Capital, acting as both financial advisor and equity co-investor, has attracted EUR 1.2bn of investment into the project. This is the first major PPP project in Russia to be financed without government support.