Private equity eyes Russia’s depreciating infrastructure(3)

With an estimated $1 trillion needed over the next 10 years, the scale of investment required to replace, modernize and expand Russia’s aging infrastructure is tremendous.

Russia is a developed industrialiased market.  However, years of underinvestment have led to the current need to upgrade important aspects of the infrastructure. Power and transportation are currently among the most active sectors.  For example, Russia is the world’s second largest railcar market (in terms rolling stock), yet its railcar fleet is one of the oldest.

Other strategically important infrastructure assets are also either substantially depreciated or operating in excess of their capacity. Take Russia’s electricity grid, which is more than 70 percent depreciated, putting many regions at risk of blackouts.  

Christopher Rose

Similarly, between 1995 and 2008, road network length in Russia increased only one percent while the number of passenger cars grew 125 percent, leaving many major cities and freeways suffering significant traffic congestion. This has already created significant pent-up demand for toll roads and bridges.

All this presents an opportunity, and one which has already been embraced by a number of investment groups. In 2010 for example, Macquarie Renaissance Infrastructure Fund (MRIF), jointly managed by Australia’s Macquarie Group and emerging markets-focused firm Renaissance Group, invested in Brunswick Rail.  

The Russian power sector is also seeing increased interest from private equity.  In May 2012, a consortium including the Russian Direct Investment Fund (RDIF) – the $10 billion fund established by the Russian government in 2011 – MRIF, Xenon Capital Partners' Rusenergo Fund and AGC Equity Partners bought a 26 percent stake in OGK-5, a company which supplies approximately 5 percent of Russia’s electricity.  

The key drivers of the Brunswick and OGK-5 investments — predictable cash flows, high correlation with GDP and significant pent-up demand — illustrate why Russian infrastructure is attractive for long term investors such as pension funds, mutual funds and endowments.  Moreover, the prospect of co-investing alongside RDIF in large deals may cause global funds like Apax Partners, Apollo Global Management, and The Blackstone Group to take a closer look at Russian infrastructure.  

However, Russia will need to overcome a number of legal and financial challenges before private investment becomes a more significant part of the country's infrastructure financing.  For example, Russian law currently provides a limited number of enforceable security instruments for secure project financing.  In addition, some consider Russia’s budget policy as too restrictive for long-term infrastructure projects.  The maximum term for public budgets in Russia is three years while the average term of infrastructure projects is 25 to 30 years.

Nevertheless, several high-profile projects, including the new Moscow-Saint Petersburg highway and the Western High-Speed Diameter toll project, have recently obtained financing from top-tier Russian and international financial institutions. Recent legislative amendments suggest the legal framework for Public-Private Partnerships (PPPs) is improving. In May of this year, some progressive changes were introduced to Russia’s Federal Concession Law in the context of road infrastructure projects, such as the ability to pledge rights to several creditors simultaneously. Expanding the applicability of these amendments to cover a broader range of sectors, including social and municipal infrastructure, as well as modifications to the budget legislation and the development of a federal PPP law, will help spur the private sector investment Russia needs to modernise its aging infrastructure.

Pavel Nazarov is a director at Macquarie Renaissance Infrastructure Fund.  Based in Moscow, he is responsible for all aspects of sourcing and executing transactions in the infrastructure space in Russia.

Christopher Rose is a partner at global law firm Squire Sanders, based in Moscow and London and focusing on private equity in Russia and Central and Eastern Europe.