By Gusev Alexander, Research Fellow, German Institute for International and Security Affairs (SWP)

Modernization of the energy infrastructure and an increase in energy efficiency represent mutual interests for the government and municipal authorities as well as for businesses. Budget deficits at the regional and municipal levels and the reduction of transfers from the federal budget create barriers to upgrade obsolete infrastructure. This leads to the search for extra-budgetary funding, which in the world is based on a public-private partnership (PPP). Implementation of projects using the PPP mechanisms may increase the investment attractiveness of the region, create additional workplaces, and for private investors may be a certain guarantee of stability.

However, for the successful realization of PPP projects it is necessary to create an appropriate legal framework that provides long term guarantees for investments and adequate risk sharing, as well as protections for investors.

The first point is the development of the legal framework for PPPs in Russia. Currently, the law on PPPs exists in 45 regions of Russia, but this has more of a declarative character as it does not create the necessary legal framework that protects the interests of the state and business. Nevertheless, this is a positive trend as regions seek to attract investments, which in turn would contribute to the development of local businesses, create jobs and increase tax revenues.

The first trial to create a common legal framework for a PPP was made in June 2012 when the Ministry of Economic Development published a draft of federal law “On public-private partnership”. The adoption of this law intends to create a legal basis for the implementation of PPP projects in Russia and thus to intensify cooperation between business and government. Despite the fact that the bill establishes sufficient conditions for the regulation of PPPs, some aspects of the projects are not properly worked out that could then affect the efficiency of project implementation.

The next important question is what PPP model should be used in the realization of smart grids projects? Currently in Russia concessions are the most common form of PPP because they have been successfully applied in road construction. Besides, the use of concessions as the main form of PPP is largely due to the existence of the federal law on concessions. However, globally there are about ten financial and legal models that are widely used in the implementation of PPP projects. The federal draft establishes two main forms of public and private participation in PPP projects.

The third important aspect is the evaluation of the implementation of ongoing and completed PPP projects in the electricity sector. Currently the share of PPP projects in the energy sector is decreasing. In 2008-2010 PPP projects in the electricity sector accounted for 23% of all projects, but in 2012 only 11%. One of the possible reasons may be the completion of the liberalization of the electricity market, which provides a relatively low investment yield because of regulated tariffs. In addition, most of the Russian PPP projects have low quality, and project quality could be improved by attracting external experts and using international experience.

The size and profitability of PPP projects is estimated differently by banks and government representatives. If the authorities consider 10-20% in rubles as an acceptable financial level of return on equity in pilot PPP projects, then the credit institutions believe that 20% is the bottom limit. Possible measures to increase the bank ability of projects may be better budget guarantees, better transparency of tender procedures, attracting long term investments from pension funds and insurance companies, etc. There are more than 200 pension funds in Russia, with the largest eleven occupy 90% of the market. Two of the largest funds, Gazfond (Gazprom) and NPF Welfare (RZD) control, about three-quarters of the market, or about $10 billion of buffer stocks. Non-state funds are interested in investing in large scale infrastructure projects, where the government guarantees a sustainable profit. One possible investment instrument is infrastructure bonds.

In conclusion, it can be said that the representatives of both government and the private sector agree that it is necessary first of all to improve the current legislation and to build a common policy in the field of PPPs. Of particular importance is a balanced allocation of risks between the public and private sectors. Improving the quality of projects and the provision of state guarantees will undoubtedly stimulate the development of PPP projects in Russia.

Gusev Alexander will be discussing this issue in more detail at Smart Utilities Russia 2013.