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RUSSIA > EQUITY RESEARCH > INFRASTRUCTURE

JULY 15, 2014

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Copyright © 2003-2014. Gazprombank (Open Joint-Stock Company)

Research Department

INDUSTRY REPORT Mikhail Ganelin

+7 (495) 983 18 00 (ext. 5 45 83)

Sergey Vasin +7 (495) 983 18 00 (ext. 5 45 08)

Russian infrastructure A big ship sails far

The expansion of infrastructure is an imperative for the long-term

economic growth of any country, but securing sources of funding remains

a complex challenge. In this report, we analyze key global infrastructure

expansion trends as well as ways and means to fund infrastructure rollout

projects in various countries. Our main focus is on Russian

transportation, which accounts for 80% of all infrastructure investment in

the country.

Assuming that the global economy grows at 3.3% per year, GDP will

double by 2035. The main contributors to growth include a rise in the global

population (+20% by 2035) and urbanization (the urban population is expected

to increase by 40%), while rapid growth of household income will lead to

accelerated growth of international trade and tourism. Under this scenario,

global air passenger traffic will double as soon as 2020, air freight will triple, and

container shipments will quadruple. In addition, the throughput capacity of most

existing transport channels between Asia and Europe is capable of raising

cargo turnover on average by another 50%. This increment would clearly be

insufficient in case of faster than expected expansion in the coming decades.

The minimum need for infrastructure investment to support economic

growth is 3.5% of GDP, or $57 trln until 2030 ($3.2 trln per year). However,

there is a 20-40% shortfall in infrastructure funding in most countries. State

investments in infrastructure total about 65%, but their ability to ramp up funding

will be limited going forward due to high debt and budget deficits. The role of

private investors, who contribute 35% of infrastructure investment, is

conspicuously on the rise. The governments of various countries are working

out incentives for investors in an effort to strike a reasonable balance between

risk and rewards from infrastructure projects.

In Russia, the rate of infrastructure investment averages 3.6-4.2% of GDP,

or roughly in line with the global average. By 2020, infrastructure investment

will reach $650 bln ($90 bln per year on average). These funds will suffice for

moderate expansion of infrastructure and gradual improvement of its quality, but

not in the event of accelerated expansion. Large projects, such as construction

of infrastructure for the Sochi Winter Olympic Games, will give way to other no

less massive projects, such as construction of the Power of Siberia and South

Stream pipelines, expansion of the Baikal-Amur Mainline and Trans-Siberian

railways, construction of toll roads under concession terms, and the possibility

of deploying the Moscow-Kazan High-Speed Railway with the participation of

private investors. According to our estimates, $25-40 bln of private investments

will be needed until 2020. The bulk of transport infrastructure investment will be

directed to road construction (45%), while rail transport will take 20% (including

the Moscow-Kazan High-Speed Railway and subway facilities), pipeline

transport should account for 30%, while ports and airports will comprise the

remaining 5%.


JULY 15, 2014

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CONTENTS

Expansion of global infrastructure: exponential investment growth on the way ......................... 3

World poised for higher infrastructure demand ............................................................................................................................................ 4

Infrastructure investment needs seen at least 60% higher by 2030 .................................................................................................... 5

Sources of infrastructure funding — will resources suffice? .................................................................................................................... 6

Special infrastructure bourse could be established in Japan .................................................................................................................... 8

Examples of investment tools used in various countries for infrastructure projects .................................................................. 11

Current status of Russia’s infrastructure needs ..................................................................................... 18

Russia’s transport infrastructure: rapid growth or concurrent expansion? .................................................................................... 20

Plan of development for transport infrastructure until 2020 ................................................................................................................ 22

How will Russian infrastructure be funded and where will the resources come from? ............................................................. 25

Moscow — largest investor in transport infrastructure ........................................................................................................................... 25

Russian roads: fighting ‘disaster’ brings noticeable results .................................................................................................................... 28

Avtodor: road concessions promise high yields ........................................................................................................................................... 31

Glavnaya Doroga Consortium: first completed PPP project in the road construction field ...................................................... 34

Key market players: competition tightens after the Olympics ............................................................................................................... 35

Railway infrastructure: removing bottlenecks and building high-speed lines ............................................................................... 35

Higher investment in railway infrastructure is unavoidable .................................................................................................................. 37

Airports: a tasty morsel for investors ................................................................................................................................................................ 40

Seaports: state and business working in tandem ......................................................................................................................................... 44

Public-private ventures for the expansion of port infrastructure ........................................................................................................ 45

Pipeline infrastructure: Russia’s raw material artery ................................................................................................................................ 46

Other infrastructure segments ..................................................................................................................... 48

Power grid complex ................................................................................................................................................................................................... 48

Telecommunications ................................................................................................................................................................................................. 49

Public utilities ............................................................................................................................................................................................................... 50

Appendix ............................................................................................................................................................... 51

Largest construction companies in Russia: main players and trends ................................................................................................. 51


JULY 15, 2014

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EXPANSION OF GLOBAL INFRASTRUCTURE: EXPONENTIAL INVESTMENT GROWTH ON THE WAY

According to OECD forecasts, global GDP is set to grow at an annual pace of

3.3% per year and double by 2035, amounting to $145 trln. China will overtake the

US within the next few years in terms of GDP, calculated as purchasing power parity

(PPP), and become the world’s largest economy, with GDP surging 2.5-fold by 2030

compared to 2013. The GDP of India, the world’s third-largest economy, will triple by

2030 in terms of PPP, while Russia’s GDP will double during this period, moving from

sixth to fifth place among the world’s biggest economies. By comparison, the US

economy is expected to increase by just 40% over this period, while Europe will

expand by 30%. The main factors underpinning growth will be a rise in the population

(+19% by 2030) to 8.3 bln, urbanization (the urban population is set increase by 40%

by 2030; while its proportion will grow from 52% to 58%), faster growth of household

income, as well as further expansion of international trade and tourism.

Given the above pace of growth, the load on infrastructure in most countries is

set to grow exponentially over the next decade, and its timely development will

become the hallmark of steady growth of the global economy. According to

estimates by OECD experts, if global GDP doubles by 2035, the volume of passenger

traffic during the same period will increase by 2.5-fold, air freight will triple, and

container shipments will quadruple. Meanwhile, the throughput capacity of existing

transport channels between Asia and Europe could push up cargo turnover by 50% on

average, while the effect would wear off within 6-8 years. Given that the design,

construction and expansion of large infrastructure facilities will take years, decisions

concerning the ways and means to finance them should be made in the near future.

Size of GDP vs. country’s position in PPP ranking, $ trln Global GDP growth vs. transport sector indicators

Source: PWC, IMF Source: OECD

1

2

3 4 5 6 7

2

1

3

4 7

5 6

0

5

10

15

20

25

30

35

US CHINA INDIA JAPAN GERMANY RUSSIA BRAZIL

2013 2030

0

100

200

300

400

500

2010 2012 2014 2016 2018 2020 2022 2024 2026 2028 2030

GLOBAL GDP PASSENGER TURNOVER CARGO TURNOVER CONTAINER CARGO TURNOVER


JULY 15, 2014

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Population growth will be accompanied be an increasing share of urban population, bln people

GDP per capita growth

Source: United Nations Source: US Department of Agriculture

Increasing infrastructure investments — a tested and tried way to stimulate

economic growth. Higher infrastructure investments create new jobs in the short term,

stimulate economic growth in the medium term, and lower the transport costs of

companies while improving the standard of living of households in the long term.

According to estimates by McKinsey, an additional 1% of GDP investment in infrastructure

will create 3.4 mln new jobs in India, 1.5 mln in the US and 1.3 mln in Brazil. Given the

similarity of economic indicators between Brazil and Russia, the number of jobs that would

be created in Russia would also match, i.e. 1.7% of the entire economically active

population of the country. According to estimates by the Economy Ministry, aggregate

investment in Russia’s transportation infrastructure yields about 0.3% of GDP growth. In

addition, a 10% decline in aggregate transportation costs for all types of goods would add

0.12% to GDP, according to estimates by the Center for Strategic Research. Furthermore,

high-quality transportation infrastructure raises the mobility of households, who would be

capable of moving with greater ease between areas of cities and regions, for a number of

reasons, including the search for employment. This would improve the structure of the

labor market, lead to overall growth in household income and ultimately stimulate demand,

which is one of the key factors of economic expansion.

World poised for higher infrastructure demand

The biggest passenger plane in the world, the Airbus 380, which is capable of flying

over 800 passengers, executed its maiden voyage in 2007. This was the response of

the European aircraft corporation to conspicuous growth in demand in the field of air

transport and tourism.

In 2012, China commissioned the largest hydroelectric generation facility in the world,

Three Gorges on the Yangtze River with capacity of 22.5 GW, which is 1.5 times

more than the previous world leader, Brazil’s Itaipu hydroelectric power plant. Total

investments exceeded $26 bln. When the facility was under design, the HPP was

expected to provide 10% of China’s power needs. However, during the 20 years it

took to build the plant, power consumption rose at a mind-boggling pace, and the

HPP is currently capable of generating less than 2% of the country’s power.

By 2017, the largest airport in the world, with a six-runway hub, will be built in Istanbul.

The facility will be capable of handling a passenger flow of 150 mln (by comparison, the

biggest airport in the world, currently located in Atlanta, is capable of handling 90 mln

passengers per year). Turkish authorities are convinced that the new airport will become a

major hub connecting East and West, Africa and Europe. The total amount of investments

in the project, to be implemented on concession terms, is about $30 bln.

3.3 3.3 3.3 3.4 3.4 3.4 3.3

3.2 3.6 3.6 3.9 4.3 4.6 5.0

0.0

1.0

2.0

3.0

4.0

5.0

6.0

7.0

8.0

9.0

2000 2005 2010 2015 2020 2025 2030

RURAL URBAN

0

50

100

150

200

250

300

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

2028

2029

2030

WORLD US BRAZIL EUROPE

RUSSIA CHINA INDIA TURKEY


JULY 15, 2014

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The 684 km Moscow-St. Petersburg Toll Road, with a maximum speed limit of 150 km

per hour, is to be built by 2018. The total cost of the road is $10 bln, to be funded

through concession agreements with private investors. The need for such a highway

has arisen due to a significant increase in freight turnover between the country’s two

largest cities.

The Nicaragua Canal could be built by 2019 between the Caribbean Sea and the

Pacific Ocean, with the facility routed through the territory of Nicaragua. It aims to

provide an alternative to the Panama Canal, the throughput of which has reached

maximum capacity. In 2013, the government of Nicaragua outsourced the

concession project to Hong Kong-based HKND Group for 50 years. Construction of

the canal is expected to get under way around end 2014. The cost of the project is

roughly $40 bln, and aside from the canal, the plan is to build two seaports, an

airport and an oil pipeline.

Infrastructure investment needs seen at least 60% higher by 2030

According to estimates by McKinsey Global Institute, the minimum need for

infrastructure investments stands at $57-67 trln from 2013 through 2030

(averaging $3.4 trln per year). This estimate is based on the historical volume of

investments in infrastructure over the past 18 years at 3.5-3.8% of GDP. However,

these forecasts fail to take into account faster than anticipated growth of household

income and accelerated development of infrastructure in countries where infrastructure

is traditionally underfinanced (for example, in Brazil and Russia). Taking into account

these factors, infrastructure needs could easily exceed 5% of global GDP ($80 trln),

meaning that investment would essentially double compared to the previous period.

In the opinion of McKinsey, the aggregate stock of infrastructure assets should

amount to an average 70% of GDP in order for it to be maintained in proper

condition. The countries where this percentage is lower (e.g. Brazil, Russia, India and

even the US) should ramp up infrastructure investments at a rapid pace, while those

above that baseline (Japan, China and Germany) have the opportunity to reduce the

volume of investments in the coming years.

Estimated value of infrastructure assets in various countries as a % of GDP, 2012

Investments in infrastructure in various countries: % of GDP (1992-2011) and investment need until 2030

Source: McKinsey Source: McKinsey

16%

57%

58%

61%

64%

71%

76%

179%

0% 50% 100% 150% 200%

BRAZIL

UK

INDIA

RUSSIA

US

GERMANY

CHINA

JAPAN

6.9%

6.4%

4.9%

4.0%

3.6%

3.1%

2.6%

4.7%

8.5%

1.5%

3.4%

2.6%

2.6%

5.0%

0% 2% 4% 6% 8% 10%

INDIA

CHINA

BRAZIL

RUSSIA

US

EU

JAPAN

1992-2011 2013-2030


JULY 15, 2014

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In Russia, the stock of infrastructure assets relative to GDP (61%), while less than

the recommended GDP threshold, is still roughly in line with the baseline asset-

to-GDP ratio of 70%, but is quite close to such countries as the US (64%) and the

UK (57%). This is due to the fact that all types of infrastructure are to be found in

Russia: highways and railroads, airports, ports, pipelines, power grids (including

nuclear), and water supply. Notably, there are not very many countries in the world

possessing such diversified infrastructure. A case in point is Brazil, which has excellent

highways but hardly any railroads, while many countries have no nuclear power and

only a few have such a developed pipeline system. A number of problems in the US, the

UK and many other developed nations are due to extensive infrastructure depreciation,

as many facilities were built around the middle of the 20th century and therefore are in

need of modernization.

Global breakdown of investments in infrastructure

Source: World Bank

Sources of infrastructure funding — will resources suffice?

There will not be enough funds for full-fledged infrastructure development in all

countries around the world. According to various estimates, the lack of funding in a

number of countries reaches 20-40% of their needs. Thus, worldwide infrastructure

investment in 2014 should amount to about $2.6 trln (3.6% of global GDP), whereas we

assume that no more than $2.1 trln will actually be invested.

Investments in infrastructure broken down by regions

Source: Gazprombank estimates

29%

8%

1%

4% 21%

20%

17%

MOTORWAYS

RAILROADS

SEAPORTS

AIRPORTS

ENERGY

WATER SUPPLY

TELECOMMUNICATIONS

42%

19%

7%

13%

15%

17%

3%

5%

5%

12%

2% 2%

CHINA

JAPAN

INDIA

NORTH AMERICA

EUROPE

RUSSIA

NEAR EAST

LATIN AMERICA

OTHER ASIA

AFRICA

AUSTRALIA AND OCEANIA


JULY 15, 2014

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Breakdown of infrastructure investments by sources of funding

FUNDING SOURCES AMOUNT OF INVESTMENTS IN 2014, $ BLN SHARE

State budgets and funds 1,350 65.4%

Bank loans 160 7.7%

Loans extended by international financial organizations 25 1.2%

Share capital of infrastructure companies 40 1.9%

Own funds of infrastructure companies 125 6.0%

Corporate bonds 365 17.7%

Total 2,060 100%


The key onus for infrastructure investment falls to the government, which

accounts for over 65%. First of all, this is due to the fact that a significant part of

infrastructure performs a social function and does not involve generation of revenue (for

example, the construction of city roads or water supply systems), and for this reason

such projects are of no interest to private investors. In the second place, many

infrastructure facilities are still unable to generate high enough returns to interest private

investors, so for this reason the state is forced to step in (for example, building airport

runways, port dredging operations, or construction of railroads with low freight-traffic

density). According to our estimates, budget-funded infrastructure will amount to some

$1.4 trln in 2014, and it will be traditionally sourced from tax receipts, excise duties or

sovereign wealth funds. That said, we do not expect to see any substantial increase in

budget spending on infrastructure in the coming years, since debt and budget deficits

are forcing governments to curb spending, including infrastructure outlays.

State debt to GDP ratio, %, 2012

Source: IMF

Private investments as equity and debt financing account for about 35% of all

infrastructure investment. In 2014, the volume of private investment in

infrastructure will amount to about $700 bln, of which 30% ($164 bln) will be raised

from infrastructure company profit and equity placements from these companies

among portfolio investors, while the other 70% comes from bond issues and bank

loans, including those issued by international financial institutions, such as the

World Bank, EBRD, Asian Development Bank, etc.

0 50 100 150 200 250

RUSSIA

CHILE

CHINA

TURKEY

THAILAND

INDIA

BRAZIL

SPAIN

CANADA

FRANCE

UK

US

ITALY

GREECE

JAPAN


JULY 15, 2014

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Equity financing. Equity financing accounts for less than 2% of aggregate

infrastructure investment, although investors’ interest in infrastructure projects is

growing from year to year. The number of ad hoc infrastructure funds investing in

the shares of infrastructure companies has risen in recent years from zero to over

700. While in 2004, infrastructure funds took in about $2.4 bln, this figure shot up to

$40 bln by 2013. The return on investment in infrastructure facilities by such funds

falls within the range of 10-16%, according to data from Pregin research agency.

Special infrastructure bourse could be established in Japan

Japan Exchange Group, which runs the Tokyo Stock Exchange, intends to set up a

new stock exchange as part of the Tokyo exchange that would specialize in

infrastructure investment. This bourse should be up and running by 2015. The

securities of infrastructure companies and funds are expected to be listed on this

venue. Infrastructure funds are often closed, raising money mainly from a limited

number of institutional investors. By listing on the new market, they will be able to

raise money from a larger pool of investors, including individuals, who are likely to

treat them as an alternative to real estate investment trusts.

The idea of setting up this bourse is regarded as a major challenge given the

Japanese government’s goal of reducing infrastructure spending. Japanese

airports (Kansai International Airport and Sendai Airport) have already shown

interest in this exchange. Moreover, a large number of projects aimed at deploying

alternative sources of energy are being worked out in Japan. These projects

require private investments and it would be extremely important for them to see this

infrastructure bourse get off the ground. It should also not be ruled out that

companies and funds from neighboring Asian countries would also be interested in

making placements on this bourse.

Breakdown by types of investment funds Volume of funds attracted by infrastructure funds, $ bln

Source: Preqin Source Preqin

Bank loans. According to Infrastructure Journal, bank loans account for nearly

$160 bln per annum. The annual dynamic of loan facilities provision to

infrastructure companies is hard to track, though commercial banks have recently

been reluctant to provide loans for projects with long payback periods. After the

2008 financial crisis, the average cost of borrowing for infrastructure objects,

especially those based in emerging countries, grew 1-2 pps. The requirement

regarding the borrowed to own funds ratio rose to 70:30 vs. a pre-crisis 90:10 in

order to mitigate lending risks. This caused an increase of the weighted-average

cost of capital for an infrastructure project. We do not rule out that the cost of

borrowing will continue to grow further due to an increasing number of riskier

infrastructure startups in emerging countries.

2%

43%

42%

13%

INFRASTRUCTURE FUNDS DIRECT INVESTMENT FUNDS

HEDGE FUNDS REAL ESTATE FUND

2.4 5.2

17.9

34.3

24.7

10.7

32

24.3

29.7

40.7

0

5

10

15

20

25

30

35

40

45

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013


JULY 15, 2014

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Corporate bonds. Debt financing via corporate bond issuance accounts for about

18% of total investment in infrastructure. According to Bloomberg, the overall

volume of bonds issued by companies in infrastructure sectors (energy, telecoms,

construction) in 2013 stood at $365 bln, of which 25% occurred in the US,

approximately 25% in Europe and 15% in China. The bulk of placements are

concentrated in the energy (50%) and telecommunications (25%) sectors. The

volume of placements in infrastructure sectors has recently soared, which seems

attributable to a tightening of lending requirements by commercial banks for long-

term infrastructure projects, on the one hand, and the rollout of the QE program in

the US that caused a decrease in the cost of public borrowing. We believe the key

investors in infrastructure bonds are pension and hedge funds as well as

commercial banks.

Volume of corporate bonds issued in infrastructure sectors, $ bln Pension savings as % of GDP, 2012

Source: Bloomberg, Gazprombank Source: OECD

Numerous countries have been recently been striving to arrange public-private

partnerships (PPP) in infrastructure development. As a result, the overall volume of

private investment under the PPP scheme has almost quadrupled over the past 10

years, to $180 bln in 2012. That said, the share of PPP in overall infrastructure

investment stands at a modest 8%. Furthermore, the global financial crisis of 2008

halted this growth due to the aforementioned reasons: a reduction of state spending on

infrastructure and a tightening of lending requirements by commercial banks. At the

same time, the noticeable growth of investment on the part of infrastructure funds

pertains to the most attractive projects that can well do without state support.

0.0

50.0

100.0

150.0

200.0

250.0

300.0

350.0

400.0

2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 0% 50% 100% 150% 200%

INDIA

CHINA

INDONESIA

RUSSIA

TURKEY

KOREA

THAILAND

GERMANY

NORWAY

PORTUGAL

SWEDEN

BRAZIL

PERU

JAPAN

HONG KONG

DENMARK

CHILE

CANADA

US

AUSTRALIA

UK

SWITZERLAND

NETHERLANDS


JULY 15, 2014

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Dynamic of private investment in infrastructure under PPP schemes, 2008–12, $ bln

Breakdown of investment in infrastructure under PPP schemes, 2008-12

Source: World Bank Source: World Bank

The key issue on the short-term agenda to be resolved in order to scale up

investment in the sector is finding a reasonable risk-return ratio for infrastructure

projects. Investment risks related to infrastructure projects used to be quite high, while

their potential returns were modest, thus limiting interest among private investors.

Various states are currently offering financing tools to private investors in order to

mitigate risks related to investing in infrastructure. In particular, governments are

providing guarantees of minimum traffic for investment in transportation, protection for

private investment against inflation, and guarantees of minimum payments to investors

upon completion of construction. Ahead of the 2014 St. Petersburg International

Economic Forum, Ernst & Young conducted a survey regarding the investment

attractiveness of Russia’s infrastructure. The survey revealed that 68% of respondents

cited insufficient guarantees of ROIC as a key obstacle in attracting private investment

in infrastructure. The private sector is ready to invest in Russian infrastructure, although

it expects government assistance in reaching a required rate of return (at least for the

first projects), for instance, through the ‘availability payment’ mechanism.

Types of PPP

TYPE OF PARTNERSHIP DESCRIPTION WHO BEARS OPERATING RISKS UNDER PROJECT?

EXAMPLES

BOT: Build – Operate –Transfer or ВООТ: Build – Own – Operate – Transfer

A concession holder exercises construction and maintenance (mainly, on the right of ownership) within a set time frame, thereafter the object is transferred to the state.

State/investor Widely applied in India for road construction.

BTO: Build – Transfer – Operate

A concession holder constructs the object, to be transferred to state (concessor) ownership immediately after the completion of construction. Thereafter, the object is transferred to operation by a concession holder.

State/investor In Russia: construction of a section (334-543 km) on the Moscow – St. Petersburg toll road.

ВОО: Build – Own – Operate A concession holder builds the object and operates it under ownership rights; the time frame is unlimited.

Investor

This type of contract is widely spread in construction of cargo handling terminals at seaports as well as passenger terminals of airports.

O&M: Operations and Maintenance

Operations and Maintenance: a regulatory body signs a certain service provision and/or maintenance contract with a private company.

State In Russia: servicing of the federal М-4 Don highway (225-633 km)

BBO: Buy – Build – Operate

Buy – Build – Operate is a type of sale involving reconstruction or extension of an existing object. The state sells an object to a private sector that performs necessary improvements for efficient operation.

Investor

This type of partnership is widely used in Brazil, where the state arranges large-scale privatization of infrastructure objects: namely, motorways, airports and seaports. The Russian example is the privatization of energy assets held in the 2000s.

LDO or BDO: Lease –Develop – Operate or Build –Develop – Operate

A private company rents or buys from a regulatory body existing property/equipment, invests own funds in renovation and upgrade, and operates it pursuant to the terms of a contract signed with the

State

In Russia: Moscow government is currently in talks regarding the transfer of metro coaches (depots) to be serviced and upgraded by private investors.

0

20

40

60

80

100

120

140

160

180

200

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012

ENERGY TELECOMMUNICATIONS TRANSPORT WATER SUPPLY

42%

29%

27% 2%

ENERGY TELECOMMUNICATIONS

TRANSPORT WATER SUPPLY


JULY 15, 2014

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TYPE OF PARTNERSHIP DESCRIPTION WHO BEARS OPERATING RISKS UNDER PROJECT?

EXAMPLES

regulatory body.

Turnkey Turnkey construction. State Conventional building contracts.

DB: Design – Build A private company is in charge of design and construction under the project.

DBO: Design – Build – Operate

A single contract is signed for design, construction and operation.

Source: Gazprombank

Examples of investment tools used in various countries for infrastructure projects

China

China is the world’s largest investor in infrastructure, with the volume of investment over

the past 20 years averaging 8.5% of GDP. The bulk of investment is earmarked for motor

and railroad construction, as well as energy development. According to McKinsey, the cost

of Chinese infrastructure assets stands at 76% of GDP, exceeding the lowest

recommended threshold of 70%. It appears that in the coming years there will be a

shrinkage of investment in infrastructure to 6-7% of GDP, although it will remain at the

highest level globally at nearly $400 bln per annum, or 15% of the world total. Chinese

state banks, including China Development Bank, play the key role in financing Chinese

infrastructure, with the latter accounting for around half of local investment in infrastructure.

Top Chinese banks – key investors in the country’s infrastructure

NAME ASSETS, $ BLN DESCRIPTION

China Development Bank

1.220

Established in 1994 to finance China’s infrastructure projects. A 100% stake is owned by the state through the Finance Ministry. Bonds ($800 bln) account for more than 70% of the bank’s liabilities and are considered risk-free, as China’s Finance Ministry provides guarantees. In 2012, the bank placed $200 bln in yuan-denominated bonds (with a coupon rate of 3.85-4.75%), or half of China’s overall investment in infrastructure. The bank’s bonds account for 20% of China’s domestic bond market. Local companies and commercial banks are the major buyers of these bonds.

Industrial and Commercial Bank of China

2.837

China’s largest bank by size of assets. The state is a controlling shareholder, but some of the shares are publicly traded. Approximately 80% of liabilities are in the form of deposits, while the share of debt in the bank’s liabilities stands at below 2% ($40 bln). Around 15% of assets are in the form of infrastructure financing. In 2013, the bank allocated ca. $30 bln to infrastructure companies.

China Construction Bank

2.490 The major source of liabilities is retail deposits (nearly 80% of liabilities), while other types of borrowing account for only 8% ($240 bln). Around 15% of assets ($370 bln) are in the form of infrastructure financing.

Bank of China 2.276 Deposits account for approximately 70% of liabilities, while bonds comprise 15% ($360 bln, of which $280 bln is internal borrowing and $80 bln external).

Source: Gazprombank

High-speed railways — government financing prevails. Over the past 20 years,

China has created an extended railway network with a total length of 15,000 km

and maximum traveling speed of up to 350 km/h. To support and expand railway

infrastructure, state-run China Railways Corporation (the prototype of Russian

Railways), which owns the country’s entire railway infrastructure, uses various

sources of funding. In particular, 40-50% of the total investment needs come from

state banks and are guaranteed by the government (China Development Bank,

Industrial and Commercial Bank of China, and China Construction Bank), about

40% is in the form of CNY-nominated bonds, and the remaining 10-20% is ensured

by provinces through which the railroad will pass. China Railways is the world’s

largest transportation company, with assets exceeding $600 bln. The company’s

liabilities total about $460 bln, of which $170 bln are in the form of bonds. To build

the section of the railroad, a separate company might be created with a controlling

stake belonging to China Railways, while the remaining part will be sold to

investors, namely Chinese insurance and construction companies participating in

construction of this road.


JULY 15, 2014

12

According to an infrastructure report prepared by Ernst & Young, from 1997 to

2007 China conducted a six-stage campaign to increase train travelling speed. As

a result, construction of tunnels and bridges allowed for more declivity, the turning

radius was reduced and continuous welded rails were laid. In 1997, the total length

of high-speed tracks, where trains could pick up speed over 160 km/h, stood at

752 km. By 2007, their length was increased to 14,000 km. Following extended

discussion among experts on which type of high-speed train to choose – traditional

or maglev – in 2006 the PRC’s State Council chose the former (HSR). The next

stage was the development of the high-speed train series CRH (China Railway

High Speed), which ensured a further increase in travelling speed. In 2004, the

Railways Ministry announced a tender to supply 200 high-speed trains that could

conduct transportation services at a speed of over 200 km/h. Applications were

filed by such large companies as Alstom (France), Siemens (Germany),

Bombardier Transportation (Germany), and consortium of Japanese investors

headed by Kawasaki. As a result of the tender, contracts were signed with Alstom,

Bombardier and Kawasaki, while Siemens was not among the winners, as it

refused to lower the price for the trains and technology transfer. The following year,

Siemens reduced the price, which allowed it to win the tender to supply 60 trains to

conduct transportation service at a speed of 300 km/h. Each foreign manufacturer

adapted the supplied high-speed train to China’s unified standards. Train assembly

was performed either jointly or with the assistance of Chinese manufacturers.

Thanks to technological cooperation, Chinese engineers were able to design their

own high-speed trains, based on trains made by foreign manufacturers. Chinese

trains carry passengers from Beijing to Shanghai (1,463 km) in less than six hours,

i.e. twice as fast compared with previous-generation trains. High-speed trains also

allowed an increase in carrying traffic, resulting in higher capacity for the railway

transportation system. As high-speed trains used the same tracks as freight trains,

the only way to further increase the speed and capacity was to build high-speed

lines for passenger trains. Recently, China launched a campaign to build dedicated

high-speed tracks for passenger transportation.

Toll roads — private financing prevails. China embarked on active construction

of toll roads in the early 1990s. The total length of toll roads currently approaches

100,000 km, linking all provinces and major cities in China. Total investment

exceeded $260 bln ($2.6 mln/km). China's State Council and the Transport Ministry

approve projects and construction standards, while their implementation and

financing is performed by the administrations of involved provinces. Originally the

provinces financed up to 90% of road construction from their budgets and through

loans. Once construction is completed, the toll road is incorporated into the capital

of a new company, the shares of which are placed on an equity exchange among

international investors. Administrations spend the received money to build a new

road. Thus, currently about 45% of road construction funds are self-raised, namely

through the sale of shares via IPOs and cash flow from existing toll roads. The

remaining 40% of the investment is still provided by provinces (through loans) and

only 15% comes from the federal budget. Currently more than 15 such companies

with a total market capitalization of $53 bln ($115 bln inclusive of debt) are trading

on the Hong Kong Stock Exchange. Their distinguishing features are high margins

(EBITDA margins of 40-60%) and solid dividends. The average P/E multiple of

these companies for 2014 stands at around 10.0x, which is close to the average of

Hong Kong’s Hang Seng Index.


JULY 15, 2014

13

China’s publicly-traded companies – owners of toll roads

COMPANY TICKER MCAP, $ MLN. EV, $ MLN FREE FLOAT

CHINA COMMUNICATIONS CONSTRUCTION 1800 HK 10,361 25,246 100.0%

CHINA RAILWAY CONSTRUCTION 1186 HK 9,227 18,826 90.9%

CHINA RAILWAY GROUP 390 HK 9,181 30,711 90.9%

JIANGSU EXPRESS 177 HK 4,698 5,296 100.0%

ZHEJIANG EXPRESSWAY 576 HK 3,941 3,827 100.0%

SHANDONG HI-SPEED 600350 CH 2,277 4,338 12.7%

SHANGHAI TUNNEL ENGINEERING 600820 CH 2,142 4,415 35.5%

SHENZHEN INTL HOLDINGS 152 HK 2,090 4,541 47.4%

HOPEWELL HIGHWAY INFRASTRUCTURE 737 HK 1,474 1,470 29.2%

SICHUAN ROAD&BRIDGE 600039 CH 1,373 3,599 49.3%

SICHUAN EXPRESSWAY 107 HK 1,255 2,419 98.9%

SHENZHEN EXPRESSWAY 600548 CH 1,163 2,710 14.9%

JIANGXI GANYUE EXPRESSWAY 600269 CH 1,045 2,058 46.2%

ANHUI EXPRESSWAY 995 HK 1,037 1,490 95.0%

FUJIAN EXPRESSWAY DEVELOPMENT 600033 CH 932 2,427 44.7%

YUEXIU TRANSPORT INFRASTRUCTURE 1052 HK 850 2,028 100.0%

Total

53,047 115,400

Source: Bloomberg

China’s high-speed railroads financing breakdown China’s toll roads financing breakdown

Source: World Bank Source: World Bank

India

Over the past 20 years, India’s investment in infrastructure has averaged 5% of GDP,

which was insufficient given the country’s average annual GDP growth rate of 7%.

Under the new five-year development plan (2013-17) the Indian government has

decided to double the amount of investment vs. the previous plan to $1 trln, or $200 bln

annually (10% of GDP). The bulk of investment will focus on transportation (35%),

utilities (34%) and telecommunications (17%). This is the most ambitious plan to

stimulate the economy among developing countries, although it is unlikely to be fully

implemented due to a shortage in funding of about $300 bln. The Indian government

plans to provide 53% of the required investment, 25% of which will be covered from the

state budget ($250 bln), 11% will come from extra-budgetary sources, and 17% through

public borrowings. The remaining 47% is comprised of private investment, including

40%

40%

10%

STATE BANKS BONDS REGIONAL BUDGETS

15%

40%

45%

STATE BUDGET BORROWINGS INTERNAL FINANCING (IPO, CASH FLOW)


JULY 15, 2014

14

15% from investors’ own funds and 35% through borrowing. However, so far the

confirmed size of private investment amounts to ca. $300 bln.

China has offered India financial support and is prepared to invest the $300 bln shortfall

in the country’s infrastructure. China is apparently interested in engaging its construction

companies, equipment and materials. However, the Indian government is in no hurry to

accept the proposal, as a number of infrastructure sectors are considered strategic

(telecommunications, utilities) and do not allow Chinese capital.

Sources of funding implied by the plan (2012-17) Confirmed non-budgetary sources of funding (2012-17)

Source: Deloitte Source: Deloitte

Potential non-budgetary sources of funding for Indian infrastructure under the five-year

development plan until 2017 include the following:

Commercial banks. They could invest about $120 bln over the next five years,

accounting for 12% of the total investment required and 42% of all currently

available private investment.

Non-bank financial institutions ($64 bln; 22%). India has many specialized non-

bank financial corporations, targeting infrastructure investment. They are India

Infrastructure Finance Corporation (IIFCL), National Highways Authority of India,

Rural Electrification of India, Power Finance Corporation (PFC), and Indian Railway

Finance Corporation.

Insurance companies ($1 bln; 3%). Insurance companies that are not involved with

life insurance business are obliged to invest no less than 15% of their assets in

Indian infrastructure.

Key infrastructural financial organizations in India

COMPANY DESCRIPTION CAPITAL STRUCTURE

India Infrastructure Finance Company Limited (IIFCL)

A state-owned corporation established in 2006 to support infrastructure projects. The company participates in infrastructure projects as a co-investor, offering direct financing or providing guarantees to improve the credit quality of infrastructure bonds. The company also takes part in implementation of over 200 projects with a total value of $77 bln.

The company’s assets stand at $5.8 bln. The total value of bond placements amounts to $4.9 bln with a coupon of 8.0-8.9%. In 2013, the company issued loans and guarantees in the amount of $1.9 bln. The company’s bonds are not state-backed, although its ratings are at the sovereign level.

National Highways Authority of India (NHAI)

Government agency for road construction and management.

The state budget is the main source of financing for the agency. At the same time, the regulator has a small number of public loans totaling $2.5 bln carrying 7.4-8.3% coupon rates.

Power Finance Corporation State-run corporation that was specially created in order to attract investments to India’s electric power generation sector.

The Indian government owns 73% of the company’s shares, while free float accounts for the remainder. The company’s MCap stands at $4 bln. The overall number of loans (mainly public) stands at $24 bln with coupon rates ranging from 8.0-9.7%.

Rural Electrification Corporation Limited

State-run corporation specially created to attract investments into India’s power grid assets.

The Indian government holds 65% of the company’s shares with the remainder in free float. The company’s MCap stands at $5.5 bln. Public loans

24.8%

10.6%

16.5%

14.8%

33.3%

STATE BUDGET

NON-BUDGETARY FUNDS

PRIVATE INVESTMENTS

GOVERNMENT BONDS

INVESTORS' OWN FUNDS

42% 22%

8%

3%

25% COMMERCIAL BANKS

NONCOMMERCIAL FINANCIAL INSTITUTIONS

EXTERNAL BORROWINGS

INSURANCE COMPANIES

EQUITY FINANCING


JULY 15, 2014

15

COMPANY DESCRIPTION CAPITAL STRUCTURE

taken out by the company total $18.7 with coupon rates ranging from 8.0-9.7%.

Indian Railway Finance Corporation

Indian Railways’ 100%-owned subsidiary. The company attracts cash from the market to finance the purchases of equipment for subsequent lease to the parent company.

The company’s total assets stand at $12 bln, of which $11 bln are in the form of public offerings.

Infrastructure Development Finance Company

The company was established in 1997 as a government agency for financing various infrastructure sectors. Sometime after that, the company turned into a joint-stock company and offered its shares on the stock exchange.

The company’s total assets amount to $12 bln. The government owns 17% of the company’s shares, while international investors hold the remainder.

Indian Leasing and Financial Services

The company was established in 1987 by the central bank of India and a number of other state bodies. Later, Life Insurance Corporation of India, ORIX Corporation (Japan), and Abu Dhabi Investment Authority also became the company’s shareholders. The company attracts investment in India’s infrastructure facilities. It also builds and manages highways, energy facilities, ports, city infrastructure, and water delivery systems.

Total investments stand at around $25 bln. The major shareholders are Life Insurance Corporation of India (25.34%), ORIX Corporation (23.00%), Abu Dhabi Investment Authority (11.09%), Central Bank of India (8.34%), State Bank of India (6.98%), and ILFS Employees' Welfare Trust (13.65%).


In addition, the offerings of infrastructure bonds, the incomes from which are not taxed

(tax-free bonds), are widespread in India. The government sets an annual limitation on

such offerings. For example, the government allowed non-banking financial corporations

to issue only $9.2 bln in tax-free bonds in 2014; while private investors were allowed to

issue about $5.0 bln. Moreover, the government sets tax holidays for infrastructure

companies for a period of up to 10 years.

Total ivestments in India, $ bln Investment structure in India

Source: IBEF Source: IBEF

Railways. India has the world’s fourth-longest railway network. Daily passenger

traffic via this network amounts to 30 mln people (vs. about 3 mln passengers

travelling via Russian Railways’ network per day). In 2013, Indian trains carried

about 1.0 bln tonnes of cargoes (vs. 1.2 bln tonnes in Russia). State-run Indian

Railways owns the entire railway infrastructure. The new government development

plan for 2013-17 envisages that investments in railway infrastructure will increase

by 2.5 times to $100 bln. However, investments for 2014 are planned at $12 bln,

which is comparable with Russian Railways’ capex. About 40% of the company’s

investment is financed by the state budget, 30-35% is allocated from company’s

net income and borrowing, and the remaining 25-30% is attracted from additional

sources, including around $1 bln from private investors. Indian Railways includes a

special investment unit called Indian Railway Finance Corporation, which focuses

on attracting private investment. The unit’s assets amount to $12 bln. The

investment company mainly uses the attracted funds to finance the purchases of

locomotives and rail cars, which are subsequently leased out to its parent company

Indian Railways. In early 2014, the company placed several bond tranches

denominated in Indian rupees totaling about $5 bln. The maturity of the bonds was

set at 10-15 years and the coupon rates ranged from 8.2-8.6%. That said, these

0

10

20

30

40

50

60

2009 2010 2011 2012 2013 2014 2015 2016 2017

HIGHWAYS RAILWAYS

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2007 2008 2009 2010 2011 2012

PRIVATE PUBLIC % OF GDP


JULY 15, 2014

16

bonds were not subject to income tax. In addition, the Indian government is

allowing an increasing number of private investors to take part in projects for the

construction of railway infrastructure facilities, i. e. depots, storage facilities, railway

stations, and even special separate rail lines approaching ports in order to speed

up the elimination of existing bottlenecks. Construction of the Western and Eastern

railway corridors with a total length of 3,300 km is now one of the main

infrastructure projects in India. The implementation of this project is to be

completed in 2017, and should increase cargo turnover throughout the country.

Total investments in the project amount to $16.7 bln.

Highways. India has the world’s second-largest highway network (4.7 mln km).

More than 60% of cargoes are carried throughout the country via highways. The

development of a highway network is one of the top priority tasks of the Indian

government. Under the public private partnership, over 50% of private

investments are allocated for highway construction. The bulk of investments are

conducted under the “build-operate-transfer” principle, which envisages a private

investor (or consortium of investors) building a road and using it for 20-30 years,

with the investor eventually returning the road to the government. The Indian

government supports investors by allocating special grants for road construction

(up to 40% of the project value). The Indian government also awards

infrastructure projects with 100% tax holidays over the first five years and 30%

holidays for the following 30 years.

Brazil

The Brazilian experience of attracting private investment to the infrastructure sector is

quite interesting, although it still cannot be recognized as very successful. Since the

mid-1990s, the country’s authorities have demonstrated their commitment to mass

privatization and concession of infrastructure facilities. As a rule, an investor that is

ready either to pay the maximum price for an asset, or to set the minimum tariff for use

of the infrastructure, is selected as the winner in the privatization of roads, airport and

postal terminals. However, Brazil’s infrastructure sector is still poorly developed. The

country was ranked 114th out of 148 countries rated by the Global Competitiveness

Index (GCI), and total investment in Brazilian infrastructure does not exceed 1.5% of

GDP. The main problem involves the high political and economic risks and quite low

returns on investment (ca. 6%). The country suffers from complex and lengthy

bureaucratic procedures, which considerably impede the implementation of

infrastructure projects and decrease returns on private investment.

Projects involving the construction and management of highways and railways offer low

returns on investment. However, investment in airport and seaport infrastructure

remains quite attractive. For example, the Singapore port operator Changi and Brazilian

construction company Odebrecht recently offered $8.2 bln on the tender to get the

airport in Sao Paulo in concession, which is four times the initial price of the tender.

In contrast to China and India, Brazil suffers from a lack of government bodies that

support and attract investment in the infrastructure sector. The Brazilian Development

Bank is the only such organization with assets exceeding $300 bln. However, the

efficiency of the bank’s efforts to develop the country’s infrastructure sector is unclear,

as the bank also supports other branches of the economy, i. e. social, education, and

healthcare sectors, small businesses, environmental projects, etc. Each year, the bank

invests $80-90 bln in the Brazilian economy, of which 35-40% is comprised of

investment in infrastructure projects.

A few years ago, in an effort to attract more private investment to the infrastructure

sector, the Brazilian government set the terms for an offering of special infrastructure

bonds, which must meet the following criteria:

The funds raised via the bond offering must be only used to finance the company’s

investment program;


JULY 15, 2014

17

The minimum maturity is four years;

The bonds carry a fixed coupons or coupons linked to inflation rates;

The bonds can be redeemed ahead of schedule no earlier than two years after the

bond issuance;

Proceeds from the bonds are not subject to tax (earlier the income tax stood at

6%).

The Brazilian government expects that the bonds will generate up to 10-20% of total

investment in the infrastructure sector. However, Brazilian companies still unwillingly

use infrastructure bond offerings as a low-cost way to attract investment, since such

borrowings remain expensive. Only a few companies have thus far placed infrastructure

bonds with inflation-linked coupons ranging between 9.5-14.0%.

US

According to the American Society of Civil Engineers (ASCE), US demand for

investment in economic infrastructure amounts to about $3 trln for the period through

2020, or more than $400 bln annually. However, because of efforts to reduce the

country’s budget deficit, the planned investment (both public and private) in the

infrastructure sector turned out to be far below the real needs standing at $1.8 trln

through 2020, or around $220 bln annually (less than 2% of GDP). The decrease in

investment in US’ infrastructure is a matter of great concern in that country. Some

experts believe that capital that was earlier withdrawn from the country could become an

additional source of investment in US infrastructure. Lawmakers have suggested

exempting capital returned to the country from taxes, while obliging to invest these funds

in US infrastructure bonds.

The bulk of investment will be shared between two infrastructure segments – highways

(61%) and energy (36%).

Highways. Road construction and reconstruction is financed through the Highway

Trust Fund, mainly replenished with proceeds from fuel excises at a level of 18.3

cents/gallon. The fund’s annual income stands at around $45 bln, but these

proceeds fail to cover its expenses. The major issue is that given the flat level of

inflation, excises have not been raised for the past 20 years, while the growing

number of cars has been accompanied by diminishing fuel consumption, which has

a negative impact on the fund’s financials. Each state is entitled to set its own fuel

levy in order to arrange financing of regional roads. Alaska has the lowest size of

26.4 cents, while New York enjoys the highest rate of 69.6 cents. US fuel levies

average 48.8 cents, or 13.3% of the average retail price of a gallon of gasoline.

Railways. The particularity of the US railway infrastructure is that the segment is

wholly owned by private railway operators, who mainly focus on cargo

transportation (53% of total turnover throughout the country), while passenger

transport accounts for a minimal share.


JULY 15, 2014

18

CURRENT STATUS OF RUSSIA’S INFRASTRUCTURE NEEDS

In 2013, Russia ranked 93rd among 148 countries by the quality of its infrastructure in the

rating of the Global Competitiveness Report 2013-2014, which is calculated by the World

Economic Forum (up eight positions compared to the previous year). Incidentally, this

rating is based on the opinions of entrepreneurs who do not always have a clear picture of

the actual status of the quality of infrastructure in the country. For example, oddly enough

Russia ranks 138th in terms of the Road Quality Index, coming between the Republic of

Chad and Yemen, which seems ridiculous. By the quality of its railroads, Russia ranks

38th, trailing such countries as Finland (6th) and Singapore (10th), countries where a

railroad system barely exists. Moreover, in terms of overall quality of infrastructure, other

CIS countries, including Kazakhstan and Ukraine, rank considerably higher than Russia –

in 64th and 70th position, respectively. Given that this index is overly subjective and does

not reflect the actual status of infrastructure, we believe that the country’s dynamics in the

index over a number of years is of greater relevance, as it is capable of a capturing trends

and conveying changes in the quality of infrastructure.

Russia's position in the rating of countries in terms of the quality of infrastructure

Source: World Competitiveness Index

Changes of Russia’s position in the rating of infrastructure quality

RUSSIA 2008 RUSSIA 2012 RUSSIA 2013 CHINA 2013 BRAZIL 2013 INDIA 2013

Overall quality of infrastructure 81 101 93 74 114 85

Quality of roads 106 136 36 54 120 84

Quality of railroads – 30 31 20 103 19

Quality of seaport infrastructure 72 93 88 59 131 70

Quality of airport infrastructure 79 104 102 65 123 61

Source: World Competitiveness Index

1 2 3 6 10

14 15 19

23 25 28 34

41 45

51

61 64 70

74 82 85

93 98 101

106 114

120

137

0

20

40

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160

SW

ITZ

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D

HO

NG

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FIN

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FR

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JULY 15, 2014

19

Russia’s infrastructure investment needs total at least 4% of GDP. Large-scale

investments are required in virtually all infrastructure segments, including highways and

railroads, power grids, water supply, telecommunications, ports and airports. According

to estimates by McKinsey, Russia spent an average 3.4% of GDP on infrastructure from

1999 through 2011. This figure is broadly in line with our own estimates. By comparison,

global infrastructure investments during this period averaged 3.8% of GDP (3.1% in

developed countries and 5.5% in developing countries). However, going forward the

volume of investments would have to be raised to at least 4% of GDP in order to

maintain domestic infrastructure in good shape and secure its harmonious expansion in

line with GDP growth. Thus, assuming that average annual GDP grows by 2.5% until

2030, the total need for infrastructure investments in Russia during this period would be

RUB 60 trln ($1.7 trln), or about $100 bln per year.

Planned infrastructure spending in Russia will be about 3.6-4.2% of GDP until

2020. In order to assess the magnitude of planned infrastructure investment in Russia,

we analyze a large number of federal target programs spearheaded by the RF

government, Russia’s transport strategy until 2030, federal spending and regional

infrastructure budgets, as well as the investment programs of natural monopolies

(Gazprom, Transneft, Russian Railways), and of companies that invest in infrastructure

(mainly in power engineering and telecommunications). On the basis of these

documents and our calculations, about 3.6-4.2% of GDP will be spent on infrastructure

projects or RUB 3.2-3.6 trln per annum ($90-100 bln), roughly on par with investments

by large developed countries. Infrastructure investments will reach RUB 22.5 trln, or

about 2.2% of global infrastructure investments by 2020. These resources should suffice

for moderate expansion of domestic infrastructure (including highways and railroads), to

raise its quality and efficiency, but would not be enough for accelerated expansion

compared to Russian economic growth. For this reason, many infrastructure restrictions

will remain in place in the country.

A distinguishing feature of investments in the Russian economy is the large proportion

of spending on construction and servicing of pipeline transport. The main investors here

are Gazprom and Transneft, which will sink at least RUB 800 bln per year into

infrastructure by 2020. The structure of Russia’s infrastructure spending, as is the case

in most countries around the world, is dominated by investments in transportation

infrastructure (55%), mostly for the expansion of highways (45%), whereas pipeline

transport investments come second with a proportion of 25%. The other 20% includes

investments in telecommunications, power grids (investments in generating assets are

not classifiable as infrastructural according to our classification) and public utilities

(mainly water supply; housing maintenance and repair are also not regarded as

infrastructure investments).

The RF president and government are aware of the importance of raising

infrastructure investments, since this is one of the key factors stimulating

economic growth in the country. Specifically, the president tasked the government

with expanding infrastructure in a number of areas over the coming decade, as follows:

Double the construction of federal highways from 2013 through 2022 compared

with 2003-12.

Expand the total length of federal highways compliant with statutory requirements

and transport operating standards to 44,000 km (83% of total infrastructure).

Increase the aggregate cargo handling capacity of Russian seaports by 302 mln

tonnes (port capacity currently stands at 800 mln tonnes).


JULY 15, 2014

20

Estimated key directions of investments in Russia’s economic infrastructure (less VAT), RUB bln

2010 2011 2012 2013 2014E 2015E 2016E 2017E 2018E 2019E 2020E

Transport (less pipes) 820 993 1,390 1,572 1,346 1,576 1,912 2,037 1,894 1,775 1,760

% of total 39% 37% 52% 55% 49% 51% 55% 56% 56% 56% 58%

Pipes 689 991 632 657 764 869 861 887 848 752 671

% of total 33% 37% 24% 23% 28% 28% 25% 25% 25% 24% 22%

Power grid system* 235 311 283 279 275 265 270 268 214 207 202

% of total 11% 12% 11% 10% 10% 9% 8% 7% 6% 7% 7%

Telecommunications 322 381 355 335 348 342 350 349 342 351 358

% of total 15% 14% 13% 12% 13% 11% 10% 10% 10% 11% 12%

Public utilities** 18 19 27 32 40 54 59 74 58 62 66

% of total 1% 1% 1% 1% 1% 2% 2% 2% 2% 2% 2%

Total 2,083 2,696 2,687 2,875 2,774 3,106 3,453 3,615 3,356 3,147 3,057

As % of GDP*** 4.5% 4.8% 4.3% 4.3% 3.9% 4.1% 4.2% 4.0% 3.4% 3.0% 2.8%

Source: Gazprombank

* we do not include power generating assets in infrastructural investments

** we consider mainly investments in water supply, but not in house repairs

*** declining investments to GDP ratio after 2018 is attributable to completion of large-scale infrastructural pipelines, although we do not exclude the likelihood of emergence of new projects

Russia’s transport infrastructure: rapid growth or concurrent expansion?

The vast expanse of Russian territory clearly reveals the need of households and

companies for advanced and reliable transport infrastructure. The country’s total

territory is equal to 17 mln km2, with the maximum length from West to East reaching

about 10,000 km (by comparison, Canada, the world’s second-biggest country, is about

half as big). By virtue of the large distances and export orientation of the Russian

economy, the proportion of transportation expense in the cost of production of some

companies can reach 30%, which means that having an efficient transport system

makes these companies competitive on the global market. In terms of the Logistic

Performance Index, Russia ranks 94th among 155 countries. This index is tracked by

the World Bank, which factors in the quality of transportation infrastructure, customs

procedures, ease of delivering consumer goods, and a number of other criteria. The

mobility rate of Russia is also considerably lower than in developed countries, and this is

a key factor in the expansion of employment and tourism, growth in income and

spending, and, consequently, the overall economic development of the country.


JULY 15, 2014

21

Logistics performance index, 2013 Population mobility index

Source: World Bank Source: Gazprombank

Transportation costs of Russian companies are higher than in developed

countries. In the USSR, there was a powerful transport infrastructure, which, until

recently, was more or less capable of meeting the needs of Russia’s rapidly growing

economy. However, traffic handling capacity in the most developed areas has peaked in

recent years and is essentially no longer capable of coping with growing demand. This

situation has given rise to massive traffic jams (average speed on downtown Moscow

roads is 20 kph, compared to 40 kph in large European cities); it has also created

bottlenecks on railroads and reduced the speed of rolling stock (average speed of

freight trains decreased by 12% to 300 km per day in 2013).

Dynamic of Russia's cargo turnover, bln t/km Growth index of infrastructure indicators

Source: State Statistics Service Source: State Statistics Service, Gazprombank estimates

The rate of investments in development of Russia’s transport infrastructure is

already close to that of developed economies, about 3% of GDP. These funds are

sufficient for moderate expansion, but are insufficient for qualitative

improvement. Countries with developed infrastructure spend an average 2.5-3.0% of

GDP per year on maintenance and development, in line with World Bank

recommendations. According to our estimates, Russia also spends about 3% of GDP,

including investments in pipeline transport. Net of that item (only highways and

railroads, airports and ports), the proportion of GDP spending has reached 2.3% in

recent years, although it was less than 1% in the mid-2000s. There is no point in

comparing Russia with China or India, where spending on transport infrastructure is

considerably higher, as these countries frequently create infrastructure from scratch,

whereas Russia went through this phase during industrialization in the 20th century.

1 2 3 4 5 9 10 13 16 24 28

35 42

50 54 65

71

88 90 99

125 135

149

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ZA

KH

ST

AN

RU

SS

IA

BE

LAR

US

AZ

ER

BA

IJA

N

MO

NG

OLI

A

KY

RG

YZ

ST

AN

0.5 0.4

2 2.2 2.9

4

0.27

1.4 1.6

0.5 0.4

0.3

0.8

0.32

0

1

2

3

4

5

6

ITA

LY

FR

AN

CE

US

EU

UK

TU

RK

EY

RU

SS

IA

INTERNATIONAL FLIGHTS PER 1 PERSON DOMESTIC FLIGHTS PER 1 PERSON

0

1,000

2,000

3,000

4,000

5,000

6,000

7,000

1970

1980

1991

1993

1995

1997

1999

2001

2003

2005

2007

2009

2011

2013

BY CARS BY INTERNAL WATER TRANSPORT

BY AIR TRANSPORT BY RAILROAD

0

50

100

150

200

250

2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013

CARGO TURNOVER PRIVATE CARS PER 1,000 PEOPLE FEDERAL ROADS RAILWAYS PIPES


JULY 15, 2014

22

Investments in transport infrastructure, % of GDP

Source: McKinsey, Gazprombank

* including pipeline transport

** excluding pipeline transport

Plan of development for transport infrastructure until 2020

Russia has a large number of detailed federal and regional special-purpose programs

devoted to the development of transportation infrastructure. These programs provide

detailed overviews of infrastructure projects and deployment costs, but no reference is

made to clear-cut sources of funding. Furthermore, these programs incorporate a

plethora of expenses unrelated to infrastructure issues (for example, passenger air

traffic subsidies, purchase of locomotives, and rolling stock for the railroad industry, as

well as construction of vessels). As a result, programs are often revised and

underfinanced. Nonetheless, they make it possible to analyze the dynamics of industry

development, pinpoint key investment areas, determine their overall trends, and assess

the priorities and status of large projects. The above programs can be summed up as

follows:

Federal Special-Purpose Program Upgrade of the Transport System of Russia 2010-

2020

Transport Strategy until 2030

Federal Budget Spending for 2014 and Subsequent Years

Regional Budgets Spending for 2014 and Subsequent Years, Including Moscow and

St. Petersburg

Investment Programs of Natural Monopolies: Russian Railways, Gazprom, Transneft

and State Company Russian Highways (Avtodor)

In order to assess the size and dynamics of the transport infrastructure market, we

made a number of adjustments to these programs by excluding all expenditures that are

not directly related to infrastructure (for example, subsidization of passenger air travel),

and adjusted them for VAT (18%). We also adjusted some programs downward, since

none of them has been 100% executed. The average implementation rate of federal

programs is 85-90%, while the fulfillment of regional programs is even worse. According

to our estimates, investments in transport infrastructure, not including pipeline transport,

have nearly doubled since 2010 and totaled about RUB 1.5 trln (net of VAT) in 2013.

The table below highlights the main growth factors.

2.3% 2.6% 2.8% 2.9% 3.0% 3.0%

3.3% 3.3% 3.4% 3.7%

6.0%

8.0%

0.0%

1.0%

2.0%

3.0%

4.0%

5.0%

6.0%

7.0%

8.0%

9.0%

RU

SS

IA**

JAP

AN

GE

RM

AN

Y

FR

AN

CE

US

A

RU

SS

IA*

UK

SW

ED

EN

CA

NA

DA

AU

ST

RA

LIA

IND

IA

CH

INA


JULY 15, 2014

23

Estimated aggregate investments in transport infrastructure, RUB bln

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Federal roads 238 296 375 428 427 495 640 714 664 732 791

Regional roads 308 360 548 620 448 470 493 518 544 571 600

Railroads 198 234 288 274 233 277 277 277 168 168 168

Moscow - Kazan Highspeed Railway 0 0 0 0 0 50 250 300 300 100 0

Metro 38 50 98 134 125 150 141 125 125 126 127

Airports 22 37 59 67 55 47 52 56 57 57 54

Sea ports 15 16 22 51 59 88 59 47 36 20 20

Pipes 689 991 632 657 764 869 861 887 848 752 671

Total 1,508 1,984 2,022 2,229 2,110 2,445 2,774 2,924 2,743 2,527 2,430

% of GDP 3.3% 3.5% 3.2% 3.3% 3.0% 3.2% 3.4% 3.3% 2.8*% 2.4% 2.2%

Less pipes 820 993 1,390 1,572 1,346 1,576 1,912 2,037 1,894 1,775 1,760

% of GDP 1.8% 1.8% 2.2% 2.4% 1.9% 2.1% 2.3% 2.3% 1.9% 1.7% 1.6%


* declining investments to GDP ratio after 2018 is attributable to completion of large-scale infrastructural pipelines, although we do not exclude the likelihood of emergence of new projects

Other large-scale projects follow the rollout of Olympic facilities in Sochi, but will

there be enough resources? We expect infrastructure investments to decrease by 5%

to RUB 2.1 trln this year compared to 2013 after the completion of the Olympic facilities,

due to sluggish economic growth and a decline in budget spending. The main reason for

the decline is a drop in regional road fund revenues (-24% YoY) due to deterioration of

economic conditions in the regions and higher budget deficits. Investments in transport

infrastructure could once again increase in subsequent years. The fact is that in the

wake of Olympic construction, there are a large number of projects which aim to build

toll highways and expand railroad infrastructure; the Moscow government is pouring

massive funds into expansion of the subway and major thoroughfares, and preparations

are being made to host the World Footfall Championship in 2018. Taking into account all

plans of the government and state-owned companies, the total volume of investments in

transport infrastructure should amount to RUB 18 trln (net of VAT) until 2020.

Admittedly, these estimates include such ambitious projects as the construction of the

Moscow-Kazan High-Speed Railway, with an estimated cost of RUB 1 trln, while the

decision on funding has not yet been adopted. On the other hand, up to RUB 1 trln

should be earmarked to upgrade infrastructure in Crimea, although these data have not

yet been factored into our estimates as the government will likely revise this figure

further down the road.


JULY 15, 2014

24

Aggregate investments in transport infrastructure, RUB bln (less VAT)


Breakdown of investments in transportation, 2014-20


Conservative and negative development scenarios are feasible for the transport

infrastructure market. There are not many sources that can be used to boost

infrastructure, so as a conservative scenario, we assume that the volume of investments

will remain unchanged at the level of 2012-13. After completion of the Olympic facilities,

the government and investors plan simply to reallocate part of the free cash flow toward

new facilities. A negative scenario could materialize in case of substantial deterioration

in macroeconomic conditions and a decline in budgetary revenues. This scenario could

pan out if there is a sharp decline in oil prices, say to $80/bbl or less. In such cases,

infrastructure expenses are the first to be cut (mainly to support social spending) and

the reduction could be as much as 25-30%. The same thing happened during the

economic downturn in 2009.

238 296 375 428 427 495 640 714 664 732 791 308 360

548 620

448 470 493

518 544 571 600

198 234

288 274

233 277

277 277 168

168 168

0 0

0 0

0 50

250 300

300 100 0

38

50

98 134

125 150

141 125

125 126 127

689

991

632 657

764

869

861 887

848 752 671

0.0%

0.5%

1.0%

1.5%

2.0%

2.5%

3.0%

3.5%

4.0%

0

500

1,000

1,500

2,000

2,500

3,000

3,500

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

FEDERAL ROADS REGIONAL ROADS RAILROADS MOSCOW - KAZAN HIGHSPEED RAILWAY METRO AIRPORTS SEA PORTS PIPES % OF GDP

25%

20%

9% 6%

5%

2%

2%

31%

FEDERAL ROADS

REGIONAL ROADS

RAILROADS

MOSCOW - KAZAN HIGHSPEED RAILWAY

METRO

AIRPORTS

SEA PORTS

PIPES


JULY 15, 2014

25

How will Russian infrastructure be funded and where will the resources come from?

There are quite a few sources of funding available for infrastructure programs, but they

will all experience difficulties in expanding their revenue base over the next few years.

The sources are as follows:

Federal budget

National Wealth Fund (NWF)

Regional budgets

In-house resources and funds borrowed by natural monopolies (Gazprom, Transneft,

Russian Railways) to implement investment programs

Budgetary resources, in-house resources and funds borrowed by state company

Avtodor

Pension funds

Private investors

Federal and regional budgets

Federal and regional funds account for over half of all transport infrastructure

expenditures until 2020. Federal budget spending goes toward the repair of federal

roads, regional subsidies for maintenance of regional roads, construction and

reconstruction of airport and port infrastructure (mainly runways, mooring berths and

to conduct dredging operations, i.e. areas where private investments are not

admissible). Regional budget spending is allocated toward construction and

reconstruction of regional and municipal roads and the development of public

transport, such as subways. Specifically, in 2013, consolidated budget spending on

roads (road funds) amounted to RUB 1.24 trln. We expect road fund expenditures to

decrease by 6% vs. 2013 to RUB 1.16 trln in 2014. In our opinion, actual road fund

revenues will be even lower, by at least 10% due to a decline in the revenue base of

regional budgets.

Moscow — largest investor in transport infrastructure

Moscow’s transport infrastructure is regarded as one of the most overloaded among

the world’s largest cities. About 20% of its inhabitants spend three hours or more on

the road per day, while the average speed of vehicle traffic flow does not exceed 20

km/h, or half as fast as in European cities. In 2010, municipal authorities launched

large-scale reconstruction of highways, the subway, and the ring railroad. In 2014,

municipal and federal budget spending will amount to about RUB 400 bln, or 30% of

all expenses in Russia on transport infrastructure (not including pipelines) and

Moscow’s Gross Regional Product (GRP). The government of Moscow expects to

invest over RUB 3 trln in infrastructure until 2020. The key large-scale project

involves expanding the Moscow Subway, which, at a total cost estimated at over

RUB 1.4 trln, will expand the total length of lines by 50% to 460 km, including the

deployment of 72 new stations. Investments also include 70% renewal of rolling stock

(to be funded on public-private partnership (PPP) terms. Another RUB 1.4 trln is

slated for investment in the expansion of the road network. This amount will be used

to build new roads (78 km) and reconstruct existing roads (400 km). The program

calls for construction of the Kutuzovsky Prospekt Northern Relief Road by raising

RUB 40 bln in private investments. Consequently, the transportation environment in

the city should improve significantly. The program is to be funded from the municipal

budget by tapping loans, selling property, and using the proceeds from excise duties

and taxes. Part of the funds will be appropriated from the federal budget.


JULY 15, 2014

26

Source of spending for transport infrastructure Breakdown of Moscow spending on transport infrastructure, 2014-20

Source: Gazprombank estimates Source: Moscow government

National Wealth Fund

The National Wealth Fund (NWF) could potentially spend up to 60% of its

resources (RUB 1.7 trln) on infrastructure projects. To stimulate economic growth,

the Russian government passed a resolution to use part of the NWF resources that

were formed through additional oil export revenues, for infrastructure investments. In

addition, 40% of NWF resources could be invested in any investment infrastructure

projects or deposited in Vnesheconombank, which also funds infrastructure projects.

Another 20% could be allocated for projects with the participation of the Russian

Private Investment Fund (RPIF) or Rosatom, that would each be assigned 10%, or up

to RUB 290 bln. In addition, part of these resources (RUB 474 bln) has also been

deposited in Vnesheconombank. So far, the allocation of RUB 300 bln from the fund

has been preliminarily approved for the implementation of two large infrastructure

projects: expansion of the Trans-Siberian Railroad and the Baikal-Amur Mainline as

well as the Central Ring Road in the suburbs of Moscow.

Meanwhile, another RUB 150 bln project targeting construction of the Moscow-Kazan

High-Speed Railway has been postponed. Perhaps funds will be channeled into

upgrade of the transport infrastructure in Crimea, including a bridge across the Kerch

Strait, with an estimated cost of RUB 200 bln. The Economy Ministry also plans to tap

NWF resources in such projects as expansion of the Moscow Aviation Hub,

development of the Elegest coal field, construction of the Elegest-Kyzyl-Kuragino

railroad, construction of smart power grids, expansion of the Baikal-Amur Mainline and

Trans-Siberian Railroad, and construction of the Khankhikivi-1 NPP in Finland.

State monopolies: Russian Railways, Gazprom, Transneft and Avtodor

These companies will account for about 40% of all investments in transport

infrastructure in 2014-20. The bulk of these funds will be expenditures incurred by

Gazprom and Transneft for pipeline construction. According to the investment programs

of both monopolies, their infrastructure outlays can be expected to rise in the coming

years, due to the construction of South Stream and Power of Siberia. On the other hand,

the government insists that the monopolies cut their expenses and freeze their tariffs,

which means that some investment programs could be reduced in comparison with the

previous years.

Pension funds

In many countries, pension funds act as the main source of funding for long-term

infrastructure projects. However, these resources are still quite small in Russia given

that the Pension Fund is running a deficit, so their further accretion would appear to be

dubious. As of end 2013, the cumulative component of the Pension Insurance Fund (at

the disposal of a state management company and private management companies)

32% 30% 28% 29% 32% 37% 41%

22% 21% 19% 18% 20%

23% 25% 2% 2% 10% 12% 14%

7% 3%

44% 42% 38% 37% 34% 33% 31%

0%

20%

40%

60%

80%

100%

120%

2014 2015 2016 2017 2018 2019 2020

FEDERAL BUDGET REGIONAL BUDGETS

NATIONAL WEALTH FUND PRIVATE INVESTORS

NATURAL MONOPOLIES

1,408; 44%

1,445; 45%

357; 11%

METRO

STREETS AND ROADS

RAILROADS

RUB 3,210 BLN


JULY 15, 2014

27

stands at about RUB 2.8 trln, or only 4% of GDP. These resources are invested in

bonds of Russian issuers (21.6%), state bonds (43.7%) and deposits (22.1%). By

comparison, pension accruals amount to 15% of GDP in Brazil, 60% in Chile, 74% in the

US and 160% in the Netherlands.

Further growth of the cumulative component of pension funds is complicated by the fact

that the Pension Fund is running a deficit. The most recent reform of the domestic

pension system at end 2013 led to a decrease in mandatory contributions to the

cumulative part of pensions from 6% of payrolls to 2%. As a result, the inflow of new

accruals into pension funds will slow down to a minimum and will hardly become a new

source for funding infrastructure.

Value of assets in which pension savings are invested, RUB bln Breakdown by types of assets in which pension savings are

invested, 2013

Source: Finance Ministry Source: Finance Ministry

Private investments

Given the deficit of budget funds and the Pension Fund, private investments

remain the only potential source capable of increasing infrastructure spending.

Up to RUB 1.4 trln of private investments could be required until 2020, or about 8% to

fund all of the planned transport infrastructure projects until 2020. Not including

construction of the Moscow-Kazan High-Speed Railway, the need for private

investments decreases to RUB 750 bln before 2020, or 4% of total investments.

Private investors are currently investing resources in segments of transport

infrastructure with the highest return on invested capital, mainly in ports and airport

terminals. However, interest has been rising recently in road concessions due to the

attractive long-term returns, which could amount to 10-17% of invested capital.

According to estimates by Avtodor, investors will sink about RUB 370 bln into road

concessions until 2020. The preliminary construction cost of the Moscow-Kazan High-

Speed Railway is up to RUB 1 trln (net of VAT), while only half of the funding has been

secured so far, and the other half is to be financed by private investors. Construction of

Yamal-based Sabetta Port is underway, where private investments amount to about

RUB 25 bln. Construction of cargo terminals is underway at Ust-Luga and Taman, while

Far East ports are being expanded. The government of Moscow intends to actively raise

private investments to fund municipal infrastructure, including the construction of parking

lots, servicing of subway cars and building of toll roads. Assuming that all announced

investment projects are completed on schedule, the volume of private investments could

increase from an expected RUB 87 bln in 2014 to RUB 400 bln in 2018. However, in

practice such marked growth is quite unlikely. The implementation of some of these

projects will most likely be rolled back, and some will simply be downsized.

0

500

1000

1500

2000

2500

3000

2006 2007 2008 2009 2010 2011 2012 2013

5.9%

22.1%

43.7%

21.6%

2.0% 4.7%

CASH

DEPOSITS

STATE SECURITIES

CORPORATE BONDS

SHARES

OTHERS


JULY 15, 2014

28

Estimated need for private invwestments to finance transport infrastructure, RUB bln


Degree of attractiveness of infrastructure objects for investors

SECTOR INVESTMENT ATTRACTIVENESS

COMMENTARY

Port infrastructure (containers and grain terminals)

High Investment in expansion of port infrastructure, in particular the construction of containers and grain terminals, is the most attractive, in our view. The payback period for such projects may be 5-7 years, assuming the territory is prepared for terminals construction.

Airport passenger terminals

High

Passenger terminals of large airports with passenger flow of at least 1 mln per year are attractive. Essentially, these comprise commercial real estate that concentrates a large number of passengers with high income levels, which allows the setting of high rental rates. Moreover, airports in Russia occupy a virtual monopoly position in a given region.

Road concessions Medium Investment in road infrastructure through concessions is considered more risky than in port or airport terminals. They require closer cooperation with the government and are more dependent on changes in the macroeconomic environment.

Port terminals (commodities)

Medium Most commodity port terminals in Russia are owned by large commodity companies that aim to control the entire transportation chain and their transportation expenses.

Railroad concessions Low In Russia, private investors do not invest directly in railroad infrastructure, but global practice shows that the attractiveness of investment in railroad concessions is relatively low due to excessive capex and a long payback period.


Russian roads: fighting ‘disaster’ brings noticeable results

Over 50% of total investments in transport infrastructure is comprised of road

construction and maintenance. After decades of underfunding in road construction,

the situation is gradually improving. Road funds have been restored, they are receiving

higher state budget funding, and fuel excise taxes are being hiked, but the most

important is the evolving public-private partnership (PPP) in road concession

agreements, which is becoming more attractive for investors with each year. Thus, for

instance, unlike previously when 1-2 local contractors participated in tenders for

sections of the Moscow – St. Petersburg toll road, now 3-4 companies are participating

in new tenders for construction of other sections of the road. Bridge construction over

the Lena River was contested by two consortia with the support of foreign construction

companies (China Construction Corporation and Vinci).

We refer to the consolidated federal budget, which provides data on the size of federal and

regional road funds. Since 2010 they have more than doubled to reach RUB 1.2 trln in

2013, accounting for nearly 2% of GDP. This is substantially lower than China’s spending

on road construction, but much higher than the developed markets’ level of less than 1%

of GDP. By our estimates based on forecasts of the federal special-purpose program

‘Development of the Russian transportation system until 2020’, investments in road

construction and reconstruction in 2014-20 may total around RUB 8.4 trln (adjusted for

18% VAT and 90% performance of the target).

70

239

376 380

237

87 70 70

114

151 155

102 87

70

0

50

100

150

200

250

300

350

400

2014 2015 2016 2017 2018 2019 2020

INCLUDING CONSTRUCTION OF MOSCOW - KAZAN HIGHSPEED RAILWAY

EXCLUDING CONSTRUCTION OF MOSCOW - KAZAN HIGHSPEED RAILWAY


JULY 15, 2014

29

Road funds, RUB bln

Source: Finance Ministry, consolidated state budget for 2010–13

In 2014 a 100% normative funding of federal road repair and maintenance will be

launched, also via introduction of charges for heavy haul vehicles. Russia has a

three-level road network including federal, regional and municipal roads. The total length

of federal roads is 51,000 km, or only 5% of the overall network (1.1 mln km), however

these are precisely the key routes for cargoes and support liaison between regions. The

government’s primary goal is deep reconstruction and adjustment of these roads to

normative levels. We anticipate that total investments in federal road reconstruction will

reach nearly RUB 430 bln in 2014 and stand at around RUB 800 bln by 2020. According

to the federal special-purpose program outlook, road construction volumes will grow

from 566 km this year to 1,345 km in 2020. Federal road financing comes from the

federal road fund, which accumulates federal budget funds as well as 28% of fuel excise

tax proceeds. A potential decline in budget income caused by a drop in oil prices could

hinder the government’s plans. As a rule, budget funding of infrastructure objects would

be the first to get cut in this case.

One of the additional sources of federal road funding will be the introduction of charges

for the passage of heavy-haul vehicles (total weight of over 12 tonnes) along federal

roads. The underlying idea is that heavy trucks cause the most severe damage to roads,

and therefore they are required to offset repair costs. The charge is expected to stand at

RUB 3.5/km and will be adjusted for inflation annually. This will facilitate the

accumulation of over RUB 100 bln annually in the federal road fund. The project was

initially expected to kick off in 2014, but was later rescheduled for 2017, as the

controlling and levying mechanisms are still pending. There were numerous

postponements of the tender date to develop digital controlling and levying systems, but

it will likely finally be determined this year.

Target indicators of Russia’s motor roads

TAREGET INDICATORS OF RUSSIA’S ROADS DEVELOPMENTS

2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020

Length of federal roads, compliant with normative requirements, km

19,545 19,755 21,098 23,225 26,923 31,561 36,505 41,501 44,085 45,362 46,040

Share of length of federal roads, compliant with normative requirements, %

39% 39% 42% 46% 53% 62% 71% 79% 83% 85% 85%

Construction and reconstruction of roads of federal importance, km

411.9 309.6 355.2 451.5 566.2 652.5 734.2 1159.5 1296.7 1199.1 1344.8

Source: Federal special-purpose program

281 349 442 504 508

364

425

646

731 554

98%

93%

91%

96% 96%

89%

86%

83% 84% 84%

75%

80%

85%

90%

95%

100%

0

200

400

600

800

1000

1200

1400

2010 2011 2012 2013 2014E

REGIONAL ROAD FUNDS

FEDERAL ROAD FUND

PERFORMANCE OF FEDERAL ROAD FUND TARGET, %

PERFORMANCE OF REGIONAL ROAD FUNDS TARGET, %


JULY 15, 2014

30

Reconstruction of regional roads: money is expected from fuel excise tax hike,

but will it actually happen? The total length of regional roads is about 450,000 km,

while their quality differs strikingly depending on the region. Regional roads are financed

from regional road funds accumulating transport tax gains, the lion’s share of fuel excise

tax gains (72%), as well as federal budget subsidies. The government has approved a

fuel excise hike schedule until 2016 with a breakdown into various fuel types that is

expected to lead to an increase in road funds. An excise hike, however, will cause

gasoline price to increase on average by RUB 1-3 for end consumers, which might

trigger public disapproval. The problem might be exacerbated in case of ruble

devaluation and an oil price increase leading to more expensive gasoline, even if an

excise hike does not occur. Moreover, the government intends to conduct a tax

maneuver in the oil and gas sector, which will change the road funds funding pattern via

fuel excises. In 2013, proceeds from regional road funds were planned at RUB 867 bln

(+12% YoY), while the actual figure missed the target by 16%, standing at RUB 731 bln.

The consolidated budget for 2014 specifies a 24% decline in regional road funds

proceeds (to RUB 658 bln) amid a serious deterioration of the regional economy, a

reduction of budgetary earnings as well as the need to allocate fuel excise proceeds to

other projects. Notably, the share of excises in the price of 1 liter of gasoline in Russia

does not exceed 17% vs. almost 50% in Western Europe.

Fuel excise dynamic, RUB/tonne

Source: Gazprombank

0

2,000

4,000

6,000

8,000

10,000

12,000

14,000

LOWER THAN CLASS 3 CLASS 3 GASOLINE CLASS 4 GASOLINE CLASS 5 GASOLINE CLASS 5 DIESEL

SINCE JAN 1,2012 SINCE JUL 1, 2012 SINCE JAN 1,2013

SINCE JUL 1, 2013 SINCE JAN 1,2014 SINCE JAN 1,2015


JULY 15, 2014

31

Avtodor: road concessions promise high yields

Federal Road Agency Avtodor will raise over RUB 300 bln in private

investments via road concessions until 2020. In 2009, the government founded

the state corporation Avtodor, which focuses on forming the backbone high-speed

federal road network and solicitation of private investors. Avtodor assumed control

over three existing federal roads: М-4 Don (Moscow – Novorossiysk), М-1 (Moscow

– Russia-Belarus border) and М-3 (Moscow – Russia-Ukraine border) with a total

length of 2,500 km. The corporation is currently engaged in large-scale

reconstruction of these roads, leading to an increase of the speed limit on some

sections from 90 km/h to 150 km/h. At the same time, some previously toll -free

sections have become toll-ways (where a toll-free alternative is feasible). The

average fee on these sections approaches RUB 1.5-2.0/km for passenger cars,

which is cheaper than in Europe. Avtodor is also responsible for the construction of

new high-speed toll-roads: Moscow – St. Petersburg (total length of 670 km) and

the Central Ring Road of Moscow Region (total length of 521 km). Both

constructions should be finalized before the 2018 FIFA World Cup, which basically

guarantees priority financing vs. other transport sector projects. The overall

construction cost exceeds RUB 600 bln. Both roads should substantially raise the

transportation efficiency of Russia’s central part while also contributing to the

development of transportation corridors.

Existing and prospective roads managed by Avtodor

Source: Avtodor

UFA

TULAKIROV

TVER

STAVROPOL

ARKHANGELSK

KURGAN

OREL

PSKOV

MURMANSK

VOLOGDA

KOSTROMA

PETROZAVODSK

NOVOROSSIYSK

SYKTYVKAR

VELIKY NOVGOROD

VORONEZH

SARATOV

IZHEVSK

YAROSLAVL

MOSCOW

ST. PETERSBURG

MAKHACHKALA

ORENBURG

RYAZAN

PENZA

LIPETSK

PERM

CHELYABINSK

ROSTOV-ON-DON

VOLGOGRAD

OMSK

ASTRAKHANELISTA

BELGOROD

1 М-1 BELARUS

2 М-3 UKRAINE

3 М-4 DON

4 М-11 MOSCOW —ST. PETERSBURG

Central Ring Road of the Moscow Region

5

2

3

4

Roads and high-speed highways

transferred into trust management

of Avtodor

Roads and high-speed highways

under construction transferred into

trust management of Avtodor

Perspective roads and high-speed

highways to be launched by 2030

5SMOLENSK

1

BRYANSK

KALUGA

KRASNODAR

VLADIMIR

ULYANOVSK

NIZHNY

NOVGOROD

KAZAN

SAMARA TYUMEN

YEKATERINBURG

TAMBOV

POPULATION DENSITY

UKRAINE

BELARUS

KAZAKHSTAN

0-10K PEOPLE.

60+K PEOPLE.

40-50K PEOPLE.

20-30K PEOPLE

10-20K PEOPLE.


JULY 15, 2014

32

Avtodor intends to spend RUB 1.4 trln on road construction in 2010-19, or approximately

22% of total projected investments in federal roads. A total of 70% of this amount should

come from the state budget, while 30% will be attracted from investors.

Avtodor project pipeline in 2010-19

2010-19

Total investments, RUB mln 1,392,814

Subsidies from the state budget and Russian Investment Fund, RUB mln 1,024,353

Non-budgetary funding, RUB mln 368,462

Anticipated total length of roads under trust management by 2019, incl: 3,570 km

Reconstruction of existing roads 964

Construction of new roads 959

Length of toll-sections 1,295

Source: Avtodor

Road concessions could bring high long-term yield to investors. Avtodor offers

investors two types of concession agreements: direct toll concession and availability

payments concession.

Types of investment agreements

Concession agreements

Direct toll concession Availability payments concession

Long-term agreements Operator contracts Investment agreements in the pre-launch stage

Object of contracts

Construction (reconstruction) Capex co-financing Repair and maintenance, fee collection As an option: development of project documentation, land-use planning,

construction site preparation

Development of a DTMS* Repair and maintenance Fee collection

Development of a pre-project and project documentation

Term Depending on object lifetime: 20-30 years 10-15 years Up to 4 years

Source of revenues for investors

User fees Availability payments: Maintenance fees Investment fees (returns, penalties and bonuses depending on operation)

Concession holder compensation

* digital traffic management system

Source: Avtodor

The direct toll concession scheme suggests that an investor (concessioner) receives

all of the proceeds from automobile traffic. The key risk facing an investor relates to

traffic volumes that might turn out to be less than forecast (higher traffic, however,

means additional money for investors). This type of concession is used in projects (or on

road sections) involving peak traffic. The share of private financing in such projects

amounts to 40-50%, while potential IRR might reach 15-20%. For instance, North-West

Concession Company, which is engaged in construction of a 15-58 km section along the

Moscow – St. Petersburg road, expects the project’s IRR to reach approximately 17%.

The availability payment concession scheme suggests that a concession provider

(i.e. Avtodor) collects 100% of the traffic proceeds. At the same time, the concessionaire

bears traffic risks. A private investor receives a fixed amount comprised of ROI (own or

borrowed funds), a maintenance fee and fixed interest on invested capital usually

calculated as the inflation rate plus 4-8% depending on the tender outcome. Thus, the

overall yield on average can stand at 11.0-14.0% p.a., which seems quite attractive with

a 25-30 year investment horizon. Moreover, Avtodor intends to offer bonuses to

investors in case actual revenues exceed the target, which would boost the overall yield

by 1-3 pps. This type of concession is used on road sections with less intense traffic and

longer payback periods, and therefore the share of private investors does not exceed

25-30% of total investments.


JULY 15, 2014

33

Investor payout scheme

Direct toll Availability payments

Source: Avtodor Source: Avtodor

There are other types of investment agreements with Avtodor available, but these are

mostly service contracts and suggest smaller-scale investments as opposed to

concessions.

Avtodor has already launched several PPP projects. The first such project – a new exit

from the Federal Highway M-1 (Belarus Highway) Moscow-Minsk to the Moscow Ring

Road with a length of 18.5 km – was completed in late 2013. Four out of five sections of

the Moscow – St. Petersburg toll-way and one section of the Central Ring Road of

Moscow region are currently under construction. Respective operator contracts have

been signed with investors for servicing of the М-4 Don road.

Current PPP projects in road construction

PROJECT NAME LENGTH, KM

TRAFFIC, ‘000 CARS PER DAY

TOTAL INVESTMENTS, RUB BLN

SHARE OF PRIVATE INVESTMENTS

CONSTRUCTION PERIOD

CONTRACT TYPE

CONCESSION TERM, YEARS

PRIVATE INVESTORS

М-1 Belarus (Odintsovo bypass)

18.5 N/A ~23.7 100% 2010-13 Direct toll 99

Glavnaya Doroga Consortium: AM Lider, Brisa, FCC Construction, Alpine Bau, Stroytransgazconsulting

Moscow – St. Petersburg (15-58 km)

43 77 56 60% 2011-14 Direct toll 26

North West Concession Company: Mostotrest and Vinci JV


72 12-15 60 10% 2012-15 Availability payments

22 Mostotrest



26 Mostotrest



27

Two Capital Cities Highway Consortium: VTB Capital, Vinci

M-4 Don (517-544 km) 29 8.4-9 17.4 11% 2014-16

Long-term investment

contract

23

Mostotrest

Western High-Speed Diameter, central section

12 N/A ~100 50% 2013-13 Direct toll 30

Northern capital city highway consortium: VTB Capital, Gazprombank,

OPERATION STAGE(MAINTENANCE — REPAIR — OVERHAUL)

CONCESSIONAIRE

Investors(shareholders)

Financing banks

TOLL ROAD

PROCEEDS

LOAN

REPAYMENTROI

OPERATION STAGE(MAINTENANCE — REPAIR — OVERHAUL)

CONCESSIONAIRE

Investors(shareholders)

Financing banks

TOLL ROAD

PROCEEDS

LOAN

REPAYMENTROI

AVTODOR

OPERATION CHARGES


JULY 15, 2014

34

PROJECT NAME LENGTH, KM

TRAFFIC, ‘000 CARS PER DAY

TOTAL INVESTMENTS, RUB BLN

SHARE OF PRIVATE INVESTMENTS

CONSTRUCTION PERIOD

CONTRACT TYPE

CONCESSION TERM, YEARS

PRIVATE INVESTORS

Astaldi, Ictas Insaat, VEB, EBRD

Central Ring Road (1st stage)

49.5 33-39 64.8 10% 2014-18

Long-term investment

contract

23

Stroytransgazconsulting

Bridge over the Lena river

21 N/A 54.9 - 2014-21 15

Transport concessions consortium (Sakha): VTB Capital, Stroyproekt, Bamstroymekhanizatsiya, Construction company Most

Source: Gazprombank

In 2014-15 Avtodor intends to arrange around 10 tenders with a total value of more than

RUB 700 bln and attract around RUB 200 bln in private investments. Therefore, there

will be an increasing need to finance these projects with the help of infrastructure bonds

and bank loans.

Currently planned PPP projects in road construction field

NAME OF SITE LENGTH, KM (TOLL SECTION)

TYPE OF PPP TENDER PERIOD

CONSTRUCTION PERIOD

TOTAL CAPEX SHARE OF PRIVATE CAPITAL

ESTIMATED TRAFFIC, ‘000 CARS PER DAY

CONCESSION PERIOD, YEARS

M-1 Belarus 33-456 km

347 Availability payments 2014 2014-25 197 35% 23-38 30

M-4 Don 21-225 km

151 Owner-operator contract (О&M)

2014 2014-15 7.6 45% 20-37 10

M-4 Don 633-715 km

84 Availability payments 2014-15 2015-17 33 25% 13-15 25-30

M-4 Don 1,091-1,319 km

207 Owner-operator contract

2014 2014-15 14 50% 12-18 20-30

Moscow-St. Petersburg 58-149 km

90 Concessionary agreement (direct toll)

2014 2015-17 64.7 40% 20-23 30

Bridge over Kerch straight

5 n/a 2015-16 2016-20 200 n/a n/a n/a

New exit to Moscow Ring Road from M-7 Volga (bypass around Balashikha and Noginsk)

69 Concessionary agreement

2015-16 2017-20 60.7 48% 95-110 30

Central Ring Road (3rd start-up facility)

105 Availability payments To be confirmed 72.8 35% 30-40 30

Central Ring Road (4th start-up facility)

97 Availability payments 2015-17 68.9 35% 30-40 30

Total 1,361 706.3

Source: Avtodor Russian Highways

Glavnaya Doroga Consortium: first completed PPP project in the road construction field

The end of 2013 saw the completion of the first PPP project to build a bypass road

around Odintsovo in Moscow Region (exit to the Moscow Ring Road from the federal

highway M-1 Belarus Moscow-Minsk) with a length of 18.5 km. The Glavnaya Doroga

International Consortium includes AM Leader (with a 50% share), Brisa (10%), FCC

Construction (15%), Alpine Bau (15%) and Stroygazconsulting (10%). The total

volume of investment stood at about RUB 23.7 bln. The project was financed through

bank loans and infrastructure bonds, with Gazprombank acting as a financial

consultant for the project.


JULY 15, 2014

35

Key market players: competition tightens after the Olympics

A road concession is a complex and capital-intensive project that requires profound

technical knowledge and long-term financial resources. Therefore, winning a tender

requires the formation of a consortium of investors, usually comprising representatives

of financial institutions, Russian construction companies, and foreign construction and/or

consulting companies, which possess international expertise in managing toll roads. The

key players on the Russian road concession market include:

Financial institutions: Gazprombank, Sberbank, VTB Capital.

Russian construction companies: Mostotrest, Stroygazconsulting, SK Most.

Foreign construction companies: Vinci (Road Moscow–St. Petersburg), Alpine

Bau/FCC Construction/Brisa (exit to the Moscow Ring Road from the federal

highway M-1 Belarus Moscow–Minsk), Astaldi/Ictas Insaat (Western High-Speed

Diameter).

The completion of the Olympic facilities frees up significant construction resources that will

be involved in the building of new roads. For instance, such companies as Scientific

Production Association Mostovik, Crocus and Stroygazconsulting have expressed interest in

road construction, despite their historically marginal exposure to the sector.

Railway infrastructure: removing bottlenecks and building high-speed lines

Railway infrastructure accounts for 85% of total cargo turnover in Russia (net of

pipeline transportation). Russia ranks third in terms of rail lines length amounting to

86,000 km, after the US (250,000 km) and China (97,000 km). The cargo turnover

breakdown is dominated by coal, oil and products, construction materials and iron ore.

For large industrial enterprises, especially exporters, efficient operation of the railway

infrastructure is crucial in making decisions to boost production. However, a

considerable lack of funding in the railway infrastructure segment coupled with an

increased number of freight cars on the network lead to so-called bottlenecks – road

sections with limited traffic capabilities. This, in turn, will result in an extended idle period

for rail cars and prevent timely cargo pick-up, exerting an extremely negative impact on

the overall cargo turnover of the Russian railway network.

Length of railway lines Cargo turnover breakdown, by type of transportation

Source: World Bank, Gazprombank estimates Source: Russian Railways

53.41

23.73

4.99 6.90

19.46

5.84 3.50 9.00

0.00

10.00

20.00

30.00

40.00

50.00

60.00

0.0

50.0

100.0

150.0

200.0

250.0

EU

US

RU

SS

IA

CH

INA

IND

IA

CA

NA

DA

BR

AZ

IL

AR

GE

NT

INA

LENGHTH OF RAILWAY LINES, '000 KM

DENSITY OF RAILWAY LINES, KM PER 1,000 KM

17%

21%

31%

53%

53%

85%

77%

31%

29%

40%

33%

9%

6%

48%

40%

7%

14%

6%

0% 20% 40% 60% 80% 100%

EU

CHINA

BRAZIL

US

INDIA

RUSSIA

BY RAIL BY ROAD BY SEA


JULY 15, 2014

36

Rail cargo volume breakdown, 2013 Average level of transportation component in the price of rail cargo

Source: Russian Railways Source: Russian Railways

Major rail cargo traffic routes

Source: Russian Railways

Railway infrastructure is not coping with growth in cargo turnover and is thus

contributing to the economic slowdown. The total length of bottlenecks stood at

8,100 km (9.4% of the total length of the railway network) in 2013 and is increasing by

500 km per year. The bottlenecks largely occur at approaches to sea ports, in Kuzbass

(where a major volume of coal is mined) and sections of the Trans-Siberian Railroad

and Baikal-Amur Mainline. According to Center for Strategic Research Foundation

estimates, should a lack of funding occur, the length of the bottlenecks in 2015 could

reach 14,500 km (17% of the total rail network) and 19,200 km (22%) in 2020. The

major negative outcome of such bottlenecks would involve more frequent failures of

outbound transportation, with warehousing volumes reaching 100-200 mln tonnes.

These estimates are based on the country’s economic development outlook, the

production dynamic of select industries, and Russian Railways’ ability to handle the

additional cargo volumes. “The amount of investment needed to remove the bottlenecks

29%

23% 16%

10%

22%

COAL OIL AND PRODUCTS

CONSTRUCTION MATERIALS IRON ORE

OTHER CARGO

34%

29%

19% 17% 15% 15%

13% 10% 9% 8% 7% 6%

0%

5%

10%

15%

20%

25%

30%

35%

40%

ST

EA

M C

OA

L

TIM

BE

R

CO

CK

ING

CO

AL

CR

UD

E O

IL

IRO

N O

RE

CE

ME

NT

FU

EL

OIL

NIT

RO

GE

N F

ER

TIL

IZE

RS

GR

AIN

PIG

IRO

N

DIE

SE

L F

UE

L

ALU

MIN

UM

MOSCOW

MURMANSK

VANINO

NAKHODKA

VOSTOCHNIY

VLADIVOSTOK

VYSOTSK

PRIMORSKUST-LUGA

NOVORSSIYSK

TUAPSE

ROSTOV-ON-DON

KALININGRAD

Coal

Oil

Iron ore

Ferrous metals

Grain

KUZNETSK COAL BASIN (KUZBASS)

FIELDS IN EAST SIBERIA

PECHORA BASIN

DEPOSITS IN THE URALS

DONETSAK COAL BASIN

KURSK MAGNETIC ANOMALY

WESTERN SIBERIA OIL AND GAS BEARING PROVINCE

VOLGA-URAL OIL AND GAS BEARING PROVINCE

METALLURGICAL PLANTS IN KUZBASS

METALLURGICAL PLANTS IN THE NORTH WEST

METALLURGICAL PLANTS IN THE CENTRAL PART

METALLURGICAL PLANTS IN THE URALS

ST. PETERSBURG


JULY 15, 2014

37

totals about RUB 1.0-1.1 trln in 2012-20. That said, budget losses total RUB 1.3-1.5 trln,

with that for GDP standing at RUB 5.5-6.4 trln… This indicates the high general

economic efficiency of investment in projects related directly to the removal of network

bottlenecks”, according to the Center’s research, dedicated to the assessment of major

infrastructure projects. Based on the Center’s estimates, every 10% decline in total

transportation costs for all types of goods in all regions leads to a 0.12% increase in the

country’s GDP. That said, every 10% decline in railway transportation costs accounts for

a 0.04% increase on average in the country’s GDP.

Increase in cargo volumes on railway network, mln tonnes

Source: Center for Economic Development

Higher investment in railway infrastructure is unavoidable

In the coming years the volume of investment in railroads may increase

significantly due to funds from the federal budget and the National Welfare Fund.

The main investor in the development of railway infrastructure is Russian Railways. The

total amount of the monopoly’s investment program averages RUB 400-500 bln per

year, 60% of which is spent directly on infrastructure, while the remaining part involves

the purchase of locomotives, safe railway operation and other costs. Russian Railways’

investment program is financed through proprietary and borrowed funds, as well as via

subsidies from the federal budget. The latter is largely spent on social projects, which

are considered sunk costs for the company (for example, transportation facilities in

Sochi). Due to the limited tariff growth for natural monopolies, the company’s ability to

boost capex will be constrained in the near term. Hence, incremental growth in

investment is possible only at the expense of the federal budget, NWF or VEB funds.

MOSCOW

ST. PETERSBURG

Years Total Growth, %

2011 83.6 6

2015 81.3 -3

2020 94.6 13

APPROACHES TO PRIMORSKY KRAI


2011 95.6 8

2015 118.6 24

2020 136.0 42

EXITS FROM EAST SIBERIA TO THE EAST


2011 279.8 4

2015 313.1 12

2020 345.1 23

APPROACHES TO THE URALS FROM THE EAST


2011 107.2 -1

2015 150.0 40

2020 168.2 57

APPROACHES TO NORTH CAUCASUS

APPROACHES TO VANINO-SOVGAVANSKYHUB


2011 84.9 8

2015 112.8 33

2020 122.2 44

APPROACHES TO THE FAR EAST


2011 215.4 7

2015 231.6 8

2020 260.8 21

EXITS FROM KUZBASS TO THE WEST


2011 156.6 5

2015 196.3 25

2020 232.3 48

APPROACHES TO THE NORTH-WEST


2011 18.2 11

2015 37.3 105

2020 51.1 181


2011 275.1 8

2015 323.8 18

2020 366.0 33

APPROACHES TO URALS FROM THE WEST


JULY 15, 2014

38

Russian Railways’ investment program, RUB bln

Source: Russian Railways, Gazprombank estimates

Sources of funding for Russian Railways’ investment program


Expansion of the Baikal-Amur Mainline and the Trans-Siberian Railroad (Eastern

Polygon) — the fight against bottlenecks has begun. The Russian government has

decided to tackle the removal of bottlenecks along the railway network. The draft law to

upgrade the Trans-Siberian Railroad and Baikal-Amur Mainline by 2018 has been

approved, which should facilitate an increase in rail capacity by 55 mln tonnes to 271

mln tonnes. The total cost of the project amounts to RUB 560 bln, which Russian

Railways will not be able to compensate through existing tariffs (as the main type of

cargo delivered via railroad is low-tariff coal), hence the project will be partly financed

using funds from the federal budget (RUB 110 bln) and the National Welfare Fund (RUB

150 bln). Project implementation will allow coal companies to significantly boost coal

transportation volumes from Kuzbass to Far East ports and for further export to Asian

markets. In 2013, about 120 mln tonnes of coal was exported to Asia, meaning that

once the infrastructure modernization is completed, this amount might increase by 30%.

However, such companies as Deloitte, Ernst & Young and PricewaterhouseCoopers,

which perform the technological and pricing audit of the project, are cautious regarding

197 230 273 226

143 142 137 137 137 164 214

50 66

76 119 101

101 101 101

101 101

101

100 200

250

200 50

0

200

400

600

800

2010 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

CONSTRUCTION OF MOSCOW-KAZAN HIGH-SPEED LINE SAFE RAILWAY OPERATION

OTHER PROJECTS ROLLING STOCK RENOVATION

RECONSTRUCTION OF MOSCOW RAILWAY HUB RECONSTRUCTION OF BAM AND TRANSSIB

INFRASTRUCTURE DEVELOPMENT

21% 24%

4%

27%

25%

2% 10%

28%

18% 15% 21%

25%

68%

55% 52% 50% 38%

0%

10%

20%

30%

40%

50%

60%

70%

80%

90%

100%

2010 2011 2012 2013 2014E

OWN CASH FLOW

CONTRIBUTION TO SHARE CAPITAL FROM THE BUDGET

PROCEEDS FROM SALE OF SHARES OF SUBSIDIARIES

MARKET BORROWINGS

INFRASTRUCTURE BONDS


JULY 15, 2014

39

the achievability of Russian Railways’ targets. According to the auditors, due to the

refusal to develop several coal deposits, freight traffic could rise by only 30 mln tonnes.

On the other hand, the expansion of the Baikal-Amur Mainline and the Trans-Siberian

Railroad may, on the contrary, promote the development of new fields located in Siberia

and the Far East, in particular the huge Elga coal deposit owned by Mechel. Aside from

that, the travelling speed of container trains will also increase, leading to Russia

strengthening its position as an attractive transport corridor between Europe and Asia.

Infrastructure development of the Eastern Polygon

PROJECT RUB BLN SOURCES OF FUNDING

Development of Baikal-Amur Mainline’s eastern part 41

RUB 302 bln from Russian Railways’ own sources of funding, including infrastructure bonds in the amount of RUB 41 bln

Existing projects to develop Eastern Polygon 40

Infrastructure upgrade 221

Development of Baikal-Amur Mainline’s western part (Taishet-Tynda) 176 RUB 260 bln via budget funding, including RUB 150 bln from the sale of Russian Railways preferred shares to the NWF, and a RUB 110 bln contribution to share capital from the federal budget (common shares) Development of Trans-Siberian Railroad within Eastern Polygon 84

Total 562


Development of high-speed line Moscow–Kazan: expensive project amid

economic instability. The Russian government is forcing an increase of the traveling

speed of high-speed trains to 400 km/h. The first project involves the construction of a

new line Moscow–Kazan with a length of 770 km, allowing for a decrease in travel time

between the two cities from 14 to 3.5 hours. There is a possibility that the line might be

extended to Ekaterinburg after 2020. In accordance with the tender documentation, the

maximum possible cost of the project amounts to RUB 1,068 bln. The government

intends to complete the construction of the line by the 2018 FIFA World Cup, but we

doubt that this target is achievable within such a limited timeframe. The main problem

lies in the lack of funding, as about half the sum could be provided by the National

Welfare Fund (RUB 150 bln), the federal budget, Russian Railways and VEB, while it

remains unclear where the remaining part will come from. The government is exploring

the possibility of inviting private investors as part of the concession, but the conditions

have yet to be disclosed. For this reason, the final decision on construction of the line

has yet to be made, as the government remains unsure whether such a line is needed.

Thus, we do not rule out that the project may be shifted until a later date. Aside from the

issue of the project’s cost, its impact on Russia’s economy will be tremendous – apart

from a substantial increase in demand for construction materials, it will strengthen

regional ties, thus leading to the development of tourism, higher mobility of the

population and an increase in disposable income. Russian Railways will get the chance

to relieve existing busy railway lines from passenger trains, which will help address the

bottlenecks and considerably increase the traveling speed of freight trains.

Cost and potential structure of funding for the high-speed line Moscow–Kazan, RUB bln (incl. VAT)

COST OF RAILWAY LINES FOR THE FOLLOWING SECTIONS

Moscow-Vladimir (Russian Railways) 192

Vladimir-Nizhniy Novgorod (concession) 227

Nizhniy Novgorod-Cheboksary (concession) 232

Cheboksary-Kazan (concession) 137

Total 788

Other objects (costs are divided in proportion to each participant)

Communications 48

Railway stations 37

Depots 26


JULY 15, 2014

40

COST OF RAILWAY LINES FOR THE FOLLOWING SECTIONS

Rolling stock 50

Utility systems 67

Road construction 54

Total 282

GRAND TOTAL 1,068

Sources of funding

Russian Railways facilities 384

National Welfare Fund 150

Federal budget 64

Russian Railways own funds 31

Issuance of infrastructure bonds using VEB pension funds 139

Concession participants 684

Own funds 43

Government-backed infrastructure bonds 100

Loans 225

Irrecoverable subsidies (yet unidentified source) 317

Total 1,068

Source: Interfax

Operating and projected lines of high-speed passenger service


Airports: a tasty morsel for investors

The number of airports in Russia declined by about five-fold to 300 after the

collapse of the Soviet Union due to a lack of funding and shrinking number of

passengers in the regions. However, by the mid-2000s, air transportation began to

recover rapidly. Average annual growth reached 14% in 2010, one of the highest rates

in the world due to a boom in tourism and the fact that some passengers switched from

traveling by trains to planes. Passenger traffic rose 18% to record 142 mln in 2013, a

number that is significantly higher than in 1991, while the bulk of traffic was routed

through the Moscow Aviation Hub (MAH), which is running at nearly maximum capacity.

Meanwhile, virtually no large regional hubs have arisen so far in Russia.

Rapid transit (up to 200 km/h) using existing railway lines

High-speed service (up to 400 km/h) using new railway lines

Terminal stations

Travelling time3 hrs 45 min

30.07.2010 Route launch date

HELSINKI

ST. PETERSBURG

BOLOGOYE TVER

VLADIMIR NIZHNY NOVGOROD KAZAN EKATERINBURG

CHELYABINSKSMOLENSKKRASNOYEMINSK

Future construction

3 hrs 45 min

17.12.2009

3 hrs 55 min

30.07.2010

2 hrs 30 min 2017

Until 2030

Ca. 4-5 hrs2018

SARATOV OMSK NOVOSIBIRSK

SUZEMKA BRYANSKKYIV

2015

YAROSLAVL

SOCHI

MOSCOW

ADLER

15-17 hrs Until February 2014

ROSTOV-ON-DON KHARKIV BELGOROD KURSK TULA

2014 Intermediate stations


JULY 15, 2014

41

Number of airports in Russia Number of passengers at airports, mln

Source: Association of CIS Airports, Gazprombank estimates Source: Association of CIS Airports

The Moscow Aviation Hub (Sheremetyevo, Domodedovo and Vnukovo airports)

accounts for over 50% of passenger traffic. Traffic picked up by 17% to 75 mln

passengers in 2013. Over 70% of all flights are routed through Moscow due to weak

demand for air transportation in the regions. For this reason, MAH infrastructure is

steadily on the rise. In times of peak traffic, which occurs on holidays and during the

summer, airports are unable to cope with the traffic flow, as a result of which aircraft

spend extra time in the air, which means extra expenses, while terminals are

overcrowded with passengers. Experts acknowledge that without large-scale investment

in the construction of new runways, expansion of terminals and upgrade of air traffic

systems, the handling capacity of the MAH could peak, capping further growth among

aviation companies. For example, even now the country’s second-biggest airline,

Transaero, is forced to fly through all three Moscow airports, since the capacity of its

core airport Domodedovo is temporarily exhausted.

Russia's largest airports, mln passengers Breakdown of passenger traffic, 2013

Source: companies Source: Association of CIS Airports, Gazprombank estimates

About RUB 380 bln (net of VAT) has been allocated for the development of airport

infrastructure until 2020 according to targets set forth in the Federal Special-

Purpose Program Development of the Transportation System of Russia and our

estimates. The largest projects include construction of terminals and third runways at

Sheremetyevo and Domodedovo airports. The scope of funding for regional airports has

been significantly expanded. Under the above-mentioned program, investments are

expected to peak in 2013 (RUB 79 bln), although most projects are running behind

schedule. For example, the construction of the third runway at Sheremetyevo got under

1450

13

02

1169

10

11

876

849

756

639

579

533

496

451

423

411

393

383

351

330

329

332

315

304

297

1 19 33 43 54 58 63 67 68 69 70 70 70 70 70 69 69 69 69 70 70 70 70

0

400

800

1,200

1,600

1991

1992

1993

1994

1995

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

TOTAL NUMBER OF AIRPORTS INCL. INTERNATIONAL

98

42 41 38 36 36 39 43 48

54 57 63

75 82

76

94

106

120

142

10%

20%

30%

40%

50%

60%

0

30

60

90

120

150

1991

1996

1997

1998

1999

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

2013

MAH REGIONAL AIRPORTS SHARE OF MAH, %

0.0

5.0

10.0

15.0

20.0

25.0

30.0

35.0

DO

MO

DE

DO

VO

SH

ER

EM

ET

YE

VO

PU

LKO

VO

VN

UK

OV

O

KO

LTS

OV

O

TO

LMA

CH

EV

O

PA

SH

KO

VS

KY

SO

CH

I

UF

A

KU

RU

MO

CH

2010 2011 2012 2013

53% 10%

3%

3%

4%

27%

MOSCOW ST PETERSBURG EKATERINBURG

NOVOROSSIYSK SOUTH OF RUSSIA OTHER

134 MLN PASSENGERS


JULY 15, 2014

42

way quite recently, while at Domodedovo negotiations between the state and the airport

owners are in progress, and the project was supposed to start several years ago. Thus,

the investment targets shown in the special-purpose program have been rolled back to

2014-15. Furthermore, we expect funding for airport infrastructure to be expanded

substantially in some regions ahead of the World Football Championship, which Russia

will host in 2018.

Volume of investments in upgrade of airport infrastructure, RUB bln (incl. VAT)

Largest airport reconstruction projects, 2010-20, RUB bln (incl. VAT)

Source: FSPP, Gazprombank estimates Source: FSPP

Large airports are attractive investment targets, while it is much more challenging

for small regional airports to bring in private capital. Airport infrastructure can be

broken down into four key components:

Runways and landing strips. By law, such facilities can only be owned by the

state, and for this reason, the latter is entitled to invest in their construction and

reconstruction. However, in practice airport owners are willing to invest in runways

on concession terms due to the shortage of financial resources and foot-dragging on

the part of the state. The government is generally amendable to this idea in

exchange for large investments in the industry and is currently in the process of

working out the relevant procedures. In all likelihood, a pilot project will be launched

at Domodedovo airport.

Airport terminals are part of the airport (legal entity) owned by a private investor

(for example, Domodedovo, Koltsovo, and Tomachevo airports) or the state

(Sheremetyevo, Kazan airports). Investments in the upgrade and expansion of

terminal facilities with heavy passenger traffic are extremely attractive to investors,

since they offer high returns on investment. Terminals are commercial real estate

with a concentration of people with a high level of income with a low level of

competition. At the same time, such projects tend to be quite capital-intensive. For

example, construction of the new terminal in Pulkovo Airport and renovation of the

old facility will cost over EUR 1 bln and is being carried out as part of a PPP.

Fueling complexes are usually located in each large airport. Historically, they are

part of the airport, but most of them are eventually bought out by oil companies, for

which fueling is an important sales outlet for petroleum products.

Other infrastructure facilities. These include parking, aircraft sheds, repair shops

and food production plants. They also usually belong to private investors – airport

owners.

26

44

70

79

64

56 61

67 67 67 64

13 18

35 40

30

16 15

7 5 5

0

10

20

30

40

50

60

70

80

90

2010

2011

2012

2013

2014

E

2015

E

2016

E

2017

E

2018

E

2019

E

2020

E

TOTAL INCL. MAH

13

18

19

20

22

24

26

29

31

52

105

0 50 100 150

KHRABROVO (KALININGRAD)

KURUMOCH (SAMARA)

NOVIY (KHABAROVSK)

TOLMACHEVO …

IRKUTSK

KOLTSOVO (EKATERINBURG)

YAKUTSK

VNUKOVO

UZHNIY (ROSTOV-ON DON)

DOMODEDOVO

SHEREMETYEVO


JULY 15, 2014

43

Main investors in Russian airports

INVESTORS/SHAREHOLDERS AIRPORTS PASSENGER TRAFFIC, 2013 COMMENTS

State airports

Sheremetyevo (state stake 83.4%)

29.3 Aeroflot and VEB are minority shareholders.

Airports of Kazan, Ufa, Mineralnye Vody, Perm

Regional airports are gradually being privatized.

East Line Group Domodedovo 30.8

The largest airport in Russia. The facility is currently overloaded but there are plans to expand the handling capacity of its terminals over the next few years. The company planned to hold an IPO in 2011 but then called it off.

Vnukovo-Invest Vnukovo 11.2 The main shareholders of Vnukovo are Vitaly Vantsev and Lev Kvetnoi.

Gates of Northern Capital

VTB Capital, Fraport

Pulkovo (St. Petersburg)

12.9

The first concession-based airport project. A consortium of international investors headed by VTB Capital, Fraport, the EBRD and others won a tender to manage the airport until 2039. The project provides for construction of a new terminal (completed) and reconstruction of the old one at a cost of EUR 1.1 bln.

Novaport

Roman Trotsenko (50%), Meridian Capital (50%)

Tolmachevo (Novosibirsk)

3.7 There is a struggle between Tolmachevo and Koltsovo over the title of Siberia’s main airport hub.

Chelyabinsk 1.2

Volgograd 0.6

Astrakhan 0.3

Tomsk 0.4

Barnaul 0.4

Airports of the South

Bazel-aero (50%)

Sochi 2.4 In 2011, Bazel-aero sold a 50% stake to Sberbank and the operator of Singapore’s Changi airport for $320 mln.

Changi (30%) Pashkovsky (Krasnodar)

2.2

Sberbank (20%)

Gelenjik 0.2

Anapa 0.6

Airports of the regions

Renova (100%)

Koltsovo (Ekaterinburg)

4.3

Kurumoch (Samara) 2.2

Rostov-on-Don 1.9

Strigino (Nizhny Novgorod)

0.9



JULY 15, 2014

44

Seaports: state and business working in tandem

Unlike other transportation infrastructure, most Russian ports meet advanced

requirements and run at an average 70% of total capacity. All in all, 63 seaports

operate in Russia with a total handling capacity of 846 mln tonnes of cargo per year. In

2013, their aggregate cargo turnover reached 580 mln tonnes (+3.9% YoY), which

implies an average utilization rate of about 70%. In the turnover structure, export cargo

(mainly crude oil, petroleum products and coal) accounts for about 80%, which

highlights the commodity-driven basis of the Russian economy. Russian ports handle

100% of all domestic grain exports, 80% of all crude oil and petroleum products and

60% of coal. Imports account for 8% of cargo turnover, mainly via trucks and containers

carrying equipment, consumer goods and auto parts. The rest is classifiable as transit

goods and coastal shipping.

Cargo turnover in Russian ports, mln tonnes 10 largest Russian ports

Source: RF Association of Commercial Seaports, Gazprombank estimates Source: Gazprombank, Transport Ministry

*The port’s capacities will rise to 150 mln t by 2020.

Breakdown of cargo turnover in Russian ports Cargo turnover in Russian ports, 2013

Source: RF Association of Commercial Seaports Source: RF Association of Commercial Seaports

Railroad approaches to ports are the main limitation on rapid expansion of port

infrastructure. Their handling capacity is insufficient to meet demands from cargo

shippers. As a result, periodical backlogs of cargo shipments form at the approaches of

ports in the south and Far East. Furthermore, despite the fact that Russian Railways has

invested large amounts in de-bottlenecking areas around ports, the situation could

improve considerably only after the Baikal-Amur Mainline and Trans-Siberian Railway

are refurbished in 2018. Coal companies have the potential to increase coal exports to

Asia, but it remains untapped due to railroad congestion.

549 591

630 699

731 761 791

829 845

407 421 451 455

496 526 535 566 589

60%

62%

64%

66%

68%

70%

72%

74%

76%

0

100

200

300

400

500

600

700

800

900

2005 2006 2007 2008 2009 2010 2011 2012 2013

CAPACITIES, MLN TONNES CARGO TURNOVER, MLN TONNES

UTILIZATION RATE, %

-4.1%

-14.7%

33.9%

0.3%

13.6%

32.7%

17.0%

8.3% -0.6% -0.5%

-20.0%

-10.0%

0.0%

10.0%

20.0%

30.0%

40.0%

020406080

100120140160

NO

VO

RO

SS

IYS

K

PR

IMO

RS

K

US

T-L

UG

A*

BIG

PO

RT

ST

. P

ET

ER

SB

UR

G

VO

ST

OC

HN

Y

MU

RM

AN

SK

VA

NIN

O

NA

KH

OD

KA

TU

AP

SE

PR

IGO

RO

DN

OE

CAPACITIES, MLN TONNES CARGO TURNOVER IN 2013, MLN TONNES YOY CHANGE

78% 8%

8%

6%

EXPORT IMPORT TRANSIT CABOTAGE

589 MLN T

35%

21%

17%

8%

4%

3%

2%

1% 1%

8%

OIL PETROCHEMICALS COAL

CONTAINERS IRON GRAIN

FERTILIZERS ORE TIMBER

OTHER

589 MLN T


JULY 15, 2014

45

Expansion of port infrastructure is a capital-intensive process, but most projects

involving the construction of marine cargo terminals tend to have a faster

payback period than other transportation infrastructure investments. EBITDA

margins can reach 80% at grain terminals in ports, and about 60% at container ports.

Terminals handling transshipment of oil and petroleum products operate with profit

margins of 40-50%. Coal terminals are a separate case, as most of them are owned by

coal companies (Mechel, Kuzbassrazrezugol, SBU), and for this reason, they achieve

lower profit margins. This is unsurprising, given the high cost of shipping coal as

reflected in the selling price, which means that control over the whole transportation

chain is a key facet of the coal business.

EBITDA margin

Source: companies, Gazprombank estimates

According to the special-purpose program until 2020, about RUB 330 bln (net of VAT)

will be invested in infrastructure, according to our estimates. The largest projects

include expansion of the capacities of the ports of St. Petersburg, Ust-Luga and

Sabetta. The ownership structure of the port is similar to that of airports. All cargo terminals

(warehouses, cranes, loading machines) are owned by stevedores, which are private

companies, whereas the mooring berths and body of water are controlled by the state. For

example, dredging operations at the port are carried out only by way of the federal budget. It

should be noted that the state has made concerted efforts over the past decade to expand

infrastructure and deploy new ports. For example, a major Russian port Ust-Luga was built

from scratch on the Baltic Sea. The Arctic port of Sabetta is currently being built on the

Yamal Peninsula, and the idea of constructing Taman, a large port on the Black Sea, is

under consideration. In line with the special-purpose program, about 30% of the funding for

these ports is to be invested by the state, while the rest (about RUB 230 bln) is to be

provided by private investors over seven years, or RUB 36 bln per year.

Public-private ventures for the expansion of port infrastructure

The multi-purpose Ust-Luga port is one of the largest-scale transport infrastructure

projects since the breakup of the Soviet Union and provides an apt illustration of a

public-private partnership (PPP). The construction of this port began in 1999 at a

distance of 70 km from St. Petersburg in the Gulf of Finland. This place is suitable for

servicing deep-water vessels and year-round navigation. The total volume of state

and private investments over the past 10 years amounts to about $7 bln. The port’s

cargo turnover was 63 mln tonnes in 2013 (+34 mln tonnes YoY). The port’s

capacities should reach 180 mln tonnes by 2020. To date, such major Russian

companies as Kuzbassrazrezugol, Global Ports, Gunvor, NOVATEK, Sibur,

EuroChem, OMK, etc have built their own cargo terminals there.

58% 55%

43%

26%

19%

0%

10%

20%

30%

40%

50%

60%

70%

GLOBAL PORTS (CONTAINERS)

NCSP (MULTI-PURPOSE)

TUAPSE COMMERCIAL

SEAPORT (MULTI-PURPOSE)

SEA PORT OF ST. PETERSBURG (MULTI-

PURPOSE)

VOSTOCHNY PORT (COAL)


JULY 15, 2014

46

In 2012, the construction of Sabetta, a new Arctic port, got underway in Yamal.

This is the key facility of the Yamal LNG infrastructure project, which is being

developed by NOVATEK, Total and CNPC, including the deployment of

capacities for the production, storage and shipping of liquefied natural gas on

the basis of the Yuzhno-Tamkeyskoye field, the resource base. The total cost of

construction for the port infrastructure is RUB 73.2 bln (and could possible rise

by another RUB 10-20 bln), of which 65% is state funding and the rest comes

from private investors. The project is slated for completion by 2017.

Development of the Taman Port on the Black Sea. The government is working

on a project to expand the capacities of this port in order to attract cargo traffic

(coal, fertilizers, ore), part of which is currently routed through Ukrainian ports.

Negotiations are in progress with private investors (including Global Ports, UCL

Ports, SUEK and Metalloinvest) who are prepared to erect their own cargo

terminals there. If the project gets the go-ahead, the port’s capacities could

reach 70 mln tonnes by 2020 and 100 mln tonnes by 2030. The total volume of

planned investments is over RUB 200 bln.

Major transport infrastructure expansion projects

MAJOR PROJECTS

TOTAL, RUB BLN, 2010-20

1 Construction and reconstruction of infrastructure facilities of seaport of St. Petersburg 83

2 Construction of seaport facilities in the village of Sabetta on the Yamal Peninsula, including the creation of a maritime approach canal in Ob Bay

73

3 Construction and reconstruction of infrastructure facilities in Ust-Luga Port 65

4 Construction of a deep-water port in Baltiisk (Primorskaya Bay), Kaliningrad region 63

5 Construction and reconstruction of infrastructure facilities in Vanino Port 54

6 Construction of bulk cargo terminals in Taman Seaport (off-budget sources) 25

7 Construction and reconstruction of infrastructure facilities in Olya Port, Astrakhan region 20

8 Construction and reconstruction of infrastructure facilities in Arkhangelsk Port 14

9 Construction of coal terminal, Sakhalin region 13

10 Construction of LNG transshipment terminal in Teriberk, Murmansk region 12

Total 421

Source: Federal Special-Purpose Program Development of the Transportation System of Russia

Pipeline infrastructure: Russia’s raw material artery

The vast expanses of Russia and its rich hydrocarbon resources give rise to the

need for construction and maintenance of the world’s largest oil and gas

transport (pipeline) infrastructure. The pipeline system accounts for 45% of Russia’s

aggregate cargo turnover, with a total length of 230,000 km, including 175,000 km of

high and low-pressure gas pipelines and 55,000 km of oil pipelines. About 30,000 km

(15%) of pipeline has been added to the system over the past 15 years.

Gazprom and Transneft are the largest investors in pipeline infrastructure. With

the launch of the East Siberia – Pacific Ocean (ESPO) oil pipeline the peak of

construction of the line has already been passed and Transneft’s main investments are

related to maintenance of the existing networks. Meanwhile, Gazprom continues to

actively build and roll out its gas pipeline system. According to our estimates, the total

volume of investments in Russia’s pipeline system will reach RUB 5.5 trln by 2020, or

about 30% of all transport infrastructure investments. Roughly 80% of investments will

be made by Gazprom, while Transneft and oil companies will contribute the other 20%.


JULY 15, 2014

47

Breakdown of investments in pipeline infrastructure by main market players, RUB bln


Gazprom accounts for about 80% of investments in the pipeline system.

According to the company’s investment program, over $345 bln could be spent during

2013-20. In line with our estimates, investments in pipeline infrastructure could reach

about $152 bln (RUB 5.2 trln). The gas monopoly’s largest pipeline projects are South

Stream, Power of Siberia and Bovanenkovo–Ukhta.

Transneft’s investment program for 2014-2018 amounts to RUB 458 bln. The bulk

of investments should be allocated for projects in Siberia and the Far East, including

Zapolyarye-Purpe and Kuyumba-Taishet oil pipelines. There are also plans to expand

the ESPO in order to export oil up to 50 mln tonnes of oil per year to China. We have

added another RUB 170 bln to Transneft’s investment program, an amount that the

company could spend on expanding the ESPO oil pipeline from 50 to 80 mln tonnes

by 2020. These investments are not part of the company’s current investment

program and have yet to be approved, although a government recommendation has

been made. Only about 30% of Transneft’s capital investments come from the

company’s own sources, while the rest is borrowed funds, including those obtained

through partnerships with oil companies.

408

741

523 496 526

700 720 767 770

682 608

225

210

109 161 189

136 95 87 78

70

61 633

950

632 657

715

836 815 854 849

752

669

0

100

200

300

400

500

600

700

800

900

1,000

2010 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

TRANSNEFT GAZPROM


JULY 15, 2014

48

OTHER INFRASTRUCTURE SEGMENTS

Below we provide an overview of other infrastructure sectors. The latter will be

analyzed in greater detail in subsequent research reports.

Power grid complex

We treat the power grid complex as a part of infrastructure, whereas generation falls

beyond the scope of our definition of infrastructure.

The lack of required investments in Russia’s power grid complex over the past 20

years has led to a high degree of grid obsolescence. According to data in the

Strategy for Development of the Power Grid Complex of the Russian Federation, the

share of distribution systems which have outlived their standard service life has reached

50%; 7% of grids have exceeded two service lives. Total depreciation of distribution

grids has reached 70%. Depreciation of trunk grids stands at 50%. The condition of

power grids in Russia is considerably worse than in other large countries, where the

depreciation rate ranges from 27-44%.

Power industry investments are one of the top priorities of infrastructure funding

in the world. Russia is no exception, as about 8% of the infrastructure

investments, which we have estimated until 2020, will be directed to the power

industry. The main source of funding for power grid companies is project bonds. In the

US, 75% of power grid projects have been funded by project bonds over the past 12

months, while the proportion stands at 56% in China and 47% in Russia. The total

investment program of the power grid complex for 2014-20 is estimated by Russian

Grids and FGC at RUB 1.7 trln, i.e. an average RUB 243 bln per year. Below, we

discuss the separate investment programs of these two companies.

Investment programs of power grid operators on the Russian market, RUB bln

Source: companies Gazprombank estimates

Russian Grids consolidates about 70% of the country’s distribution grids directly and

90% of backbone grids through its subsidiary Federal Grid Company (FGC). In order to

fund its investment program (distribution grids), Russian Grids has raised a considerable

amount of debt financing. However, the company’s net debt/EBITDA of 3x limits its

ability to enter the borrowing market anytime in the near future. In addition, 40-50% of

the investment programs of grid companies are funded by borrowed resources. FGC’s

total need for funding until 2025, under current plans, stands at RUB 247.6 bln, of which

RUB 48.3 bln will come from in-house resources, as well as technological connection

fees worth about RUB 43.3 bln. An additional RUB 199.3 bln should be raised from

other sources.

93

155 131 147 144 134 138 136 130 123 117

142

157

152 132 131 131 132 131

84 84 85

235

311

283 279 275 265 270 268

214 207 202

0

50

100

150

200

250

300

350

2010 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

RUSSIAN GRIDS FGC


JULY 15, 2014

49

Telecommunications

Investments in telecommunications infrastructure are viewed as a priority in

many countries and the state contributes funding in many cases. This sector of

the Russian economy was deregulated back in the 1990s, as a result of which most

infrastructure projects were completed in 1998-2008, when trunk fiber optic cables

were laid, and mobile voice networks were rolled out. Mobile networks were

upgraded to 3G in large cities in 2007-12, while a spate of fiber optic networks were

deployed by large operators as an alternative to Rostelecom. The joint annual

volume of capex in the industry by the Big Three operators and Rostelecom is

projected to average RUB 296 bln per year in 2014-20, amounting to just 2% of the

total volume of infrastructure investments, with most of the funding expected to

come from in-house resources.

Large outlays by operators over the next 7-10 years are related to the

construction of 4G (LTE) mobile networks. According to the requirements of 4G

licenses issued to the Big Three and Rostelecom, operators are to invest at least

RUB 15 bln per year during 2013-19 in the rollout of LTE networks. Thus, the total

amount of the program will reach at least RUB 420 bln. The project is to be funded

mainly using in-house resources.

The telecommunications sector is high-tech. Industry equipment becomes obsolete

and needs to be replaced or updated every 5-7 years. For this reason, operators are

forced to make capital-intensive investments equal to about 14-16% of revenues for

network maintenance in a competitive environment. OECD research shows that 10%

broadband internet penetration adds 1.5% to a country’s GDP.

Elimination of the digital divide by the deployment of advanced fixed-line

telephony networks in sparsely populated areas is another large project that will

require additional resources to be raised due to the long payback period.

Rostelecom will likely act as the operator for this project, with total investments from

2014-17 estimated at RUB 65 bln. The project will probably be funded by the company’s

operating cash flow, although the government is currently exploring whether

compensation can be tapped from the Universal Service Fund, to which all operators

make contributions (1.2% of their annual revenues).

Investment programs of telecom operators on the Russian market, RUB bln

*2010-20 data – Gazprombank estimates Source: companies, Gazprombank estimates

26% 31% 32% 27% 26% 26% 27% 26% 25% 26% 26%

25% 19% 25%

24% 26% 25% 24% 24% 23% 23% 23%

20% 19% 13% 18% 18% 17% 18% 18% 19% 18% 19%

13% 15% 14% 17% 16% 17% 17% 17% 17% 17% 17%

17% 15% 16% 14% 14% 15% 15% 15% 16% 16% 16%

322

381 355

335 348 342 350 349 342 351 358

-10

40

90

140

190

240

290

340

390

-10%

10%

30%

50%

70%

90%

110%

130%

150%

2010 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

ROSTELECOM MTS MEGAFON VIMPELCOM OTHER* CAPEX, RUB BLN


JULY 15, 2014

50

Public utilities

The depreciation rate of Russia’s public utilities complex has reached about 60%,

and total investment needs amount to RUB 1.5 trln. Total losses in heat networks

reach 30% due to the obsolescence of utility facilities, while leaks and undocumented

water discharge during transportation in water supply systems amounts to 60% of the

total amount entering the network in a number of cities.

The mechanism for federal special-purpose programs (FSPP) provides for only partial

funding of the required amounts from budgets, which means that the sector has a

severe need for private borrowed funds. The total amount of funding via FSPPs is

estimated at RUB 509.7 bln (net of VAT) in 2010-20, including RUB 265.9 bln from off-

budget sources.

FSPPs for investment in the Russian public utilities sector, RUB bln

Source: FSPP

Latest data on depreciation rate of key facilities in public utility infrastructure (2009)

Source: State Statistics Service

17.6 19.4

26.7

32.4

39.7

54.1

59.5

73.9

57.9 62.2

66.3

0

10

20

30

40

50

60

70

80

2010 2011 2012 2013E 2014E 2015E 2016E 2017E 2018E 2019E 2020E

54%

55%

57%

58%

60%

63%

63%

65%

0% 10% 20% 30% 40% 50% 60% 70%

DISPOSAL FACILITIES

BOILERS

PUMPING STATIONS

POWER GRIDS

TOTAL DEPRECIATION

SEWAGE

HEAT NETWORKS

WATER PIPES


JULY 15, 2014

51

APPENDIX

Based on the above analysis and in light of international experience in attracting

investment to infrastructure, we provide a list of recommendations and alternative

means of attracting additional investment.

The creation of a specialized exchange or section of an exchange, where

infrastructure funds and companies can place their securities. This measure would

expand the investor base, including the attraction of individual investors.

The establishment of normative requirements for insurance and pension funds to

invest a certain share of funds in infrastructure securities.

Capital amnesties, which have been introduced in offshore zones, in exchange for

their owners’ commitment to invest in national infrastructure securities.

The introduction of tax breaks for infrastructure projects, including the use of

infrastructure bonds, freed from tax payments on coupon income, a reduced profit

tax or the provision of long-term tax holidays.

More active increases of fuel excises.

More active participation of regions in infrastructure development. The attraction of

regions to infrastructure investment through the issue of bonds and bank loans. In

China and the US, regions account for a large share of financing of transportation

infrastructure. Among Russian regions, the most advanced in this area is the city of

St. Petersburg, which financed the construction of the Ring Highway and the

Western High-Speed Diameter via the attraction of private investors.

More active attraction of foreign construction companies for participation in tenders

to construct infrastructure objects in order to reduce their cost.

Largest construction companies in Russia: main players and trends

Thousands of construction companies operate in Russia, but only around 30 can be

considered large players with revenues of more than RUB 10 bln. In turn, no more than

10 of these companies can be considered general federal contractors in the sphere of

transportation infrastructure, while the others have a limited presence in separate

regions, fulfill their work via subcontractors and specialize in only one type of activity. In

the coming years, we believe the following trends will be observed in Russia’s

infrastructure construction market:

Increase in the size of a contract’s value. Government tenders can offer

construction contracts in the amount of up to RUB 100 bln, which include not only

construction, but also servicing of a project over the course of 15-30 years following

its completion. Such contract volumes can be granted only to large players that

possess significant material and financial resources.

Tightening of competition. The completion of infrastructure in Sochi led to the

freeing of a large amount of construction resources, which will now participate in

new tenders along with those companies that already traditionally take part. For

example, Crocus Group is considering the possibility of participating in the

construction of toll highways, even though previously it had not been involved in

transportation construction. As a result, the value of a contract will decline along

with the profitability of the contractor.

The creation of an international consortium for participation in concession

projects. A large infrastructure project within the framework of the State-Private

Partnership requires the participation of a large financial institution, Russian

construction contractors and international consultants. Several groups are already

being formed, with the participation of the largest Russian banks (Gazprombank,

Sberbank and VTB), which will dominate the concession market.


JULY 15, 2014

52

Entry to capital markets (equities, infrastructure bonds) with the aim of

attracting financing for concession projects. In conditions of a deficit of state

resources, the capital markets will be the only alternative for the attraction of funds.

We expect a significant increase in the number of infrastructure bonds in the

coming years.

A possible increase in the number of foreign players on the Russian market.

Currently such companies find it difficult to enter the Russian market due to the

significant differences in construction standards and the distance of projects from

technical bases. However, the government is considering the possibility of

harmonizing Russian construction standards with those of Europe. Foreign

construction companies are currently mainly participating in the construction of

airport and port infrastructure.

Largest construction companies in the sphere of transportation infrastructure

COMPANY SECTOR SHAREHOLDERS REVENUES, RUB MLN

PARTICIPATION IN LARGE INFRASTRUCTURE PROJECTS

Stroygazconsulting Construction of pipelines, roads, metro

Ziyad Manasir, Ruslan Baisarov

387,885

Bovanenkovskoye and Zapolyarnoye fields, gas pipelines Sakhalin-Khabarovsk-Vladivostok, Bovanenkovo-Ukhta, Ukhta-Torzhok, oil pipeline East Siberia – Pacific Ocean (ESPO), coastal segment of sea gas pipeline Nord Stream, compressor station Portovaya, Federal Highway Kolyma, new entry to Moscow Ring Road from Federal Highway M-1 “Belarus” Moscow-Minsk, and others.

Stroygazmontazh Construction of pipelines

Arkady Rotenberg 324,698 Gas pipelines Bovanenkovo-Ukhta, Sakhalin-Khabarovsk-Vladivostok, Gryazovets-Vyborg, Pochinki-Gryazovets and other others. Construction of main pumping station.

Mostotrest Universal contractor Arkady Rotenberg, N-Trans Group, NPF Blagosostoyanie

123,705 Construction of parts of the Moscow-St. Petersburg track, roads and overpasses in Moscow and Moscow region.

RZDstroy Construction of railroads

Russian Railways 92,000 Russian Railways’ largest contractor for construction and reconstruction of railroad infrastructure.

Mezhregiontrubo-provodstroy

Construction of pipelines

n/a 55,607 Construction of gas pipeline Bovanenkovo-Ukhta, improvement of Kirinsk gas condensate field, construction of Sabetta port.

SK Most Universal contractor Management, Gennady Timchenko

45,634 Construction of transportation infrastructure in Sochi, Moscow-St. Petersburg track, Sabetta port.

Mosinzhproject Construction of metro, roads

Moscow government 44,656 Fulfills the functions of general contractor for construction of new stations of the Moscow metro.

Transyuzhstroy Construction of railroads

Anatoly Antipov (65%), Alexander Shevelev (15%).

38,871

Development of throughput capacity of the railroad infrastructure of the Baikal-Amur Railroad (BAM), complex development of the Novorossiisk transport node, reconstruction and development of the Small Ring of the Moscow railroad.

NPO Mostovik Universal contractor Management 32,671

Design and construction of the world’s largest suspension bridge on Russky island through the East Bosphorous Strait in the city of Vladivostok; design and construction of 2014 Olympics facilities in Sochi (large ice hockey arena with 12,000 capacity, bobsleigh track, transport infrastructure objects); design and construction of the Butovskaya line of the Moscow metro; construction of bridge through Irtysh in the north of Omsk region; construction of the Omsk metro.

Podvodtrubo-provodstroy


n/a 21,830 n/a

DSK Avtoban Construction of roads

Alexey Andreev 21,189 Reconstruction of the M-7 “Volga”, M-8 “Kholmogory” and M-4 “Don” highways. Construction of transport interchanges.

Metrostroy Construction of metro

Management, government of St. Petersburg

19,560 Construction of the metro in St. Petersburg.

Svarachno-Montazhny Trest


Management 19,287 Pipeline construction.

VAD Construction of roads

Management 18,964 Construction of roads in the North-West district.

Mosmetrostroy Construction of metro

Management 15,395 Large contractor for construction of the Moscow metro.

Mostootryad-19 Construction of roads and bridges

Management 15,351 Construction of roads and bridges in the North-West district. Including the Western High-Speed Diameter.

Volgomost Construction of roads and bridges

n/a 14,863 Construction of roads and bridges throughout Russia


JULY 15, 2014

53

COMPANY SECTOR SHAREHOLDERS REVENUES, RUB MLN

PARTICIPATION IN LARGE INFRASTRUCTURE PROJECTS

Mostostroy-12 Construction of roads and bridges

Management 14,589 Construction of objects mainly in Yamalo-Nenets and Khanty-Mansiisk districts.

Ingeokom Universal contractor NPO Mostovik 14,000 Construction of infrastructure in Sochi and Moscow.

Stroyinnovatsiya Universal contractor Summa Group 12,430

Participation in construction of ESPO, ESPO-2, BPS-2. Implementation of project to prepare for construction of Central Ring Highway in Moscow region, reconstruction of M-29 “Kavkaz” and M-8 “Kholmogory” federal highways.

Source: company data, Gazprombank estimates

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