Question marks hang over PPP projects

THE OUTGOING Robert Fico cabinet failed to wrap up all the necessary details to commence construction projects that are designed to complete the highway connecting Bratislava and Košice. The closing date for reaching a financing agreement for the biggest of three public-private partnership highway construction projects, the so-called first PPP package, was extended again from June 30 to August 30.

THE OUTGOING Robert Fico cabinet failed to wrap up all the necessary details to commence construction projects that are designed to complete the highway connecting Bratislava and Košice. The closing date for reaching a financing agreement for the biggest of three public-private partnership highway construction projects, the so-called first PPP package, was extended again from June 30 to August 30.

The original deadline was mid October 2009, but it has been postponed multiple times. The reason for the first postponement was difficulty in arranging loans because of the financial crisis and this year environmental objections to parts of the plan surfaced from Brussels. The missing nod from the European Commission is preventing the start of construction of 75 kilometres of highway between Martin and Prešov. Construction companies involved in this project are worried that its postponement or possible cancellation could significantly impact employment in the construction sector which has already been hit hard by the economic crisis.

The postponed deadline means that it will be the new cabinet of Iveta Radičová which will decide about the future of this PPP project. Before the June 12 parliamentary election the centre-right parties which now make up the governing coalition had criticised this particular PPP project as grossly overpriced. The then-opposition parties said they preferred building highways and other road infrastructure using EU funds, state budgetary funds, or funds saved by citizens that are in the second pillar of Slovakia’s old-age pension scheme.

Under this first PPP package, the state will pay the Slovenské Diaľnice consortium, led by French company Bouygues Travaux Publiscs SA and including Slovak companies Doprastav and Váhostav-SK, more than €9 billion for construction and maintenance of the highway over 30 years, according to the ČTK newswire. Originally, this sum had been set at €7.8 billion.

Outgoing Construction Minister Ľubomír Vážny has rejected criticism of any mismanagement of this PPP project and says completion of the project is now in the hands of the new government.

“Apart from the complicated environmental issue, which I failed to resolve at the last three-hour meeting, the project is adequately prepared,” said Vážny, as cited by the SITA newswire. The outgoing minister also added that the next cabinet can create conditions for reaching the financing closure and construction of D1 highway can commence since the deadline was moved to August 30. He added that any significant change in the current method of financing the project might postpone completion of D1 highway to 2020 or even later.

The European Commission has given its tentative approval for Slovakia to construct five highway sections stretching 75 kilometres between Martin and Prešov if solutions are prepared for mitigating any negative environmental impacts stemming from sections of the highway that traverse protected natural areas.

Brussels’ conditional approval cleared the way for the European Investment Bank (EIB) to take final action on a loan of €1 billion for the project. In late April, the European Bank for Reconstruction and Development (EBRD) approved a loan of €250 million as its part in the financing of the highway project. These loans will be used to finance five sections of the D1 highway between Martin and Ružomberok and from Poprad to Prešov, parts that are in the first PPP package.

The cabinet of future Prime Minister Iveta Radičová, which will come into power in the second week of July, said it will re-assess the current PPP projects. The incoming coalition said that it wants to review the experiences from projects already underway, aiming to make future highway construction in the country more effective.

Of the three PPP highway construction projects, only the so-called second PPP package involving construction of stretches of the R1 dual carriageway has achieved financial closure and that was done in August 2009. The project covers the financing, construction, operation and maintenance of sections of the R1 road from Nitra to Selenec, Selenec to Beladice, and Beladice to Tekovské Nemce and a northern bypass around Banská Bystrica. The remaining two PPP packages involve construction of the last stretches of D1 highway connecting Bratislava and Košice via the so-called northern route.

Concerns of construction firms

Construction companies are worried that postponement or possible cancellation of the planned highway projects could worsen their already poor economic situation. In mid June Doprastav and Váhostav-SK, the two large Slovak companies that are part of the consortium that won the first PPP package, said that its cancellation may force them to lay off 1,500 people and that additional self-employed construction workers may also find themselves without work. Doprastav representatives spoke about a layoff of about 1,000 workers from its total labour force of 3,200 and Váhostav-SK said it may need to lay off 500 from its workforce of 1,800.

Doprastav’s director general, Dušan Šamudovský, is convinced that a halt in this PPP project will have a negative impact on the entire construction industry in Slovakia. Váhostav’s director general, Ján Kato, said construction of the D1 highway could provide direct work to 10,000 to 12,000 people.

“In March we believed that the PPP project would start,” Doprastav president Dušan Mráz said, as cited by SITA. “We will have to wait for the new government and see what its stance will be. The development is so negative for us that we have lost the ability to employ people.”

Sector hit hard by the crisis

After years of significant growth, sometimes in double digits, construction companies in Slovakia experienced a steep decline in 2009. Construction company executives expect this downward trend will continue for the rest of 2010 and are expressing only a moderately positive outlook for 2011.

A report titled Qualitative Study of Slovak Construction in 2010, prepared by CEEC Research in cooperation with KMPG Slovensko and IPSOS Tambor, stated that Slovak construction companies are modifying their forecasts for business in 2010 downward. According to the study, released on June 17, representatives of Slovak construction companies who were surveyed in May said they now expect the decline in business in 2010 to be 7.1 percent, significantly worse than their previous prediction of a 3.2 percent dip.

“These figures show that the shock in the form of a 11.3 percent decline in the sector in 2009 (which came after continuous growth in previous years) was not a one-off correction, but will continue also this year,” the study states.

Mráz, who is also the vice-chairman of the Association of Construction Entrepreneurs of Slovakia (ZSPS), said at the presentation of the study that he does not expect the sector to meet even these reduced expectations, adding that the construction industry may finish 2010 with an even steeper decline than in 2009.

Mráz ascribed the poor prospects to a significant drop in residential construction as well as in retail and office construction coupled with the current uncertainty in building transportation infrastructure.

“During the recent past, building construction was a driving force in the overall construction sector in Slovakia,” he said. “It experienced an unprecedented boom as a lot of apartments were being built. Today we know what the situation is in the sale of these apartments. As a consequence no new investors are gushing in and there is an almost zero demand for such construction. The second driving force was retail and office construction. Here the decline is similar to residential construction. Infrastructure, especially construction of highways and railways was the third driving force and here the drop was the deepest. Construction of industrial real estate declined, too,” said Mráz.

Companies indicated in the survey that even though the primary summer construction season had begun their capacity utilisation remained low. Compared with February’s 65 percent utilisation rate, this indicator increased in May to only 69 percent. As many as 61 percent of the surveyed companies said that they have fewer contracts than one year ago while in February 43 percent of the companies reported themselves to be in that situation. The number of months for which companies have current orders has also decreased though it varies by construction segment.

Orders with zero or negative margins

To deal with their near-empty order books, construction companies are now more willing to accept new construction orders with a zero or even negative profit margin.

“In 2007 and 2008 no company was willing to accept an order with a zero or negative margin,” said Jiří Vacek, managing director of CEEC Research. “Currently, the situation is that companies need to use at least some capacities. Every third company confirmed that it is willing to accept such an order. This trend is especially evident among civil engineering companies when almost every second one is ready to accept such an order.”

Mráz does not see accepting such orders as a prospective solution for the future.

“This is the so-called way to hell,” he told The Slovak Spectator, adding he understands that the companies see this as a way to survive and salvage work opportunities for their employees.

This phenomenon is occurring among large companies as well as small ones Mráz said. He expects that this may have a negative impact on R&D in construction and on employment of school graduates, among other undesirable outcomes.

The study also reported that companies are more willing to violate their standards of risk management in order to get an order and companies are also being asked more often for a bribe, with bribes being solicited from civil engineering companies more so than from companies in building construction.

The report noted that construction companies continue to view bureaucracy, lack of access to financing, and insufficient demand as the key problems facing the construction sector.

The study reported that the key priorities of Slovak construction companies over the next 12 months are to further improve the effectiveness of their business and find better financing for their construction projects.

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