The state automobile road agency (Ukravtodor) is entering the active phase of its reform. In addition to the latest steps toward separating the functions of economic management and administration, innovative steps are expected to be taken to eliminate the shortcomings of the system for accumulating funds for financing construction of roads - through the creation of the State of Road Fund. In parallel, there are plans to start an experiment that will demonstrate whether it is possible to implement the principle of paying contractors based on the quality of roads and not the volume of works in the road construction industry. Ukravtodor believes that such an approach can eliminate the permanent problem involving the quality of road surfaces across the country. Experts believe that transfer of local roads to local administrations is the most important and long-overdue step. Given the proposed ratio for distribution of funding between local and state roads, whether it will be possible to bring local roads into proper condition remains an open question. All these innovative steps should help the agency reach an annual budget of UAH 40-50 billion, which is about double its current annual budget.

Division of powers The Cabinet of Ministers approved a package of documents for transformations in the road construction industry on July 3, and these documents will soon be sent to the parliament for consideration. Ukravtodor’s head Yevhen Prusenko announced this to reporters. The documents provide for amendment of the Law of on Automobile Roads and the Law of on Local Government Administrations. The focus of the reforms will be separation of the functions of economic management and administration by distributing the relevant powers between the Ministry of Infrastructure, Ukravtodor, and the State Road Safety Inspectorate (Ukrtransinspektsia). In addition, the documents envisage creation of a State of Road Fund and transfer of local roads to local self-government agencies.

Many of the things that Ukravtodor now describes as reforms are either processes that were launched a long time ago or issues that have been under discussions for many years and are long overdue in this industry. For example, the obvious need to separate economic management and administrative functions has always existed here, just like in the railway industry. Formally, this separation began when the state contractor for construction of roads (the Automobile Roads of Ukraine state joint-stock company) was transformed into a separate entity, says Mark Magaletsky, the head of infrastructure and energy at the Ukrainian office of the European Bank of Reconstruction and Development (EBRD).

The innovative steps should help Ukravtodor to reach an annual budget of UAH 40-50 billion, which is about double its current annual budget

In an interview with the Center for Transport Strategies in March last year, Magaletsky insisted that Ukravtodor was not a symbiosis of the contractor but an agency that places orders for construction of roads. "The separation of its administrative functions from its economic functions … essentially happened a long time ago. One cannot say that the state joint-stock company (the Automobile Roads of Ukraine state joint-stock company) is part of the structure of Ukravtodor. Although it is subordinated to it, (the level of subordination) varies in different ways at different stages. In principle, the state joint-stock company lives its own life," the banker said in the interview. Moreover, officials at Ukravtodor itself are stressing that the involvement of the state joint-stock company in construction and maintenance of roads is minimal. "Regarding reconstruction, major repair, and routine repair work, the volume of such work performed by the state joint-stock company is only 6.5% and the rest is performed by private companies," said Prusenko.

The EBRD representative also emphasizes that the involvement of the state joint-stock company in in the road works that are financed by the bank is minimal. "If you look at the main large-scale projects that are currently being implemented, you will not see the state joint-stock company anywhere there. Take our projects for example, scores of construction contracts were concluded with contractors," said Magaletsky. He added that the state joint-stock company focuses mainly on maintenance of roads and that this "is a completely different business."

In the future, according to Prusenko, the liberalization of the industry will also reach this segment. For now, a competitive environment has been created only in the area of road design and construction. "Today, we have absolutely normal competition in design of roads. The Ukrgiprodor state institute, which is under our control, received 35% of the volume at a tender last year and everything else went to private entities. In the area of operation of roads, we still have to work," said Prusenko (he means involvement of more third-party companies in performance of routine repair and maintenance of roads).

The functions in the industry will be distributed between the Ministry of Infrastructure, Ukravtodor, and Ukrtransinspektsia. As Infrastructure Minister Volodymyr Kozak explained, the Ministry of Infrastructure will be given the function of determining the strategic direction of development, Ukravtodor the functions of construction of public roads and organization of the production process, and Ukrtransinspektsia the function of overseeing the quality of road works.

At first glance, this separation of functions significantly reduces the current powers of Ukravtodor, which essentially places orders for road works within the scope the loans provided to it, performs road works (since the Automobile Roads of Ukraine state joint-stock company is its subsidiary), and oversees the quality of the works. This is because the state supervisory bodies – the State Financial Inspectorate and the Audit Department – do not have effective levers for influencing the processes taking place there despite having the authority to review the finances of Ukravtodor and the volumes of work it performs. For people knowledgeable about this issue, it is not a secret that that Ukravtodor fiercely resisted some aspects of the reforms for a long time and that this resistance was one of the reasons for the delay of the reforms. In particular, experts have long been saying that it is necessary to transfer local roads to local authorities, as has been done all over the world.

On the other hand, it is important who will be authorized to raise and distribute funds for financing construction of roads under the new system. Everything will remain unchanged if the Ministry of Infrastructure is limited to formal management functions such as drafting strategies and determining the areas where work is required while Ukravtodor and Automobile Roads of Ukraine continue to perform the functions of customer and contractor. That is probably what will happen because it is uncharacteristic of the Ministry of Infrastructure to place orders for road construction works. These distinctions will become clear later because the draft legislative acts have not yet been published.

A pilot project under which payment will be based on results - the condition of the road - rather than the volume of pothole repairs will begin on the Kiev-Chop road this year

According to experts, it would be more logical to privatize Automobile Roads of Ukraine, which operates in a competitive sector. This is especially so, considering the fact that – as representatives of Ukravtodor itself affirm – this entity does not receive any preferences and participates in tenders for construction of roads on equal terms with other market participants. In that case, it could operate more efficiently as an independent private company. Perhaps the secret of such attachment of Ukravtodor to Automobile Roads of Ukraine is specifically the fact that the road maintenance and operation sectors have so far been left out of the liberalization process. After all, the most "delicious" road contracts are here and not in road construction. In fact, routine repair of roads is the bottomless pit into which the bulk of the funds allocated annually for Ukravtodor’s basic operations go. According to Ukravtodor, a total of UAH 15.9 billion was allocated for the needs of the agency this year, out of which UAH 8.4 billion was intended for debt payments and UAH 5.1 billion for repair and maintenance of roads. In addition to this amount, UAH 3.15 billion in international loans will be spent. This is exactly what is spent on road construction and, as we can see, it is considerably smaller that the funds allocated for "routine maintenance."

New contracts and a road fund But the aim of reform is also to tackle the problem of inefficient repairs, according to the management of Ukravtodor. This will be the goal of an experiment that involves changing the type of contracts that are concluded with contractors. To begin with, the experiment will involve only the construction of the Kiev-Chop highway. "A pilot project will begin on the Kiev-Chop road in the Lvov region this year, under which payment will be based on the end result - the condition of the road - and not the volume of potholes repaired. The approach will be thus: we pay every month for the road condition stipulated in the in the contract, certain defects should be repaired within three days and certain defects within seven days. If there is a delay or if the quality of the service fails to meet the required quality standard, then [the contractor] receives less money," explained Prusenko. This approach has been under discussion in the industry for a long time. Even in his first interview with the CTFS, the EBRD’s Magaletsky said that it had long been proposed that Ukravtodor attempt to conclude OPRC (Output- & Performance-Based Road Contracts) contracts with contractors. "You need to repair a road after the winter, and you invite a contractor to repair the defects. However, in this case, the contractor is interested in the volume of the work being big enough, and it is desirable for the contractor for these defects to reappear one year later. That is the type of motivation,” Magaletsky said. Under the new approach proposed by the EBRD, the contractor will receive a road section, and it will be responsible for ensuring that this section of the road is in a normal condition during a period stipulated in the contract. This means that the contractor will have no interest in reappearance of the defects that have already been repaired.

The initiative on establishment of the State Road Fund seems contradictory. On the one hand, the argument in favor of its creation is convincing. The State Road Fund should function as a separate state budget fund, from which, in contrast to a special-purpose fund, money cannot be withdrawn for any purposes other than road construction. Revenue into the fund will be generated from the sources that are intended for road purposes under the law (tax on imported automobiles, excise duties on petroleum products, payments for excess load on vehicles).

As Prusenko stated in an interview with the Ukrainska Pravda online newspaper earlier this year, budget revenues from excise duties on petroleum products alone should total around UAH 19 billion in in 2013. However, just over UAH 5 billion was allocated from the special fund for the needs of Ukravtodor, which means that the funds are not used for the intended purpose.

However, one issue involving the creation of the State Road Fund engenders doubt that the situation on Ukrainian roads will improve significantly. Funding will be distributed between state and local roads in a 61:39 ratio. It is worth mentioning here that out of the 170,000 kilometers of roads in Ukraine today, 117,000 kilometers or nearly 70% are local roads. During the reform, these roads will be transferred onto the books of local governments, which will receive 39% of the total proceeds into the road fund for maintenance these roads. The remaining 30% of the roads are state roads that will remain under Ukravtodor, and 61% of the proceeds into the road fund will be allocated for their maintenance. Meanwhile, Ukravtodor itself acknowledges that at least 100,000 kilometers of local roads out of the 117,000 are presently are in need of major repairs.