Feature

posted 22 Jun 2010 in Volume 12 Issue 12

CEE/SEE: Emerging Opportunities

The energy and infrastructure sectors are set to heat up in Central, Eastern and South-eastern Europe, reveal partners Andreas Schmid and Dubravka Gruji of Wolf Theiss.

Central, Eastern and South-eastern Europe (CEE/SEE) is slowly emerging from the economic downturn. A new phase of development is underway, offering a plethora of business opportunities to both investors and the law firms advising them.

In times such as these when the private sector is having difficulty getting large deals done on its own and governments are striving to apply anti-cyclical measures, there are an increasing number of transactions being promoted or sponsored by the public sector. This trend is most prevalent with regards to large-scale infrastructure and energy projects. For investors and their legal advisors, these projects present both attractive opportunities and some unique challenges.

Key Facts

1. FDI in central and eastern Europe increased by five times between 2003 and 2008

2. FDI in alternative energy in central and eastern Europe grew by 31% in 2009

Laying foundations

Throughout much of the region, a considerable portion of the existing infrastructure has reached the end of its lifecycle, with most of it dating back to the Communist era. Accordingly, this infrastructure needs to be both modernised and expanded in order to handle increasing demand. Following the credit crunch, countries in the region have begun to focus once again on infrastructure projects as a means of boosting the local economy, as well as to lay the foundation for future economic growth.

Numerous projects are currently either being developed or tendered – particularly road and highway projects – in Romania, Bulgaria, the Czech Republic, the Slovak Republic, Serbia, Macedonia and Bosnia & Herzegovina.

There have been a number of airport privatisations in Prague, Bucharest, Zagreb and Pristine, as well as railway modernisation projects in Bosnia & Herzegovina, the Czech Republic, Bulgaria and Romania.

The development of sports and leisure facilities such as soccer stadia are also underway, particularly in Croatia, Hungary and the Czech Republic. There are many more examples in other infrastructure segments.

The number of utilities projects in the fields of solid waste, waste water and water is also likely to increase substantially.

Demand for energy

The energy sector across former Eastern Bloc countries has also not received much in terms of investment since the end of the Communist era. While the existing facilities for producing and storing energy have deteriorated, demand has of course increased.

The energy sector will thus become one of the region’s most active areas of investment, with opportunities ranging from conventional energy power plants to gas pipelines.

There are a number of energy projects which are currently in the development or implementation phase in the region. This includes conventional energy projects in Bosnia & Herzegovina, Croatia, Kosovo, Romania, Serbia and Ukraine, as well as nuclear power plants in Bulgaria, Hungary, the Slovak Republic and Romania.

With the ongoing liberalisation of the regional energy markets, privatisations of major energy companies in countries such as Croatia or Serbia are also likely. However, while opportunities abound, this overall wave of investment in the region differs in several respects from the pre-crisis boom years.

Financing challenges

With less liquidity in the market, sponsors for non-EU projects are finding it more difficult to get financing. Banks and financial investors are not only looking into the quality of projects in terms of their economic feasibility, but also require legal documentation to be of a higher quality and tendering procedures to be fully aligned with international best practices.

In that respect, there is much more transparency and legal certainty around tenders than in previous years. Non-EU countries have brought their own laws and regulations much closer to international best practice by generally adopting EU standards, either because they are on the brink of acceding to the EU or they see the benefit of modernising their public procurement systems. This gives investors more confidence in the process, reducing the risk that they could later be denied financing over a compromised tender procedure.

The role of multilateral development banks – such as the European Investment Bank and the European Bank for Reconstruction and Development – has increased over the past couple of years, as they have stepped in to provide much needed additional liquidity. However, these institutions come with their own set of demanding funding criteria, occasionally making the process more complex or lengthy.

Energy projects will benefit from the European Commission’s decision earlier this year to release €2.3 billion to improve gas and electricity infrastructure as part of the EU’s Economic Recovery Package. With these funds, the EU has said it will co-finance up to 50% of project costs, which it believes will have a leverage effect of bringing in up to €22 billion in private sector investment. The €2.3 billion is expected to be available until the end of 2011.

Untapped potential

The EU’s commitment to foster the use of clean energy has spurred greater momentum in the development of renewable and alternative energy facilities. In CEE/SEE, major energy companies and other project sponsors continue to show interest in renewable energy, particularly in light of commitments by both EU member states and non-EU countries to generate a greater percentage of energy from renewable sources.

While the renewable energy sector is very much in vogue these days, it remains largely untapped in CEE/SEE. This will change in the months and years to come, particularly as such projects are highly incentivised by national governments (by application of special RES feed-in tariffs or otherwise) and are less capital intensive than many conventional energy projects. Early investors who have explored the region’s potential in this sector have generally been very satisfied with the results.

The EU’s strict requirement for all member states to reduce their dependence on fossil fuels is subject to a tight timetable, with 20% of energy targeted to be obtained through renewable sources by 2020. Since the funds available to this end are limited, governments will have to turn to the private sector.

Besides conventional and renewable energy projects, nuclear power also represents an opportunity in the region. Still, nuclear power projects are bound to encounter a variety of challenges, both political and financial. In Bulgaria, for example, the Belene project – a planned 2,000MW plant – has been put on hold due to a lack of financing. This delays Bulgaria’s opportunity to become a net exporter of energy, together with important revenue that could be used by the country to invest in additional much-needed infrastructure and energy projects. It is yet to be seen how capital-intensive projects such as nuclear plants will be structured, tendered and financed.

PPPs on the rise

Public-private partnerships (PPP), which are common in certain parts of Europe, do not yet have a long tradition in the region. CEE/SEE governments, however, see them as an advantageous arrangement for the financing of various projects. While a number of PPP projects have been put on hold over the past couple of years, this situation is about to change and, in the foreseeable future, PPPs should become the preferred project structure.

As governments in the region step up their activities by putting more PPP projects on the drawing board, new and more sophisticated structures that are developed and tested in mature markets are likely to be adapted to the less developed markets in CEE/SEE. For law firms that are on top of their game in such structures, this represents a powerful opportunity, especially when working with regional law firms that are right at the forefront of these developments.

The tendering, structuring and financing of large, expensive infrastructure and energy projects is rarely simple, smooth or quick these days, especially in CEE/SEE. There is still much left to be desired in terms of local sensitivity to international best practices and standards. This is truer of the non-EU countries in the region than of EU member states in the region.

Emerging markets

International and regional law firms have a bright and busy future in CEE/SEE countries as the markets pick up and the latest wave of investment moves into the region.

Comprising several emerging markets, CEE/SEE has often suffered from under-developed local legal frameworks, inexperience of the public sector, capacity constraints and private sector weariness of the risks involved.

However, the secondary market for PPP projects is currently being developed, which will help bring new opportunities for law firms in the region.

In addition to infrastructure and energy projects (whether PPP or structured within the framework of traditional procurement), law firms will be busy with the current wave of distressed asset transactions. Generally speaking, the companies coming onto the market in this manner may be only a few months away from breaching a loan covenant or even outright insolvency.

In this kind of situation, the risk for buyers is considerably higher than usual since they have to act very quickly, leaving less time for thorough due diligence investigations. For those investors which have cash on hand, these scenarios often present an opportunity to buy competitors, supply chains and market access far more cheaply than they could have just a couple of years ago. Law firms which serve clients that are ready to make a move on this basis will also benefit from these opportunities.

– andreas.schmid@wolftheiss.com; dubravka.grujic@wolftheiss.com