PROJECT INFORMATION DOCUMENT (PID) CONCEPT STAGE. Ukrzaliznytsya 7 Tverska Street Ukraine

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1 Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized Public Disclosure Authorized PROJECT INFORMATION DOCUMENT (PID) CONCEPT STAGE Project Name Railway Modernization Region EUROPE AND CENTRAL ASIA Sector Railways (100%) Project ID P Borrower(s) UKRAINE RAILWAY Implementing Agency Ministry of Finance Ukraine Ukrzaliznytsya 7 Tverska Street Ukraine Environment Category [ ] A [X] B [ ] C [ ] FI [ ] TBD (to be determined) Date PID Prepared December 12, 2007 Estimated Date of June 2008 Appraisal Authorization Estimated Date of Board October 2008 Approval 1. Key development issues and rationale for Bank involvement Report No.: AB3526 Railway transport is critical to Ukraine s economic development, for three reasons: (i) Ukraine s natural resource endowments and strong metallurgical industries give rise to a demand for very high concentrated flows of bulk materials. Such traffic can be carried much more cheaply by rail than by road transport; (ii) Ukraine is an important and growing transit country for bulk traffics such as oil and grain from Russia and Kazakhstan to the Black Sea Ports. These commodities demand the freight logistics of heavy haul rail transport to minimize logistics cost and maximize market opportunities; and (iii) Ukraine has many large cities located km from Kiev. These are distances at which inter-city rail transport can be most competitive over bus services and against airline competition. Transport Market Share. These economic, geographic and demographic characteristics have created a very busy mixed-use railway. In 2006, Ukrzalistnitza 1 s turnover was USD 4.5 billion. Rail transport carries over 80 percent of Ukraine s freight traffic (measured in ton-km) and around 60 percent of public long-distance passenger traffic (measured by passenger-kms). The railway operates to the same infrastructure and train operating standards as its eastern neighbors. It is therefore a key contributor to Ukraine s regional economic integration. Not surprisingly then, while the rail network density (in terms of route-km/ square km) is around 20 percent less 1 Ukrzalistnitza is the Ukrainian National State Railways, referenced as UZ thereafter in this note.

2 than that of the European Union (EU) its rail network utilization, in terms of traffic-kms/route kms, is nearly three times as high as that of the EU. Transport Market Trends. The modal shares of road and airline transport will likely grow as those modes develop to serve new industries and social needs, but the railway network will continue to play a major role in Ukraine for the long-term future. Indeed since 2000, rail freight transport has increased by 39 percent (an increase in tkm that is greater than the total freight carried by railways in France) and intercity passenger transport has increased by 39 percent (an increase in passenger business greater than the total passenger traffic carried by rail in Sweden or Portugal). The attraction and retention of traffic on railways contributes to a transport system that in overall terms is safer and less environmentally damaging than the alternatives. The efficiency of railways will have a significant impact on Ukraine s economic competitiveness. Railway Infrastructure and Governance. During the years of transition, investment in Ukrainian Railways was not sufficient to maintain assets in a steady state. The reduction of investment in transport infrastructure that occurred in the 1990 s was a response to serious railway budgetary constraints and declining traffic levels as the national economy plummeted and then restructured. However, the investment hiatus led to railway assets that are now comparatively old, often technologically outdated, and that have deteriorated in quality. With resurgent economic growth over a number of years, Ukraine now faces the prospect of serious bottlenecks in the quality and capacity of its rail infrastructure and rolling stock assets. In addition to asset modernization, there is a need to modernize Ukraine s railway sector governance. Market forces are increasingly determining the generation, distribution and market shares of transport demand. In this environment the ability of Ukraine s railway industry to adapt to market forces will determine whether its promising market performance since 2000 can be maintained. This need to adapt is driving efforts by railway management to reform. On-going Sector Reform. UZ, with support from EBRD, 2 has undertaken a number of reforms in recent years while still essentially a department of government. It has transferred its social, housing and educational functions to more appropriate administrations; it has created specialist entities for non-core businesses and divested over 200 of them; it has transferred Metro Systems in Dnepropetrovsk, Kharkov and Donetsk to Ministry of Transport. UZ has established a medium-term rolling business planning cycle, and provided its 2006 Business Plan to the Bank. It is operating at a small after-tax profit (about US$ 250 million per year) over the last few years. 3 Reform Process. However, UZ s management recognizes the need for more fundamental corporate reform of Ukrainian Railways itself and has submitted a 10 year reform strategy to the Council of Ministers. The starting point for these reforms would be the corporatization of UZ to re-establish it as a joint-stock company at arm s length from the Government. The Council of 2 EBRD has provided a series of loans to UZ, including one in 1999 for track maintenance machines, and one in 2004, a loan for track maintenance machines and reconstruction of a tunnel. Throughout this period, EBRD has provided support to UZ to develop its restructuring program. 3 Based on the new Ukrainian Accounting Standards, transformed to IFRS.

3 Ministers approved the Concept of the State Program on Reform of Ukrainian Railway Transport in December It envisions a three stage reform process: Commercial Management. In the first stage of reform, commercial activities of railways would be separated from policy activities government. UZ would become a joint stock company, and the six regional railways would be merged into one railway entity. Passenger Separation/Funding. In the second stage of reform, freight and passenger activities will be separated. At present UZ receives minimal compensation for public service obligations and cross-subsidizes these services from freight profits, effectively a crude tax on production and/or trade. The proposal is gradually to replace the cross-subsidy with direct budgetary support from Central and (where appropriate) regional/municipal governments (though it is acknowledged that in Ukraine s budgetary situation this may take many years to achieve). Gradual Introduction of Competition. In the third stage of reform passenger and freight services would be completely separate from infrastructure and open access to the infrastructure for competing companies would be established. Draft Railway Law. These reforms have been expressed in a draft railway law which UZ has been circulating to interested ministries. Passage of the law has been delayed by the current unsettled political situation, but UZ now expect passage in mid UZ s restructuring plan is ambitious, but it is one in which the Bank has extensive prior experience and which through continuing engagement and dialogue it should be able to support. UZ Investment Program. Between 2007 and 2015, UZ plans to invest nearly US $ 19 billion to renew it capacity to provide rail service and meet the predicted increase in transportation demand. UZ s investment priorities include: railroad infrastructure modernization especially for international transport corridors (East-West, North-South); launching high speed passenger train services; rolling stock renewal; adoption of energy efficient technologies and mitigation of environmental impact through electrification of tracks; use of information technologies and stateof-the-art train traffic control systems. 4 Bank Program. The Bank would take a programmatic approach to the railway sector reform, supporting an agreed reform path through a series of specific investment loans (SILs). IBRD would focus on upgrade of infrastructure. Rollingstock would be financed through more commercial sources. EBRD is preparing a $750 million non-sovereign loan for rolling stock, of which $500 million would be syndicated to commercial banks. IFC has also expressed interest in financing UZ rollingstock. Project Linkage with the CAS and CPS. The CAS Progress Report (2005) identifies the quality of infrastructure as an emerging constraint to growth. This report indicates that the Bank will help the Government identify priority projects that address bottlenecks in physical infrastructure and provide fast, world-class solutions. The proposed project would support the first pillar the Country Partnership Strategy to contribute to sustained economic growth and improved competitiveness of Ukraine. 5 In particular, it will be a part of the core program for making use 4 UZ has agreed to provide a detailed investment program. 5 IBRD and IFC, Country Partnership Strategy for Ukraine, p. 46.

4 of Ukraine s transit potential and improving transport infrastructure. 6 The CPS recognizes that... maximizing Ukraine s unique potential as a transit country is a top government priority going forward. Consequently, the government has provided ample room for external borrowing by Ukravtodor (the State Road Agency) and Ukrzalistnitza (the State Railways) to finance upgrading of roads, complete electrification of the railway network and purchases of new rolling stock Proposed objective(s) The development objective of the proposed project would be to improve railway service in the North-South freight corridor between Russia and the Black Sea. 3. Preliminary description The project would upgrade a North-South freight corridor, which is a priority for UZ and would relieve congestion on an overcrowded parallel route. The estimated total cost for the proposed Railway Modernization Project is about US$1.1 billion, of which the World Bank would finance US$ 450 million, while EBRD and counterpart funding would be US$ 650 million. The proposed project has two components. Component 1: Technical services [US$5 million WB financing] This component has yet to be fully defined but is likely to consist of the following subcomponents to be implemented either by UZ or the Ministry of Transport and Communications (MOTC): Capacity Building to UZ: Systems and training to assist in the changes in corporate culture and business process attendant on conversion from a Government Department to a joint stock company including the adoption of line of business approach [US$2 million]. Passenger Public Service Obligations: Independent identification and quantification of cross-subsidies from freight to passenger services and development of a long-term strategy for implementation of a passenger public service contract system based on institutional and measurement models being developed in the European Union [US$2 million]. Technical Assistance to MOTC: advisory services and review of laws and regulations to improve sector governance. [US$1 million] Component 2: Infrastructure Upgrade to Poltava-Dzhankoy Line [US$445 million WB financing] 6 IBRD and IFC, Country Partnership Strategy for Ukraine, p IBRD and IFC, Country Partnership Strategy for Ukraine, p. 32.

5 The project would upgrade a railway route that runs north-south from Kharkiv near the Russian border to the Crimea in the South (Kharkiv-Poltava-Mykolaiv-Dzhankoy) 8. To accommodate expected traffic growth, UZ plans to shift freight trains from the Kharkiv-Zaporizhya-Dzhankoy route to the upgraded Kharkiv-Poltava-Mykolaiv-Dzhankoy route, allowing the Kharkiv- Zaporizhya-Dzhankoy route would to be operated primarily as a passenger route. This project is part of an overall strategy 9 to separate main passenger routes from freight routes to allow higher speed (e.g., kph) passenger operation and provide capacity for growing traffic. 10 The proposed investment would electrify 11, complete double tracking and improve signaling on the line from Kharkiv-Poltava-Mykolaiv-Dzhankoy route. The estimated cost of the entire project is shown in the table below. Estimated Cost of Line Upgrade (US$ millions) Investment Poltava - Koristivka Zham ynka Vadim Vadim Dzhankoy Total World Bank Financing Electrification Track Signaling Total : , UZ has confirmed in principle that the project would be jointly financed by the EBRD and the World Bank. Monitoring Indicators The project Log Frame attached in Annex to the present note, proposes the following project Monitoring and evaluation indicators: (i) increased capacity to handle freight traffic expressed in TU-km 12 per km; (ii) reduced transit time & improved reliability of freight services in corridor expressed in hours before and after the project implementation; (iii) reduced operating costs in the corridor expressed in US$/TU-km/year; (iv) improved energy efficiency along the corridor measured in kw used per TU-km; and (v) reduced impact on the environment expressed in tons of CO2 emission per TU-km. 4. Safeguard policies that might apply The Bank s standard environmental requirements will apply to the proposed Railway Modernization project. It is expected that the nature of the works considered under the project 8 A parallel existing route between these points (Kharkiv-Zaporizhya-Dzhankoy) is operating at capacity. 9 The Concept of the Program Implementing Passenger High-Speed Traffic at Railway (2004) and the State Program Implementing Passenger High-Speed Traffic at Railway (2007). 10 UZ was originally designed to operate passenger and freight trains as similar speeds. As the desired speeds diverge, different track characteristics are needed by the different traffics, and capacity is lost by faster trains needing track possession to overtake and pass slower trains. 11 The investment would largely take place on existing railway premises. In some cases, however, the electric substation would have to be connected with existing power sources (~10-15 km of transport team line could be required). 12 TU.km is equal to the sum of freight ton-km plus passenger-km.

6 would result into classification as a Category B project for environmental assessment purposes under the Bank s OP/ BP 4.01, Environmental Assessment. An Environmental Assessment (EA) Report including Environmental Management Plan (EMP) will be prepared. Independent Consultant will support the Borrower with public consultation on the EA. Those public consultation with project affected parties and NGO s will be held during the scoping meeting to discuss the ToR for the EA and to identify negative and positive environmental and social impacts related to the project, propose possible mitigation measures to be implemented to avoid potential negative impacts, and identify relevant and priority environmental issues that are of concern to affected parties. 5. Tentative financing Source: ($m.) Borrower 556 International Bank for Reconstruction and Development 450 European Bank for Reconstruction and Development 100 Total Contact point Contact: Michel Audige Title: Lead Transport Specialist Tel: (202) Fax: Maudige@worldbank.org