Olympic Costs and Investment Uncertain

Editor's note: This is the ninth in a series of reports about the effect of the global financial crisis on Russia.

The announcement that Sochi had won the right to host the 2014 Winter Olympics generated cheers and expressions of greater self-confidence from across the country last year, but you couldn't blame people for having some doubts after the economic news of recent months.

Prime Minister Vladimir Putin, president at the time, attended the voting last year in Guatemala City to lobby for the bid personally and was positively beaming after the announcement was made.

But as his government wrestles with the financial crisis and private investors continue to bleed cash, the $12 billion — unprecedented for a Winter Olympic Games — allotted to prepare the Black Sea resort city to host the games might be looking like an increasingly steep price to pay to boost national prestige.

Preparations to host the Olympic Games have never come off without a hitch, and the organizers of the 2012 summer games in London are already talking about scaling back some of their grandiose construction plans due to an inability to secure bank loans.

But the statements from the Sochi Organizing Committee, state corporation Olimpstroi, which was created to manage state expenditures on the projects, and Dmitry Kozak, recently appointed as deputy prime minister to oversee the preparations, remain positive and ambitious.

"We have no fears about the realization of the project," Kozak told reporters on Friday. "So far, everything is moving forward as planned."

The appointment last month of Kozak — someone Putin has regularly made point man in dealing with the country's most pressing issues — came as a sign of how important maintaining central oversight and control of Olympic preparations is to the government.

The original Federal Target Program calls on the federal government to provide 186 billion rubles, or about 60 percent, of the total 314 billion rubles ($11.6 billion) to fund the games.

"Not one element is being pulled out of the program, but saving on costs has been established as a task," Kozak said, adding that costs could end up being 10 percent to 15 percent lower.

In a positive twist, the global recession will likely help the government spend less by putting downward pressure on prices for materials. Cement prices, for example, have fallen by 50 percent over the last three months.

Lower expenditures would buck a trend. In October, for example, the State Duma voted to increase Olympic-related expenditures in the federal budget by 23 billion rubles over the next two years. Then, two weeks ago, Putin approved an increase in funding for Olimpstroi of 29.7 billion rubles, bringing the total to 181 billion rubles.

But the precipitous fall in world oil prices — by about two-thirds since early summer — has raised questions about the state's ability to cover all expenses laid out in the budget. The government has said that a world oil price of $60 per barrel was necessary to cover all expenditures in 2010, for example. The current price is about $50.

Following the passage of the budget for 2009-2010 by the State Duma, the Federal Audit Chamber published a statement on its web site criticizing the "insufficient transparency of legislation pertaining to the preparation and holding of the games."

Audit Chamber head Sergei Stepashin advised the Duma to pay special attention to increases to the budget for the games.

Audit Chamber representatives refused to comment further for this story on financing for Sochi.

Kozak, meanwhile, disagreed with the Audit Chamber statement.

"The legislation is crystal clear," he said Friday.

Despite falling materials costs at present, the end cost could still end up higher than anticipated, putting even more strain on the budget.

"The original figure of $12 billion dollars could easily double by the end," said Irina Pilman, who works as an analyst for Standard & Poor's on the Krasnodar region, where Sochi is located.

The costs of many construction projects were miscalculated because the IOC's requirements for infrastructure quality were not fully taken into account, Pilman said.

At the same time, inflation is likely to reduce the purchasing power of the funds set aside for Sochi. The Ministry for Economic Development said this month that the inflation rate would finish at about 13.2 percent for this year.

The Krasnodar regional government, which is financing some of the municipal infrastructure projects, has seen costs rise while the projects are still only in the planning stages.

"We had to add a lot to the list, because many of the sites are in dire need of repair, which was not reflected in the original plan," said Tatyana Yolich, who heads the region's department overseeing its work on preparations for the games.

The original plans called for the Krasnodar region to put up 9 billion rubles over the next five years, Yolich said, but that figure has already grown to 14 billion rubles.

Kozak said in late October, after meeting with potential investors from the American Chamber of Commerce, that the final budget estimates for the games would be ready by the spring.

"We will have the projected cost and the lineup of investors by then," Kozak said.

Russia is not alone, as the hosts of the next two Olympics — the 2010 winter games, in Vancouver, Canada, and the 2012 summer games in London — are also working under tough conditions.

All three hosts are "doing their best to manage any risks associated with the economic downturn," IOC spokeswoman Emmanuelle Moreau said in e-mailed comments.

Not addressing Sochi in particular, she said the IOC is closely monitoring the potential impact of the financial crisis on the Olympic Movement.

The Sochi Olympics were initially pitched as the perfect opportunity for public-private partnerships, with Olimpstroi holding events at the Sochi Economic Forum and meeting separately with U.S., Arab and Austrian companies as potential investors in October.

So far, the major investors are Interros, the holding company for metals and mining tycoon Vladimir Potanin, Basic Element, majority-owned by billionaire Oleg Deripaska, and the state-controlled energy company Gazprom.

Interros is committed to building Rosa Khutor, a ski resort in the area that will host Olympic events.

Potanin has recently suffered a number of setbacks from the financial crisis, with the value of shares in Norilsk Nickel, one of Interros' holdings, plummeting by 60 percent in recent months.

Interros spokeswoman Nina Dementsova said the company considers its investment in Sochi "absolutely reliable" because the Olympic project is being overseen by the government, which will "do everything in its power" to make the games happen.

That "everything" has already included a loan from state-owned Vneshekonombank, also known as the Development Bank, which signed a contract with Rosa Khutor in September to provide loans for $750 million of the project's total planned expenditure of $1.375 billion over the next 15 years.

Rosa Khutor is the only company to secure government financing for an Olympic project so far, but a Vneshekonombank representative said others have applied for loans for their projects, although she declined to provide names.

Both Rosa Khutor and another Sochi resort being built by Gazprom were in the works long before the city was picked to host the games.

If the biggest private investor in Sochi, Basic Element, were approved for a Vneshekonombank loan, this would be the second time the government-owned institution has come to Deripaska's aid. Last month, the bank provided RusAl, which is part of the Basic Element conglomerate, with $4.5 billion to refinance a previous Western loan coming due.

Basic Element itself is investing 60 million euros ($75 million) in the reconstruction of the passenger terminal at Sochi airport. It is also expected to construct a cargo port and the $3.5 billion Olympic Village and media center at Sochi's Nizhneimeretinskaya Bay.

Kozak said Friday that no private investor had pulled out of its Olympic commitments.

Basic Element spokespeople declined to provide information about financing for the project or possible changes to investment plans, saying only that the "realization of all the main projects is going as planned."

Some things, notably land issues, don't seem to be going as planned.

Organizers have had to deal with opposition from some residents of Imeretinskaya Valley, the location of Olympic complex's "lower cluster," including the main Olympic Village and port to be built by Basic Element. Some formed the "Union of Imeretinskaya Residents" and refused last month to sell their properties without being provided homes and land of equal value nearby in exchange. The start of construction will require 230 land plots to be turned over by their current residents. Appraisals were performed on many of the properties in August and September, when land prices were at their peak.

On Friday, Kozak said the properties would be purchased as needed, with possible adjustments to previous estimates.

"We are not going to rush to buy the land," he said. "Land prices, which spun out of control in August, have to be adequate and fair."

He said that only two lots have to be acquired by the end of this year for the projects to go ahead. Other landowners remain in the dark about the future of their properties.

Local residents are not the only ones confused by the land ownership issue. Key investors like Rosa Khutor have also been caught up: The company originally dealt with the Sochi National Park for land-usage rights, but the property has since passed under control of the Federal Property Agency, leaving Rosa Khutor up in the air.

Company spokeswoman Natalia Kudryavtseva said it had "minimized construction work" while negotiations continue on a lease with the new owner.

But Paul Mathews, president of Ecosign, the company designing the resort, put it differently, calling the situation a "Mexican standoff" and saying work had been halted since summer.

"There are always problems that repeat themselves in different Olympic cities," said Mathews, who has been involved in planning skiing facilities for four different Olympic Games, including for Vancouver in 2010. "But the land ownership issues are uniquely Russian."

Whether it is because of "uniquely Russian" issues or the constraints imposed by the financial crisis, foreign companies have not been eager to sign on either as investors or developers.

Viktor Kolodyazhny, the former mayor of Sochi, who was named to run Olimpstroi after Semyon Vainshtok resigned abruptly in April, has held a number of meetings with foreign companies, including at the American Chamber of Commerce event last month.

So far, no foreign investors have stepped up for any of the 20 Olympic projects that remain unclaimed.

Advertised as opportunities for public-private partnerships from the outset, the tenders for many Olimpstroi projects continue to be pushed back, and time is ticking. It's not clear how long the government will continue to wait before simply opting to foot the bill itself.

The crisis might actually help here, as companies in dire straits might be drawn to any chance to get new business.

"Companies have less money for their own projects, and state-run banks are more likely to give out credits to projects that have state interests at stake," said Olga Shirokova, an analyst with Blackwood.

Some developers may even get into Sochi to get access to liquid assets from the state budget, Shirokova said.

But not everyone agrees that this could happen.

Working in government programs is not the right environment for a developer's objectives, making a return on investment and the sale of high-quality buildings, said Adrian Salter, Chairman of the Real Estate board of the Association of European Businesses.

"When you consider that Russia has one of the largest sovereign reserve funds in the world, to count on foreign investment at a time of world financial crisis is not logical," Salter added.

If so, Russia will have to count more on its own reserves, funding remaining structures and financing the larger private investment projects through government banks. Sochi might end up looking more like a Keynesian New Deal than the public-private endeavor originally intended.