By John Helmer in Moscow
De Beers report heightens geotechnical and political challenges in Archangel diamond mining project.
To adapt the old saw, a great many fresh girls are going to be obliged to make diamonds their best friends before Grib, Russia’s newest, and possibly largest, diamond pipe, can make enough profit to justify digging.
Located in Arkhangelsk region, one thousand kilometres northwest of Moscow, Grib was discovered in 1996; it is the largest kimberlite pipe newly found in Russia. Developed initially by Archangel Diamond Corporation (ADC), a De Beers-controlled company, it was the target of a 10-year hostile takeover by Vagit Alekperov and Alisher Usmanov, who between them control substantial Russian oil, iron-ore and steel assets. De Beers sued for recovery in Sweden and damages in the US.
With LUKoil, Alekperov’s oil company, which wholly owns the local licence-holder for Grib, Arkhagelskgeoldobycha (AGD), De Beers and ADC signed an out of court settlement a month ago. This provides for a staged development plan for the new mine, starting with a down-payment of $100 million from De Beers and ADC, once the new project framework has been approved.
ADC’s briefing paper on the deal, dated April 17, suggested there was more value to the Grib pipe than had been publicly acknowledged before. “The Grib mineral resource comprises a large indicated mineral resource estimated to contain 50.2 million carats at US$105 per carat and an inferred mineral resource estimated to contain 24.3 million carats at US$119 per carat to a depth of 774 metres below surface.” This sums to $8.2 billion.
According to the ADC report, “by extending the resource at depth, the estimated resource represents an overall increase in diamond content from the 67.4 million carats of +1mm diamonds, at an average diamond value of US$79 per carat, first reported by Archangel in 1999.”
By digging deeper, ADC claimed there was even more value. “Located directly below the estimated inferred and indicated mineral resources, an additional potential mineral deposit has been estimated to contain 6.8 million to 12.9 million carats at US$118 per carat to a depth of 1,050 metres below surface, such estimated tonnage, grade and diamond value are conceptual in nature as they result from insufficient drilling to define a resource.” If it’s possible to mine to the thousand-metre mark, that makes a hypothetical addition of $1.5 billion, for a grand total of $9.7 billion.
The good news led to the lifting of the trading suspension for ADC shares, and the price rocketed from 35 Canadian cents on October 31, just before suspension, to C$2 on April 28. Very little volume was traded, as if ADC shareholders were waiting for even better news. This didn’t happen. Instead, on May 1, ADC released the NI 43-101 technical report on the Grib project. The 155-page document, drafted by De Beers analysts Johan Ferreira and Wolf Skublak, and dated April 8, took some digesting. Then on May 13, about one million ADC shares were sold, dropping the price by 7% on the day. It has continued falling, and is currently reported at C$1.55.
The dampening news in the De Beers report on Grib is that the net present value (NPV) of virtually every imaginable application of one pit design, calculated according to a half dozen interest rates, turns out to be negative. The NPVs have been figured for ADC’s 50% less one share in the project, after taxes and royalties are paid, and including withholding taxes of 10%.
NM Rothschild, acting as financial advisor to ADC, helped with the financial modelling.
An alternative pit design for Grib reduces much of the projected red ink. But most of the new NPV numbers are in the double-digit millions of dollars; at very best, they fail to produce an NPV of more than $398 million. So soon after the resolution of the decade of fighting over the diamonds, the NI 43-101 report thus begs the question of whether the raiders knew what they were doing; and also whether this is a diamond mine worth developing.
Several tiny disclosures in the report represent an interesting footnote to what happened last November, when a spike of buying demand lifted ADC’s share price suddenly, and then led to the Torpnto stock exchange’s suspension. According to Ferreira and Skublak, “in July 2007, ADC, De Beers, LUKoil and AGD came to an agreement in principle, set out in a memorandum (the “Memorandum”) initialled the same month. This Memorandum was nonbinding and subject to finalisation of legal, financial and technical due diligence, agreement on a number of key terms, the agreement of contractual documentation and other matters for the acquisition by ADC of a minority interest in AGD and settlement of the long-standing Verkhotina dispute.”
This agreement, apparently confirming the intention of both sides to end the long-running conflict, has not been revealed before. Nor was the site visit by the De Beers expert team to the Verkhotina project area and the pipe on September 25, 2007; also disclosed for the first time in the new report. Nor was a subsequent agreement between De Beers and LUKoil in October on designing an open pit mine, rather than an underground one, for preliminary valuation and feasibility studies. The new relationship between De Beers and ADC and their former foes at LUKoil and AGD apparently led also to the disclosure that, in late 2007, AGD applied to Rosnedra (the Russian Federal Agency for Subsoil use) for approval of licence amendments to allow greater flexibility in the development planning for the proposed mine, and grant more time in which to reach start-up. Rosnedra’s authorization came through on April 1, 2008.
It has long been known, and reported by Mineweb, that in addition to the pressure of foreign litigation, Alekperov and AGD were under the domestic pressure of licence revocation by the federal authority, with the risk that the asset they thought was theirs – at least to snatch from ADC – might be cancelled, and then auctioned off to the highest bidder.
What ADC executives thus knew, following their initial agreement with Alekperov and AGD in July, may have leaked, and become the inspiration for share-buying on November 1, the day after ADC hit rock-bottom of 35 cents. For the next day, on no apparent news, the share price went up by 43%. On November 9, share trading was halted, and remained so for six months. As Mineweb has also reported, ADC executives kept mum throughout the period, when it is now clear they were finalizing the out-of-court deal that had been reached the previous July.
So what is the value of the deal ADC is offering, and De Beers will underwrite, for a cumulative $225 million to be paid to LUKoil for a 49.99% stake in the new project?
Note there isn’t much time to gather the required Russian government approvals, notably from the newly established foreign investment review board. According to the April agreement, “all conditions precedent must be satisfied prior to 1 June 2008 failing which either LUKOIL or Archangel is entitled to terminate the Transaction.”
Ferreira’s and Skublak’s technical report notes several sizeable mining risks that present administrative, political and commercial hurdles that have yet to be dealt with. Soft rock and high salinity of water in the lower aquifer around the kimberlite mean that the mine pit must be designed with an unusually shallow slope. This in turn requires such a wide circumference for the pit’s boundary, it cannot be dug, without going over the current licence boundary. Down below, in order to get to the depths where the added diamond value appears to lie, the water is so saline, it threatens the surrounding water courses and forest, if it were disposed of without treatment. Also, the surrounding forest is classified and protected as two statutory natural reserves. If an open pit is to be cut across the amount of land surface required, the mine licence holder must get government approval to cut into one protected reserve, and compensate by adding non-mineable land to the second reserve.
The politics of licence modification in Russia are notorious for inviting hostile raiding and greenmail. In addition, the Grib mine will require an agreement on access and use of local infrastructure, such as road and power lines, which are currently under the control of Russia’s diamond miner Alrosa, whose subsidiary Severalmaz is working away at several pipes of the Lomonosov diamond field, a few kilometres away from Grib. There have been informal talks between Severalmaz and AGD, but no negotiation yet between Alrosa, De Beers, and LUKoil.
Until this week, it was unclear who at the federal level would be top dog and decision-maker for approving the foreign investment structure of the new deal, and supervising the subordinate levels of government in issuing the administrative clearances. Sources inside the Ministry of Natural Resources and Rosnedra have told Mineweb that, although Minister Yury Trutnev was reappointed on Monday, there is chaos in the chain of command below him. State prosecutors are also investigating charges of misconduct by officials engaged in the supervision of mining and resource licences.
Alexei Kudrin, Minister of Finance and Deputy Prime Minister, is nominally in charge of the Russian diamond sector, and chairman of the Alrosa board. But he is a weak figure, compared to Vyacheslav Shtirov, the president of the Sakha republic, where Alrosa does most of its diamond mining. Shtirov cannot be sure that in the reshuffle of regional government posts, he will be reappointed to his. Neither Kudrin nor Shtirov played any part in the De Beers-LUKoil deal. But if the latter and Sergei Vybornov, chief executive of Alrosa, have in mind to participate in the Grib project, either by buying into the LUKoil or the De Beers stake, they will have to apply for permission from higher authority.
The week’s new government appointments now suggest that this must be Igor Sechin, the new deputy prime minister in charge of industry. A former KGB officer like the outgoing president, Vladimir Putin, and the most powerful of his Kremlin aides, Sechin has now taken administrative control of the Russian oil sector; of all movement by land or sea of energy exports; of ports and shipbuilding, and of the raw materials, minerals and metals required for Russian industry consumption. Sechin, it can also be assumed, will supervise the new government board to review investments by foreign companies in strategic sectors of the economy.
Russian law has long barred a foreign diamond miner or investor from majority or operational control of a Russian diamond mine. The new law on strategic economic security, which came into force on Putin’s signature on April 29, requires government review and approval of all new projects in which a 10% equity stake or more is sought in a diamond mining project by a foreign-owned company. ADC acknowledged the requirement, and also the lack of time, in a notice to the market on May 7: “The New Law provides that from the time of receiving an application for consent, the Russian Government has up to three months (which can be extended by up to a further three months in exceptional circumstances) within which to assess such an application and make its decision, although it is currently unclear when the procedures for making an application will be finalised which could affect the timing of obtaining the Government Consent. Given that (pursuant to the current terms of the Share Purchase Agreement among Archangel, LUKOIL and De Beers Société Anonyme with respect to the Transaction) all conditions precedent must be satisfied prior to 1 June 2008, Archangel has commenced discussions with LUKOIL to agree an extension to the 1 June 2008 deadline in order to allow for the obtaining of the Government Consent.”
How long an extension will be required will depend on how long Sechin takes to arrange the start-up of this Russian equivalent of the Committee for Foreign Investment in the US. At the moment, there is no telling. It can be said, however, that compared to oil, gas, and metals in Russian production and trade, the $3 billion annual output of Russian diamonds is so small, there is no record of Sechin having paid much attention to how the diamond concession has been managed. Putin was compelled to pay more than the usual amount of presidential attention in 2006 and 2007, but that was because of resistance to the federal takeover of Alrosa by the Sakha authorities, led by Shtirov. That having been settled, more or less, last year, the interest on the part of senior Kremlin officials in the diamond concession has dwindled.
In the meantime, the negative sentiment which the Ferreira-Skublak report appears to have inspired in the market towards ADC is pushing at the underlying diamond values, which were used in the NPV calculations. The technical report acknowledges that average carat values were drawn from the De Beers price book for July 2007. Rising diamond prices since then, and long-term projections of global demand outstripping supply, suggest that the dollar values used for the Grib’s NPV calculations must be modified upwards.
In addition, it is obvious that too little kimberlite has been lifted from Grib, and too few carats extracted, to reduce the margin of error in the financial model. It is known that about 800 carats have been sampled from Grib so far. But at least four times that number, or about 3,200 carats would be required for more confident sampling. With an estimated grade of 1 carat per tonne, at least 3,200 tonnes of ore should be extracted from the pipe for further calculations. This is unlikely to happen before next year.