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By John Helmer in Moscow

At the Antwerp diamond conference Alrosa and De Beers switch positions on value of diamond beneficiation.

Diamond-miners are wolves; diamond-cutters are sheep.

At least that’s the way it has usually appeared to the governments of countries fortunate enough to supervise lucrative mineable diamond deposits. Expressed in terms of the diamond supply pipeline, the mark-up in value of diamond mine sales, compared to the costs of production at the minehead, can be a wolfish 500%. By contrast, the mark-up in value of the polished, which cutters realize in relation to the cost of the rough they buy, can be a sheepish 25%.

Why, then, for the decade of the 1990s did Alrosa and the Russian government resist the advice of De Beers, and insist on preserving, indeed expanding, the domestic diamond-cutting industry? In those years, De Beers managing director Gary Ralfe never tired of telling his Russian counterparts that profitable mining companies don’t make cost-efficient diamond manufacturers. Stick to what you know best, Ralfe told Alrosa – dig up the stones, and sell them to us.

Listen now to Ralfe’s successor, Gareth Penny, talking last week to a gathering of global diamond policymakers, miners, and manufacturers at the traditional European centre of the diamond trade, Antwerp.

“For the African diamond producing countries, beneficiation is not optional, not a passing whim motivated by political correctness, but an imperative, an absolutely essential and critical part of their macroeconomic policy designed to uplift their economies to provide education, jobs and healthcare for their people, and to make poverty history. We embrace this imperative completely and with great energy. Today, De Beers, with its partners, contributes more than US$4.6 billion dollars to African economies every year. De Beers, with its long African history, now has a further opportunity to make a really significant and sustainable contribution to the development and prosperity of the countries in which it operates.”

And more: “we don’t embrace this out of some misguided enthusiasm or altruism. No, we embrace it because it makes good business sense and because it is the right thing to do.”

And look at what Sergei Vybornov, chief executive of Alrosa, the world’s second diamond miner after De Beers, had to say to the same gathering:

“One of the tendencies to watch is the development of a diamond cutting and polishing industry in the diamond-mining countries of Africa. Botswana, Namibia, Angola, South Africa and Democratic Republic of Congo contemplate setting up large cutting and polishing facilities that will consume rough diamonds in volumes equivalent to those being currently processed by traditional diamond processing centers – Israel, Belgium and India. This most recent tendency has some serious flaws.”

Referring to Alrosa’s experience in polishing its own rough, Vybornov went on: “the reality of the modern cutting and polishing business is that it operates at the very low margins. Alrosa’s operations clearly demonstrate that the processing industry is and has always been an extremely poor instrument boosting state revenues with insignificant social effects.”

Little noticed in the reporting, but not missed in the corridor talk in Antwerp, was the extraordinary reversal in the positions of the two dominant diamond miners in the world. De Beers now says it is wholeheartedly in favour of beneficiation. Alrosa says it is a waste of money, and should be abandoned. In argument, Penny says politics is primary; Vybornov says profit is all that counts.

Why the switch?

Some in the industry believe that Penny is singing the song of the diamond jeweller, the most profitable position on the diamond pipeline, toward which the De Beers group has been heading ever since Nicholas Oppenheimer took the company private several years ago. At that time, he engaged consultants to tell him he should restructure his company to go to the very end of the pipeline, where the profit margin is even greater than it is at the minehead.

In this interpretation, Penny is anticipating the future when he and the Oppenheimers will no longer be diamond miners at all; when Anglo American will have ended their management contract, acquired full control of the De Beers diamond mines; and De Beers will have become a brand-name generating 500% in mark-up for the diamonds in diamond jewellery – and nothing more.

Why the switch at Alrosa? Its reasons are a little difficult to spell out in a polite, family newspaper.

A decade ago, the Russian government held the world’s largest and most valuable stockpile of rough diamonds. Unsorted in some sizes, under-valued in market terms, subject to administrative orders without effective audit, inventory, or fiscal control, they were a resource which officials from President Boris Yeltsin on down considered their own black treasury. From this they funded election campaigns and themselves. The carrying cost of the stones was minimal to zero. Their foreign sales value, even at a sub-market dumping price, allowed huge mark-ups. Naturally, these encouraged every form of export transaction the imagination of diamantaires was capable of. From these humble beginnings, great diamond-cutting empires were built; and three well-known Israelis in the business today, Lev Leviev, Beny Steinmetz, and Dan Gertler, got their start.

The emptying of the state stockpile has been documented in criminal indictments and convictions in San Francisco, for which some served jail time; and in a notorious presidential pardon, before trial, for the Russian official responsible

Vybornov knows very well how the diamond beneficiation system of Russia in those years worked as a conduit for discounted domestic rough to become fully priced polished goods abroad. He knows, because for the past several years, he has been actively trying to close down the conduits, and eliminate intermediation in Alrosa’s sales system, so as to capture and centralize more profit margin. If Alrosa believed it could earn a greater margin exporting its stones, then management secured the federal Finance Ministry’s permission to short the domestic buyers. With limited domestic demand for diamonds until recently, Russian manufacturers lacked the political clout to combat this policy.

Vybornov and his immediate predecessor, Alexander Nichiporuk, also expanded their global mining reach, increasing the volume and profitability of their mining projects in Angola, and looking to establish new mines in Democratic Republic of Congo, Namibia, and elsewhere in southwestern Africa.

So, as De Beers withdraws from mining, Alrosa advances – and that seems to be the real script behind the Antwerp speechifying.

On the attack, Vybornov said the diamond pipeline is too long – there are too many dealers and speculators in the middle. An “alarming trend”, he said, is “the growing number and volumes of speculative transactions with rough. Today there are 4 major producers of rough, each having a dealer network of its own, thousands of small producers and dealers. New world-class diamond trading centres are being intensively created. It would hardly be an exaggeration to state that in the last 15 years the value chain has become much longer and the number of speculations on the market is unprecedented. Dealership is a common element of the diamond market. However, under certain circumstances this classic checks and balances business may turn into the instrument of chaos.”

To stop the rot, according to Vybornov, the “major global upstream players should sit together with major downstream players and should determine a set of measures to drive out any speculation from the market or at least reduce it to the minimum level.” If that sounds suspiciously like a new diamond supply and pricing cartel, resurrected out of the ashes which De Beers and the European Commission tried burying last year, then Vybornov made clear he is thinking of a combination with leading jewellery retailers, not other mining companies. “The diamond’s way from the mine to the jewellery store should be shortened to the maximum extent possible. We believe the ideal structure would be direct sales of rough diamonds to established globally jewellery brands. ALROSA has started direct sales to Tiffany & Co., and we are confident that such sales will breathe a new life into the jewellery trade.”

As for shortening the middle of the pipeline, Vybornov had nothing to say about Antwerp, Tel Aviv, New York, and Bangkok – the world’s established high-volume diamond trading and cutting centres. “I would like to appeal to our African friends: please think twice and learn from Russian experience when you make the decisions regarding beneficiation. Let me just remind you that it is not common practice to build a uranium treatment plant near a uranium deposit.”

According to Vybornov, Africa’s lack of experience and skills is a major barrier to entry into maunufacturing. “The overall quality of cut diamonds, produced by new African nations may not be up to the industry standards, due to the lack of cutting traditions and schools. Their sales and marketing may also be problematic because of virtual non-existence of local dealer networks and blockade by competitors-traditional participants of this fragile market,” he remarked.

The argument is the same as Ralfe’s a decade ago. But Vybornov added what he described as Alrosa’s lessons from its own polishing ventures. The profitability of one of Alrosa’s cutting ventures, “Diamond World,” according to Vybornov, “amounts to 2.06% of their full cost price. This is less than the interest rate in Russian banks and far below the annual inflation rate.This is typical for Russian diamond processing factories.”

“Those in the African diamond mining countries who decide to set up large national processing facilities should by all means reject their populist argumentation. They should focus entirely on the economic side of such projects.”

Company reports from Alrosa indicate that revenues from polishing within the company are more volatile than rough sales. In 2006, polished sales amounted to $141.1 million. This was down 1.8% compared to 2005, but up 7.8% compared to the 2004 result. Alrosa’s annual report for 2006 explained the downturn as due to “the lower currency efficiency coefficient” – read falling dollar to rouble – and also due to the dwindling of sales through a joint polishing venture with Lazare Kaplan International, a New York firm.

This year, according to projections issued by the Alrosa board at the start of October, polished sales will be $159.7 million; this is a gain of 13%.

The annual report indicates that the company includes 6 diamond-cutting subsidiaries or affiliates, but the report does not identify them. There is no mention in the report of “Diamond World”. Putting Alrosa’s diamond manufacturing operations into context, rough diamond sales in 2006 totaled $2.9 billion; this means that cutting comprises just 4.9% of Alrosa’s domestic revenue base. Alrosa’s sales of rough to the Russian market, including the local cutters and polishers, comprised 49% of total rough sales in 2004; 59% in 2005; and 56% in 2006.

Representatives of the Russian cutting plants reacted critically towards Vybornov. The head of the Russian Diamond Manufacturers Association, Ararat Evoyan, told Mineweb: “I don’t want to comment on Africa. I think it is improper for a company’s president to give advice to these countries. Besides, the Russian experience is not negative. It is unique and positive. If Diamond World received 2% in the last year, which was a very bad year for cutting, the overall result is good. The main problem of cutting in Russia is the price of rough diamonds – they are too expensive.”

Evoyan also attacked Vybornov’s proposal to end US dollar pricing for diamonds as nonsense.

According to Vybornov, “is there anything in common between the Russian ruble, South African rand, Canadian and Namibian dollars? You know the answer – their exchange rates against the US dollar keep rising. I think the time is coming to look out for another currency, which is less dependent on global economic and political trends.”

Evoyan responded: “Most rough ends up in the US market. His proposal is nonsense, because the price is fixed in dollars because of supply markets, not because of somebody’s will.”

Valery Morozov, head of Ruis Diamonds and Leviev’s Moscow representative, said Vybornov was reacting to Alrosa’s rising cost burden, and squeezed margins, that follow the firming of the rouble against the dollar. “I understand very well Vybornov’s position – for Alrosa, this situation creates additional pressure. But diamonds are not only a Russian market commodity. Take, for example, the commodity which is more important for world markets – oil. The price there is fixed in dollars with the same problems, so why should diamonds be traded in another currency? Rough diamond prices are also dependent on polished diamonds, and they can’t be separated. Europe is an important market for polished, but not the main one.”

Morozov said Vybornov was mistaken on the profitability of cutting enterprises in Russia other than Alrosa’s. “Of course, cutting doesn’t make such profits as mining, but it is not correct to say that in Russia it is loss-making. This is an issue for each individual enterprise. Based on our experience, we show nice profit.” Pointing the finger at Alrosa’s rough supply policies, Morozov said: “If we could solve the question of rough supply, the profit would be even bigger.”

He added that beneficiation programmes in Africa serve the important fiscal control function of enabling governments to value (and tax) mined diamonds more accurately. “The issue there is not purely about profit. Besides, a company whose core business is mining, like Alrosa, can expect difficulties in cutting. Cutting for them is not so profitable.”

Evoyan and Morozov, along with other sector experts in Moscow, were sceptical of Vybornov’s announcement that he is negotiating a long-term rough supply agreement with Tiffany’s. Evoyan retorted: “He thinks that if he would sell to Tiffany, they would share with him the profit and will pay him a higher price – they will not. Besides, this [Tiffany purchase] is at maximum 5% of his sales, so where he will put the rest?”

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