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By John Helmer in Moscow

Fyodor Andreyev was appointed chief executive of Alrosa, the state-owned Russian diamond monopoly and world’s second diamond miner after De Beers, a year ago, after the Kremlin decided to change the diamond concession. Ousted were the chief executive Sergei Vybornov and Otar Marganya, mediator and fixer between the company, the Sakha government, the federal treasury, and the Minister of Finance, Alexei Kudrin, who doubles as Alrosa’s board chairman. The Sakha president Vyacheslav Shtirov asked to go at the time, but was told to wait. He departed at the end of May this year.

What had been happening inside Alrosa in the run-up to this change has not been disclosed publicly. Some of the details are in classified reports of audits by the Accounting Chamber, the state auditor headed by former prime minister Sergei Stepashin.

Alrosa’s financial reports have been relatively unrevealing, except for a tell-tale clue on the company’s debt line. Starting under the first of the federal Ministry of Finance appointees to the chief executive’s post, Alexander Nichiporuk (2005-2007), and accelerated under Kudrin’s second choice, Sergei Vybornov (2007-2009), Alrosa’s gross debt went from Rb41.4 billion (end-2004: $1.49 billion) to Rb134.4 billion (end-2008: $4.6 billion). That’s a threefold increase. The question begs for answer — where did the money go?

Starting in 2006 under Nichiporuk, Alrosa also began a foreign exchange hedging programme with banks. This included five unnamed foreign banks, plus VTB, the state lender where Marganya filled an executive vice president’s chair. From Note 6, titled “Derivative Financial Instruments”, in the auditor’s notes to Alrosa’s annual financial reports, PriceWaterhouseCoopers explains that Alrosa placed regular bets with the banks by selling US dollars at “a strike price fixed at the exchange rates ranging from RR26.56 to RR26.84 per US$1, averaged quarterly.” Evidently, Alrosa was protecting itself against a strengthening of the rouble against the US dollar, and a concomitant rise in its US dollar costs, and decline in the rouble value of its US dollar-denominated sales of diamonds. According to the Russian Central Bank charts, the rouble rate was firmer than the strike price in 2007, when the currency averaged Rb24.55 to the dollar; and during the first half of 2008, when the rouble dropped to a low of Rb23.13, before the global crash of oil and other commodities reversed the rate to Rb29.38.

As currency hedges go, this has been a consistent money-spinner – losses for Alrosa, gains for the banks. At the end of 2006, a net gain of Rb902 million was reported, and was positive on Alrosa’s income line. At the end of 2007, Vybornov’s first year, the value of the forex contracts gained another Rb5.1 billion, and was a positive offset on Alrosa’s debt account. At the end of 2008, Vybornov’s second year, the company reported that it had lost Rb25 billion. At the end of 2009, Vybornov’s last year, the forex gain was Rb10.7 billion. Net loss that year was Rb6.3 billion.

Andreyev isn’t responsible for these operations, nor for the run-up of the debt. He was appointed to clear it as swiftly as possible. Vybornov and Marganya were part of the problem, and Shtirov too. They have gone, but Kudrin is still in place at the Russian treasury, still in place as chairman of the Alrosa, and still Andreyev’s boss. Kudrin might be called to account by either the Prime Minister, Vladimir Putin; or the Deputy Prime Minister in charge of mining and resources, Igor Sechin; or the State Duma; or the head of the control directorate of the presidential administration, Konstantin Chuichenko, Dmitry Medvedev’s lawyer. But there is no sign that Kudrin has been called, or that the diamond account is big enough in the Russian scheme of things to attract their attention.

There is every sign, though, that Kudrin told Andreyev – sink the debt, and while you are doing it, run silent, run deep.

Submarining diamonds isn’t what Alrosa is supposed to do, and Andreyev (Kudrin too) aren’t members of the Russian secret service. And yet in the year he has served as Alrosa’s chief executive, Andreyev has given no unscripted public interview, and answered no questions from the specialized industry press. To bank analysts and Sakha parliamentarians, however, he has issued a stream of good financial news, all genuine, and some of it more revealing than Alrosa has reported in the past.

Based on the 2009 results, when De Beers had shut down its mines, Alrosa claimed the number-1 spot in the world diamond miners’ table. With output of 34.8 million carats, Alrosa had a 30.1% market share; De Beers with 22.6%; Rio Tinto with 15%; BHP Billiton with 3.9%; and everyone else combined with 26.6%. In a preliminary report for the first quarter, issued by Alrosa on July 8, output was 8.6 million carats, down from 9.2 million carats in the same period of 2009; calculated value of that production is $564.9 million, down from $610.3 million a year ago. This report suggests that when Alrosa was delivering its rough last year to the state stockpile agency Gokhran, the per-carat price was $66.34; this year the production value has been adjusted downward to $65.69.

However, as Andreyev’s latest report indicates, there were no deliveries to Gokhran in the first quarter, while commercial sales have rebounded to $935 million. That compares very favourably to $671 million achieved in Q1 2007, and $614 million in Q1 2008.

In rouble terms, revenues for the first quarter rose to Rb27.1 billion ($876 million). Costs jumped to Rb16.380 ($528 million), driven largely by rising oil charges, which consume about one-third of the company’s operating costs. On the profit line, Alrosa is reporting a first-quarter net income of Rb1.8 billion ($59 million).

Debt at the start of the period was $3,790 million, costing at an average annual interest rate of 12.39%. At the end of this year, the debt aggregate is projected to fall to $3,490 million. The average interest rate charge at March 31 was down to 7.85%.

In terms of marketing strategy, the new report says: “In Q I 2010 ALROSA signed three-year supply agreements with Indian diamond companies Rosy Blue, Diamond India Ltd and Ratilal Becharlal & Sons to the total of $490 million. In 2009 sales under long-term supply agreements made up 21% of the aggregate sales. According to projections, in 2010 their proportion will increase to 56%. Long-term agreements provide for adjustment of the diamond assortments and prices by the parties on a quarterly basis conditional on the situation on the global diamond market, and a possible increase in amounts of rough goods to be supplied.”

While Alrosa says its aim is to sell 70% of its stones on long-term agreement, this year’s projection indicates that spot sales still comprise 44% of total.

The full text of the July 8 report.

At about the same time as this was posted by the company, perhaps just before, a brief questionnaire was sent to Andreyev. The July 8 release doesn’t answer most of the questions. So to help inform the international diamond market, including Alrosa’s global clients assembling this week in Moscow at the 34th World Diamond Congress, here they are:


QUESTIONS FOR MR FYODOR ANDREYEV ON THE EVE OF THE 34TH WORLD DIAMOND CONGRESS

1. At the beginning of this year you raised the possibility of spinning off and listing Alrosa’s Africa assets, and in a separate IPO, the Nyurba mine. Since then it has been disclosed you have sold the Luo mine in Angola. What is your plan for Africa? What is your plan for Nyurba?

2. You appear to have run into opposition on the part of the Sakha Il Tumen and the regional government and parties to your idea for privatization of Alrosa’s shareholding, and a sale of shares to the public. Why is it important to you to privatize the company, and how do you think you can win over the critics and opposition?

3. Can you comment on your announcements that Alrosa is divesting and selling its non-core mining assets after the company financial report reveals that you are also bound by option agreement to take the oil and gas assets back at a substantial increase over the reported sale price?

4. Now that the exclusive sales channel between Alrosa and De Beers is no longer in place, can you give a breakdown (in carats or value, and in percentages) of how Alrosa’s rough market is distributed this year between domestic and export; within domestic, between Gokhran and commercial buyers; and within exports, between the different diamond centres?

5. How many sightholders do you have at present, and what is the distribution in your current delivery contracts between spot sales, and longer-term period sales?

6. Does Alrosa still have plans to brand its rough diamonds?

7. Does Alrosa already have, or is the company seeking marketing agreements with well-known retail brands, such as Tiffany and Faberge?

For the time being, Andreyev is refusing to answer. Try them with him yourself.

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