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By John Helmer in Moscow

A 21-day ultimatum has been issued to the Russian government to put up the Grib pipe in Arkhangelsk for development by a joint venture between De Beers and LUKoil; or else De Beers will walk out of Russian diamond mining for good.

Sources close to De Beers claim that some senior executives in London are bluffing, in order to halve the $100 million payment which De Beers must pay LUKoil, if the agreement is finalized with the Kremlin by December 31. These executives believe that falling global demand, declining diamond prices, and a growing shortage of cash oblige De Beers to seek a modification of the terms of agreement, signed with LUKoil in mid-April. But some De Beers executives are more reportedly pessimistic. After a recent review of project costs, they are proposing to abandon the Arkhangelsk project altogether, and expect that LUKoil and the Russian government will oblige them by ignoring the ultimatum’s New Year deadline.

The ultimatum came in a press release from De Beers’s Toronto subsidiary, Archangel Diamond Corporation (ADC), labeled “notification of a Termination Event”.

The text is as follows: “Investors will be aware that the severe and adverse economic conditions have had a dramatic impact on exploration and mining projects on a global basis. These conditions are also seriously affecting the diamond industry, including current and planned diamond mining operations. In light of these events, Archangel Diamond Corporation (“Archangel”or the “Corporation”) (TSXV:AAD) has considered its position relating to its proposed acquisition of a 49.99 per cent equity interest in OAO “Arkhangelskoe Geologodobychnoe Predpriyatie” (“AGD”) pursuant to the Share Purchase Agreement (“SPA”) between OAO “LUKOIL”, the Corporation and De Beers S.A. dated April 15 2008, as amended and other transaction agreements signed at that time, and all as described in the Corporation’s news release dated April 16, 2008.”

“Together with its wholly owned subsidiary, Archangel has today notified OAO “LUKOIL” (“LUKOIL”) of a Termination Event. Under the terms of the SPA, a Termination Event includes a Material Adverse Change. Such term means, in the context of a Termination Event, a material and adverse change in or effect on the Verkhotina Business or assets relating to the Verkhotina Business or operations or condition (financial or otherwise) of AGD. Pursuant to the SPA, if such Termination Event is continuing thirty days after notification thereof, then Archangel and/or its wholly owned subsidiary may terminate the SPA within the period of five business days after such 30 day period. If the SPA is so terminated, this will result in the other transaction agreements being terminated.”

While this gives LUKoil until mid-January to come to agreement with ADC and De Beers, the notice implies that the effective deadline is only three weeks away. “In addition, two conditions precedent stipulated in the SPA, namely, approval under the Russian Federation law on foreign investment in strategic assets and approval under the Russian Federation competition law, are still outstanding and have not yet been satisfied. If the outstanding conditions precedent are not satisfied by December 31, 2008, under the SPA either Archangel or LUKOIL may thereafter terminate the SPA. This will result in the other transaction agreements being terminated. As regards the former condition precedent, discussions are currently ongoing between Archangel and the Russian Federal Anti-Monopoly Service (“FAS”) regarding the draft ancillary agreement and the application for consent made in August 2008 by its wholly owned subsidiary. There can be no assurance that agreement on the final terms of an ancillary agreement will be reached in any event and there can be no assurance that one party would not unilaterally decide at any time to treat such discussions as at an end. If this occurs, the effect would be that consent for the transaction would be refused.”

Polished Prices.com reported last month that De Beers has been frustrated by the unreadiness of the Russian government agency reviewing the joint venture deal, the Federal Antimonopoly Service (FAS), to devise clear terms of a diamond cutting and polishing agreement, which the mining venture must accept in order to proceed. De Beers believes that without clarity on what such a beneficiation agreement would cost, and on whether LUKoil will share the cost proportionate to its equity stake, there is a serious financial risk in continuing.

The April agreement with LUKoil provides that De Beers would hold a 49.99% stake in the mining venture, and LUKoil would hold the rest, if the project agreement goes through. De Beers would act as technical consultant to the project, retained by the project operator, Arkhangelsgeoldobycha (AGD), the LUKoil owned geological company and license holder. The price De Beers and ADC have agreed to pay is divided into three tranches — $100 million in down-payment, when and if the transaction closes; $75 million when LUKoil and ADC agree to go ahead with the construction of a diamond mine at the Grib Pipe and AGD gives its accord to mine; and $50 million when commercial diamond production starts. It is estimated by the Russians that the mine go-ahead would be unlikely before 2011; commercial production by 2015.

These payment and equity arrangements indicate a total valuation of the mine asset at present at $450.1 million.

The spokesman for LUKoil chief executive, Vagit Alekperov, told Polished Prices.com: “Formally, we have time until December 31. That is the date by which the decision on the deal should be made. It is premature to talk numbers. There is no FAS approval yet, so the number is not significant before the approval will be granted. If there will be no approval, there could be no deal.” Alekperov had said last month that he expected the deal to close by the end of December.

If the deal collapses and De Beers walks away, it is unclear whether De Beers intends to renew the costly litigation proceedings it launched in Stockholm and Denver, Colorado, after accusing LUKoil and other Russians of raiding the licence, and violating the original terms of the joint venture.

Dropping the litigation, if that is what De Beers decides to do, would open the way to other international miners, with an interest in the Grib pipe, to make their bids for the project. Before diamond values crashed a few weeks ago, De Beers had estimated the deposit to contain 74 million recoverable carats, worth about $8.2 billion.

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