Page 1 of 2 Diamond cartel meltdown By John Helmer
MOSCOW - With the end of 2008, the last of the legendary diamond cartel deals
has sunk back into the murk from which it originated when Cecil Rhodes created
his African Diamond Syndicate in 1873.
Following a ruling three years ago by the European Commission (EC), Africa's De
Beers and Russia's diamond miner Alrosa have wound up a series of trading
agreements - secret and open - that date back almost 50 years. Although the EC
ruling, which threatened such agreements, was subsequently overruled by the
European Court of Justice, De Beers and Alrosa decided separately that their
best interests would be served if, from now
on, they produced and traded competitively. From January 1, Alrosa no longer
sold and exported a fixed quantity or value of rough diamonds each year to De
Beers.
At the peak, in the 1990s, De Beers was buying more than US$1 billion worth of
Russian rough from Alrosa through official channels, while also doing
profitably on the leakage, or unofficial trade.
Before January is out, it will also be clear whether the Russians have decided
to roll up De Beers's coat-tails, and oust Archangel Diamond Corporation (ADC),
a De Beers-controlled Canadian subsidiary, from its position as co-owner and
operator of the newest of Russia's diamond mines in the Arkhangelsk region, in
the northwest of the country.
Does this mean that the Russians believe that Alrosa, which accounts for about
one-quarter of the global supply of mined diamonds, is better positioned to
weather the market-wide collapse of diamond value than De Beers, which controls
about 40% of diamond output? Because Alrosa is backed by Russian state
financing, treasury guarantees, and the capacity of the state stockpile to
absorb Alrosa's diamonds until they can be sold, the answer is a tentative yes.
Therein lies the potential for a revolution in international diamond clout.
By contrast, De Beers long ago disposed of its diamond stockpile and
reorganized its corporate strategy to emphasize profit-making at the end of the
diamond pipeline where diamond jewelry is sold, mostly to Americans, followed
by Japanese and Chinese. Mining in territory that is potentially hostile
politically, and competitive financially, De Beers is now only as strong as the
family that controls the company.
Luxembourg-registered De Beers, with its roots deep in South Africa, is owned
and controlled by Nicky Oppenheimer and his son Jonathan, directly and with a
cross-shareholding in the Anglo American Corporation. A 15% stake in the De
Beers holding company is also held by the Botswana government. The Oppenheimer
father and son face a vote of confidence by the Anglo American board later this
year, and if that goes against them a rack of family dominoes may start to
fall.
Alrosa, on the other hand, is wholly state owned, with just over 50% of the
closed-issue shares held by the federal government in Moscow, and 32% of the
shareholding held by the Sakha republic government in the Russian far east. The
company's financial weaknesses must be measured against the depth of the
Russian treasury's pocket. In the longer term, its strength lies in unmined
diamond reserves. These were publicly valued this year at about $110 billion.
De Beers' diamond reserves are not reported. Anglo American, which reports
detailed reserves data for all its mining divisions, omits to state the diamond
reserves it claims through its stake in De Beers and publishes no diamond
reserve data by volume and or value.
Two-thirds of De Beers's annual production of diamonds is mined in Botswana;
30% in South Africa; and the remainder in Namibia, Tanzania and Canada.
Alrosa's Russian production is virtually all mined in the Sakha region. The
Russian company also earns income from the sale of its share of diamonds mined
in Angola, where one mine is operational and two are in development.
While the published production and financial data of the two diamond giants
can't be compared precisely, De Beers says its annual sales from rough
diamonds, as of 2007, amounted to about $6 billion. In the same year, Alrosa
reported a comparable aggregate sales figure of almost $3 billion. In 2008,
sales by the two companies were shrinking at different rates - De Beers
apparently faster than Alrosa. By year's end, the two control control about
two-thirds of global diamond production and exports of rough.
The prospects for 2009, according to estimates given at a diamond industry
conference in Antwerp in November, are for a contraction of at least 10% in
demand for diamonds in the retail jewelry market, with a deeper decline in the
US and Europe; a reduction of about 20% in demand for loose polished diamonds
in the wholesale market; and a 35% fall in the demand for rough diamonds from
the minehead.
While diamond jewelers claim that a 10% downturn isn't the end of the word for
them, a cutback or loss of one-third of diamond mine production is more serious
for the mining companies.
For the time being, there has been no policy response from De Beers, except for
a report on how to sustain demand at the retail end by focusing on even more
expensive luxury applications of diamonds for the steadily expanding class of
rich Chinese and Indian consumers - "the new maharajas" they are termed in the
report, entitled "Luxury Considered" [1].
According to Stephen Lussier, executive director at De Beers and head of
marketing strategy, "The scarcity value of diamonds is increasing as more
wealthy investors buy traditional jewelry as a hedge against struggling stocks
and inflation".
Alrosa is also moving in the direction of luxury branding but is keeping its
plans secret. More openly, the Russian diamond miner is taking steps to secure
its current and future mining operations against the demand crash.
The first test was announced last month, when the state-controlled bank VTB
extended a $1.6 billion loan to enable Alrosa to clear its most pressing
foreign dollar-denominated debt. The inclusion of Alrosa in the Kremlin's list
of Russian companies to be supported through the crisis followed on December
25.
A decision on whether Kremlin permission for De Beers to operate the
Arkhangelsk region diamond mining project will be withdrawn can be expected
shortly. This follows an ultimatum, issued last month by De Beers, for the
Russians to accept an agreement for 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 the ultimatum was a bluff by senior executives
in London, in order to halve the $100 million payment which De Beers must pay
LUKoil if the agreement is finalized with the Kremlin. 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 the agreement,
signed with LUKoil last April.
But some De Beers executives are reportedly more pessimistic. After a recent
review of project costs, they are proposing to abandon the Arkhangelsk project
altogether. Reportedly, they expect they will be able to pass the blame to
Moscow, and 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, issued on December 8, 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 SA 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 [December 8]
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
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