Diamond Cutting Enterprises and the Free Market in Rough Diamonds

By Docent Tatiana Pototskaya, Marketing Department of Kristall PC OJSC

A partially free market in rough diamonds is developing independently from the world diamond monopoly De Beers. In other words, in 2004, the free market comprised 50 percent of the primary rough diamond market, worth .7 billion.

The main suppliers of diamonds to this market were Russia (through ALROSA) – 20 percent of the world total; Canada (predominantly through BHP Billiton’s Ekati Mine and the Diavik Mine, which is owned by Rio Tinto and Aber Resources) – 14 percent; Angola (through ALROSA, LLD and Endiama) – 9 percent; the Democratic Republic of Congo (through MIBA) – 9 percent; and Australia (through Rio Tinto’s Argyle Mine) – 3 percent. The main consumers of rough diamonds were the diamond polishing industries in India (34 percent); Israel (24 percent); Russia and the diamond trading intermediaries in Belgium (34 percent), the UAE (4 percent) and the United States (3 percent). 

When the Russian trade press refers to the free market in rough diamonds, it always means the foreign market, as the domestic markets are dominated by the diamond mining monopoly ALROSA.
 
Our purpose is to show why Russian diamond manufacturers are trying on the one hand to achieve close cooperation with ALROSA, and on the other hand regard De Beers as a promising partner.

In our opinion, the major problem of the world diamond industry today is the lack of coordination between price increases in rough and polished diamonds. Thus, for the last six years, rough diamond prices have been rising by up to 8 percent per annum, while prices for the best selling weight categories of polished diamonds have been declining, by 3 percent per year for 0.5 carat diamonds and by 0.3 percent per year for 1 caraters. For this reason, the diamond polishing plants in Russia are facing a rough diamond shortage.

The various proposals that have been put forth to solve this problem can be classified into three groups: First, more rough could be supplied to domestic plants at the expense of Russia’s exports; second, rough imports could be increased and diversified; or third, Russian reserves of rough diamonds could be tapped.

So, the first proposal is to solve the problem of the rough diamond shortage by reducing exports from Russia. In the Russian internal market, the only supplier of rough diamonds to the domestic cutting industry is ALROSA. That is why its policy with regard to diamond marketing is the main factor determining conditions in the whole diamond manufacturing sector. To what extent are the Russian diamond manufacturers’ hopes that the rough diamond supply situation will improve in the near future justified? 

The diamond trade in Russia can be divided into two parts: trade on the domestic market and exports to the foreign markets. These are approximately equal in volume: .16 billion goes to the external market and .13 billion to the internal market. Over time, this proportion is likely to change. Change may stem from the interference of the European Commission with the De Beers-ALROSA cartel. The EC initially gave approval to the basic parameters of the proposal by ALROSA and De Beers for a reduced but still significant long-term sales contract between them. This proposal was intended to settle an antitrust investigation initiated by the EC in January 2003.  Under its terms, ALROSA was to sell De Beers rough diamonds worth 0 million in 2005, 5 million in 2006, 0 million in 2007, 5 million in 2008, 0 million in 2009, and 5 million in 2010 and every year thereafter. However, in 2005, the EC’s Antitrust Committee withdrew its earlier approval and asked De Beers to end its contract with ALROSA before 2009. This reduction in diamond sales to the world market (most of the stones mined in Russia were traditionally exported to the international market through De Beers) may lead to an increase in the rough diamond supply to the domestic market.
 
The second proposal is to solve the problem by increasing and diversifying rough diamond imports. Russia’s international trade in rough diamonds comprises 98 percent exports and just 2 percent imports, in both value and weight terms. This situation does not serve the Russian diamond manufacturers’ interests. After all, increased imports of rough diamonds would partially solve the industry’s supply problems. But how realistic a prospect is that? Gem-quality stones comprise 58 percent of rough diamond imports by carat weight and 97 percent by value; thus, it becomes obvious that only large diamond manufacturers can afford to buy such an expensive commodity (at an average price of 6 per carat) in any significant volume. This high average price in turn reflects Russian manufacturers’ specialization in “Russian cut” diamonds. Who are these large manufacturers of diamonds? The most expensive rough diamonds, with an average price of over 0 per carat, are mined in Namibia, Sierra Leone, Guinea, Angola, the Central African Republic, Tanzania, Canada and China. Diamonds are mined in significant and steady quantities only in Namibia (the “private preserve” of De Beers and LLD), Angola (ALROSA and LLD) and Canada (BHP Billiton, Rio Tinto and Aber Resources). Hence, we can draw the conclusion that the main suppliers of high-quality diamonds to the world market are De Beers, LLD, ALROSA, BHP Billiton, Rio Tinto and Aber Resources. Let’s try to consider the possibilities of cooperation with each of these companies.

De Beers. When it comes to gem-quality diamond imports, Russia’s main trading partner is the United Kingdom, which supplies it with 88 percent of its imported rough in value terms and 68 percent in carat weight, with a rather high average price of ,200 per carat. This proves that De Beers, whose Diamond Trading Company is based in London, is the main foreign supplier of diamonds to Russia’s diamond manufacturers. It also shows that Russian diamond manufacturers have no well-organized system of supply, unlike the leading foreign diamond manufacturers such as Lazare Kaplan International or LLD. At the same time, we should recall that out of 137 diamond manufacturers in Russia, only one is a DTC sightholder; thus, the share of rough diamonds supplied by De Beers is only 10 percent of the total. To increase this share is rather difficult, since De Beers demands much of its clients.
Still, are there any opportunities to broaden cooperation with other multinational corporations? LLD has a well-developed diamond polishing business, so this company is more of a competitor than a partner. The Canadian companies should also be excluded from the list because the country’s diamond polishing industry has similar problems to those in Russia. Only ALROSA is left.

So, to really solve the problem of rough diamond supply to the Russian diamond manufacturers by considerably increasing diamond imports is hardly possible, although reducing rough diamond exports is quite a real possibility.

The third proposal is to solve the problem by tapping Russia’s rough diamond reserves. The principal reserves Russia holds are “special size” large diamonds (10.8 carats and more), which have been sold at auction by ALROSA and Gokhran, the Diamond Chamber of Russia, since 2003, under a new law on the import and export of natural rough and polished diamonds that was approved by presidential decree in November 2002. As of January 2006, 11 of these auctions had been held. Most high-quality rough stones, with an average price of ,000 per carat, are sold in this way. Those domestic diamond manufacturers that specialize in high-quality polished diamonds are interested in these auctions, while on its part, the Finance Ministry is obviously seeking to exchange the state-owned rough diamond reserves for precious metals, which are currently regarded as more liquid and hence more suitable for national reserves.

It is difficult to compile definitive figures for the Diamond Chamber auctions, but according to unconfirmed data (reliable information on the matter is a state secret), the diamonds now held by the Diamond Chamber of Russia total 200 million carats worth billion. By comparison, 142 million carats of rough worth .9 billion are mined throughout the world annually.

On average, ALROSA and the Diamond Chamber of Russia hold three auctions of diamonds weighing 10.8 carats or more a year. Every year, over 1,130 lots worth nearly 0 million and weighing a total of 50,000 carats are sold at auction. As a rule, over 35 domestic companies take part in the bidding. Apparently, the main participants in such auctions are diamond polishing companies, mostly corporations or individually-owned companies from the United States, Israel, Belgium, India, the Netherlands, Luxembourg and the United Kingdom (British Virgin Islands), i.e., countries that are either traditional strongholds of the diamond polishing industry or those with favorable financial laws. It is clear that because of the low purchasing power of Russian consumers, the diamonds bought at these auctions are not going to end up on the Russian retail market. The buyers are mainly aiming at the international retail diamond jewelry markets. Thus, the Diamond Chamber’s rough diamond auctions are supposed to satisfy the needs of domestic diamond manufacturers (which are also focused on foreign markets—about 90 percent of diamonds polished in Russia are exported) and also to supply the high end of Russia’s rough diamond exports.

In 2005 about 674 boxes containing 5,000 rough diamonds with a total weight of 83,000 carats were sold for 4 million at auctions in Russia that were open to international bidders. Organizations from Russia, Belarus, Israel, India, Belgium, the United States, the UAE, Japan, Italy and Switzerland took part in these tenders. The most active and regular participants were the companies from Belgium, Israel and India, while the least active were from Italy, Japan and Switzerland. In our opinion, the system of auctions in question is a mechanism for ALROSA to form a new marketing network analogous to those of De Beers, Rio Tinto and BHP Billiton. But it is not clear whether this mechanism takes into account the interests of the domestic high-end diamond manufacturers.

After all, to produce lower quality diamonds to meet the needs of the Russian consumer is potentially unprofitable for a number of objective reasons—namely, the high primary cost of diamond manufacturing in Russia, which is conditioned by the high level of technology and skilled labor required. After Russia joins the WTO and all restrictions on imports (customs duties and a 20 percent tariff) are abolished, the domestic manufacturers of inexpensive polished diamonds will not be able to withstand competition against producers from China, India and Thailand, whose polishing costs are lower than in Russia—cutting a 1 carat stone costs - in Russia, in China and - in India. Already at present, the official market share of imported diamond jewelry in Russia totals 15 percent, but the real figure approaches 40 percent and includes illegally imported small and low-quality diamonds from southern, eastern and southeastern Asia. With time, when the low labor cost countries improve the quality of their diamond polishing, even high-quality rough stones may become unprofitable to process in the Russian Federation.

Summing up the above analysis, we can say that Russian diamond polishing companies are playing an active role in the world diamond market, while attempting to solve the problem of rough diamond shortages through action in the domestic market and the problem of insufficiently varied rough diamond assortments by action in the world markets.

References:

1. Diamond Chamber of Russia: http://www.diamond-chamber.ru
2. “EC gives preliminary approval to the new proposals for a long-term contract between   ALROSA and De Beers.” AK&M, December 20, 2004.
3. World Bank: http://www.worldbank.org
4. Russian Finance Ministry: http://www.minfin.ru
5. National Credit Agency: http://www.creditnet.ru
6. “Cutting Charter.” Kommersant Money, 2004, No. 28
7. “Customs and Tariffs of the Russian Federation.” Russian State Customs Committee, 2002, p. 577
8. Shcherbakov, D. “Prospects for the diamond market’s development.” Jewelry Review, 2003, No. 11
9. “Rough Price Hike.” Rapaport Diamond Report, 2004, No. 3
10. “Global Diamond Production.” Rapaport Diamond Report, 2004, No. 10