The diamond market cooldown in 2015 due to – among other reasons – massive sales of rough diamonds by mining companies in previous years and a slim chance of quick market revival compelled ALROSA to ponder over a search for a revolutionary solution. “In the event that there is no standard level of demand in 2016, we would think over the production volumes… We are elaborating the situation development scenarios and, no doubt, these could be related to lower output,” said Ilya Ryaschin, First Vice President of ALROSA, in late November when answering the analysts’ questions about the results reported for nine months. His statement was not a great surprise but such moves came at a much higher price for ALROSA than for De Beers that had announced about them earlier.
De Beers, in its response to falling demands from its sightholders at its sights and 18-percent decline in prices cut down its production targets three times in 2015 – from 32-34 mln carats down to 29 mln carats - and at the end of the year, the company announced the shutdown of its most cost-ineffective Snap Lake mine in Canada. De Beers got rid of the depleting mines in the southern Africa as far back as 2009, so now it is decreasing the production at De Beers’ operations, in particular, at the Orapa mine.
ALROSA has limited possibilities in manipulating the output as the company’s main deposits are located in the permafrost zone in Yakutia and the people of the mono-industry towns are their employees. That is why ALROSA refrained from such unpopular efforts to the last and preferred to adjust the sales level. Within 9 months, it has reduced the sales by 20% down to 23 mln carats, which makes 27% in terms of value (with a 15% price decline). The unsold roughs accumulated in stocks that exceeded 20 mln carats by late November, but ALROSA considers 12-14 mln carats to be optimal. “Further significant growth in stocks is already economically difficult for the company,” explained Ilya Ryaschin.
ALROSA does not incur direct losses due to increasing the stock, but the more diamonds go to the stock, the smaller is the economic effect from the company’s core operations. The ALROSA’s revenue projection for 2016 is conservative and equals to $3.5 billion. By comparison, the ALROSA’s revenue in 2014 exceeded $5 billion.
The official predicted diamond production in 2016 is 39 mln carats (in 2015, 38 mln carats were produced) and it was confirmed by ALROSA in late December. As for the potential decline in production, the analysts either refrain from accurate predictions about its scale, or prefer to make prognosis of the sales. In 2016, Bank ‘Otkrytie’ expects sales to be at the level of 26 mln carats (as compared to estimated 27 mln carats in 2015) on the background of further decline in the market.
In 2008-2009, when ALROSA’s sales almost discontinued, the support was rendered by the GOHRAN that purchased the rough diamonds for $1 bln, but at present, the budget has limited possibilities – the annual limit of the GOHRAN does not exceed $120 mln at the current exchange rate. Moreover, now the GOHRAN purchases mainly precious metals.
The company promises to make their decision about the production level based on the results of Q1 2016, thus keeping a chance for the market to bounce. Having encountered the need to solve these problems at the end of the year, in any case, ALROSA would not be able to start these actions at its Yakutian operations before the end of Q1. Moreover, this time fence probably looks very optimistic in this respect.
It has to be said that further prospects of cutting the production look vague. Shutting down the production process and mothballing an operation under the Yakutian conditions means to invite the expenditures required for restoring the mining machines and equipment to working condition, and the underground operations would also require rehabilitation of all the infrastructure facilities.
Specifically, for the underground Mir mine that approached the designed capacity this year only after solving the problems of water inflow, the shutdown of the drainage infrastructure is especially harmful, if possible at all.
According to Oleg Petropavlovsky of BKS, it is logical that the main candidate to be cut down (if it comes to that) seems to be Severalmaz, a less profitable asset of ALROSA. The average temperatures in the remote district of the Arkhangelsk Region do not differ much from those in Udachny or Aikhal, but the profitability of Severalmaz is still much lower than that of the Yakutian operations in spite of the four-fold increase in the beneficiation plant’s capacity in 2014. The Severalmaz’s diamond ore grade is among the lowest in the peer group – 0.5 ctpt, and as for the quality, the Arkhangelsk rough diamonds are inferior to the Yakutian ones. For example, the results of Q1 2014 showed that the average price of Severalmaz’s rough diamonds was $61.3 as compared to $149 of the Yakutian roughs. For several years already, the company has had net loss. During 9 months in 2015, Severalmaz produced 1.453 mln carats of rough diamonds (25% year-on-year growth) and it accounted for 5% output in the peer group for that period.
The Yakutian pipe Zarnitsa, a pioneer in the diamond mining in Yakutia with diamond grade of 0.2 ctpt, looks desolately. The main task of the Zarnitsa pipe is to supply additional ore to beneficiation plant No. 12 of the Udachny Mining and Processing Plant (MPP).
Here, we should touch one more challenge that the company may face in 2016. ALROSA has continuous costs at its beneficiation plants, said Nikolai Sosnovsky of UBS. No matter what the feed of the beneficiation plants is (and the very fact of the feed), their maintenance and servicing cost the company a fixed sum of money. The more the factory feed is, the higher profitability is, and by lowering the production (it means, the ore supply to the beneficiation plants) ALROSA would get lower financial results keeping the costs unchanged.
Nikolai Sosnovsky thinks that technologically it is easier to decrease mining on the alluvial deposits than on the primary ones. Alluvial deposits of Almazy Anabara and Nizhne-Lenskoye account for about 18% of the ALROSA’s annual output (beside these mines, there are alluvial deposits at the Nyurba, Mirny and Udachny MPPs).
“May be, it is easier to shut down the alluvial mines, but why should one do it if these are profitable and the production cost at these operations is lower than at the kimberlites,” said the representative of one of the ALROSA’s clients who knows the mining conditions and the assortment on the Nizhne-Lenskoye deposit. The rough diamonds from the alluvial mines are mainly rather high quality and are in demand with the clients, said another source in the rough diamond market. He reminded that the assortment of roughs from Almazy Anabara and Nizhne-Lenskoye were fully bought by Ruiz Diamonds owned by Lev Leviev and Smolensk-based Kristall.
“I think the probability is that new low grade projects won't be launched,” said one of ALROSA’s clients.
The construction of the mining operation on the Verkhne-Munskoye deposit with the reserves of 25 mln carats is among these projects. The ALROSA’s investments in this project are RUB63 billion. The construction of a railway spur requires RUB8.53 bln more and the company applied to the governmental commission on investment projects in the Far East to get them. The application was approved on December 24 but the prospects of the new projects - except Verkhne-Munskoye, as well as the Zarya pipe - are not optimistic at all now. Moreover, even in early 2015 ALROSA told about the possible reviewing its development plans regarding these low-grade deposits. However, the ore from these deposits is required for higher efficiency operation of the Udachny MPP (Verkhne-Munskoye deposit) and Aikhal MPP (Zarya pipe).
After all, in case of the most radical scenario, ALROSA could partly ‘freeze’ the development of the underground mines in Yakutia, for example, at the Udachnaya pipe and review the mining schedules, according to Nikolai Sosnovsky. The Udachnaya pipe’s diamond ore grade is 0.8 ctpt. The Udachnaya pipe accounts for 10% of the ALROSA’s output but the production is mainly in the pit that has been under operation since 1971. By 2016, it will be depleted and replaced by the underground mine launched in the middle of 2014 with the anticipated diamond production of 3.63 mln carats.
Ironically enough, but in the event that the rough diamond market would become weak in 2016, ALROSA will not have to sacrifice anything. As 2015 showed, the De Beers production programme was not very resilient and the company efficiently responded to the market state changing for the worse. At the end of December, Debswana, the main De Beers’s operation, announced about the mothballing of Damtshaa and the decrease in the ore processing at Orapa, and to counterbalance this, the production at Jwaneng will be increased, where the rough diamond prices are higher. “If the market does not recover, it is more probable that De Beers will be the first to start shutting down its operations. In this case, ALROSA does not need to do anything,” thinks Oleg Pavlovsky of BKS. He explained that nowadays, De Beers was working on the brink of the breakeven point as for EBITDA and its cash flow was negative, it means that some further curtailing is inevitable.
It is no secret that the two largest diamond miners sometimes keep a much closer watch on the actions of each other than on the market trends. It is clear that one can say with certainty about any market trend only if it is implemented and validated by ALROSA and De Beers. After the tough competition in ‘who will be the first to cut down the sight/decrease the price’ in 2015, in 2016 we shall watch a rather exciting race ‘who will be the first to shut down a mine’.
Sergey Bondarenko for Rough&Polished
