The performance results of De Beers and ALROSA in 2009 prove that the current prices for rough diamonds are unable to facilitate sound operation of the pace-setting diamond miners. De Beers’ sales went down 57% to the level of the crisis-stricken 1974, while their rough output decreased 73%. ALROSA posted a net loss of 13.4 billion roubles in the first quarter 2009 and so far has not released its half-year statistics. However, some available data give grounds to say that this Russian company will also have disappointing half-year results: it stopped diamond mining and beneficiation in most of its quarries and factories dismissing their staff on mandatory leaves. ALROSA’s uncollateralized debt has already significantly exceeded $3.5 billion with a misty outlook for its servicing.
In the pre-crisis period (2006 - three quarters of 2008) ALROSA needed about $2.3 billion to cover all its expenses for production and sales. At the time, the average price of Russian rough fluctuated within $67.11 - $68.56. Taking into account that ALROSA’s profitability index by EBITDA averaged around 30% it may be said that the break-even point (where the number of units sold, or number of services provided, produces gross profit equal to all the fixed overhead costs of operations) approximately corresponds to an average price of $50 per carat of rough produced by the Russian company.
Right now demand for Russian rough diamonds on the spot market is so insignificant that there is no way to have any idea about real prices. Nevertheless, the available information on occasional transactions suggests that the average price for ALROSA’s traditional diamond assortment balances around $40 which is roughly correspondent to a 40-percent drop from the pre-crisis level. These data are confirmed by the statements made by the representatives of another Russian diamond miner, Uralalmaz, whose spot prices were equally down 40%.
De Beers’ profitability index by EBITDA in 2007 and 2008 was below that of ALROSA reaching 17%. So theoretically speaking, this South African company should have been more affected by the drop in prices for diamonds. Let’s take a risk to suggest that the purely symbolic profit of $3 million (1% of the similar figure in 2008) posted by De Beers in the 1H 2009 results is nothing but a tribute to the hopes of its creditors with whom the company is negotiating the restructuring of a $1.5 billion debt due next March. However, the company’s net debt zooming towards the startling level of $4.06 billion is by far more telling about the real situation.
Rio Tinto reported it had cut its diamond mining operations by 72% in the second quarter of 2009, while in the Argyle Mine Field it dropped 86% since the company stopped its beneficiation facilities and ceased the construction of an underground mine. On the contrary, BHP Billiton increased its output in the same period by 5% and reported that its underground Koala Project at the Ekati Mine was put into full-scale operation.
BHP Billiton’s boosting diamond output on the backdrop of a deep failure experienced by its major competitors may cause surprise, but it should be taken into consideration that the “diamond sector” of this diversified company is relatively small, while its financial position is on the whole much more stable than that of Rio Tinto and Anglo American (the major shareholder and one of the key creditors of De Beers) to say nothing of ALROSA. This, together with a specific sales system, is evidently enough to generate a sufficient margin of safety making experiments possible.
Since there are no objective prerequisites pushing up the demand for diamond jewelry in the United States, Japan and Europe, it is unrealistic to hope for a quick return of rough prices at least to a level corresponding to the pre-crisis break-even-point for diamond-mining companies. It is equally unrealistic to invest into diamond advertising and marketing in an environment of ever deepening unemployment and fast growing diamond miners’ own debts. If De Beers has rolled back to the sales level of 1974 it would be logical to suggest the diamond market is ready to roll back to the same level (or near it) as well. In 1974, the diamond market value was hardly above $7 billion, almost ten times down from 2008 even if corrected for inflation, and this difference is impressive. Please bear it in mind that the energy crisis of 1973-1975 was much milder compared to the current one.
It is very likely that in the present circumstances the rough market will be forced to follow the shrinking polished market which will sufficiently quickly (and maybe irreversibly) result in a price slump for rough diamonds due to the workings of the classic “demand-and-supply” mechanism, which will leave no chance to be influenced by anyone. In fact, this mechanism has already been kick-started by African producers and implicitly backed up by the sales strategy of BHP Billiton. The efforts by ALROSA and partially by De Beers to rescue prices by limiting supply could not last for a long time. The period of budget surplus in Russia has come to an end and it is unlikely that Gokhran will be able to buy rough diamonds in any significant amounts in future. In 2008, Anglo American’s net debt hit a record high of $11 billion continuing to grow in the first six months of 2009 at a frightening rate and accruing another $4.5 billion. For Anglo American it is hardly a number one priority task to save its “diamond department” in this situation.
It is a hard decision to accept the slump in diamond prices as unbiased reality and be ready for their further fall, to adjust supply making it consistent with the contracted demand and sell, and to resort to radical cuts in personnel (20%-40%), but it is the only way to make diamond companies profitable once again. The more time it takes to come to such a decision, the more painful the consequences.
