It seems that diamond marketers are susceptible to apprehensions more than anyone else. As soon as Rio Tinto announced its intention to go out of the diamond business, experts started to release excited comments: if two companies are planning to sell their diamond mines (shortly before that a similar desire was expressed by BHP), this means they are not optimistic about the future of the diamond market.
Indeed, in case the two companies will decide to sell their assets (so far what we see is just idle talk and no deals), this will change the market structure. But should there be such a big worry about its future?
Nothing personal, just business
In terms of rough output Rio and BHP are respectively the third- and fourth-largest diamond miners in the world. But let's be objective: if Rio Tinto is the third-largest on the list after De Beers and ALROSA, still it does not mean that these companies are entirely comparable. In 2011, Rio produced 11.7 million carats of diamonds, while ALROSA, for instance, recovered 34.5 million carats. On the backdrop of global output reaching about 130 million carats (by rough estimate), Rio commands about 10% of the world market, whereas the two giants control more than 50%.
Rio’s current operations are Argyle in Australia and Diavik in Canada. The legendary Argyle, once used to churn out 40 million carats a year, now goes at a pace of 7 million and currently open-cut mining there is almost completed and will end next year. To continue operation, Rio is building an underground mine in Argyle expecting its peak capacity to reach 20 million carats per year. But even this will not last long: by 2019, underground mining in Argyle will also be finished.
The Diavik Mine in Canada yields 6-7 million carats a year (its forecast for 2012 has already reached 8.3 million), but one should not be oblivious that in fact Rio owns only 60% of its output, while the other 40% belong to its partner in the project, Harry Winston. From 2010, Diavik switched over to underground mining, and the current mine plan for the diamond filed is extended up to 2022.
These mines are different not only by their output and geographical location, but also by the quality of rough they produce. According to a Bain report, the average per-carat price at Divik is $107, while that of Argyle is $16. Of course, having a well organized system of marketing, the company has no sales problems, but this does not add uniformity to its product range.
Argyle provides $151 million of revenue a year, while Diavik brings in $600 million (of which Rio nets $400 million). These figures may seem hefty, until you look at the company's total revenue for 2011 which is $60.5 billion. Rio’s net profit from its diamond mining segment in 2011 was only $10 million compared to $5.8 billion of overall profit earned by the company.
With that, the company has to invest to maintain diamond mining operations. For example, to complete the underground construction at Argyle Rio needs to invest another $500 million bringing up the total project cost to $2.1 billion.
Looking at these figures, it becomes clear that the main reason for Rio to get rid of its diamond business is not at all the uncertainty about its future. The company is trying to make its operations more efficient. It is not the first time that Rio has such a desire. It is strange there was no one to recollect that just a few months ago the company put up for sale its $8-billion-worth aluminum operation (incidentally, yielding a far greater revenue than diamonds) exactly for the same reason. Rio Tinto derives the greatest revenue and profit from its iron ore market segment and it is logical that Rio wants to focus on this sector. Nothing personal, just business.
Will there be changes?
Experts are wary with regard to a possibility that if BHP and Rio will sell their diamond assets this may result in a fundamental change in the shape of the diamond market. What kind of change is there really to take place?
De Beers or ALROSA are unlikely buyers for Rio’s and BHP’s assets. For the past few years, De Beers has been selling its own old mines to "second tier" players focusing on major projects with a long mining life. The representatives of ALROSA have also repeatedly stated that this company is not interested in old mines having short life cycles. So there is no point to expect that the global diamond mining leaders will expand their business and scale up production by purchasing these assets.
Experts believe that the most likely candidate to purchase these mines is Harry Winston. It seems logical enough: the company already owns 40% in Diavik, while Ekati, which is put up for sale by BHP, is also located in Canada, so the company will have no problems stemming from geographical diversification of business. The only question is whether Harry Winston has the necessary amount of money. Ekati was originally estimated at $1 billion, although now the bidding range is at a $600 million level, according to sources. Diavik is also unlikely to be valued less than $1 billion. At the end of 2011, Harry Winston had around $100 million in cash and cash equivalents. The company will have to lean on a bank or investment fund to buy the assets.
The potential fate of Argyle looks much more interesting: besides being high-cost this project is also located at a notable distance from other existing diamond fields. And due to the specifics of extracted rough it will unlikely be of interest to large second-tier companies (such as Petra and Gem Diamonds), which used to work in Africa and deal with large stones of high quality. In my opinion, Argyle may look attractive to a Chinese or Indian company due to its relatively close location and its mined rough matching the needs of the local polishing industry.
It would be safe to assume that this will be how far any possible change to the structure of the diamond market may go. Rio Tinto’s line on the list of the “world's largest diamond miners” will be taken by someone else, but Diavik will not stop to produce its 8 million carats due to some change in ownership, and Argyle’s life span will not turn longer. It is also unlikely that geographically there will be any fundamental shifts in the supply of diamonds: for example, small-size rough (such as mined at Argyle) is anyway being currently bought in large quantities by diamond cutters in China and India.
Experts fear that some change in the market structure will bring about deep transformations in marketing and pricing. Anything is possible, but it is difficult to imagine some fundamentally different ways of selling diamonds compared to long-term contracts, auctions and spot market. For instance, most Rio’s products (also according to Bain) are contracted for a long term. It is unlikely that a change in ownership will disrupt all of these long-term contracts in an instant. After these contracts will expire there may be an increase in the share of rough sold around the world on the spot market or at auctions, but then again, first of all it will be "Indian goods." Experts say that some part of diamonds from Diavik owned by Harry Winston is already being sold on the spot market right now, as well as diamonds from Ekati. But demand for diamonds is in any case outpacing supply, so an increase in the number of tenders should result in higher prices for rough, which is generally positive for the industry.
Prices and demand for diamonds are now starting to recover after a sag in late 2011. At the last DTC sight prices went slightly upwards on the background of some decrease in supply. According to market sources, ALROSA has so far avoided raising prices, but the overall situation in the market preconditions such a step. The recent jewelry fairs, including Hong Kong, proved there was higher interest on the part of buyers and stronger demand, and it should be kept in mind that it is demand for final products that determines demand for rough. In short, the market is gradually winning back the stability which was lost six months ago. Of course, it would be horrible to lose it again, but it does not do any good to panic at the slightest pretext: if several mines will change their owners this will hardly upset the overall balance.
Elena Levina for Rough&Polished
