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De Beers South African Strategy

Apr 6, 2005 12:21 PM   By Martin Rapaport
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Gary Ralfe, managing director of the De Beers Group, and Gareth Penny, managing director of the Diamond Trading Company (DTC), met with Martin Rapaport in Cape Town, South Africa, to discuss the changes in South Africa’s political and economic environment and how they will impact De Beers and the diamond industry.

Martin Rapaport: How important is South Africa to De Beers?

GR: South Africa is very important to De Beers as a major source of diamonds. We produced a billion dollars worth of diamonds in South Africa last year. The 40 percent of the world diamond production produced by De Beers all comes from southern Africa and in geopolitical terms, South Africa is one of the most important diamond-producing countries — even if not the largest diamond producer.

South Africa is also important sentimentally. It is the birthplace and home of De Beers. It is where we have accumulated our intellectual capital including many of our managers, engineers, mineral researchers and technicians. It is no coincidence that Gareth and I are South Africans, just as Nicky and Jonathan are.

MR: How important is De Beers to South Africa?

GR: De Beers is high on the list of matters addressed by the South African government. Diamonds enjoy a reputation, glamour and interest that are often greater than their financial interests to a country. Diamonds are a very small part of South African GDP [gross domestic product] and an even smaller part of government tax revenues. I use those two criteria to distinguish South Africa from Botswana and Namibia, where the diamond-mining industry is of overwhelming economic importance in terms of GDP, foreign exchange and fiscal revenue.

De Beers black empowerment is a subject that the government looks forward to us implementing and is something we are going to do this year. De Beers is, in many ways, iconic; it is one of the oldest and most prestigious of South African mining companies. Government is immensely proud that De Beers is the one example of a South African company that is the major player in its global industry.

Finally, Harry Oppenheimer was a South African statesman and member of parliament. I think the position of the Oppenheimer family — now embodied in Nicky — is a very important one and naturally the family’s business is of interest to South Africa.

MR: How will the new regulatory environment affect De Beers?

GR: The Minerals Development Act addresses black empowerment and the conversion of old-order rights. The government is using its legislative leverage intelligently to encourage Black Economic Empowerment (BEE) and to transform ownership of South Africa’s wealth to reflect the better demographics of South African society. These issues are clearly impacting us.

We take heart from the fact that President Mbeki and others say that this transformation should be compatible with economic growth. We heartily endorse government’s efforts to procure both economic growth and a more equitable transformation of our society.

Regarding the Diamond Amendment Bill that is on its way to parliament and has been published for public comment, our approach is to engage in close dialogue with government. We recognize that government is seeking greater beneficiation and job creation in diamond and jewelry manufacturing. De Beers wishes to help government accomplish its aims and approaches this bill in a spirit of collaboration and cooperation.

Gareth Penny: I think government is clearly trying to encourage jobs and greater beneficiation of the diamonds that are mined and supplied in South Africa. We are engaged with government in a positive process to assist them in meeting those needs while still trying to ensure that the transformation is done in a commercially viable way.

MR: How does De Beers plan to meet the BEE requirements? Are you considering a government partnership as you have in Botswana?

GR: We would feel very comfortable with government as our partner, but South African policy is toward privatization, so a government partnership does not fit in with government strategies on ownership. Our shareholders are working with a view to create the right sort of structure. There are a number of models, including partnering with existing black companies that are able to procure equity capital as well as community trusts in the case of mines such as Kimberley or Limpopo. We are also considering how we can make stakeholders of the surrounding communities and involve the historically disadvantaged employees of De Beers itself as well as the National Union of Mineworkers (NUM). These are the general sorts of models. We may mix, match and combine several of the models into a two- or three-pronged structure.

MR: What is De Beers going to do with their unprofitable South African mines? Will you keep on losing money for political reasons or will you shut them down?

GR: We can’t go on running unprofitable mines forever. It is one thing to run a mine unprofitably with the expectation that the dollar will strengthen and De Beers will then get more rand for our diamonds. That has been part of our thinking over the past couple of years. Many believed that the weak dollar was temporary. But that is not the case now. The current consensus is that we are in for a prolonged period of dollar weakness. Therefore, De Beers is urgently seeking to turn these mines around.

Some of the mines are very close to the end of their reserves. Koffiefontein and De Beers underground mines will fall into that category and their lack of profitability is not of major consequence. Cullinan, on the other hand, is a long-term major resource. We have to do everything we can to make sure that improved mining methods and increased efficiencies at Cullinan are going to turn that mine around. Cullinan will be an important source of carats for De Beers and the DTC.

Although our decisions must be commercial, they will have social consequences. De Beers has a conscience. We employ 10,000 people in South Africa. There is a lot of depravation and poverty in South Africa and there are insufficient jobs. Obviously, one way to save money is to reduce the workforce, but the social consequences are horrible for those losing their jobs. Given our ethics, this is a matter to be approached with extreme care and caution.

MR: If the U.S. dollar is a problem can you foresee a time when the DTC will sell diamonds for euros or another currency?

GP: Since everyone in the diamond industry trades in dollars, we do not expect to change the currency used for payments to the DTC.

GR: Not only are 55 percent of the world’s diamonds sold to American consumers, but also diamonds going to China and Saudi Arabia are sold in currencies linked to the dollar. At least two-thirds of the world’s diamond jewelry offtake is effectively being priced in dollars.

MR: What is your view of the current status of beneficiation in South Africa and how do you see it evolving given the new mining act?

GR: De Beers Consolidated Mines (DBCM) produced a billion dollars of diamonds in South Africa last year and the DTC sold $577 million back to its 14 South African sightholders, which was up 8 percent from 2003. So it’s fair enough to say that in terms of beneficiation we are ahead of the pack. But that does not mean that we can rest on our laurels. Gareth and his team are taking a collaborative approach with the government and what they are trying to achieve. We recognize their goal of expanding diamond jewelry manufacturing and the concept of “mined and manufactured in South Africa.”

De Beers has a global business model based on the efficiencies of consistent assortments produced by aggregating all productions together. Our productions are being aggregated for the moment in London and then sold to a global industry. Given the high-value and low-volume nature of diamonds, transport is not a difficult matter. We recognize the need to be sensitive to governments in southern Africa, not just in South Africa, but in Namibia and Botswana, as well. Can we evolve or adapt our model? Can we reserve a certain percentage of what we produce to see if there is scope for a South Africa brand? These are matters that are under discussion.

GP: We are engaged in political dialogue. The jewelry manufacturing industry in South Africa is tiny; it’s only 0.4 of a percent of the world’s jewelry. There is probably a lot of room to grow it and many things we can do.

MR: Is it possible to cut diamonds in South Africa without providing sightholders with specials or finding other ways to subsidize the rough?

GP: Yes, but only at a certain level. Martin, I’ve seen you use the 10 percent rule before. Basically you must be able to cut the rough diamond at a cost that is no more than 10 percent of the value of the rough diamond. With $40 to $60 per carat cutting costs in South Africa, there is a relative benchmark level for rough at more than $400 per carat. You can be competitive with better rough because the cutting costs are low relative to the value of the finished product, allowing for reasonable profitability.

MR: Is it possible to have nonsubsidized sustainable South African diamond cutting at a level of some $50 million per year?

GP: Yes, we think so.

GR: I would like to add that when I began working with De Beers in the 1970s we had been selling diamonds to South Africa cutters for over 40 years at 90 percent of the London price. This was required by law and remained a compulsory subsidy until replaced in the 1980s by apartheid–related subsidies to encourage decentralization. By the 1990s, when Gareth was looking after the South African industry, I remember him telling me that the South African industry was finally on a level playing field with the rest of the world in terms of competitiveness.

MR: Are there opportunities for South African diamond brands?

GP: South African brands are slowly emerging. Whether or not these brands require South African diamonds will depend on what the brand stands for. I think there is a limit to country-of-origin brands. Our consumer research does not feature origin highly on why people buy diamonds and I think the Canadian brands will probably show that there is limited appeal. This doesn’t mean to say that it can’t be done, but it’s probably more suitable for a niche market such as the South Africa tourism sector.

MR: Why is there a rush of sightholders to South Africa? Is that because of a perception that it will be easier to get rough diamonds in South Africa?

GP: I don’t know if it’s a rush, but there has been a systematic flow of international companies coming here. More recently that’s increased because we’ve made it clear that we are going to support sustainable beneficiation in producer countries. Sightholders are waiting to see how matters develop in Namibia and Botswana and are interested in the possible opportunities in South Africa. People who can compete better against existing companies believe that they will be able to secure supplies from African producers.

GR: We look forward to seeing further investment and beneficiation in southern Africa. We note there is a flourishing diamond-cutting business in South Africa, which is already using up all of the available rough diamond resources. In other words, it will be difficult to find more rough in South Africa for additional cutting operations. In relation to Botswana and Namibia, there is scope for beneficiation by cutting premium articles to compensate for the higher costs of manufacture. Investors should be aware that both governments are sensibly saying, “We are not interested in a subsidized industry.”

MR: What role will Diamdel play in South Africa?

GR: Diamdel has a particular importance in South Africa. It takes about 10 percent of the total $577 million that we market here. Of course, we see it as an obvious tool to help accomplish the government’s desired transformation, ensuring that rough diamonds be available to historically disadvantaged people (HDP). Other than becoming an empowerment partner to an existing sightholder, the new entrants will be able to access rough diamonds through Diamdel.

MR: Will you be selling Diamdel to the South African government?

GR: We would like to create a business model for Diamdel that ensures guidance and direction from government. We are looking for some sort of partnership, but not necessarily in an equity structure. But we are open to all things. We are saying to government: We have a good vehicle here; please help us to use it in a way that is going to accomplish your strategy.

MR: Does De Beers have room to grow in South Africa?

GR: That’s a very taxing question. I believe that De Beers certainly has the capacity to grow in South Africa. We have the intellectual ability and new prospecting technology, which is why I say there may be another Venetia or two. But there are legacy issues that we have to deal with. De Beers is still perceived to be too big a kid on the block. With 80 percent of South Africa’s diamonds mined by De Beers, there is a feeling in certain quarters that De Beers is too big and shouldn’t expand further in South Africa. That is why we are cooperating closely with government to try and reduce the legacy issues.

MR: Would De Beers ever go into diamond cutting?

GR: Absolutely not. We have never been able to make a success of it so we’re not going in that direction. Not while I’m in charge anyway.

MR: Are the new government regulations realistic and sustainable?

GR: We have South African sightholders and we are using Diamdel to help beneficiation. I don’t think there is anything unsustainable about trying to develop a South African brand or cutting sector. Nobody is suggesting that suddenly all of South Africa’s diamonds must be polished in South Africa. You heard the minister say very clearly that South Africa is not in competition with India or China. I think beneficiation is sustainable and that there is nothing revolutionary about this. I also think that there is a lot of common ground between our position and that of the government.

MR: How will developments in South Africa affect what’s happening in other countries, such as Botswana and Namibia?

GR: In terms of Botswana and Namibia, I believe that there has been massive black empowerment through our partnership with government. As far as beneficiation is concerned, the issue in Botswana and Namibia has a different dimension. There is not $577 million worth of diamonds being cut in these countries. De Beers began joint-venture polishing factories in both countries, but neither was successful although they have evolved. There is recognition between ourselves and each of the governments that one needs to develop the cutting industry in both countries and there is dialogue with the ministries in each country to see how one can achieve a reasonable, sustainable expansion of cutting.

What it comes down to is that we look to our government partners to help us find the reasonable balance between encouraging more factories, which clearly has the great spin-off of job creation, and letting rough diamonds gravitate to wherever in the world they will be most economically cut and, therefore, fetch the best price and the most government revenue. The one does not completely exclude the other. In other words, you can have a small, modestly growing local industry that will not disturb the international price levels that Botswana’s diamonds, for example, are going to achieve. But if you try to manufacture everything inside Botswana, then everything is going to be subsidized because the local cutting costs are well above the ten or 12 dollars per carat of India.

MR: Sustainable beneficiation can therefore be defined as the ability to develop and add value to countries’ basic resources without subsidies. Governments feel the cost of unsustainable beneficiation in their pocket. Governments should not get carried away with the idea of using diamond revenue to subsidize job creation.

GR: I quite agree with you.

MR: Will cutters be able to get preferential access to rough diamonds; should they have sustainable nonsubsidized cutting capability in a place like Botswana and Namibia?

GR: That’s something that we’re working on with government. It will be for diamantaires to make their own decisions about investment.



MR: What is your outlook for South Africa over the next ten years?

GR: I am optimistic about South Africa. There is a good chance that we can graft social development onto the political miracle that has taken place here and that we will therefore accomplish the social transformation South Africa must have to save itself from internal conflict. Let us be absolutely clear, there are too many have-nots in South Africa, so there is a vast job of transformation that needs to be done. I think there is a good chance that it will happen.

As we transform South Africa, more parochial concerns like BEE equity requirements will be less important. Actually, I myself am a convert; if 26 percent saves us from revolution then transformation is a very good thing. Beneficiation will also help us accomplish something even more important than ownership participation and that is employment equity.

On the mining side, ten years out there will be empowered blacks working, managing and owning De Beers. We hope to have discovered diamond mines and that our transformation policies will enable government to issue us the prospecting licenses that we are applying for.
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Tags: African Diamonds, China, Consumers, De Beers, Diamdel, DTC, Gareth Penny, Government, India, Jewelry, Manufacturing, Mining Companies, Namibia, National Union of Mineworkers (NUM), Polishing, Production, Sightholders, South Africa
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