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Price Fixing: Does Anyone Care?
Feb 2, 2005 2:22 PM
By Martin Rapaport
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The recently proposed agreement between De Beers, Russia’s ALROSA and the European Commission (EC) raises serious questions about the integrity of diamond prices and the competency of the EC. We are witnessing an outrageous attempt to legalize the sale of diamonds from ALROSA — the world’s second-largest producer to De Beers the world’s largest producer and distributor — while ALROSA’s sale of diamonds to De Beers operates as a form of price support that is tantamount to price fixing.
We are shocked to find evidence that such activity is taking place and deeply concerned that absent intervention of third parties the new EC Commissioner for Competition Neelie Kroes intends to legitimize and legalize such behavior. We call upon the EC Commissioner to carefully investigate the De Beers/ALROSA agreement and its implication on diamond prices and to investigate how it is possible that the EC came to support and “intend to approve” the irrational De Beers/ALROSA commitment proposal.
The Story
Our story begins in March of 2002 when the EC initiated an investigation triggered by notification of the De Beers-ALROSA Trade Agreement. In the agreement, De Beers agreed to purchase $800 million in rough diamonds annually from ALROSA for a period of five years.
On January 17, 2003, the EC issued a Statement of Objections stating that:1
- The De Beers Trade Agreement breaches the European Union (EU) prohibition on restrictive agreements by preventing ALROSA from competing with De Beers in the European market and does not qualify for an exemption from such prohibition.
- De Beers performance under the De Beers Trade Agreement constitutes an abuse by De Beers of its dominant position in the diamond market.
- ALROSA ad hoc sales to De Beers pursuant to per-shipment, willing-buyer/willing-seller arrangements, as described above, which have to date approximated the sales level of the De Beers Trade Agreement, amount to a constructive implementation of the De Beers Trade Agreement by the parties and should, therefore, be viewed in the same way as the De Beers Trade Agreement under EC competition law.
For the next two years — i.e. 2003 and 2004 — the EC investigated the agreement but did not stop De Beers and ALROSA from implementing their ad hoc sales, which according to their Statement of Objections constituted an abuse in violation of Articles 81 and 82 of the EC Treaty. In fact, ALROSA sold De Beers $635 million — 34.4 percent of sales — in 2003 and another $279 million — 25 percent of sales — during the first half of 2004. While the EC may be proud that ALROSA sales declined significantly in the first half of 2004 and that non-De Beers sales outside Russia surged, we must ask why the EC allowed ALROSA to continue selling to De Beers if such sales were “abuse.” We have not heard of any EC investigation into the Russian deal during 2003 or 2004 and believe that the EC was busy holding unilateral talks with De Beers and the Russians without the benefit of discussion with other parties regarding the impact that any potential agreement would have on the rough and polished markets.
Sure enough, at the very end of 2004 and at the end of the reign of Commissioner Mario Monti, a deal was struck. De Beers will drop the amount of diamonds they buy from ALROSA from $700 million to $275 million over the next six years and a new Article 9 “Commitments” provision implemented. Article 9 says if the abusers commit to stop abusing, the EC may “conclude that there are no longer grounds for action.” Apparently the EC has concluded that if De Beers buys less and keeps purchases under $275 million after six years there is no abuse. Furthermore, to make sure things are “fair,” after taking three years to come up with this “solution” the EC allows “interested parties” an entire 30 days to rebut their “deal.” It is all very neat, tidy and legal.
Unfair Regulation?
Amazingly, that’s how the EC works. They do not disclose their Statement of Objection. They have secret talks with one side for a few years. Then they give the rest of the world 30 days to react to a deal crafted with the abusers. If no one speaks up in opposition — bingo — the problem goes away. The EC relies on adversarial testimony to establish perspective, but if the other side is afraid to speak because they will lose their De Beers or Russian connection — tough luck. When complaints are filed they put out questionnaires in place of research, but once again who in our industry is going to take the time and risk to answer complex detailed questionnaires?
Okay, so now Rapaport enters the game. At first glance we see lots of problems. Aside from the fact that the process is biased, how did the EC come up with $275 million as the magic number? Has there been any study? If so, where is it? Have they considered the impact on the polished markets? Why is the limit of $700 million set for 2005 greater than the $635 million De Beers bought in 2003 and 25 percent higher than the $560 million that De Beers is estimated to have purchased in 2004? Why did the EC approve a Commitment allowing De Beers to increase purchases from ALROSA instead of decreasing them? This is irrational.
And most importantly, is abuse a relative value? Is it okay to practice abuse and eliminate competition as long as you practice less abuse as time goes on? Article 9 clearly states that commitments must “meet the concerns expressed to them by the Commission in its preliminary assessments.” Clearly that is not being done in the initial years — why is the EC suggesting this plan? Lots of questions, but yet no smoking gun.
Frankly, the EC process is very troublesome. Even more problematic is the fact that if De Beers keeps gobbling up “outside rough” — i.e. rough they do not mine — for its Supplier of Choice (SOC) restricted distribution programs or its Diamdel “lets play with the market” programs, legitimate free-market traders will be “crowded out of business.” Rough diamonds are already in very scarce supply and now with De Beers able to increase its purchases from Russia and having no constraints on how much it can buy from other outsiders, what chance does the medium-size or little guy have in this business? And if all the medium and small guys get pushed out, retailers are going to have very limited competition among polished sellers. In fact, before you know it, everyone will be paying De Beers prices for polished. We will have witnessed the migration of De Beers “abuse” from rough to polished. So frankly, at this stage, I am not too happy with De Beers, the Russians and certainly not with the EC who is busy protecting De Beers instead of the free markets. It looks like the free-market team has been outmaneuvered and there is no way for any of us to get a fair shake.
The Smoking Gun
Then like manna from heaven comes this wonderful, honest and open document from ALROSA — 316 pages of highly accurate and detailed facts and figures. The report was prepared by ALROSA in association with JPMorgan and ING Financial Markets to meet the full disclosure requirements of a successful $300 million bond offering this past November. It contains everything you ever wanted to know about ALROSA, but were afraid to ask. And what a document it is! Consider the following quotes:
On November 16, 2004, John Helmer in the Moscow Times quoted from the document saying, “ALROSA also admitted that its strategy is to withhold supplies of diamonds from domestic Russian cutters so as to ‘ manage domestic demand to achieve prices for our diamonds that are comparable to, or higher than, the prices established under the De Beers Trade Agreement.’ This has never been publicly conceded by ALROSA before, but it is has long been a bone of contention for the domestic manufacturers, who have accused ALROSA of discriminating against them.”
“The remaining diamonds are offered to domestic purchasers and, to the extent that these diamonds remain unsold on the Russian market, they are sold to other export customers and, to the extent they remain unsold to De Beers. As described below ‘Domestic Sales of Gem and Near-Gem Rough Diamonds.’ We attempt to manage domestic demand to achieve prices for our diamonds that are not less than the prices established in accordance to the De Beers Trade Agreement.” 2
Referring to the Russian price list for diamonds, “In setting these correction factors, our objective is to manage the allocation between domestic and export markets so that the prices we receive domestically are not less than the prices we could receive from sales to De Beers and on the export market. … We estimate that the capacity of Russian diamond polishers is greater than the amount of diamonds we supply to the domestic market.”3
“The prices paid by De Beers for our rough diamonds are based on a schedule of prices agreed between De Beers and ourselves. This schedule of prices is set forth in the De Beers Trade Agreement and is amended from time to time. Pending resolution of the Statement of Objections with respect to the De Beers Trade Agreement, we have made ad hoc sales to De Beers at prices agreed between the parties on the basis of our past commercial relationship and by reference to current market prices.”4
In 2003 and for the six-month period ended June 30, 2004, we sold $927 million and $559 million, respectively, of our rough diamonds to domestic purchasers. … Our domestic sales are primarily made to Russian cutting and polishing companies. We believe that we supply the vast majority of diamonds purchased by these companies. We believe this is partly due to the fact that Value Added Tax (VAT) would apply to purchases of rough diamonds from sources outside of Russia that would significantly reduce the margins that these companies could achieve by polishing imported diamonds. …The Russian cutting and polishing industry mainly produces polished diamonds for export. We believe that except for a small number of companies, Russian cutting and polishing operations have minimal working capital and generally perform work based on advances provided by large diamond companies outside of Russia.5
What Does This Mean?
Based on the document and the likelihood that the statements in the document are correct, it would appear that there is basis for demanding an investigation and filing a complaint with the EC charging that ALROSA’s sales of diamonds to De Beers operate as a form of price support that is tantamount to price fixing.
It would appear that the relationship between De Beers and ALROSA and/or the way that ALROSA interacts with information provided by De Beers, provides a floor price for rough diamonds in Russia that is in sync with the prices that De Beers charges for diamonds. It appears that the price specified in the De Beers Trade Agreement act as an “intervention price” at which ALROSA can sell its diamonds to De Beers if it is unable to achieve those prices independently.
Furthermore, as Russia is a primary global source of polished diamonds it appears that the floor price of rough diamonds based on the prices in the De Beers Trade Agreement provides a floor price for polished diamonds being exported from Russia. It appears that this prevents Russian cutters from competing with polished diamonds coming from sightholders.
At this time we would like to make it clear that we are not yet charging De Beers and/or the Russians with price fixing. We are, however, calling for a full investigation of this matter and preparing to file a formal complaint with the EC.
These are but a few of our initial observations. Additional analysis and investigation is obviously necessary.
Questions for the EC
If the EC has been investigating ALROSA and De Beers for about three years, how is it possible that it missed something as large and important as the ALROSA bond-offering document? Even if the EC missed the document why did it never consider if it was proper for the largest and second-largest diamond producers to share secret and proprietary price information? It appears that the EC never even considered the possibility of price fixing in spite of the De Beers monopolistic background and the SOC investigation.
Is this due to incompetence, poor management, a lack of budget or perhaps it is just the way the EC system operates; a system whereby the abusers are given the opportunity to twist the minds of the regulators without the intervention of the victims. By the time the victims have any say, the EC has already come to a compromise decision that must somehow be reversed. And this reversal must take place with every possible disadvantage to the victims. The victims do not have access to the information needed and often they do not have the funds necessary to do battle with the abusers. In the view of this writer the EC system is extremely unfair.
Consider now that the victims will be given 30 days to respond to the proposed Commitment to the EC by De Beers and ALROSA. If they do not respond in a convincing manner, we believe the Commitment proposal will be automatically approved. The commitment states, “De Beers shall implement the above Commitments by concluding a trade agreement with ALROSA that is similar in principle (in particular, pricing, sorting and valuation) to the notified Trade Agreement.” How is it possible to properly respond without obtaining the Trade Agreement, which is specifically referred to and is an integral part of the Commitment? Yet when you ask the EC for a copy of the Trade Agreement, you are refused. The EC will not even give you its Statement of Objections. It appears that the EC is redefining the concept of blind justice.
Furthermore, adding insult to injury, we were treated to the following well-publicized statement made by Gary Ralfe at the Diamond Trading Company (DTC) sightholders cocktail party on January 11, 2005: “Just before Christmas the new Commissioner for Competition indicated that (subject to a mandatory consultation period) she intended to approve a proposal by De Beers and ALROSA and, after due process, we expect that this will be made into a formal arrangement with the European Commission.” Given the fact that most everyone with information and resources capable of rebutting the Commitments has a direct or indirect supplier relationship with De Beers or ALROSA, it is hard to underestimate the chilling effect of the statement. While the people at the Commission have clearly told me that no such indication was ever made, the commissioner has not denied it and Gary Ralfe has not retracted it. The word on the street is that it’s true and few, if any, are willing to risk their relationship with their suppliers over what appears to be a done deal. While there may be no bias, there is the appearance of bias and that must be addressed.
Perspectives — De Beers and ALROSA
De Beers is an organization with many perspectives. We believe it is important to recognize all the good aspects of the company, particularly their devotion to driving demand for diamonds even if it is not just their diamonds and their very successful positioning of diamonds as the ultimate symbol of committed love. The DTC SOC program is also a great idea that is creating major inroads in the market for branded diamond jewelry and linking the high added-value fashion sector to the diamond industry. Finally, De Beers is actively working with others, including this writer, to help promote development in some of the most difficult areas of the world.
Having said this, we must recognize that De Beers needs to get its house in order. Their confrontational attitude toward freely competitive markets is no longer acceptable. Simply put, De Beers is going to have to learn to let go and leave the diamond markets alone. The diamond business is no longer a zero-sum game. The time has come for De Beers to accept and embrace the notion of freely competitive markets and to make a public commitment to refrain from doing anything that disturbs the ecology of free markets.
There is an obvious and urgent need for De Beers to provide an independent, transparent and public economic impact study explaining how SOC impacts free, fair, open and competitive markets. Such a study should provide clear guidelines and limitations for De Beers ensuring that they are able to develop their distribution systems in a manner that does not threaten alternative free markets. If De Beers was to develop a mine, they would need an environmental impact study — so here too, if they develop a selective and restrictive distribution system there must be an economic impact study.
Getting back to the issue at hand, De Beers must recognize that they can no longer play the Russian game. The world is growing increasingly transparent. Anything and everything they do will eventually be held up for examination. In the context of antitrust regulation and De Beers dominant market position, the maintenance of secret agreements with competitors is suicidal. Simply put, leave Russia alone.
As for ALROSA, it is time for them to let go of their De Beers crutch. While we recognize ALROSA’s need for a secure financial future, such a future need not be dependent on their relationship with De Beers and/or co-management of their markets with De Beers. Rough diamonds are a secure and scarce commodity with many buyers and few sellers. As global demand expands, this scenario is likely to stay with us for the foreseeable future. It is time for the Russians to have more faith in their product and more faith in themselves. ALROSA will find that it does not need De Beers to reach its goals.
Finally, it is important for both De Beers and ALROSA to take responsibility for the consequences of their actions. At this stage we do not know what will happen, but we are sure that a sensationalist press could have a field day highlighting consumer insecurity regarding diamond prices. If consumer confidence is as important an issue to De Beers and ALROSA as it is for everyone else in the diamond trade, it would be wise for De Beers and ALROSA to maintain a relationship that is above suspicion.
Toward a Solution
In the opinion of this writer, the current phenomenon whereby De Beers goes to the EC for clearance on numerous issues is not viable. While the EC is a reasonable regulatory agency, it is not equipped to micromanage De Beers development and business activities. It is absurd to assume that the EC with its current budget can understand all aspects of every deal. There needs to come into place a reasonable and rational long-term approach that ensures the viability of open markets alongside De Beers.
Since De Beers mines about 50 percent of world diamonds, it is rational to suggest that De Beers limit its activities to the diamonds they mine. The adoption of such a policy would help ensure that the other 50 percent of the world’s diamonds were beyond De Beers reach and therefore available for the open, free, fair and competitive markets. This would go a long way to ensure that De Beers did not crowd out free-market players. After all, shouldn’t half of the world’s diamonds be enough for De Beers? Furthermore, restricting De Beers to what it mines provides an easily understood natural barrier between De Beers and the free markets.
Regarding De Beers dominant market position, regulators may still be interested in how De Beers sells the diamonds that it mines and De Beers may still be under some regulatory constraints — especially if new mines are established and production increases. Nevertheless, the benefits to free trade provided by De Beers disengagement from outside markets and the resultant ability of such outside markets to freely compete with the De Beers system will significantly reduce and may even eventually replace the need to regulate De Beers.
Frankly, I believe that if De Beers is willing to honestly embrace and support the idea of truly competitive markets co-existing with SOC, an optimal, sustainable and acceptable solution may be available and should be explored.
If you are concerned about this topic, contact rafi@diamonds.net.
1We have not received the Statement of Objections from the EC, but are quoting references found in the ALROSA Finance S.A. Preliminary Offering Circular, October 15, 2004, page 24.
2IBID, 122
3IBID, 126
4IBID, 64
5IBID, 125
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Tags:
Alrosa, De Beers, Diamdel, DTC, European Union, Jewelry, Polishing, Production, Regulation, Russia, Sightholders
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