RAPAPORT... As the global diamond market braces itself for one of its worst crises, Russia’s largest miner seems to be doing better than others. It’s not cutting down production and sells its rough to the state treasury. But what will happen to its rough going forward? ALROSA president Sergey Vybornov talked to Rapaport about how the crisis has reshaped his company’s strategy and the new highs it targets.
Rapaport Magazine: How do you evaluate the first quarter of 2009?
Sergey Vybornov: The first quarter of 2009 was difficult, not only for our company, but for many others. We stopped supplying the market and other companies reduced supplies, one way or another. We decided not to stop production because in Yakutia, conditions are such that it’s more expensive to restart the production once it has been stopped than to maintain it.
At the moment, we are going to the market with long-term contracts. Fifteen companies in Antwerp are ready to buy rough at prices between the current lows and the unprecedented high prices of August 2008. These are certainly reasonable prices and they will be fixed for a period of six months to three years. The companies participating in this deal have large credit leverage and cash. By the end of 2009, the value of these signed contracts will be $500 million to $600 million. There are other companies willing to work with us, but I don’t think that we will increase the overall supply to the market sharply. It’s too dangerous to flood the market with rough. However, we may increase supplies if the positive dynamic of the past month continues. We intend to wait a couple of months to see where the rough we are selling goes in the diamond pipeline and then take further steps.
RM: Are these contracts part of your new supply strategy?SV: We’ve been talking about our need to shift to long-term contracts for two years now and we’ve spent a lot of time with our clients discussing a price formula. But, while we were talking, rough prices were going up 10 percent to 15 percent a month. In such a situation, it’s difficult to establish a price formula. Moreover, diamonds are not a stock-exchange commodity, so it is very difficult to identify reference points to which we can link their price. The current economic crisis changed the situation. I think the share of long-term contracts will constitute more than half of the company’s sales.
RM: What level of prices are you trying to hold when selling to Gokhran and to Antwerp companies?
SV: I can’t say the exact levels of the prices because there is still some bargaining going on, but they are quite high, more along the levels of early 2007.
RM: There is strong concern that rough prices are artificially high and that they damage the diamond trade. Martin Rapaport brought up this concern in the April issue of Rapaport.SV: Martin is right to an extent. Yet, we should look at this problem from a different angle to see what happened — and why — in the U.S. market. Diamond items shouldn’t be sold at a price of $50 to $100. That causes consumers to lose their trust in diamonds. Such prices degrade the image of diamonds as an eternal value. How can a symbol of love be worth $100? Actually, one of the goals of the marketing initiative that we are starting, along with De Beers and other companies, is to raise the value of diamonds in people’s minds.
RM: What’s happening with this marketing initiative now?SV: It’s called the St. Petersburg initiative, because it was first discussed when the heads of diamond-mining companies held an informal meeting in St. Petersburg in June of 2008. Everyone expressed concern that little effort is given to the promotion and marketing of diamonds as an eternal value. Now, we are on the finishing line and the lawyers are finalizing the legal documents. There will be a group of 15 to 20 people who will work on marketing — and the project will have a considerable budget. At the moment, everyone is tight on cash because of the economic crisis, but when the project is working in full force, its budget will be $50 million to $70 million annually.
There is a real danger — and ALROSA and De Beers both realize it — that the market niche currently occupied by diamonds may be taken over by other luxury goods. I’ve read research saying that diamonds are competing now with plasma TV screens as the most popular Christmas gift. The competition with other luxury goods is really tough, and we must make these joint efforts to protect our position in the luxury goods market.
RM: You’ve asked the Russian Ministry of Finance to stop the auctions of rough from the country’s state treasury Gokhran. Why do you think the auctions could damage the market?SV: After the collapse of the Soviet Union, the country’s budget was in bad shape. To raise cash, the treasury sold its stocks and the market fell. At the moment, Gokhran is buying substantial deposits of rough. We would not like to see all those stockpiled goods bring down the market again. Also, the worst thing to do these days is to sell diamonds at auction, because they will go for a great discount. When the market recovers, I hope Gokhran will sell these deposits and I hope we will coordinate our sales.
RM: What about the stockpiles held by treasuries, banks and companies? What are you doing to keep them from floating to the market and tearing it down?
SV: We are trying to freeze the stocks in investment products. For this purpose, we launched a diamond investment project with Leader, a Russian-based capital management company. One part of the project is a $0.5 billion mutual fund; the other is selling polished diamonds of perfect characteristics to private investors. These will be 1-carat to 10-carat diamonds, including fancy colors, polished by us or under our supervision.
Maybe it’s not a big amount, but this is stock that won’t go to the market. People who invest in diamonds are long-term investors. I am less concerned about the stocks in Gokhran than about the stock in unknown banks. We do not know how big these stocks are in reality. Some are of the opinion that the same rough has been pawned several times. The legal status of some deposits is not clear as well.
When the crisis started, it was estimated that there were $3 billion of rough stocks. It was a responsible approach that the producers reduced supply. This approach has meant that stock levels have reduced somewhat. I feel there is practically no Russian rough on the market currently. The clients who have stocks are sitting on them, and there are just a few of them. We hope that the price of Russian rough will be the first to go up because of its color and clarity characteristics.
RM: What about stocks in Africa? SV: I think that Angola’s budget is in better shape, but I am not as sure about the budgets of Namibia and Botswana. Those budgets are totally dependent on the revenues from diamond mining. The logic behind closing the production is you still are retaining the stocks, only you are leaving them underground.
RM: How have ALROSA’s Africa projects been influenced by the crisis?
SV: Catoca is selling rough at a discount, but at a price that covers the cost of production, which is good under the current market conditions. As for LUO-Camatchia-Camagico, there have been geological miscalculations at that site that are now affecting the costs, so that project is not going very well, but we are a minority shareholder there.
RM: You have lowered production prospects for 2009…could you translate these cuts from dollars to physical volumes?SV: We are not cutting back on the overall volume but we stopped work at the oldest mines, such as Zarnitsa. At some of these mines, we had continued production more for image purposes as they were below the profitability level.
These older mines only account for 4 to 5 percent of the production, so, overall, we are not cutting mining. When we move to the underground, the levels of production will fall, but we will offset that by increasing the production at the open mines. In July, we are opening Mir underground mine and in December, we are scheduled to start underground operations at Aikhal.
RM: What are your relations with De Beers at the moment?
SV: De Beers has many limitations imposed by the European Commission (EC) when it comes to relations with us. We could still discuss some joint projects after the economic crisis ends. De Beers left the joint project with LUKOIL on the Grib pipe, which is located 25 kilometers [15 miles] from our deposits. The mining conditions are very difficult there because of the swampland and it was good to have De Beers, with its century of experience, working there.
RM: Are you interested in the Grib pipe?
SV: Once the financial crisis is over, if Severalmaz decides to go public, then it would be interesting to have the Grib on the balance sheet. [ALROSA is a major shareholder of Severalmaz.] But I do not think that mining it under the current conditions is profitable.
RM: You said recently that ALROSA can become the world’s number-one miner. Can you elaborate?SV: We do not have competition in mining. ALROSA is a state-owned company developing national resources. We have good prospects in Yakutia and we will be announcing the discovery of new pipes this summer. The influence of De Beers is falling as it reduces production but right now we are maintaining the volume of our overall production. We asked our investment consultants to look at small companies we could acquire, which could be both greenfield and brownfield projects.
These projects do not have capital and thus would cost little to acquire if they are listed in London, or if they have been delisted. [Greenfield projects are located on semirural, undeveloped land and brownfield on commercial or industrial land that is abandoned or underutilized and even sometimes contaminated. Both greenfield and brownfield projects are seen as “bargain” properties that have potential for development and acquiring them would be a commitment to that development.]
RM: What are the deposits to be announced this summer?SV: Legally speaking, we already have opened them. But diamonds are considered strategic deposits, so a special government commission must investigate them before the discovery can be announced. I hope that since ALROSA discovered the deposits, we will be awarded the right to explore them. Yakutia has $103 billion worth of economically effective deposits that include undeveloped deposits and those where we have closed operations. We may re-open them if the rough prices go up and mining there becomes profitable.
RM: There have been rumors that you may be leaving your post as ALROSA president soon. Is this true?
SV: I wouldn’t even dream of that. ALROSA has only one shareholder — the state — who could fire me, and it has said it does not plan to do so. Our plans for these long-term contracts have caused some disaffection among those who work with the company and those who work within it and that’s why the rumors began. But the fact remains that no one wants to sign a long-term contract with a person who is not known to them or a person who will not be around for the contract.
Article from the Rapaport Magazine - June 2009. To subscribe click here.