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Diamond Industry Implications From Ukraine Crisis

Apr 7, 2014 4:16 PM   By Isi Morsel
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RAPAPORT... It is not unusual for international geopolitical events to have an influence on the diamond industry. The diamond industry depends on several factors such as economic stability, the need of producing-countries to generate income from their natural minerals, the interest of countries in generating income through salaries and taxes across manufacturing and, of course, a desire to wear diamond jewelry. The annual value chain of the diamond industry, from mining to retail, is near $100 billion dollars globally.

This is not a large figure in proportion to the overall global economy, but for some countries, such as Belgium, this is an important component of the local economy.

In February 2014, a civil uprising in Ukraine resulted in President Viktor Yanukovich fleeing and the appointment of a new government. In response, starting on February 26, pro-Russian military forces started to take control of the Crimean peninsula. Within a month, the Russian backed forces took control of all military bases in the peninsula. Concurrently, a referendum to secede from Ukraine and join the Russian Federation passed, despite vocal condemnations from the U.S., European Community and others that called the actions a violation of Ukraine sovereignty.

In the U.S., President Barack Obama signed three executive orders regarding the conflict. In the first, executive order 13660 signed on March 6, 2014 and titled “Blocking Property of Certain Persons Contributing to the Situation in Ukraine,”  Obama wrote:

“[T]hat the actions and policies of persons -- including persons who have asserted governmental authority in the Crimean region without the authorization of the Government of Ukraine -- that undermine democratic processes and institutions in Ukraine; threaten its peace, security, stability, sovereignty, and territorial integrity; and contribute to the misappropriation of its assets, constitute an unusual and extraordinary threat to the national security and foreign policy of the United States.”

He therefore declared a national emergency to deal with that threat, and ordered to block property owned, held or controlled by a list of Russians.

In the third executive order, number 13662 dated March 20, “Blocking Property of Additional Persons Contributing to the Situation in Ukraine,” Obama expanded the scope of the property sanctions to include “(…) financial services, energy, metals and mining, engineering and defense and related material.”

Historically, economic sanctions are a means to an end, usually a political one. And typically, the economic sector is not in favor. Ostensibly, that is part of the intended play – an economic sector applying pressure on the government to comply or compromise to avoid financial fallout. At times, this happens on both sides of the conflict. Economic sectors from the country applying the sanctions also want to avoid the economic consequences of losing some or all of their business.

The addition of mining activity in these sanctions immediately raise concerns in the diamond sector that they would include Russian diamond miner ALROSA. The company is partly owned by the Russian government (43.9 percent) and the Republic of Sakha (Yakutia) that is part of the Russian Federation (25 percent), giving additional reasons why ALROSA may be added to the list of blocked companies. However, following an IPO in October 2013, investors, including U.S. asset management group Lazard and investment firms Capital, Highbridge, OppenheimerFunds and PIMCO today hold 16 percent of ALROSA.

With the U.S. and EU taking the lead in confronting Russia, the concern that ALROSA and Russian diamonds may be included in an international ban is highest in the diamond community of Antwerp, Belgium.

What is the Threat?
Not only is the U.S. imposing sanctions on Russia over the Crimea crisis, so is the EU.  On March 17, the EU decided to freeze the assets of 21 people, viewed as relating to the Russian takeover of Crimea, stating in Article 2 “All funds and economic resources belonging to, owned, held or controlled by any natural persons or natural or legal persons, entities or bodies associated with them as listed in
Annex I shall be frozen.”

On March 21, the EU expanded the list to 33 people. Although currently only people are targeted, the language of the decisions leaves it open to add entities as well. Further, the second round of sanctions imposed by the EU may be followed by additional sanctions that widen the scope. According to German Chancellor Angela Merkel, "We are ready to start stage three if there is further escalation with a view to Ukraine; those are economic sanctions and we asked the European Commission today to do preparatory work for possible economic sanctions."

ALROSA's Business
ALROSA is the world’s largest diamond miner by volume and the second largest by value. The company mines in the Russian Federation, mainly in Yakutia, has a stake in the Catoca mine in Angola and is exploring for diamonds in several African countries, as well as in its own home territories. In addition, the ALROSA polishes some of its diamonds, mainly for price discovery.

In 2013, the company mined 36.9 million carats of diamonds and sold 38 million carats of diamonds, including 26.7 million carats of gem-quality diamonds with an average price of $176 per carat (p/c).

Total rough diamond sales are estimated at $4.8 billion in 2013. Together with polished diamond sales, total diamond sales are estimated at more than $5 billion in 2013 (ALROSA has not yet published results for fiscal 2013). The value of rough diamond sales alone is estimated to represent more than a third of the global rough diamond supply in 2013. ALROSA is by all accounts an important supplier of diamonds.

Antwerp Diamond Center
Antwerp is one of just few diamond trading centers, serving as home to some 1,500 diamond trading companies with a total annual turnover estimated at more than $50 billion.

In 2013, Antwerp imported $13.12 billion worth of rough diamonds, a rise of 7.1 percent year on year,  and exported $14.64 billion worth of the goods, up 5.3 percent from the previous year. These figures are impressive, but somewhat misleading. The diamond industry suffers from inefficiencies. This is mainly an issue with polished diamonds; however, the rough diamond sector is not completely immune from  it. Most all of the diamonds imported into Antwerp are exported, but some make their way back, inflating the import figures.

The Antwerp diamond center is an important component of the Belgian economy. Rough diamond imports are 3.8 percent of the country’s total exports. Loose diamonds (polished and rough diamonds) represent about 8 percent of Belgium’s international trade. In addition it created over 5,000 jobs directly, and many more jobs indirectly.

Rough diamonds are the lifeline of the local diamond industry and a continued supply is essential for the livelihood of Antwerp’s diamond center.

Possible Impact
ALROSA supplies Antwerp with more than $2 billion worth of diamonds annually. These supplies include rough diamond purchases by Belgian companies in Moscow, auctions and other rough diamond sales by ALROSA in Antwerp via its subsidiary ARCOS Belgium N.V. and polished diamond sales.

For 2013, these sales are estimated at $2.38 billion, rising by some 17.6 percent from 2012. This supply from ALROSA represents 18.2 percent of Antwerp’s total rough diamond imports. Representing such a large source of diamonds, ALROSA's  supply is not just a vital part of the local industry; it is currently an essential component of the economy that is irreplaceable.

In light of the banking and financing constrictions that the Antwerp diamond center is currently facing, largely based on a diamond company’s ability to trade, a sudden removal of a main source of supply will have a devastating impact on the diamond center. Taking away ALROSA's  supply from Antwerp will bring this center, which is very sensitive to any fluctuations, to its knees. This will not just affect the viability of many of the local businesses, especially the larger ones. The halo affect will include lost jobs and essential income for the country.

How real is the threat?
The U.S. and EU are not employing a brinkmanship strategy. In fact, it looks like the worst is already behind us. Russian President Vladimir Putin seized an opportunity to retake control of the Crimean peninsula and flex some international muscle. He has achieved his goal and does not seem to be interested in any further grand standing. That is, he is likely to continue and try to exert influence on Ukraine, but not in the blunt way military forces took over Crimea.

In his executive orders,  Obama placed a number of conditions to expand sanctions. In Executive Order 13660, sanctions are limited to “persons contributing to the situation in Ukraine.” ALROSA is not involved in any way in the aggressions and is not known to hold any assets in the Crimea that can be viewed as “contributing to the situation.”

All three orders require that sanctions be placed on persons “determined by the Secretary of the Treasury, in consultation with the Secretary of State.” However, the U.S. Secretary of the Treasury did not name any mining entities after executive order 13662 was signed. This order was issued following the annexation of Crimea.

From a U.S. standpoint, the kind of deterioration that warrants exercising the measures is an additional move of troops, essentially an invasion of Ukraine. According to a senior administration official who spoke at the White House following the signing of executive order 13662, “it would be a substantial escalation for Russia to move into southern and eastern Ukraine. That is part of the context for the executive order that the President signed today.”

The stake in ALROSA held by U.S. investment firms should not be ignored either. Considering the number of sanction candidates available, U.S. authorities would likely want to avoid sanctions against a company partially owned by its citizens.

While tensions are still high between both sides, in recent days, Putin has made several gestures of taking a step back. Putin called Merkel and told her he is pulling back forces and subsequently, the number of troops along Russia’s border with Ukraine has been reduced.

Conclusion and Outlook
The U.S. has placed a high bar for further sanctions. Not only that, Russia is not attempting to near it; in recent days, it has been making efforts to end the crisis, with a political victory in hand and no intention to risk it.

Without any further acts perceived as aggressive by the West, further economic sanctions are not expected at this point. While the crisis may seem over, tensions still exist and matters may deteriorate quickly and surprisingly. Due to the fragility of the Antwerp diamond center, it is vital to avoid any sanctions on ALROSA by U.S. or EU authorities. Therefore, it is important to lobby EU authorities and explain the importance of this supply to the Belgian economy. Much is at stake and the cost of losing a major supplier reaches far beyond the diamond industry.

Jobs will be lost, income from taxes will evaporate and defaults will take place. The economic fallout must be avoided. Moreover, even if the Antwerp diamond center avoids the fallout, ALROSA may seek to divert some of its supply to other destinations such as Mumbai. There are already signs that ALROSA is preparing itself for such a move that must be halted by demonstrating strength and confidence in the vitality of Antwerp’s diamond sector.

Written by Isi Morsel of Dali Diamond.

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Tags: Alrosa, Antwerp, Banking, Isi Morsel, Russia, sanctions, Ukraine
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