Death Of A Monopoly, A Fluctuating Market And The Diamond Industry [Ventures Africa]
(Ventures Africa Via Acquire Media NewsEdge) VENTURES AFRICA – For the last decade, the diamond industry has been the poor cousin in the portfolios of large, diversified mining companies. Weak prices and poor consumer demand have constrained profits, while a paucity of diamond discoveries have limited new sources of supply. 2012 was a particularly tough year, one which most players in the industry would rather forget. Costs rose, and a liquidity crisis in India nearly caused the collapse of the country's diamond-cutting and manufacturing business. BHP Billiton and Rio Tinto put their diamond assets on the market in a bid to cut costs and focus on more profitable industries. Just a year earlier, the Oppenheimer family had sold the balance (40 percent) of their diamond empire to Anglo American in a $5.2-billion deal. Some critics said the move reflected a lack of faith in the future of the industry, as well as in the company itself.
All of this negativity was turned on its head in June this year. Rio Tinto, which is the second largest mining company in the world, announced that it had scrapped the sale of its $1.3-billion diamond business. It was not prepared to sell its assets at bargain prices when in fact the medium to long-term fundamentals for diamonds look increasingly attractive. "We have valuable, high-quality diamond businesses that are well positioned to capitalise on growing demand for luxury goods in Asia and continuing strong demand in North America," said Alan Davies, CEO of Rio Tinto Diamonds & Minerals, at the time.
This move will likely shake up the industry, which today is dominated by De Beers and Alrosa, the world's biggest diamond companies by value and volume, respectively. Kieron Hodgson, Resources Analyst with Charles Stanley Securities in London, believes Rio Tinto must now demonstrate that it can create shareholder value from its diamond division, which remains subscale at present. "That could mean doing a complete U-turn and starting to look to acquire assets," he says. "Rio was once a significant force in the diamond industry. They have an opportunity to become on par with De Beers or Alrosa if they really want to."
But today, challenging a company like De Beers is easier said than done. The diamond industry has undergone substantial reorganisation in the last decade, and in the churn, a new generation of smaller and nimbler diamond miners emerged. They will not easily relinquish their place in the sun. "There are few opportunities for growth in the diamond market," says Johan Dippenaar, CEO of Petra Diamonds. "This is due to the true scarcity of diamonds. There are about 30 mines globally which produce the vast majority of the world's diamonds. Most of these mines have been in operation for decades already and some for over 100 years. A lot of money has been spent exploring for diamonds, but very few economic deposits have ever been found."
The catalyst for the recent change was the break-up of the De Beers monopoly, which had allowed the company to control diamond selling and pricing for close on 100 years. Restless producers had already begun testing the idea of selling diamonds outside De Beers' unified Central Selling Organisation, now the Diamond Trading Company, in the 1960s. Then, in the 1990s, Australia and Angola began selling diamonds independently. In 2005, the European Commission accepted De Beers' commitment to reduce and eventually end its purchase of rough diamonds from Alrosa, a move that finally broke the conglomerate's hold on the industry.
De Beers sold down its long-term stockpiles of diamonds in the same year, which meant that diamond prices were subject to pure market forces for the first time. The move introduced price volatility and all the producers have had to adapt.
"These changes enabled the establishment of smaller, independent diamond mining companies which previously did not exist," says Dippenaar. These include 'mid-tier' producers like London-listed Gem Diamonds and Petra Diamonds, as well as Canada's Dominion Mining. In the tier below are smaller companies like Lucara, listed on the Toronto and Botswana stock exchanges, and Firestone, which is listed in London. These companies typically buy infrastructure from larger players who are looking to keep only their major assets. Their holdings are smaller and often more intensively and effectively mined, with surprising results. Gem Diamonds' Letšeng Diamonds, for example, based in Lesotho and 30-percent owned by the government, has since May this year discovered three diamonds each weighing over 100 carats.
A New Era for De Beers?
With the smaller, nimbler companies pulling for success and Rio Tinto focused on developing its assets, so too will Anglo American be determined to extract value from De Beers. That is, if it chooses to hold onto the company. Anglo American's new CEO, Mark Cutifani, who joined the company in April 2013, is currently overseeing a detailed strategic review. "As a major diversified company‚ we need a more focused articulation of the value proposition that will guide our strategic position‚" he says. Simultaneously, De Beers is busy with its own review. "We all realise that the decades of relative stability are over," Philippe Mellier, De Beers CEO, told the company's Sightholders (rough diamond buyers) earlier this year. "Leadership [...] requires the ability to acknowledge the current situation and adapt to fast changes of the industry before those around you do."
This means figuring out a way to become more profitable in a tough economic environment. De Beers still churns out between 30 and 40 percent of the world's rough diamonds annually. Although its grip on the industry has loosened, the company's executives seem comfortable with the status quo. "We are no longer the 'custodian' of the diamond industry," Mellier told journalists at a media briefing in Tel Aviv in June. "We are, by value, the biggest seller of rough diamonds with more than one-third of global production. But we are no longer the overwhelming force."
De Beers is focused, he says, on cutting costs, strengthening the connection to the market, and better anticipating market swings, so that volatility does not have to mean instability. "We are reviewing operations throughout the diamond pipeline; from the type of mines we search for to the mines we invest in, to the ability of our mines to rapidly meet demand, to providing [Sightholders] with the most reliable distribution channel in the industry, to developing synthetic detection technology that maintains the integrity of the natural diamond pipeline, to optimising our brand heritage to build the diamond dream in new markets," Mellier said.
The company's downstream activities are a top concern in its review. De Beers strongly believes that branded diamonds are the future of diamonds. In 2001, it initiated its Supplier of Choice distribution strategy and established a partnership with leading luxury goods company, LVMH, as a step towards developing its brand name into retail. It went further still in the late 2000s, relinquishing its role as steward of the industry and focusing on generating consumer demand through its Forevermark brand. By that time, its generic marketing had effectively ceased. De Beers would continue to promote the image and prestige of diamonds as a stable and secure asset, but it would no longer function as a category marketer for all diamonds.
This year will see another watershed moment for De Beers, but one that suggests the company remains firmly in charge of its destiny. It is shifting its diamond sorting and sales hub from central London to Gaborone, the capital of Botswana. Producer countries are determined to become more involved in the value chains of their own natural resources, and both De Beers and Anglo American have started to recognise this rising sentiment. "Once concluded, [the shift] will constitute one of the biggest transfers of value and expertise from Europe to Africa," said Cynthia Carroll, former CEO of Anglo American, shortly before handing over to Cutifani. Dippenaar, of Petra Diamonds, sees the move as a major change for the industry – it will lead to Southern Africa becoming one of the world's major diamond centres. It is also good news for Petra, as it means more diamond buyers will be travelling to the region.
Botswana isn't the only country to gain clout in the diamond industry's reorganisation. India has swiftly become the dominant market for cutting and polishing – largely thanks to generous government loans. "It's estimated that 9 out of 10 diamonds are polished in India, so in that sense it has already supplanted Belgium and Israel as the key diamond cutting centres," says Dippenaar. (New York, Antwerp and Ramat Gan still remain the key centres for higher-value diamonds, he notes.)
India and China have begun consuming more diamonds, too. "In the past, Indian consumers just bought gold. Now they are increasingly buying diamonds set within gold jewellery," says Dippenaar. "We see this as a tremendous opportunity for Petra, because we are expanding output at a time when diamond demand is forecast to continue to grow." According to research published by consulting group Bain & Co, global diamond production recovered to about 124 million carats in 2012, up from 120 million carats in 2011. This is well off highs of 176 million carats in 2006 but Bain predicts that production will continue to grow in the coming years.
The sale of engagement rings in the US, Europe and Japan is working well to further boost diamond demand. As Chinese and Indian consumers adopt certain Western traditions, diamond sales are growing in these regions as well. According to Varda Shine, De Beers Global Sightholder Sales Executive Vice President, the medium-term financials look positive, mainly due to rising demand for diamonds among the growing middle class in Asia and India, combined with the lack of new diamond mines. Moreover, the odds of a major new diamond deposit being found and commercially developed in the next decade are low. The Murowa deposit in Zimbabwe in 1997 was the last large find. Even if a producer does make a major new discovery, the chances of production getting underway within 10 years are remote.
While the fundamentals for the diamond industry have begun to improve, Charles Stanley Securities' Hodgson believes Rio Tinto's decision to remain in the industry will benefit the entire sector. The company's strength and balance sheet could prove invaluable, he says. "The danger we had with BHP Billiton moving away, and potentially Rio too, was that further capital expenditure within the industry would have fallen away," he says. This could have stymied the sector's overall growth.
Though they have found success so far, mid-tier producers face a major challenge: exploration projects can cost hundreds of millions of dollars. Raising that kind of capital is not easy – unless you are a De Beers, Rio Tinto or Alrosa. Seismic shifts may have occurred in diamonds over the past decade but it looks like the players who remain will be around for the foreseeable future.
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