CNBC Business | A diamond in the rough

A diamond in the rough

Calls by Russian diamond giant Alrosa for a industry regulator may not be all that they seem, says Felix Lowe

This industry needs more regulation,” proclaimed Sergey Vybornov, president of Alrosa, the world’s second largest diamond mining company, at its Moscow headquarters in May. “I don’t mean a kind of monopoly. I would call it a regulatory force,” he stressed.

Although these comments were intended to soothe an industry that is reeling as prospecting costs rise and high street sales of diamonds fall, such bullish rhetoric could have adverse implications – especially in the wake of the TNK-BP imbroglio, which has further damaged Russia’s reputation for dealings with foreign investors.

Far from dispelling fears of a monopoly, Vybornov’s comments recall De Beers’s grip on the industry almost a decade ago, when 80% of the world’s rough diamonds were sold via its Central Selling Organisation in London. In a bid to improve its image and concentrate on mining and marketing, De Beers ended its cartel in 2000 after the turbulent 1990s had ushered the break up of the Soviet Union, turmoil in Africa and financial losses. A subsequent anti-trust ruling brought an end to its traditional market share of more than 50% of Alrosa’s output. Although the EU regulation has since been overturned, Alrosa cut its sales to De Beers from $750m to $550m this year, with plans to terminate all its sales to De Beers in 2009.

Alrosa’s position in the industry has radically altered accordingly. With some of the richest deposits in the world, central and regional government owning a combined 90% stake – Russia’s finance minister Alexei Kudrin is chairman – and a mooted IPO in 2009-10, Alrosa is poised to become even more powerful. Ernie Blom, former president of the World Federation of Diamond Bourses, noted that: “It [Alrosa] is a significant player as it is, but in the future Alrosa should soar.”

Although some industry watchers are mindful of Vybornov’s “regulator force”, he insists he just wants cross-industry cooperation to navigate the chaos engulfing the industry. While the global credit crunch has badly hit commercial sales of jewellery in the US, where 43% of the world’s polished diamonds were sold in 2007, there is a booming trade in rare, larger stones, which are stalked by multimillionaires from emerging markets such as China, the Gulf and Russia. The price for five-carat gems that could fetch $1m has risen 75% since January and diamonds are being viewed increasingly as a commodity or alternative investment.

Vybornov is certainly on the charm offensive. In May, in a keynote speech at the World Diamond Congress in Shanghai, he called for an industry-wide marketing effort to drive prices higher in accordance with other luxury goods. “We produce diamonds but sell them as if they were glass,” he said in a short speech which attacked the $50 “Big Mac” or “one-night stand” rings which Vybornov sees as depreciating the allure of diamonds. Meanwhile, Alrosa flew a group of Western journalists to the Siberian province of Yakutia to marvel at its open-cast mines.

Underpinning the market’s fragility, ABM Amro, the industry’s leading financier, says the estimated $18bn bank debt tied up in diamonds is rising at a faster pace than polished sales, which reached $19.8bn last year. There are growing fears of a repeat of the 1980 diamond crash, where prices for one-carat stones jumped 500% and then dropped all the way back in the space of 14 months.

Players at every level are affected by the challenges of the day: mining and prospecting costs are increasing; an overcapacity in manufacturing means the middlemen, whose margins are as low as 1%, are being squeezed; Indian workers, who it is jokingly said polish 15 out of every 10 diamonds in the world, are revolting; US retailers, hit by the recession, are going bankrupt.

Some suggest that it is hardly surprising that Alrosa has been vocal about the need for industry change, given it must find new customers to absorb rough diamond production that last year was valued at $2.78bn. At the same time, to compensate for its reduced supplies, De Beers is embarking on the largest mine-building programme of its 120-year history, including the opening, in July, of two projects in Canada – the company’s first sites outside Africa.

Vybornov estimates Alrosa mines in Yakutia, which specialists claim is home to the world’s clearest and highest quality gems, contain proven reserves of $110bn lasting two generations. The company is also increasing and diversifying its projects in Africa.

This level of power could prove dangerous, according to one leading diamond consultant. Martin Rapaport, who runs an online market for diamonds with listings of $3.1bn worth every day, has questioned the motives behind 50-year-old Vybornov’s determined actions since taking the helm of Alrosa in February 2007.

“Vybornov has a very Russian take on things,” warns Rapaport, who predicts a “tsunami” of strife will soon hit the industry. “Vybornov is just a milker. He simply wants to control the diamond pipeline and this idea of a regulator force shows he is essentially a price junkie bent on increasing profits and monopolisation.”

Nevertheless, this summer Vybornov called an impromptu diamond summit in St. Petersburg. Far from the sinister price-fixing affair first feared, the open-table conclave gave producers, retailers and manufacturers the unprecedented opportunity to discuss the possibility of vertically integrated partnership schemes and cohesive marketing policy to improve the image and value of diamonds.

For the first time firm outlines were made regarding the possibility of setting up an industry organisational body such as the Platinum Guild. Chaim Even-Zohar, an Israeli diamond consultant who had previously labelled Vybornov a “wild card” due to his unpredictable nature, now praised him for having “the guts [to] assume a worldwide leadership role in the diamond industry”.

Whatever Vybornov’s true motives, the vertical integration of an industry as unique and insular as the diamond trade is unlikely. De Beers has gone its own way and any attempted IPO by Alrosa may suffer from foreign investors’ perception of Russian business. Vybornov may have sowed the seeds of a new regulatory regime: a Russian one.