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The tobacco is excellent. The pipe of peace is put out.

19 november 2018

“We lit the pipe of peace. The tobacco is excellent." Actually, the establishment of the Soviet diamond mining industry started with this coded telegram sent by the geologists who discovered a primary diamond deposit in Yakutia.

For the diamond industry of the Soviet Union and that of Russia, the legendary kimberlite pipe named Mir (which means ‘peace’ in Russian) is the same as the Vostok spaceship for the Russian cosmonautics. Mir is the first primary diamond field launched into commercial operation. The largest diamond in Russia was unearthed at Mir. The Mir open quarry is visible from space. The City of Mirny, which is the capital of Russia’s diamond province, grew around the Mir mine. Mir earned tens of billions of dollars for the country and became a world-famous mining engineering facility.

The underground mine of the same name was launched in 2009 in the presence of Vladimir Putin. The mine was flooded in 2017 as a result of a technogenic catastrophe, taking away the lives of several miners.

Now it is time to turn attention to the latest information about this mine.

The Long-Term Development Program of ALROSA Group designed for 2018-2024 does not provide for investments aimed at identifying solutions and preparing works to restore the Mir mine: “Investments in the Mir mine in the Long-Term Development Program of ALROSA Group for the period of 2018-2024 and in the Long-Term Investment Program of ALROSA Group for the period of 2018-2024 are not taken into account due to the lack of approved technical solutions for further implementation of the project.” The same document indicated that as of the start of this year, Mir’s C1-category reserves amounted to 129,733,900 carats (which is about US$32 billion in current market prices) of high-quality rough diamonds suitable for underground mining in the course of 17 to 20 years. This information was confirmed by Alexey Filippovsky, Deputy CEO of ALROSA at a telephone conference call for investors, which took place in early November 2018.

ALROSA stated that the damage from the accident at Mir did not exceed 12 billion rubles and is fully covered by the insurance payment. This amount of the declared insurance coverage fails to correspond to the actual damage, since it does not take into account the cost of the lost underground part of the mine (permanent mining workings in the skip, cage and service shafts, backfill feeding system), as well as the headgear infrastructure (drop hammers, buildings of hoisting machines, backfill complex) with a book value of at least 25 billion rubles (PWC, the auditor of ALROSA did not initiate the creation of a reserve for impairment of fixed assets while certifying the company's statements for 2017 - most likely due to the fear of materialized risks to lose the audit contract).

The cost of diamonds remaining underground is also not included in the mentioned amount of the insurance event, these reserves are still on the company’s balance sheet and are taken into account in all existing geological and project documents. Such an accounting trick can serve as a consolation for the shareholders of the company, but it does not cancel the fact that ALROSA’s clients will certainly not see even a single carat of diamonds from the Mir mine over the next five years. It is not excluded that these diamonds may never appear on the market.

Mir, the birth cradle of the Soviet diamond industry did not just give one tenth of ALROSA’s diamond output in carats, it gave the best part of it, second only to diamonds extracted at the Internatsionalny mine in terms of content and quality. The “quality” here is the key notion and the loss of Mir may have irreversible consequences for ALROSA.

The reason is that the modern diamond market is being rapidly fragmented under the influence of modern technology and innovation. It is falling into two segments, in which pricing is influenced by various factors. The first segment deals with large-size high-quality rough (5 grainers and above). Both demand and prices for these diamonds will rise in the foreseeable future. DPA’s marketing strategies will be covering such stones, and they will be turning into real natural polished diamonds that are irreplaceable. The second segment deals with small-size rough, the “Indian goods,” already priced much lower and likely to lose value further. The main pricing factor in this segment is the expansion of synthetic diamonds. Even now, the cost of production of small-size jewelry-quality synthetics is several times less compared with natural diamonds of the same grade, and this difference will only increase over time. Natural rough in this segment will be knocked out of the market by synthetics in the same way as it happened with natural industrial diamonds, the market share of which is now expressed in single digits of percent.

If such a prediction is correct, then the loss of Mir may be fatal for ALROSA. The company’s product mix has a catastrophically large share of small-size and cheap goods due to the decline in production at its best diamond fields. Yury Okoyomov, Deputy CEO of ALROSA says that small-size rough accounts for about 40% of ALROSA’s production by weight and for 20-25% by value; Interfax, citing ALROSA's customers, provides data on 70-80% of small-sized rough in ALROSA’s production mix. The discrepancies are obviously caused by the question: “What should be considered as small-size rough?” But we are unlikely to make a big mistake if we assume that rough diamonds weighing 2 grainers and below account for more than half of ALROSA's production in terms of volume and at least for one-third in terms of value. Such goods will fall in price and be forced out of the market by synthetics in the near future. Actually, this is happening right now.

The risk of edging out a significant share of ALROSA’s goods from the market seems to be well recognized by the company’s management. Thus, Alexey Dyachkovsky, Deputy CEO of ALROSA said the company may incur significant financial losses if “one-carat polished diamonds will go down in price across the board.” Mr. Dyachkovsky believes that the reason for a possible fall in prices is the expansion of synthetic diamonds. However, unlike De Beers, ALROSA does not take the slightest steps to stop this threat. In any case, there is not a word about this in the “Long-Term Investment Program of ALROSA Group” quoted above or in any other publicly accessible documents of the company.

The diamonds mined at Mir, Inter and the pipes of the Nakyn ore field were a necessary element of the company's development strategy, which allowed it to maintain “afloat” the projects dubious from the point of view of economic efficiency, whose profitability initially fluctuated around zero. Without these mines that provide a reliable resource “rear” for ALROSA, it would be an unreasonable risk to start mining low-grade near-industrial-quality diamonds from the Arkhangelsk pipes and rough located far from the production infrastructure of the Verkhne-Munskoye low-grade diamond field. Now there is no Mir; Inter and Udachny stay idle for months due to the orders from Rostechnadzor (Russia’s Federal Environmental, Industrial and Nuclear Supervision Service); the Nyurba pipes are being quickly “eaten up” by open-pit mining operations; the underground mine of Aikhal started to suffer from the quality and value of rough extracted at lower mining levels; the Yubileiny open-pit is being rapidly reduced due to selective excavation of rich blocks, probably even to the detriment of the existed plans and projects for mining operations. All the more or less rich ore reserves in the company’s warehouses have been developed in line with the logic of maintaining the financial performance of ALROSA Group, which often does not leave miners a reserve for proper operation. And the rest of the primary deposits produce mostly the above-mentioned "small-size" rough, the market fate of which is quite unenviable.

If synthetics together with new efforts of Indian colleagues will finally manage to collapse prices of small-size rough, ALROSA's earning power will fall sharply, and the company will have to be fragmented in the wake of the market; in fact, this will be disintegration into separate parts. Commercially viable diamond fields will be most likely developed by independent companies, while the rest will be mothballed with corresponding consequences for their infrastructure and personnel. This scenario looks, of course, apocalyptic. But it is not a zero probability at all. Unfortunately, gloomy forecasts sometimes come true. Ten years ago, in an interview given to the author of this article, Lev Puchkov, one of the leading Russian experts in the development of underground mining systems, spoke about the low quality of ALROSA’s mines, where he said major accidents should be expected: “... All the mines now under construction there are notorious for their utterly low level of mining work safety. … Dangerous mines being built now will turn into a future super-problem.” We would have been happy then to make a mistake...

Sergey Goryainov, Rough&Polished