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ALROSA and Mugabe's legacy

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Earlier this year, ALROSA announced a new testing ground for its activity in Africa. This testing ground, unexpectedly for market analysts and African experts, was Zimbabwe, the country that survived the fall of Robert Mugabe’s seemingly unshakable regime in November 2017 and now interested in an inflow of foreign investment to revitalize its economy. In the beginning of the 2010s, this country was claiming to be one of the world’s top three diamond producers, but currently, for natural and man-made reasons, it occupies modest positions. Nevertheless, according to the management of ALROSA, Zimbabwe, along with Angola, is one of the two African countries with a very high geological potential.

FUTURE JV

ALROSA and the Zimbabwean authorities announced agreements to develop diamond mining in this African country in January this year, when Emmerson Mnangagwa, the new Zimbabwean President was on a visit to Moscow. Earlier, a subsidiary of ALROSA - ALROSA (Zimbabwe) - was established in Harare and was staffed with geologists, mining engineers and other specialists to conduct pilot activities. As stated by ALROSA, its operational activity in Zimbabwe aims to “implement projects for exploration and mining operations with a view to establish joint diamond and other ore mining enterprises.”

ALROSA’s investments in activities in Zimbabwe are so far small - in January, the miner’s representatives at a meeting with analysts voiced an amount in the range of $ 10 million for 2019. This is actually a fee for the access to geological information. The budgets of potential projects may not be used, if for example there will be no commercially viable diamond reserves - as it happened with the Kimang exploration project in Angola (JV between ALROSA and Endiama), for which expenditures were planned at $ 15 million over 3 years. On the other hand, costs may increase as soon as the company finishes the exploration phase and starts developing diamond fields or discovers the need for additional research on promising targets.

The promising targets have already been identified, according to Vladimir Marchenko, Deputy Chief Executive Officer of ALROSA. These are the areas going through the exploration stage, brownfield and work projects at existing facilities. ALROSA has prepared and brought into line applications that will be submitted after signing a legally binding joint venture agreement with the Zimbabwean side. The agreement is expected to be signed in the second half of July (Zimbabwean officials also confirm that the agreement will be concluded soon). At some of the sites chosen by ALROSA, activity may begin this coming fall.

SANCTIONS AND OTHER RISKS ASSOCIATED WITH ZIMBABWE

The information about the company’s interest in the existing fields alerted analysts of the stock market. “Such acquisitions may adversely affect the dynamics of free cash flow due to higher fees compared with new fields. At this stage, we regard the news as moderately negative,” said a review by VTB Capital about ALROSA’s plans in Zimbabwe.

Another negative factor to which VTB Capital drew attention was the legal risks arising from the demand of non-governmental organizations to exclude Zimbabwe from the Kimberley Process. ALROSA’s management singles out Zimbabwe, along with Angola, among the most promising countries in terms of geological potential. But these two countries differ not only in potential reserves of diamonds. It is Zimbabwe and Angola that the Civil Society Coalition (CSC) cites as countries, in which state and private security forces “commit atrocities to clear land for full-scale mining.” This is about violence against miners, working mainly on the Marange diamond fields. Based on examples of such crimes, the coalition of human rights groups advocates that Zimbabwe’s diamonds be classified as “conflict diamonds”. “In the case of this scenario, diamonds from Zimbabwe may be subject to a ban on sales in world markets,” says a review by VTB Capital.

At a meeting on the reform of the Kimberley Process held in Mumbai in June, no sanctions were imposed on Zimbabwean diamonds. Meanwhile, Blue Nile, the largest online retailer, announced its own sanctions, and this cannot but deliver a blow to the attractiveness of the diamond business in the country. “Because of the reported human rights abuses in Zimbabwe's Marange diamond district, Blue Nile will not purchase or offer diamonds from that area,” Blue Nile said in a statement expressing concern about the ethical standards of doing business in Zimbabwe.

In order to minimize possible risks, ALROSA emphasized that it did not consider the largest conglomerate of Marange deposits in Zimbabwe, which is under US sanctions. In 2013-14, Marange was one of the largest diamond deposits in the world, producing about 17 million carats of rough diamonds. Since then, its output has plummeted, and the legal status of "blood diamonds" has not changed. Despite the change of the ruling regime in Zimbabwe, Marange diamonds are still under US sanctions because of allegations of human rights violations in mining and the impact of proceeds from the sale of precious stones on the demolition of democracy in this African country.

Similar EU sanctions were lifted in 2011, and the Kimberley Process, after some hesitation, found Marange diamonds to meet their standards. However, because of the sanctions imposed by OFAC on key operators and stakeholders in Marange, diamond manufacturers supplying such polished goods to the key US jewelry market have to separate Marange diamonds from others in the manufacturing process. The US sanctions make the transfer of USD proceeds from the sale of diamonds in Zimbabwe more complicated and also lead to a number of difficulties in insuring the supply of stones. The major buyers of rough diamonds in Zimbabwe are companies from China, India and South Africa, which mix Marange diamonds with diamonds mined in other places, making them indistinguishable. It has been assumed that most of the diamonds from Marange are sold on the diamond exchange in Dubai, and from there they penetrate to the West.

VOYAGE FOR CONTROL

The shareholders' agreement will presume ALROSA’s control over Zimbabwean projects. “We are not an investment company, we will no longer participate in foreign projects without control,” said Marchenko. From our side, we will add that assigning Zimbabwean projects to the company's main business and consolidating them on the balance sheet will allow shareholders to receive income from investments in this country. But ALROSA can also indirectly share possible losses with shareholders. In contrast to the situation in Angola-based Catoca, where ALROSA has only a share in dividends, the fate of projects in Zimbabwe and their cash inflows (or outflows) will theoretically be “embedded” in the price of ALROSA shares.

Despite the fact that Zimbabwe has abandoned the “reform” of the Mugabe diamond mining sector, Zimbabwe still has a law on wider rights for the local population (Indigenization and Economic Empowerment Act). According to this law, 51% in the capital of all enterprises in the country should be in the hands of Zimbabweans. This populist law passed in 2008 is considered to be one of the favorite brainchild of former President Robert Mugabe, who earned the title of “the world's best expert on seizing property from foreign investors.”

The consequence of the law was the departure of large investors from the country, such as Rio Tinto and Anjin, the latter being the owner of businesses in the Marange area until 2016. Investors did not accept the proposal of the Zimbabwean authorities to consolidate into a joint venture with the state-owned Zimbabwe Consolidated Diamond Company (ZCDC) created to encourage “transparency and stop smuggling” and give it control over their enterprises. In 2016, Rio Tinto responded to this idea by selling its Zimbabwean assets (both diamond producing Murowa and coal producing Sengwa) through offshore companies to protect both its own rights and the rights of the buyer, which was RioZim, a minority shareholder of Murowa. At the same time, Zimbabwe was also abandoned by ALROSA, which was engaged in exploration in this country. De Beers, the discoverer of Marange left Zimbabwe in the early 2000s.

Now ALROSA is optimistic about the prospects for gaining control over projects in Zimbabwe. “The company's position on the controlling stake has not changed, to which the Zimbabwean side is sympathetic,” says a source in ALROSA. “The legal framework of Zimbabwe is quite extensive, there are special permits that allow to bypass some of the legislative norms.” An example is platinum producers, which are 100% controlled by investors from South Africa.

The policy pursued by the new Zimbabwean authorities suggests that only four companies will mine diamonds in the country. Two of these are ZCDC mentioned above and Murowa Diamonds, which operates independently of it and which is developing the Murowa diamond mine, which previously belonged to Rio Tinto. The main owner of Murowa, RioZim, is controlled by a private foundation, which is Global Emerging Markets (GEM) founded by Harpal Randhawa.

Other participants include China’s Anjin (a joint venture between the Chinese Anhui and the Zimbabwean military) and Vast Resources listed in the UK and operating in team with Botswana Diamonds, the former partner of ALROSA in the exploration joint venture in Botswana. Local media reported that De Beers received an offer to come back, but this idea did not appeal to De Beers.

ZCDC will be ALROSA’s partner under the agreement. Other combinations and alliances, except for partnership with ZCDC, are not considered by ALROSA, said Marchenko. ZCDC was in the spotlight this last May, when the management of this corporation was dismissed on charges of corruption and abuse of office. According to ALROSA, as a result, the situation in the Zimbabwean state-owned company has improved. “The situation in ZCDC does not worsen, but on the contrary we feel it is being corrected,” said a source in ALROSA.

ZIMBABWE’s DIAMONDS

Diamond mining in Zimbabwe, after reaching 12 million carats in 2012 mainly due to Marange, has declined sharply in recent years. In 2017, ZCDC, which still has a monopoly on diamond mining in Zimbabwe, produced only 1.8 million carats, mainly on conglomerates in Marange. About 740,000 carats per year are produced by Murowa, which plans to mine up to 5 million carats by 2022. ZCDC plans to increase production to 10 million carats by 2023.

Some insight regarding the quality of Zimbabwe’s diamonds may be achieved from the Kimberley Process data. The average value of rough diamonds in Zimbabwe in 2017 was $ 69.94 per carat, which is higher compared with 2016 and 2015 ($ 50). This value is significantly lower than the average value of gem-quality diamonds produced by ALROSA, which was at the level of $ 143 per carat for the last three quarters. Marange still accounts for the bulk of rough diamonds produced in the country. Marange diamonds tend to be small and marked with a brownish-green tint, noted in his review Paul Zimnisky, a well-known analyst and consultant. Due to the status of being “bloody” and limited distribution systems, their value is even lower by 25% and as a result their average value was $ 20-45 per carat for a long time, which is lower than the world average ($ 100 per carat, according to KP estimates).

Responding to a question about the quality of rough on the sites in Zimbabwe, which are of interest to ALROSA, Vladimir Marchenko, Deputy CEO of ALROSA said that this kind of rough is completely different. “Studying the opportunity to start work, we bought some rough for our gemological needs at auctions contained in two lots with large stones - one for $ 500 per carat, the second for $ 2000.” The experts of ALROSA’s United Selling Organization examined the morphology of the purchased stones.

Of course, ALROSA’s experts have comprehensive information about the quality of rough diamonds and diamond reserves in Zimbabwe, but today the idea of ​​developing operating activities in this country seems to be more politically motivated and therefore quite controversial from an economic point of view. It is not very clear why several months after leaving the exploration joint venture in Botswana due to fundamental unattractiveness of projects at an early stage of exploration, ALROSA is starting similar activities in another African country, notes Sergey Goryainov of Rough & Polished, where, among other things, the authorities do not have a name for being predictable. The conditions of doing business in Zimbabwe during the late period of Mugabe’s rule used to change dramatically, and so far, there is no obvious evidence that the situation has stabilized. “There is no certitude that ALROSA takes into account all the risks for a foreign investor in Zimbabwe. After all, without a long and comprehensive examination, it is difficult to find out which of the defense minister’s hypothetical nephews will outrun the competitors and control the mining industry,” says Sergey Goryainov.

Unlike China, which, before moving on to major investment projects, prefers to secure political influence and ensure stabilization, Russian expansion in Zimbabwe looks like an attempt to cling to a possible testing ground for systemic participation in political processes in Africa, conclude the authors of "What’s Behind Russia’s Newfound Interest in Zimbabwe?", a review of the Carnegie Moscow Center. Russia’s initiative is embraced by the Zimbabwean authorities, who, in the opinion of the authors of the review, realize that “the Russians will not be able to convert the results of their assistance into direct political or economic power, and even the simple monetization of influence is not yet being discussed.”

But right now, on the backdrop of cooling demand in the diamond market and a 30-percent decline in sales, ALROSA more than ever needs positive drivers, not negative. So far, the company’s entry in Zimbabwe does not look like this. In addition to the completely unobvious monetization, this move is more likely to have signs of ALROSA being drawn into expansion in a toxic market. Expansion may have a limited scope for business, but - as it is proved by the sad experience of RusAl, which carried the burden of OFAC sanctions for almost 10 months, - you never know which argument can be decisive for the formidable American regulator capable of blocking oxygen to companies of any industry, scale and geographical affiliation.

Igor Leikin for Rough&Polished