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Adding fuel to the fire - COVID and the benefit performance of Angola

25 may 2020

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Catoca diamond mine                                                                                                                Image credit: Catoca

As it became known, last week Angola sold at least five ‘modules’ (parcels) of goods supplied by its main diamond producer, Sociedade Mineira de Catoca. Five modules contain the entire monthly production of this company. According to market information, the rough diamonds could have been sold at $ 72-74 per carat.

Catoca already had some diamond sales this year, but it is the sale occurred last week that can be safely called the first Covid-period trading session in the current “frozen” market. What are the takeaways? They are, in my opinion, very controversial.

It immediately comes to one’s mind that some market activity is still on and demand for diamonds has not vanished, so once the borders will be opened everything will be back on track, though with certain adjustments, of course. Catoca’s monthly production is not small, presumably over 600,000 carats. The fact that Indian companies bought the entire amount suggests that demand is there. Moreover, the GJEPC coquettishly proposed to transfer the ban on the export of rough to India from May 15 to June 1 while Angola is selling off everything it can. This is understandable – it’s every man for himself.

However, the question of possible consequences for the market remains open - this is what it is worth to explore. And to do this let us look back to the recent past.

One year before the pandemic, prices for Catoca’ diamonds exceeded $ 100 per carat. If in 2017, Catoca’s diamonds were sold at $ 82-86 per carat, then starting from January 2018 their price quickly flew over the bar of $ 100 heading higher, towards $ 110, 115... At the same time, the new leadership of the Angolan diamond industry made flashy statements about the ongoing fight against the corrupted legacy of the past regime, thus explaining the rapid increase in prices it offered for Catoca’s goods.

Simultaneously with the start of fighting against the “damned past”, there occurred a “split” in the new management of the Angolan diamond industry. The once integral structure of Endiama, to which the country’s state diamond trader Sodiam was subordinate, turned to be divided into two functional units: Sodiam was made an independent trader, and Endiama was made responsible primarily for the development of diamond mining in the country. Diamond producers, including Catoca, of which Endiama is a shareholder, were allowed to sell up to 60 percent of their goods on their own, while Sodiam preserved the right to purchase first. In addition, it should be borne in mind that above all this there is the country’s regulatory ministry. This “split” predictably led to a conflict of bureaucratic interests which brought about a sharp rise in the commission going up to more than 10 percent from 6.5 percent, which buyers were obliged to pay to the state if they bought their goods directly from the producer. Then this commission was again reduced by half. There is still no public system of access criteria for buying Catoca’s diamonds, there are no sightholders or long-term contract holders, and neither Sodiam nor Endiama hold regular tenders for these products. In general, since 2017, the Catoca sales system has certainly not only failed to add transparency, but rather the other way around. It is noteworthy that there were no additional investments in the mining industry of Angola during the two years of rising diamond prices.

While Philippe Mellier used to squeeze every penny out of De Beers’ sightholders exploiting the inertia of the past trusting relationship between the monopoly and its customers based on the principle of “I sell for as much as I get paid”, Angola’s current “diamond” policy is based on an even more elusive foundation, which is the exploitation of hopes and expectation of future preferences.

If the price of the past week transaction was indeed $ 72-74 per carat, then in my opinion it is not quite correct to talk about a radical price reduction from the level of $ 100 per carat and above. It makes sense to compare this price with the one that was practiced in the market before the “episode of anti-corruption fight”, and at that time it was maintained at about $ 85 per carat. Consequently, the price of $ 72 per carat is not very comfortable for current buyers, as there are too many factors that make this purchase another "investment in the future", work for stock, rather than useful for the current business. The price of $ 85-88 per carat in 2017 was a good price for buyers leaving them a “strong” margin. The sales system, of course, was completely opaque, although very understandable. Everything depended on the decision of one person, no objective criteria existed, only loyalty. But the loyalty was worth it.

In 2018, Angola decided to change the sales system, it needed money to increase production. And this is a really important task. The cost of production in Angola allows it to compete effectively with other producers; Angola has the promising Luaxe diamond pipe and if it reaches the stage of a project at estimated capital costs this would allow the country to lay claim to a leading position in the world in terms of volume and profitability of its diamond business. Actually, a 20-percent increase in the price of Catoca diamond goods could have generated almost $ 200 million a year, which would have permitted the country to independently invest in Luaxe, exploration, and alluvial diamond fields. But that did not happen.

The new diamond marketing policy has sparked genuine interest among rough diamond buyers. Companies were mentally prepared to see higher prices hoping to get stability, transparency and guaranteed supplies in return. Actually, there are not so many companies willing to buy rough worth tens of millions of U.S. dollars from Angola on a monthly basis and paying for it 100 percent upfront. Even the largest shareholder of this company, Russia’s ALROSA, which is also one of the few market participants, if not the only one, which can pull the cart of the Luaxe project, started again to buy Catoca’s rough and pay for it a high price.

However, the rising value of goods did not induce higher investments in the extractive sector, and now there are no such opportunities. There is an opaque sales system, low prices and a lack of prospects for diamond mining.

It seems to me that the price of $ 72-74 per carat (excluding the state commission) is too high in the current environment, this is another sale in “lieu of future merits”. This is not particularly good news for the market as a whole.

A February batch of Catoca rough diamonds was recently also delivered from Angola at prices that were different from the prices of rough supplied last week. Consequently, there are already two conflicting stocks of Angolan rough in the market. I would not be surprised if Angola decides to continue sales lowering prices, which will confuse the already “fortunate” buyers, who bought it last week at $ 72-74 per carat. I don’t think the elegant splashing fuel onto a burning house will be appreciated anywhere.

De Beers plans to hold its trading sight in the coming June. The sales system of De Beers, unlike that of Angola, is much more understandable and the steps taken by the company to give its customers the right to reject 100 percent of rough offered for sale are adequate to the situation. Of course, Angola's sale of 600,000 carats of diamonds two weeks before the planned sight will definitely not draw tears of tenderness from De Beers’ management and the corporation’s shareholders - the government of Botswana and Anglo American.

Angola could contact ALROSA and offer it to buy rough in stock to support the mining sector. In the end, the country does not have a more trusted partner. But ALROSA has naturally always been interested in strengthening its influence on the marketing policy of Catoca, where it is a shareholder, as well as in strengthening its control over the Luaxe project, where it is the main technical contractor and investor. For some reason, I’m sure that the Angolan side is not happy about strengthening anyone’s influence on sales. Investments are welcome, and it’s better if they are made just on friendly terms, but it’s not the case with sales. However, there are no such "patient" partners around.

Summing up, it is possible to say the following. In the two years that Angola skimmed off additional margins from the market promising a “transparent sales system” based on “public criteria”, it could have been possible to attract sufficient funds to independently develop Luaxe, alluvial projects and lay claim for a leading position in the global diamond market. This did not happen. There is no system, no auctions, no investment in production. There are the same sales to a minimum set of customers defined by opaque decisions. If the past management was accused that part of the profit from the sale of Catoca diamonds settled in the pockets of a narrow group of people, then it is even less clear where the money generated by the high diamond prices in the past two years is gone. Perhaps the money went to Angola’s budget, but certainly was not used to develop the diamond mining sector, which is the second source of livelihood after oil for the country. Angola could count on a reliable and trusted investor, which is ALROSA, but Angola does not do it.

What is happening will in the long run obviously push De Beers to strengthen the marketing program for the “provenance” of diamonds in jewelry consumption markets, especially in the United States, in order to minimize the unpredictability of hasty decisions of some market stakeholders. This is especially true for the market of engagement rings. Perhaps the two largest diamond mining companies, ALROSA and De Beers, will accept additional informal criteria for sightholders, which will take into account their actions during the crisis. Of course, synthetic diamonds will be there in the picture. They look attractive to the leaner middle-class wallet and are more predictable material for the jewelry business from all points of view.

The coronavirus pushed some market stakeholders to act as if it’s every man for himself. This is an understandable principle, although the fragile diamond business has always stuck to the more efficient "one good turn deserves another". But it doesn’t matter what principle is at play - any of them should be bolstered by a real long-term strategy that is adequate to the life horizon of mining projects, not monthly sales. I dare to suggest that someone has such a strategy, but in our case, it is not Angola.

Sergey Goryainov, Rough & Polished