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ALROSA gets second bailout

31 august 2020

Industry insiders increasingly spread rumors that the decision to purchase the ALROSA's rough diamonds by Gokhran has been made in principle and that the diamond sorting and grading have allegedly already begun under this agreement. The value of this transaction ranges from $0.5 bn to $2.0 bn but most believe that the deal will be at the level of $1 bn.

The situation resembles the crisis of 2008-2009. Then, ALROSA was forced to exit the market completely, however, without stopping their production. Gokhran bought their rough diamonds for $1 bn in 2008, and for another $872.1 mn in 2009. These purchases saved ALROSA and ensured its quick recovery when the market improved; by the end of 2009, the company became a global leading miner and its market share increased from 22% to 29%. De Beers that did not have such support had to stop mining and, as a result, it reduced its market share from 30% down to 23%.

However, the current crisis has a number of differences that cast doubt on such an optimistic scenario. First and foremost, it is the state of the Russian budget. In 2008, the average annual price of Brent oil was $97.28 per barrel, in 2009 it was $64.17. Today, you can only dream of such prices. And if we take into account the drastic reduction in oil exports in accordance with the Russia-OPEC agreement, the dire state of the gas market, much lower tax collection rate due to the slowdown in many sectors of the economy due to the pandemic, and the notorious sanctions, we have to admit that purchasing ALROSA's diamond stock by Gokhran (if this takes place) is a truly heroic thing.

While in 2008-2009, such a move both saved ALROSA and also gave it strength to achieve a quantum leap in the market, today, it looks like a palliative measure that cannot solve the problem fundamentally. The stock purchased from ALROSA during the previous downturn was sold off by Gokhran 8 years later only when the diamond market looked rather good. Today, when there is practically no market at all, Gokhran acts as a regulator removing a rough diamond glut reaching millions of carats and thereby giving hope for the diamond industry recovery. But given the state and very gloomy prospects of the Russian budget, the temptation to sell this stock at the first signs of the market revival will be enormous. The consequences will obviously be fatal.  

Nevertheless, this purchase is the only way to save the leader of the Russian diamond industry; there is no other alternative. The signs of recovery from the United States, China and India are so far less impressive amid the threat of the next wave of COVID-19, political turbulence and possible trade wars. It is unlikely that ALROSA will be able to resume its sales at the pre-crisis level by the end of the year and the situation risks becoming irreversible without the Gokhran's support.

So, for the second time in its history, Gokhran will act as a regulator of the diamond market on a national (and, generally speaking, global) scale. Note that both the 2008-2009 crisis in the diamond market and the current one took place amidst the single-channel structure breakdown and De Beers' refusal to play the monopoly regulator role. The system that prevented the excesses on the market for decades and kept the price of diamonds from destructive volatility has become a thing of the past, and now every responsible market player must perforce bear a part of this heavy burden.

What is a weakness in the diamond pipeline? This is undoubtedly the upstream, i.e. mining. Its huge capital intensity, long planning horizons, high levels of technical risk cannot be compared with the expenditure of time and money on organizing diamond polishing and retail. Well, in fact, can a store or a cutting and polishing factory be compared to a quarry and a mine? One of the positive features of the single-channel system was its ability to effectively protect the rough diamond producers by passing the accumulated market entropy on to the sightholders, polishers and retailers. First of all, every downturn hit them hard, mining operations suffered much less. What's interesting, not only the mines of De Beers, Soviet Uralalmaz, Yakutalmaz - and later - Russian ALROSA regularly received their ‘anti-crisis bonus’. The matter is, De Beers bought the contractual quantities of rough diamonds from the USSR and Russia regardless of the state of the market; no matter whether there was a crisis or not, the contracts were fulfilled. This was the case until 2007. After 2007, every company was left one-on-one against a crisis, and now, for the second time, Gokhran has to try and play the role De Beers played in its monopoly era.

The detailed information on prices, volumes and assortments of diamonds purchased by Gokhran in 2008-2009 was not revealed, only integral figures were announced. It is unlikely that any detailed data on the diamond stocks will be published under the current deal. But there is little evidence for thinking that this transaction will be carried out at market prices. The reason is simple - there is no market as such today. What will determine the amount of the transaction? Only the current needs of ALROSA as it is necessary to ensure the company’s survival. Surprising as it may seem, such an anti-crisis solution, to a certain extent, brings us back to the times of the USSR and, accordingly, to the era of the single-channel diamond market.

Indeed, what was the structure of the Soviet diamond industry? Uralalmaz and Yakutalmaz sold all their diamonds to Gokhran at conditional rouble prices. These prices had nothing to do with the market diamond prices, but they were calculated so that Uralalmaz and Yakutalmaz did not have any problems to pay the wages, geological exploration, and the capital expenditures for the development of their production, infrastructure, social services, etc. And the mining industry - being the backbone of the industry - worked flawlessly, as regular as clockwork, regardless of the state of the global diamond market at that moment.

The Ural and Yakut rough diamonds were supplied to Gokhran, and Almazyuvelirexport sold most of them to the world diamond monopoly De Beers under long-term contracts. These deliveries also practically did not depend on the state of the market (Pacta sunt servanda!), De Beers actually took all the price risks. A smaller part (the so-called ‘control quantity’) was sold on the free market, which allowed the verification of the negotiated prices. Of course, this scheme included the De Beers’ margin but it was an adequate price for going through no crisis in the Soviet diamond industry.

The disintegration of the Soviet Union,  and the ‘parade of sovereignties’, in which Yakutia played almost the key role, led to a new diamond industry structure, but the agreement with De Beers, the main guarantee against a downturn, was in force until 2007. And later on, two crises, one heavier than the other, showed that the old scheme made more sense. So, why not to convert a temporary emergency scheme into a permanent, reliable mechanism?

There is mining - the backbone of the diamond industry, it must have the maximum possible protection against a market turbulence and also guarantee the necessary and sufficient financing of the mine development planning over a long-term horizon. And there is also a trading company operating in the foreign market and taking all the risks associated with price fluctuations and other downturn. This may seem in part to be a return to a planned economy - well, the purchase of ALROSA's stocks by Gokhran bears little resemblance to the apotheosis of the free market.

All new is well forgotten old. This simple truth is especially useful in the midst of a crisis.

Sergey Goryainov, Rough&Polished