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Mine. Sell. Divide.

07 december 2020

The Russian diamond industry has a unique feature - it was founded and developed for quite a long time within the framework of the economic system, which is commonly called ‘planned’, ‘command-administrative’, ‘socialist’. In the face of today's ordeal, which the diamond market is undergoing due to the COVID-19 pandemic, it seems very interesting to assess the results of the similar ‘stress tests’ underwent by the USSR diamond industry. Maybe, the USSR experience can be useful when making anti-crisis decisions?

Two serious crises hit the world economy in the second half of the 20th century, in 1974-1975 and 1980-1982. The causes of these crises lay far beyond the boundaries of the diamond market but they had an enormous effect on the industry as by 1976, the polished prices fell by 50% and the global diamond production (except for the USSR) declined by 25%, back to the 1958 level. In 1982, the prices for polished diamonds slumped by 5 times, and the production of gem-quality diamonds (except for the USSR) sank to the level of twenty years ago. The forced reduction in supply and demand in all the diamond pipeline segments was total and very painful, especially for the cutting and polishing enterprises. Perhaps, the only consolation was that the market temporarily got rid of numerous ‘useful idiots’ trying to promote the ‘investment diamonds’.

How did Yakutalmaz and Uralalmaz fare during these years of ordeal? Surprisingly, they simply did not notice any crises. Yakutalmaz set world records in the production rates, for example, while the normal target for the De Beers mines in South Africa was to mine 10 metres per year, this figure was, on average, twice higher in Western Yakutia, and it exceeded 40 metres per year at the International pipe during the crisis of 1974-1975. In 1975, the largest beneficiation plant No. 12 of the Udachny Mining and Processing Plant (MPP) was launched, and huge funds were invested in the infrastructure and geological exploration. In 1975, Uralalmaz reached its historical peak production. The author of these lines was an employee of Yakutalmaz in 1982. Сrises? Job cuts? Delays in wages? Temporary shutdowns of the production units? In those days, they simply did not know such words.

Why was not the mining sector of the USSR diamond industry affected by the world crises at all? The answer is simple - the diamond mining and sales (export) were carried out by different departments that were not connected with each other administratively or financially. Yakutalmaz and Uralalmaz handed over their products to Gokhran (State Precious Metals and Gems Repository) at conditional prices having nothing to do with the real market, those prices were calculated in such a way that the enterprises had quite enough money for the production, upgrading the technology, geological exploration, developing the infrastructure, etc. Thus, mining, the most capital-intensive core of the industry, was reliably protected against the price turbulence in the global diamond market, which, in turn, made it possible to choose rather effective - and most importantly - reliable solutions in the production planning and development.

The idea of ​​dividing the mining and sales segments of the diamond industry arose long before starting the development of the Yakut deposits, it goes back to 1946, to the decree of the Council of Ministers of the USSR signed by Stalin ‘On the development of the national diamond industry’. The first attempt to combine the production and sales at one structural department was made after the death of the leader, when the Special Main Directorate of the Ministry of Internal Affairs was closed down and Uralalmaz was transferred to the Ministry of Metallurgical Industry. “The Uralalmaz management and its enterprises are on the state budget and do not have a settling price for their products. The Uralalmaz enterprises are financed within the annual production budget, regardless of hitting the target,” - this is an extract from the letter sent by Colonel A. Malgin, head of Uralalmaz, to Minister I. Tevosyan in 1953 who considered it possible to combine the production and export of the rough diamonds at his ministry.

The Tevosyan's idea did not go any further as he worked for the diamond industry for a very short time, as in February 1954, the diamond industry was taken over by the P. Lomako’s department who was a dedicated follower of the old scheme. With minor changes, the ‘Stalin’s version’ of the diamond industry structure existed until 1988. The rough diamonds were mined by Uralalmaz and Yakutalmaz, kept by Gokhran, sold by Vneshtorg, the USSR Ministry of Foreign Trade, (or sometimes by authorized units of the security services), and later - by Almazyuvelirexport. This scheme had its own undoubted advantages. The main thing was that each line of activity was headed by experienced professionals. Since the organizational structures of various parts of the Soviet ‘diamond pipeline’ were independent of each other, no conflicts of their interests could arise.

In the USSR times, Uralalmaz and Yakutalmaz were always managed by highly qualified mining engineers, and they picked their teams. Moreover, the problems of financing any project did not exist for them at all. The enterprises did not depend on the price fluctuations in the world market and were not affected by them. And the mining operations - capital-intensive, inert ones, with long planning horizons - functioned like a single well-oiled machine.

The sales activities required quite a different kind of qualification. It is still difficult to quantify the results of the efforts made by the Soviets in organizing the export of the Ural and Yakut rough diamonds, since many documents are still classified and important detailed information has not been published yet. But on the whole, it should be admitted that the USSR received exceptional preferences as the De Beers’ trading partner, therefore, the high professionalism of the people responsible for this area is also beyond doubt. In the end, it was De Beers that was forced to take on the market risks when agreed to purchase the signed quantities of the Soviet rough diamonds, regardless of the then current situation in the market.

It was this agreement that saved the Soviet diamond mining sector during the crises of 1974-1975 and 1980-1982. Not a single mining, geological and infrastructure project in Yakutia and the Urals has been stopped or terminated due to the severe slump in the prices for rough and polished diamonds in the world market. Of course, that significantly increased the efficiency of the industry in the post-crisis years.

In 1988, when the USSR was already on its last legs, the ‘Stalin’s scheme’ of organizing the diamond industry was broken. By the decision of the Politburo of the CPSU Central Committee, Glavalmazzoloto (Chief Committee on Diamonds and Gold) was established as a union ministry, which took over the functions involving the rough diamond mining and selling. Formally, this decision fully corresponded to the spirit of the Gorbachev’s notorious ‘perestroika’ (reformation period) and, at first glance, seemed a promising revolutionary innovation, the creation of a sort of the ‘Soviet De Beers’ company with all the advantages of an independent player in the world market. In fact, this was largely a response to the centrifugal trends, such as the separation of the diamond-bearing regions from the rest of Yakutia or the transformation of the Udachninsky MPP (which provided up to 80% of the country’s diamond production in those years) into an independent company with the right to export their rough diamonds; there existed many similar ideas in the last years of the USSR.

It remained clouded where the market risks would be under the proposed new structure of the industry. This alarming circumstance was partly compensated by the appointment of V. Rudakov as a head of Glavalmazzoloto because he had exceptional mining competence, administrative experience in managing the industry, and a talent for negotiating with the foreign partners. Alas, none of the next leaders of the national diamond industry had such a set of professional strengths. 

The ‘Soviet De Beers’ born in the death throes of the USSR and having thrown off the shell of Glavalmazzoloto, turned into ALROSA in 1992 inheriting the principle of ‘those export who mine’. But surprisingly soon, a group of influential opponents emerged who demanded to divide ALROSA into ‘mining’ and ‘selling’ parts. The ‘crusading stunt’ was headed by E. Bychkov, chairman of Roskomdragmet (Russian Committee on Precious Stones). Formally, this proposal looked like a desire to return to the time-tested ‘Stalin’s scheme’, but the ‘devil is always in the details’. The apologists for dividing the ALROSA company were at the same time in favor of terminating the agreement with De Beers, which, from their point of view, was ‘enslaving’. In their opinion, the Russian exporter had to enter the market independently to become a direct and obvious competitor to the diamond monopolist. It was not difficult to predict how such a demarche would have ended in the first half of the 1990s. Thank God, this attempt failed.

ALROSA entered the market by combining the ‘mining’ and ‘sales’ divisions and preserved the Soviet legacy in the form of an exclusive agreement with De Beers, which served as a fairly reliable damper of the market fluctuations. The scheme seemed perfect, but in fact, it was fraught with a threat that began to manifest itself soon. The fact is that the vector of the diamond company development from the point of view of a mining engineer and that of a financier responsible for the profit for shareholders are oppositely directed, a conflict of interests is inevitable in this case. It was this contradiction that formed the basis of those erroneous decisions that led to the disaster at the Mir mine in 2017.

ALROSA felt relatively comfortable under the ‘umbrella’ of the agreement with De Beers, but in 2006, the mechanism of salvation started falling down dangerously - the European Commission demanded to terminate the agreement as it violated the antitrust principles of trade. And the crisis of 2008-2009 had already put the company on the brink of survival. As you know, Gokhran, that is, the state budget, saved the Company and took on the market risks. To some extent, that was a return to the ‘Stalin’s scheme’ like ‘we take rough diamonds from you at the prices that are not the market ones but calculated so that you can smoothly continue your production activities’. The situation is the same now. In fact, a trend is emerging: while the diamond prices grow, or at least are steady, ALROSA is the leader in the world diamond market, a full-fledged competitor to De Beers, etc. As soon as there is a crisis - pardon, we get back to basics, to the practice of Yakutalmaz and Uralalmaz like in the Soviet times. One can admire such a flexible position, of course, but, alas, it has its budgetary limitations, since the budget of the Russian Federation is obviously much less stable than the USSR budget. Moreover, Gokhran, sooner or later compelled to sell this ‘crisis’ rough diamonds, inevitably enters into a certain competition with ALROSA.

Unlike ALROSA, De Beers has no government support. Its sales division Diamond Trading Company (DTC) purchases the rough diamonds in agreed volumes and on the basis of approved pricelists from the mining companies belonging to the De Beers group and as per the existing agreements (including those with the governments of some diamond-mining countries) in Canada, Botswana, Namibia and South Africa. Further, the parcels of these rough diamonds are made as a DTC proposal and sold on the market through a contract system and at auctions. Does that ring any bells with you? I guess, Lomako would have applauded. It should be added that DTC, as part of the De Beers group, purchases the rough diamonds in different countries and sells them mixed. The backbone of the diamond trading business lies in the marketing competencies, which makes it possible to conclude long-term monopoly agreements on the purchase of the goods with rather tough negotiators, such as the governments of the southern African countries. Even the existing rough diamond classifier used all over the world is essentially a DTC classifier. The DTC employees responsible for the development of the pricing and assortment policies, interaction with clients, undergo serious personnel selection, including through their experience in making their independent decisions on the purchase of rough diamonds in such African countries as the DRC, Sierra Leone, and Angola. In addition, considerable attention is paid to ‘political’ supporting the ‘comfortable’ sales through various industry and non-governmental organizations where mostly former De Beers employees work.

So, comparing the Soviet model of the diamond industry, the current Russian model and the De Beers model against the background of the current severe crisis, we come to the following conclusion: the most logical scenario for the ALROSA Group’s business development is to carry out the rough diamond sales through a separate company. Its ​​responsibility should include all issues related to the diamond marketing such as the development of an assortment and pricing policy, as well as their customer policy, training of personnel, the cost management, defining and implementing diamond sales forms including long-term contracts, tenders, auctions, the promotion of unique stones and special-size diamonds. The trading company should purchase the rough diamonds according to the agreed pricelist from the mining company of the ALROSA group, thus taking on the market risks from the mining divisions of the group.

Sergey Goryainov, Rough&Polished