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De Beers has set about to discipline sightholders

30 june 2014

Just as the diamond mining environment is getting more complicated, diamond producers are forced to make more efforts to maximize profits. The most direct way to that goal is to change their distribution policies.

It would seem that it is impossible to come up with something more progressive than the system of sightholders established by De Beers, within which customers are obliged to buy boxes containing rough diamonds of different quality on a regular basis at prices set by the company for each sight without a possibility to bargain. In general terms, this scheme is the only possible way for a large diamond miner interested in selling the entire range of produced goods. During the Intention to Offer (ITO) rounds, the customers sel ected by De Beers apply for amounts of rough they need permitting the miner to plan the quantity and assortment of diamonds entering the market.

The versatility immanent to the system of long-term contracts practiced by large-scale producers is proved by a recent example of Dominion Diamond. This company has dramatically increased its production expanding its 40-percent interest in Diavik by adding the Ekati Mine bought from BHP Billiton. BHP used to sell rough recovered from Ekati at auctions in Antwerp, but Dominion, having strengthened its position, plans to switch over to long-term contracts. Dominion’s contract system, under which the company will supply rough to 30 long-term customers, will be launched in July. Similar to the sights run by De Beers, Dominion will hold trading sessions for its customers 10 times a year.

This system is based on the interest to maintain stable prices for rough, which would be subject to greater risks if diamonds were not delivered to a narrow circle of partners trusted for years, but to countless dealers, whose ghostly stability would be taken as guarantee against overstocking the market, should it face a spate of volatility. De Beers used to resort to this system for decades channeling through it the bulk of mined rough - now this flow reached 90% of the company’s output (while the remaining 10% is sold at online auctions run by Diamdel).

However, judging by the experience of 2014, De Beers is ready to make serious changes in this pattern, as it helps to protect prices in hard times, but not conducive to maximum gain during relatively favorable times, which may include the first half of this year marked by 7-10-percent growth in diamond prices (according to Rapaport). Such changes were probably a response to rejections of goods at the March sight of De Beers, when prices rose by 3.5-4% and some part of rough remained unsold.

During its March, May and June sights De Beers presented the theses of future innovations, including those relating to the formation of ITO and ordering additional goods, according to Mike Aggett, CEO of H. Goldie & Company, a diamond broker, who wrote about it in his blog in mid-June. He noted that now De Beers was not focused only on financial performance of its customers, as previously. The miner intends to attach prime importance to the so-called gating criteria for sightholders. There are reports that the new approach raised concerns among some of the sightholders. Further clarifications on these issues are expected next month.

According to a recent statement by Philippe Mellier in an interview to Bloomberg, the previously prevailed principle of financial stability gives way to customers’ track records and their purchasing power during previous sights. In fact, De Beers is adopting the know-how of ALROSA, which for several years has been putting into practice a similar selective approach, despite some not quite market-specific aspects typical for the Russian gem industry. It looks paradoxical if you remember that it was De Beers which used to be a trendsetter. It was from De Beers that ALROSA borrowed the system of long-term contracts introducing it in 2009. However, the new approach to changing the distribution system of ALROSA is so drastic that it deserves a separate study.

Henceforth, closing the ITO for 2014-2015 De Beers will take into account the compliance with previous ITOs, as well as Ex Plan purchases of rough and purchases at auctions, so that the most pro-active buyers could become sightholders. New supplies will depend on the demand from sightholders for diamond categories not included in the ITO for 2013-2014.

Back in late March, De Beers announced the appointment of five new sightholders for the remainder of the 2012-2015 contract period, during which contracts with Suppliers of Choice are valid. According to Paul Rowley, Executive Vice President, De Beers Global Sightholder Sales, “Each of our new Sightholders has demonstrated consistently strong requirements for De Beers rough diamonds via their auction purchases.”

Actually, De Beers resorted to sightholder rotation in the past as well - as a rule, this was done in case of violating the requirements of Best Practice Principles. Thus, the company of Lev Leviev, whose actions damaged the interests of De Beers in Russia, lost its sightholder status in 1995 due to the mismatch with this practice.

The damage caused to De Beers by sightholders, who fail to buy their amounts of diamonds or who occupy their positions claimed by more purchase-driven prospect customers, may not be so obvious. But the struggle going on to narrow the gap between prices for boxes sold to sightholders and prices in the secondary market looks now as one of the main elements in the policy pursued by De Beers set to achieve a 5-percent annual growth in rough prices and provide the return on capital required by Anglo American.

So far, all the details of the new selection criteria set by De Beers for sightholders are not available, but it should be noted that higher discipline for dealers is a step in the right direction. After all, the consequences of negligent behavior on the part of De Beers’ sightholders are affecting De Beers in much the same way as they are affecting the entire industry. Rejected goods during sights trigger shortages of rough in the secondary market consequently forcing up premiums, which more often than not stimulate speculation rather than a civilized commodity-money circulation between the links of the diamond pipeline. According to Tacy's report on the state of the diamond market in 2013, dealers (it would be logical to include into this category sightholders not engaged in manufacturing and mostly reselling rough) have been gaining higher profit margins in the past two years skimming ever more fatty “cream” fr om resale operations, and it is the resale sector, which is the only one in the entire diamond pipeline demonstrating strong growth and profit margins.

Of course, overdosage leading to excessive supply of rough at sights is harmful for the correct operation of the entire framework. However, analyzing the experience of the past few years, we can conclude that the sight in March 2014 was an exception rather than the rule. In 2012, sightholders, conversely, did not receive the required amount of rough due to production problems at Jwaneng.

Igor Leikin for Rough&Polished