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Vyacheslav Shtyrov: A blocking stake in ALROSA should be owned by the Russian Federation and the Republic of Sakha (Yakutia) should have a blocking stake as well - this is a fair proportion

03 march 2011

Vyacheslav Shtyrov was in charge of ALROSA in 1996-2002 and then from January 2002 to May 2010 he was President of the Republic of Sakha (Yakutia). Currently, he is Deputy Chairman of the Federation Council at the Federal Assembly of the Russian Federation.

ALROSA completes its transformation into an open joint stock company. How would you define the main goal in this process?

The basic sense of making ALROSA a public company is to give it necessary flexibility in raising funds for the long-term development strategy. Mineral resources of all diamond mining companies are depleting, and pretty quickly. I do not think that in the foreseeable future there may be made some sensational discovery of new deposits equal to Udachny, Mir, Jwaneng or Orapa. Of course, it is believed that the geological potential is at least 50% yet to be claimed - but still it is just a potential. A lot of efforts and a lot of money are required to use it. And new deposits will not be as effective as those that have already been worked out. These will be hard-to-reach areas with difficult mining and geological environment; diamond pipes may possibly be discovered on the shelf of the Arctic seas. Exploration and mining in new areas will require new ideas, equipment and techniques, and all this involves large-scale investments. The development of existing fields noted for their low content of diamonds also requires new techniques and consequently new financial resources. This is a top priority problem facing all the diamond companies in the world, and ALROSA is no exception.

These resources may have different origins - the company's own funds, borrowed funds or raised capital. It is true that currently ALROSA may meet its major investment needs from traditional sources: by way of channeling a significant part of profits into capital investments or managing depreciation or attracting funds through project-tied lending or just applying for regular credits – these are all well-established instruments. But we should realize that in the near future, these instruments may not be enough anymore. Therefore, turning ALROSA public should be viewed primarily as creating preconditions for using new financial instruments - that's the main idea of this process.

To what extent making the company public will influence the quality of corporate governance?

The quality of management processes currently underway in the company does not cause any concern among its shareholders. Two years ago, there was established a body of independent directors, which proved itself well. The independent directors are sufficiently exacting to issues under consideration by the Supervisory Board, both in terms of current activity and in terms of development strategy. The company’s reporting is based on Russian and international standards and its external and internal audit looks efficient. So in terms of corporate governance quality there was no special need to convert the company into an open joint stock corporation.

The single-channel system of organizing the world diamond market has gone, and today there are companies (De Beers, Leviev, HW) which create their own "diamond pipelines" - from mining to their own branded jewelry retail. Is this kind of task appears to be pressing for ALROSA?

Mining activities and creating brands are different dimensions and they cannot be viewed as alternatives. ALROSA has a few areas in which it can develop, increasing its effectiveness. The main priority is to maintain the company’s output levels and preserve its market share.  A no less important task is to improve the system of diamond sales. In this aspect, ALROSA has gone through a certain evolution, since there was a time when we were focused on the single-channel system created by De Beers. This system was successful in maintaining the market balanced and its efficiency was at least proved by the fact that for many decades diamond prices were rising faster than the rate of global inflation. But time has come when the single-channel scheme lost its vitality. The world diamond market saw the emergence of such producers as Rio Tinto and BHP, for which the share of their diamond divisions was relatively small in the overall balance, so they were not willing to participate in the global "diamond pipeline" and this shattered the single-channel system. Botswana, Namibia and South Africa in their political evolution have adopted programs aimed at domestic processing of diamonds in order to increase the added value and employment. Thus, significant flows of rough started to avoid the "diamond pipeline" and, though being under control, they had their own destiny. The situation in Russia in the 1990s also played its role, especially when a large part of diamonds used to be sold on the domestic market under the outwardly well-intentioned slogans to develop the country’s cutting and polishing industry, while in fact diamonds were dumped into foreign markets without any control, destroying the single-channel “diamond pipeline.” A significant role in the fate of the single-channel system has been played by the European Union, which opposed to the monopolistic regulation of the diamond market.

These circumstances led to the point at which the old system ceased to exist, and each diamond producer started to look for its own scenario of market behavior. De Beers established the “Supplier of Choice” program, entered into an alliance with LVMH and started to promote its own jewelry brand. There have been attempts to create something similar at ALROSA as well, but, unfortunately, they were evolved neither ideologically nor in practice. All the changes in the market took place in recent times, and it was necessary to react quickly to adapt, but the company’s management was changed too often and new teams offered their own views, which did not help to devise a clear and well-balanced sales policy for a long time. Now the company is developing its sales strategy and so far everything is more or less normal in its current activities, while strategically it will yet have to find new mechanisms, using among other things the experience gained in joint projects with Lazare Kaplan.

The company’s sales policy is to be improved, but we should realize that mining production is the basics of ALROSA. If we take the current level of technology and the level of remaining mineral resources, then I think that the company will be able to live without any problems for another 10-15 years. But the mining industry is a capital-intensive industry and 10-15 years will pass very quickly; so if today the company will not take adequate action on production development, there will be a sharp decline in output with all ensuing consequences.

What kind of decisions should be taken?

First of all, there should be a total expansion of exploration followed by discovery of new deposits. It is believed that the potential of Yakutia, the main diamond-bearing province in Russia, has been explored only for 50%. The same can be said about the North-West of Russia. For various reasons, primarily because of the crisis, quite insufficient amount of money was invested in exploration in recent years. But now there should be a powerful effort exerted in this direction: we need new technical ideas, and these ideas will require considerable resources. Secondly, today we are using barely one tenth of the deposits which contain diamonds. But the remaining 90% may also be put into operation aided by an increase in world market prices, while on the other hand, we need new technologies to make mining on low-grade fields profitable. Take for example the Zarnitsa diamond pipe, the first discovered in the USSR. Now it is not profitable and sometimes it is put into operation, and sometimes it is mothballed. But to bring it into operation on a permanent basis, we must get rid of transporting ore 30 km to the existing preparation plants, since the diamond content there is one carat per ton and transportation of ore by trucks puts cost-effectiveness down the drain. To build a new mining and concentration complex on this diamond pipe is irrational – investments will not pay off. So, we need to find such techniques which will make it possible to dress ore on the pit’s edge and then bring it to the existing factory for further processing. There are also reserves in terms of geographic diversification – the company should move to new territories in Africa and the North-West of Russia.

The company may hope for a success achieved by geologists or count on new methods of beneficiation or it may be lucky to gain vantage positions in new diamondiferous areas. But ALROSA’s plans are aimed at industrial diversification involving iron ore project Timir. How much realistic is this vast scheme?

The time when the company’s output will start to decrease is not far off. The Udachny open-pit mine used to generate 12 million tons of ore per year, while the underground mine will produce 4 million tons - and this is the biggest diamond mine in the world. Let us assume that due to depleted mineral resources diamonds in the world market will go up in price and the company will not lose in terms of sales revenue. But the scale of mining operations will be sharply reduced giving the company free reserves which should be properly used. And, of course, first of all, it should pay attention to areas that are technologically close to its core business. Production of iron ore involves the same open-pit opertions and at some point there will also emerge underground mines and this mining business has almost a similar system of ore dressing. The company's personnel and engineering potential may in the first place be demanded within such projects, and this is the right decision.

Of course, there is a significant problem to be solved by the company for it has small knowledge of this market. There are various ways to tackle it – the company may learn it on its own or attract competent partners to the project to take part in marketing production.

The company has already made attempts to diversify into other industries which failed – once it ventured, for instance, into the oil and gas sector which was quite established making it very difficult to find a favorable niche for a beginner. These were bad shots incurring sheer losses, so the company withdrew from this sector, and rightly so. But the company has every good reason to develop in technologically close industries. Therefore, I believe that if the company has found such a worthy project as Timir it is good luck in itself; there are not so many projects of this kind the world over, and in Russia Yakutia is the last area where they exist.

I admit that there will come a time when iron ore will turn into a core business for the company, while its diamond division will be of minor importance both by the scale of production and sales revenue. Let's take similar companies around the world. In the 1960s and 1970s, it was a very fashionable trend to create conglomerates and entities which owned capital and derived profit from enterprises in different sectors - in the mining industry, banking or engineering... I would like to stress that here we do not mean portfolio investors, but real ownership and management of enterprises. So, very quickly these conglomerates started to lose ground in the markets to specialized companies. As early as in the 1980s the process of specialization turned to be dominant. But where is the limit of specialization? Is the technique of mining diamonds very different from the technique of mining iron ore? Or coal? These are similar techniques within one and the same line of mining. So, you may have a specialized company with a multi-commodity market. Such companies exist worldwide, these are Rio Tinto or BHP, and they are successful; China is now moving towards establishing such companies. I think that ALROSA was right to take this course and it should have been done earlier. Unfortunately, ALROSA missed the opportunity to participate in the coal industry.

But will ALROSA have enough funds for such diversification?

If it will manage the business properly and find a good team of engineers - I would like to stress it, engineers, not managers, because the latter are of secondary importance – and if it will be able to hit the right engineering solutions, new, modern and technologically smart solutions, if it will develop a correct strategy gradually commissioning factories and breaking into the market, then the company could do with its own funds - this is my expert opinion. It may venture an IPO just for guarantee or additional safety. Generally speaking, there is nothing dangerous in an IPO, the only thing to be observed is the interests of Russia and those of the Republic of Sakha (Yakutia) which are the company’s main shareholders. Or the company may simply sell some part of its shares. This is what it is made public for. Which part of shares can be sold so as to make the major shareholders satisfied with the remaining control? For the Russian Federation, this question is not very relevant, although in fact the company has not yet been removed from the list of strategic enterprises. For Yakutia, it is more important not only practically, but ideologically as well. A blocking stake should be owned by the Russian Federation and the Republic of Sakha (Yakutia) should have a blocking stake as well - this is a fair proportion.

And is it possible to attract a strategic investor to ALROSA? Rio Tinto, for example?

As I believe this is not necessary. This is not the best option, and there are several reasons to it. This is not the case with a portfolio investor interested in growing stocks – this will be a company that is actually engaged in the industry. Inevitably, there will be competing interests. Commodity markets are subject to trade fluctuations. In whose favor will a strategic partner use them? I do not know a single positive example of participation involving foreign strategic investors in the Russian mining industry. Not a single! Except for small projects in the gold mining industry operating in Magadan or Chukotka. But again, not as a principal. I can give you an example: in August there will be a very important event - Mechel will deliver the first shipment of coal from the Elga coal deposit, one of the largest on the planet. If we look into the history of this project, in all kinds of feasibility studies made by foreign companies, we shall see that this coal was supposed to be mined in the 22nd century.

ALROSA has also had a stretch of bad experience when they tried to bring Batman to the Nyurba Project, and as a result they were forced to pay the forfeit, just to get rid of the problem. Even large Russian companies find it hard to strike alliances among themselves. When it was discussed how to develop oil fields in Yakutia, it was assumed there would be an alliance of Gazprom, Surgutneftegaz and Rosneft to operate there, this was in 2003. But as soon as it came to implementation, there immediately emerged difference in interests, approaches, financing, etc. However, companies that have complete control over the project – like Mechel or Surgutneftegaz - succeed, preferring to raise funds instead of attracting strategic investors.

Participation of strategic investors holds back the decision-making process formidably. When a few major players put their money at risk and no one wants to take the major risk, everything is bogged down in endless negotiations.

OAO Nizhne-Lenskoye is the property of the Republic of Sakha (Yakutia). Last December, an auction was held to distribute new diamond placer sites. How do you explain the bargaining heat there (32 bids), given that Yakutia being a shareholder of both ALROSA and Nizhne-Lenskoye actually haggled with itself? Is it not reasonable to merge ALROSA and Nizhne-Lenskoye in the future?

OAO Almazy Anabara, a subsidiary of ALROSA, and OAO Nizhne-Lenskoye, a 100-percent property of the Republic of Sakha (Yakutia), are specialized in developing placer deposits. I am sure that if we give a careful consideration to the mineral resources base of these companies, the conclusion will be the only one - they must merge. Because working individually they do not have enough mineral resources to maintain their current production levels. Their areas of operation are constantly intersecting. Previously, we solved this problem by administrative means just forcing them apart as boxes to their corners: you'll be working here and you there. But life goes on, placers are depleting and interests collide which leads to situations where they are fighting with each other, bringing payment for a deposit to staggering heights. Nizhne-Lenskoye is seated on territories potentially pregnant with major primary deposits, so there is need to invest big money in exploration, but the company has no such funds. In addition, these businesses are operating across vast territories in the Arctic bearing overlapping expenses for bringing in fuel and for transportation schemes, which also results in overhead. This is the case when competition is not for the benefit. They need to merge. How? It is a matter of negotiations between the authorities of Yakutia and ALROSA’s management. I am not going to offer any solutions instead of them. But hypothetically – taking into account that ALROSA is in the process of issuing securities and Yakutia’s share in the company suddenly turned to 22.1% - the republic may contribute Nizhne-Lenskoye to raise its shares to a blocking stake in the parent company. Or maybe these businesses will be merged into a separate company to operate on placer deposits, and ALROSA and the Republic of Sakha (Yakutia) will define their stakes there. But in any case, they should be merged.

There are tense negotiations going on between De Beers and the Botswana government regarding a new sales pattern for rough diamonds produced in Botswana. Wouldn’t it be expedient to support the position of Botswana’s government at the level of Russian state institutions and propose an alliance between ALROSA and Botswana with a view to strengthen Russia’s positions in the diamond market?

Unfortunately, right now the Russian government is distant in treating the interests of our companies abroad. There is a lot of talk about it, but no protection is offered, in contrast, say, to Chinese government agencies. Maybe it would be reasonable to work with Botswana, and Namibia, and even South Africa, although it should be understood that they will not wish to have someone else dominating them instead of De Beers and it is important to look for acceptable compromises. But there is no one particularly dealing with this problem, and it seems that it does not occur to anyone in the government. ALROSA itself also abandoned its initiatives in Africa - except for Catoca the company has nothing there. I hope this is temporary. I highly appreciate the current management of ALROSA and its President Fyodor Andreev, who proved to be a vigorous and creative professional and who was successful to pull the company out of crisis. And I hope that soon ALROSA will take an interest in African projects.

What is your position as a legislator with regard to the regulatory and legal framework of the diamond market?

The legal framework governing the circulation of precious metals and gems is badly behind the requirements of reality. The law on precious metals and gems was enacted in 1998 and it fixed outdated approaches to regulating these markets; these approaches have already become a hindrance to developing the diamond business. Changes are taking place - Russia is preparing to join the WTO; there was established the Customs Union; the single-channel system, to which this law was to some extent tied, has disappeared. It is time to further liberalize the domestic market and movement of diamonds. Now there is no use saying that it is not in the interests of ALROSA. ALROSA may stop its sales on the international market entirely and sell only domestically, allowing anyone to buy and carry anywhere. Prices have almost caught up with the global level, and ALROSA rejects the role of a patron and a source of preferences for diamond cutting enterprises. The market has changed dramatically and requires changes in the legislation. This understanding has not arrived today. Two years ago on behalf of Finance Minister and Deputy Prime Minister Alexey Kudrin there was established a special work group staffed by experts from the Ministry of Finance, Ministry of Economic Development, the government of Yakutia, diamond-mining and diamond-cutting companies to analyze the situation and submit proposals to amend the legislation. This group prepared substantive proposals, which for various reasons were not duly considered, among other things because of crisis phenomena. Now, after consultations with the Finance Ministry, we returned to this issue, and on January 31 the Federation Council held a broad meeting attended by this work group and other experts; it was decided that we are ready to prepare specific amendments to the law on precious metals and gems, which describe the movement of diamonds and diamond market, but not yet ready to consider issues relating to subsoil use in the diamond and gold mining industry. And so far, as I believe, it is not timely to raise the issue of changing the tax system. The issue was divided into three parts, and, based on the protocol decisions of 31 January one of the groups will start its work aimed at preparing specific amendments to the Law on Precious Metals and Gems with regard to circulation of precious metals and gems. Another group will have to do a longer job and come up with proposals to change the terms of subsoil use. It is necessary to drastically cut the amount of all kind of permits and harmonize the provisions of all the laws pertaining to use of natural resources: the Law on Subsoil, Forest Code, Water Code, rights of the constituent entities of the federation and municipalities. But these problems are very complicated, and we must seek a reasonable balance.

Unfortunately, no movement is seen about the law on a special economic zone for diamond cutting and jewelry manufacturing in Yakutsk. Initially, a dispute erupted about what diamond processing means. In the first instance, the Ministry of Economic Development offered the opinion that diamond cutting refers to primary processing of raw materials, and according to the existing law creating special economic zones for primary processing of raw materials is prohibited. It took almost two years to prove that manufacturing of polished diamonds was not primary processing, because primary processing ends at the stage of rough grading. Polished diamonds are a finished product, and it can fall within a permission to create a special economic zone. This barrier is now overcome, but others have arisen. For instance, one is dealing with a permission to create a customs terminal. Due to the latest meeting between the President of Yakutia and Prime Minister of the Russian Federation the issue has shifted from the dead point, and probably will be solved. Then we shall be able to return to this project.

Sergey Goryainov, Rough&Polished