Will Putin crash the Global Diamond Market?

Will Putin crash the Global Diamond Market?

In the mid-1990’s when the Russian Federation was being created out of the ashes of the former Soviet Union, Valdimir Putin’s infamous vodka swilling, bottom pinching predecessor  Boris Yeltsin was involved in a process that was to create the Russian oligarchs who made their fortunes accumulating Russian mineral and energy assets at knockdown prices. In gold, aluminium, nickel, oil and gas Yeltsin allowed the oligarchs to accumulate vast fortunes from disposing of the nation’s assets cheaply.

As the Russian economy  collapsed into an crisis of unparalleled  proportions in the 1990’s in the face of the break-up of the Soviet Union and large sections of the Russian population on fixed incomes such as pensioners slid into grinding and previously unimaginable poverty more and more of the nation’s jewels began to leak onto the global market.

In the early 1990’s De Beers was still king of the global diamond market and almost all countries that discovered new diamond deposits used the De Beers cartel, the Central Selling  organization (CSO) which would  buy up stocks of diamonds that were leaked to shore up the decline in revenues that occurred when the Soviet Union collapsed and became the completely resource dependent exporter that it is today. The leaking of US$1 billion of Russian rough diamonds onto the global market at the time was a serious challenge for De Beers as it had annual sales of USD4.5 billion on average over the period. The evidence is that De Beers seems simply bought up the leaked Russian goods onto the market in order to assure no serious decline in prices.

 In the past De Beers had acted in case of Argyle in Australia and Zaire to punish large companies and countries that tried to operate outside the CSO. De Beers would do this by dumping large quantities of very similar quality diamonds on the market just when the recalcitrants were trying to sell their assets outside the CSO. This depressed prices massively and all though it hurt De Beers, it hurt the chisellers even more because De Beers had deeper pockets and was better able to take the loss. The lesson for everyone in the diamond market, including Botswana, was clear- don’t mess with De Beers because they can seriously undermine any player who acts outside the cartel.

Putin in the Global Economic Crisis

If you fast forward some 15 years you get some indication of just how shrewd Putin could be with the management of diamond resources. In 2008/9 the global diamond market collapsed, prices fell through the floor and there is no more Central Selling Organization as De Beers had dismantled its cartel arrangement in 2000 and moved to a new “Supplier of Choice’ strategy which, while no longer a monopoly, was supposed to maintain its control of the market in other ways.

Without a CSO to buy up excess diamonds the only option was to shut the mines and contract production until the price and demand recovered. That was the De Beers strategy. Mines in Botswana were closed for several months and production decreased in Namibia, South Africa and Canada- countries that are known as the ‘De Beers Zone’. But this was not Putin’s strategy. What he did instead was to in effect guarantee a low but adequate price of diamonds to Alrosa and he instructed Gokhran the Russian Federation’s State Precious Metals and Gems Repository, to buy USD1.2 billion worth of diamonds at the height of the crisis in 2009. In retrospect Putin was astute and two years later Gokhran re-entered the world diamond market selling part of its stockpile that it had reportedly purchased at USD71/carat at approximately USD131/carat. Russia did not lay off its miners and continued producing and its Ministry of Finance made a tidy profit from the transaction.

One can compare this to Botswana where De Beers shut the Jwaneng mine, Botswana  saw its GDP plunge 8% in 2009 and the country went  into significant debt for the first time. Public debt rose from 5.7% of GDP in 2007 to almost 18% in 2013.Botswana borrowed USD1.5 billion in June 2009 from the African Development Bank in order to stabilize the national economy. It is easy enough to conclude that Putin was really clever and the De Beers/Botswana policy was simply short-sighted. But being shrewd requires money and Putin could afford to be clever in 2009 because the Russian Ministry of Finance had revenues from multiple high value minerals and hydrocarbons. Botswana on the other hand only has revenue from diamonds and hence  for Botswana to stockpile diamonds would also have been clever but certainly much riskier because it is far more exposed to the diamond market than the Russian Federation.

The Putin-Modi Diamond Deal

In  early December Putin and Indian PM Modi attended the World Diamond Conference in Dehli, with both leaders keen on ramping up direct exports of diamonds to India. A reported USD 2.1 billion deal was signed with Alrosa for direct exports. India currently exports polished diamonds worth $20 billion and both governments want to see more direct imports. Only about 20% rough diamonds are sold directly from Russia to India and Alrosa  seeking to avoid the potential impact of EU and US sanctions. But Indian diamantaire normally prefer to buy their diamonds through tax-free Dubai or Switzerland where they can transfer price any profits they may have mistakenly declared. Nevertheless, almost immediately after the Russia-India agreement in New Delhi  Indian sightholders at the most recent Gaborone sight of De Beers (DTCB) began giving up their boxes  citing the cheaper goods available from Alrosa than from De Beers and the squeeze on their margins caused by galloping rough prices. It was reported that 25% of the December Gaborone sight remained unsold. In a thoroughly globalized market like diamonds the impact of EU sanctions on Russia is now reverberating through southern Africa.

 Putin in 2015- Boris II?

What Yeltsin faced in 1993 was fundamentally different to the crisis that Putin faced in 2008 and may yet prove to be much more severe than what Putin now faces. Yeltsin faced a complete meltdown of the Russian economy and was desperate for money to stave off economic collapse. This year and next we shall see the stuff from which Putin is made because he will now face a major economic crisis that even he recognizes will last at least two years. Yeltsin pretty well knew that any diamonds that he sold onto the world market behind the back of the De Beers cartel would be bought by the CSO at prices that would not undermine the world diamond market.

But now there is no cartel. In 2013 oil and gas made up 68% of Russian exports and its price has fallen by more than 50% in a year and is trading at less than USD50/barrel. A similar portion of the Russian budget comes from oil and gas revenue. Russia also faces economic sanctions as a result of its annexation of the Crimea and its aggression in Eastern Ukraine. No-one can be certain as to the precise magnitude and duration of the decline of the Russian GDP this year though analysts are predicting a fall of 6% of Russian GDP in 2015. Putin himself believes that the crisis will only last two years. But if the crisis becomes much worse will Putin order an acceleration of production and  export of Russian diamonds to make up for the loss of government revenue? Putin of course knows that there is now no cushion in the diamond market. Since the economic crisis of 2008 De Beers has contracted production in its zone significantly which is one of the main reasons why rough prices have been rising as rapidly as they have during the last five years during the economic crisis.  

But the real long term question is whether Putin is likely to act in the diamond market in the same way as Boris Yeltsin did 20 years ago? In December Russia was reported to have begun selling its gold stockpiles but it is not a significant enough increase to severely effect the gold market. In the diamond market Russia is the world’s largest producer of mined diamonds by volume and unlike gold, any increase in supply would  have profound effects on the global diamond prices. A Russian policy of leaking or dumping diamonds is, at this point,   highly improbable given that there is no longer a CSO and a floor to the diamond price and so Russia is likely to maintain a stable supply situation unless the severity of the economic crisis intensifies to the point where Putin becomes financially desperate and morphs into Boris II? And in such a case the world will have much more to worry about than just the price of diamonds.

These are the views of Professor Roman Grynberg and not necessarily those of any institution with which he may be affiliated.