Russians to Resolve Overhang with Upcoming Sales
June 04, 09 by Chaim Even-Zohar
From a few days in Antwerp, it is clear that Alrosa will resume rough diamond exports in a major way in the immediate future. It is also clear that they will not be able to do so if they don't price their goods realistically. The market is not in the mood to make long term commitments on fixed prices, especially, if the fixed price is wrong to begin with.
Disclosing precise diamond stock figures has never been one of Russia’s strongest suits. What we can monitor, however, is a stock build-up over the past nine months. While Russian rough exports exceeded $1.5 billion in the first nine months of 2008, it exported in the final quarter slightly less than $80 million, mostly cheaper Indian goods. By our “back of the envelope” calculations, based on total mine production of 36.9 million carats at $2.5 billion, in 2008, Russia produced some $500 million more than it sold (assuming some $400 rough million sales to the local market). In the first six months, production (at 2008 prices) would be in the range of $1.2 billion, of which some $150 million was sold to Gokhran. These sales “don’t count,” as they become part of the Russian stock overhang.
All the talk about the 15 financially independent (i.e. cash-rich) Antwerp dealers entering into long-term supply contracts has, until now, proven to be well-intended hogwash. First of all, the final text of these contracts' has not yet been agreed – so nobody has had a chance to sign. Moreover, only a few (mostly Indian) manufacturers have in principle agreed to sign – but there are still miles to go between intention and implementation. For domestic policy reasons, the contracts agreed (and fixed) selling price is around the price level of early 2008. Any way one looks at the 20 boxes making up the selling mix of Russian rough exports, prices are still some 20 percent above the current market price.
The idea behind these contracts is that they may be valid for three years, with an exit without penalty every six months. If the price of rough diamonds goes up, one might at some point find the goods cheap. Thus one over pays now, hoping that within a year or so the situation will be different – as rough prices could have bounced back to their 2008 peaks (which is needed to make the Russian contract somewhat livable.) Don’t hold your breath.
Russia has declared that it has a revised 2009 rough diamond sales target of $2.5 billion. That can only be achieved if (1) it dramatically revises its selling prices and (2) it convince Gokhran to buy far more than it has sold so far.
Threat is Real
The threat posed by a Russian stock build-up is real. Even though Alrosa’s CEO Sergei Vybornov tries to assure the market that it will not see a repeat of the dumping of the 1990s, we remain highly skeptical and increasingly more concerned. Vybornov is saying all the right things: “The situation is completely different and the mentality changed a lot,” Vybornov said in an interview with Bloomberg. “Nobody wants to destroy the market.” This time, the state and Alrosa will coordinate to avoid a repetition of [the 1990 dumping of rough and polished to generate foreign currency] that “crushed the market for a very long time,” Vybornov said.
The problem is that it is not up to Vybornov. One cannot ignore press reports that he may not last until the end of June as CEO; that his ousting is imminent. As this is something we have heard already for many months, it might or might not happen. The “devil you know” is always preferable than the one you don’t know. Word has it that Yakutia’s president Vyacheslav Shtyrov may come back as Alrosa CEO. His previous stint in that job (which he held until 2002) was quite controversial.
Price Discovery Problem
There is a reason for the highly out-of touch selling prices. Until this year, the Russians had the benefit of being familiar with (and having) the De Beers price book. Not any more. Having a dozen or so Antwerp dealers look at parcels and give a price will not do the job. For Russia to optimize sales, it needs to know all the price points in its production – some 15,000 price points, which it no longer has.
Alrosa recently hired an ex-De Beers executive, Michael Brooker, to help them overcome the problem of sorting and assortments. Brooker worked in the Russian buying department of De Beers as a negotiator with the Russians. Thus, he was intimately familiar with the pricing mechanism and the price book. But we must assume that he doesn’t have a current copy of the London price book.
In the Russian diamond bureaucracy, increasing selling prices isn’t difficult. Getting the approval for price reductions is far more complicated. It is said by some Moscow sources that the prices Alrosa charged for its sales to the Gokhran were too high – and that this has caused a problem. If Alrosa is able to enter into supply contracts with Antwerp (mostly Indian) dealers, at inflated prices, at least the “Gokhran-problem” (if there is such problem) is off the hook.
Vybornov is slated to visit Israel shortly to convince Israeli rough dealers to sign up for supply contracts. Last year, Israel imported some $200 million worth of rough from Russia, and its buying potential is larger. It just depends on price. Russian rough sales and selling prices have become mostly “coffee table talk” – with little action.
Money pours in from Banks – not from Sales
Remarkably, Vybornov is successful raising new money to replace maturing debts all the time. This week Alrosa received an $80 million loan (14 months maturity) from Russia’s UniCredit group. That amount is not so significant for Alrosa, but the news is helpful for the company’s standing in the financial markets as it shows that it has access to financing not only from state-owned banks (like VTB), but foreign commercial banks as well.
In December 2008, Alrosa borrowed some $160 million from VTB for a 600-day period to refinance current short-term payables on loans received from Russian and foreign investors. Moreover, VTB opened a credit facility of $100 million for Alrosa to bolster working capital in March. However, how long can Alrosa go on borrowing?
By volume, Russia’s production has surpassed Botswana and is now the world’s largest producer. Unlike Botswana, however, Russia’s mining production is continuing at full speed. Thus, its expenses are also running at full capacity – without any meaningful income.
Vybornov may have learned the lessons of the 1990s. But he is not alone in Russia – and certainly doesn’t speak for all other relevant players. There are a lot of loose carats out there waiting to find new owners.