De Beers may spurn low-margin Russia supply

De Beers has decided it is no longer interested in low-margin profits from stockpiling diamonds, meaning access to Russian diamonds may become less important.

JOHANNESBURG (Reuters)  - 

Diamond giant De Beers is likely to snub an opportunity to market more gems from Russia, a key producer, as it distances itself from its former role as cartel operator to focus on high-margin business.

The move would be further evidence that the $14 billion global rough diamond market was opening up after decades of domination by De Beers, which has set itself challenging profit targets.

De Beers' move to a modern business model will, analysts say, probably see it shrug off a European court decision last week that lifted curbs on De Beers buying diamonds from Russia's Alrosa, the second largest producer.

De Beers has ditched a strategy aimed at cornering supplies and stockpiling gems to control prices, making access to Russian supplies less important.

"De Beers is not interested any more in getting maximum carats, De Beers is not interested in dealing with goods on a marginal basis," diamond consultant Chaim Even-Zohar said.

"I don't think that De Beers is going to buy from Alrosa, the return of being a dealer is not that big," he said by telephone from Israel.

De Beers, 45 percent owned by mining group Anglo American Plc, declined to comment on the European court decision, saying it needed time to study the judgment.

LOWER MARGINS

The court last Wednesday struck down a decision by the European Commission designed to stop De Beers buying rough diamonds from Alrosa by 2009.

De Beers had in 2002 agreed to extend its relationship with the Russian state diamond producer and market $800 million worth of its output a year, sparking opposition from European regulators.

The two miners account for around three-quarters of world production and Russian supply helped De Beers corner 80 percent of the world diamond trade over a decade ago.

But as De Beers attracted scrutiny from anti-trust authorities and chalked up losses from buying up surplus gems and holding stockpiles, it ditched that strategy in 1999.

Today, De Beers' share of the rough diamond market has slipped to just over 50 percent and that is due to drop further as it winds down its trading relationship with Alrosa.

Its trade with Alrosa is due to fall by $100 million to $500 million this year and to $400 million in 2008.

De Beers' agreement to phase out distribution of Russian gems appeared to result from pressure from European regulators, but analysts say it fits in with its new business model.

De Beers' margin on handling Russian diamonds was around 5 percent, less than half the level for selling its own mined output, a mining analyst in Johannesburg said.

"De Beers has probably made a plan to work without Alrosa," he said. "The whole business model at De Beers is in a state of flux."

LEANER GROUP

The expected decision to forgo the low-margin sales of Russian gems might also help De Beers meet financial targets set in late 2005 to boost return on capital employed from 14.3 percent in the first half of that year to 20 percent by 2009.

De Beers acknowledged at that time that its former strategy had "destroyed value" during the 1990s.

In an effort to boost profitability, it has been shedding less profitable mines and restructuring. A tighter, leaner group will enable it to deal with a more competitive environment against big mining groups that have been encroaching into the lucrative diamond business.

Both Rio Tinto and BHP Billiton have expanded diamond activities and each are estimated to have a market share of under 10 percent.

De Beers might also have to contend with a move to introduce futures contracts into the opaque market within the next couple of years.

The opportunity to lock in prices is likely to be attractive to the sector's value chain, in which the $14 billion value of rough diamonds skyrockets to $62 billion when diamond jewellery is sold in retail shops.

From Alrosa's perspective, while it has previously benefitted from the De Beers marketing prowess, analysts say it has been forced to develop its own sales channels.

A spokesman for Alrosa said De Beers would have to decide whether it was interested in increasing purchases from Russia, but the Russian company was focusing on domestic sales.

"The strategy of the company's development is to sell the main part of rough for all clients here in Moscow," Andrey Polyakov said in an email reply to questions.

Another mining analyst in Johannesburg said Alrosa may have lost interest in heavy sales to De Beers. "I think Alrosa has made a lot of progress on alternative distribution avenues."

(Additional reporting by Sabina Zawadzki in Brussels)

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