Will Putin use diamonds to rescue Russia?
In the mid-1990s, when the Russian Federation was being created out of the ashes of the former Soviet Union, Vladimir 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 mineral and energy assets at knockdown prices. In gold, aluminium, nickel, oil and gas, Yeltsin allowed the oligarchs to accumulate vast fortunes by disposing of the nation’s assets cheaply.
As the Russian economy collapsed 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 poverty, more and more of the nation’s jewels reached the global market.
In the early 1990s De Beers was still king of the global diamond market and most countries that discovered new diamond deposits used the De Beers cartel, the Central Selling Organisation (CSO), which bought up stocks of diamonds to shore up the decline in revenues that occurred when the Soviet Union collapsed and became the resource-dependent exporter that it is today.
The leaking of $1-billion of Russian rough diamonds on to the global market was a serious challenge for De Beers because it had annual sales of $4.5-billion on average. It bought up the Russian goods to ensure there was no serious decline in prices.
In the past De Beers had acted in the case of Argyle in Australia and against the then Zaire to punish large companies and countries that tried to operate outside the CSO. De Beers would do this by dumping large quantities of similar quality diamonds on the market just when the recalcitrants were trying to sell their assets outside the CSO. This depressed prices and, although it hurt De Beers, it hurt the chisellers even more because the company 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 it could seriously undermine any player who acted outside the cartel.
Putin and the economic crisis
If you fast forward about 15 years you get some indication of just how shrewd Putin could be with the management of diamond resources. In 2008-2009 the global diamond market collapsed, prices fell through the floor and there is no CSO. De Beers had dismantled its cartel arrangement in 2000 and moved to a new “supplier of choice” strategy that, though 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 was, in effect, to guarantee a lower but adequate price for diamonds to diamond company Alrosa. He instructed Gokhran, the Russian Federation’s state precious metals and gems repository, to buy $1.2-billion worth of diamonds at the height of the crisis in 2009. Two years later Gokhran re-entered the world diamond market, selling part of the stockpile it had reportedly purchased at $71/carat for about $131/carat. Russia did not lay off its miners and its ministry of finance made a tidy profit from the transaction.
The Putin-Modi diamond deal
In early December 2014 Putin and Indian Prime Minister Narendra Modi attended the World Diamond Conference in Dehli. Both leaders were keen to increase direct exports of diamonds to India. A reported $2.1-billion deal was signed with Alrosa.
India exports polished diamonds worth $20-billion and both governments want to see more direct imports. Only about 20% of rough diamonds are sold directly from Russia to India and Alrosa, seeking to avoid the potential impact of European Union and United States sanctions.
Almost immediately after the Russia-India agreement, Indian sightholders at De Beers’ Gaborone sight began giving up their boxes, citing cheaper prices from Alrosa 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 globalised market that includes diamonds the impact of EU sanctions on Russia is now reverberating through Southern Africa.
Putin in 2015 – Boris II?
The 1993 and 2008 crises were fundamentally different. Yeltsin’s may yet prove to be much more severe than the situation Putin now has to deal with. Yeltsin faced a complete meltdown of the Russian economy and was desperate for money to stave off economic collapse. This year and next we will see what Putin is made of because he will face a major economic crisis.
Yeltsin knew that any diamonds he sold on 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.
Now there is no cartel. In 2013 oil and gas made up 68% of Russian exports. The oil price has fallen by more than 50% in a year and is trading at less than $50 a barrel. A similar portion of the Russian budget comes from oil and gas revenue. Russia is also dealing with economic sanctions as a result of its annexation of the Crimea and its aggression in Eastern Ukraine.
Analysts are predicting a fall of 6% for Russian gross domestic product in 2015. Putin believes the crisis will only last two years. 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? Will he act in the diamond market in the same way as 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 affect the gold market severely.
Russia is the world’s largest producer of mined diamonds by volume and, unlike gold, any increase in supply would have a profound impact 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. So Russia is likely to maintain a stable supply situation – unless the severity of the economic crisis intensifies to the point where Putin becomes desperate and morphs into Boris II.
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.