Thinking The Unthinkable

Argyle Diamonds, Australia’s large diamond mine, almost certainly will not renew its rough diamond marketing contract with De Beers’ Central Selling Organisation when it expires next month, say key executives of the company.

An independent Argyle would sell some 40 million carats yearly – most but not all smaller, lower-quality goods – on the open market through its office in Antwerp, Belgium. Argyle is the single largest producer of diamonds used in mass-market jewelry in the U.S., Japan and other Asian countries, and its move toward independence could foreshadow a fundamental change in the way rough diamonds are sold worldwide. One critical element: in a newly competitive market, the bedrock De Beers policy of price control would face real-world challenges of supply and demand.

Details of just how Argyle would market its goods were still being worked out at presstime. “Our sales office in Antwerp will handle nearly all of the rough,” says Mike Mitchell, who heads Argyle’s rough sales division. “But it’s inevitable that 95% of our production will end up in India, because the industry there has the capabilities and the skills to take everything.”

Argyle has been test marketing, test pricing and walking existing and potential clients through its sales process in Antwerp in preparation for the change. Such experimenting could have a significant and early impact on the diamond business in the U.S.

An Argyle break from the CSO would mean a higher commitment to serving the U.S. market, says Martin Hurwitz, president of Market Vision, Beverly Hills, Cal., the U.S. marketing representative for Argyle and the Indo Argyle Diamond Council. This would be done by expanding IADC and increasing advertising support for the smaller-diamond market. “De Beers hasn’t given much support to the market for smaller diamonds,” says Hurwitz. “By contrast, all of our efforts are geared to that market.”

Hurwitz believes some large U.S. retailers might become regular buyers. “Buying rough diamonds is a new concept to most of them,” he says. But Argyle is talking with several large chains, says Hurwitz, adding that no deals have been made as yet.

Corporation vs. government: An Argyle break from the CSO also would fuel the growing belief that several large corporate mining blocs instead of the CSO will control diamond trade in the future.

These large mining companies are taking an increasing interest in diamonds and have a much greater competitive mentality than the governments with which the CSO is accustomed to dealing. They also have the will and the means to remain independent from De Beers (which is, after all, a corporate rival in their eyes).

“If the CSO is interested in keeping its single-channel marketing system, it must come up with an entirely new way of thinking,” says Phil Plaisted, who heads the diamond division of CRA Mining, one of Argyle’s corporate parents. “Corporate mining operations take a much more rigorous approach to the business than governments such as Botswana and Russia. We’re accountable to our shareholders and have to maximize revenue and control costs to keep profits. Governments don’t think that way. De Beers has to adjust to our way of thinking or simply become one of several major players in the diamond market.” He believes De Beers is moving too slowly in changing its attitude.

Analysts see three major diamond marketing blocs developing:

  • De Beers, with its own mining resources plus others that it taps through the CSO.

  • RTZ-CRA, a recently merged British conglomerate that is now the world’s largest mining company with 1995 revenues of $8.9 billion. In addition to Argyle’s known output, CRA-RTZ has a promising find of better-quality diamonds in Canada and is conducting intense exploration elsewhere in the world. In coming years, it very likely will be able to increase its market share as it taps and sells new diamond output.

  • BHP, a large Australian mining group that controls the major Canadian diamond find.

For the foreseeable future, De Beers would keep the lion’s share of the market – more than 70% by value – by controlling the productions of its own South African mines, those in Namibia and Botswana, and the majority of official output from Russia and Zaire. Argyle represents less than 8% of value even though it produces about 40% of world output by volume.

De Beers also has customer loyalty – and perhaps fear – on its side, at least for now. Many of Argyle’s top customers are CSO sightholders and there’s an undercurrent of dread that the CSO may force these people to choose: them or us.

Privately, Argyle execs believe the CSO has evolved from the old days when clients could be written off for minor infractions of the rules. They don’t believe their clients would suffer for buying Argyle goods. “I think CSO officials have learned it’s a new world and they have to be more accommodating,” says Jim Sharp, who heads Argyle’s Antwerp sales office.

CSO officials say there would be no reprisals against Argyle customers even though the CSO did write off several large buyers of Russian goods in 1993. De Beers says it did so because they were selling these goods at below-market prices for a fast buck and exporting rough under the guise of joint-venture polishing operations.

Allowing for all the imponderables, no one can foretell what may happen a decade from now when an independent Argyle could be selling its own output as well as that of other mines.

Clean slate in the U.S.: Argyle’s desire for independence is more than just a search for a better deal. Its corporate parents have substantial U.S. interests and are well aware the U.S. government has no love for the De Beers cartels. Recent U.S. Justice Department investigations of De Beers’ dealings with General Electric over industrial synthetic diamonds and its relations with the New York diamond trade show the government won’t hesitate to go head-to-head with De Beers.

“It’s fairly certain the CSO won’t get production from the Canadian finds because BHP and Kennecott [an RTZ subsidiary] are too involved in the U.S. to risk running afoul of the government,” says one Antwerp dealer who has followed the issue. “Argyle got its 22% market window [the amount it can sell outside of De Beers under the current contract] because CRA and Ashton [another Australian mining concern with an interest in Argyle] worried about this. But now that RTZ is involved, the pressure to steer clear of the CSO entirely will certainly increase.”

Many observers believe the recent RTZ-CRA merger and U.S. antitrust laws will make it difficult for RTZ-CRA to throw in with De Beers – even if De Beers were to grant everything on Argyle’s wish list.

Accepting coexistence? There’s also growing belief within the industry that De Beers executives may be learning to live with the idea of a market-sharing system. As evidence, they cite CSO Chairman Nicholas Oppenheimer’s willingness to accept “peaceful coexistence” with the Russians had the two sides failed to agree on a new contract this spring.

Tim Capon, a director of De Beers, denies such is the case and warns it would be “extremely difficult” to maintain a stable market with several major players. “Would three major sellers all inhibit selling to ensure market stability?” he asks. “Or would they try to increase their own market share?” He points to recent Russian sales on world markets, in defiance of their contract with the CSO. “Here we had two large groups vying for market share and immediately we saw the Russians undercutting to gain an edge,” he says.

Ironically, it was the Russians who showed the world that a potential competitor to De Beers could sell more than $2 billion worth of rough without collapsing the entire market. “The Russians did this irresponsibly and we’re all still here,” says one key dealer in Antwerp. “Argyle has to look at this and say that a company selling independently, rationally and responsibly could pull it off without any problems to the diamond market.”

The CSO takes a different view, saying that if it hadn’t signed a contract with Russia to rein in the flood of small goods, the long-term price erosion of that end of the market would be devastating to everyone including Argyle.

What about prices? If Argyle does market direct, price becomes the critical issue. Argyle would allow for some wiggle room on the downside, says Argyle’s Mike Mitchell. But he stresses there’ll be no bargains or fire sales in Perth or Antwerp.

“By law we couldn’t fix prices in tandem with the CSO, with a nod here and a wink there,” he says. “But we will follow the market, adjusting prices slightly upward or downward according to market conditions.”

Jim Sharp, whose Antwerp operation sold some $70 million worth of goods last year, says prices will remain realistic. “We won’t discount to make sales, nor will we try to defy gravity if the market won’t support our prices.” The challenge, he says, is to follow the market very closely and tailor prices accordingly.

Argyle executives stress that competition with the CSO needn’t mean slashing prices and dumping rough to gain market share. Nor do they see themselves soliciting CSO producers – the Russians or anyone else – to come over to their side. “We have a huge commonality of interest with the CSO,” says Mitchell. “We have to spend $500 million or more bringing a diamond mine into production. We need a stable market and respectable margins to make that investment worthwhile.”

De Beers’ Tim Capon remains skeptical. “Competition always has price implications,” he says. “We saw the Russians causing us to lose market share so we reacted with a price adjustment last June.” But Capon says De Beers wouldn’t initiate a price war with Argyle because it has to maintain credibility with its clients and producers in the CSO. “We produce as many smaller diamonds as Argyle and want to keep stability in that market as much as in the larger goods,” he says.

If someone else starts a price war, however, the CSO is prepared to join, he says, citing as precedent the CSO’s first-ever price decrease imposed last June.

For its part, Argyle says it has the will and means to stockpile goods that aren’t selling. Mitchell says this is a crucial difference between corporate mining companies and the governments that De Beers deals with on a regular basis. Governments need quick, certain returns and don’t have the means to market or stock diamonds. But Argyle’s parents take a long view and are very committed to the diamond industry, says Mitchell.

Bombay connection: The backbone of Argyle’s customer base is composed of large diamond firms that also manufacture jewelry in the free export zones outside of Bombay. Many are members of the Indo Argyle Diamond Council, which markets their jewelry in the U.S. through trade shows and a new traveling exhibit. They aim squarely at large jewelry merchandisers, including such major players as Wal-Mart and TV shopping outlets.

Argyle has spent nearly a decade building a stable, loyal clientele in India, helping its clients improve their operations and get their jewelry into the U.S. market. Argyle executives call their arrangement “The Mine to Market Deal” and say it’s their biggest competitive tool should they break with the CSO.

“We’ve gone into our customers’ factories and assisted them in upgrading and improving their diamond polishing,” says Andrew Murray, Argyle’s information manager. “We’ve helped them improve their jewelry manufacturing operations, helped them choose designs which sell in the markets they want to reach and helped them sell directly to the U.S. through the Indo Argyle Diamond Council. At the end of this process, we understand their businesses very well, so we can provide the best [diamond] assortments for their particular needs and then help them market their products. This is where we differ from the CSO.”

The 21 jewelry manufacturers operating under the Indo Argyle banner did $50 million in sales in the U.S. last year and are expected to do $70 million this year, says Murray. He notes the council probably will be expanded to other countries if Argyle does go market direct.

On the downside, some worry the relatively small group of Indian clients could organize into a secondary cartel that could turn around and dictate terms to Argyle. But executives of Argyle think this won’t happen for several reasons:

  • The help they’ve given to Indian clients is too valuable to risk for a short-term price-bargaining advantage.

  • The firms’ client list is too widely varied to lend itself to such an arrangement.

  • All these firms are intensely competitive with each other.

  • Rough diamonds comprise a sellers’ market, so finding additional buyers to break the “cartel” wouldn’t be difficult.

As an aside, Argyle says it’s been at the mercy of a single large customer (the CSO) since its inception and that diversifying to 20 or 25 clients is much healthier.

Divided opinions: Dealers in Bombay have mixed feelings about Argyle going it alone, but they don’t doubt their country’s thriving industry could absorb these goods.

The industry in Bombay grew very fat and prosperous on the large quantities of cheaper Russian rough that have flowed into the country since 1992. For example, rough diamond imports grew from 38 million carats worth just under $2 billion in 1990 to 90.4 million carats worth $3.2 billion in 1995.

Indian manufacturers acknowledge there’s an oversupply of some types of diamonds, particularly the very smallest. But they say most of their growth is solid and sustainable. They also say Argyle wouldn’t nearly fill the void left by the cut-off of Russian supplies likely to follow the new CSO-Russian agreement. “Last year we imported more than $3 billion worth of rough,” says one of India’s top diamond manufacturers. “Argyle is only $300 million or $400 million, so it’s small by comparison.”

This manufacturer believes single-channel distribution is best for the industry, but says the system has broken down permanently. In his view, too many dealers and manufacturers have become dependent on outside Russian goods to return to the old days of waiting for the CSO to give them larger allocations. “We all realize we can do the business if we can get the goods,” he says.

Some dealers worry, however, that another large producer leaving the CSO network would compromise market confidence. Having two large sources of rough in the market would make it very difficult to coordinate rough supplies with demand, they say.

“In the last few years, manufacturers have learned to watch their bottom lines more closely, so there’s less risk of overproduction,” says Pravin Shankar, manager of Ravashankar Gems in Bombay. “This means there will be times when we won’t buy rough. What will happen then?” Still, he and others believe the problem is timing, not India’s ability to take these goods. “The industry here is a monster that must be fed well,” he says.

Double whammy: Argyle officials want the break from De Beers because they’ve been hit hard by a 25% purchase reduction the CSO imposed on all producers some four years ago (it was later cut to 15%). Revenues dropped from US$406 million in 1992 to US$362 million in 1993. Then in summer 1995, the CSO announced an average 11% reduction in prices for smaller, cheaper quality rough.

Argyle now has about $70 million worth of rough stockpiled at its headquarters in Perth because of the CSO’s deferred purchases. But Argyle believes – and many of its clients agree – that the markets in India and Antwerp could readily absorb and sell these stockpiled diamonds plus the mine’s $400 million annual production.

For Argyle the stakes are much greater than a better bottom line. Its long-term survival depends on whether it can begin underground mining at its site in 2003, when the open pit becomes too deep to work effectively. Most analysts agree this US$150 million project may not be possible economically unless Argyle escapes the CSO’s deferred purchase limitations and gets better prices for its quality goods.

Under its current contract, Argyle sells 78% of its production by volume through the CSO. This includes all gem diamonds and even the mine’s fabled pinks, which Argyle must repurchase from its Perth polishing factory. Argyle sells the remaining 22% through its Antwerp sales office.

“When we signed this contract, we thought it would benefit us, but it hasn’t,” says Gordon Gilchrist, Argyle’s managing director. “We were hit with deferred purchases shortly afterward. We made the noble sacrifice to protect the diamond market, but still found prices for our goods eroded.”

Argyle officials are rankled that the CSO intervened when the market for larger diamonds faced challenges (for example, instituting the purchase reduction and spending $650 million to mop up better-quality diamonds that flowed out of Angola after a civil-war cease-fire at the same time that demand in the U.S. and Japan fell because of recession four years ago). But a year later, say the officials, the CSO declined to intervene when Russia began to sell small “technical” diamonds (cuttable rough that had been classed as industrials) at 20% or more below the prevailing market. The Argyle officials believe the CSO is less willing to defend the market for small diamonds because it gets most of its income from larger sizes. “In short, we were getting all of the restrictions and reaping none of the benefits from this contract,” says Gilchrist.

The Australians also believe that De Beers officials question the value of “going underground” to continue mining at Argyle because the market already has so many small diamonds. This hasn’t heightened their trust that the CSO is acting in their interest.

Tim Capon denies that De Beers wants Argyle to close rather than go underground. But he acknowledges that some informal statements by company officials could have been misinterpreted that way. He also says the CSO didn’t try to mop up the flood of small Russian goods because officials doubted they could succeed. “We never had the degree of market control at the bottom end that we’ve had at the top,” he says. “We understand Argyle’s frustration in watching prices erode, but we believe things would have been much worse if we hadn’t imposed the deferred purchases, which included our own mines.”

Capon says the CSO is “constantly reviewing” its deferred purchase policy and hopes to reduce or eliminate it because of the new contract with Russia. “We do not have a timetable, but we are actively looking at this,” he says.

Who started price cuts? De Beers executives say privately that Argyle contributed to the price slide for smaller diamonds by cutting prices of its own goods in Antwerp four months before the CSO announced its reduction. Argyle says it had to reduce prices because the Russians had so undercut the small-goods market. “We had no takers for our goods because people were buying comparable material from the Russians far more cheaply,” says Jim Sharp of Argyle’s Antwerp office. “We had to follow the market.”

Argyle agrees there’s a glut of small goods on the market but believes it’s temporary, particularly since the Russians have been reined in. Argyle’s Mike Mitchell, who is the lead negotiator in discussions with the CSO, says he’s certain that enough demand exists to absorb all of Argyle’s production and more. Prime growth markets for small diamonds, he says, are Japan (where he says diamonds under 6 points now comprise 55% of the market), Taiwan, South Korea, China and India.

Argyle’s one concession to market oversupply has been to stop mining the smallest sieve sizes, rough under 5 points. This caused a 7% drop in mine production last year and may result in a 15% decline this year. The effect on Argyle’s bottom line will be minimal, say company executives.

A long-considered move: Argyle and CRA executives stress that any break with De Beers is a rational decision and one that’s been a long time coming. Indeed, the Australians were reluctant to sign the current contract in 1991 because of the control it gave to a rival mining company. “We signed eventually for several reasons,” says CRA’s Phil Plaisted. “We believed at the time the contract would meet our financial objectives, and we felt we weren’t prepared properly for a break.”

Argyle began planning for a possible break in two ways:

  • The company took a long, hard look at enlarging its customer base, staff, facilities and competitive strategy.

  • It embarked on an economy drive to make the mine more efficient. A redesign of extraction, crushing and recrushing operations more than tripled throughput to 10 million tons yearly. Diamond production grew from 35 million to more than 40 million carats yearly.

Early last year, the mine revamping was complete and even Argyle’s most ardent skeptics called it an engineering marvel. The company announced its economies saved some $40 million yearly just before the CSO announced its 11% average price reduction on smaller, lower-quality diamonds. The cost of that move to Argyle’s bottom line last year: $40 million!

Without the economy drive, the operation would have become marginally profitable at best – yielding far less than the 20% return on revenues expected by CRA management, say Argyle executives.

But Argyle’s long-term survival depends on whether it can afford to spend US$150 million to develop an underground shaft. Original plans called for the mine to go underground around 2010. But the economy drive and resulting acceleration in operations will force a decision possibly as soon as next year.

The good news, says Argyle’s Andrew Murray, is that tests show the main pipe, AK1, is wider than originally believed and the diamond quality and ore grade are consistent with what’s being mined now.

The bad news is a less-than-50-50 chance of making the investment pay off if Argyle remains obliged to hold back 15% of its production and loses the markup on goods sold to the CSO. (CSO buying prices are about 10% lower than prevailing market prices, and there is an 8%-10% service charge to cover advertising and other operations.)

Analysts say selling direct would allow Argyle to recoup its income losses. “The underground project would be much more certain if we could sell all of our production and recoup some of the CSO’s price cuts,” says Gilchrist.

ADDING TO THE MIX

The RTZ-CRA merger could add some better quality rough to Argyle’s offerings if some planned exploration projects come to fruition.

Most promising is a Canadian project run by RTZ-owned Kennecott. Samples from an underwater site in Lac de Gras are still being evaluated, but analysts believe the mine could produce up to 1 million carats yearly of better-quality material.

Meanwhile, CRA is searching for alluvial deposits off the north Australian coast. Some geologists believe these may have come from a cluster of rich diamond-bearing kimberlite pipes that eroded into the sea millions of years ago. Diamonds have been found there, but analysts say it could be a decade before they can determine the project’s financial feasibility.

Argyle’s junior partner, Ashton Mining, is studying the Merlin Project, a potential mine in Australia’s Northern Territories. Samples from a cluster of 12 kimberlite pipes show several have a grade of 45 carats per 100 tons of ore with quality in the middle range, averaging $50 to $100 per carat. “It’s not a company-making find,” says Ashton President John Robinson. “But it would be a nice adjunct to Argyle’s production.”

Other projects include the small but high-quality Ellendale alluvial mine near Argyle, which has been operating for more than a decade, and other prospects in Indonesia and Finland.

It’s not a foregone conclusion that Argyle would market these productions, but it already has a sound marketing organization in place, say CRA and Ashton executives.

“We’re very committed to diamond exploration and mining and are very willing to spend millions of dollars searching for them,” says CRA’s Phil Plaisted. “At the end of the day, the CSO will have to come up with an entirely new strategy to keep us happy. Otherwise, we’ve got the resources and commitment to market these goods ourselves.”

Rough from Argyle is lower in quality than diamonds from most other mines, but the mine remains the world’s single largest diamond producer by volume.

ARGYLE DIAMONDS PRODUCTION AND REVENUE

Source: Argyle Diamond Sales
1995 1994 1993 1992 1991
ORE PROCESSED (millions of metric tons)
AK1 diamond pipe 8.9 7.9 7.0 6.8 6.0
Alluvial 5.3 4.6 3.9 3.5 1.3
Total 14.2 12.5 10.9 10.3 7.3
DIAMONDS RECOVERED (million carats)
AK1 diamond pipe 37.4 39.7 38.4 36.6 33.4
Alluvial 2.4 3.1 2.5 2.4 1.6
Total 39.8 42.8 40.9 39.0 35.0
REVENUE
US$ (millions) $362.4 $347.9 $362.1 $406.4 $319.0

Argyle has spent nearly a decade creating a loyal clientele in India by helping its customers streamline operations and build sales in the U.S. Here a number of firms exhibited at The JCK Show in Las Vegas under the auspices of the Indo Argyle Diamond Council.

THE MAJOR PLAYERS

Large mining companies used to pay scant attention to diamonds. They’re not a commodity that can be mined and sold in bulk. They have to be sorted into myriad qualities. They’re generally found in remote regions ruled by corrupt or mercurial governments. And the market for them is considered too small to warrant attention.

But when Australia’s Argyle Mine became the first diamond venture to involve a large corporate player other than De Beers a decade ago, it found that homework and hard work helped overcome most of these problems.

Now other big mining groups have taken an interest in diamonds. Here’s a look at the key players:

DE BEERS

De Beers, headquartered in Kimberley, South Africa, is the traditional leader of the diamond world. The company has two divisions: De Beers Consolidated Mines, which manages the company’s South African assets, and De Beers’ Centenary of Lucerne, Switzerland, which manages all other assets.

De Beers operates its own mines in South Africa, including the new Venetia operation, Premier, Finsch and coastal diggings. It also owns a half interest in the diamond mines in Namibia and Botswana.

The company earned $624 million in 1995. Its diamond account (profit on diamond sales minus mining and trading expenses) totaled $760 million. De Beers controls 75%-80% of the world’s rough diamond trade through its marketing arm, the Central Selling Organisation. The CSO sells all production from its own mines and affiliates and the majority of production from Russia, Zaire and Australia. The CSO’s total rough sales were $4.53 billion last year. It also has stockpiled diamonds valued at $4.673 billion.

The company is actively exploring for diamonds in Canada and several African countries. But it hasn’t announced any promising finds.

De Beers has no direct representation in the U.S. because its control of the rough diamond market violates U.S. antitrust laws.

De Beers is affiliated with Anglo American Co., South Africa’s largest mining house, with interests in gold, coal and other minerals. Minorco, its financial arm, administers holdings in other businesses around the world.

RTZ-CRA

RTZ and CRA recently merged to create the world’s largest mining company with combined revenues of $8.9 billion and profits of $1.3 billion in 1995. CRA is headquartered in Melbourne, Australia, and RTZ in London. The company also owns a majority stake in Kennecott, the large U.S. mining group, which is headquartered in Salt Lake City.

The company is diversified into virtually all minerals except oil. It earned $218 million from the Argyle Diamond operation and is the majority holder (through Kennecott) in a diamond project near Lac de Gras in Canada’s Northwest Territories.

RTZ-CRA says it has 200 targets for diamond exploration in various parts of the world.

ASHTON

Ashton of Melbourne, Australia, is a smaller but important diamond mining company.

Nearly all of its $150 million in annual revenue comes from its 40% share in the Argyle Mine. Ashton says it’s committed to exploring new diamond deposits and has a promising smaller mine called Merlin in Australia’s Northern Territories. The company is looking for diamonds in other parts of the Pacific, as well.

BHP

BHP, Australia’s largest mining company, recorded profits of $1.2 billion in fiscal 1995. The Melbourne-based company has interests worldwide in base metals, coal, copper, platinum and gold.

BHP attracted the attention of the diamond world several years ago when it teamed up with a small Canadian exploration company called Dia Met. That partnership touched off the largest diamond rush in modern history by uncovering a cluster of diamond-bearing kimberlite pipes near Lac de Gras in the Northwest Territories. This mine is expected to produce 2 million carats or more yearly when it becomes operational in 1998.