What does any sanctions on Russia entail for the global Diamond industry?

The global diamond industry stands to face challenges as the current political tension between Russia and Ukraine escalates. With the USA, UK and the European Union threatening Russia to impose economic and trade sanctions, Russia, the largest source of rough supply of diamonds as of today, is at the brink of economic isolation which would pose profound threats to the global diamond industry. Under such circumstances, we have taken time to review the current status of Russia and forecast what kind of changes might occur if Russia continues to take it stand against Ukraine.

About Russia and ALROSA

Russia is a major source for rough diamonds that trade on the global markets through ALROSA, the Russian state-owned diamond company, which owns almost all diamond production and mines in Russia. ALROSA has 9 primary mines for diamonds, 10 alluvial mines and 2 mines that are currently in development. ALROSA mines and sells two kinds of diamonds: gem quality (almost 65% of volume) and non-gem quality. On October 28, last year, Russian government has spinned off 16% stake in ALROSA and the shares have been trading on the MICEX stock exchange in Russia since then.

Russian Federation is the world leader in rough diamond production in terms of volume (estimated to produce over 33 million carats in 2013). Out of this volume, ALROSA accounted for approximately 97%. Bain & Co. noted that ALROSA accounts for 27% of the global diamond production. Most of the mining occurs in Yakutia and Arkhangelsk in Russia and some mines in South Africa.

ALROSA holds largest reserves too that are sufficient for the next 20 years of production. ALROSA sells through long-term contracts with companies across Russia and rest of the world. Currently, there are 42 such contract holders to whom ALROSA would provide raw materials and diamonds in a pre-agreed range and volume on monthly basis. ALROSA also sells a part of its mined diamonds through auctions, competitive bidding, and one-off contracts through its major trade offices in the USA, Belgium, Switzerland, UAE, China, UK and Israel.

Impacts if sanctions are levied on Russia

It is evident that Russia holds a large supply of global rough diamonds and could dramatically alter the landscape if any sanctions were to be levied on Russia regarding international trade and economy. ALROSA holds a contract with several USA companies having their offices or subsidiaries in the Europe. One such example would be Tiffany & Co.’s subsidiary, Laurelton Diamondsa Inc., in Belgium, which purchases rough diamonds of worth almost USD 60 Million from ALROSA annually. Another example would be Sotheby’s, one of the leading auction houses.

As of first half of 2013, nearly 65% of Belgian rough diamonds were procured from ALROSA. On December 1, last year, ALROSA and AWDC signed a three-year agreement for cooperation regarding exchanging market intelligence, trade information, business opportunities and technology.

Most of the gems mined by ALROSA lag behind those mined by De Beers in quality. This ensures an affordable rough supply for polishing markets in India and China. With any sanctions levied, this affordable supply would come to a halt for these markets. Procuring any supply from De Beers would be costly because the gems are of higher grade. For any company that still intends to procure from De Beers, or for any company from the Europe who already purchases rough from De Beers, it would prove to be costly as there is a very high chance that De Beers would raise the prices of its rough supply.

Any export sanctions on Russia would destabilize the already week supply-demand balance in the global industry. This would fuel the increase in prices of the rough diamonds that would put additional pressure on the already low margins of cutters and polishers in economic markets like India and China. Any company that procures rough prior to such a situation would definitely have an advantage over the rest of the market. But in case of no such restrictions on Russian exports, the prices still tend to increase because of several reasons outlined below.

In this year, ALROSA will also prepare for the new contract period and expects that the long-term agreements increase this year. ALROSA also targets on increasing the experience of long-term partners and on-spot traders as well.

However any restrictions or bans on visas for Russian citizens or officials by the USA, UK or any European country would see similar repercussions being carried out by Russia. This would definitely strain the trade relations between major companies that deal directly with ALROSA or other diamond traders from Russia.

There might be a chance of freezing of assets of Russian individuals and companies that are in the western economies. However, this kind of steps might not be encouraged by any western leader for the fear that many western companies have huge investments in Russia as well and the pressure from these companies would discourage the western governments to take these steps.

ALROSA planned to export over 36 million carats of rough diamonds this year a major portion of which would be exported to the European markets, including Antwerp, and India and China. ALROSA has also believed that the prices for the rough would increase this year fuelled by stable demand from the USA paired with increasing appetite for diamonds from India and China.

With these sanctions, any loans or credits to Russia and allied parties might be refused by international financial institutions. Prohibition of importation and exportation of goods might be a possible step. This would clearly hit hard the traders, small companies and local polishers in the Russian diamond industry.

The Russian banks might be banned from using the USA financial system or the international financial network. However, such an extreme step is doubtful to be implemented considering the various personal agendas of all G7 leaders.

The UK Prime Minister, David Cameron, was supposed to suggest certain sanctions that may be formally agreed at an emergency summit of the EU leaders in this week. These suggestions include blocking of visas for Russian business people. It is evident that Russia would follow suite which would make it virtually impossible for any company to visit Russia to trade diamonds. Any dialling down of economic cooperation between Russia and the EU would establish walls between the banks in either markets to guarantee payments or credits in trading.

The UK is still not explicit with the range of sanctions against Russia, including economic and trade barriers, with hopes that Russia might resort to a more diplomatic solution regarding Ukraine. However, the UK and the EU alike believe that there is a need to send a strong and clear signal to Russia that it will face serious punishment for violating Ukrainian sovereignty. There are signals of OSCE and NATO being involved too.

There are alternate routes to facilitate diamond trade through Russia. While the western economies are threatening Russia with these sanctions, major eastern economies that are pretty active in diamond trade are not following suite, such as China, Hong Kong, Japan and Singapore. These routes will still be open. However, with sanctions on the Russian banks, removal from the International financial network and freezing of assets, in spite of these alternate routes, the global diamond industry will be affected. Any sanctions on Russia or removal of trade channels will affect the global diamond industry.

Many western companies and investors have heavily invested in this fastly developing large landmass and that would make it counterproductive for the western economies if any sanctions were imposed. With Russia being one of the key export markets for the UK and Germany, those countries are treading carefully in connection to any sanctions.

Basis of our assumptions: Current steps taken against Russia

The primary warnings of the western nations, most importantly the G7 leaders, included economic isolation, trade restrictions and sanctions, fines, removal of military support and removal of Russian banking system from the international financial network.

On Monday, 3rd March, The Pentagon of the USA has suspended all the existing military exercises and activities with Russia. All the trade talks and meetings designed to strengthen the business and trade relations between the USA and Russia have been suspended to exert more pressure on Russia to take back its troops from the region of Crimea of Ukraine. Even the European Union threatened Russia to freeze visa liberalization and economic cooperation talk.

Like the USA and UK, the EU had also boycotted the G8 summit in Sochi. The French foreign minister has given an ultimatum to Russia to show clear signs of goodwill and withdraw their troops from the Ukraine borders before Thursday when the EU leaders are meeting in an emergency summit. Failing to do so would ensure that Russia see punitive measures being implemented by the EU.

This crisis has already started to manifest in form of economic repercussions for Russia. The Russian stock markets began to plummet, with Moscow’s main MICEX index dropping nearly 10% in early trading on March 3rd. The losses expanded to 12.5% by mid-afternoon wiping out USD 58.4 Billion of the shareholder value, more than what was spent on the Sochi Olympics. The Rouble has fallen to an all-time low, below 50 to the Euro and below 36.4 to US Dollar, both all-time record lows, which forced the Russia’s central bank to raise its key lending rate from 5.5% to 7%.

The world oil prices surged too by USD 2-3 per barrel. Dealers estimated that Russia’s central bank sold upto USD 10 Billion of its gold and foreign exchange reserves to compensate the Rouble’s fall. The financial giant of Russia, Sberbank was badly hit too. Shares in Russian state-owned Gazprom fell by more than 10%. Russia’s biggest oil producer Rosneft saw its shares falling by more than 8%. European stock markets fell by around 2% amidst the region’s uncertainty. The FTSE 100, in London, lost 1.6%. Germany’s DAX too fell by 3%. Commodities including crude oil and wheat surged in their prices.The stocks have fallen and gold rose in Asia, where the Nikkei in Japan lost 1.3%.

The Emergency Meeting between the European foreign ministers on Monday 3rd March saw the Eastern Economies led by Poland and Lithuania push hard for strong EU actions against Russia. Poland has also called in an emergency NATO meeting on Tuesday. The meeting between Germany and Russia in Geneva yielded no results. Kremlin has warned, in fact, the USA that Russia would emerge victorious in spite of the sanctions and that they would reduce their dependency on the USA to zero.

Vladimir Putin has said that they are ready to host the G8 summit but if the Western leaders do not want to attend, they do not need to. He also said that, in spite of the threats from the Western leaders, Russia would never back off its troops. Such statements show how stern Russia is with its stand and leaves us with imaginations of what would the next few days bring with them.

We would not have considered this an issue if not for the unstable political situation that is posing a serious threat to a major economy in the diamond industry, Russia.

**The gravity of the situation can be clearly understood from the statement from William Hague, the UK Foreign Secretary, who in Kiev said that the crisis in Ukraine was the biggest the Europe had faced in this century.** John Kerry, the US Secretary of State, is travelling to Ukraine on Tuesday, 04th March, probably as we write this piece.

If the issue is resolved calmly

We hope that this issue is resolved calmly. Under such circumstances, even though our arguments posed above would be invalidated, this whole experience at least tells us how much the global diamond industry is depended on Russia upto an extent and any actions taken by or against Russia would have effects on the global diamond industry.

We understand this article takes into consideration a lot of surface issues. We aimed at the pace rather than at the depth and looked at an holistic view rather than an in-depth analysis.