Diamonds: changing values in Africa (Source: Mining Journal)

The most striking feature of the diamond industry is that cutting and jewellery manufacturing has virtually always been geographically remote from the actual mining operations, writes Dr Chris Hinde

Although the diamond-mining industry is relatively young, the age of the diamonds themselves can be measured in hundreds of millions of years.

Diamonds are created at depths of 120-190 km in the mantle of the earth, and are transported to the surface in volcanic magma (called kimberlite or lamproite). The oldest of these diamonds were crystallised some 2.5 billion years ago (for example, the stones found in South Africa), while some of the youngest are only 40 million years old (as in Tanzania).

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BELGIUM, the Netherlands and England have derived considerable economic benefit from the diamond industry, even though they do not have a single mine. Indeed, until the early 20th century, producer countries derived little added value from their diamond resources. This is because the early diamond discoveries took place in European colonies, and the easily-transportable minerals were brought home.

Thus, the diamond industry developed initially in Antwerp in the 16th century, but shifted soon afterwards to Amsterdam, and to the lesser contemporary centres of Venice and Lisbon.

The annual world production of natural ‘rough’ diamonds has been steadily increasing over the past 35 years (output was around 40Mct in 1970) and diamonds have now been discovered in over 35 countries. However, the bulk of the production comes from half a dozen sources: Botswana remains the largest producer by value (26%) followed by Russia (an estimated 19%) and Canada (12%). The next largest diamond producers are all in Africa: South Africa (with 10%), Angola (9%) and the Democratic Republic of the Congo (8%).

Canada is the most recent addition to the community of diamond-producing countries. Indeed, about half of worldwide diamond-exploration expenditure is now being spent in Canada and, as a result, the country’s relative share is expected to rise significantly in the next decade.

Out of the current annual diamond production of 180Mct, some 36Mct (20%) is of genuine gem quality (polished mostly in Israel, South Africa, Belgium, Russia, New York, China and Thailand), some 81Mct consists of near-gems (almost all processed in India) and the other 63Mct are very low-value industrial goods. Australia (23Mct), the DRC (22Mct), Russia, South Africa and Botswana are the major producers of these latter diamonds.

Polished market

Diamonds are processed (manufactured) in some 30 countries; the main centres are India (which employs 96% of the global diamond-manufacturing workforce), Israel, Belgium, South Africa, China and Thailand.

The average yield for polished stones in the huge Indian industry is some 22% (out of the rough), while, for the gem categories, the worldwide yield is some 48- 50%. This makes for an annual diamond production of some 30-32Mct, valued at around US$19 billion at pwp.

The percentage mark-up at each stage will change according to the vagaries of the market. However, on average, if one takes the mined stone as value ‘100’, the five stages in the pipeline can be evaluated as below:

Relative value addition in diamond pipeline:
- Mined stone 100
- Sorting 115
- Polishing 127
- Polished dealing 133
- Jewellery manufacturing 166
- Retail 320

In almost all diamond-producing countries (by law or tradition), mineral wealth belongs to the people. Yet, in past centuries, diamonds were shipped back to European cutting and trading centres. The situation only improved marginally after African countries earned their independence.

Not surprisingly, relations historically between governments and producers have been strained. Yet in recent years, the voices of government have become too loud to be ignored, and their commercial role in the industry has gradually become more influential.

Indeed, from an historical perspective, this governmental role has never been more important than it is today. The industry’s largest corporate producers, such as De Beers and Alrosa, seem to have lost control of their own destiny. The governments of the leading producer countries (especially Russia and some African countries) and the international governmental bodies (such as the competition authorities within the EU) are determining the rules by which the companies must operate.

The main issues confronting the producers centre on the marketing systems and on the sharing of the diamond wealth with producer governments.

The extra income earned by government is perceived to come at the expense of the corporate diamond producer. It does not necessarily have to be this way, but it is clear that the relationship between host government and producer companies is often confrontational, if not outright hostile, as they argue about how to divide the mined-resource wealth among themselves.

This divergence of interests is presently most dramatically seen in South Africa. There, the new Diamond Amendment Act allows the government to channel all domestic rough-diamond production to the local diamond cutters and polishers, forcing the producers to sell their rough to a local government-owned and -operated diamond dealership, or to sell the output to companies. Moreover, to give inefficient domestic manufacturing units an economic advantage, an export tax is creating, in effect, a subsidy for local cutters. Botswana and other major African producers may soon be following in South Africa’s footsteps.

Thus, in this first decade of the 21st century, we are witnessing a dramatic shift in the producer-government relationship that will impact on the diamond industry for many years to come.

Producer governments are no longer just interested in maximising revenue; they are also searching for extra and wider societal benefits. Extractive resources, such as diamonds, can generate a great deal of what is called ‘resource rent’ (or economic rent), which is basically income above the normal return from invested capital.

Whatever returns on capital can be realised in the normal business environment, they are invariably many times larger in the natural-resource sector, and particularly so where the products are as scarce as diamonds.

The sustainable and equitable management of diamond resources requires the recovery of an appropriate resource rent by the producer government so that the local population receives its fair share of the country’s mineral wealth. We are now entering into an era in which diamond resources in certain African countries are set to decline (in the absence of major new discoveries) or may even be exhausted altogether (such as in Namibia and Sierra Leone). Government policies are shifting from mined-revenue optimisation to beneficiation and diversification – even when this may run counter to market-economy principles.

A major objective of diamondproducing governments is (or should be) to recover resource rent and to use it for the benefit of the country. Unfortunately, corruption is rife in some countries and the diamond wealth is squandered by the governing elite. As a result, national economies are deprived of maximum benefit from their natural resources. Angola, the DRC, Sierra Leone and Liberia fall within this category. Responsible diamond exploitation requires that rents from this non-renewable mineral resource be invested in other kinds of economic activity that can replace the employment and incomes of the resource-based industries once they are exhausted.

Properly invested, income from natural-resource development can become economically sustainable. Even though non-renewable resources are, by definition, not sustainable, they can be used to create a permanent source of income.

Some countries whose economies are highly dependent on diamonds (like Botswana and Central African Republic) are being pressured by the International Monetary Fund to diversify their economies and to decrease their dependence on natural resources.

Resource management objectives

The governments of diamond-producing countries have, historically, generally followed two alternative approaches to the management of their resource wealth:

1. Commercial exploitation to maximise economic rent, which is then appropriated by the government (through taxes, royalties, dividends, etc) for use on behalf of society; or

2. Managing the resource to achieve a combination of economic and social or political objectives. In this approach, an assessment of the purely economic benefits may play a more limited role in decision-making.

In the past, the world’s two largest diamond producers (Botswana and Russia) were satisfied with the revenue derived from mostly exporting rough diamonds (the first option above). In recent years, these countries have moved, or are moving, to domestic beneficiation, which is much more a political and societal imperative (motivated by pressures to provide employment to local people) than an economic consideration.

However, it can be shown that in the 1980s the Soviet Union achieved higher revenue from the export of rough diamonds than it did by exporting polished diamonds. This was because of the highly inefficient and uneconomic manner in which the rough was processed into polished stones.

Indeed, while acknowledging the vast wealth the diamond industry can produce for its stakeholders, negative resource rent can result from fluctuating rough and polished diamond prices, the strengthening of currencies of producer countries against the US dollar (which is the currency in which diamonds are traded worldwide) and governmentinduced distortions in the terms of trade.

Diamonds are easily transportable, and the traditional view is that diamond processing should move to those countries in which the conversion of rough into polished makes most economic sense. However, the overriding policy sentiment in African-source countries is one of ‘payback’. Through their colonial, and even post-independence, periods, natural resources have always been taken out of Africa, denying local people most of the benefits.

The industry must acknowledge the inherent right of producer governments to try and implement their nations’ political and economic aspirations. However, any activity within the diamond value chain that does not make economic sense should give rise for concern. Like everything in life, there must be a balance between the politically desirable and the economically feasible.

Historical production

Until the second quarter of the 18th century, the only known mining sources of rough diamonds were India and, to a smaller extent, Borneo.

The discovery of diamonds around 1730 in Brazil, a Portuguese colony, ended India’s monopoly as a producer of rough diamonds, and, for a time, weakened the hold that London and its diamond merchants had on the import trade.

The central positions of London (as rough distributor), Amsterdam and Antwerp (as main cutting centres) were already well established when, in 1870, diamonds were discovered in South Africa (the individual South African producers were amalgamated by De Beers Consolidated Mines Ltd in 1888).

The diamond-mining industry is relatively small compared with other natural-resource sectors; less than 180Mct (under 36t) of diamonds are mined annually. These stones are valued at barely US$13 billion (an average of just US$75/ct), at an operating cost of around US$5 billion.

The diamond value chain (so-called ‘pipeline’) consists of exploration, mining, sorting, distribution, trading of rough stones, processing (ie converting the rough into polished stones), grading, jewellery manufacturing and retailing.

In progressing through the pipeline, global rough-diamond production becomes worth over US$19 billion in polished diamonds [polished wholesale prices (pwp), sometimes also called excutting centre prices]. This activity ultimately translates into a jewellery-manufacturing value of some US$31 billion, and a retail price of over US$68 billion (although these values include the non-diamond components, such as precious metals, semiprecious stones, design, distribution cost, marketing and advertising).