The Separation of Power (or lack thereof?) in the Rough Diamond Industry

For the majority of the 20th century the diamond industry was conspicuously controlled De Beers, hoarding of over 80% of the worlds rough diamond supply in an attempt to manage global supply and thus prices.  

However, a series of events over the last two-and-a-half decades reduced De Beers controlling share to 35% (the summation of the dark grey segments on the pie chart below).   

In a monopoly one seller dominates the entire market. In an oligopoly a small number of large sellers dominate the market.  While an oligopoly does consists of multiple players, the sellers can still individually set production quantities and prices and significantly influence the market.

When discussing the presence of a monopoly or oligopoly, seller is the key word, and even though most diamond mines have multiple owners, usually only one entity manages the operations of the mine including diamond sales. This is important to distinguish because the potential for pricing power comes from having a significant enough stake in supply relative to the industry as a whole, thus creating the opportunity for price leverage. 

To put this in context, most of De Beers mines are jointly owned by De Beers and the country that they operate in.  Technically the mines are owned by subsidiary companies jointly owned by De Beers and the respective government such as: Debswana (De Beers + Botswana) in Botswana; Namdeb (Namibia + De Beers) in Namibia; and De Beers Consolidated Mines (De Beers + Ponahalo Holdings Ltd-Broad Based Black Economic Empowerment) in South Africa.  

While the ownership split of these subsidiaries is 50/50, almost all of the diamonds produced are sold via De Beers' distribution system DTC, or Diamond Trading Company.  De Beers partners (the governments) do have an ownership stake in DTC as well, but the DTC entity has pricing power because holistically it controls the selling of an estimated 35% of global diamond production.

DTC sells the large majority of its diamonds to a pre-selected group of buyers referred to as Sightholders via 10 organized sales a year referred to as Sights.  De Beers sets the selling price for the diamonds sold at Sights, which are sold on a take-it-or-leave-it basis.  Even with no price flexibility, Sightholders are loyal because they view the quality and quantity of diamonds offered by Sights as unmatched.  

For DTC, a reliable diamond supply offered translates to loyal customers, which in turn translates to pricing power for De Beers.  De Beers will adjust the quantity of supply offered via DTC in order to match demand, which has afforded De Beers the ability to keep their offering prices very stable, albeit with a moderate upward trend. 

The second largest rough diamond selling entity in the world by value is ALROSA (RTS: ALRS). ALROSA's domestic mines were wholly owned by Russian state and local governments and related administrations before going public last year and carving out a publicly traded float of approximately 23% of the company. ALROSA sells 50-70% of their domestic production via long-term contracts which work in a similar manner to DTC’s Sightholder system.  The balance of ALROSA's diamonds are sold via auctions, other bidding systems, and one-time contracts. ALROSA sets the price of the diamonds that it sells via long-term contract, and their buyers are loyal for the same reason as Sightholders: the diamond supply is reliable and high quality. 

Outside of De Beers and ALROSA, there are 6 other entities that control the selling of at least 1% or more of global diamond supply: Dominion Diamond Corp (TSX: DDC), Rio Tinto (NYSE: RIO), the Government of Angola, Petra Diamonds Ltd (LSE: PDL), the Marange fields, Gem Diamonds (LSE: GEMD), and Lucara Diamond Corp (TSX: LUC).  Most of these entities sell their diamonds via tenders, auctions, and spot sales. 

Dominion Diamond and Rio Tinto currently are estimated to control 7.2% and 6.7% of global supply respectively.  While both companies have interests in more than one diamond mine, they share production from Canada’s largest producing and most profitable mine, Diavik.  While Rio Tinto is the operator of Diavik, the mine provides physical production for both Rio and Dominion in accordance with a joint venture split, which is 60/40 respectively.  According to Rio Tinto, the diamond price discovery process is agreed upon between both companies and the respective shares of physical production are sold independently. The calculated market share numbers in the pie chart above reflect Rio and Dominion’s sellable rough diamond inventory share, not the cumulative ownership share in their mines. 

The government of Angola is the 7th largest diamond producing country in the world, and one mine, Sociedade Mineira de Catoca (Catoca), represents over 75% of the country's production.  ALROSA owns 32.8% of Catoca, however, Angola’s state-owned trading company, Endiama EP, also a 32.8% owner of the mine, operates the mine and manages all of the mine's diamond sales, according to ALROSA. In this case ALROSA does not receive physical delivery of diamonds from the Catoca mine, and instead receives straight revenue after the diamonds are monetized. Thus, ALROSA's 32.8% stake in Catoca is not reflected in the company's global market share number of 27.4%.

Petra Diamonds operates 6 mines in Africa, and owns a 74-75% stake in all of the mines.  According to Petra, the company manages 100% of the mines operations across the entire diamond mining chain, from mining to diamond sales.  Their partners are in effect passive partners and receive their share in straight revenue after the diamonds are sold.  Given this structure, Petra controls 100% of the diamond selling from its 6 mines equating to a 3.2% share of global rough diamond sales.

The Marange fields are comprised of almost 500 square kilometers of alluvial diamond mine in eastern Zimbabwe.  The fields are primarily operated by 7 commercial producers, which recently began collectively selling their diamonds in organized selling events in Antwerp and Dubai, representing 2.5% of the global market in terms of value.

Rough diamond supply sold by tenders, auctions, and spot sales tend to reflect the true market value for rough at any given time, and thus these prices influence De Beers and ALROSA when they set prices for Sights and long-term contracts.   

The two largest players in the industry represent a powerful market share of 62.5% and discretionally set selling prices for most of their diamonds.  The next three largest entities combined represent another 20.2% of market share but tend to use more of a “market dictated” process to price their diamonds.  

Is the rough diamond industry a monopoly, oligopoly, or neither?  I’ll leave that for you to decide.

Update: October 22, 2014

Its worth noting that while De Beers and their partners (Debswana, Namdeb, and Ponahalo Holdings) sell almost all of their combined production through DTC as a single selling entity, which is the industry’s largest selling entity in terms of value sold, in 2013 Debswana began selling a portion of its production independent of DTC under an entity called Okavango Diamond Corp. Okavango is a Debswana sales arm, wholly owned by the government of Botswana.  According to an agreement struck in 2012 with De Beers, Okavango has the right to purchase and sell 12% of Debswana’s total production, which will ‎rise to 15% by 2016.  In 2014, diamond sales by Okavango represent an estimated 1.3% of global rough diamond sales.

As of October 2014, the government of Namibia is negotiating an arrangement similar to Okavango with De Beers, which would give Namibia the right to sell a portion of Namdeb diamonds independent of DTC.

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De Beers is 85% owned by Anglo American plc (LSE: AAL) and 15% owned by the Government of the Republic of Botswana. Trans Hex is a public company trading under the symbol "TSX" on the Johannesburg Stock Exchange. LUKoil is a public company trading under the symbol "LKOH" on the Russia's RTS  Exchange. At the time of writing the author held a long position in Stornoway Diamond Corp.

This was published in the London Mining Journal and Kitco and was highlighted in Creamer Media's Diamond Report and Mining.com.