The Diamond Trade: De Beers, Russia, and the Industry Today

Diamonds represent one of the world’s most valuable and sought after natural resources. The global retail value of diamond jewelry is estimated to be $72 B, with an average of 130 M carats of raw diamonds being produced annually. Prior to 1867, however, diamonds could only be found in Brazil or India, or on the hands of the wealthy elite, and annual gem diamond production amounted to little more than a few pounds.

Source: http://www.miningartifacts.org/South-African-Mines.html

Source:
http://www.miningartifacts.org/South-African-Mines.html

The nature of the diamond trade changed drastically following the discovery of diamonds in South Africa and the ensuing mining mania, which mirrored the California Gold Rush of 1849. The De Beers Mining Company, founded by Cecil Rhodes in 1870, emerged victorious from this frenzy and established a monopoly that would dominate the industry for decades to come; by 1887, De Beers was the sole owner of South African diamond mines.

The De Beers monopoly was built upon supply control. In order to regulate the supply of diamonds into the market, De Beers took control of distribution channels and formed the Central Selling Organization (CSO), which functioned as the company’s marketing apparatus and controlled around 90 percent of the world’s diamonds. CSO suppliers, eager to sell their stones, were forced to sign an exclusivity agreement that prevented them from forming outside contracts with other distributors.

With the CSO in place, the De Beers conglomerate functioned as follows: De Beers determines the amount of diamonds that it plans to sell in a given year. Each producer is promised a fixed percentage of this total quantity, meaning De Beers pledges to buy that portion of diamonds from the producer and bring them to market through the CSO. Once the number is set, a subsidiary of De Beers purchases diamonds from all producers, including De Beers own mining operations. De Beers then sells the diamonds to dealers via the CSO and charges producers a handling and marketing fee. To prevent price decrease, De Beers purchases any excess supply of diamonds in the market and stores them in its infamous vaults.

The ability of the De Beers cartel to control prices was threatened by economic depression and outside actors. When inflation was high or the stock market was suffering in a given country, investors would capitalize on the stability of diamond prices by holding large quantities of the gem. De Beers faced the threat of a market flooding if these investors were to engage in a mass sell-off.

Additionally, as has been noted in previous blog posts, cartel members are always haunted by the prospect of profits that could be made outside of the fixed arrangement. In 1957, Russia entered the picture following the discovery of large quantities of diamonds in Siberia. De Beers recognized the threat and struck a deal with the Soviet government to purchase 95 percent of Russia’s annual rough diamond output at a 10-20 percent premium, thus ensuring that all Russian diamonds could be properly channeled through the CSO. Following the collapse of the Soviet Union, Russia was in a state of economic decline and sensed the substantial revenue increase it could realize were it to take its diamonds straight to market. In 1984, Russia broke from the cartel and flooded the Antwerp clearing house with polished diamonds. As a result, De Beers experienced a sharp decline in profits, and other suppliers threatened to follow in Russia’s footsteps.

Although De Beers was eventually able to renegotiate with Russia under new terms, the integrity of the monopoly had been compromised as the power had swayed in favor of the producer. By the 1990’s, several new sources of diamonds had emerged and De Beers could no longer maintain near-complete control of the diamond trade.

In 2013, for the first time in 100 years, market forces were recognized as the driver of diamond prices, not monopolistic behavior. De Beers now controls only 35 percent of the world’s diamonds, compared to 90 percent for most of the 20th century, and the company posted a 45 percent decrease in operating profit in 2015.

Source: http://roughdiamondbuyers.com/?tag=rough-diamond-prices

Rough Diamond Prices: 2011 – 2015 Source:
http://roughdiamondbuyers.com/?tag=rough-diamond-prices

To keep profits from falling each year, major producers rely on demand driving ad campaigns instead of supply controlling market manipulation. The diamond industry has shifted its focus away from the U.S. and Europe and onto the newly minted upper classes of China and India.

Despite the industry’s best efforts, diamond prices fell roughly 15 percent in 2015 and threaten to continue on the recent downward trend. Moving forward, the industry will either have to penetrate new markets or come to terms with the shrinking size of its consumer base.

 

 

Sources
Biesheuvel, Thomas. “Diamonds’ Former Monopolist Bows to Market Forces to Spur Demand.” Bloomberg Business. Bloomberg, 8 Sept. 2015. Web.

Epstein, Edward J. “Have You Ever Tried To Sell a Diamond?” The Atlantic. Atlantic Media Company, 1982. Web.

Goldschein, Eric. “The Incredible Story Of How De Beers Created And Lost The Most Powerful Monopoly Ever.” Business Insider. Business Insider Inc., 19 Dec. 2011. Web.

Kuo, Lily. “De Beers (and the Entire Diamond Industry) Pins Its Hopes on China and India.” Quartz. Atlantic Media Company, 18 Feb. 2013. Web.

Kretschmer, Tobias. “DeBeers and Beyond: The History of the International Diamond Cartel.” New York University Online. London Business School, 1988. Web.

O’Connell, Patricia. “The Issue: De Beers’ Multifaceted Strategy Shift.” Bloomberg Business. Bloomberg, 6 Jan. 2009. Web.

Zimnisky, Paul. “Diamonds: Driven by Market Forces for the First Time in 100 Years.” ResourceInvestor.com. 9 Apr. 2013. Web.

Gazprom and the Uncertain Future of Russia’s Natural Gas Industry

Natural gas is a very important good in the Russian economy. In 2013 alone, natural gas exports totaled 14% of their total exports—a whopping number only surpassed by crude oil (33%) and petroleum products (21%). Interestingly, the majority of this natural gas is exported to the European market, but Russia has taken steps to increase exports elsewhere, notably through a 2014 deal that will see $400,000,000,000 in natural gas shipped to China over the next 30 years.Russian Exports

And though the natural gas export business plays such a pivotal role in the Russian economy, there is only one player in the game—Gazprom, a firm that has a government sanctioned monopoly on natural gas exports. The reasGazprom's Logoon, according to First Deputy Energy Minister Alexey Texsler: Russian gas should not “compete with itself” in foreign markets, as such competition would only lead to lower prices and decreased export revenue for the motherland.

But the Russian energy industry, and the Russian economy as a whole for that matter, have struggled in recent years. Very low crude oil prices have put a strain on the Russian budget, in turn creating problems in the natural gas sector, where export revenues have fallen 28.5% in the last year.

This graph from NASDAQ shows the fall of oil prices over the last year.

This graph from NASDAQ shows the fall of oil prices over the last year.

Rosneft, Russia’s largest exporter of crude oil, has turned towards natural gas production in the wake of oil restrictions imposed on Russia due to both their conflict with Ukraine and low global prices. To do so, they have pressured the Russian government to end Gazprom’s natural gas monopoly, a move that has reignited questions about Gazprom’s effectiveness and the solubility of the Russian natural gas industry as a whole. That begs the questions: is Gazprom’s monopoly still advantageous for Russia? And, should Russia even continue to export natural gas?

A recent paper by scholar Marina Tsygankova sheds light on some possible answers. For one, Tsygankova’s analysis of the Russian natural gas industry finds that abolishing the Gazprom monopoly would lead to more combined profits for Russian producers in both domestic and foreign markets. However, she also notes that liberation of the Russian natural gas export market would lead to firms divesting in domestic sales to instead flood the European market with their product. This would lead to an increase in domestic price and a corresponding loss in Russian consumer surplus, which she finds outweighs any producer gains realized by eliminating Gazprom’s export monopoly.

Based off of the empirical evidence Tsygankova presents, Russia certainly should not sell more natural gas by ending Gazprom’s export monopoly. Moreover, she notes that given the entrance of shale natural gas into the gas market, the export market for Russia’s natural gas could become even more uncertain should European nations that are so reliant on Russia for energy decide to diversify their gas consumption. Ultimately, the ramifications of continued political pressure by firms like Rosneft and market entrance by shale gas producers could end up dealing a huge blow to both Gazprom and Russia’s financial security, which could destabilize one of the most important players in global politics and international relations.

Sources: US Energy Information Administration (includes export graph), World Affairs, Bloomberg and Energy Economics article

Images: Wikipedia for logo and NASDAQ for prices