Market NewsCommentRio Tinto's 'Diamond Supply Agreement' - the day after

Rio Tinto's 'Diamond Supply Agreement' - the day after

By Daniel Horowitz.

The latest development of the Argyle / Rio Tinto story illustrates well the point I was trying to make on the PolishedPrices forum last week.
Some years ago, Rio Tinto was contemplating extending the life of the Argyle mine beyond what was originally planned. An extensive study was performed, which revealed there were significant reserves left in the deposit.

The open pit, however, was getting close to its maximum capacity.

The only way to tap the full potential of the deposit was to go underground. This, however, effectively came down to building a new mine as far as financing was concerned.
In order to substantiate the investment, Rio Tinto made projections of likely returns.

The conclusion was that these projections did not give enough incentive to go ahead with a project that could require as much as $1 billion.

Rio Tinto then figured a ground-breaking, staggering and most narcissistic scheme ever conceived in diamond mining history.

Explicitly asking for client's "support", Rio "suggested" a three-year agreement whereby clients would be contractually bound to purchase rough diamonds at prices calculated at Rio's sole discretion.

The clients received a draft proposal to which they had to agree within a fortnight. Effectively, they were asked to choose between this bizarre arrangement or be cut off from Argyle supply. Most of them signed the contract, albeit reluctantly, because rejecting it would have meant an immediate cessation of their business.
Now it seems Rio Tinto itself is beginning to consider the Argyle 'Diamond Supply Agreement' may not be tenable, as it is allegedly offering a way out.

Whilst Rio appeared at times to be in a position to endlessly pressurize its clients, dictate rules defying common sense, ignore basic market intelligence as well as bank recommendations, now they seem to be locked in the very trap they sought to avoid.
The myth whereby there would always be more demand than supply for rough diamonds has vanished.

Just like other producers, Rio Tinto is facing the harsh reality.

Prices of rough are dramatically down, liquidity is scarce, clients have lost confidence and banks are having nightmares.

What will happen to the new Argyle mine is anyone's guess, but prices of its product have plunged somewhere between 35% to 50% below what the 'Diamond Supply Agreement' is based upon, depending on sizes and quality.
"What is sure is that for years to come there will be no diamantaires around to go for prices that are not in sync with market conditions."

Some Rio managers must feel embarrassed. Not only seem their strategy a failure for their clients, but it must have turned out as a disaster for themselves. 

The good news is that this is not the end of the world. The diamond market will return to normality, so let's hope large diamond mining companies will devote their attention exclusively to mining, and not try and control the downstream diamond market under any form or shape.

I can only reiterate that, having been a consultant to major diamond producers for many years, I have come to the conclusion that marketing run-of-mine through tenders or some form of auction is the only way to provide reasonable comfort to the entire chain of stakeholders. 

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