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By John Helmer, Moscow

Alrosa, the Russian diamond miner, signed an agreement on Wednesday [November 28] to supply selected rough diamonds to Tiffany of New York. Signing with Alrosa chief executive Fyodor Andreyev was Andrew Hart, president of Laurelton Diamonds, a Belgian subsidiary of Tiffany, as well as executive vice president of Tiffany Corporation in New York. The Alrosa press release reports that there had been single-lot supply deals on spot market terms between the two in the past, but this is the first long-term agreement between them. According to Andreyev, it “will make our partnership permanent and serve to increase the supply of diamonds to Tiffany.”

This is the second time in a month when Alrosa has publicized diamond supply contracts. On November 13 Alrosa announced it had signed a two-year contract with Conroy Cheng, executive director of Chow Tai Fook, the Chinese diamond-cutter and jewellery manufacturer of China.

Industry sources reported in Moscow that the Tiffany deal calls for supply of about $60 million worth of rough per annum over three years. Russian sources told PolishedPrices.com that they expect Tiffany to improve on the standard selection offered to Alrosa sightholders, and to be able to pick stones of up to $200 per carat in value. At that value, Alrosa may be committing about 300,000 carats to Tiffany. If the contract allows Tiffany to pick and choose, then the $60 million value may be a target for the maximum Alrosa will agree to sell Tiffany each year, no matter how high the average carats per stone will run in the assortment.

According to an Alrosa report issued on October 4, the average price for gem-quality diamonds sold in the first half of 2012 was $195.20 per carat. That compares with an average $196.90/ct for the year 2011, and $123.30/ct for 2010.

Selectivity is a sore point with domestic Russian cutters and manufacturers, particularly as Alrosa insisted on run-of-mine selection on the part of De Beers’s buyers during the multi-year supply agreements with the Central Selling Organization of De Beers which ran between 1959 and 2009. Run of mine (ROM) is the term used by diamond miners in their sales contracts to require buyers to take stones in the assortment to be found when they are mined. Because cherry-picking the larger, high-quality diamonds would leave miners with large remainders of less saleable stones, De Beers pioneered the method of selling their diamonds in boxed assortments which combined mixes of all gem sizes and qualities. Buyers were obliged to take or refuse the lot. Alrosa has generally followed this practice, but there are well-known tricks of the trade to improve the buyer’s preference, cutting thereby his costs and increasing his profit margin.

An international diamantaire explains there is nothing exceptional in this. “Tiffany will want specific assortments – everyone does, especially when they have a high-end premium retail clientele. I have no idea what their deal with Alrosa will entail as far as rough categories are concerned. But with their trading office in Antwerp, they can easily sell on any rough (from any source) that does not meet their strict criteria. If any producer sells higher than average ROM assortments to a client, then they are by definition left with lower quality goods for which they have to find a home.”

The terms recently announced between Tiffany and South Africa’s DiamondCorp’s contract to buy rough from the re-opened Lace Mine include a first right of refusal which appears to suggest cherry- picking. According to the DiamondCorp announcement of November 16, “the Offtake Agreement will take effect from the First Funding Date until the end of the life of the mine. Subject to any purchases by the South African State Diamond Trader, the Offtake Agreement will give Laurelton Diamonds, Inc. the right to purchase, on commercial terms related to fair market value, production from the Lace Mine which meets the quality and colour standards required to yield Tiffany quality polished diamonds. Special stones and those diamonds which do not meet the Tiffany standard will be excluded from the Offtake Agreement.”

In Russia this exclusion would mean cherry-picking, and it’s illegal because it discriminates against other diamond buyers, notably Russia’s domestic cutters and manufacturers. These are led by the state owned Smolensk Kristall and by Moscow-based Ruis Diamonds, owned by Lev Leviev.

According to Ararat Evoyan, the veteran spokesman for the Russian diamond manufacturing industry, Tiffany will be getting “standard lots. Alrosa has 19 contracts with foreign partners. I think [the Tiffany terms] will be comparable. Under [Russia’s] current antitrust law, they have to sell standard lots [to everyone].” Evoyan believes the terms will have no impact on domestic supply “because that would be a violation of the law.”

A leading Russian cutter told PolishedPrices.com Tiffany may be offered cherry-picking rights. “The price can be around $100 per carat…Generally those who work under contract with Alrosa [get the] average price, and so far as I know, no more than around $200 per carat. But maybe they’ll make exceptions for Tiffany because Tiffany specializes in higher quality stock. On the scale of Tiffany, [$60 million in annual purchasing] is still quite a significant transaction.”

The source concedes that the policy of the Federal Antimonopoly Service (FAS), Russia’s competition watchdog, is “the requirement that the policy must be the same for all customers, in pricing and a unified [supply] program, so noone was getting special preferences. ” He suspects, however, that Alrosa may be introducing “tinkering with contracts”. If that happens, he added, “I don’t think this will have a profound effect on the domestic market…some clients will leave, others will come instead.”

Sergei Goryainov, a leading industry analyst at Rough & Polished in Moscow, said it is difficult to tell how many carats Tiffany will buy, or what the average carat price will be for the contract. “Alrosa’s product sale strategy was not disclosed. I think it will be a premium commodity – precisely above [one] carat.” The assortment for Tiffany, he believes, “is likely to be similar to the one sold in the domestic market to Smolensk Kristall. Kristall works with premium rough. $60 million is, frankly, not a very large amount. But still, Alrosa’s production of premium rough is not rubber, because next year the total production of rough of this class is likely to be close to the volume of this year. And if Alrosa adds a delivery commitment to someone, then from someone else that rough will have to be taken.”

According to Goryainov, it is possible there will be an additional source of supply of higher-value stones from the alluvial workings at Nizhne-Lenskoye in Yakutia. The Sakha republic administration will be selling a 51% share in the republic’s heavily indebted Nizhne-Lenskoye company in December. This is expected to result in a no-contest award to Alrosa for about Rb3.5 billion ($113 million). If Alrosa becomes part-owner of the source, an additional share of the output, which has been going to Smolensk Kristall until now, may be available to fill the Tiffany contract. The extra supply, Goryainov estimates, may be worth between $70 million and $80 million.

State-owned Smolensk Kristall, Russia’s largest diamond cutter, expects Alrosa will stick to the letter of the Nizhne-Lenskoye supply contracts, and that there will be no violation of the rule against cherry-picking. Tiffany’s Hart has not responded to requests for comment. An Alrosa spokesman said “we do not comment on details of agreements – not with Tiffany, nor with any other company.”

According to Goryainov, a long-term contract for Tiffany would make no sense unless it can exercise its “special assortment positions. Usually, large customers who buy from Alrosa can work, not only as a [diamond] cutter under their [clients’] orders, but also as a dealer. This is normal and it is a common practice. That is, a certain amount of rough, which they buy from Alrosa, is then resold by them on the secondary market. But the Belgian subsidiary of Tiffany is very little on the secondary market; it is almost not there at all. That is, it is only concerned with cutting under the orders of Tiffany. Therefore, to conclude a contract with Alrosa in which they might get a decent share of rough which would not be actually used for their work – that has no sense. Therefore, we conclude that they have signed an agreement for rough which is needed for cutting by Tiffany and for further use in their jewellery lines.”

In the past, high-quality rough from the Sakha republic’s share of placer (alluvial) deposits in the jointly-owned Anabar mining company in Yakutia has been sought from the regional government by other well-known international jewellery companies. Alrosa has helped to block the deals. For reasons neither Alrosa nor the Sakha government has explained publicly, direct sale to the international diamond companies of the republic’s share of rough from the Nyurba open-pit mine and the Anabar alluvial workings has also been curtailed.

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