Would a �cartel-lite� or ODEC for Diamonds work?
Roman Grynberg | Friday December 5, 2014 08:27
Given the P25 billion in expansion announced by Debswana in Maun last week costs of extraction will no doubt rise and while production may continue government revenues will surely decline. The obvious question is whether there is another way that Botswana and other diamond producing countries can delay the decline in revenue for at least a few more years.
According to the estimates presented by Dr Rob Davies from Zimbabwe recently at a conference in Gaborone there is scope for Botswana to have a ‘gentleman’s agreement’ with other major producers to slow production of diamonds even further than has been the case. With diamonds as with other commodities the only problem in the market is to find a gentleman with whom you can have an agreement. In what is probably the first public estimates ever it was found that a 1 percent increase in price of rough diamonds will only result in 0.45 percent decrease in demand for rough diamonds. Unsurprisingly Dr Davies results show that the demand for rough diamonds is what economists call ‘inelastic’ i.e. unresponsive to changes in price. This means that it is possible to decrease production and simultaneously increase profits and government revenue at the same time because consumers will not stop buying. Dr Davies estimated that 25% decrease in production would eventually yield a 16% increase in government revenues.
Planned Contractions?
It was certainly noticed by the International Monetary Fund in its recent 2014 publication on Botswana that the country has become the ‘swing producer’ in the world diamond market. This is in fact not strictly the case and while Botswana is by far the biggest producer in the De Beers zone i.e Botswana, Namibia and South Africa all have undergone significant decreases in production since the onset of the ‘Great Recession’ which began in 2008. Production was dramatically cut in Botswana from the 30 Mct plus production which was common before the economic crisis to much more modest levels. In 2013 production was a around 23 Mcts. But the decrease in supply from the De Beers zone in the post 2009 period was helped by the natural decline of diamond production in what were previously substantial low value producers like Australia. If the Kimberly statistics are to be believed, then total world production of diamonds peaked in 2005, long before the Great Recession, at 176 Mcts and declined sharply during the recession but has never recovered and in 2013 was 130 Mcts or 26 percent off its peak.
But while Botswana diamond production went through the most dramatic of decreases simply because it was the largest producer in the De Beers zone, similar patterns of decreasing diamond production were experienced in Namibia and South Africa. Irrespective of the origins, the decline in production has given rise to some of the most spectacular price results seen in the rough diamond market for decades. Unit export values for Botswana rough diamond rose at the their fastest rate since the early 1980’s. This is hardly what economists expect; for prices to rise so rapidly during one of the most sluggish periods of economic growth on record since the great depression of the 1930’s. And yet what it took was simply an act of restricting supply to the market in a perfectly legal way ie. by keeping the stones in the ground. Part of the observed decline was of course the natural decline of diamond mines in Australia and other locations.
No gentlemen in diamonds?
So could Botswana and other diamond producers limit production even further to increase returns? In theory yes, but in practice there are several caveats. Any further restrictions in supply and increases in price could result in even greater incentives to substitute, often illegally, synthetic diamonds which are undetectable to the naked eye for mined diamonds in the production of jewellery. The anecdotal evidence, despite what some of the diamond bourses want to believe, is that nefarious penetration of the diamond market for smaller stones is already occurring in a significant way. While global production is declining China is now the world’s biggest producer by far with no mines to speak of and production estimated at around 6-10 billion carats of industrial diamonds.
But even if the world’s’ diamantaires’ are even willing or let alone able to keep the synthetics out of the value chain for a few more years there is the perennial problem of any such ‘cartel-lite’ approach to managing the diamond markets – it is the problem of chisellers. A cartel whether light or heavy version like the Central Selling Organisation run by so successfully by De Beers until fifteen years ago, is that they are like a marriage between pathological philanderers where the parties want the marriage but everyone wants to cheat ie, chisel on their partners. The nice thing about diamonds is that mined diamonds are really scarce in nature and hence the possibility that when the countries inside the tent decide to cut production that someone outside will just ramp up production as happens so frequently with OPEC and the oil industry is just not there… well at least not entirely.
No Russian Free Riders – Bring Putin in!
Russia has for the last several years just kept its production relatively static but being the world’s largest producer by volume any agreement to keep the diamonds in the ground would need an agreement between Russia and Botswana at very least. Together Russia and Botswana make up some 45 percent of global production. Including Namibia and South Africa would strengthen the arrangement and bring the share of world trade to 55 percent, but the real interlopers at the margin are Zimbabwe ( 10mcts in 2013), Angola(9mcts) and DRC (15mcts) which are significant diamond producers but whose borders are so porous and whose regulatory systems are so opaque that any agreement by them to restrict production would be of no commercial value. Even though promises about output levels from these countries are virtually meaningless it is important that if such an arrangement is ever developed that they are inside rather than ‘outside the tent’. The only other producers of any significance Australia (11mcts in 2013)and Canada (10.5 mcts) would almost certainly never agree to join such an arrangement.
A production restricting ‘cartel lite’ arrangement that focused on the larger diamonds( i.e. grater than melee size ,0.2 carat) and an agreement to limit these rarer but more valuable stones may have a significant effect on the market and would not require De Beers, Alrosa or BHP-Billiton to involve themselves in what would, at a commercial level be an illegal cartel, that would result in legal action by both the EU and the USA. However, this would be a perfectly legal inter-governmental agreement to conserve a scarce resource which all countries have the right under WTO rules to do. An obvious threat to such an arrangement would be new entrants e.g. like the diamond discoveries in Zimbabwe over the last decade. However, new and significant discoveries of diamonds are actually quite rare and the industry consensus is that few major additions to mined supply are expected.
The final possible threat to this sort of arrangement might come from the ‘grand diamantaire’ -those billionaires further down the value chain, who because of their own diamond stocks and massive financial resources were able to destabilize the De Beers control of the diamond market in the early 1990’s. At the time De Beers cartel was able to discipline anyone who got in their way. But those days are now long gone and these ‘grand diamantaires’ must constitute the most serious threat to any supply restricting arrangement. Could they successfully destabilize the market as Lev Leviev did in the 1990’s. If Botswana and Russia were to co-operate then the answer is probably not.
For Botswana this arrangement might work to delay the inevitable decline in diamond revenues for five or ten years. But in diamond deals there are no sure thing and whether an ‘ODEC’ (Organization of Diamond Exporting Countries) that keeps diamonds in the ground succeeds would have a good deal of luck involved- as is always the case with diamonds.
These are the views of the author and not necessarily those of any institution with which he may be affiliated.