Double deals in Russia's new stone age

According to De Beers, Moscow is not playing fair in the diamond game. Paul Farrelly reports

It Was a sprawling, concrete, Soviet monstrosity of a hotel in which the great and the good of the Russian diamond industry gathered for a glittering reception on the Thursday before Christmas. The celebration? Russia's accession, after 40 years of production, to the Inter- national Diamond Manufacturers Association.

One by one, at the Moscow Renaissance Hotel, the power brokers of this most byzantine of industries, lauded Russian achievements. Alexander Livshits, the finance minister, gave a glowing tribute; then came Yevgeny Bychkov, newly installed at the top of Russia's manufacturing club.

However, Ray Clarke, the head of De Beers' office in Moscow, was unusually muted. De Beers' director, Tim Capon, explained last week: "Wisely in his speech, Ray limited himself to saying just a few words of congratulations."

Mr Clarke's reticence was due to the fact that the day before, after taking part in a marathon talks session, De Beers had finally tired of Russian duplicity over diamond leaks. From Tuesday, the South African giant - which controls two-thirds of the world's diamond sales - will no longer buy Russian gems unless it revives a dormant deal that was finalised in September. Meanwhile, De Beers itself has announced sales of $4.8bn for 1996 - an all-time record.

The Russians, though, are fighting too - among themselves for control of one of their top hard-currency earners.

Mr Capon said: "Either the agreement is ratified, or it is ditched. We are happy to buy from Russia, but only on a fair basis. They will probably want to sell a significant shipment in January. And we will discuss it with them."

Relations with Russia have never been easy. In the early 1960s, at the height of the cold war, Krushchev and Brezhnev denounced South African apartheid. But behind the scenes, business went on.

In 1963, De Beers' chief Ernest Oppenheimer wrote in its annual report that a Russian boycott meant trade was off. Secretly, though, he cut a deal to buy all of Russia's diamond exports, an arrangement that persists, by and large, until this week.

Russia first entered De Beers' cartel in 1958 after discovery of vast deposits in Yakutia - now the semi-autonomous republic of Sakha - 5,000 miles east of Moscow in Siberia. Until then, De Beers' Central Selling Organisation (CSO) had been dominated by Angola, Namibia and the South African industry built up by De Beers' buccaneering founder, Cecil Rhodes.

Now, Russia is the second largest producer by value, behind Botswana which was co-opted by the CSO in the1970s. Last year, Russia sold $1.4bn of rough diamonds, a fifth of the world's total. Sakha's Udachny mine is the world's second biggest after Australia's Argyle, the big new arrival of the 1980s. Leaks were always a feature of the trade. But by 1995, they had reached epidemic proportions - worth more than $1bn a year - threatening De Beers' ability to mop up gems and hold up the prices. In February, De Beers finally reached a new outline agreement with Almazy Rossii-Sakha (ARS), the joint Moscow and Sakha firm that markets Russian output. The deal was to be for three years, not five; and there was a guarantee to give Russia 26 per cent - $1.2bn - of global sales. Finally, Moscow's huge, leaky stockpile was tied in.

This deal also eventualy included letting the pick of $650m of stones go to Russia's own cutting industry. De Beers would buy the "rejects", but only if the other $550m was "run of mine" - that is, a normal sample of production.

According to De Beers, however, the Russians showed bad faith all round. Leaks started again in June, in the run-up to Boris Yeltsin's re-election, and have escalated to reach $500m this year. The company also suspects the Russians of cheating on official supplies. "We were getting shipments that others had cherry-picked. We were treated as a dustbin," Mr Capon said.

However, De Beers still holds some cards. Russian stones are mostly small, the market least crucial to the company. In June, Argyle, a small- stone producer, quit the cartel. De Beers hit back by cutting bottom-end prices - while luxury price rises stuck. Now, while dealers in the top cutting centres of Antwerp, New York and Israel, are celebrating this Christmas, India's industry, at the bottom, is in turmoil.

"From the quality coming out of the Russian stockpile, it appears that it is running down," said Roger Chaplin, mining analyst at brokers T Hoare. "There will be more pressure on small-end prices. That is not good news for Russia, nor Argyle, but not necessarily bad for De Beers."

De Beers also has some Russian allies. And the country needs hard currency. Last week, ARS chief, Vyacheslav Shtyrov, complained to the Moscow government about delays in the deal. ARS needs to invest in its mines and a $500m loan through the National Westminster bank depends on a deal with De Beers.

Ultimately, however, Russian politics, helped along by De Beers' upping the stakes, will be the ultimate arbiter. Mr Shtyrov's stance reflects a battle between Sakha and Moscow for control of the industry. There is much to sort out. The Russian tax police are now investigating ARS and Moscow, too, is riddled with intrigue. Mr Livshits' finance ministry is tussling with the industry ministry for control of the key Committee for Precious Metals and Stones, Komdragmet.

The re-emergence of Mr Bychkov is hardly a good omen. A key Yeltsin confidant, he has long been a thorn in the sides of ARS and De Beers. He was fired in February as head of Kondragmet after allegedly raking off money from illicit diamond sales.

Statements in the past few days also point to a struggle between the Kremlin and Prime Minister Viktor Chernomyrdin for the glittering spoils.

"Diamonds are one of the few things they can readily turn in to hard cash," Mr Capon said. "So we are reasonably optimistic that we could conclude a deal, if they resolve these issues."