When governments enact laws, one must expect and assume that these serve the best interests of the people affected by these laws. The latest draft of the Diamond Amendment Act in South Africa contains some provisions which make considerable sense – and others one could take issue with. What may be difficult to understand is that there is no provision which will allow the DTC to continue to sell the so-called “London mix” to its clients in South Africa. Unlike previous draft, there seems to be no “escape” provision which will allow the producers to negotiate special arrangements with the government.  

The mines may well belong to De Beers, but freedom to sell its mining output in any way it see fit is now being severely curtailed. Actually, the new draft law gives the government the right to demand that all the diamonds produced by De Beers Consolidated Mines MUST be sold to a government agency – the Government Diamond Trader – which will then act as some kind of Diamdel, selling to local industry. The law will give the government the right to purchase everything (at prices set by the Government Diamond Valuator), though in practice it is expected that purchases will be limited to 10% of the De Beers output. We don’t know that for sure; it is up to Minister to decide – and the law gives the Minister the right to revise that level at his/her discretion.

Any and all rough diamond exports, including the De Beers production, will be subject to a 15% export tax. The latest draft did not provide for a lower figure, as had been widely expected. Some traders are concerned that this tax will lead to massive smuggling by almost everybody else – but De Beers will not be able to do so.

The new act requires De Beers – and other producers -- to do three things: 

     First offer everything for sale to the Government Diamond Trader;
     Then offer the remaining goods to the domestic market through a bourse;
     And what is still left can be exported subject to a 15% export duty.

The purpose of this editorial is not to analyze the latest draft, but rather wonder how this will impact De Beers and the domestic market. To view these issues in perspective, it must be recalled that the total 2004 rough diamond mining output of South Africa is estimated at 14-15 million carats worth $1.2-$1.3 billion. Figures are not precise. The total share of the De Beers seven operating mines is 13.7 million carats worth about $1.02 billion at selling values. The average value of the South African production is $70 p/c, though the domestic manufacturing sector uses rough of about $725 p/c.

It is important to understand the particular characteristics of the South African diamond production – it is quality-wise not the best. We would characterize the production as follows:

-          Generally, medium and lower colors including many capes (strong yellow tint);

-          A preponderance of small diamonds from the Finsch mine;

-          Many industrials plus a number of extremely rare larger stones from the old Premier mine;

-          Fine shapes and good quality stones from the Namaqualand alluvial deposits;

-          A good all round range of sizes and qualities from the Venetia mine. Whilst it is a highly profitable mine its production is weighted heavily in the commercial colors and medium qualities.

-          The Kimberley mines and Koffiefontein produce a good proportion of high yielding sawable stones.  However the production from these mines is relatively marginal and high cost as the mines are kept going more for political reasons than commercial.

-          Does not produce many collection goods. Up to piques VS2 the goods are o.k.; however, from S1 and down the piques are very black (and thus easy to see by naked eye).

-          Approximately 19% of the country’s production is rough in excess of 0.67 carats, but once the lower qualities have been excluded (as these are considered non-economical for domestic production), only some 3.5% remains.

-          The better qualities tend to have attractive proportions, allowing for a higher processing yield. These goods are more valuable than comparable rough of lesser models.

Prior to 1992, the South African industry received its rough requirements from the domestic production. In order to decide what rough “must” stay in South Africa, what rough may “freely” be exported (that means without tax and without first being offered for sale locally), or what rough must be offered locally but can be exported if there are no buyers, the government and the producers agreed to divide the South African production into three categories:

(1)   South African Goods: All large stones of 10.8 carats and up. All stones which have a value above $450 per carat, and all fancy colors (in all sizes). These goods MUST be sold to the domestic market and cannot be exported.

(2)   Conditional Goods: These are goods which are suitable for manufacture in South Africa as determined by the industry. These rough diamonds can be exported if the local industry is not willing to purchase these goods.

(3)   Unconditional Goods: These are goods which are not suitable for manufacture in South Africa and can be freely exported.

In terms of carats, some 86.5% of the goods are “unconditional”, cheap goods unsuitable for local industry. The South African goods are only 3.5% by carats; the conditionals are another 10%. In terms of value, however, it is a different story.

In the Past: Subsidized Rough
Most Sightholders were very unhappy with that system (that came about as a result of the Diamond Act of 1986), but the fact that there was a 7%-10% discount on the prices kept the system going somewhat. Then the local Sightholders petitioned the government to be allowed to get a London mix – which gave better assortments, but also raised prices.

It was, if I remember correctly, former DTC director Peter Somner who concluded an agreement in December 1992 which allowed De Beers to take almost all its goods to London and supply South African sights with London mix – provided that certain South African goods would be returned to South Africa (or actually remain in the country) in any event. The agreement has been amended from time to time, with the latest changes made in November 2004.

The so-called “economically cuttable category”, which refers to those type of diamonds which can be profitably processed by the South African diamond cutting industry, presently amount to 51% of the De Beers production by value.

As a sign of good faith in support of the government’s beneficiation policies (and as a bargaining strategy), the DTC sold some $577 million worth of diamonds to the domestic industry in 2004, which is the equivalent of some 57% of the De Beers production by value.

In other words, the DTC is selling MORE diamonds to the South African industry than is required under the present law – a strategy we’ll discuss below in greater depth.

In 2005, the DTC plans for almost $580 million worth of sales into that market, a significant increase over the 2004 figure.

Provision in New Act May Trigger Decline of Industry
Indeed, De Beers Managing Director-Designate Gareth Penny, keen to retain the right which had been negotiated to sell London mix to the South African market, has promised the South African government that he will sell to the local industry far more than the amount of economically suitable rough produced by De Beers in South Africa, provided there is no export tax and no restrictions on exports to London.

 “In 2003,” said Gareth Penny in a policy seminar last year, “only 51% of our production was economically cuttable in South Africa; however we sold the equivalent of 127% of the value of these economically viable goods to South Africa from our London mix. Allow us to take out our goods, and we will sell MORE to the diamond manufacturers in South Africa than the levels required by law.”

It isn’t clear yet whether the Government will accept that deal. The latest draft of the new law requires that all rough must be traded through a government controlled trade center and there is even talk about 10% of all production being sold by government (a “window to the market”) so that there is no uncertainty about the very touchy issue of transfer-pricing. 

The case made by De Beers for allowing it to sell London mix to the South African manufacturers certainly is very persuasive. We noted earlier that the DTC sold $570 million in 2004 to the South African market. A confidential document, obtained by this author, shows clearly that in the better goods the DTC supplied 43% more rough diamonds than it mined in South Africa in these categories in 2004.  This certainly underscores that the demand for better goods by the S.A. cutters greatly exceeds the supply from the domestic De Beers mines.

On the other hand, in the cheaper goods, there was no demand for most of the domestic production, and the output from the mines exceeded the domestic requirements by 39%.

The 43% greater supply of better quality goods to the local market above the level of domestic mining output in these categories, shows that the special (Section 59) arrangements are good for the local industry. Nevertheless, the explanatory notes to the new law say that the development of a local industry has been “hampered” by this arrangement. We don’t understand what prompts that observation.

With the greatest respect for the South African government, which has put enormous efforts into understanding the industry and in thinking how its domestic industry can be most effectively supported, we fail to understand the rationale behind the relevant provisions which will cause De Beers, effectively, to sell more than 40% fewer quality goods to the market.

The explanatory notes accompanying the latest draft state that “at present, the Diamonds Act, 1986 (Act No. 56 of 1986) (‘‘the Act’’), does not drive the beneficiation of the diamond resources in the Republic even though South Africa is one of the largest producers of diamonds in the world. In addition, the Board of Directors of the South African Diamonds Board (‘‘the Board’’) is dominated by the industry and the Board, as an institution, is funded through levies, thereby further strengthening industry control. Government initiatives and policies are not always in the best interest of the Board, resulting in decisions not being implemented or being delayed indefinitely,” says the explanatory note.

“The [existing] Act,” it continues, “does not provide for the local supply of rough diamonds to the local diamond cutting and polishing industry. However, in terms of section 59 of the Act the Board may enter into an agreement with ‘‘any producer, dealer or any association or organization of producers or dealers in pursuance of which any such producer, dealer, association or organization allocates or offers unpolished diamonds ... cutters or tool-makers’’ in order to ensure that cutters and tool-makers obtain a regular supply of unpolished diamonds. There is no obligation on producers to offer a portion of their unpolished diamonds to the local market. Local beneficiation (value addition) is hampered by these ‘‘section 59 agreements’’ with producers in that the majority of producers choose to export rough diamonds for beneficiation elsewhere in the world, creating wealth and jobs in those countries.”

The latest draft of the bill states as one of its specific objectives “to repeal section 59 of the Act. Local producers will have to offer their production to the Trader as the first step in any further dealings by the producers.” If this provision in the new law leads to the reduction of domestic manufacturing capacity by some 30%, which may be one of the ramifications of this clause, it seems that it would be in the best interest of the South African to give some more thoughts to the final-final draft.

If, however, the provision was only included to increase bargaining leverage over De Beers, to get the diamond giant to agree to a whole wish-list of other things, only to “withdraw” the provision at the last moment, we can only salute the government. Somehow, we hope that the conjectured latter option is the correct one. This certainly would be in the best interest of the South African domestic diamond manufacturing industry.