Botswana: The New Swing Producer

When the experts of the International Monetary Fund (IMF) issue in-depth reports on a specific country, the governments involved generally listen – especially in developing countries in Africa. These reports aren’t unilateral exercises; they are the outcome of an extensive bilateral consultation process with the relevant governmental bodies.

This month’s IMF report on Botswana particularly focuses on the role of diamonds. But, far more significantly, the report reflects the IMF’s and the government’s understanding of the policies – or the needed policies – to optimize the economy’s benefits from the commodity.

IMF Looks at Botswana’s Diamonds
Somehow, many diamond industry players and stakeholders (such as banks) naively want to believe that the days of the cartel-controlled supply mechanisms, which guarantee growing diamond prices and produce artificially sustained market shortages, are long behind us. The enormous volatility in diamond prices encountered in recent years should definitely prove this.

However, the IMF and, presumably, the Botswana government, see it differently.The IMF sees Botswana increasingly becoming a “swing producer.” According to an economist, a swing producer is “a supplier or a close oligopolistic group of suppliers of any commodity, controlling its global deposits and possessing large spare production capacity. A swing producer is able to increase or decrease commodity supply at minimal additional internal cost, and thus able to influence prices and balance the markets, providing downside protection in the short to middle term.”

In its latest report [Country Report 14/204; July 2014], the IMF warns Botswana that in order to ensure accurate GDP and budget assumptions, “the authorities need to ensure that the forecasting framework accords special attention to the developments in both mineral revenues.” It also points out that “mineral revenues are driven by volume of diamond production and international diamond prices. The former is growing increasingly volatile, as Botswana [is] becoming a ‘swing Producer’ of diamonds and production rising and falling to balance market demand.” [Emphasis added.]

Volatility of GDP Growth
The IMF probably couldn’t care less about the international diamond market. It is concerned about Botswana. Forget about popular perceptions of the role of diamonds in Botswana. The IMF, when looking at GDP growth, finds Botswana “particularly unstable in comparison to a peer group of middle income countries and Southern African Customs Union (SACU) neighbors. This reflects the unstable diamond sector and its impacts on GDP growth year to year.”

In terms of volatility in GDP and volatility in government expenditures (spending), Botswana ranks among the worst countries in the peer group used by the IMF to draw conclusions. (On the other hand, the country’s stability in controlling inflation, averaging annually below 2 percent in the 2002-2012 period, is laudatory.) As, traditionally, diamonds account for 25 percent of the country’s GDP and 33 percent of government revenues, none of this is surprising. We should also not be surprised that the IMF continues to caution that, at some point, the diamond party in Botswana will be over, especially as it warns about “the sustainability of the course of spending in light of anticipated medium to long-term falls in diamond revenues.”

Interestingly, the IMF’s estimates of Botswana’s diamond exports forecast a growing trend in nominal terms: from $4.75 billion in 2012, to $6.63 billion in 2013, rising to $6.87 billion in 2014 (actually, a decline in real terms considering the price increase), to $7.71 billion in 2015, gradually growing to $8.02 billion in 2018.

In terms of carats, the IMF sees a decline in 2014, in which it says Botswana will produce 22.4 million carats (against 22.7 million carats last year), but then expects a slight steady growth to reach 24.9 million carats in 2018. In terms of diamond export growth (in values), it calculates a 3.6% annual growth until 2017, when it jumps to 4.3%.

These “straight lines” are puzzling, because if there were significant “buffer stocks” in Botswana (or, maybe, still at the Debswana mine level), they would be off-loaded in accordance with international demand – something that doesn’t seem to be the case. If Botswana is “stocking” diamonds, if it acts as a “swing producer,” then it is keeping the diamonds in the ground. That’s not a marketing decision; it is underpinned by economics.

Leaving Diamonds In The Ground
As we have written before, though the marketing message of natural diamonds says that “diamonds are forever,” the strength of the marketing and pricing strategies of the producers is fully based on the fact that the sources of production (the mines) are not infinite. The IMF, in that sense, unwittingly and strongly supports the corporate strategy of the main diamond producer, De Beers, followed by others, which is based on the belief that there will be no major new diamond mine discoveries in the years ahead.

The coalescence and congruity between IMF views and the Botswana “swing producer” policies in place are truly remarkable. As we have previously asserted, since anti-trust constraints – if these are still relevant today – have made it impossible to formally control prices through controlling the distribution of rough (and maintain buffer stocks, when appropriate), De Beers is now using its (still around >40%) market share to control diamond prices through controlling its supply – leaving diamonds in the ground.

De Beers produced some 38.1 million carats in 2001, which rose to a peak of 51.1 million carats in 2006 before falling to 27.9 million carats in 2012. Last year, the miner produced 31.2 million carats, and it is expected that this figure will remain constant for a few years before tapering off. We maintain that the company’s marketing and pricing strategy is based on an assumed future “supply shortage” (gap), which will drive prices up.

The Centrality Of The ‘Shortages’ Message
Sometimes, I feel that if the world were to suddenly discover another Argyle and Venetia mine simultaneously, it may be a nightmare scenario rather than a source of joy. (And if these hypothetical discoveries were to be outside of Botswana, the Botswana government and the IMF would need to go back to the drawing board.) Neither De Beers nor Botswana acts as if it feels an immediate or intermediate threat of huge news discoveries.

We recall that it was in 2010 when it became clear that there had been no major new mine discoveries for the last 15-20 years and, thus, it became sensible to adopt a policy of leaving diamonds in the ground and producing only in accordance with demand. Not doing so would reduce prices.

IMF Ignores Synthetics
Interestingly, the IMF ignores the possibility that synthetics (lab-grown diamonds, or LGDs) may upset its supply and demand calculation. This is odd, as already in 2005, the IMF (in an Angola policy report) wrote: “One prospective world development casting a shadow on the [diamond] sector is the potential impact of synthetic diamond production.” (Already in 1987, the IMF warned about the “development of synthetic substitutes and new materials” replacing commodities, something synthetics has caused already in natural industrial diamonds.)

As any additional demand for diamonds (LGD or otherwise) will affect prices, it is almost an existential necessity for Botswana to avoid a situation where LGDs become an accepted substitute for natural diamonds by consumers.

Diamond producers have the right (and even the obligation to shareholders and other stakeholders) to defend their business. A finite product’s producer decision to mine or not to mine is based on myriad considerations; leaving diamonds in the ground also has an opportunity cost – revenues received now could possibly be invested in higher revenue-yield instruments rather than leaving the diamonds in the ground. Much depends on the sophistication of scenario planning.

A rapid acceptance by consumers of LGDs – either as a substitute for natural diamonds and/or as an ecologically/reputational preferred product – will almost automatically trigger a need for producers to consider alternative mining and exploration policies. If the certainty falls away that the prices of those diamonds that are left to mine in the future will be higher, mines would step up production today – even if that means lowering of diamond prices.

Botswana Researcher: Production Policies Must Change
The nation’s leading policy think-thank, the Botswana Institute for Development Policy Analysis (BIDPA), recently issued a position paper calling for an immediate review of current mining policies that aims at decreasing the pace of depletion of current mining deposits in order to enjoy greater long-term revenues. Our postulation on the direct relationship of the entry of LGDs and the policies of natural diamond producers isn’t just theory – there is empirical evidence to support it.

The BIDPA concludes: “The pace and extent of diffusion of technology, the number of countries and firms with access and interest in expanding production means that a policy in Botswana of decreasing the pace of depletion of the existing stock of mined diamonds may prove counterproductive, and the optimum policy may prove to be the opposite i.e. the rapid depletion of existing stocks.” [Emphasis added.]

At the turn of the century, sitting on a huge “buffer stock” of diamonds, De Beers officially abandoned its supply control (cartel) policies, in a relatively short period sold off its stockpile, and supposedly aims at selling whatever it produces. Now Botswana has become the new swing producer, leaving the diamonds in the ground. The IMF seems to support these policies – and they definitely would know better than us.

The only question we would ask is why the IMF identified synthetic diamonds as a policy issue in 2005 (when the threat was mostly theoretical) and has conveniently ignored it in 2014. A position paper by the IMF on this issue would certainly be welcome – and may well be long overdue.