Ukraine Conflict: No Easy Answers for Diamond Business

Pranay Narvekar, partner at Pharos Beam Consulting LLP, is a leading expert on many of the crucial strategic, financial and structural problems facing the diamond industry pipeline. He can be reached at pranay@pharosbeam.com

War, in any form or for any reason, always has a catastrophic impact. This is true of the Ukraine conflict and the world has clearly expressed its deep sympathy for the country's people.  War also can significantly upend businesses and their strategies, both locally as well as globally.  The conflagration will probably have that outsized impact on the diamond business.

The diamond industry entered 2022 after a stupendous 2021, led by robust U.S. consumer demand with significant profits across the value chain.  Even without the Ukraine conflict though, 2022 was expected to be much tighter. The year started with a frenzy of speculative buying, quite opposite to underlying fundamentals. Many companies, flush with profits made in 2021, looked to restock or trade in both rough and polished, but the Ukraine conflict provided a rude jolt.

Financial sanctions were the weapon of choice for most large nations.  Russia accounted for about 25-30 percent of all rough diamond supplies and a disruption on those supplies will have a severe impact on the supply chain.

The absence of rough supplies from Russia in the last couple of months actually allowed the midstream to digest some of the excess purchases they had made during the first two months of the year and it can probably make do without it for a few more.  However, the industry is very worried about the long-term impact of the sanctions on Russian rough. From a diamond industry perspective, there are two issues, which need to be separated. 

The first is the imposition of sanctions by the U.S. government.  The initial round of sanctions on direct purchases did not have any significant bite, as there was very little direct rough coming to the United States from Alrosa.  The more recent inclusion of Alrosa on the OFAC Specially-Designated Nationals (SDN) list is a much more serious issue.  Banks are unable to process any payments which were meant for Alrosa. Even transactions through non-dollar currencies, which did not route through the U.S. (and hence were not under sanctions) also stopped as banks decided that they could not risk penalties from the U.S. government.

Most rough diamonds are polished in India, especially Russian diamonds, which are smaller and of slightly lower quality.  Russia's share of these diamond categories increased after Argyle stopped production. In many cases the value added by labor is more than 30 percent of the polished price.

In India alone, the 35 million carats of Russian rough probably provides direct employment to 200,000-250,000 polishers (with about 1 million family members), most of whom earn less than $4,000 per year.  This would be more than 35 percent of polishers in India.  Including the indirect workers and their families, there could be a potential impact on the livelihood of 2-3 million people.

Interestingly, other rich countries, have made exceptions to the sanctions on Russia for commodities like oil, gas, uranium and titanium which could significantly affect their local industries[PN1] .  It would be interesting to see if the Indian government too tries to ensure access to the Russian rough, especially with the state which has been affected the most expected to go into election season.

The second issue is that companies (retailers and brands) have decided, due to moral, social, or political compulsions, that they would not want to want to buy diamonds polished from Russian rough. 

This scale was unlike anything we have ever seen before. In the past, efforts had been made on similar sanctions on other countries, which did not have a major impact on the pipeline.  But this time it might be different.

Segregating the pipeline has always been theoretically possible, but managing such a procedure would be costly and it would not be equally shared.  It is quite straightforward for the larger stones which are typically certified, as these are tracked individually through the supply chain.  These also account for a big chunk of value of the diamond production.

The challenge for tracking Russian origin rough lies in the smaller stones, many of them Russian[PN2] , which are mixed and remixed multiple times before they are finally polished.  It becomes almost impossible to economically track these small stones through the system. 

In the past, the U.S. consumers did not show an inclination to bear these segregation costs, but that might be different this time around. Our past work on this showed that the cost for the entire pipeline would be nearly $1 billion of additional midstream cost, or nearly a 5 percent extra cost on the polished side.

If such a large chunk of the diamond supply is unavailable, retailers and brands could face stock unavailability, especially in the main Christmas season.

Based on the profile of the Russian goods, certain types of polished could see a shortfall of up to 50 percent, if Russian supplies are not available.  Other rough producers would clearly be the beneficiaries of this outcome, but unless they increase production, polished prices and the price points at which that jewelry is sold might need to be reworked upwards, to adjust for the non-availability.  This could significantly impact the overall demand for jewelry in those markets.

Retailers and brands could also look to increasing the share of laboratory grown diamonds (LGD) with few companies already taking such steps. But LGD supplies are also finite, especially when it comes to the small diamonds, and prices would undoubtedly benefit from the supply shortfall.

The Ukraine conflict has meant that almost the entire diamond pipeline is in an uncomfortable position, with no easy answers.  A long and drawn-out conflict would only result in a painful adjustment for the entire pipeline and significant increase in jewelry prices for the consumers.  As always, the consumers will vote with their checkbooks and determine the exact impact on every company in the pipeline.

This article also appears in the current WDC newsletter.