Last year, the ‘Knot’, the highly rated American wedding magazine, asked 12,000 newly wed couples whether they had chosen a natural or a lab-grown diamond for their engagement ring. This year they published the result… 36% chose the latter. In context, that’s by weight, not value, and engagement rings make up only 25% of the diamond jewellery market, but even so, that’s a worryingly big number.

In fact, the natural diamond industry is under threat as never before. The Natural Diamond Council does a fantastic job of promoting the “Diamond Dream” but it’s massively underfunded. Russia is (for obvious reasons) persona non grata, and the Kimberley Process is unsuited and unable to bring in the necessary changes. So yet again the industry falls back on the partnership which has given stability to the industry for the last half century – De Beers and the government of Botswana… except you may not have noticed; their relationship may be about to go up in smoke.

The 50:50 joint venture

By way of background, the Government of Botswana and De Beers both own 50% of Botswana’s largest diamond mining company ‘Debswana’. The profits are split 81.8% to Botswana; 19.2% to De Beers, but the development capital is split according to the shareholding, i.e. 50:50. So (in just one example) for its 19.2% profit share, De Beers pays half the costs of the $2bn ‘Cut 9’ development at Jwaneng (which only comes into production in 2027), and half of the $6bn to go underground (which will only come into production in 2034). That profit ratio, which is so in Botswana’s favour, would scare away most global mining companies, but it worked because the mines were so rich that it was a reasonable return (although as the mines get deeper, the increasing costs don’t make it as attractive as it once was), but more importantly it also worked because De Beers sees this as a partnership where the people of Botswana must be the main beneficiaries, for the betterment of all the people.

To their credit, De Beers continues to make a significant financial, environmental (not least in the Okavango) and social contribution to the country. During Covid, De Beers secured half a million Moderna vaccines for Botswana and contributed millions of dollars to support local communities in the procurement of medical supplies, logistical support, vulnerability assessment support plans…etc, Why? – it’s part of their DNA.

The marketing contract

De Beers had a ten-year marketing contract whereby 25% of Debswana’s production was sold direct through their wholly owned auction company (Okavango Diamond Company – ODC); 40% was sold by De Beers to diamantaires who cut and polished some of their diamonds in-country and the remaining 35% De Beers sold to their own customers. If they sold the diamonds for more than the expected price, they shared the upside with Botswana; if prices fell, they took all the pain themselves. A 5% fee covered the costs of sorting and sales (any profit remaining was split with Botswana) and De Beers received a further 5% marketing fee, which (only partially) contributed to De Beers’ corporate overheads, its funding of 50% ($45mn) of the Natural Diamond Council, and tens of millions of additional marketing for promoting ‘ForeverMark' and ‘De Beers Jewellers’, all of which went to promoting natural diamonds (Botswana also owns 15% of De Beers).

De Beers has also built a state-of-the-art diamond tracking system (Tracr) ‘best-in-class’ diamond grading (IIGDR), is the only diamond company to spend millions on R&D to defend the ‘integrity’ of natural diamonds… the list seems to go on and on, but all of these benefit Botswana. I challenge anyone to find a better deal in any other country.

Yet three years ago this marketing agreement came up for renewal, and it has been rolled over again and again, but next month is D-Day. Why is it still unsigned? Because the President of Botswana, President Mokgweetsi Masisi, has decided that he has found a much better sales model which will transform Botswana’s revenues from diamonds. That model is based on the current sales agreement between Canadian listed Lucara Diamonds and diamond manufacturer HB Antwerp…. and it was reading Lucara’s recent results which jogged me into writing this article. It also seems that the government has taken against De Beers… but let’s have a look at what has got President Masisi and the Botswana government so excited.

The HB/Lucara agreement.

Since mid-2020, Lucara has sold its +10.8 carat diamonds to HB, who use their proprietary technology to calculate the value of the polished outcome; Lucara receives an ‘initial payment’ based on a (undisclosed) percentage of that value. HB’s fees haven’t been made public, but market insiders suggest they take a 5% manufacturing fee and 15% margin (total 20%). When the polished diamond is sold, HB makes a ‘top-up’ payment to Lucara for the difference between the ‘initial payment’ and the sale value (minus HB’s margin). In the event that the polished diamond sells for less than the initial payment (plus HB’s fee) Lucara has to reimburse HB.

What can they do for Botswana?

You can only congratulate HB… what a great deal – they are achieving margins that most manufacturers can only dream about – by my estimate, their revenue to date from this deal (costs plus margin) is around $86mn (19.4% of the total polished value – seems to add up!).

But isn’t this also a game-changer for Lucara, and by inference, Botswana? To find out how good it is, you only have to read the numbers that HB are being quoted on. Just to grab a couple…   

• In October last year, an article in Botswana’s ‘Sunday Standard’ entitled “Masisi to ditch De Beers for Lucara and HB Antwerp?” quoted HB founder Rafael Papismedov (better known perhaps as an adviser to Congolese President Felix Tshisekedi… “with Lucara, HB Antwerp has… increased the market price per diamond by more than 45%”.
• Another article in the same newspaper stated that HB “… promises a more than 45% increase in Botswana’s diamond revenue…”.
• Just in case you missed that, Africa Intelligence recently quoted HB Antwerp as claiming that their agreement allowed ‘Lucara Botswana’ “…to earn 40% more than it would from selling at rough diamond market prices!”. These guys are obviously geniuses.

But before we start doing high fives around the room, let’s just double check the numbers, because if these claims have merit, we should be saying so; if they don’t, it’s even more important to call it out.  

Outside impact of Lucara’s results 

Lucara’s agreement with HB commenced in the second half of 2020, but three factors impacted short term; first Covid; second, the time lag between rough diamonds sold to HB and their final sale in polished form; and third, a longer time lag to polish the larger, more complex stones. All of which meant some of the ‘top-up’ revenue would be outstanding at any given time. But the good news was that the wind was in Lucara’s sails; +10.8 carat diamond prices performed well during the pandemic and rose significantly in the boom of 2021 (even if they have come back down since).

What their results actually tell us

Using the numbers in its quarterly reports since the agreement started, Lucara has received ‘initial payments’ from HB of $285mn (for 56,066 carats), and ‘top-up’ payments of $73mn (a 25% premium net of HB’s fees) equal in total to $6,385 per carat.

But that 25% premium is not all ‘value added’. Lucara have never claimed that the ‘initial payment’ is the market price of a rough diamond – it patently isn’t, by the way. It is a set (undisclosed) percentage of what HB decide is its polished value. Even if an independent valuer gives a market valuation on the rough diamonds (I have found no proof that they do), that comparison isn’t shown to shareholders who might want to make their own judgement, but in truth, I’m not a shareholder so, so what? because it’s very important when looking at this from Botswana’s perspective, so let me explain in numbers.

The value of the 10.8 carat diamonds in the ground

Since the HB agreement was signed, Lucara have mined almost exclusively from one part of the deposit (not in Q1 2023, but most of the diamonds sold would have been recovered in Q4 2022), the high value South Lobe – M/PK(S) and EM/PK(S).

In December 2019, Lucara published an ‘NI 43-101 Technical Report’ and in the ‘value distribution model’, the ‘+10.8 carat diamonds’ in the South Lobe had an estimated rough diamond value of $7,600 per carat (importantly this model excludes exceptional diamonds like the 813 carat Constellation which sold for $63mn). Yet with the HB deal, Lucara have only realised $6,385 per carat. To be conservative, I’ll add on an assumed $25mn of ‘top up’ fees still to come through: still only $6,831 per carat … where’s this fabled 40% premium? They can’t even get to the resource numbers.  

Maybe they weren’t recovering larger stones? Except the eight quarterly reports for 2021 and 2022 all quote words to the effect of… “recoveries during the quarter were within the expected range of the South Lobe resource model. I think a pig just flew past my window.

Let’s deal with a simple truth about the diamond business. The diamond industry is filled with some of the brightest and sharpest traders in the world: most are razor sharp! No diamantaire is going to pay one company 40-45% more for a polished diamond than he can get from someone else. GET REAL!  

Is there an easy solution? Of course! Let HB tender for +10.8 carat diamonds at ODC’s auctions along with everyone else, then they can buy them at market price and demonstrate that they can make this fabled 40%. Hold on, though, there’s a better way. In its recent tender, ODC didn’t sell about $20mn of diamonds because the bids weren’t high enough. Since ODC knows what those bids were and therefore what the prevailing market price was, why doesn’t the government ask HB to buy those diamonds (at those prices) to demonstrate how they make an additional 40%. If they do, I’ll eat my hat … don’t worry, my hat is quite safe.

What is the government up to? I can quite see why they want 24% of HB…it’s a money printing machine, but for whom, and at what opportunity cost to Debswana (and let’s not forget its partner De Beers)? At the same time, they seem to be ‘allowing’ a concerted media campaign to attack De Beers… to squeeze the last pips out of the lemon. I’ve literally just read a very recent article in the (Botswana) ‘Sunday Standard’ to see the claim that “Research has revealed that De Beers makes upwards of 300% more from Botswana’s diamonds than [the] Botswana government mostly from jewellery manufacture and retail”. Really? Anything to do with jewellery sits in De Beers Jeweller’s (DBJ) accounts, and in 2020 DBJ lost $15mn on sales of $139mn and in 2021 DBJ lost $13mn on sales of $164mn (2022 hasn’t been filed yet). Whatever the journalist is smoking could he please share it around! There won’t be any winners from this fight… but it does have the potential to harm everyone, especially Botswana.

The message to Botswana’s parliament and the whole country must surely be: it takes decades to build up the enviable reputation Botswana has; it only takes a few weeks to damage it permanently. Why is the government doing this? Why are they putting up a huge sign saying “Botswana isn’t open for business”?

 

Richard Chetwode holds a number of non-executive roles in the diamond and property industry. He is a part-time journalist and is currently writing a book on the diamond industry in World War II (“When Diamonds changed Forever”). All the opinions in this article are his own but while efforts have been made to ensure the accuracy and reliability of the information provided in this article, neither can be guaranteed. and information in this article is strictly for informational purposes and should not be considered investment or financial advice. Consult your investment professional before making any investment decisions.