Toadapt the old saw, a great many fresh girls are going to be obliged to makediamonds their best friends before Grib, Russia's newest, and possiblylargest, diamond pipe, can make enough profit to justify digging.
Locatedin Arkhangelsk region, one thousand kilometresnorthwest of Moscow, Grib was discovered in1996; it is the largest kimberlite pipe newly found in Russia. Developed initially byArchangel Diamond Corporation (ADC), a De Beers-controlled company, it was thetarget of a 10-year hostile takeover by Vagit Alekperov and Alisher Usmanov,who between them control substantial Russian oil, iron-ore and steel assets. DeBeers sued for recovery in Sweden and damages in the US.
WithLUKoil, Alekperov's oil company, which wholly owns the local licence-holder forGrib, Arkhagelskgeoldobycha (AGD), De Beers and ADC signed an out of courtsettlement a month ago. This provides for a staged development plan for the newmine, starting with a down-payment of $100 million from De Beers and ADC, oncethe new project framework has been approved.
ADC'sbriefing paper on the deal, dated April 17, suggested there was more value tothe Grib pipe than had been publicly acknowledged before. The Grib mineralresource comprises a large indicated mineral resource estimated to contain 50.2million carats at US$105 per carat and an inferred mineral resource estimatedto contain 24.3 million carats at US$119 per carat to a depth of 774 metresbelow surface. This sums to $8.2 billion.
Accordingto the ADC report, by extending the resource at depth, the estimated resourcerepresents an overall increase in diamond content from the 67.4 million caratsof +1mm diamonds, at an average diamond value of US$79 per carat, firstreported by Archangel in 1999.
Bydigging deeper, ADC claimed there was even more value. Located directly belowthe estimated inferred and indicated mineral resources, an additional potentialmineral deposit has been estimated to contain 6.8 million to 12.9 millioncarats at US$118 per carat to a depth of 1,050 metres below surface, suchestimated tonnage, grade and diamond value are conceptual in nature as theyresult from insufficient drilling to define a resource. If it's possible tomine to the thousand-metre mark, that makes a hypothetical addition of $1.5billion, for a grand total of $9.7 billion.
Thegood news led to the lifting of the trading suspension for ADC shares, and theprice rocketed from 35 Canadian cents on October 31, just before suspension, toC$2 on April 28. Very little volume was traded, as if ADC shareholders werewaiting for even better news. This didn't happen. Instead, on May 1, ADCreleased the NI 43-101 technical report on the Grib project. The 155-pagedocument, drafted by De Beers analysts Johan Ferreira and Wolf Skublak, anddated April 8, took some digesting. Then on May 13, about one million ADCshares were sold, dropping the price by 7% on the day. It has continuedfalling, and is currently reported at C$1.55.
Thedampening news in the De Beers report on Grib is that the net present value(NPV) of virtually every imaginable application of one pit design, calculatedaccording to a half dozen interest rates, turns out to be negative. TheNPVs have been figured for ADC's 50% less one share in the project, after taxesand royalties are paid, and including withholding taxes of 10%.
NMRothschild, acting as financial advisor to ADC, helped with the financialmodelling.
Analternative pit design for Grib reduces much of the projected red ink. But mostof the new NPV numbers are in the double-digit millions of dollars; at verybest, they fail to produce an NPV of more than $398 million. So soon afterthe resolution of the decade of fighting over the diamonds, the NI 43-101report thus begs the question of whether the raiders knew what they weredoing; and also whether this is a diamond mine worth developing.
Severaltiny disclosures in the report represent an interesting footnote to whathappened last November, when a spike of buying demand lifted ADC's share pricesuddenly, and then led to the Torpnto stock exchange's suspension. According toFerreira and Skublak, in July 2007, ADC, De Beers, LUKoil and AGD came to anagreement in principle, set out in a memorandum (the Memorandum) initialledthe same month. This Memorandum was nonbinding and subject to finalisation oflegal, financial and technical due diligence, agreement on a number of keyterms, the agreement of contractual documentation and other matters for theacquisition by ADC of a minority interest in AGD and settlement of thelong-standing Verkhotina dispute.
Thisagreement, apparently confirming the intention of both sides to end thelong-running conflict, has not been revealed before. Nor was the site visit bythe De Beers expert team to the Verkhotina project area and the pipe on September 25, 2007; also disclosed for the first timein the new report. Nor was a subsequent agreement between De Beers andLUKoil in October on designing an open pit mine, rather than an undergroundone, for preliminary valuation and feasibility studies. The new relationshipbetween De Beers and ADC and their former foes at LUKoil and AGD apparently ledalso to the disclosure that, in late 2007, AGD applied to Rosnedra (theRussian Federal Agency for Subsoil use) for approval of licence amendments toallow greater flexibility in the development planning for the proposed mine,and grant more time in which to reach start-up. Rosnedra's authorization camethrough on April 1, 2008.
Ithas long been known, and reported by Mineweb, that in addition to the pressureof foreign litigation, Alekperov and AGD were under the domestic pressure oflicence revocation by the federal authority, with the risk that the asset theythought was theirs - at least to snatch from ADC - might be cancelled, and thenauctioned off to the highest bidder.
WhatADC executives thus knew, following their initial agreement with Alekperov andAGD in July, may have leaked, and become the inspiration for share-buying onNovember 1, the day after ADC hit rock-bottom of 35 cents. For the next day, onno apparent news, the share price went up by 43%. On November 9, share tradingwas halted, and remained so for six months. As Mineweb has also reported, ADCexecutives kept mum throughout the period, when it is now clear they werefinalizing the out-of-court deal that had been reached the previous July.
Sowhat is the value of the deal ADC is offering, and De Beers will underwrite,for a cumulative $225 million to be paid to LUKoil for a 49.99% stake in thenew project?
Notethere isn't much time to gather the required Russian government approvals,notably from the newly established foreign investment review board. Accordingto the April agreement, all conditions precedent must be satisfied prior to 1June 2008 failing which either LUKOIL or Archangel is entitled to terminate theTransaction.
Ferreira'sand Skublak's technical report notes several sizeable mining risks that presentadministrative, political and commercial hurdles that have yet to be dealtwith. Soft rock and high salinity of water in the lower aquifer around thekimberlite mean that the mine pit must be designed with an unusually shallowslope. This in turn requires such a wide circumference for the pit's boundary,it cannot be dug, without going over the current licence boundary. Down below,in order to get to the depths where the added diamond value appears to lie, thewater is so saline, it threatens the surrounding water courses and forest, ifit were disposed of without treatment. Also, the surrounding forest isclassified and protected as two statutory natural reserves. If an open pit isto be cut across the amount of land surface required, the mine licence holdermust get government approval to cut into one protected reserve, and compensateby adding non-mineable land to the second reserve.
Thepolitics of licence modification in Russia are notorious for invitinghostile raiding and greenmail. In addition, the Grib mine will require anagreement on access and use of local infrastructure, such as road and powerlines, which are currently under the control of Russia's diamond miner Alrosa,whose subsidiary Severalmaz is working away at several pipes of the Lomonosovdiamond field, a few kilometres away from Grib. There have been informal talksbetween Severalmaz and AGD, but no negotiation yet between Alrosa, DeBeers, and LUKoil.
Untilthis week, it was unclear who at the federal level would be top dog anddecision-maker for approving the foreign investment structure of the new deal,and supervising the subordinate levels of government in issuing theadministrative clearances. Sources inside the Ministry of Natural Resources andRosnedra have told Mineweb that, although Minister Yury Trutnev wasreappointed on Monday, there is chaos in the chain of command below him. Stateprosecutors are also investigating charges of misconduct by officials engagedin the supervision of mining and resource licences.
AlexeiKudrin, Minister of Finance and Deputy Prime Minister, is nominally in chargeof the Russian diamond sector, and chairman of the Alrosa board. But he is aweak figure, compared to Vyacheslav Shtirov, the president of the Sakharepublic, where Alrosa does most of its diamond mining. Shtirov cannot be surethat in the reshuffle of regional government posts, he will be reappointed tohis. Neither Kudrin nor Shtirov played any part in the De Beers-LUKoil deal.But if the latter and Sergei Vybornov, chief executive of Alrosa, have in mindto participate in the Grib project, either by buying into the LUKoil or the DeBeers stake, they will have to apply for permission from higher authority.
Theweek's new government appointments now suggest that this must be Igor Sechin,the new deputy prime minister in charge of industry. A former KGB officer likethe outgoing president, Vladimir Putin, and the most powerful of his Kremlinaides, Sechin has now taken administrative control of the Russian oil sector;of all movement by land or sea of energy exports; of ports and shipbuilding,and of the raw materials, minerals and metals required for Russian industryconsumption. Sechin, it can also be assumed, will supervise the new governmentboard to review investments by foreign companies in strategic sectors of theeconomy.
Russianlaw has long barred a foreign diamond miner or investor from majority oroperational control of a Russian diamond mine. The new law on strategiceconomic security, which came into force on Putin's signature on April 29,requires government review and approval of all new projects in which a 10%equity stake or more is sought in a diamond mining project by a foreign-ownedcompany. ADC acknowledged the requirement, and also the lack of time, in anotice to the market on May 7: The New Law provides that from the time ofreceiving an application for consent, the Russian Government has up to threemonths (which can be extended by up to a further three months in exceptionalcircumstances) within which to assess such an application and make itsdecision, although it is currently unclear when the procedures for making anapplication will be finalised which could affect the timing of obtaining theGovernment Consent. Given that (pursuant to the current terms of the SharePurchase Agreement among Archangel, LUKOIL and De Beers SociÃ©tÃ© Anonyme withrespect to the Transaction) all conditions precedent must be satisfied prior to1 June 2008, Archangel has commenced discussions with LUKOIL to agree anextension to the 1 June 2008 deadline in order to allow for the obtainingof the Government Consent.
Howlong an extension will be required will depend on how long Sechin takes toarrange the start-up of this Russian equivalent of the Committee for ForeignInvestment in the US. At the moment, there is no telling. It can be said,however, that compared to oil, gas, and metals in Russian production andtrade, the $3 billion annual output of Russian diamonds is so small,there is no record of Sechin having paid much attention to how the diamondconcession has been managed. Putin was compelled to pay more than the usualamount of presidential attention in 2006 and 2007, but that was because ofresistance to the federal takeover of Alrosa by the Sakha authorities, led byShtirov. That having been settled, more or less, last year, the interest on thepart of senior Kremlin officials in the diamond concession has dwindled.
Inthe meantime, the negative sentiment which the Ferreira-Skublak report appearsto have inspired in the market towards ADC is pushing at the underlying diamondvalues, which were used in the NPV calculations. The technical reportacknowledges that average carat values were drawn from the De Beers price bookfor July 2007. Rising diamond prices since then, and long-term projections ofglobal demand outstripping supply, suggest that the dollar values used for theGrib's NPV calculations must be modified upwards.
Inaddition, it is obvious that too little kimberlite has been lifted from Grib,and too few carats extracted, to reduce the margin of error in the financialmodel. It is known that about 800 carats have been sampled from Grib so far.But at least four times that number, or about 3,200 carats would be requiredfor more confident sampling. With an estimated grade of 1 carat per tonne, atleast 3,200 tonnes of ore should be extracted from the pipe for furthercalculations. This is unlikely to happen before next year.