Alrosa, the Russian diamond mining and trading company, has placed $500 million worth of Eurobonds for a term of five years. This is $200 million more than it had planned to place earlier. The placement of bonds came at the heels of a series of leaks that hinted at a reshuffle of top management and controversial deals.

Alrosa plans to spend the money on modernization of mines, notably the conversion of open pits into underground mines in the Arctic circle region of Yakutia.

According to a Russian diamond-industry source, in order to meet its debts, Alrosa must pump fresh capital into its mines in the Sakha Republic, where old open pits like Udachny have been declining in output faster than new underground mines and new pits have been able to offset.

Keeping output and sales up is vital, said the source. "Alrosa now needs about $1 billion in long-term money, but it already has about $1 billion in short-term debt. In 1998 and 1999 the company was heavily indebted domestically, and devaluation [of the ruble] helped repay those debts when export demand and prices were good."

"Over the next three years," he warned, "there is the danger that export demand and prices will fall; that sales revenues will fall, and production decline, making debt repayment more difficult."

Assuring bondholders that Alrosa has the capacity to solve its problems has proven difficult, especially when many in senior management have been facing charges that they are beneficiaries of a scheme to divert funds from export sales. In April, the Russian state auditor, known as the Audit Chamber, issued a summary of a new set of allegations, suggesting that company executives and kin had benefited from the dealings of a London diamond-trading firm called Arcos.

Alrosa has disposed of charges of tax evasion many times in the past, but what is different about the fresh allegations coming from the Audit Chamber is that they allege that management of the company, in association with the circle around former Sakha President Mikhail Nikolayev, have been the beneficiaries of trading schemes that divert substantial funds from diamond export sales. The Audit Chamber is run by former Prime Minister Sergei Stepashin, who is said to be close to President Vladimir Putin.

Alrosa spokesman Valery Novikov has vigorously denied that Alrosa has acted illegally, and counterattacked with charges that the Audit Chamber has "made numerous violations of their own official procedure." He claimed that Alrosa’s relationship with De Beers Diamond Trading Co., which buys up to $1 billion worth of diamonds from Alrosa each year, would not have survived in such good shape if the allegations were true.

According to a statement released by the chamber, a check conducted in January and February of this year turned up discrepancies in the way Alrosa had managed the London-based firm Arcos, which purportedly conducts marketing operations on Alrosa’s behalf, and for which it receives annual payments from Alrosa of at least 1.4 million Btish pounds (about $2 million).

The auditors claimed they had been unable to document $400 million worth of diamond-sale transactions out of a total of $1.2 billion in transactions reviewed. The auditors also say that they uncovered evidence that Arcos pays a substantial salary to Tatyana Nikolayeva, daughter of ex-President Nikolayev. In the Sakha Republic, Alrosa is the principal enterprise. Nikolayev currently sits in the Federation Council as one of Sakha’s two senators.

According to unconfirmed reports, the auditors’ findings have been sent for follow-up action by the state prosecutor.

Alrosa has been claiming that it has been a victim of incompetent auditing and a deliberate disinformation campaign on the even of bond issue. Novikov told The Russia Journal that "everything that was published so far in the statement of the Audit Chamber concerning Alrosa shows either absolute ignorance on the part of the auditors about the subjects they checked; or absence of a serious desire to really understand what they have studied; or else the reason for such a report may that someone ordered it."

This is a hint that conflict between senior executives of the company, including German Kuznetsov, and Vyacheslav Shtirov, the ex-chief executive office and current president of Sakha, may have spilled into the political arena in Moscow. That might explain some of the very public charges and accusations that have been traded in the recent months.

Market insiders agree that claims by the Audit Chamber are inflammatory and groundless. "De Beers would know more about diamond trade practices than the Russian Audit Chamber and they would never allow such significant amounts of rough stones to leak into the system," said an Antwerp-based diamond trader familiar with Alrosa’s business.

London sources told The Russia Journal that in their contacts with Arcos, company officials had always complained that they were paid too little to afford the high costs of living in London. They added that charges of diversion of funds by Alrosa management are nothing new, but proof has always been lacking. A former Alrosa official close to the senior management from Sakha told TRJ that the charges are "absurd and mean. Not one of these charges can be proved because they are lies."

All abroad

As the company gets a stamp of confidence from lenders, questions linger about its quota policy for domestic trade versus export to De Beers.

Russian diamond manufacturers have told The Russia Journal that Alrosa’s insistence on trading abroad as much of its diamond output as it can does not make commercial sense, from the perspective of the company’s balance-sheet.

They say that domestic diamond cutters offer to buy Alrosa diamonds at a 15-20 percent premium over the De Beers export price. In addition, when it sells its stones for export, Alrosa must pay a 6 percent export duty to the federal treasury.

The local manufacturers say that Alrosa could receive "at least 25 percent" more for its diamonds if it sold domestically, rather than for export. The manufacturers said they have been looking for the reasons reason this does not happen.

Almost all domestic diamond cutters and polishers are critical of Alrosa for holding back on domestic sales in order to maximize exports of rough to De Beers, and then to reserve the most profitable stones for Alrosa’s affiliated manufacturers inside Russia.

Valery Morozov, who heads Ruiz Diamonds, the second largest diamond manufacturer in Russia, told The Russia Journal "unfortunately, the situation with supplies of rough to Russian polishers doesn’t improve, and our potential, which amounts to about $500 million [worth of cut diamonds] per year – is not used to the fullest, but only to about one-third."

Vladislav Antonov, head of Smolensk-Tasche, a Russian diamond cutting joint venture with a Belgian company, told The Russia Journal that his production of polished diamonds fell from $21 million in 2001 to $10 million last year, primarily because of Alrosa’s tactics. "The volumes of production over the past few years decrease due to problems with supplies of rough. The problem of the shortage of rough is common for all Russian polishers. I think that in principle the policy of Alrosa doesn’t correspond to the stated aim of supplying domestic polishing industry first. I think that Alrosa is now moving on a very dangerous path."

Yury Fetisov, head of Mosalmaz, another of the smaller diamond manufacturers, said his firm produced about $30 million in polished stones last year, up from $20 million in 2001. He is hoping to grow to $35 million this year, but that depends, he said, on whether Alrosa makes the rough available. "Our main supplies of rough come from Alrosa. We could increase production by about 20 percent. I think that Alrosa should develop its sales to the domestic market especially because there are problems with sales to De Beers."

"There are always problems with supplies from this source [Alrosa]," added Victor Komissarov, general director of Alpro, another of the small Moscow manufacturers.

In 2002, according to Ararat Evoyan, president of the Russian Association of Diamond Manufacturers, the Russian industry produced up to $850 million worth of polished stones, primarily for export. But affiliates of Alrosa report a sharp drop in their output of polished stones from $140 million in 2001 to $105 million last year.

It is unclear why this happened, and Alrosa sources will not say.

Other industry sources believe that mismanagement is one reason. According to Morozov, despite the favoritism for supply and price which Alrosa accords its manufacturing affiliates in Moscow and Sakha, the ventures "didn’t produce the economic effect that was expected."

Pandora’s mines

An industry source told The Russia Journal that another reason for the decline in Alrosa’s own diamond polishing output is that the company is no longer happy supplying rough to its joint venture in Moscow with Lazare Kaplan Int. (LKI), one of the largest diamond cutters in the United States. Once planned to produce up to $200 million of polished stones per year, the LKI venture is linked to a complex scheme of lending by U.S. banks for mine-equipment purchases by Alrosa. Repayment terms are much more costly for Alrosa, the source told The Russia Journal, than alternative sources of funds, so LKI is no longer in favor.

Evoyan said: "I doubt that aggregate production [of polished stones] in 2003 will be significantly higher than last year. The main reason for that is the deficit of rough supplied to Russian polishers. In general, the year is expected to be a year of stagnation on the world polished market at best.

However, this doesn’t influence Russian production much, as the main limiting factor is the shortage of rough. Alrosa’s domestic sales of rough are not very stable. I hope that if the company will increase its output – which will require substantial investment into underground mines – it will sell more on the domestic market. Russian polishers still offer better prices compared to De Beers."

Morozov, whose company is owned by Lev Leviev, the billionaire Israeli rival to De Beers, told The Russia Journal that Alrosa’s alliance with De Beers continues to disadvantage the domestic manufacturing industry. But he acknowledges that Alrosa’s bid to borrow abroad at lower interest depends on the predictability of the monthly shipments of diamonds to De Beers and the cashflow that results.

"If the Russian polishers would get some of the volumes and the type of assortment of rough that De Beers gets now," he said, "it makes sense to increase production of polished. If instability of supplies from Alrosa continues, and the assortment doesn’t improve much, it may not make much sense to increase polished production in Russia."

Industry sources told The Russia Journal that Alrosa has rejected all attempts to raise and secure foreign funds outside of the De Beers marketing relationship. The sources say that Alrosa is also reluctant to sell rough to the state stockpile agency Gokhran at the price the Finance Ministry sets (roughly 5 percent below market). Domestic cutters buy about $100 million worth of rough from Gokhran each year, but as stockpiles of cuttable stones have dwindled, Gokhran must buy new supplies from Alrosa’s mines.

Just how much Alrosa produces and sells is also in doubt. According to Alrosa’s chief executive Vladimir Kalitin, his company mined $1.466 billion worth of rough diamonds in 2002 – more, he claimed than the company’s target for the year of $1.420 billion. The new figure contradicts an official company statement in January, which indicated that last year Alrosa mined $1.378 billion in diamonds. That figure marked a decline of 17 percent on the 2001 level.

Kalitin responded to speculation among European diamantaires that the company has been unable to meet its production targets, because of a sharper decline than expected at its Udachny open-pit mine, and slower growth than planned at its new Jubilee and Nyurba mines, as well as from its underground conversions.

According to Kalitin, "There is no ground for saying that the company’s mineral-resources base is depleting. We have a mineral-resources base that enables us to produce $1.8 billion to $1.9 billion worth of diamonds per year for 40 to 45 years. Mine output will not be decreasing. We will keep our production at the level of $1.5 billion to $1.8 billion in the next few years and will later increase it." In January, the company projected production this year at $1.41 billion. Another press release, issued on March 5, claimed that by 2005 output would reach $2 billion.

Yury Dudenkov, head of Alrosa’s marketing division, disputes the charges of favoritism. "We consider our partnership with De Beers to be beneficial to us," he told The Russia Journal. He admitted there had been a decline last year in Alrosa’s polished production, but he did not explain why. "The volume of our sales on the domestic market has not been changing much in the past few years," Dudenkov said. "We have sold between 49 percent and 52 percent of our mined rough on the domestic market.

But he also claimed that studies by Alrosa have shown that "it is optimal to supply $750 to $780 million to the domestic market, because if we offer more, buyers on the domestic market take less, and become too selective." Rejecting demands for an increase in domestic sales, and a lower volume of exports to De Beers, Dudenkov said, "we are now at the level of domestic sales which we consider optimal."