Igor Sobolev Interview with the Federal Media – March 4, 2015

What was ALROSA’s economic performance for the last year to enter 2015?

I would say that 2014 was quite a successful year. We have achieved the planned figures with the production of 36.2 million carats. This is slightly below the figures of 2013, but this decline was planned and caused, among others, by addressing the problems of the Mir underground mine. The production decline has not affected our sales. By early 2014, ALROSA had nearly 18 million carats in stock and part of these rough diamonds was prepared for sale, which enabled our sales departments to operate on the market according to its conditions. With regard to rough diamond value, Bain, the company that carried out an in-depth market study, forecasted that the international demand and international supply of rough diamonds will be nearly equivalent until 2018, in other words it forecasted five years of stable prices. Despite these forecasts, 2014 was rather successful in terms of sales with the prices rising quite fast in the first half-year, while in the second half we faced a certain decline in demand. However, we finished the year with positive results and for the first time in the Company's history we have earned over USD 5 billion from sales of rough and polished diamonds. Our revenue under the Russian Accounting Standards is nearly RUB 159 billion. As for the profit, the situation is ambiguous. The Company's profit under the Russian Accounting Standards is nearly RUB 23 billion. The IFRS final statements have not been prepared yet but we are expecting the loss. It should be noted that we are talking about the ‘paper’ loss, since the International Financial Reporting Standards require that a corporate debt is revised at the rate as at the last day of the year. In this case the Company's rough diamond sales that during the year are recalculated at the rate of the month when the deal was closed. The result is that our average rate at sale is lower than the average rate at which the debt was recalculated. Again, we are talking about the ‘paper’ loss, which does not mean that the Company faces any cash problems, the more so as we have quite a long-term debt and we are absolutely comfortable with it. In 2014 we even managed to reduce our debt by more than USD 550 million due to successful sales. We hope that this year the things will go the other way round. At the beginning of this year the US dollar rate was high and the revenue therefore will be high in rouble equivalent.

On March 10 ALROSA starts mining at Botuobinskaya kimberlite pipe. Could you please tell more about this deposit, what deposit prospects are expected?

We start mining at Botuobinskaya kimberlite pipe because we need to suspend the production at Nyurbinskaya pipe, our major deposit of Nyurba MPD, for the reconstruction. Nyurbinsky open-pit mine has reached the interim level of 300 metres, and now we need to perform operations that would allow us to mine at greater depths. Putting into operation of the new kimberlite pipe was synchronized so as to get the processing capacity of Nyurba MPD fully loaded and to ensure the stable production of MPD of about 7.5 million carats per year. In 2015 Botuobinskaya will produce about 1 million carats of rough diamonds. Later, when the reconstruction of Nyurbinskaya kimberlite pipe is over, both these kimberlite pipes will produce ore at full capacity and we will have a reserve margin in case of any preventive stoppage at any of these open-pit mines. The optimum exploitation of production capacity is one of the major parameters of effective production for any enterprise. MPD consist of numerous facilities, in particular factory, tailings dump, water intake facilities, housing settlement. If the production declines while the fixed costs remain unchanged, the performance of an enterprise sinks to low. We have planned our diamond production so that Botuobinskaya be engaged during the open-pit mine reconstruction period, and then they will be operating in parallel, the total ore production however is still limited by the current processing capacities. Commissioning of Botuobinskaya pipe will not result in the increased production. It will certainly have better diamond content than Nyurbinskaya, and quality of diamonds will be higher. However there will be no radical growth.

In recent years the Company maintained approximately the same production level. In the near future the Company expects production to increase up to 41 million carats. Why this particular production level was planned under the strategy? Is it some sort of technological limit of your processing capacities? Or is it the supply level you consider the best for the market?

There are several factors here. Growth to 41 million carats provided for in our long-term development strategy resulted from our previous years’ investments. All our major projects have already passed the investment stage and now they are at the stage of reaching the production capacity, which is true, for example, for underground mines. The production growth will be driven mainly by Severalmaz. Prior to commissioning of the new processing facilities, it dealt with the production of about 600 thousand carats per year. The production will grow to 2 million carats this year, it will gradually reach 4 million carats by 2018, and at its peak production will reach 5 million carats per year.

As to the sites in Yakutia, our key objective here is to maintain stable production levels. In case an enterprise has certain design capacity, it must be loaded to the maximum. Any decrease or increase has certain drawbacks. Of course we can go for one-time increase of diamond production in Yakutia, but in doing so we would make our prospective situation worse: the faster we mine, the faster the reserves are depleted. We should arrange our work so that our single-industry towns are not adversely affected. The production growth would certainly require the construction of new processing facilities and new investments, and we will not go for it.

And of course we take into account the market situation. The analysis shows that in the last 4 years all major diamond-mining companies have been heavily investing in their development. At the moment the market needs no increased supply which would result in cutting rough diamond prices. Being a major market player, ALROSA is trying to act accordingly and be more circumspect about the international balance between supply and demand to avoid market fever.

With regard to the international production level, the study by Bain shows that from 2018 onward the major part of international capacities will start to retire. Thus, Argyle, a large mine in Australia currently producing 7 million carats, will start decreasing its production after 2018. The deposits are getting naturally depleted. And from 2018 onward the demand for diamonds is expected to outpace supply, i.e. we will start facing the shortage of rough diamonds.

You said that from 2018 onward the capacities will start to retire. And what would be your forecast as to when the production will start growing again?

When forecasting the situation on the diamond market, discovery of new diamond deposits is taken into account. It is worth noting that for the last 10 years no new deposits have been discovered worldwide. Even if assume that some market player discovers a new kimberlite pipe, commissioning of a new deposit takes over 5 years. And during these 5 years the existing deposits will clearly continue to be depleted. Generally speaking, geologists in their forecasts state that all easily accessible deposits with outcrops that have been mined in inexpensive ways are depleted. All international diamond provinces have been carefully researched. Discoveries of new deposits, if any, will be one-time and they will clearly not be able to replace some 30 major diamond deposits currently operating.

Could you please tell us about the Company’s plans for 2015? Do you expect any changes in the strategy this year?

We have approved the long-term development strategy not so long ago, it was last year. In 2015 we expect the production growth up to over 38 billion carats. The growth is driven by the effect that our previous investments start producing. At Mir underground mine we are increasing the production from 500 thousand to 700 thousand tons of ore. Severalmaz is rapidly reaching its production capacity, the second kimberlite pipe, Karpinskogo-1, has been commissioned, and now we are testing the ore processing there. I do not see any factors in terms of production that could change our strategy.

In theory the market situation may change so that the prices fall. In this case, I guess, we will have to revise our production parameters at some low-margin mines. We are constantly analysing these factors and as of today they are not likely to happen.

As to any other operations in addition to the diamond production, at the moment our strategy approved by the shareholders is based on the assumption that ALROSA is a single-product company and is not involved in any other non-core business. The possibility of developing cutting operations is currently being discussed at different levels. I believe that cutting operations cannot be in our top focus area. Even the revenue figures show that rough diamond sales bring USD 5 billion to ALROSA, while polished diamond sales bring USD 100 million.

Once again, the corporate development strategy is approved by the shareholders. For the sake of argument, they can amend it somehow, the world is changing, the market is changing, and the strategy cannot be static.

You have mentioned low-margin deposits. Which projects did you talk about?

I have already mentioned that the world is currently facing natural depletion of deposits. Nowadays we are entering the situation when the investments will go to low-grade deposits, and we have never carried out mining operations at such deposits.

At the moment ALROSA has two deposits planned to be involved in mining in order to maintain the stable production in Yakutia. These are Zarya of Aikhal MPD and Verkhne-Munskoye deposit of Udachny MPD. Zarya kimberlite pipe is a complex one as it has low diamond content and is overlain with a 100-meter magmatic rock. First of all, it requires investing in overburden operations. To reach the ore, we will need 4 years to remove the waste rock. Second, because of this 100-meter overlay we cannot take proper bulk sampling to assess the content and cost of rough diamonds. For this reason all economic calculations related to Zarya pipe include possible risks, for example, the risk of error in respect of rough diamonds. And though geologists state that the sample rough diamonds indicate high prices, in our feasibility study we significantly understate these parameters, we are very conservative in our approach.

However we plan to start mining operations at this deposit. First of all, the calculations show that this project, though not supereffective, is still effective. Second, if we do not commission it, by 2020, mining operations at Komsomolskaya kimberlite pipe at the Aikhal MPD will be over, and the processing plant will be underutilized. The infrastructure must work at full capacity. Zarya kimberlite pipe will be able to maintain the stable production, and this will also mean additional taxes and jobs.

At the moment it is suggested to consider mining at Zarya by a subsidiary which would give it the status of a regional project and the right to tax exemptions. During one of the recent meetings, Yury Petrovich Trutnev suggested that we consider the development of TOR (territory of advanced social and economic development) for this project. All the above should be assessed.

You state that this project has been assessed as profitable so far. Is there any diamond price level where your projects turn unprofitable?

Of course, but it should be understood that this level is different for different deposits. Each mine has numerous characteristics. Apart from rough diamond price, there is content and colour, large rough diamonds prevail in some deposits, and small ones in others. You cannot describe it with just one figure. In fact, this is the reason why diamonds are not investment goods. When you talk about 1 carat of diamonds, you say absolutely nothing, 1 carat may cost tens of millions or several cents only. We have a key indicator, i.e. the cost of ore. Thus, the ore from Internatsionalny underground mine is over USD 1,600 from a ton even in book prices. And there are mines that give USD 80 from a ton.

Is Severalmaz also considered low-grade?

Severalmaz, of course, has quite poor deposits compared to those in Yakutia. However, we have managed to turn it to a project that can be effective. According to our estimates, as early as this year Severalmaz will reach breakeven point in terms of operating margin, it will not be unprofitable as it has been for the past few years. In terms of investments return, the project is obviously a long-term one.

However there are some concealed positive effects that we have not considered in our feasibility study. For example, we have finished supplementary exploration of Pionerskaya pipe that showed the large volume of ore. We have even considered a development project for Severalmaz and studied the possible increase of processing the current 4 million tons to 10 million tons because the existing resource base offers this possibility. However, in view of the factors I have mentioned earlier, we decided to gradually mine all kimberlite pipes of the Lomonosov deposit with our existing processing facilities within 30-40 years. All the necessary funds have been already invested in the project, the costs will not increase any more, and therefore the production increase from 2 to 5 million carats will only improve the performance of Severalmaz.

It appears that the share of Severalmaz in ALROSA production will increase to about 2% under the strategy implementation process. Aren't you concerned about the revenue decline since rough diamonds of Severalmaz are cheaper than the ALROSA’s rough diamonds from Yakutia?

We do not forecast any revenue decline in spite of the fact that rough diamonds from Severalmaz are cheaper than those from Yakutia. Today we are testing the so-called crater part in Severalmaz. Rough diamond concentration in this rock is low. In perspective, by 2018 we will reach the richer ore that was the basis of this project. And as a result we will reach the 5-million carat diamond production without increasing the physical level of ore production.

The company forecasted a 3% rise in rough diamond prices in 2015. However we observe the weaker demand on the market. Does it mean that you will revise your forecast?

We have not revised our forecast in respect of the 3%-rise at this year-end yet, and it would not be right to revise it on the basis of the first two months only. However, the results of January and February show a weakening demand. The clients still have sufficient stocks. We have not changed our prices in January, and we have slightly reduced them in February to support the market. We monitor plenty of factors prior to establishing the prices. We assess the demand and supply, we study publicly available sales performance of other companies, our analysts constantly prepare the information about jewellery sales in the USA, China and India, we take into account the currency exchange rates including the rate of Indian rupee since India is the largest manufacturer of polished diamonds these days. This is a complicated and complex process, and, once again, being a large market player, we should prevent sharp fluctuations and be quite reserved in our forecasts.

According to the recent information ALROSA is ready to start gold mining. What deposit is this and what production volumes are we talking about?

We are not talking about gold mining as a separate business operation, it is an accompanying mining of gold in our alluvial mines. In 2012 our enterprise Almazy Anabara started putting a question about the accompanying gold mining. They found gold in diamond sands of alluvial deposits. It is quite low and the processing of these sands as gold-bearing only cannot be profitable. These sands must be removed from the riverbed, washed, processed, and nobody is going to do all that. However, the process of mining rough diamonds in the alluvial deposits is in fact 99% similar to the process of alluvial gold mining. The sands are delivered to a scrubber, then the heavy residue, i.e. rough diamonds and small stones go to processing, and everything left, including gold, flows into a vault. Technically, a small device can be installed to collect gold parts as they leave the scrubber. In other words, no investments are required, and we will get additional commercial product.

Starting from 2012, Almazy Anabara has been trying to get a state license for the accompanying gold production. Our legislation however does not provide for the opportunity to change the license, only to receive a new one. The regulating authorities suggest organizing a new tender, which we consider unacceptable, given that we have already incurred 99% of the costs and included the gold and platinum reserves in our books. Now the ball is in the court of the Federal Subsoil Resources Management Agency, and I believe, in the near future we will be able to find a solution of this problem. If we obtain a licence in 2015, in 2016 we will be able to get about 200 kilograms of precious metals, and in perspective, when we start mining in the Molodo areas, up to 500 kilograms.

Could you please tell about the programme of passing airports to federal ownership?

Prior to the IPO, we actively started the programme of the non-core assets disposal. At that time the Company was overloaded with subsidiaries and only diamond mining subsidiaries were bringing profit. There were some other subsidiaries necessary for the Company’s current operations, in particular ALROSA-Gaz, Vilyuyskaya GES-3, ALROSA-Lena that provides transportation services. ALROSA owned and still owns the airports. Traditionally there were no other companies in Yakutia capable of funding them. At the same time the airports are located in the regions where even ALROSA does not operate. The question is: if the airports’ operation brings us over 200 million loss each year, why do we need this loss? We have been heard and at the level of the Government of the Russian Federation it was decided to transfer the ownership of these airports to the newly established branch of the federal enterprise Aeroporty Severa (Airports of the North). Now we are working hard on this transfer. We hoped the process to be finished in 2014, but it was delayed due to procedural issues. I believe that in the first quarter we will transfer the small airports, and then airports in Lensk and Polyarny. Mirny airport still remains the Company’s property as it is our base airport. However, we are discussing the question of the state participation in funding the reconstruction of the take-off runway at the airport in Mirny since ALROSA somehow turned to be the only company owing the take-off runway with all other runways long under the state ownership. We offer the co-funding of the reconstruction of the take-off runway to be subsequently transferred to the state.

Nowadays the need to produce high value added products in Russia is widely discussed. In your case the products are polished diamonds. Do you think we should start considering the development of cutting industry in Russia and what is the prospective?

When you use the term high value added products you disregard the cost of the polished diamond manufacture. First of all, the yield is as low as 40%. Second, up to 80% of diamond manufacture costs are labour costs. The cost of cutting one carat in Russia was over USD 100 per carat before the US dollar rate changed, while in India it is only USD 40. In respect of polished diamonds the added value may in fact be high, however the margin is low. ALROSA owns three cutting factories which we, first of all, need to monitor the market. And still, during all this time and with all this support, we could not turn them profitable. If we talk about further development of the cutting industry and its support by the state, then the question is why the state would need to fund the production of luxury goods? There are many other industries that need this support much more, for example some knowledge-intensive industries, mechanical engineering.

Now, after the USD exchange rate plummeted, labour costs in Russia in dollar terms are lower. The question however is whether this is a short-term event or long-term trend. I believe that now, on the basis of several months, it is too early to estimate any projects on the cutting industry development based on this data. Though we certainly understand the state's interest in this project–it implies potential employment and taxes.

You have mentioned that Mir underground mine will reach production of 750 thousand tons of ore by 2015. Does this mean that the Company resolved all problems related to the increased water inflow?

As to Mir underground mine, the projected water inflow together with technical water in the shaft was 40 cubic meters. At some point in 2011 we started to face the inflow of over 200 cubic meters. There was even a time when we feared that mine drainage would fail if the water continued to inflow at the same pace. The mine drainage was projected with the six-time reserve capacity of 240 cubic meters. However, at its peak it reached 1,200. Nobody expected that the pillar between the pit and shaft would be water-permeable. Water inflow also impeded ore breaking by continuous mining machines, and these machines had to operate in slush. The operating safety was affected adversely. At Mir underground mine we use back filling of empty chambers with cement mixtures. If there is a water inflow at the stage of backfilling, the cement will not harden and no safety can be guaranteed. Under these circumstances we could not gradually work to reach the planned design capacity and had to focus on the water inflow problem. In the first half of the past year this was actually the only thing we were busy with. On the very top level of the underground mine we constructed three trident-shaped drifts that collect 90% of water. We have also built the mine drainage with a capacity of 1,200 cubic meters, and in the first quarter it starts operating as per normal. Now, in 2015, the Mir underground mine will produce 750 thousand tons of ore per year, and in 2016 it should reach the design capacity of 1 million tons per year. We will now have the water inflow problem for the whole period of the deposit mining, but now we know how to handle it and we do not make any drama of it, any deposit has its complications.

Nowadays everyone is talking about the need for import substitution and the use of Russian technical equipment only. Do you face any problems with the use of imported technical equipment? Have you already changed your procurement plans in accordance with the new tendencies?

The rising USD rate is clearly the major problem. The machinery that cost 20 million in rouble terms suddenly costs 40 million. Of course we cannot allow such sharp rise to happen, and at the same time it is not clear whether the situation is temporary or long-term. The first thing we did was that we suspended all our purchases of mining technical equipment that does not affect the main production. We have created an interim commission and it reviews the problems of imported technical equipment on a weekly basis. In respect to some equipment we decide to go for import substitution. At Yubileyny open-pit mine we have tested a 136-ton BelAZ, which was developed specifically for us. But the main factor is that we avoid mentioning any specific manufacturer in the technical specification published on our website. If European manufacturers offer us better prices compared to Russian ones, we will purchase their equipment.

But of course each case is to be examined individually. At the Udachny underground mine all our technical equipment is produced by Sandvik. We still need to purchase a few more units. Purchasing a few units of equipment from another manufacturer will be irrational in terms of further supply of spare parts, interchangeability, etc. So we are using quite a balanced approach.

This page was last updated on 12 March 2015 at 18.08