The diamond industry that Rio Tinto is looking to sell out of has a lot in common with the gold industry. There is no investment market overlay as there is in gold, but the physical supply-demand equation is just as tight.
Global production will be worth about $US14 billion this year, with Rio diamond mines, including the 100 per cent-owned Argyle mine in north-western Australia and the 60 per cent-owned Diavik mine in Canada, accounting for about 10 per cent of it, behind Russia's Alrosa group (28 per cent) and the 85 per cent Anglo American-owned De Beers (24 per cent).
The diamonds will all be bought, keeping physical supply and demand in balance, as it is in the gold market, despite the recent gold investment market gyrations.
On a trip to Argyle I took with Rio this week, the boss of Rio's diamonds and minerals businesses, Alan Davies, said the consumer demand outlook is geographically and demographically similar, too. Rio's output is mainly coloured diamonds, and they cater to a "bling" jewellery market that is growing in countries that include China and India, where discretionary income is expanding.
Rio is, however, dealing with a paradox as looks to sell its diamonds business after completing a $2.2 billion underground mining expansion at Argyle that will extend the mine's life until 2020 at least, and cleaning up Argyle's balance sheet by booking write-downs of almost $1 billion in the past two years.
Moves by Rio and other producers in the 1990s to break away from the De Beers diamond marketing monopoly helped create the supply-demand balance that is a key lure for potential buyers, but the breakaway required the creation of independent production and distribution networks: diamonds became a more complicated business after De Beers' dominance faded, and one result is that the list of potential buyers is limited.
Rio sold almost all of its Argyle diamonds through De Beers between 1983 and 1996, and with about 80 per cent of global production under its control, De Beers ruthlessly manipulated supplies and propped up prices by building stockpiles that rose from $US1.5 billion in 1981 to a peak of $US4.8 billion in 1998.
De Beers was never greatly interested in the coloured stones that formed the bulk of Argyle's production, however, and in 1996 Rio decided to independently market all of Argyle's diamonds. De Beers responded by flooding the market with Argyle stones, but the independence movement grew, and in 2000 De Beers announced that its days as the "custodian of the supply side" were over. Diamond stocks were back at "work in progress" levels by 2011 when the Oppenheimers sold their 40 per cent stake in De Beers to Anglo American.
The independent production and marketing network that Rio created to break free of De Beers is topped by three operating diamond mines, Argyle, Diavik and Murowa in Zimbabwe, and a promising development prospect, Bunder, in India. There is a sales and marketing business run from London and Antwerp that includes offices in Hong Kong and New York, a massive subcontract cutting operation in India that is run from offices in Mumbai, and a separate business that sells Rio's most precious diamonds, Argyle Pinks, in tenders that can fetch up to $US1 million a carat.
Rio estimates that global supplies will be flat over the next decade as production at existing mines fades and new mines take longer to find, finance and develop - and potential investors who believe Asia's boom will drive demand higher over the same time could value Rio's diamonds business at $US3 billion or more. The $US5.1 billion price that Anglo American paid the Oppenheimer family in 2011 to boost its stake in De Beers from 45 per cent to 85 per cent implies a similar price for Rio's full suite of diamond assets.
Rio is considering options that range from a full corporate sale or float to a partial sell-down and the sale, spin-out or float of individual assets including Argyle, and its options are fluid because the menu of potential buyers is limited. It is a complicated business, as Davies freely admits.
Rio is right to look for an exit. Argyle will be a second quartile cost performer after underground production ramps up to 20 million carats a year by 2015, but the entire diamond business just isn't big enough for a group of Rio's size. The global diamond industry's revenue this year will be about half as much as Rio's iron ore division books, for example.
There are some tire-kickers, including Rio's 40 per cent partner at Diavik, Dominion Diamond Corp. It paid BHP Billiton $US500 million for another Canadian diamond mine, Ekati, late last year, and would like to own all of Diavik.
With a market capitalisation of about $1.3 billion, Dominion can't have a boundless appetite, however. Rio will be cock-a-hoop if it totally offloads the diamonds division at the price it wants.