Edahn Golan: Method and Challenges of KP’s Proposed Diamond Valuation System

Mining and Exploration
27/11/2016 21:31

Diamond industry analyst Edahn Golan breaks down the rough diamond valuation system that was one of the key topics this year in Kimberley Process (KP) discussions. The heart of the issue is whether a method can be hashed out so that rough diamond producers receive a "reasonable" (read 'fair') price for their rough diamond parcels on the international market. The solution suggested is that rough diamonds would be valuated by converting the transaction prices retailers and jewelry makers pay for polished diamonds into rough prices, minus the manufacturers' costs and margins. A fine idea in principle, but the question is how it would be achieved. Golan address the how, the feasibility and the trouble spots involved in implementing a workable system. 

How?

The suggested methodology, called 'reverse price engineering" is as follows: The fair price per carat of a rough diamond equals the total price of its polished output, divided by its total rough diamond weight in carats less polishing costs and margin - which Golan calculates at 15%. In equation form: Total Polished Price/Rough Carat Weight  – Costs+Margin (15%) = Rough Price P/C. The precondition is the ability to track the transaction price (not asking price, as on B2B websites) of polished diamonds in more or less real time, and update it continually. An application of the equation: "let’s assume a 0.30-carat polished diamond manufactured from a 1-carat rough diamond sells to retailers for $1,500 p/c, or a total of $450: $450 / 1 ct – 15% = $382.50 P/C. The value of a 1-ct rough diamond that a $1,500 p/c 0.30-ct polished diamond is created from thus equals $382.50 p/c."

Price Discovery Complications - Yield, Identifying & Sorting

"Yield – the size and type of polished diamond that can be manufactured from a rough diamond is a somewhat tricky stage because polishing expertise comes into play here. However, most manufacturers, the largest for sure, know how to polish efficiently and on a grand scale, so variations are limited." First hurdle crossed. The next hurdle is much more complicated, and is one of the chief obstacles to a workable solution, namely: how to obtain uniform agreement on, as well as a methodology to, the 'art' of sorting rough diamonds (by size, model (shape), clarity and color) which is known and applied by sorters on the ground all around the world. Sorters around the world will have to be, "trained to sort the goods in the same way and according to the same protocol ... The importance of this stage cannot be undermined because it reveals the value of the rough goods."

Combining Price Discovery and Identifying & Sorting

The two components, writes Golan, "price discovery and the sorting system, need to connect." The assumed methodology will be that the reverse engineering component will take place centrally, while rough diamond sorting will occur locally by people trained at the various diamond trade centers. "After completing their training, they will be part of what is currently called LIVA – Local Intelligence Valuation Agency – in their country." So when an alluvial diamond digger or a diamond buyer arrives at the customs or diamond office to get a KP certificate and export his goods, the trained customs official would sort the rough diamonds and then multiply the value of each sort of category by the weight of rough in that category. That outcome will be compared to the value the exporter gave the goods (and they should have access to transaction prices for polished diamonds in more or less real time).

Snags & Solutions

After having covered the how and why it is necessary to battle undervaluation of rough diamonds when they are exported from producing countries such as Sierra Leone or Angola, Golan raises several potential problems: "For example, what should a customs official do if a parcel is brought to be exported and the stated value of the parcel is lower than the value the system assigns to it? Conversely, what if the difference is big – how do you define a large difference, more than 5%? More than 15%? More importantly, if the difference in valuation is substantial, what then? Are the goods exported anyway? Is this reported in any way?" And who is picking up the tab? Should producing countries pay for the data collection, system, and training? Or should consumer countries foot the bill?

Golan concludes: "To be clear, there is a solution for everything, and countries where a meaningful quantity of rough is produced by the informal sector are the countries the proposed valuation system could probably serve best. After all, the KP was formed to prevent the trade in conflict diamonds. As such, it protects the integrity of the rough diamond supply chain. It is in this capacity that the rough diamond valuation system was suggested. Its aim is to help prevent wrongdoings in initial valuations that may shortchange producing countries that rely on royalties and taxes from diamonds. No doubt a noble objective."