Beneficiation and Job Creationin the South African Diamond Industry

A Mining Industry Perspectiveon the Diamonds Amendment Bill 2005

1

Submission to the Parliamentary Portfolio Committee on Minerals and Energy by the Chamber of Mines of South Africa

12 October 2005

Confidential

2

IntroductionRole of the Chamber and Who is Being Represented

Since its establishment in 1887, the Chamber of Mines has established itself as the pre-eminent voice of South Africa’s private sector mining Industry.By 2004 the Chamber represented both large and small, local and international mining companies, and its members accounted for 90% of the country’s mineral production by value.The Chamber’s 4 diamond members account for nearly 100% of South African diamond mining production.A Chamber task team on diamonds was established to produce a Chamber response to the Diamond Amendment Bill.

Confidential

3

Overview of presentation

General principles of beneficiation

Assessment of the economic impact of the Diamonds Amendment Bill

Conclusion

Confidential

4

THERE IS BROAD SUPPORT FROM BUSINESS ON THE OBJECTIVE OF ADDING VALUE (BENEFICIATION) TO SOUTH AFRICA’S MINERALS

The mining sector and business in general is of the view that adding value to South Africa’s minerals is a meritorious objective.

Of course the key questions include:

– How to define beneficiation?

– Who are the lead agents to drive beneficiation?

– How to encourage/facilitate beneficiation?

Confidential

5

BENEFICIATION IS AN OFTEN MISUNDERSTOOD CONCEPT -

The term beneficiation elicits mixed reactions, but much is based on the view that South Africa is exporting all its minerals in “raw form” and that employment and extra revenues are forfeited to the advanced and developing countries that do all the processing.

Much of the attention is on why the South African mining sector allows this to happen? This happens without sufficient investigation of what type of beneficiation is being talked about and who the key actors should be?

Yet significant beneficiation does take place in South Africa – where the commercial opportunities exist and depending on how beneficiation is defined.

Confidential

6

A WORKABLE DEFINITION FOR MINERALS BENEFICIATION

“The term beneficiation, used broadly to describe the successive processes of adding value to raw materials from their extraction through

to the sale of finished products to consumers, covers a wide range of very different activities. These include large-scale and capital-intensive operations like smelting and technologically sophisticated refining as

well as labour-intensive activities such as craft jewellery”.

Minerals Policy White Paper, Oct 1998

Confidential

7

THE FOUR STAGE BENEFICIATION PROCESS

Stage Mineral beneficiation process category

Process flow-chart Labour intensity

Capital intensity

1

2

3

4

The action of mining andproducing an ore or

concentrate (primaryproduct)

The action of converting aconcentrate into a bulktonnage intermediate

product (such as a metalor alloy)

The action of converting theintermediate goods into a

refined product suitable forpurchase by both small &

sophisticated industries (semis)

The action ofmanufacturing a final

product for sale

Run-of-mineores

Washed &sized

concentrates

Mattes/slags/bulk

chemicals

Ferro alloys /pure metals

Steel/ alloysWorkedshapes &

forms

Workedshapes &

forms

Workedshapes &

forms

High High

Low High

Low High

Medium tohigh

Medium tohigh

IndustryCluster

Mining

Mining

Refining /Manufacturing

Manufacturing

Mining

Manu-facturing

Confidential

8

DEFINING BENEFICIATION

MINING BENEFICIATIONMining has competency/skill in the mining and in certain

parts of the concentrating/refining areas.

MANUFACTURING BENEFICIATIONManufacturing companies have core skills and competency

in this arena (understanding customer needs, product development, design, skills, markets, distribution chains,

technology).

Confidential

9

THE SEPARATION OF MANUFACTURING BENEFICIATION FROM MINING BENEFICIATION IS VERY IMPORTANT

This is a crucially important issue because much of the focus in the beneficiation debate has been on why the mining sector has not done enough to drive the manufacturing/fabrication beneficiationarea - despite acceptance by the DME and government that the beneficiation being focused on is at the manufacturing level.

Given the globally accepted and driven Anglo Saxon model of specialisation, it is very unusual to see a mining company operating at all levels of the value chain.

Confidential

10

DOES THE AVAILABILITY OF MINERALS CONSTITUTE AN ADVANTAGE FOR THE MANUFACTURING BENEFICIATION SECTORS?

For precious metals and diamonds the products are generally available in any of the world’s markets at internationally determined prices.

The vast majority of manufacturing beneficiation (jewellery fabrication and diamond cutting) takes place in countries that produce little or no mine production of precious metals and diamonds.

So the answer is that the availability of mined precious metals and diamonds at world determined prices is not an advantage.

Confidential

11

Global share of diamond mine production by value versus global share of diamonds cut and polished

by value, 2004

0102030405060

Botswan

a

Russia

Canada

South

Africa

Angola

DRCNam

ibia

Austra

liaBelg

ium

USA

Thailand

, Chin

a & othe

rs

Israe

l

India%

of w

orld

tota

l

Mine production by value Cut diamonds by value

Confidential

12

Gold, share of world mine production by volume versus share of jewellery fabrication by volume

2004

0

5

10

15

20

25

South

Africa

CISUSA

Austra

liaChin

aPeru

Canad

aInd

ones

iaBraz

ilUAE

Pakist

anMala

ysia

Egypt

Saudi

Arabia

Turkey Italy

India

% o

f wor

ld

Share of mine production volume Share of jewellery production

Confidential

13

MANUFACTURING BENEFICIATION IS DRIVEN BY COMPETITIVE ADVANTAGE ISSUES & NOT BY THE AVAILABILITY OF RAW MATERIALS

COMPARATIVE ADVANTAGE issues such as natural resources are no longer considered to be a key driver of

manufacturing beneficiation investment.

COMPETITIVE ADVANTAGE issues such as cost competitive production, skills and craftsmanship, etc., are now the key drivers of manufacturing beneficiation

investment.

Confidential

14

WHAT ARE THE KEY DRIVERS OF THE MANUFACTURING BENEFICIATION INDUSTRY (E.G. JEWELLERY FABRICATION)?

Competitive production, high productivity, low costs vs competitors.Craftsmanship and specific skills.Access to markets (domestic and foreign). Most successful jewelleryproducers have started with a large domestic market.Good market intelligence (what customers want, the latest designs?)Low costs of doing business (red tape, labour laws).Low materials funding costs (i.e. low interest rates).Duty free, VAT free and low tax rate areas for manufacturing.Quality assurance (Hallmarking) for final markets.Research & development & innovation incentives and capabilities.Appropriate and competitively priced infrastructure.

Confidential

15

A comparison of corporate tax rates, KPMG Survey 2003 and 2004

05

1015202530354045

Japa

n

USA

Ger

man

y

Sout

h Af

rica

Can

ada

Indi

a

Arge

ntin

a

Fran

ce

Braz

il

Chi

na

Mex

ico

New

Zea

land

Turk

ey

Aust

ralia

Indo

nesi

a

Peru

Thai

land UK

Kore

a

Cze

ch R

ep

Mal

aysi

a

Portu

gal

Boliv

ia

Taiw

an

Ukr

aine

Rus

sia

Pola

nd

Slov

akia

Hon

g Ko

ng

Chi

le

Hun

gary

Irela

nd

% ta

x ra

te

Confidential

16

Relative labour productivity as measured by value added per US$1 labour purchased, 1999/2000 (source UNIDO)

5.4 5.35.0 4.8 4.7

3.73.3

2.5 2.42.0

1.7

0

1

2

3

4

5

6

Irelan

dS-K

orea

Turke

y

Brazil

China

India

Malays

ia

USA

Poland

South

Africa

New Ze

aland

US$

val

ue a

dded

Confidential

17

Overview of presentation

General principles of beneficiation

Assessment of the economic impact of the Diamonds Amendment Bill

Conclusion

Confidential

18

Key Questions

Positive Impact of Bill Negative Impact of Bill

Access to diamondsAccess to diamonds

Competitiveness of manufacturers

Competitiveness of manufacturers

Jobs in beneficiationJobs in beneficiation Jobs in mining production

Jobs in mining Jobs in mining productionproduction

Competitiveness of mining producers

Competitiveness of Competitiveness of mining producersmining producers

Other issuesOther issuesOther issues

What is the balance?

Note: We have answered these questioned in our written submission to the PPC. In this presentation we high-light the core arguments. Data differences between the two submissions are due to more information having become available since the written submission.

Confidential

19

Access to diamonds, in principle, will be increased

19 SA sight-holders

113 mid- / long-term customers

[no pre-selection]

SDT selected customers

Low volume, high quality / value

TranshexTranshex othersothers

Diamdel

Diamdel

DTCDTC

SDTSDTDEECDEEC

>90% of volume

De BeersDe Beers

Weak data

on how SDT will select customers

Weak data

on likely DEEC price levels

Weak data

on potential effects of ‘cherry

picking’

Current Anticipated*

19 SA sight-holders

113 mid- / long-term customers

[no pre-selection]

Privately selected

customers

Tender housesTender houses

Diamond Bourse

Diamond Bourse

>90% of volume Low volume, high quality / value

De BeersDe Beers TranshexTranshex othersothers

Diamdel

Diamdel

DTCDTC

production

trading

buyers

* Considering introduction of amendment bill

Confidential

20

SA based manufacturing of SA diamonds gains a cost advantage illustrative

SA rough,cut & polished in SA

SA rough,cut & polished int’l

Non-SA rough,cut & polished int’l

200

30

10

240230210

$/ct $/ct

15%*

10

200

10

$/ct

0%*

200 210200 200

3030 ?30

Price of rough

Export duty

Cost of rough to manu-

facturer

Manu-facturing

cost

Cost ofpolished

Price of rough

Export duty

Cost of rough to manu-

facturer

faManu-cturingcost

polishedCost of Price of

roughExport duty

* The amendment bill introduces a 15% export duty on all SA rough exports.

Cost of rough to manu-

facturer

faManu-cturingcost

polishedCost of

Introduction of export duty

Will market tolerate higher

price point?

Cost advantage for manufacturer

Confidential

21

Given the cost differential between South Africa and India…Cutting & polishing costs

0

20

40

60

80

100

120

USA Israel SouthAfrica

Belgium Thailand China India

$/ct

47 99

FRIDGE estimates

De Beers estimates

0

20

40

60

80

100

120

USA Israel SouthAfrica

Belgium Thailand China India

$/ct

40 74No

data

73 $/ct

Medium price differential

57 $/ct

Medium price differential

Medium estimated price differential between SA and India: 65 $/ct

Weak data

Large variances of data points

Confidential

22

…manufacturers will have to make a trade-off…

0

20

40

60

80

100

120

140

160

0

100

200

300

400

500

600

700

800

900

1000 Value of rough [$/ct]

Export costs,posing additional cost for manufacturing internationally*

Price differential at 65$/ct,posing additional cost for manufacturing in SA**

433More economic to export

and cut and polish internationally

More economic to cut and polish in South Africa

export costs > price differential

export costs < price differential

$

* Modelled on the assumption of a 15% export duty** In our written submission we assumed a price differential of only $30. This had to be revised given the data cited above.

Predictedcut-off point

Confidential

23

Manufacturers cannot afford to cut diamonds at a loss

Estimate of the distribution of South Africa's diamond production by volume per value category

81.26

10.74

3.36

1.11

0.82

1.38

1.26

0 10 20 30 40 50 60 70 80 90

<$100/carat

$100 to $200

$200 to $300

$300 to $400

$400 to $500

$500 to $1000

>$1000

% of production (volume)

break even point for cutter ~$433 per carat

Confidential

24

…and it appears that up to 1,650 additional jobs could be created

200 400 600 800 1,000 1,200 1,400 1,600 1,800 $/ct

20

40

60

80

100

%

Predicted cut-offpoint: 433

Current cut-off point: 750

108,

350,

000

SA Production of Diamonds (volume)**

Employees in Beneficiation Associated

with SA Production

20001,650

Weak data

On actual distribution of

types of diamonds

Weak data

What is the current

appropriate cut-off point?

Weak data

On potential job creation

Weak data

Unclear how many jobs are

being created in total globally

112,000

SA current practice

SA pot

ex

ential with 15% port duty* g

Other geo-

raphies*

96.7% =14.5bnct

1.5% = 220mct

1.8% =270mct

* Estimates assume same carat/employee relationship as practiced currently in SA.** Graph reflects DBCM production only. DBCM production constitutes the vast majority of SA production.

Confidential

25

However, the amount of potential new jobs needs to be adjusted for other consequences: Possibly, only less than 1,000 new positions are realistic!

1650

320

399

279

652

0

200

400

600

800

1000

1200

1400

1600

1800

Potential newjobs

lower importsfrom De Beers(15%, by value)

lower productionfrom De Beers(30% of current

production)

lower ct/job ratio(20%)

net new jobs

?

Weak data

How will De Beers react? Weak data

Will mines have to close and production decreased?

Weak data

What is the appropriate ct/job

ratio?

Note: De Beers mines assumed under threat include Namaqualand, Cullinan, Kimberly (surface). Other marginal mines may also be closing but not necessarily due to 15% revenue reduction created by impact of export duty to be introduced.

Confidential

26

Still, the bill does provide a positive impact.

Positive Impact of Bill Negative Impact of Bill

Jobs in mining production

Jobs in mining Jobs in mining productionproduction

Competitiveness of mining producers

Competitiveness of Competitiveness of mining producersmining producers

dMore equitable acce

mondsd

ss to

iaMore equitable access to

iamonds

Cost advantage for

manufacturerCost advantage for

manufacturer

1,000 jobs in

beneficiation1,000 jobs in

be

Other issuesOther issuesOther issues

neficiation

However, how do the negative unintended consequences compare?

Confidential

27

SA based manufacturing of SA diamonds gains a cost advantage – on behalf of the SA diamond mining producers!Rough worth 200 $/ct on the international market will be traded at 15% less in South Africa: The producer will only receive 174 $/ct for rough worth 200 $/ct.

illustrative

SA rough,cut & polished in SA

SA rough,cut & polished int’l

Non-SA rough,cut & polished int’l

174

26

10

210200210 15%*

10

200

10

0%*

200 210

174 174

2626

!

$/ct $/ct $/ct

Transfer of margin

26

Price of rough

Export duty

Cost of rough to manu-

facturer

Manu-facturing

cost

Cost ofpolished

Price of rough

Export duty

Introduction of export duty

Same price point!+

Cost of rough to manu-

facturer

faManu-cturingcost

polishedCost of Price of

roughExport duty

* The amendment bill introduces a 15% export duty on all SA rough exports.

Cost of rough to manu-

facturer

faManu-cturingcost

polishedCost of

Cost advantage for manufacturer

Revenue reduction for

producer

Confidential

28

These reduction in revenues probably will have severe job implications in mining

4,000

6,000

2,000

12,000

0

2000

4000

6000

8000

10000

12000

14000

16000

De Beers SADPO Transhex total secondary joblosses?

Estimated number of Jobs Threatened in Mining Industry

Weak data

What are the secondary

effects of job losses?

Weak data

Will 15% export duty result in

lower revenues and job losses?

Note: De Beers mines assumed under threat include Namaqualand, Cullinan, Kimberly (surface). Other marginal mines may also be closing but not necessarily due to 15% revenue reduction created by impact of export duty to be introduced.

Confidential

29

In addition: other issues pose concerns

Concerns regarding general objectives of governmentKimberly processPromotion of broad-based socio-economic empowermentPromotion of small-scale and artisinal miningPromotion of investor confidenceDismantling of trade barriersUpholding int’l standards

Legal concernsConstitutionality of billCompliance with int’l trade commitmentsLegality of SDT selection process (“cherry picking”)Anti-competitive over-regulation (government diamond valuator)Money Bill

Note: All of these concerns are documented in detail in our written submission.

Confidential

30

Our conclusion – based on preliminary data:Negative impact may very well outweigh positive impact

Positive Impact of Bill Negative Impact of Bill

and othernd other nd other cprov

withoLegal

concerns

Legal aconcerns

Legal aoncerns

data situation isi

assessment very difficult

ut furth

collaborative efforts

Revenue reduction for producers

Revenue reduction for

Revenue reduction for producersproducers

12,000 jobs threatened in production

12,000 jobs threatened in

12,000 jobs threatened in productionproductionMore equitable access to

diamonds

More equitable access to diamonds

Cost advantage for manufacturers

Cost advantage for manufacturers

1,000 jobs created in beneficiation

1,000 jobs created in beneficiation

onal

detailed

er

Confidential

31

Overview of presentation

General principles of beneficiation

Assessment of the economic impact of the Diamonds Amendment Bill

Conclusion

Confidential

32

Conclusion: Assessment of the Economic Impact of the Diamonds Amendment Bill

Net impact of bill appears to be negative– 1,000 beneficiation jobs created– 12,000 mining jobs threatened

But we don’t know– The exact extent of positive impact

Level of price differential between South Africa and low-cost producerImpact of industry reaction on availability of rough in South AfricaImpact of 15% cost advantage on creation of jobs in beneficiation

– The exact extent of negative impactHow exactly the SDT will workHow many jobs may be jeopardized in miningHow to balance other concerns (legal and other side effects)

We should undertake a more comprehensive study toAssess potential positive and negative impact of billWhere appropriate, develop other means to achieve objectives

Chamber is keen to contribute byFacilitating industry processHas started to pull together fact-sheet

Confidential

33

FOR SOUTH AFRICA TO PROMOTE GREATER MANUFACTURING BENEFICIATION WHAT IS REQUIRED?

Don’t try and force mining companies to subsidise beneficiation or to go into areas where they have little competence or skills.

Provide an enabling environment that attracts the manufacturing fabrication companies to come and invest in SA. These include:– Improving access to foreign markets for manufactured products.– Quantum leap productivity levels.– Lowering the cost of capital in SA.– Access to inputs at world competitive prices (e.g. steel)– Providing the right types of skills for such projects.– Improving logistical infrastructure (cost, efficiency, etc.).– Incentives for R&D.

Confidential

34

BACKUP

Confidential

35

BACKUPCalculating cut-off points

Cost differential between South Africa and low cost producer Cut-off point $/ct

10 20 30 40 50 60 65 70 75 80

5% 200 400 600 800 1,000 1,200 1,300 1,400 1,500 1,600

10% 100 200 300 400 500 600 650 700 750 800

15% 67 133 200 267 333 400 433 467 500 533

20% 50 100 150 200 250 300 325 350 375 400

25% 40 80 120 160 200 240 260 280 300 320

30% 33 67 100 133 167 200 217 233 250 267

35% 29 57 86 114 143 171 186 200 214 229

40% 25 50 75 100 125 150 163 175 188 200

45% 22 44 67 89 111 133 144 156 167 178

50% 20 40 60 80 100 120 130 140 150 160

55% 18 36 55 73 91 109 118 127 136 145

60% 17 33 50 67 83 100 108 117 125 133

65% 15 31 46 62 77 92 100 108 115 123

70% 14 29 43 57 71 86 93 100 107 114

80% 13 25 38 50 63 75 81 88 94 100

85% 12 24 35 47 59 71 76 82 88 94

90% 11 22 33 44 56 67 72 78 83 89

95% 11 21 32 42 53 63 68 74 79 84

100% 10 20 30 40 50 60 65 70 75 80

As proposed by amendment bill

SA export

duty

Median of FRIDGE study and De Beers estimates

Confidential

36

BACKUPDe Beers Employees and Production

Mine number of employeesvolume produced

(carats) economic state of mine

potential 'jobs under threat' if mining bill is

implemented

potential 'production under threat' if mining

bill is implemented

Venetia 900 7,187,300 healthy - -

Finsch 1,600 2,108,481 healthy - -

Kimberly, underground 1,900 205,063 plans to close - -

Kimberly, surface 300 1,845,564 marginal 300 1,845,564

Cullinan 1,300 1,304,416 marginal 1,300 1,304,416

Namaqualand 2,500 909,706 marginal 2,500 909,706

Koffiefontein 500 113,481 plans to sell or close - -

The Oaks 70 68,943 plans to close - -

sum 9,070 13,742,954 4,100 4,059,686