Rio may sell its diamond assets

Rio Tinto (RIO-N, RIO-L, RIO-A) is pondering whether its diamond assets have lost its sparkle.

The world’s third-largest miner has launched a strategic review of its three diamond mines and one advanced diamond project to determine if they fit its strategy of operating “large, long-life, expandable assets.”

The diversified producer holds 60% of Canada’s Diavik mine, 100% of the Argyle mine in Australia and 78% of the Murowa mine in Zimbabwe. It is also advancing its fully-owned Bunder diamond project in India.

This review comes only months after rival BHP Billiton (BHP-N, BLT-L, BHP-A) put its Canadian diamond assets — the 80%-held Ekati mine, near Yellowknife, and 51% of the Chidliak project on Baffin Island — up for sale.

(Chidliak’s former minority owner Peregrine Diamonds [PGD-T] recently bought BHP’s 51%-stake for $9 million, while the company’s stake in Ekati is still up for grabs.)

Now Rio is weighing its options to retreat from the diamond industry.

“The diamond market outlook is very positive, with demand growing strongly and lack of new discoveries limiting supply,” said Harry Kenyon, the chief executive of Rio’s diamonds and minerals division, in a statement.

India and China are expected to drive long-term growth in demand, accounting for around 40% of diamond consumption by 2020.

But given Rio’s diamonds make up a fraction of its yearly earnings, the company is considering a potential divestiture or different ownership structure.

“Similarly to BHP this is due to the company’s inability to generate scale within the sector, despite rising diamond prices and profitability,” BMO Capital Markets analyst Edward Sterck writes in a brief report.

Adding it’s worth noting that the miner’s diamond projects are either “quite mature” or located in “politically difficult operating regimes,” such as Zimbabwe or India.

The open-pit Argyle mine in Australia, which contributes one-fifth of the world’s natural diamond production, has been suffering operational problems, and a costly expansion underground. Completion of the underground mine is slated for late 2013, which should extend Argyle’s life to at least 2019.

While Rio’s joint Diavik mine, located 300 km northeast of Yellowknife, continues to perform well, it only has around 10 years left.

Rio, which is currently mining three diamond-bearing kimberlites at Diavik through open-pit and underground methods, says the open pit should soon be depleted, but the underground mining is anticipated to carry operations past 2020.

Harry Winston (HW-T, HDW-N) owns the remaining 40% of Diavik. In early March, Bloomberg reported Harry and groups led by KKR & Co. and Apollo Global Management are negotiating to buy BHP’s interest in the Ekati mine.

Leaving investors wondering if Harry will also launch a bid to fully-own Diavik?

Sterck predicts it’s unlikely the company will buy Rio’s stake without a partner, despite its mining division being debt-free.

The review process may take some time, says Rio’s Kenyon, adding for now business will operate as usual.

Sterck speculates Rio, as well as BHP, may have problems finding a strong enough party to sell their maturing diamond mines to, which could handle environmental liabilities and eventually closure liabilities.

“One of the problems is it is quite difficult to identify anyone who’s interested in diamonds who fits into that category. So, I suspect after these reviews are completed it could be that BHP and Rio Tinto come to the conclusion that there isn’t any one of high enough caliber to sell to.”

Last year Rio produced 11.7 million carats, a 15% reduction from 2010 owing to higher costs and lower production volumes at Argyle.

For 2011, the miner saw company-wide profits fall 59% to US$5.8 billion due to an US$8.9-billion impairment charge related to its aluminum business. However, adjusted earnings were up 11% to a record US$15.5 billion.