Rio may sell its diamond assets

Rio Tinto (RIO-N) is pondering whether its diamond assets have lost their sparkle. The world’s third-largest miner has launched a strategic review of 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.

The review comes only months after rival BHP Billiton (BHP-N) 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 remains 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,” says Harry Kenyon, the CEO of Rio’s diamonds and minerals business division.

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

But given that Rio’s diamonds make up a fraction of its yearly earnings, the company is considering a 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.

Sterck notes that the miner’s diamond assets are either “quite mature” or located in “politically difficult operating regimes,” such as Zimbabwe and India.

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

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

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

Harry Winston Diamond (HW-T, HDW-N) owns the remaining 40% of Diavik. In early March, Bloomberg reported Harry Winston and groups led by KKR and Apollo Global Management were negotiating to buy BHP’s interest in Ekati, leaving investors wondering whether Harry Winston might launch a bid to fully own Diavik.

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

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

Sterck speculates that Rio and BHP may have problems finding buyers for their maturing diamond mines that can handle the environmental and closure liabilities.

“One of the problems is that 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 anyone of high-enough calibre to sell to.”

Last year Rio Tinto produced 11.7 million carats, or 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 following an US$8.9-billion impairment charge related to its aluminum business. Rio’s diamonds and minerals division contributed US$252 million to last year’s earnings.