De Beers empire loses its sparkle: Richard Dowden, Africa Editor, reports on how one family's iron grip on every part of the multi-billion-pound diamond industry is being threatened by illegal mining

THE DE BEERS board meeting on 11 August this year began normally: apologies for absence from two Rothschilds, a proposal for a new board member. As usual the board met under the sepia prints of the founders, Cecil Rhodes and Sir Ernest Oppenheimer, in the old colonial style, two-storey, brick and wrought ironwork headquarters at Kimberley in South Africa. The Oppenheimer family is sentimental.

The mood of the meeting was far from sentimental. De Beers announced that earnings had fallen by a quarter and announced that it may have to cut the final dividend and defer the purchase of 25 per cent of production from the major producers. The news hit the stock exchange like a thunderbolt - De Beers had tried to talk up the market and predicted that diamond sales, in the doldrums for 18 months, would pick up. Not only did De Beers seem in trouble but it had got wrong the one answer it is believed to be infallible on: the state of the diamond world. De Beers' shares lost a third of their value, taking with them much of the Johannesburg Stock Exchange.

The gentlemen of De Beers are supposed to be infallible because they set the question. Indeed they invented it - a huge complicated glass bead game with thousands of players, lives and livelihoods dependent on it. Billions are spent on mines from the Namibian desert to the Siberian permafrost. They produce industrial diamonds, but the huge profits are in gemstones. Millions of hours are spent examining piles of rough diamonds, dividing them and subdividing them into 7,350 categories. Cutting and polishing is an art involving years of apprenticeship and skill. Then the stones are re-sorted into another 5,000 categories. Dealers, cutters, polishers, jewellers - the price of a diamond increases nearly 10-fold between leaving De Beers' vaults in Charterhouse Street and arriving in the shop window. The industry depends upon a regular supply at a steady price, and that De Beers provides. The diamond world is like a family, sometimes at war but always close. De Beers is the head, indeed the fount, and no one in the diamond business wants its demise.

The diamond world is like a huge edifice based on a faith that diamonds are forever, that they are rare, that they are - and always will be - valuable. Diamonds are forever is double-edged. It also implies 'don't resell them'. Apart from antique jewellery, second- hand diamonds are worth about 20 per cent of new diamonds. The public has to keep buying new diamonds and in the inner sanctum at the De Beers headquarters in Charterhouse Street in London the mantra runs: 'Nobody needs one, everybody wants one.' Gem diamonds are as useful as a shattered windscreen. De Beers' crusade is to keep them desirable or, as a New York dealer put it: 'The diamond market is sustained by the erection.'

Diamonds do not follow market forces. When demand drops, De Beers limits the supply. One of the articles of the diamond creed is that the price does not drop - technically it has not fallen since 1931. In good times, De Beers makes huge windfall profits from its stockpile. In bad times it uses those profits to sustain the stockpile. Under US law, De Beers is a cartel and illegal. The company cannot operate there, but in Britain the government and its agencies turn a blind eye. Diamonds are excluded from the published monthly trade figures. No one complains. Which? has never done an investigation. There is no consumer lobby because most people buy only one diamond and rarely know which of the 5,000 categories they are buying.

There has been a sharp decline in diamond sales recently. The closures in the Ratners chain are only part of a worldwide collapse. That is the recession. Nicky Oppenheimer, the grandson of Ernest, the founder, points out: 'We're going through a very difficult period but we have an extremely strong balance sheet which is designed simply for the sort of circumstances we're in now.'

But there are now two extra threats to the whole diamond edifice - Angola and Russia. The size of the Angolan threat was laid out in a sorting room in Charterhouse Street earlier this year. Along one wall, eight glistening pools of diamonds had been laid out like eight upturned bags of sugar. One pile had large stones in it, like sugar lumps. Along another wall were four smaller piles. The longer line - worth about pounds 20m - was four months' worth of smuggled Angolan diamonds. The shorter line was all Angola's legally mined diamonds. De Beers says it is only buying half the smuggled Angolan production.

De Beers buys the smuggled stones in Antwerp - the marketplace for the 20 per cent of world diamond production which is not bought by De Beers at source. De Beers' office there intervenes in the rough market and buys to keep the price up. It is a vital link in the system. Paul Hunter, the cheerful young chain-smoking buyer, spends between pounds 2m and pounds 3m a week on Angolan diamonds. In the worst week, he spent nearly pounds 25m. The Angolan diamonds are brought to his office by African or Lebanese dealers who commute from Luanda or Kinshasa to Antwerp.

In Angola, traders take lorryloads of clothes, videos, radios, refrigerators and cars to swap for diamonds in Lunda Norte in the north-east. It is empty bush, but the prospectors took advantage of the ceasefire in Angola and moved in last year. What started as a few small pits near the Cuango river has exploded into a diamond rush, a huge, organised operation involving tens of thousands of diggers. I flew over one of the biggest operations recently - the helicopter pilot said it was too dangerous to land and pointed to a bullet hole in the perspex. 'Keep waving to them. If you see anyone go for a gun, just shout,' he said.

We chugged down the Cuango river at tree- top level and then suddenly the thick green bush turned into a moonscape. On a wide bend in the river about 2,000 men were working in chain gangs, quarrying out a crater the size of a cathedral. Others were carrying the pale yellow gravel down to the river in gunny sacks to be washed. The diggers were in shorts and shirts or bare-backed, and they stopped digging and waved, some angrily. Among them we saw about 20 soldiers in Unita uniforms carrying guns. Under the peace agreement they should not have been out of the ceasefire collection points. The implication is that Unita is organising or 'protecting' the illegal diggings. We swooped over a huge settlement of grass tents. In amongst them were trucks and new four-wheel-drive vehicles. Some diggers ran off as the helicopter approached. It seemed strange that these people, as poor as any in Africa and simply digging in an almost uninhabited corner of their own country, should be threatening a worldwide financial empire.

The other threat to De Beers is longer-term and less controllable. Russia started producing diamonds in the 1950s and is now the biggest single producer in terms of value. At first Moscow sold to De Beers and kept in the cartel. In 1963, anti-apartheid legislation prevented the Soviet Union from dealing with a South African company. So De Beers set up a company called City West East Ltd to buy Russia's diamonds. It operated in London but City West East was never registered at Companies House.

Although the Russians kept in the De Beers' system, they did not quite play their game. The treasury in the old Soviet Union stockpiled the best diamonds and cut and polished others. They also sold a representative 5 per cent of their diamonds by tender to Antwerp dealers. This 'window on the market' told them if De Beers was paying them a just price, so they could leak other stones on to the market when the price was right. De Beers gritted its teeth but never missed the annual dinner given by the Commercial Section of the Soviet Embassy in London.

Almost all Russia's diamonds come from the north-east Siberian province of Yakutia. In 1990, De Beers signed a five-year deal with the Soviet Union under which De Beers lent dollars 1bn ( pounds 584m) a year over five years in exchange for the Soviet Union's diamond production and the stockpile. During the break- up of the Soviet Union, Yakutia fought successfully to be allowed to market 20 per cent of the diamonds independently. This week, Russia and Yakutia agreed to form a joint company to mine and sort the diamonds, but relations are still strained between them. De Beers directors hurried back and forth to Moscow to persuade everyone to stay with the De Beers' system. The reorganisation of Russia's diamond industry is causing deep anxiety in Charterhouse Street. Who is De Beers to deal with - and trust?

Many Russians question why they had to sell the 'national treasure' to a Western monopoly. There is popular pressure to increase the amount cut and polished in Russia to sell direct to the market. This year it will cut and sell about dollars 700m worth - about 40 per cent of production by value. And De Beers has discovered to its discomfiture that there is still a huge stockpile of diamonds in the Russian treasury. De Beers still does not know how big it is or what the Russians intend to do with it. It could be dollars 1.5bn worth. If that suddenly came on to the market, it would break De Beers. But the Russians know that if they did that, diamonds would be worthless.

In their desperate search for foreign exchange, however, the Russians have started to sell more polished diamonds on to the Japanese market. Their rough diamonds are also leaking out. These stones were those retained for cutting and polishing in Russia but, in the general economic confusion following the collapse of the rouble, the cutting factories - and the Russian mafia - found they could buy them cheap for roubles and sell them to Antwerp dealers for dollars.

Political chaos is likely to cause more stones to leak on to the market, but it will reduce production - this year it is expected to decline by 20 per cent. But the Russians have long experience and knowledge of the diamond world. They retain their window on the market and their stockpile, and they might try to take over the leadership of the cartel from De Beers and call the tune - and the price. Meanwhile, they will probably continue to leak diamonds on to the market, further draining De Beers' resources.

The De Beers system may be under greater pressure than at any time in the past 60 years, but it is unlikely to snap. Nicky Oppenheimer, the deputy chairman, admitted the company is borrowing money, and some estimate its cash reserves are down to zero.

Ironically, the danger time for De Beers will come when the diamond market improves. By imposing the 25 per cent quota, De Beers presents the producers with three options. They either lay off workers and close mines, they stockpile, or they sell on to the open market and allow the price to drop. Most countries will stockpile. If and when the good times come again, De Beers will want to buy those stockpiles. The temptation for the producers - even those contracted to De Beers - will be to make large, quick profits by selling off their stockpiles directly to a thirsty market. The last time there was a stockpile outside De Beers' control it was accumulated by Botswana during the early 1980s slump. Botswana sold it to De Beers in exchange for two seats on the board and a 5 per cent share in the company. Is this the model for the future?

If the producers sell direct to the market, De Beers will be denied the windfall profit it makes from the stockpile accumulated in bad times. Without that profit, De Beers will be even less able to buy up all the production during the next recession. That is when the other producers will move in and take their pound of flesh. The family-run cartel will become a co-operative of national producers.

(Photograph omitted)