Australia | Oct 26 2006
By Greg Peel
“Good mining is about good planning and execution, but it helps to have some luck along the way. Had the run in uranium prices come four years later, it may have been too late for ERA. As it the stands, the company is in the process of remodelling itself.”
ABN Amro is right. Energy Resources Australia (ERA) has had a dose of luck. That is, if you call global climate change fears lucky.
The world’s either second or third largest uranium producer (depends on whose PR), two-thirds owned by Rio Tinto (RIO), is still under contract to sell uranium at around US$16.50/lb. Given that the current spot rate is US$56.25/lb, and the closure of Canada’s Cigar Lake on Tuesday has led to calls of US$100/lb soon, this seems a bit ludicrous. But such has been the extraordinary revival in the uranium industry.
Before about mid-2003, uranium was a pariah. It had been for decades, following the Chernobyl disaster and the earlier Three Mile Island scare. Only a handful of reactors were operating, mostly in Europe, Japan and the US, and plans were afoot to shut them down eventually. Uranium was stuck at about US$10/lb.
ERA’s Ranger mine in the Northern Territory was one of the famous “three mines” allowed to operate in Australia. It was considered to have a finite life, and around about now was when the company anticipated it would die out. ERA hung its hopes on the nearby Jabiluka mine, but development of that site was protested out of existence. Not only is it located in the environmentally sensitive Kakadu National Park, its development is subject to approval from indigenous “traditional” landowners.
Nevertheless, ERA’s hopes for the future lay with this site. Its future development is still not a given, even though brokers such as UBS factor in a 75% valuation for Jabiluka. With uranium at such low prices, ERA was no doubt circumspect about its own future viability. The stock market obviously agreed, given ERA shares were trading below $2.00 not four years ago.
Enter global warming. Rightly or wrongly fears of significant climate change have thrust nuclear energy back on the agenda. The uranium price began to tick up. Countries such as the UK and Sweden began to rethink their plans to terminate nuclear plants. Then China woke up to the fact that their economic boom was under severe threat from pollution, a lot of which was caused by coal-fuelled power stations. China decided to go nuclear.
Now the world is going nuclear, and even Australia is thinking about it. But after years of justifiable underdevelopment, uranium supply capacity is well, well behind the times. It is not a question of rarity – uranium is abundant in the world. But a uranium mine cannot be established overnight. Half the world’s supply was being provided by decommissioned soviet warheads, but they run out in 2013. There is a global uranium supply crisis.
The steady move up in uranium prices over the last couple of years (up 50% this year alone) has provided the impetus for ERA to keep digging. Exploration around the Ranger area could yet yield greater finds. But the real benefit to ERA of a higher uranium price is the fact that it now becomes economically viable to process the low-grade ore that has been stockpiled for years as waste.
To that end, ERA announced yesterday that it had extended its known reserves by 11,100t. This has the effect of extending the mine life of Ranger by six years. Whether or not Jabiluka ever sees a sod turned, ERA is in the box seat to start locking in contracts for at least US$56.25/lb. If this uranium is forward sold now, UBS estimates it adds another $1.75 to ERA’s valuation.
ABN Amro is very excited about what it describes as ERA’s “new lease of life”. So much that it has lifted its 12-month price target from $15.25 to $19.58. UBS had already been a bit more bullish, and has lifted its target from $17.20 to $18.80.
Only four brokers in the FN Arena database cover ERA separately from Rio. Along with ABN and UBS, Deutsche Bank holds a Buy rating. Its target of $16.72 is as yet unreviewed since the Cigar Lake news (Have A Cigar: Uranium Set To Spike, 25/10/06). The only stick in the mud is JP Morgan.
Morgans points to ERA’s wrong dose of luck – that which sees it tied into long term contracts at US$16.50/lb when commentators are calling US$100/lb soon. Morgans holds a Neutral rating, and a target of $11.11. ERA’s share price gap-jumped about a dollar on Tuesday, to $15.50, and is testing $17.00 today. That’s 53% above Morgans’ target.
Which way will the analyst move? To a higher target, or a Sell rating?
Momentum is clearly on ERA’s side. Australia has signed deals with China, to sell its uranium still in the ground. BHP Billiton’s (BHP) Olympic Dam site – the largest known uranium reserve in the world – is being greatly expanded in the next few years, but this will still only be enough to match China’s needs. India has been pushing Australia for a rethink on its policy, and just the other day the Russians were knocking at the door.
In the meantime only South Australia is coming to the aid of the Northern Territory, with reserves in Queensland and Western Australia still tied up by state policy. For the record, the industry believes that if the federal Labor party votes to scrap its anti-uranium policy in April (not a given) then Queensland will jump quickly. WA will still take two-three years.
The time frame is not overly concerning WA uranium companies, as it will take them that long to complete feasibility studies anyway. As noted earlier, it takes a long time to get a uranium mine up and running. (Go to Boardroom Radio in FN Arena’s Sources Of Wisdom for a discussion on the state of the Australian uranium industry).
ERA is probably happy that this is the case.
One little aside, however. While Cameco reels from the flooding of its giant Cigar Lake project, don’t forget that the ERA share price took a beating earlier in the year due to excessive cyclonic rains that turned Ranger into a swimming pool complex. If climate change has brought ERA luck, then this is exquisitely ironic. But as any mining analyst will tell you: as you get all excited about commodity prices, never, ever forget the risks associated with mining.
According to Thomson One Analytics, current market forecasts (6 experts) are for EPS between 30c and 19c for the year to December 2006. The range for FY07 is between 67c and 39c. For FY08 the range is an almost incredible $1.46 and 60c.