Stock: Energy Resources of Australia Limited
Code: ERA
Market Cap: $4.0bn
Recommendation: None

Following a falloff in hysteric headlines focussed on the ongoing financial crisis, the energy sector has made its way to the forefront of investor and media attention once again. Whilst there remains substantial world supplies of coal, oil and gas to drive energy markets for a considerable time into the future, the carbon footprint of these energy sources is undeniable and will become more of an issue as time goes on. As an example of the adverse impacts excessive CO2 emissions are having on our planet and society, reports out of China concede that around 1,750,000 premature deaths a year are caused by air pollution! These sort of statistics are simply unacceptable and provide the impetus for greener forms of energy to be adopted – and fast.

A beneficiary of the world’s re-examination of its energy habits has been the coal seam gas (CSG) sector of late, with heavy corporate activity occurring on our shores. A primary reason for gas’s popularity is that when used in electricity generation, it emits far less CO2 than its cousin, coal. But what about uranium? Unlike the fossil fuels, nuclear power emits no greenhouse gases whatsoever. This explains why the likes of China, India and Russia have all set in motion plans to increase their fleet of nuclear power plants to keep up with population energy demands and reduce carbon footprints.

But seeing that it produces no greenhouse gases, it could appear strange that nuclear energy only provides between 11-18% of the world’s electricity needs. However, the debate surrounding the use of nuclear energy has long existed and opponents aren’t in short supply. Negative sentiment towards uranium was seemingly justified when the tragic events of Chernobyl (Ukraine) in 1986 took place. The effects of that disaster are still being felt by the community years later. Leakage of radiation from the reactor has impacted many thousands of people, livestock and agriculture over a large geographical area. In the case of Chernobyl nuclear fall-out reached as far as areas of the United Kingdom. Supposedly poor reactor design at Chernobyl allowed the emission of radioactivity but this has not been repeated. Nevertheless, one accident is too many.

Adding to the arguments against nuclear power generation have been international concerns about nuclear weapons proliferation and long-term storage of waste products. However with advances in technology and increasing international regulatory co-operation, many countries have already embarked on initiatives which will see uranium stay in strong demand.

A major supplier of uranium has been Australia, and we have one of the most abundant supplies of yellow-cake in the world. Currently only 3 mines are allowed to operate by the Federal government. Olympic Dam and the Beverly mine in South Australia, and the Ranger mine in the Northern Territory, owned by Energy Resources of Australia (ASX Code: ERA).

ERA – 68.4% owned by Rio Tinto – is the 3rd biggest producer of uranium in the world, contributing 11% of world supply at present. In a milestone event, the company concluded its first sale of Australian uranium to China in 2008 and the expectations are for large growth in demand from China in the decades to come. Production from the Ranger mine has been consistent at over 5,000 tonnes of uranium oxide a year and although current mine-life is limited to 2012, expansions are expected to the resource base.

A cause for concern going forward is the uranium spot price which remains far below its highs of last year. Prices reached almost US$140 a pound in 2008 but are now trading at just over US$40 a pound. Despite these heavy falls, ERA has long term contracts that insulate it earnings base to some degree, but is this enough? Other determinants of the company’s profitability include contract rollovers and fluctuations in the Aussie dollar which we are keeping a close eye on.

Being debt free, ERA is in a strong financial position with cash on hand of over $100m which means that it is likely expansion studies at Ranger can be progressed without further funding. Positive news surrounding the studies could drive the share price higher however other potential catalysts include the corporate activity in the energy sector. Could major shareholder Rio Tinto be mulling a sale of its stake to shore up its balance sheet woes?

ERA’s share price has been reflecting increasing investor sentiment, breaking upward from a recent consolidation pattern. This is a positive ‘technical’ move, which short term traders would normally take as a cue for further gains. But is sentiment and a nice looking price chart enough to drive it higher?

Like astrology, palm reading, and tea leaves, charting stock prices is a ‘black art’. It is but one of the trinkets we carry in our tool belt when it comes to making investment decisions. Technical analysis has its uses, but relying on it solely can be dangerous. So while the price charts suggest ERA could be in for a higher move, investors should seek additional evidence. Are the company’s fundamentals strong enough to support the upside which the charts are suggesting? Or is the stock being driven solely by rumours and hot air?

 

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