Australia Presents Investors With Great Portfolio of Energy Choices

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What’s going to be the best asset class for superannuation funds for the next five years? We promised to take up the issue of super again in yesterday’s DR. But let’s do it in the form of more questions. Will it be government bonds? Will it be resource stocks, led by the iron ore producers and major miners like BHP and Rio Tinto? Or will it be another industry entirely?

It’s probably not fair to leave common stocks out of the question. After all, the ASX is on a 5-day winning streak and some analysts are now confident enough to say the bear is dead. No one is exactly predicting a return to the boom-time years of 2003 and 2008. But with oil up, gold up, shares up, property up, commodities up, and bonds up, it does feel a bit like 2003, when everything inflated thanks to low interest rates across the globe.

The Australian share market news is dominated by production figures this week. Back-from-the dead Oz Minerals reported that productionfrom its gold and copper mine at Prominent Hill will meet guidance. Last week Rio Tinto reported an 8% increase in iron ore production, but weaker production for aluminium, alumina, and bauxite.

We’ll get to the sector that really interests – energy – in just a moment. But to amplify a point made yesterday – keep in mind that the rally in Aussie resource stocks may be fuelled by a lending bubble in China that’s going to pop. That means resource demand and underlying commodity prices may be a lot more volatile in the years ahead, as Chinese regulators struggle with the conflicting goals of full employment and containing inflationary bubbles.

“(We) must control the risk of real estate loans,” said Liu Mingkang, the head of the China Banking Regulatory Commission, according to CNBC. He says Chinese banks must take better measures to evaluate the creditworthiness of borrowers. Liu said, “In the first half of the year, our country’s banking loans expanded rapidly and helped play an important role in stabilizing the economy, but the loans growth has led to accumulated risks also increasing.”

A real estate bubble in China would undoubtedly lead to inflated demand for construction materials in the commercial and residential real estate sector. But let’s assume the China lending bubble doesn’t pop this week. And let’s assume the value of Aussie shares is driven by underlying demand from China that IS sustainable and super cyclical. On that basis, what’ worth a look right now in the share market? How about energy.

For starters, there’s today’s news that Energy Resources Australia has reported unaudited profits that are triple what it expected. The $120 million half-year profit comes from much higher than expected uranium oxide productions and a 27% increase in uranium prices since the March low of around US$40.

The uranium spot price is coming off a low after a big correction. But as we’ve covered in Diggers and Drillers, the demand for nuclear fuel from global utilities is on the rise. Australia – with over 30% of the world’s proven uranium reserves – is in the pole position (side by side with Kazakhstan, arguably) to provide the world with what it needs.

That will only happen if the uranium mining industry really takes off. And maybe that’s starting to happen. Last week Federal Environment minister Peter Garrett approved what will become Australia’s fourth major uranium mine at Four Mile in South Australia. Four Mile is located about 550km north of Adelaide. It’s owned 75% by U.S.-based Heathgate and 25% by locally listed Alliance Resources (which zoomed up on, and even slightly before, the approval was announced).

“Production is set to begin early next year at what will be the world’s 10th-largest uranium mine,” according to Barry Fitzgerald in the Sydney Morning Herald. “Its predicted annual haul of 1400 tonnes would be worth about $260 million at current contract prices and will increase annual production of the radioactive material in Australia by 14 per cent to 11,400 tonnes.”

And there could be more on the way. “Queensland mining ‘inevitable’,” leads a story by Paul Robinson over at the ABC today.” “Just as there’s going to be uranium mining on an increasing basis in Western Australia, South Australia and the Northern Territory, we’ll see uranium mining in Queensland in due course,” says Federal Resources Minister Martin Ferguson.

“Mr Ferguson has told a Resources Conference in central Queensland, uranium mining is no different to developing coal or liquefied natural gas. ‘It’s about supplying the energy needs of other countries…We are energy rich, we do not need nuclear power, our responsibility is to mine uranium with safe hands and to guarantee that our uranium is used by countries that are only prepared to guarantee that it is used with safe hands.”

We’re not sure why Australia couldn’t benefit from nuclear power too. But the Minister is right that between coal, LNG, and uranium, Australia presents investors with a great portfolio of energy choices. And that’s not including traditional oil and gas explorers and producers.

Two more points about energy. First, the trading in shares is going to be volatile. That makes buying and holding a nerve-wracking strategy. The global economy is in transition. And with China and America wrestling over the bigger contribution to global growth – and overall resource demand – there’s going to be a lot of unpredictability to both resource prices and demand. The shares will see saw.

That means investors may have to look at more actively managing their positions in resource shares. This is not to suggest that we should all be market timers now. But you’ll want to have a strategy for dealing with volatility that allows you to lock in gains on rising share prices, but also buffers you from these big periodic falls that we expect to get as markets – and indeed the whole global economy – make the transition to a new normal.

The second issue on energy is that it may replace bulk commodities like coal and iron ore as Australia’s largest export industry. Here we’re talking about conventional off-shore LNG production AND unconventional coal-seam-gas LNG production. The unconventional LNG industry is admittedly a much newer (and we’d argue, riskier) industry that iron ore production. But that’s what makes it such an alluring investment opportunity.

If you want to know what the oil majors think of the industry, keep an eye on Santos this week. In yesterday’s Australian Financial Review, Paul Garvey reports that Santos could be a few days away from offloading a bunch of undeveloped gas fields in the Bonaparte Basin. Those fields could fetch the company nearly $500 million, according to Garvey.

But if you’re interested in the kind of transactions that might move the company’s share price, it’s Santos’ 60% stake in the coal-seam-gas fed Gladstone project that may start to attract cashed-up takeover suitors. Garvey reports that, “A series of standstill agreements preventing third parties from launching hostile takeover bids for Santos will expire in August and September.”

Santos has a 17.7% interest in Exxon-Mobil and Oil Search’s Papua New Guinea LNG project. Garvey says that project, “would be attractive to many energy companies, given its status as the most advanced LNG project now on the relatively cluttered drawing board in the region.”

It IS a cluttered drawing aboard. That means there are going to be a lot of losers and a few big winners. Between the more traditional LNG, oil, and gas firms we’re looking at in Diggers and Drillers, and the unconventional players in the Queensland CSG market that Kris Sayce is active with at the Australian Small Cap Investigator, there are a lot of intriguing firms to choose from.

Hopefully we’ve got it right that energy shares are the best way to invest in energy as an asset class. Of course shares are still shares. But one of the reasons we like Australian energy shares so much is that energy itself has become a kind of global capital – gradually replacing the worthless fiat trash pumped out in increasing volumes by governments. More on government debt as an asset class tomorrow.

Dan Denning
for The Daily Reckoning Australia

Dan Denning
Dan Denning examines the geopolitical and economic events that can affect your investments domestically. He raises the questions you need to answer, in order to survive financially in these turbulent times.
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Ross
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I believe that the energy opportunity, beyond the possibility of a USD collapse, is past. I am even more firmly of this opinion on Uranium stocks. When the hedge funds panicked and repratriated their USD’s home to settle redemptions you could have had DYL for $0.10 and ERA briefly on 1 day for $10 in the exploration and production sectors respectively. That was yippee territory and I called it like that here on DR on those days but now they are at $0.375 and $25.50 and I think it is time to take profits the very second the AUD turns… Read more »
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