Widespread fallout from gas crisis

25/06/2008 - 22:00

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It's not just Zambia and South Africa that have power problems.

It's not just Zambia and South Africa that have power problems. The loss of gas, and hence power, in Western Australia as a result of the Varanus Island gas explosion will reduce the global supply of gold, nickel, alumina and fertilisers while lifting production costs for many other products.

BHP Billiton will drop 28,000 tonnes of nickel out of the market for an early furnace rebuild at Kalgoorlie, taking the opportunity to switch its gas supply to other uses, while Minara will also suffer a cutback. This hiatus may result in nickel concentrates produced for the likes of Independence Group and Mincor, sold into the market, which would reduce the potential shortfall.

Meanwhile, the loss of 30 per cent of WA's natural gas supply capacity to an explosion on Varanus Island has done a good job for Australia's inflation watchdog, the Reserve Bank of Australia. This singular act may save Australia from additional interest rate rises, since the whole nation will now experience slower economic growth than would otherwise have been the case. The loss of 300 terajoules per day of gas supply in WA, is most likely to cripple much of that state's productive capacity for between 12 and 15 weeks, throwing hundreds of workers onto the dole queue and reducing the growth rate of the state's gross domestic product. This reduction of spending power is just what the Reserve Bank was trying to achieve by raising interest rates.

In a perverse sort of way, this massive disaster is likely to limit interest rate expansion in Australia. Loss of production at nickel, mineral sands and gold mines and processing facilities in WA, plus the flow-on effects to industry starved of its energy raw material feed, will negatively affect gross state product, reducing overall Australian GDP growth and taking some pressure off inflation rates in the most painful of ways imaginable.

WA grew very fast last year, shadowing that of its major trading partner, China. Inevitably, there was going to be some sort of speed bump to slow things down.

The Varanus Island incident should also be a wake-up call to all readers. In the future, there is no certainty that a reliable supply of water, gas or power will always be available. These are limited and scarce resources we must not take for granted.

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The sale of Glengarry's Maitland copper project in Queensland to Kagara Ltd for an effective $9 million sets up a useful benchmark that can be used to value mineralisation in the ground. This process is consistent with a long-running rule of thumb, which ascribes a value equal to 4 to 5 per cent of the current metal price to metal contained in a low-rank resource category and about 10 per cent of the metal value to metal contained in a mining reserve category. Many variables impact on the insitu value of copper mineralisation, including its location, size, grade, mineralogy, geometry and depth of the deposit, however an open market sale best describes how the market values such mineralisation.

The Maitland deposit is estimated to contain 22,500 tonnes of contained copper at a grade of 1.5 per cent copper, plus a small amount of associated molybdenum. If I ignore any value for the moly content, this sale produces an insitu value of 18 cents per pound for the copper content.

Applying that multiplier to Exco Resources' copper and gold resources in Queensland produces an insitu value of $160 million purely for its copper content and $171 million if I allow a value of $30 per ounce for associated gold, but nothing for its uranium content. This value compares with Exco's current market capitalisation of around $90 million.

In addition, Exco holds net cash of about $20 million and has an interest in a separate gold project, which I have valued at an additional $13 million, so based on the Maitland multiple, Exco should have a value of at least $200 million or more than 80 cents per share.

Similarly, Havilah Resources has a current market capitalisation of $120 million, yet valuing its equity in South Australian in situ copper resources by applying the Maitland multiple produces a value of $207 million for copper alone.

Havilah's Kalkaroo deposit may be lower grade than Maitland, but it has favourable geometry for mining and the Mutooroo project has grades similar to those of Maitland, so the comparison is valid. Havilahís deposits contain cobalt, moly and gold. Applying an insitu valuation adds $178 million, taking the value for its resources to $385 million. Havilah also holds investments and cash with an estimated value of about $45 million, taking assessed total value to $430 million, or more than $5 per share, compared with its current share price of around $1.50 per share.

Exco and Havilah are underpriced explorers and project developers, providing long-term exposure to copper and other metals. Havilah has been sold down during the tax loss selling period and is likely to recover into July and August.

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Following a couple of weeks of remarkable moves by huge companies such as Shell and PETRONAS on the coal seam methane front, QGC has begun pushing its newly acquired weight around, announcing an agreed merger with moribund Roma Petroleum and a placement from Vicpet, shoring up its position as the company's largest shareholder.

In its last round up, Briefcase had Roma on watch as a potential participant in rationalisation, which proved to be right on the mark. US hopeful and local CSM player Comet Ridge, which has been on the spec buy list for months, has pulled of an impressive funding deal in the US under which it essentially will end up with a 20 per cent interest in a local company, run by its existing management, which will have $US26 million of funding.

Comet Ridge will have the right to participate at that 20 per cent level once the funding partner Pine Brook, has spent $US26 million. This looks like a good deal, but converts Comet Ridge into a virtual investment company with projects in Australia's booming CSM business and an investment in a strongly positioned company with high equity in projects on the US Pacific north coast and in the Rockies.

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Other than a fear of the consequences for global oil supplies, should Israel take direct action against Iran's nuclear enrichment facility, the main reason that the oil price has been so strong is based on the possible conclusions of a forthcoming study of oil production from super giant oilfields, currently being undertaken by the International Energy Agency (IEA) based in Paris. The report, due out in the September quarter, is highly likely to be a watershed moment.

Previously, the big global oil agencies have ridiculed the idea of peak oil production, saying that there is plenty of oil about. This report is likely to come up with a different view and should warn of an imminent end to the 'oil age', saying that supply of oil is not going to be able to keep up with underlying demand growth.

The only way that consumption will match a limited oil supply is for the price of oil to rise to the point where demand is destroyed. Market participants are aware of the IEA's work and traders are anticipating its conclusions.

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- Peter Strachan is the author of StockAnalysis, he holds shares in Havilah Resources.

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