Red River Report - The Downfall Of A Great Australian Miner

| About: Energy Resources (EGRAF)

Summary

ERA bears little resemblance to a solvent public company.

Rio Tinto, the parent entity, has enabled ERA to mislead stakeholders.

An ASIC review into ERA and Rio’s sales agreement should be conducted.

Full report for download at timorpony.com.

An Examination Of Energy Resources Of Australia

Rio Tinto (NYSE:RIO) controls one of the world’s largest, most controversial uranium mines, the Ranger Uranium Mine. It is surrounded by Kakadu National Park, one of the most ecologically and biologically diverse in the world.

While Rio’s fortunes are inextricably linked to this mine, its misfortunes are not.

Introduction

Energy Resources Of Australia (OTCPK:EGRAF) (ERA) operates one of the largest uranium mines in the world. Eight years ago, its market capitalization was over $6 billion. Today, it is $250 million. ERA must now rely on its parent, Rio Tinto, for financial surety to meet its obligations.

In our opinion, ERA is unable to independently fulfill its obligations nor are capital markets, or the public, fully aware of its magnitude. We have major doubts over the true value of its assets and, more importantly, its cost. Valuation techniques and bias accounting choices mean its financial statements do not faithfully represent the economic reality.

ERA is out of runway on its own balance sheet. Since raising $500 million in 2011, it has spent $236 million. In the last five years, the net carrying amount of its property, plant, and equipment has been completely written off.

The carrying amount of its flagship asset the Ranger Project has swung from $349 million to negative $409 million. How much longer ERA can tolerate material non-cash items or sustain meagre operating cash windfalls, before its significant environmental obligations fall due is debatable.

To appeased concerned stakeholders, Rio Tinto has provided financial assurance via a $100 million credit facility, should ERA be unable to meet its environmental obligations. In our opinion, key conditions precedent undermine its stated objective. Raising questions why Rio created such an agreement in the first place.

The uranium price is the single most important determinant of ERA’s financial health, affecting profitability, cash flows, asset values, and the present value of its rehabilitation provision. A high uranium price means that ERA avoids further impairment of its Cash Generating Units (CGUs) and can maintain resource value. Forecasted future cash flows lower the present value of the rehabilitation provision.

Luckily, in 2014, ERA signed an exclusive sales agreement with Rio Tinto Marketing Pte Ltd., a Singapore subsidiary of its parent. This has allowed ERA to achieve sales at large premiums to the observed spot price. It has lowered costs, but also it's reporting transparency. In our opinion, this agreement gives Rio significant scope to manage ERA’s operational costs and sales. The price received warrants further investigation considering its importance to ERA’s viability.

ERA’s solvency is contingent on the economic viability of its remaining stockpiles. Inventory adjustments in 2015 indicate that the total unit cost of production exceeds its expected sales price. Should this persist, ERA’s stockpiles are no longer an asset, they are waste rocks requiring removal and an environmental liability.

In our opinion, the processing of stockpiles does not make commercial sense, let alone generate meaningful future cash flows to bridge the remaining gap created by their balance sheet obligations. It’s for these reasons we do not believe ERA has any business remaining a public company. Rio should treat ERA like the subsidiary it has always been and take responsibility of the challenges ERA faces, not divorce itself from it.

Rio Tinto - It Means Red River

Rio Tinto owns 68.4% of ERA. Its ownership and management complicate ERA's dire financial position and the true economic reality of its operations.

While the mine has always been controversial, recent regulatory and legal developments, in conjunction with significant changes in market, social, and environmental dynamics mean that not only is the operation no longer viable it also poses significant environmental, reputational, and financial risk to all key stakeholders.

ERA is owned by Rio Tinto, managed by Rio Tinto, and its sales are exclusive to Rio Tinto. While its corporate governance statement aims to “maximize the overall long-term return to shareholders.” We must question where shareholders’ interests end and the stakeholders' begin.

The nature of large mining companies operations inherently exposes them to substantial, irreversible risks. These risks are universally acknowledged and accepted. The consequences of these unlikely but adverse events are not. Rio’s accountability and culpability only increase at every critical juncture.

Energy Resources Of Australia

ERA is an environmental disaster masquerading as a public company. Poor practices, mismanagement, and director turnover raise questions over its capability to rehabilitate the site.

In our opinion, Rio is keeping ERA alive in an attempt to isolate exposure to an ever-increasing environmental liability, not to provide stakeholder assurance. This duplicity has been to the detriment of all key stakeholders and delays proper intervention.

For a public company, the only thing worse than an environmental disaster is having to pay for it. Rio did not anticipate a scenario where ERA could not meet its outstanding obligations. It faces new challenges because of the significant changes in ERA’s operational and financial position.

Rio kept ERA publicly listed and at arm’s length for perfectly reasonable strategic reasons. These reasons no longer exist. Now, it inherently duplicates management and complicates incentives. It delays adequate intervention, obfuscates responsibility, placing undue risk on one of the world’s richest ecosystems.

Its ability to execute the required rehabilitation works are complicated by the following issues, namely ERA’s;

1. Operational Structure

2. Exclusive Sales Agreement with Rio

3. $100 million Credit Facility Agreement with Rio

4. Deteriorating Financial Health and Liquidity

The scale of the required rehabilitation already poses a significant challenge. The reliability, quality, and presentation of available data suggest the true extent of required rehabilitation works are grossly underestimated.

Significant discretion, estimation, and self-reporting involved in determining the rehabilitation cost raise doubts over the quality and completeness of the information available.

Ranger Uranium Mine

ERA’s flagship asset, the Ranger mine ceased operations in 2012. Ranger is Australia’s longest running uranium mine and top three globally by production volumes.

Upon its closure in 2026, Ranger will be reclaimed by Kakadu National Park. Kakadu is UNESCO World Heritage listed and Australia’s largest park, home to a third of the country’s bird species and 1,700 plant species. The monsoonal climate is marked by significant periods of torrential rain and dry spells.

Kakadu has been home to the indigenous population for 50,000 years – The Ranger uranium mine for 38. ERA must demonstrate no environmental impacts from any radioactive contaminants for 10,000 years upon its decommissioning.

Operations at Ranger ceased late 2012. ERA now derives income from the processing of stockpiled ore. Developing Ranger has been deemed unfeasible by the 2021 authority date. ERA is looking to ‘preserve the option’ on the asset. Ranger’s highly successful life was equally colorful, punctuated by regulatory breaches, disputes with traditional owners, and environmental controversies. Examples include a 2003 Senate committee report outlining 200 environmental breaches and a toxic spill of 1.4 million litres of toxic slurry in 2013.

Ron Kelly, chief executive of the NT’s Department of Mines and Energy, said: “ERA is continuing to develop and refine closure criteria as a priority to support ongoing detailed closure planning in accordance with legal obligations. The department continues to work with ERA and key stakeholders on their development.”

Operational Structure

Understanding the structure of ERA is crucial to provide insight into its operational effectiveness, both to date and going forward. Determining who is responsible, how they are responsible, and who is accountable for Ranger is paramount.

A failure to reconcile the relationships between those responsible and those accountable has undermined the company. Conflicting interests and management turnover are evidence of this.

ERA functions as a subsidiary of Rio, in addition to 68.4% ownership;

1. Rio select ERA management (Figure 2)

2. Directors’ incentive and share-based payments are exclusively RIO shares (Figure 3)

3. No director has owned a single share in ERA since 2015 (Resigned chair, P. McMahon) (Figure 3)

4. All ERA’s sales flow through Rio Tinto Marketing Pte Ltd. - (Figure 4)

(Figure 2)

(Figure 3)

(Figure 4)

ERA’s operations occur and are managed entirely under the Rio umbrella. The only external activities are to placate the remaining 30% equity holders. The nature of ERA’s ownership and operations bears no resemblance to a public company.

ERA’s public structure unnecessarily complicates its operations, increasing the conflicts, risks, and operational complexity by orders of magnitude. Management incentive programs have introduced new conflicts, and significant director turnover diminishes operational efficiency. These factors confuse and obfuscate corporate accountability. Ultimately, they delay action, unduly increasing inherent risks.

Managers' short and long-term incentive plans vest as Rio shares (Figure 3). While a typical company’s incentive program would motivate the directors of distressed companies to pursue the best shareholder outcome, ERA is not a typical public company. Management must please its penultimate employer and is rewarded for doing so.

  1. The CEO of ERA resigned in March, and the reporting executive at Rio Tinto was terminated last December pending corruption allegations.2 Eleven senior executives, directors, and officeholders have resigned or been terminated since 2015.

We find ourselves in a position where four chief executives will handover command and oversight of ERA in under a year. The less said about the impacts this has on ERA’s governance, reporting, and day-to-day operations the better.

Under the current structure, the only stable aspect of management is its remuneration. As employees flutter between the company and its parent, we wonder who left is acting in the best interests of the company and community – or if it’s even possible.

Key Resignations

Person & Basis of Termination

  1. A Sutton Resigned as Chief Executive Officer 24 March 2017

  2. T Wilcox Resigned as Company Secretary 20 March 2017

  3. A Davies Terminated as RIO Energy & Minerals Chief Executive 16 November 2016

  4. B Cox Resigned as a Director 3 May 2016

  5. J Farrell Resigned as a Director 29 August 2016

  6. P McMahon Resigned as a Director 20 June 2015

  7. H Garnett Resigned as a Director 20 June 2015

  8. J Pegler Resigned as a Director 13 April 2015

  9. D Smith Resigned as a Director 20 June 2015

  10. P Taylor Resigned as a Director 13 April 2015

  11. G Sinclair Ceased Employment on 1 March 2015

  12. S Thibeault Ceased Employment on 30 May 2014

  13. R Atkinson Resigned as a Director on 23 September 2013

  14. D Klinger Resigned as a Director on 8 February 2013

  15. D Janney Resigned as General Manager Operations on 22 August 2012

  16. C Tziolis Retrenched as Chief Development officer on 5 October 2012

  17. P Eaglen Resigned as General Manager Environmental Strategy on 31 January 2012

Audit Report - Key Matters

Four key audit matters outlined in the 2016 annual report are independently a cause for concern; together, the precariousness of ERA’s position becomes apparent. ASIC and SEC investigations and diminished reporting quality only validate suspicions, raising concerns that their statements can be trusted.

Referenced through out the report, the four key matters are as follows:

1. Accounting for the cost of rehabilitation of the Ranger Project Area – $511.4m Provision

The company is required under the Ranger section 41 Authority (Ranger Authority) to fully rehabilitate the Ranger Project Area (RPA) site by 8 January 2026. Calculating the final rehabilitation obligation requires significant estimation and judgement by the company. Assumptions are required to be made in respect of methods of rehabilitation, costs, and timing, as well as the potential for changes in regulatory requirements, technology, and market conditions. The most significant components of the provision relate to the movement of waste rock, the transfer of tailings from the Tailings Storage Facility, and the treatment of process water. The work required may also change as a result of the outcomes of current progressive rehabilitation activity and ongoing and planned technical studies. The calculation of the provision requires significant input from specialists and experts, both within and external to the company. Given the significance of this balance and the factors outlined above, the provision for rehabilitation was a key audit matter.

2. Impairment assessment for the Ranger Cash Generating Units (CGUs) – $230.7m Impairment Charge

The company’s investment in the Ranger Project Area was a key audit matter given the significance of the Ranger CGU to the company’s operations and the judgement involved in the assessment of impairment. The impairment of $230 million for the year ended 31 December 2016 ($69 million in the current half year) reflects the continuing decline in the short-term price of uranium oxide, which particularly impacted the Ranger CGU, given the significant forecast cash inflows from producing uranium oxide from existing stockpiles within a limited time frame. Property, plant, and equipment has been written down to nil value as a result of the latest impairment.

3. Carrying value assessment for the Jabiluka Undeveloped Property – $181m Carrying Value

Assessing the carrying amount of the company’s investment in the Jabiluka Undeveloped Property was a key audit matter. Factors giving rise to this conclusion included the size of the balance and the judgement required in the assessment as a result of the long-term nature of the asset, particularly in relation to:

- Whether development of the Jabiluka resource will ultimately proceed, given it requires the consent of the Mirarr Traditional Owners under the Long Term Care and Maintenance Agreement;

- The long-term uranium oxide price, the AUD/USD exchange rate, and estimated capital and operating costs used in the probability weighted discounted cash flow model to estimate the fair value of the asset.

4. Liquidity and capital management

ERA had a cash balance of $396 million and a further amount of $70 million held in the Ranger Rehabilitation Trust Fund by the Commonwealth Government for the purposes of rehabilitation at 31 December 2016. In the event that ERA is unable to fully fund the Ranger rehabilitation programme from its cash reserves and in the absence of any other successful developments or assets sales, the company may require an additional source of finance to fully fund the rehabilitation of the Ranger Project Area. The risks to funding around the future uranium market, the maintenance of financial guarantees and the terms of the Rio Tinto credit facility, along with the related financial statement disclosures are important to understand the financial position of the company and were therefore considered to be a key audit matter.

Regulatory Inquiries

Rio is grappling with a litany of corporate governance failures and corruption allegations, both interwoven and unrelated, suggesting we cannot trust the information we are presented.

Last month, Rio director John Varley resigned as charges by the UK serious fraud squad were lodged. The charges related to his dealings at Barclays Bank and are the latest in a string of damaging events which bring Rio into further disrepute. Taking into account ERA’s own issues, these events strengthen our belief that it should not be trusted to accurately report them, or even resolve them.

ASIC Review – Ranger Project Area

The carrying value of the Ranger CGU in ERA’s 2015 annual report was questioned by ASIC last year. ERA subsequently conceding the asset “exceed fair value” booking a $161 million impairment charge. As the defining asset of ERA, this review and the auditor’s concerns are all the more worrying. They reflect ERA’s reluctance to properly report the true state of its affairs. The Ranger CGU is discussed in more detail in subsequent sections.

SEC Investigation – Mozambique Coal

ASIC’s queries into ERA’s impairment methods are not the first time Rio’s impairment methods have been questioned. In late 2016, Rio announced it was cooperating with inquiries by the SEC in relation to the timing of impairment charges booked against its disastrous Mozambique Coal deal. Rio booked a $3 billion impairment charge for the asset which was eventually sold for $50 million, subsequently making the CEO Tom Albanese’s position untenable. Much like Mozambique Coal, ERA’s value has been destroyed by market conditions and operational challenges. Its impairment was also subject to regulatory review.

Corruption Allegations – Alan Davies Fired

In December 2016, allegations of corruption led to the firing of Alan Davies, head of Rio’s Energy and Minerals division. Allegations relate to Rio’s Simandou venture in Africa, also implicating Rio’s previous CEO, Sam Walsh. For ERA, the impact of Mr. Davies firing is more than just reputational. As the reporting executive for ERA, he was the final executive in ERA’s chain of command.

Rio’s impairment methods are under investigation by the SEC, and ERA’s are under ASIC scrutiny. The executive ultimately responsible for ERA has been fired pending allegations of high level corruption. Whether this is the result of negligence, misfortune, or misrepresentation no longer matters. Rio has demonstrated it is not capable of transparent governance or reporting. There are no mechanisms in place to suggest this will change going forward.

Ranger Cash Generating Unit

Key inputs materially impact the total valuation of the Ranger CGU which is already substantially negative.

The Ranger CGU is comprised of all ERA’s assets and liabilities, excluding the deferred tax liability and asset related to Jabiluka, as well as revenue received in advance. The Ranger CGU carrying value at 31 December 2016 is $(408 million), post impairment charge.

Valuation Inputs And Sensitivities

The confidence we have in the presented value of the Ranger CGU and its components is diminished by the sensitivity of its valuations inputs. Their volatility also highlights the importance of maintaining adequate margins of safety within the company. These margins do not exist at ERA.

The 2012 ERA annual report quantifies the Ranger CGUs sensitivities to key assumptions; the AUD/USD exchange rate and the long-term uranium price - They are no longer reported, another red flag.

Per the 2012 report, a 5% change in the:

1. AUD/USD would change the recoverable amount by approximately $116 million.

2. Long-term uranium price would change the recoverable amount by approximately $132 million.

A 2012 carrying amount of $349 million means that a 5% change in either input translates to a 33-39% change in the recoverable amount. The 2016 carrying amount of the Ranger CGU is negative $408 million. While 2016's sensitivities would provide insights into its stability, unfortunately, we don’t have the luxury and must estimate their possible impact. A swing of $825 million in the recoverable amount over six years and the most recent $231 million impairment charge are evidence of the magnitude of the changes impacting the carrying amount. They reduce our confidence in the Ranger CGU valuation.

ASIC Review - Ranger CGU Impairment

Last year, a deteriorating uranium market and questioning by ASIC pushed ERA to impair the Ranger CGU. ASIC questioned the “single discount rate to the different components of the forecast cash flows” - The discount rate being ERA’s weighted average cost of capital (WACC). Conceding its carrying amount “exceeded fair value” ERA booked a $161 million impairment. Significant considering its remaining ~$250 million equity value. The constituents of the Ranger CGU should be reported separately, not just calculated separately. The components now individually discounted are the current operations, rehabilitation cash flows, and the Ranger Deeps development option. The single discount rate meant that components with a discount rate greater than the WACC had a lower hurdle rate when determining their fair value, subsequently avoiding impairment. When Ranger was impaired, it was calculated using the firm's total risk (WACC) not the components. An example of this can be seen in its 2013 annual report. A $68 million impairment of the Ranger CGU was discounted at 9.25%. We must question how the present value of ERA’s impairments has been measured to date and how they are unwound, in addition to the true value of its future obligations. ERA believes that three discount rates for the three distinct components is a “more complex valuation approach” and is not a method of obfuscation or smoothing the CGU’s volatility. ERA continues to use the “probability weighted discounted cash flow valuation” for the Ranger CGU. ASIC may be satisfied with the updated discount rates. As the CGU is consolidated, we still do not believe it has enhanced reporting accuracy or transparency.

Rehabilitation Provision

The present value of the rehabilitation provision for the Ranger Project Area is $511.4 million.

The total provision is presented below, as well as the components movements. ERA still has $45.4 million less than required to rehabilitate the project area. This includes $70 million in a Commonwealth Rehabilitation trust. Over the last five years, ERA averaged a net loss of $217 million. The quality and accuracy of the cash flows are also questionable due to the nature of its sales agreements.

ERA has unmet rehabilitation costs of $45 million with no foreseeable path to profitability. We see no possible way of meeting its fast-approaching future obligations. In short, we believe it cannot fund its obligations today, or tomorrow.

The probability weighted discounted cash flow analysis used to calculate the provision means that the true marginal dollar impact of its current rehabilitation expense is hard to quantify.

This is evident when reviewing its stated spend against the present value of the provision. ERA states it has spent $411 million over the last four years on rehabilitation. The provision has only decreased $92 million over the same period.

Assuming that the ~$200 million CAPEX spend for the brine infrastructure was not included in its total payments, the per dollar spend still only contributes, at best, half its dollar value towards reducing the provision. This should raise serious questions about the weighting and probability of expected future cash flows surrounding the provision.

Accounting choices also raise questions over how previous reporting will impact ERA’s future position. ERA’s 2013 annual report states that “Mining costs related to rehabilitation activities are allocated to the rehabilitation provision on the balance sheet and not the statement of comprehensive income”. Capitalising these mining costs does not change ERA’s net position. However, it has had significant impacts on its reporting. The rehabilitation provision is no longer a balance sheet asset, and we now expect to see these cost to shift back to ERA’s production.

Cash Flows

ERA depends upon its positive operational cash flows to meet its future obligations. We doubt the veracity of reported cash flows and question their sustainability.

Since raising $500 million in 2011, ERA’s cash balance has declined $236 million. ERA reports it has been cash flow positive since 2015. We doubt this is sustainable, even in the most forgiving scenarios.

There are two ways a company can increase its cash flows from operations. Either by increasing sales, lowering operating costs, or a combination of the two. In our opinion, a questionable sales agreement and bias accounting choices inflate ERA’s reported cash flows and lower its reported operating expenses.

Inventory And Stockpiles

ERA’s inventory has halved since its peak in 2013, Ranger’s closure means it is not easily replenished. A large proportion of the decrease has been due writing down its net realisable value. The marginal cash contribution of sales to date indicates that the remaining inventory will not generate cash flows which are adequate to meet ERA’s obligations.

ERA reported it was cash flow positive in 2015, but adjustments to the financial statements show the total unit cost of inventory was above the expected sales price. If the unit cost of production was above the average uranium price received of US $51.99 p/p. What impacts did the 2016 sales price of $41.87 p/p have on ERA’s net position? Worth keeping in mind is the fact these sales all occurred at least 50% above market prices.

Stockpile Recognition

While ERA uses adjustments to restate its inventory values, we have concerns that the distinctions between stockpiles and inventory allow ERA to make more bias accounting choices. By definition, stockpiles have already been extracted and their removal contributes to overall waste removal efforts of the site. This has given ERA scope to incorporate the cost of extraction into its rehabilitation expense. This occurs on the proviso these stockpiles are economical. Should costs be such that they exceed the expected sales price, like they did in 2015, or prices received drop in line with observed market prices, ERA’s last remaining source of cash-flows, and solvency would be eradicated. In our opinion, this has already happened.
(Figure 13)

Exclusive Sales Agreement

ERA’s cash flows and asset valuations are highly sensitive to the uranium price. It is paramount the price used is reasonable and accurate. The timing and recognition of these sales are also important. Its exclusive sales agreement with Rio raises serious red flags.

In 2014, ERA entered a sales and marketing agreement with Rio, all sales fall under this agreement. Singapore-based subsidiary Rio Tinto Marketing Pte Ltd. purchases uranium oxide from Ranger, which is then pooled and sold to its ‘global uranium customers’. The agreement required a waiver from the ASX, which was granted, due to the related party transactions (Listing rule 10.1 Related party transactions).

ERA would be bankrupt if its sales were at market prices. Fortunately, its exclusive sales to Rio Tinto Marketing, were 62% higher than the average spot price. This premium is explicitly stated in its last annual report.

In our opinion; The merit of this agreement should be investigated by regulators, the ASX waiver reviewed, the quality of its revenues scrutinized. It has not practically changed the way ERA deals with Rio. What has changed is the recognition and financial reporting of the sales. ERA’s financial position and agreements; timing, the sales premium received, and its lack of transparency are concerning.

The agreement transfers ERA’s costs to Rio, it does not reduce them, while proposed marketing benefits are captured by the existing agency agreement. Production and logistics savings do not reconcile with ERA’s operational processes, with all major processing steps occurring before the uranium is shipped to the Singapore entity, as a fungible product no less. (Figure 13)

As Rossing Uranium also signed an identical agreement, additional logistics savings are found by shipping to customers ‘geographically closer to their respective operations’ allowing ERA to generate revenues without directly or immediately incurring any of the associated costs of production.

(Figure 14)

We can infer other savings are created from:

1. Favorable payment terms

2. Re-allocation of costs incurred to the Singapore entity,

3. Re-allocation of production costs from the Rossing mine.

While we don’t have insight into the composition of ERA’s sales. We do know:

1. The sales price is critical to ERA’s solvency

2. The sales price received is at a significant premium

3. ERA can generate sales shipping Rossing’s uranium

4. Operational costs are now worn by the Singapore entity

The agreement between ERA and RIO is opaque and lacks transparency. Sales do not reconcile with market prices or movements.

The agreement creates significant opportunity to financially engineer ERA’s operations, and the ultimate parent, Rio, has material conflicts of interests.

We cannot expect Rio’s subsidiary to transact with ERA fairly, at arm’s length – nor ERA management.

Credit Facility Agreement

ERA claim its “long-term financial position is underpinned” by a $100 million credit facility with Rio. After a thorough review, we believe it is worthless.

Conditions precedent undermine the stated intention of the agreement. Namely:

1. The company has exhausted all cash reserves

2. The company is solvent at the time of draw-down

3. An increase in the rehabilitation provision of $12.5 million, give Rio the right to terminate the agreement.

Rio’s ability to walk away from the facility should the provision increase by $12.5 million is laughable, especially given the provision’s size of the $511 million and the fact its valuation is derived from its own calculations. If Rio wishes to walk away from this agreement, it is merely a rounding error away.

Furthermore, the solvency requirement contradicts the facility’s purpose. While we assume that ERA would exhaust its own cash before drawing on its parents, it will undoubtedly become insolvent in the process. These conditions are the reasons why ERA may need this facility, not why it should be revoked. The objective of this facility is to provide surety of ERA’s financial capacity, making it a pre-condition has destroyed its stated objective.

Additional reasons for our scepticism:

1. There is no provision for this credit facility in either companies' annual report.

2. Rio is providing conditional surety for a situation where it already has full responsibility.

3. Rio’s inherent incentives to sustain ERA’s operations.

This agreement does not seem to be worth the paper it is written on, it will never be drawn. It has achieved its objective, to appease stakeholders and be relieved of further scrutiny. Should it become clear that assurances were not only inadequate but by design or deception, Rio may face questions it can’t contain in a separate mining entity.

The 2016 Annual Report foreshadows a scenario where Rio divorces itself of its promises to ERA.

“The Company’s ability to continue to access financial guarantees can be influenced by many factors including, future cash balance, cash flows, and shareholder support. Should one or more of the financial guarantees be withdrawn at any time and the company is unable to access replacement guarantees, substantial additional cash would be required to be deposited into the Trust Fund. In a scenario where this occurs the Company’s cash resources available to fund the operations would reduce. The company has plans to address these risks, including the credit facility agreement with Rio Tinto”

Regulation And Self Reporting

The value and reporting of rehabilitation obligations have significant implications for ERA’s financial health, not just the environments.

Significant trust is placed in ERA to convey these obligations as accurately as possible, even though it can influence these values materially and has the incentive to do so. Significant changes initiated by ERA include: a 2011 review resulting in a $200 million+ increase in the rehabilitation provision, as well as a $74 million decrease from the ‘use of more efficient technology’ in the thickening of tailings for 2014. Operational costs are also greatly impacted by regulatory and reporting requirements, not just the value of the rehabilitation obligation.

ERA’s representation and communication of mine-site data do not accurately portray the true health of the mine site. Its interactions with the GAC and failure addressing its concerns suggest broader environmental issues and complacency. ERA has avoided scrutiny, and it has not translated into better practices. Its claim as “the most regulated and scrutinised mine site in Australia” is laughable considering its 2013 spill of 1.4 million litres of radioactive slurry and the fact it was met with no charges from the NT government.

The poor regulatory oversight and reporting of ERA is apparent when compared to the Rossing uranium mine which Rio also has a 70% stake in. Rossing’s publications are extensive, detailed, and accessible, monitoring many issues that ERA have sought relief from. Even though there have been 17 fatalities at Rossing in the last two years, it still has better monitoring and reporting standards than ERA.

Toothless regulatory oversight of the Ranger project has led to the untenable situation ERA faces today. An environmental liability that has grown beyond control and the inability or financial strength to rectify it.

Regulation In Practice Atmospheric Monitoring

ERA is highly adept at avoiding the detection of anticipated environmental issues, not its occurrence. A key example of this can be seen with the halting of atmospheric testing of radon, and other radioactive dusts at Ranger.

ERA's environmental activity is regulated by the Supervising Scientist Branch (SSB). Per the SSB, “after reviewing 16 years of data, it found the mine-derived radiation dose from the airborne dust “does not pose a public health risk”. The nearsightedness of the SSB is despicable.

Substituting the Supervising Scientist’s “evidence based” approach for a common sense one leads us to a very different conclusion.

The monitoring of radioactive dust and other deleterious elements should begin with the backfilling of millions of tonnes of waste rock and tailings, not end. Monitoring of dust and air particles should not increase during the driest wet season in two decades.

This backfilling does not happen in a vacuum, the activity inevitably increases airborne readings of harmful particles. Practically, it can’t be avoided and must be done, this is not the issue. The issue is that the SSB has frittered away one of the few key independent measurements the community had to enforce corporate accountability. It has denied key stakeholders the right to information.

N.B. Rossing reports (and breaches) the exact same tests mentioned in this section

Self Reporting In Practice - Surface Water Management

Effective water management is a fundamental element of ERA’s business and environmental protection. The extreme and variable rainfall requires intensive operational flexibility and supervision. The 2003 Senate Committee stated that,

“Monitoring at Jabiluka and Ranger was said to be lacking in rigor and independence, periodic rather than continuous, insufficient for assessing intermittent and accumulative impacts and too often used as a mechanism to downplay operational problems.”

Concerns remain 14 years later – Conducting periodic reviews, the “Independent Surface Water Working Group” (ISWWG), of which ERA is one of the four representatives, last published a report in January 2013. The four consultants involved made a total of 60 recommendations; 15 became key actionable recommendations.

The stated concerns of the Mirarr Traditional Owners (TOs) in this report were arranged into four broad categories:

1) surface water management and releases,

2) existing monitoring practices, compliance framework and management responses in relation to surface waters,

3) downstream monitoring to provide confidence that the environment is being protected, and

4) the integrity and reporting of, and stakeholder access to, relevant data.

The report’s summary downplays the significance of key issues and does not adequately address the very real concerns of the GAC. It states ERA’s regulatory systems are “of a very high standard”, yet:

1) A consultant found “no written information that explained the scientific basis for the termination of ERA’s previous routine sediment monitoring, an issue of concern to the Mirarr TOs.”

2) It rejected real-time monitoring of certain areas, recommended by two consultants.

3) Recommendation six demands the: Routine ‘metals (including radionuclides) in bush food monitoring program be re-introduced.

Continuous monitoring was rejected this even though “Several reviews have endorsed the continuous monitoring program implemented by the Supervising Scientist and recommended that it form the basis of a revised statutory monitoring program for Ranger Mine” as recently as December 2015.

As of its latest annual report, a key recommendation, the reinstatement of routine heavy metal checks on fresh water mussels (A source of food for the Mirarr ‘aquatic bush tucker’) is still outstanding. Four years later.

To reiterate – Of the 15 recommendations, the only one outstanding four years later was the monitoring heavy metals bush food monitoring.

These concerns are not theoretical, immaterial, unreasonable, or (sadly) unfounded.

In March 1985, Ranger discharged ~160,000,000 litres of water from a settling pond which was only supposed to hold rainfall runoff. The OSS reported some mussels in the creek aborted their larvae. It also appeared that the migration routes of some fish were altered during the release.

On face value, it is encouraging that many of the key items within the report have been actioned. However, this is not a process ERA should have input, or influence over. The sheer complexity, detail, and nuance of measurement can support interpretations of almost any argument regarding the water's quality.

Data omitted, inaction, and selective measurements provide just as much insight as the information that is included in the report. ERA cannot be trusted to self regulate its operations.

Outlook

Actions taken by ERA to rehabiliate the Ranger Project Area are already falling short of expected outcomes. The challenges faced are insurmountable.

ERA believes that it can independently generate the funds required to fund Ranger’s rehabilitation. We do not believe it can independently generate sales above its own cost of production.

In addition to this, the sheer number and complexity of steps involved to properly rehabilitate Ranger paint a grim picture for the area. ERA does not have the capacity or ability to fund anything other than perfection. Efforts to date are far from seamless.

In May, the Assistant Secretary to the supervising scientist stated “the current tailings deposition strategy has not achieved the expected outcomes” and as a result, the method of deposition is being changed from subaerial (airborne) to subaqueuos (through water).

Not only must ERA change tack with regards to its deposition strategy, it must also repair recently installed rehabilitation infrastructure, which has failed. In the same hearing, the Assistant Secretary describes the structural failure of a brine injection well into Pit 3. These wells are a integral part of Ranger’s water treatment process. These failures no doubt increase the time and total cost of the rehabilitation works.

These events, big and small, are indicative of the challenges ERA face at every step of this massive undertaking. Any one of these issues can significantly increase the total cost of rehabilitation. Any one of these issues could potentially push the cost out of ERA’s financial capacity. Any one of these issues create grounds for Rio to revoke its $100 million credit facility.

Conclusion

It is unlikely ERA or Rio Tinto have done anything illegal. What has happened is much worse. The Ranger uranium mine will likely conclude its operations as it begun them, with the blind support of our own government, regulatory bodies, and capital markets.

ERA has navigated every breach with eloquent diplomacy, operating with impunity, its directors maintaining grace and poise as they return from their secondments.

Management is adept at anticipating potential problems but not their solutions. How much longer it can maintain a facade of corporate and social responsibility is dependent on how much longer it can delay its insolvency.

Rio’s history extends 200 years. If it wants to operate for another 200, it will need the social licence to do so. This license is quickly evaporating. The court of public opinion and increasingly capital markets are an excoriating and swift enforcer. Rio Tinto will not be “innocent until proven guilty” in such a forum. Maybe the owner of a uranium mine in a national park never should be.

The Ranger legacy which began in 1969 has roots firmly planted in marginalisation of the aboriginal people. How sad to think they may finally be given the land they now own outright, to find the possibility it may be tainted for another 10,000.

ERA has been mismanaged, its assets appear overvalued, its rehabilitation liabilities grossly undervalued. Inaction is no longer an option due to its expiring license to operate. The company appears cash flow positive, seemingly propped up by premium sales to its parents own subsidiary. It no longer has the working capital nor economics to sustain itself.

This has not gone unnoticed; ERA has been bolstered by the arrangement of a $100 million credit facility for the looming rehabilitation provision. What has gone unnoticed is the duplicity of the controlling entity providing token assistance and not real accountability. ERA is not trading insolvent, but it is trading with itself, meanwhile Rio buys enough time to shirk further responsibility and embarrassment.

(Prior to publication, ERA, Rio Tinto, and the GAC have been contacted for comment)

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Before publishing ERA, Rio Tinto, and the GAC had all been contacted for comment. As of the publication date of this report, Timor Pony Pty Ltd has no conflicts of interest, direct relations, or ownership of any of the companys covered herein. While referencing and analyzing financial statements, the opinions expressed in this report are not investment advice nor should they be construed as investment advice or as a recommendation of any kind. We are not a financial adviser. Consider seeking independent legal, financial, taxation or other advice if you believe this information relates to your unique circumstances. Timor Pony is not liable for any loss caused, whether due to negligence or otherwise arising from the use of, or reliance on, the information provided directly or indirectly, by use of, or actions based on, the information covered herein. To the best of our ability and belief, all information contained herein is accurate and reliable, it has been obtained from public sources we believe to be accurate and reliable. As evident by the contents of our research and analysis, we have spent considerable time and attention in an effort to ensure our research analysis and written materials are complete and accurate. We strive for accuracy and completeness to support our views, and we believe in good faith in everything we write, however, all such information is presented “as is,” without warranty – express or implied. Timor Pony makes no representation, as to the accuracy, timeliness, or completeness of any such information or with regard to the results obtained from its use. All expressions of opinion are subject to change without notice, and we do not undertake a duty to update or supplement this report or any of the information contained herein. This report should be considered only in its entirety. Individual sections should be read in the context of the entire report, and no section, paragraph, sentence or phrase is intended by its author to stand alone or to be interpreted in isolation without reference to the rest of the report. The section headings contained in this report are for reference purposes only and may only be considered in reference to the detailed statements of opinions in their respective sections. Use our research at your own risk. You should do your own research and due diligence before making any decisions with respect to the companies covered herein.

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