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Best Uranium Stocks to Rebound in 2011

By: The Energy Report and Rob Chang

-- Posted Wednesday, June 22 2011 | Digg This ArticleDigg It! |

While uranium prices fell after the Japanese earthquake and tsunami, Versant Partners Analyst Rob Chang says in the long term, prices must rise due to a supply shortfall and the economic necessity of using nuclear power. In this exclusive interview with The Energy Report, Chang suggests ways to take advantage of the eventual rebound.

The Energy Report: How did investors initially react to the earthquake and tsunami in Japan, and how have attitudes changed since?

Rob Chang: Many hit the sell button on uranium after the disaster. The uranium spot price prior to Fukushima was around $66.50/lb. In the three days following, it declined 30%, to as low as $47/lb. However, it didn't stay that low as it bounced back by the end of the week, finishing only about 9% lower, at $60/lb., which was a good sign. It later drifted to a low of about $55.25/lb. in early May and is now trading at $55.00/lb.—showing some strength.

Switching to the long-term price, which better indicates how utilities see things, it was around $73/lb. prior to the disaster. After the first post-Fukushima price update, it only declined $1/lb., a fantastic sign that the utilities and the producers didn't see much of a long-term impact. It has declined a little since then—and is currently down 7%, to $68/lb.

Uranium equities, on the other hand, declined about 30% following Fukushima and, despite attempts at rallying, their prices have drifted lower. It appears that investors have shifted their focus away from the fundamentals, which drove the market for the previous nine months, and now employ more of a "wait and see" approach while countries around the world reevaluate their nuclear programs. It is interesting to note, however, that despite the 30% drop from the peak before the tsunami, uranium equities are still trading higher than at this time last year. Things are still positive from that perspective.

TER: Very interesting point. Germany has announced a plan to scrap its nuclear power programs by the year 2022; Chancellor Merkel says this is just the beginning of a fundamental shift in policy. What is your take?

RC: I am skeptical. A 10-year time frame to phase out 25% of Germany's power generation seems aggressive, and Merkel's plans lack clarity. They say the power will be replaced by gas and coal plants in the short term, and then by renewable sources. But there are a lot of question marks. For example, renewable sources currently make up 17% of Germany's power generation; they are expecting that to double to 35% by 2022. That's pretty aggressive.

Economically, the cost would be ridiculous; just to phase out 25% of the world's fourth-largest economy's power generation and replace it with gas and coal, and then buy renewables, would require a vast amount of money in the form of taxes and/or tariffs. That is hard while we are still in a global recession or downturn. At the same time, even if they were able to find the money, where are they going to build new power plants? No one will want them in their backyards. An additional layer of regulation and political hand-holding would be needed; to attempt to do all this in 10 years is optimistic at best.

TER: But won't this be an overall negative for nuclear power?

RC: It could be if they succeed. However, Germany only accounts for about 4% of global nuclear power generation. So, over the long term, it might not make that much of an impact.

TER: If Germany has taken this attitude toward nuclear power, does it open the door for other countries to think that way?

RC: It does, because Germany is a large economy and one of the more powerful industrial nations. However, outside of Switzerland and Italy, it doesn't seem like many other countries are moving in the same direction. The driver behind the change in Germany is the fact that Merkel's political party is losing power. They know they need some radical changes to hold onto it, so, instead of a gradual phase out, they've adopted a more drastic one, hoping to grab votes.

TER: Let's move back to Japan. We know from unfortunate past experience that Japan has been willing to make dramatic foreign policy changes because of catastrophes, for instance at the end of World War II. Could they be rethinking their policy on nuclear power?

RC: They could be—every country is rethinking their policies—but the economics don't work well for phasing out nuclear power in Japan. Currently, 30% of Japanese power comes from nuclear generation. Studies indicate that it would cost $60–$150B to replace that with coal or liquefied natural gas (LNG), and another $17–$27B in import costs for coal and LNG. That would be an extremely expensive endeavor in an environment where they need to rebuild parts of their country—and again, the global economy isn't strong.

In order for renewables like solar power to replace nuclear, the country would have to increase capacity about 190 times from where it is right now, costing just short of $700B in capital expenditures. In terms of wind power, some estimate they would need a hundredfold increase, costing $330B. Some might suggest geothermal, but that's not possible; it would take 65 GW (gigawatts) of geothermal power at a cost of more than $200B to replace the nuclear power being generated, although the country is currently only capable of producing 23.5 GW.

TER: So, you are still bullish overall on nuclear power, and therefore uranium mining.

RC: Absolutely.

TER: What are the growth drivers for the uranium industry?

RC: Fukushima hasn't really changed those. Current demand for uranium is around 180 Mlb. from the 440 operating reactors around the world. Meanwhile, the supply from mines is around 135 Mlb. That leaves a 45 Mlb. shortfall, currently mitigated by the Highly Enriched Uranium (HEU) agreement, which downgrades Russia's nuclear warheads and redistributes the material. The agreement is set to expire in 2013, and from the reports we're getting the Russians aren't planning to downblend any more after that. If that is true, they will not be reprocessing their warheads after that date for themselves either, so that supply is disappearing.

Meanwhile, 61 reactors are under construction, already financed and moving forward. Another 25 Mlb. of uranium will be required to power these new reactors, which use approximately 400,000 lb. each. On top of that, 158 more nuclear reactors are planned, and 326 proposed. Even if only half are built, that's another significant demand for uranium when we already have a 45 Mlb. shortfall. The growth drivers for uranium are phenomenal.

TER: What does this shortage bode for the price of uranium?

RC: It has nowhere to go but up. For the marginal cost of production, you're looking at a minimum of $45–$50/lb. If you were to add on the capital expenditures required to build out these lower grade, probably deeper deposits that generally cost more to build, you are looking at a minimum of $70/lb. just to support the build-ups. And since you have such a supply shortage relative to demand, these new mines need to be built in order to power the world. For that reason, the uranium spot price must increase to $70/lb. or higher going forward.

TER: On a long-term basis—let's say 10 years—will the events at Fukushima have slowed the growth of the uranium industry?

RC: Overall, I don't think Fukushima has made a significant impact. One analysis predicts only a 4% reduction over the next 10years in uranium demand because of Fukushima. That is not very significant, especially when we have massive shortfall of supply relative to demand right now.

There will be some impact over the decade, but I think the actual impact on the markets will be short lived. It's tough to say how long it will take; it depends on the actual impact of Fukushima, which is not yet fully known. There are still ongoing efforts to fix everything there.

A parallel could be made to last year's BP oil spill. Around that time, there was a lot of negative sentiment toward oil, but now, any oil-related investment is significantly higher than it was before. Similarly, uranium could be off and running by next year. That could be optimistic, but it looks and feels like it could end up in the same situation.

TER: In a basket of individual uranium stocks, the one-year total returns are still phenomenal, anywhere from 30% up to 150% up over the past 52 weeks. But over the past three months, some of these stocks have been cut in half. Is there a bright side? Are we looking at deep value currently in stocks?

RC: There is definite value. The uranium stocks were all on an upward trend, as you noted. The uranium price itself needs to go higher, and these stocks will go with it. So yes, there is significant value in these stocks; we just need a catalyst, more interest or at least recent events to blow over for these stocks to reignite.

TER: Thank you, Rob.

Versant Partners Analyst Rob Chang has extensive financial markets experience dating back to 1995. He was a member of a five-person team running a multi-strategy hedge fund, a base metals research associate at BMO Capital Markets, a manager of resource funds at a boutique investment management company and an equity analyst covering the global mining sector at an independent investment bank. Rob has an MBA from the Rotman School of Management at the University of Toronto and holds a Canadian Investment Manager designation.

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-- Posted Wednesday, June 22 2011 | Digg This ArticleDigg It! |

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