Nuclear Energy Markets Tighten
By: The Energy Report and Edward Sterck
-- Posted Friday, January 20 2012 | Digg This Article |
Demand for uranium is expected to continue growing as China spearheads the conversion of new energy production from coal to nuclear. In this exclusive interview with The Energy Report, BMO Capital Markets Analyst Edward Sterck brings us up to date on how investors can best play this market.
The Energy Report: There hasn't been much price action in the uranium market since you last spoke with The Energy Report in early September. Does that surprise you at all and what are your expectations for near-, medium- and longer-term market action?
Edward Sterck: It doesn't surprise me particularly. Historically, a lot of utilities were operating on a fairly hand-to-mouth basis in terms of their uranium requirements. The price spike in 2007 was a bit of a wakeup call for utilities. Since then, they've been building up some buffer inventories and are pretty fully covered for near-term requirements. By near term, I mean for the next nine months or so. Consequently, they can currently choose to be quite price selective.
Looking ahead, therefore, it is quite hard to pinpoint anything that is going to act as an absolute catalyst for the uranium price in the near term, short of a significant supply disruption at any of the mines or some political upheaval. If Iran tries to close the Strait of Hormuz, that could obviously have a positive impact for oil prices and potentially the energy suite in general, possibly including uranium.
In the mid- to longer-term, however, I think that the supply-demand equation probably is going to get tighter. The supply side is currently more constrained than it has been for a while. Many of the big existing operations that have been in production for a number of years are actually struggling with declining grades and they are missing production targets. Cost inflation is also something that's been bugging the mining industry in general and that's eroding the economic profitability of operations. Cost inflation is also a big factor with the new supply that is needed to come onstream. The incentivisation price for new production is increasing fairly significantly and the timing of new projects is less certain than it was previously.
Look at the mid- to longer-term demand side of the equation: Despite Fukushima, there is still a case for strong demand growth. The countries that are the big drivers of growth in installed nuclear capacity, namely China, Russia, South Korea and the Middle East in general are pushing ahead with their plans, regardless of other events that have unfolded. Less certain supply could result in a tighter market and have a potentially positive impact on the uranium prices.
TER: It appears that China is leading the pack in terms of uranium demand. Is that the way you see it?
ES: In terms of demand growth, absolutely. China has very ambitious plans for expanding its power generation capability, and it's very incentivized to do so. It has to maintain growth in electrical power generation to keep its economic growth on course. It needs to focus on nuclear power because of the tremendous atmospheric pollution created by the coal-fired power plants in China that burn low-quality coal. Obviously, coal's health impacts are significant, and the death rate in China from pulmonary illnesses associated with atmospheric pollution are extremely high. On that basis, it is pushing forward with renewables and nuclear power. I don't see any reason for it to pull back from that now. The Fukushima disaster has only caused China to be a bit more circumspect in deciding where it will actually license nuclear reactors to be constructed.
TER: With the challenges involved in bringing uranium projects into production, it seems that anything that looks reasonably viable is a potential acquisition target for someone higher up the food chain. Do you see this trend continuing?
ES: I think that's a pretty reasonable possibility. The only caveat I'd add is that given the cost inflation in the mining business in general, it's actually quite hard to identify really high-quality, pre-production projects that make sense at current uranium prices.
TER: Over the last few years, there has been quite a bit of activity in Canada, mainly in the Athabasca basin, but we haven't seen much in the way of results yet. What do you think the prospects are for some of these companies?
ES: In the near term, it's a question of them just continuing their exploration activities and trying to develop resource bases that are of scale. I think in the Athabasca you have to be close to 100 million pounds (Mlb) or above or have a project that's shallow enough that it makes sense at smaller resource sizes. We likely need higher uranium prices before mergers and acquisitions (M&A) in that area really kick off with gusto. Meanwhile, it's just a question of continuing to try to build out the resources through additional exploration, which is a tricky job at the moment.
TER: What sort of uranium price would it take to get things really hopping again?
ES: If you plot the share prices against the uranium price, the correlation is very good indeed. Any increase in the uranium price is likely to be reflected in share prices. It's the number one driver for them. But to really get the sector whizzing along again, I think we need to see prices in the region of $60–70/lb versus the current spot price of around $52/lb.
TER: How would you describe the uranium business at this point and the prospects for companies that are in it?
ES: In the near term, prices are looking at little bit depressed, and it's hard to pinpoint an absolute catalyst beyond the potential for supply disruption or some political event. But the mid- to longer-term prospects actually look pretty healthy considering that the supply side of the equation is looking increasingly challenged. At the same time, demand is expected to continue to grow on a fairly healthy basis through the course of the next 10 years. At some point, the balance of that equation has to shift toward higher uranium prices. It's just very hard to pinpoint exactly when that's going to happen.
TER: As far as parting thoughts for investors who are currently in uranium stocks or those who may be eyeing the market, what kind of a strategy do you propose they should be looking at?
ES: I think the key thing is to focus on the higher-quality names. For the investors who are already in the space, I think it's probably been beaten up about as badly as it is going to be in the post-Fukushima environment and given the general weakness in the financial markets. So I don't see any reason to exit at this point in time, whilst noting that obviously, there are still risks associated with uranium. But for investors looking at this for the first time, or perhaps revisiting the sector, I think prices for some of the high-quality stocks look pretty appealing at the moment. Although it might be a bit of a buy-and-hold situation and it could take a little time before we really see some upside catalysts coming through.
TER: That pretty well summarizes things. Thanks, and we'll look forward to talking with you later in the year and maybe seeing a little more excitement in this market.
ES: Let's hope so.
Edward Sterck covers uranium, diamond and platinum group metal mining companies for BMO Capital Markets. He joined BMO in 2007, prior to which he was a mining analyst at Hargreave Hale. Before working in mining research, he spent more than four years trading government bond futures on a proprietary basis. Sterck holds a Bachelor of Science in geology with honors from the Royal School of Mines, Imperial College London.
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-- Posted Friday, January 20 2012 | Digg This Article |
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