By: The Energy Report and David Sadowski
Source: George S. Mack of The Energy Report
Analyst David Sadowski of Raymond James sees a lot on the horizon for uranium: a supply shortfall, escalating Asian demand and seasonality, to name just a few. As a former geologist-turned sellside analyst, Sadowski's conviction in uranium's bullish future is rock solid. In this exclusive interview with The Energy Report, Sadowski urges investors to get exposure now, as prices in this sector can climb quickly once they're set in motion.
The Energy Report: David, how does your background as a geologist help you to see value and growth potential in mining companies?
David Sadowski: Defining ounces or pounds is not an easy business. If it was, there would certainly be far more economic deposits out there and metal prices would be a lot lower. Luck is involved, but most companies use systematic evaluations like geological surveys, drilling and other data to take a lot of the guesswork out of finding the next discovery. The ability to interpret these data is equally important, and it allows an analyst to make an independent determination on the growth potential of a project rather than just relying on what management is saying. In this way, I feel like having an understanding of how economic ore deposits form is essential to developing a meaningful forward-looking opinion, particularly on early-stage prospects. In my view that's one of the most important tools for the successful analyst.
TER: You're also clearly comfortable speaking with engineers and geologists at these companies.
DS: Yes, quite right. That's a very important element to my role. You have to be able to speak the same language and understand what they're doing on the ground, and that helps the analyst determine whether or not the company is headed in the right direction. It's a key skill to have.
TER: I was also very curious about your transition to finance as a sellside analyst. You once had a responsibility to the companies for which you worked, but now your stakeholders are institutional and retail investors. What mental shifts did you have to make?
DS: As an exploration geologist, one is really focused on the rocks, sometimes even at the microscopic level, and that's a much different scope of focus than that of a mining analyst. The financial and operational outlook for the company and its share price must always be on the analyst's mind, and we're not looking at companies in isolation, as a geologist might do. If you're in the business of projecting where the commodity price is going, as I am for uranium, the scope of analysis is global and extends from government policy right down to whether we think a specific ore zone will be amenable to heap leach, for example. As you mentioned, first and foremost I look out for the interest of investors rather than the mining companies, and this responsibility demands even higher levels of objectivity, precision and rigor. It's a constant challenge and that makes it an exciting and fulfilling role.
TER: Speaking of forecasts, uranium has dipped below the $50/lb level. I'm not sure, but I think these round numbers represent psychological support and resistance levels. What minimum price level must be sustained for small or near-term producers to maintain adequate margins?
DS: Well, if we look at existing operations, the majority of them would be losing money by selling their material at $40/lb. By our estimates, there are only two potential projects that are likely to work in the $40/lb range of average realized price. When we look at the majority of additional projects needed to fill the looming supply gap, we think they need prices north of $70/lb to go forward. This is one of the key reasons why we feel the sub-$50/lb prices are unsustainable.
TER: What is your case for rising demand for uranium?
DS: We're definitely bullish on the outlook for uranium. Although prices have softened in recent months, we have a very strong conviction that this trend is soon to reverse and investors should be exposed to uranium today. Beyond the high incentive prices for new supply that we just touched on, there are three primary reasons for our view. The first one is compelling supply/demand fundamentals. Next, there is the seasonality of uranium prices. And, most importantly, there are industry catalysts. Shall we take a look at each one?
TER: Please, go right ahead.
DS: After the Fukushima Daiichi accident last year, the nuclear industry has done some soul searching and decided to take a slower, more cautious pace in the construction of new reactors globally. But what many people don't realize is that according to World Nuclear Association (WNA) data, there are nine more reactors in the planned and proposed category today than there were before the accident. Demand for nuclear power has remained resilient with ramping electricity requirements around the world, volatility in fossil fuel prices, energy supply security concerns and a global preference for carbon-neutral sources. The majority of this demand is from Asia. In fact, we estimate 82% of new capacity through 2020 will be built in only four countries—China, India, Russia and South Korea. Part of the reason for that is that state-owned utilities don't face the same problems associated with other regions, like high upfront construction costs, widespread antinuclear public sentiment and lengthy regulatory timelines. So, this continued growth should support commensurate levels of demand for uranium for decades to come.
All of this demand begs the question, where is this uranium going to come from? Well, we don't think supply is going to be able to keep up. Due to recent soft prices, many major projects have been delayed or shelved. We are projecting a three-year supply shortfall starting in 2014, and that certainly paints a very rosy supply/demand picture for investors.
Seasonality also favors uranium exposure today. Over the last 10 years, uranium spot prices have dropped on average $4/lb during the third quarter (Q3) but have rebounded by at least that amount in Q4, which is the strongest quarter of the year. This is often correlated with the annual WNA symposium, where many market participants sit down and hammer out new supply agreements. This year's conference is going to be held September 12–14 in London.
Last but not least, there are several near-term catalysts that we think will start the price upswing. In Japan, all but two reactors are now offline, and there's significant uncertainty and government debate about how many will eventually restart. As the world's third-largest nuclear fleet, it has obvious implications for future uranium demand. For a variety of economic, political and environmental reasons, we think Japan will restart most of its reactors by 2017 with the first batch of reactors likely starting early in 2013. As more units start to return to service, it will provide additional confidence that the nuclear utilities in Japan are unlikely to dump their inventories into the market, which should support prices in the near-term.
Meanwhile in China, the government paused construction approvals for new reactors immediately after last year's Fukushima accident. But with these safety reviews now successfully completed, they're poised to start re-permitting new projects, and this should undoubtedly support increased uranium contracting. Let's not forget that China will be far-and-away the largest source of nuclear demand growth for the foreseeable future. We expect a six-fold increase in installed nuclear capacity by the end of this decade.
The final major catalyst is the expiry of the Russian Highly Enriched Uranium (HEU) agreement to down-blend material from nuclear warheads into reactor fuel. This agreement has supplied the Western World for two decades but is due to conclude at the end of 2013. The Russians have repeatedly stated they're not interested in extending this agreement, and we expect this to remove about 24 Mlbs/year or 13% from the global supply. That's equivalent to shutting down the world's largest mine, McArthur River, as well as all six operating mines in the U.S. That's a massive impact. So, for these reasons we think prices are poised to turn here. We forecast prices to average above $60/lb in 2013 and north of $70/lb in 2014 and 2015 before settling to $70/lb in the long-term.
TER: These catalysts are spread out over the next 18 months, which is not a long time. Stock markets generally look ahead. So, why are prices lagging as they are?
DS: That's a good question. I think what we're seeing is a significant amount of uncertainty in the marketplace surrounding the availability of some material and who is going to be a near-term buyer. The purchasing side is largely comprised of nuclear utilities, which are usually very conservative and cautious. Based on our experience, they tend not to make rash moves and prefer to wait until all information is available before jumping into new sales contracts. For instance, they would rather have certainty on whether utilities in Japan and Germany are going to be selling any of their inventories before they start buying. This has led to very low volumes in recent months.
However, we're already starting to see contracting activity pick up with major long-term deals this month. And the WNA meetings are now only a few weeks away. This mounting activity could be just what the market needs for the metal price to shift to higher and more sustainable levels. And recent history shows that when the price moves, it can move really quickly as we saw in 2007, mid-2009 and late-2010 when the weekly uranium spot price jumped in increments of $5–10/lb.
TER: Could these current low prices force juniors to sell themselves to the larger companies, the producers?
DS: Well, we certainly expect further consolidation in the space. This industry is pretty much divided into the haves and have-nots. On one side we have state-owned utilities in countries like China and Korea, which essentially have zero cost of capital and the stated intention to build their exposure to uranium production. We also have large producers that are cashed up and looking to grow. But, meanwhile many have-not companies have been under significant pressure in this current low uranium price environment with weak balance sheets and share prices. They could be looking to either sell assets or be taken over completely.
TER: I'm surprised that acquisitions haven't been a bullish signal to the market.
DS: We definitely think that they're a bullish signal. It means that the larger companies are willing to lay out capital and put it at risk to build their future pipelines, which is a sign to us that they have confidence in where the uranium price is going and that they want to have higher production in the future to take advantage of those higher prices.
TER: David, everything you have said sounds to me like you believe that we are now in a legitimate value market in uranium equities. Is that the way you feel?
DS: Yes, definitely.
TER: I have enjoyed meeting you very much, David.
DS: Thanks for having me George. It was a pleasure to speak with you as well.
David Sadowski has been a member of Raymond James' mining team since June 2008, and now covers the uranium and junior precious metal spaces as a research analyst. Prior to joining the firm, David worked as a geologist in Central and Northern B.C. with multiple Vancouver-based junior exploration companies, focused on base and precious metals. David holds a Bachelor of Science in Geological Sciences from the University of British Columbia.
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