By: The Mining Report and David Sadowski
Source: Tom Armistead of The Mining Report
Uranium prices and mining stocks are low, but market forces will push them both higher in the next 12–24 months, says David Sadowski. Miners are jockeying for position and the Raymond James mining analyst tells The Mining Report to expect mergers and acquisitions as they prepare for the good times to come. The market's supply glut will be gone by mid-decade, and mining will have to ramp up to head off a deficit by 2020. The time to buy in is now.
The Mining Report: David, welcome. What is happening with uranium demand? And where are the trends most pronounced?
David Sadowski: Over the next decade, we expect uranium demand to grow at about 3% per year (3%/year) with about two-thirds of that incremental buying coming from China, Russia and India. China is building reactors like they're going out of style—30 units are currently under construction domestically, with 59 in the planning stage — and we've just seen China grow its presence internationally with an equity stake in the Hinkley Point power station in the U.K. Russia is building 10 reactors at the moment. It's got 28 on the drawing board, according to the World Nuclear Association, and that's going to more than offset the retirement of some of its aging reactors. Russia is heavily involved in vending reactors globally as well, with projects around the world. One interesting aspect of that is the build-own-operate model, where Russia will build and operate a plant in your country and then sell you electricity from that plant. In India, despite some headwinds with the nuclear liability law, another new reactor just connected to the grid, an additional six units are currently under construction and five dozen are on the drawing board. You've got new entrants like the United Arab Emirates, Turkey and Vietnam showing that they're very serious about nuclear as a power source.
On the other hand, although the U.S., the world's largest nuclear power producer, is building three large reactors and two more are due to start construction imminently, utilities have decided to close five small, old reactors due to challenging economics, with a handful more at risk of closure. In France you've got some talk about reducing its very heavy reliance on nuclear, while a similar debate has kicked off in South Korea. And Germany, as we all know, is looking to phase out its nuclear power plants by 2022. It's sort of a polarized mix internationally when it comes to nuclear power and uranium demand.
The underlying theme is that Western nations may have slowed their momentum somewhat on nuclear, and there's a variety of reasons for that, including upfront capital costs, which tend to be quite high; the low cost of competing sources of electricity, like natural gas; and in some cases low electricity demand and power rates regionally. Despite that, Eastern nations remain focused on nuclear reactors as a linchpin in their energy mix for its stable, low-cost, zero-emission ability to provide secure base load power.
TMR: With the market sending conflicting signals, how should investors proceed?
DS: For investors, the key thing to focus on is that irrespective of public outcry in some regions and pullback on nuclear power growth plans in others, there is still significant growth of nuclear power globally. Japan is going to be restarting its reactors. We think about 30 gigawatts or so will eventually get turned back on, with those first units firing up again mid-2014. Further clarity on the timing and number of those restarts as well as potential read-through on Japanese inventories is a key catalyst for the uranium market. The investor looking at some of these conflicting signals has to stay focused on the underlying trend and ignore the noise. We think the underlying trend is heading in a positive direction, especially in the medium- to long-term.
TMR: Ontario decided to refurbish existing nuclear plants instead of building new ones. What does this mean for the future of nuclear power in Canada?
DS: Canada has long been a major force in the global nuclear power industry. Nuclear power was first developed in the 1940s. In the 1950s and 60s, Canada developed the CANDU reactor design, a unique heavy water plant that is flexible with respect to maintenance and the fuel that can be used, supplies much of the world's medical isotopes and has been exported to several other countries. For domestic power generation, Canada is pretty reliant on nuclear power. There are 19 reactors operating today, meeting about 15% of the country's electricity requirements. We don't think the decision not to pursue new reactors at Darlington is going to change nuclear's role—the decision to refurbish the existing units is a cost-effective commitment, in-line with demand growth, to maintain nuclear as an important source of power in the country for decades to come.
TMR: Yellowcake is trading now at an eight-year low, around $35 per pound ($35/lb), but it appears to have stabilized there after sliding for three years. What is your advice for investors now and why?
DS: We believe the uranium price is more likely than not to be range-bound for the next 12 months or so given a glut of uranium supply and a significant dip of real demand in the marketplace (as opposed to discretionary demand) from utilities. In the medium to longer term, we continue to see extremely compelling supply/demand fundamentals. Accordingly, we're still inclined toward companies that can weather some spot price weakness, but are leveraged to an inevitable rise in sentiment and equity valuations in the space.
TMR: In our last interview though, you had projected a three-year supply shortfall of uranium starting in 2014. What's the current outlook?
DS: A lot has changed since we last talked. There's been a bit of a pushback in terms of when we expect Japan to start up its reactors. That has had implications for uranium demand globally. Japan created a new regulator called the Nuclear Regulation Authority. It established a rigorous new safety framework that all reactors will have to operate under and the pre-restart inspection process was started from scratch all over again. The reactors have to be upgraded to meet the new guidelines, it's going to take at least six months to inspect each power plant, and there's a finite number of inspectors.
In China as well there's been a throttle back on its growth plans following an 18-month safety review after Fukushima. That safety review was completed in late 2012. For the time being, only third-generation power plants on the coast will be permitted to commence construction going forward. That's had a bit of a negative impact. Those are just two examples.
On the supply side, mine production has been very strong since we last spoke. We've seen big rebounds in Australian and African supply. Kazakhstan has continued to grow despite obvious price headwinds. There's been some inventory selling by companies in Japan. Perhaps more significantly, requests for deferral of supply contracts by some Japanese utilities have led to the return of some uranium back to the original selling producers, who then turn around and sell that material into the marketplace. That's had a negative impact on the supply/demand fundamentals.
Even though the Russian HEU agreement ends this year, which should reduce U.S. utility reliance on this stable source of supply, we think secondary supplies will continue to be significant. The U.S. Department of Energy stated it's going to start releasing more of its material into the marketplace. We also now expect higher levels of material as a result of underfeeding at enrichment plants in both Russia and Western nations. On balance, this has all resulted in our global supply/demand shortfall getting pushed back several years.
We now see meaningful oversupply through 2016, a relatively balanced market from 2017 through 2019, but then in 2020 we see a deficit emerge that escalates very quickly to crisis levels. There is enough material to go around for now, but demand continues to grow. Existing mines are depleting and the uranium price is far too low to incentivize the mines that the market will badly need by the end of this decade. We believe uranium prices have to be a lot higher by 2015 or 2016 to provide enough lead time to bring on new supply in advance of this very large shortfall looming. It's hard to time these things exactly with respect to the uranium price, but we do see further supply disruption or even a resumption of long-term utility contracting as being that spark that moves uranium prices to where they have to get to.
TMR: Given all these conflicting trends, how are mining companies responding?
DS: The mining companies have suffered. Spot uranium prices are at eight-year lows and are not reflecting the longer-term fundamentals. For companies that have meaningful exposure to current market prices, that is to say those that don't benefit from long-term fixed-price contracts, their realized prices are on a downward trend. That is definitely factoring into equity valuations as well. We've got producers averaging well below historic levels. We typically see producers averaging well over 1.5-times price-to-net asset value, for example, and right now they're trading at fractions of that. The juniors are even more battered with reduced prospects of securing equity financing and greater challenges in quickly getting their projects into positive cash flow. But the uranium price must inevitably go higher and we see a lot of opportunity on the equity side because of that. We think there's going to be a continued trend toward mergers and acquisitions with logical consolidation in key jurisdictions such as the Western United States. Also, many larger entities are well capitalized, while potential acquisition targets are trading at bargain valuations.
TMR: You recently attended this year's World Nuclear Association Symposium. What were the takeaways?
DS: The symposium is the largest demand-side event in the industry. Normally we see an uptick in market activity following the conference as market participants from around the globe sit down in London and hammer out supply deals. That didn't really happen this year. I think what became apparent at the WNA was the demand side of the industry feels satisfied with the amount of uranium available to meet its uncovered needs over the next couple of years. That in part has led to a complete collapse of the long-term contracting market. We're just not seeing any long-term contracting right now. Year-to-date there's only been about 14 million pounds (14 Mlb) of yellowcake that has changed hands in the long-term market. That compares to about 140 Mlb/year average over the last decade. There's some thinking that at some point utilities have to resume contracting. That's really going to be what gets the uranium price moving upward in our view—that concern among utilities that they're not covered on the supply side, coupled with an increasingly apparent future supply shortfall, leading to more buying. As I've mentioned, Japanese reactor restarts and further supply cutbacks could be critical in the timing of this.
TMR: How will the opening of Canadian uranium mine investment to European companies affect your uranium companies?
DS: It's certainly good news. Elimination of the non-resident ownership policy (NROP) will permit European Union-based companies to own a majority stake in an operating uranium mine. That opens the door for companies to push forward with development of existing deposits or to buy more uranium assets in Canada.
TMR: Thank you, David. You've given us a lot of insight.
DS: You're welcome.
David Sadowski is a mining equity research analyst at Raymond James Ltd., and has been covering the uranium and junior precious metals spaces for the past six years. Prior to joining the firm, David worked as a geologist in western Canada 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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