Juniors in the oligopoly-dominated energy-metals space must break into the ranks of producers or become acquired to survive and reward shareholders, says Chris Berry, editor of Morning Notes. Strategies for success include good geographic location, sales contracts, ample cash and experienced management, but as Berry says in his interview with The Energy Report, macroeconomic conditions can turn the ambitious junior into acquisition bait.
The Energy Report: In your Morning Notes in January, you defined much of the energy mining industry as an oligopoly. What do you mean by that?
Chris Berry: Industries like uranium, lithium, vanadium, rare earths or potash typically have a few players at the top that control production and hence pricing. This is a huge barrier to entry for juniors looking to join the ranks of producers.
TER: If the majors are producing enough material to meet today's demand, what are the prospects for the juniors in this market?
CB: It's challenging in the near term because I see supply and demand in balance in many of the metals markets. This is why companies with ample cash on their balance sheets should attract attention—they can survive until demand recovers. Economic growth has slowed across the globe, which implies lower demand and less need for the many juniors out there. To prosper, juniors across any of the energy metals need a competitive advantage, which usually boils down to low production costs. Uranium, for example, is a very interesting case study in this regard. The major producers like Cameco Corp. (CCO:TSX; CCJ:NYSE), AREVA SA (AREVA:EPA) or BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK) have halted expansion plans because of the depressed spot uranium price. To break even on new projects, these companies will need a uranium price closer to, say, $70 per pound ($70/lb). These delays provide a window for near-term producers to either join the ranks of producers or become high-priority takeover targets for majors looking to lower overall costs of production and add reserves.
TER: What does this mean for the junior uranium market? What companies could run the gamut and come out winners, either by being acquired or becoming majors themselves?
CB: Uranium is unique among energy metals and that is why I think we are reading so much about it right now. Security of supply is an increasingly important factor to consider. With ARMZ recently buying out the remaining 49% it didn't already own of Uranium One Inc. (UUU:TSX) for $1.3 billion ($1.3B), I think this is a harbinger of things to come in the uranium space. The Russians realize that the Megatons to Megawatts agreement is set to end at the end of this year and are taking the necessary steps to ensure steady and reliable supply of uranium for their reactor fleet.
Speaking of Megatons to Megawatts, I think the looming end of this program can serve as one of the catalysts for higher uranium prices over the next 12–24 months. The agreement has been in force for 20 years and supplies approximately 24 million pounds (24 Mlb) of reactor-grade material to the U.S. With that set to end by the end of this year, up to 24 Mlb of uranium will go off the market, so there's a looming supply/demand imbalance here. There is one very important factor here that very few people are talking about. It involves the Transitional Supply Contract, which is an agreement signed between USEC and Techsnabexport (TENEX) of Russia to replace the uranium made available to USEC under Megatons to Megawatts. There is some confusion surrounding the exact amount of uranium that this agreement will produce. My research tells me it will be somewhat less than 24 Mlb, so a supply deficit arising from the end of Megatons to Megawatts seems likely, but not for the full 24 Mlb we read about. Combine this with some Japanese reactors coming back on-line in the coming years and the nuclear build out in the emerging world, and you can get a sense of the looming supply crunch.
A number of advanced-stage development companies could serve as interesting takeout targets for majors. One is Uranerz Energy Corp. (URZ:TSX; URZ:NYSE.MKT), which has a project in the Powder River basin in Wyoming called Nichols Ranch. Uranium One has a producing uranium mine not far from Uranerz's deposit and Cameco is active in the basin as well, so the region has clearly been derisked from a production standpoint. The company is fully permitted and should start producing uranium later this year. Of particular significance is a toll processing agreement the company has in place with Cameco. This is a signal that Cameco has vetted Uranerz's operation and Uranerz could very easily integrate into Cameco's supply chain. In my opinion, Uranerz is clearly a takeout target because of this agreement.
Another well positioned company is Ur-Energy Inc. (URE:TSX; URG:NYSE.MKT), which is on the verge of production at its Lost Creek property in southern Wyoming. There are a number of similarities between Ur-Energy and Uranerz in that they will mine and process uranium through a process known as ISR or in-situ recovery. Without getting into too many specifics, this process minimizes the environmental footprint of the mine and also boasts among the lowest costs per pound of production in the industry. Both Ur-Energy and Uranerz will survive the current low uranium price environment as their costs of production are so low relative to their competitors. Ur-Energy should ramp up production to about a 1Mlb/year run rate in 2014.