It doesn't take a Ouija board to predict a rebound in the price of uranium: Global fuel stocks are insufficient, and unmet demand for uranium is growing. In this interview with The Energy Report,David Sadowski, a mining research analyst at Raymond James, explains the forces that will push the price of uranium, and the companies that are likely to benefit. Being selective, he says, will provide the greatest rewards.
The Energy Report: David, the uranium price remains below the cost of production for many producers and the forecasts for uranium production are flat. Why are you optimistic about the uranium space?
David Sadowski: In the current price environment, supply won't be able to keep up with demand growth. That's really the core to the uranium investment thesis. The cost of uranium production spans a pretty wide range, from the mid- to high-teens per pound for the cheapest in-situ leach mines in Kazakhstan, to $50–60/pound ($50–60/lb) for some of the lower-grade, conventional assets in Africa, Australia and East Asia. So we're looking at about $40 to produce your average pound of uranium. That number is climbing on cost inflation and depletion of the best mines.
The current spot price is under $36/lb, so many operations are underwater right now. That's why we've seen numerous deferrals of projects and even shutdowns of existing mines, the most significant of which was Paladin Energy Ltd.'s (PDN:TSX; PDN:ASX) Kayelekera at the beginning of February. That's on top of operations that are at risk for other reasons. In just the last few months, we've seen four of the world's largest mines owned by Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK) and AREVA SA (AREVA:EPA) shut down on operational and political hiccups. Then you look at where the supposed growth is coming from over the next several years— Cameco Corp.'s (CCO:TSX; CCJ:NYSE) Cigar Lake and China's Husab. Those are technically very challenging, too. All of this is occurring in a world no longer benefitting from a steady 24 million pounds per year (24 Mlb/year) supply of uranium from downblended Russian warheads. In short, the supply side is a basket case.
Yet demand growth keeps chugging along. European Union (EU) and North American growth perhaps isn't what it was a couple of decades ago. Pressure from competing energy sources like liquefied natural gas (LNG) in the U.S. is causing some operators to switch off their older, smaller reactors. But reactor retirements are being more than offset by new reactor construction not only in the U.S. and EU, but much more important, in Asia and in Russia. China, India, Korea and Russia are collectively constructing 70 reactors right now.
TER: Japan and the United Arab Emirates (UAE) just announced a program to cooperate in developing nuclear technology. What's the market significance of that?
DS: There is a push toward nuclear in many of these nations in the Middle East. Not only do they have pretty strong population growth and urbanization, thus electricity growth is strong, but some of those oil-rich nations have cited a preference to sell their petroleum into the international markets rather than domestically. The UAE is a very large potential source of demand growth. It is constructing two nuclear power plants at the moment and is imminently going to break ground on two more. There are an additional 41 new nuclear reactors on the drawing board in the Middle East. So in the context of 434 operable reactors today, that's a very meaningful amount of growth potential.
Demand growth remains resilient, and supply is lagging behind. In just a few years, we think this will lead to a deficit that will quickly grow to crisis levels. That's why we're bullish. Uranium prices have to go higher to incentivize more supply to meet this looming supply gap.
TER: Why hasn't that happened yet?
DS: There are just a few forces working against the price. Since the Fukushima accident in Japan, there has been a supply glut in the marketplace. There has been a decrease in demand, with a lower level of buying by some countries, like Germany, Switzerland and, of course, Japan. Additionally, some extra supply was coming out of the U.S. government. There is an extra amount coming from enrichment underfeeding. If you add all that up, there has been essentially more supply than is required, and that puts downward pressure on prices. It's caused the utilities to take a step back from the market.
TER: So do you think conditions in the market itself will materially improve? What will that look like?
DS: For us, it comes down to when the utilities start getting involved again. While the utilities have been sitting on the sidelines over the last couple of years, high-fiving each other for not buying uranium in a declining price environment, their uncovered requirements in the future have actually risen quite dramatically. At some point, they have to resume long-term contracting to cover all those needs. Japan is a key catalyst.
Japan's reactors were slowly shut down after the Fukushima accident. Right now, none of them are operating. The country's inventories have piled up to probably around 100 Mlb. Many of these utilities have asked their suppliers to delay deliveries of fresh uranium. That material ends up in the marketplace one way or another, so it's having a price-dampening effect. In late February, however, the Japanese government announced its final-draft energy plan. Japan will restart at least some of its reactors to stop spending a ludicrous amount of money on imported fossil fuels. There are other economic and environmental benefits, but it’s the country's trade balance that is really driving the restart push.
It's these restarts that we think will spur global utilities outside Japan to resume buying. The signal will be sent that Japan won't be dumping its inventories, it won't be deferring deliveries anymore and, by the way, there is not enough supply to go around in just a few years so you better start contracting again. That's what we think is going to support prices.
TER: That basic energy plan in Japan is a draft, but there is a lot of public opinion against it. You do think its prospects are good?
DS: Consensus is that the plan is going to be approved by the cabinet by the end of March. The opposition is highly regionalized, and many pockets of the country are actually very pronuclear. Nuclear, obviously, provides a lot of jobs and generates a lot of tax revenue in these regions.
TER: Raymond James has revised its uranium supply-demand balance and anticipates a growing supply deficit beginning in 2017. What is the case for investing in the industry today with a payoff so far in the future?
DS: A shortfall beginning in 2017 doesn't mean prices don't move until 2017. In fact, in a healthy market, they should have moved already. But, again, it comes back to the utilities. They view the nuclear fuel market and their own fuel requirements as a game of risk management.
Today, many utilities are sitting on near-record piles of material, so there's not a great deal of risk to the utilities with respect to supply availability over the next couple of years. However, as these groups start to look out beyond that period to 2017, 2018 and so on, they'll realize that it could become more challenging to get the uranium they need. Given that the utilities typically contract three to four years in advance, we're very close to that window where we expect buying to ramp up again and prices to move upward. Again, critically, we expect Japanese restarts to be an important catalyst in that resumption of buying. We expect first restarts in H2/14 with a half-dozen units online by Christmas. So from an investor's point of view, we're already seeing the benefit of this outlook. That's been driving the uranium equities upward over the past couple of months.
TER: You're forecasting spot uranium prices averaging $42/lb in 2014, but three months into the year, the price is still struggling to break $36. What will drive it over $42? When do you expect that to happen?
DS: We think the move this year is likely to happen toward the end of this year, as Japanese restarts spark a return of normal buying levels by utilities. The uranium price should really start moving in 2015.
TER: What indicators should investors look for in watching the uranium price trend?
DS: One of the best indicators is Uranium Participation Corp. (U:TSX). Since the fund's inception, this stock has been a remarkably accurate predictor of where the uranium spot price is headed. When Uranium Participation's share price is above its net asset value (NAV), the market is baking a higher uranium price into its valuation of the stock because the NAV is calculated at current uranium prices. For even more precision, you can divide the company's enterprise value by its uranium holdings for a rough dollar/pound estimate on what the market is ascribing. So right now, we calculate the fund is implying $40/lb, and that's over $4 above the current spot price. This is by no means a bulletproof measure, but absent a black swan event, history tells us that this could be the destination for the price in the near future.
TER: You have said you see $70/lb as the price that will incentivize new mining. What should investors do while they're waiting for the price to reach that level?
DS: Buy uranium equities. It's that simple. We think prices are going higher, so buy uranium stocks well ahead of the upswing.
TER: Do you have a target time that you expect the price to reach that level?
DS: We're looking for the price to reach $70/lb in 2016. We forecast prices flat forward at $70 from that year onward.
TER: Which mining companies are the best investment prospects in this environment? Which are the weaker ones?
DS: They say a rising tide floats all boats. We think all the uranium stocks are probably going higher, or at least the vast majority of them. But we also believe being selective will provide the greatest rewards. Most investors should be looking at names with quality assets, management teams and capital structures.
Among producers, our preferred companies are focused on relatively high-grade projects with solid balance sheets and fixed-price contracts that can buffer them against near-term spot price weakness. After all, we think the spot price could remain weak for most of the balance of 2014.
On the explorer and developer side, the theme is the same—companies with cash and meaningful upcoming catalysts and, again, in good jurisdictions. But if you can tolerate an increased level of risk, I'd be looking at companies with lower-grade assets in Africa. Those are probably the highest-leveraged names out there.
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