Feature Stories | Aug 23 2007
By Rudi Filapek-Vandyck
Developments in the uranium market have transpired much quicker than anyone would have anticipated. After the weekly spot price surged to US$72/lb at the end of last year, the big question on everyone’s lips inside and outside the industry was: how far still?
The answer came through a further surging spot price, even though share prices of uranium miners and producers failed to keep pace from April onwards. In June TradeTech lifted its weekly spot price indicator to US$138/lb, while Ux Consulting lifted its own spot price indicator to US$136/lb, and speculation was rife we would soon see US$150/lb, and that was just the conservative scenario.
One of the uber-bullish market commentators kept on telling his readers uranium would ultimately reach a price of US$290/lb. His advice was plain and simple: Buy, Buy, Buy. And then Buy some more.
In one of his regular updates on the market, the commentator informed us about a recent conference where he sat next to a representative of a group of US nuclear utilities. The man on his right assured him uranium would soon be priced at US$60/lb again. Oh, how our commentator laughed. Surely, everyone knew that US$290/lb was the only way to go for uranium.
Meanwhile, the professional stock broking industry happily joined in the overall enthusiasm with analysts at JP Morgan, Macquarie, GSJB Were and Deutsche Bank issuing positive reports on the industry with price projections suggesting there was still some upside left for the price of U3O8 (uranium concentrate, otherwise known as yellowcake).
Both Macquarie and GSJB Were suggested US$200/lb for uranium was not unthinkable either in 2007 or 2008.
Investors in the share market were all too happy to put their money where the craze was and pushed up share prices of companies that at times only had the smell of uranium attached to them. In April, fledgling uranium producer Paladin Resources (PDN), who had become the poster boy for the new uranium era both in and outside Australia, saw its share price surge to $10.80. Not bad for a company whose share price had only been at $8 at the start of the year, and only at $2 at the beginning of 2006.
Shares of the more established, Rio Tinto (RIO)-controlled Energy Resources of Australia (ERA) had been slower in picking up the trend, as all established producers were plagued by highly disadvantageous legacy contracts. But from the moment Canada’s Cameco announced its flagship Cigar Lake mine was flooded (implying start of production was likely to be deferred) there was no holding back ERA’s share price either. That was October 2006.
Since then ERA shares have surged from the mid-teens to a high of $28.58 in April, only to come back to $15 in early August. ERA shares closed at $17.10 on Wednesday, August 23. Shares of Paladin similarly bounced heavily in the post-global credit squeeze rally. They closed at $6.49 on Wednesday.
When Paladin shares fell to $6 earlier this month, analysts at RBC Capital published what seemed a prophetic advice at the time: start piling up because you won’t see the shares this cheaply anytime soon again.
But they did. On August 16 they fell as low as $5.09.
No wonder Paladin shares have been highly sought after the recent share market correction. The average target price for the stock is $9.42 suggesting upside potential of no less than 85% from their low on August 16, and still in excess of 45% from where they are on Wednesday, August 23.
Analysts at ABN Amro still have a twelve month price target of $12.10 for the stock.
In hindsight, investors should have known it was time to head for the exit when Citi’s commodities specialist Alan Heap turned bullish on the sector. According to an old and popular saying within the financial community, the market is likely to reverse course soon when the last bear changes his view. More often than not the saying is spot on with reality.
One of the best known bearish market commentators, Morgan Stanley economist and global strategist Stephen Roach, returned from a visit to China in early May last year with the conclusion his previous concerns had been misplaced and the world economy seemed in a better shape than ever. A week later total mayhem broke loose and global equity markets suffered a correction that lasted for two months.
Of course, Roach himself denies all connection. And so will Heap. Fact is that Alan Heap stuck to uranium price forecasts that seemed completely out of sync with reality throughout most of the boom in the past four years. Finally, at the end of June this year Heap lifted his average price forecast for 2007 from US$70/lb to US$120/lb with the added projection that spot uranium was likely to remain above US$100/lb for the next two years. Guess what happened?
After peaking at US$138/136/lb in June spot uranium prices started to fall. The first decline was reported by TradeTech almost immediately after Citi released the updated uranium market forecasts by Heap.
As you would expect, most experts didn’t think too much of it. Fundamentals are still in favour of higher spot prices, their chorus acclaimed.
In early August, after spot prices had already registered a few declines, Deutsche Bank analysts reiterated their positive view on what appeared a “must have” correction in a market that simply had run too hot.
Deutsche Bank analysts were probably the first to officially switch to a bearish stance on the sector, at least for the short term. However, they were quick in adding: “we remain confident in the constructive longer-term outlook for uranium prices to reflect the global move towards nuclear power and the expected persistence of supply deficits in the market out to 2009.”
You won’t find any expert who disagrees with that view, not even if you tried really hard. The question that remains unanswered though is whether persistent supply deficits warrant prices as high as US$138/lb.
Remember, only six years ago producers couldn’t sell their product unless the price was below US$10/lb.
From early 2007 onwards something odd was happening in the uranium spot market. The U3O8 price had doubled over the previous twelve months (or nearly doubled, depending on which industry consultant’s spot price indicator one relies upon) and demand seemed to pull back. Yet prices shortly paused and soon started a rally that ended at US$138/136/lb in June.
Did nobody notice the dichotomy between falling demand and a surging spot price? Oh sure, people did notice but the overall explanation that was relied upon was that buyers had turned hesitant in the face of ever higher product prices on offer. There were rumours about hedge funds artificially pushing up the price of uranium, and even that some producers were playing the game in order to keep their share price up, but even in a small market as uranium such speculation seemed impossible to prove.
Meanwhile apparent demand fell further, and the weekly spot price kept on rising.
There were other signals things were at odds in the uranium sector. While weekly spot prices surged 84% between January and June, the long term price indicators at both TradeTech and UxC remained stable at US$95/lb. And from April onwards share prices of everything that had a faint connection to uranium no longer rose in accordance with the weekly spot price.
Then it happened –considered impossible at first, a must have correction soon after- demand had completely dried up and spot prices started to trend down as sellers started to accept lower prices. The spot price fell first from US$138/136lb to US$135/lb. This is only a short term pullback, analysts at Lehman Brothers opined.
At Raymond James the experts were not so sure. Maybe it is time for a serious pull back, Raymond James suggested. Maybe spot prices could fall as low as 50% off their peak?
Up until that point spot uranium had either paused or risen for 47 consecutive months.
Soon the spot price was back below US$130/lb, 6% off the peak. Well, that’s peanuts by anyone’s standards. This was, after all, a time when other commodities such as copper or oil made similar movements within a week, or sometimes even in a day. The market stabilised in the fourth week after the first fall. Then UxC cut a full US$10 off its price and lowered to US$120/lb. From then on things went pretty quickly further downhill.
This week UxC dropped the proverbial nuclear bomb by lowering its weekly spot price indicator to US$90/lb (off US$15 from the previous week). The long term price indicator has so far remained at US$95/lb.
This is the biggest price decline ever recorded by the industry.
All of a sudden the question asked by UxC a few weeks ago -Uranium: US$160 or US$60?- has gained significantly more weight. (The suggestion was that US$60 was probably coming first before US$160 would be seen, if ever).
All of a sudden, the global uranium sector is about to experience something else it hasn’t been used to over the past years: soon securities analysts will have to start lowering price forecasts in their valuation models.
So where to from here? Time to sell shares in Paladin Resources? Are prices of US$60/lb within sight? Have speculators gambled a bit too far, too long? Are utilities playing a canny game – trying to smoke out the hedge funds out of their territory? Has the global liquidity squeeze cut out the speculative froth from the uranium spot market?
FNArena has contacted leading industry experts and market watchers across the globe for their insights in what’s happening and what will be the likely way forward for uranium. Alas, only a few experts said they were willing to share their thoughts. After UxC dropped the bomb only one of them was left standing.
We thank TradeTech CEO Gene Clark for sharing his insights with us. The following correspondence was conducted via email between Sydney and Chapel Hill, NC (US).
Question: The dynamics have changed in the uranium market over the past month or so. Can you describe what the various factors are that have tipped over the market?
Gene Clark: “It’s pretty clear that the two basic market forces -supply and demand- reacted as one would expect to the sustained price rise of the past few years. We pointed this out in our Nuclear Market Review about a week ago, and I refer to the following graph from that report of August 10.”
(Special note: If you are reading this story via one of our third party distribution channels, you won’t find the two charts included in this story).
Gene Clark: “The yellow bars show TradeTech’s Active Demand (that is, the quantity of uranium being sought in the market at the end of the indicated month); the blue line is our Active Supply (uranium available to be placed against purchase requests or to be auctioned); and the red line is our spot price indicator (NUEXCO Exchange Value) at month’s end.
“Notice that there was a peak in buyers’ interest in the March-May 2005 time frame (coincident with the serious entry of the speculator “hedge fund” segment), at which time there was an up-tick in the price. After the fall-off in June 2005, there was a more-or-less steady run-up in Active Demand to its peak at over 6 million pounds U3O8 equivalence in November 2006, just after the Cigar Lake flooding. There has been a dramatic fall-off in Active Demand since the first of this year, to its current level of about one-tenth of the peak.
“Coincident with the Fall 2006 peak in Active Demand, the market witnessed its lowest level of Active Supply on record, at about 1.3 million pounds U3O8 equivalence. Starting in January of this year, supply started to increase and currently stands at over double the low of last year. Although this level of Active Supply is not high by historical standards, the steady trickle of new supply -prompted for the most part by cash needs of the suppliers- has had an effect on the market.
“In retrospect, one would have to wonder why the spot price took so long, after the glaring adjustments in supply and demand, to turn over. It may be very well a result of the inefficiency of this market, with so few transactions on which to peg price movements and the psychological factors readily apparent in this market – maybe more so than most other commodities markets.”
Question: Any other developments you see that could affect the market dynamics in the months ahead?
Gene Clark: “We seem to be seeing a real tug-of-war between potential buyers and potential sellers, with most of the demand being discretionary (that is, very price sensitive interest by intermediaries). It seems to me that the so-called hedge funds really hold the key here. They are into the physical market to the tune of as much as 25 million pounds of U3O8 equivalence, and apparently even more so (in market cap terms) in the equities market for uranium companies.
“To the extent we have no more surprises on the supply side (floods, fires, regulatory problems), it seems to me that the hedge fund segment will have to come back into the market heavily to drive the demand (and, thus, price) up significantly and keep the pressure on to get a really big kick upward in price, or they will be driven to playing the volatility game – by alternately (or simultaneously) being buyers or sellers to drive the price up and down.”
“One factor that seems to be keeping just below the radar screen is Cameco’s situation at Cigar Lake. Much earlier this year, they completed negotiations with their customers to defer the scheduled 2007 deliveries from Cigar Lake, but now it appears they will have to go through the same process for 2008, 2009 and 2010 deliveries. I have no doubt that this process is already underway and, to the extent that their utility customers have physical needs not otherwise covered, this could throw some non-discretionary “have-to” demand into the market.
“A factor in the opposite direction is driven by Tokyo Electric Power’s situation. With the shutdown of the Kashiwazaki-Kariwa station possibly for a year or more, that utility’s requirements will be reduced by over 3 million pounds of U3O8 equivalence per year. Several Japanese utilities were expected to be in the spot market over the next six months or so, but it is possible that excess uranium deliveries to Tokyo Electric Power could find their way into the hands of some of these other utilities, thereby reducing anticipated market demand.
“All in all, I still believe the most important factor will be the actions of the speculator segment. In spite of the large investment by this sector, as measured in our industry terms (their physical holdings are about a year’s worth of spot market transactions), in their industry’s terms this is peanuts – about the equivalence of one small hedge fund’s assets. And they need volatility to realize opportunity in this market. While this segment may be able to drive the uranium market to some extent, they have other investment opportunities in whatever other markets they choose. Thus, they could wind up finding the uranium market uninteresting if other commodities markets show greater opportunity.
“I want to make it clear that I am not being judgmental about the speculator segment. This segment is neither (in my opinion) good for the market or bad for the market; those participants are merely a fact of life and are as valid as market participants as any other segment. It is just that the uranium market has had only limited experience with their participation. With its history of what is basically horse trading in this market, the entry of any new kid into the sand pile is always viewed with trepidation by the insiders.”
Question: How long do you think the current market environment is likely to last? How low can spot prices fall?
Gene Clark: “There is a lot of speculation now about how low the price is and how far down it will go before recovering – or even if it will recover. It almost seems that this market reflects just the opposite of an old adage; in this market, “words speak louder than actions!” The rumor mill continues to churn, with indications that market participants expect prices at or below US$90, or down to US$75 (more recently), or witness last week’s rumor of “a recent deal evaluated at US$58 per pound U3O8.”
“When it comes to actually putting money on the table, we are all awaiting the outcome of the US Department of Energy’s recent auction of up to 200 tU as UF6. Because of DOE’s way of doing business, the winning bids will be released to the public, perhaps in two weeks’ time. In TradeTech’s discussions with potential bidders, we couldn’t find much interest in the material, so bid prices made last Friday (August 17) may be significantly lower than our currently published price indicator.” (TradeTech has so far not followed UxC and kept its own weekly spot price indicator at $110/lb).
“A currently popular notion is that demand is seasonally high in the Fall each year, and thus the price may recover this coming Fall. As shown in the figure below (also from TradeTech’s Nuclear Market Review for August 10), there is no empirical evidence of a cyclical pattern in the spot demand for uranium. At best, the historical data show a lower (or for 2003 an average) demand for the summer months of June and July. The phenomenon of higher than average demand for the Fall has really only occurred recently, for the year 2006, and that increase is mostly attributable to the actions of the speculator segment of the buying market, in the aftermath of Cameco’s announcement of flooding problems at Cigar Lake.”
Gene Clark: “Not everyone shares our view on this issue. Some have pointed to the perceived seasonal trend with high volume months in Fall and early Spring – based on an analysis of the years 1992-2003. They represent that this seasonal variation has been masked by the recent activity of the investment funds participation in the market. However, it is our contention that those years are of a bygone era, with low and relatively stable prices and, as such, are largely irrelevant to the current period.
“Given the historical perspective of the past four years, it would not seem wise to rely on the upcoming season of the year per se for price relief for sellers. What will make a difference is the point of view, and resulting actions, of the speculator segment, in my opinion. We are hearing expressions of buying interest by some in this segment, “once the price hits double digits.” Given that published prices are near or at double digits now, the re-entry of the speculator segment en force may be approaching. Thus, the timing of any future price hardening this Fall may turn out to be only coincidentally seasonal.
“On the other hand, what would be the incentive for the speculator segment to re-enter the market as buyers, when the price appears to be in free-fall? There could be much more money made picking off the low-lying fruit first as the price bottoms out, then driving the price up with increased purchase volume. But, where would the price bottom out? Where is the resistance level on the bottom side?
“One possible answer to this question comes from the producer and trader segments of the market, those with longer term sales contracts tied at least partially to the spot market price. Just as a hypothetical case, consider the situation of Cameco. This company has begun to publish in its earning statements a very interesting table, which shows its “Expected Average Realized Uranium Price” for the current and future years, as a function of the average spot price for the year. The table as of their second Quarter 2007 earnings report (released on July 30) shows that, for every US$20 per pound drop in the average spot price during 2008, Cameco stands to lose over US$180 million in revenue/profit. One implication of this table is, then, that Cameco might be willing to purchase as much as 2.2 million pounds of U3O8 in the spot market, for example, at US$80 per pound U3O8 if it would keep the spot price from going from US$80 down to US$60 per pound U3O8, or 3.6 million pounds U3O8 at US$60 per pound U3O8 if it would keep the price from going from US$60 down to US$40. Because Cameco is only one of several large producers in this situation, the cumulative impact of any strategic actions along these lines could have the effect of propping up prices, due to the extra demand in the market.
“On the basis of the above considerations, I would be very surprised to see the spot price fall below US$50 per pound U3O8, or even US$60 per pound.”
Question: What is your medium term view on uranium spot prices (6-12 months)?
Gene Clark: “I believe the most important issue for this period will be that it will establish what kind of market the uranium one will become. The market has now attracted the attention of the financial community, which has fostered the development of a new (to our market) generation of market instruments.
“Last September, one speaker at Platt’s second Annual Nuclear Fuel Strategies conference, Patricia Mohr of ScotiaBank, was asked what she thought the impact would be of entry into the uranium market of hedge funds and other speculator elements. Her answer was “Beware of what you ask for!” She prognosticated that the market would turn out to be very volatile, given the performance of other markets in which these groups have been involved.
“I think we will be able to establish over the next 6-12 month period whether this market will lose the interest of the financial players, due to the very limited amount of money that can be gleaned from playing this market, and thus return to the traditional one of utilities as the primary buyers and the uranium trader group as the primary sellers in the spot market – or whether the financial players will find ways to keep making money by churning volatility in the market, as suggested by Ms. Mohr.”
Question: What is your longer term view on uranium spot prices (beyond mid-2008)?
Gene Clark: “In our latest uranium market study projections (Uranium 2007), TradeTech shows the potential for a wide range of outcomes, and the transitions to get there. In nearly all scenarios, we show the potential for a rapid build-up in uranium production capability, especially in Kazakhstan and Africa, but really with contributions across the geopolitical spectrum. In juxtaposition, you have the world requirements for uranium and the regime of trade restrictions. If one believes in the nuclear renaissance (which is really a US phenomenon), we wind up with a generally tight, but manageable, supply/demand balance.
“In viewing the demand side, one needs to recognize that much of the infrastructure for manufacturing nuclear power plants has atrophied. For the summary of a recent Nuclear Energy Institute study on these issues, refer to http://www.nei.org/filefolder/manufacturing_capacity_0407.pdf and its underlying study. Given these hurdles, there may be startup infrastructure issues that could delay the current rosiest outlooks for nuclear power growth.
“The supply side (as pointed out in Uranium 2007) is not without its expansion issues. When so much of the expansion capability is vested in so few projects (the Olympic Dam expansion and the successful development of Cigar Lake), there is a great deal of risk in meeting required supply for even a modest expansion of nuclear capacity. In addition, there is the potential impact of falling prices and the current credit crunch on the production sector’s ability to raise the capital needed for these new uranium projects. In the latter issue, Cameco just this past Monday, August 20, issued a statement on its inability to redeem certain of its investments in asset-backed commercial paper. Although in its statement, Cameco does not foresee a problem with its plans due to this issue, other uranium producers (or potential producers) might be at risk due to credit crunch issues, thereby affecting their ability to bring new projects on-line as scheduled.
“Finally, there is the issue of trade restrictions. The most important of these are the US and Euratom trade restrictions against Russian-origin imports. Because of Russia’s very ambitious nuclear power program and its dwindling government stockpile, the issue would seem to be one of enrichment services rather than uranium. However, in this case the tail is figuratively wagging the dog. Let me explain. Because of operational considerations with European centrifuge plants and the commercial constraints of the USEC-TENEX Russian HEU Deal, the commercial enrichment tails assays (which drive the requirements for natural uranium feed for enrichment transactions) are much higher than the economic optimum, but necessary to balance the Western supply with demand for enriched uranium. This has the effect of making the commercial requirements (demand) for uranium higher than economically optimal. We have shown that the current “tightness” in the uranium market is really a result of this suboptimal situation, which in turn is the result of trade restrictions against Russian enrichment services. Without those restrictions, there would be ample supply capability for uranium.
“TradeTech projects uranium spot prices out for the next eight quarters, but beyond that period we focus on the long-term fundamentals, with published projections of base prices in new long-term contracts. Remembering that our current long-term base price indicator is US$95 per pound U3O8, we project a reasonable range of base prices for new long-term contracts to settle out in the US$40-70 per pound U3O8 range by the end of the next decade, expressed in constant January 2007 US dollar terms and assuming not unreasonable schedules for Cigar Lake and expansion in Kazakhstan and at Olympic Dam.”
(Readers should note that the actual spot market for U3O8 is relatively illiquid. Transactions of as little as 100,000/lb can shift the price and the much anticipated futures market has proven a failure to date. The behind the scenes reality of the uranium market is that utilities sign up for long term contracts with suppliers. Not much of the world’s uranium trade actually passes through the spot market. The spot price is merely used as an indicator, but no long term deal will have recently been settled at anything like the prevailing spot.)
