Uranium Causing A Reaction

This story features PALADIN ENERGY LIMITED, and other companies. For more info SHARE ANALYSIS: PDN

By Greg Peel

This is one of the great charts. If ever anyone asks you “What does it mean when a price has gone parabolic?” just show them this ten-year chart of spot uranium:

One could posit a view that the price action was probably fundamentally supported by real-end users up until it hit about US$60/lb in early 2007. There was a clear case to be made for a secular increase in global demand given a sudden surge in reactor plans, particularly in China, but everywhere from the UK to the US, Russia, Japan and elsewhere, which in itself was a response to the rapidly rising price of oil.

But at that price point, the surge in speculative interest led to real end-users backing off. Uranium supply for reactors is a long-term game, and long term contracts were still being transacted at US$60/lb even as the spot price continued to “go parabolic”. In the end it was just hedge funds jumping over each other that accelerated the price, and when the last fund went long the jig was up and the fall back to US$60/lb was almost as spectacularly rapid.

The speculators then departed the market to lick their wounds and end-users were pretty well stocked, so the spot price continued to drift lower to US$40/lb. It's taken about another year and a half, but finally US$60/lb is back in the cross-hairs once more. And the speculators are baaaaack!

Industry consultant TradeTech reports that US$60/lb proved a resistance level last week, but the spot price did still tick up another US$1.75 to US$59.25/lb. This followed the previous week's big US$5.50 jump, which in turn had followed the first decent move since 2008 – of US$4.00 – a fortnight earlier. That move was sparked by a sudden realisation the world's biggest uranium mines were facing real production issues. (See Big Jump In Spot Uranium )

The question of global supply is one that was addressed in a conference call with analysts this week by the CEO of Paladin Energy ((PDN)), John Borshoff. Paladin is second tier global producer and relative latecomer with plans to double production at its African mines by 2016, no sign of wilting grades, and no legacy long-term contracts at low prices to continue servicing. One could either think of comments from Borshoff as “straight from the horse's mouth” or “talking his book”, whichever side of the cynicism line one might lie. But CEOs are ever wary of “over” talking their books as overstatement is punished far more severely by the market than understatement.

The thrust of Borshoff's argument is that global supply issues are now emanating from the world's tier one uranium producers. Rio Tinto's ((RIO)) mines are on the wane and any new ones would just be a replacement, BHP Billiton's ((BHP)) Olympic Dam is expanding only as grades fall, Areva (France) is having all sorts of trouble with its African assets and Cameco (Canada) is not looking at any great production increase until after 2015.

On the other side of the fence, China is only now starting to fire up its long-term supply negotiations and is a long way from securing its 40-50m pounds per annum goal by 2020.

BA-Merrill Lynch has already laid down the tier one supply argument and thrown the gorilla – Kazakhstan – into the mix with downgraded production estimates. Merrills had also picked up on the Chinese contract issue, and the latest TradeTech report notes the Guangdong Nuclear Power Group last week signed a supply contract with Kazakhstan's Kazatomprom.

Outside of medium and long-term contract jockeying between consumers and producers last week, TradeTech notes nearly all the spot market action involved speculators.

Borshoff further noted that Japan, Korea and the Middle East are yet to secure their ambitious supply requirements, and took a swipe at the World Nuclear Association's insistence the world is still facing uranium oversupply. Basically Borshoff thinks the proverbial is really about to hit the fan.

So is it a case of US$138/lb here we come again?

Merrills thinks not. The analysts have just increased their 2011-13 average spot price forecasts by 17-27% and lifted their 2014 price to US$80/lb. They warn that lessons learned in 2007 will prevent the speculators from a similar frenzy this time. Any major price spikes could only come from some severe supply disruption. (Note that in 2007, Cameco's massive Cigar Lake project, which was slated to ultimately supply 10% of the world's uranium, flooded, setting its time line back years.)

Supply shocks aside, Merrills sees a “balanced” demand/supply equation out to 2013 and a 4mlb deficit in 2014. Merrills also warns investors of the pitfalls of repeating the stock market speculation that accompanied the spot price speculation of 2007, in which every micro-miner with even a sniff of uranium was assumed to be the next big thing and stock prices were pushed up by thousands of percent.

One of those was Paladin, except that Paladin did honestly have viable resources ready to be exploited. It is little talked about, but Paladin could potentially be a takeover target. (Who's in a buying mood? BHP?) Nevertheless, Merrills warns that the big players still have plenty of potential to build rather than buy and won't be trawling the outback for mere hopefuls.

Merrills also suggests Kazakhstan is exhibiting “supply discipline” and political risks have abated, which means the government can control global supply and thus pricing just as OPEC does oil and Qatar does natural gas. In other words, if the uranium spot price tries to run up again, the Kazakhs need only up the ante.

Goldman Sachs has also lifted its spot uranium forecasts but is a lot less exuberant than either Borshoff or Merrills. Goldmans' new 2014 spot forecast is only US$64/lb (up from US$60/lb) to Merrills' US$80/lb, albeit with a long-term contract price in 2014 of US$75/lb.

Goldmans is not as convinced the uranium market has changed “significantly” and sees it as comfortably supplied for at least the next three years. The analysts see Kazakhstan as a reason why 2010-13 will still see supply surpluses. But they do acknowledge current supply issues at tier one mines and the apparently accelerating nuclear plans out of China.

The spot price is now close to US$60/lb but Goldmans is forecasting an average only in “the low 50s” for 2011 and 2012. This is not the sort of upside which should excite investors. After 2012 the story looks a bit more interesting, given planned reactors will be reactors under construction and the sale contract between Russia and the US for the uranium out of decommissioned warheads will come to a close.

But Goldmans asks, just how far ahead are investors prepared to take the risk for?

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