FYI | Nov 22 2006
How high is the price for uranium going to run up in the near term? US$90 per pound? US$100? US$120? A recent industry update by JP Morgan suggests these are the kind of figures both investors and the industry should expect from next year onwards. The broker believes the dynamics within the industry have changed beyond recognition, leading it to raise its long term average U3O8 price forecast to US$70/lb – more than 11% above the current record spot price.
JP Morgan believes US$70/lb is the price level required to function as an incentive to stimulate investment in new capacity for the long term. This suggests the current very tight market outlook is bound to attract significantly increased supply in years from now, a process similar to what is currently happening in other commodity markets such as oil and the base metals.
Until recently, JP Morgan was a bit of an odd duckling in the Australian uranium landscape. It was one of a few major stockbrokers who covered Rio Tinto (RIO) controlled Energy Resources of Australia (ERA), Australia’s largest producer of so-called yellow cake (non-enriched uranium concentrate). But its position was firmly at odds with other forecasters regarding the industry and ERA’s future earnings. As ERA’s share price, fuelled by a continuous rising U3O8 spot price, was trending towards $20, JP Morgan’s twelve month price target of $11.11 seemed a bit outdated, to say the least.
It took a complete review of the uranium industry to turn this situation around.
The broker’s forecast of an average U3O8 price of US$90/lb for calendar 2007 suggests the spot price is likely to surpass the US$100/lb level and move swiftly beyond. The latest published weekly U3O8 spot prices by industry consultants Trade Tech and Ux Consulting put current prices at US$63/lb and US$62.50/lb respectively. Even if we assume the spot price will continue to climb over the final six weeks of calendar 2006 and reach, let’s say, US$70/lb by early next year, this would still suggest a peak price of US$100/lb throughout the year may be a bit conservative.
No wonder thus that the company update on Energy Resources of Australia came with a near tripling of the broker’s share price target: from $11.11 to $32. To make it even juicier, the analysts state they would not be surprised if ERA shares at some point would trade above this level as it is and remains Australia’s largest uranium producer with long established sales relationships plus unaccounted for exploration upside. As such the stock easily deserves a premium, the analysts argue.
The new twelve month price target equals the newly calculated Net Present Value (NPV) for the stock which, of course, incorporates all the positive assumptions the broker has now come up with. One thing has to be noted though: JP Morgan analysts did not change one iota of their production forecasts for ERA, the changes are all broader, industry related.
In fact, what is easily the most bullish research report written on the uranium industry in Australia shows in painstakingly detail how ERA’s future continues to be hampered by its pre-boom long term supply contracts. In calendar 2005, when the U3O8 spot price was in the US$30s/lb ERA sold its yellow cake at an average price of US$16/lb only. If you think that was bad, wait for what happened next. In the first half of calendar 2006, when the U3O8 spot price spent a lot of time beyond US$40/lb, ERA’s achieved average selling price actually fell.
How’s this possible?
Many of the old supply contracts contain so-called volume flex provisions which in essence allow customers to simply demand more supply at prices far below the rising spot price. While ERA management has said new contracts will no longer have such provisions, ERA customers must have had their laughs so far this year.
The old legacy will continue to haunt ERA for many years to come. On JP Morgan forecasts ERA’s average selling price is expected to climb to US$17.4/lb for this year, to US$29.4/lb for 2007, to US$40.3/lb in 2008 and to US$48.1/lb in 2009. In 2010 the average pound of yellow cake is expected to generate US$54.2/lb.
Now consider that the broker, for all these years, has put forward a U3O8 spot price forecast of at least US$80/lb.
Imagine what could happen, on JP Morgan forecasts, to the bottom line of Paladin Resources (PDN), soon to become a producer and having only forward sold an estimated 40% of Langer Heinrich production…
JP Morgan doesn’t cover Paladin. The report doesn’t flag any intention to commence covering the stock. But one could easily argue that any investor in Australia’s next upcoming uranium producer can find all the comfort that is required inside the broker’s in-depth industry report.
What it boils down to, in a nutshell, is that demand will be growing faster than previously expected because utilities have now a preference for more inventory, which provides more security, and worldwide government policies are changing. JP Morgan currently counts 27 nuclear plants as “under construction”, 64 as “planned” and 161 as “proposed but not yet approved”.
The broker also believes the market is underestimating that future reactor start-ups require inventory-build well in advance of project commissioning. Currently the report still assumes the Cigar Lake project coming on line in 2008. This, of course, comes with a big question mark. The analysts also point out that their estimates do not account for any of the 161 projects receiving approval.
Just in case anyone needed to be reminded why the world is increasingly turning towards uranium, the report sums it up as follows: “The key attraction of nuclear energy has been its low sensitivity to uranium cost, as the proportion of fuel costs in nuclear plants is only a fifth of those in gas-combined cycle plants. Uranium is also exceptionally energy efficient by mass. A single fuel bundle in a heavy water reactor, which you could hold in your hand, produces as much electricity as 380 tonnes of coal or 1,800 barrels of oil. In addition, nuclear plants have zero carbon emission.”
Until next week!
Your editor,
Rudi Filapek-Vandyck
(As always supported by the Magnificent Three: Chris, Terry and Greg)