Rudi's View | Feb 20 2007
By Rudi Filapek-Vandyck
Investors as well as producers and power utilities in the US will be closely watching the first open auction of uranium this week with one seller offering 100,000 pounds of U3O8 (uranium oxide) at so-called ‘market-related pricing terms’. In the current context this means buyer and seller will agree on a bottom price with the final, higher price to be settled at the time of delivery, probably a few months later.
The U3O8 spot price hasn’t fallen once in nearly four years and chances of it happening in the coming weeks are widely considered nil, especially with the uncertainty of Cameco’s flooded Cigar Lake project hanging over the market.
This week’s auction will break the deadlock between buyers and sellers in the uranium market that has kept the spot price thus far unchanged for most of calendar 2007. How far will the price go up? Industry insiders believe a jump to US$80/lb from a current spot price of US$75 is a real possibility.
In the shadow of the first big auction of the year, analysts, market experts and representatives of the top companies in the sector will be attending a two day conference on uranium organised by Sprott Securities in New York and Toronto on Tuesday and Wednesday. No doubt the overall sentiment at the event will be very upbeat as far as the price prospects for the commodity are concerned.
FNArena has been fortunate to lay its hand on a copy of the 120 page industry report published by Sprott Securities ahead of the annual conference which this year takes place for the fourth time. The report provides us a rare insight into the latest observations and analysis by one of the highly regarded industry experts in North America.
Conclusion number one, according to the report, is that everybody, including Sprott, has continuously underestimated how tight the uranium market would become over the past few years. As far as Sprott is concerned, this is likely to be still the case.
An example: The World Nuclear Association (WNA), whose projections are relied upon by securities analysts worldwide, currently forecasts that combined primary and secondary sources of uranium supply will just meet global demand through 2012, at which time a “significant supply shortfall” will be in place.
However, current forecasts were made before the flooding of Cameco’s Cigar Lake project which was projected to produce up to 12% of annual supply from 2008 onwards. Of equal importance is that the WNA forecasts are based upon the premise that existing production will not experience any disruptions, that scheduled production will be available on time (no delays) and at the anticipated scale, and that prospective production will ramp up relatively quickly.
Every experienced miner knows: chances of all of this happening on schedule are rather slim. In addition, the report points out the existing WNA model does not consider any impact from demand from investors/speculators or the fact that utilities themselves are attempting to amass internal stockpiles in anticipation of a fuel shortage within the next 7-10 years.
Some market participants have continuously downplayed the importance of speculators and investors in the uranium market, but Sprott displays no hesitance in the report, stating:
“Investment fund activity and continued accumulation from public entities such as Uranium Participation Corp and Nufcor Uranium have added a new layer of complexity to the uranium and UF6 markets. Though clarity lacks in the number and volume of transactions that this group of buyers have completed we estimate that between 12-15MMlbs of U3O8 equivalent has been taken from the market in the last 24 months. This accounts for between 5-7% of global uranium production. Though primarily sourced from inventories these actions add further tightness to the market and acts to set new base level pricing for the commodity. We anticipate that the current trend will continue as the uranium price continues to appreciate and supply scarcity persists.”
In addition, Sprott estimates the top ten producers missed their production targets from existing operations by circa 8.5% in calendar 2006.
Sprott’s skepticism regarding WNA forecasts seems to be in sync with the views of the world’s largest producer, Canada’s Cameco. At the recent World Nuclear Association conference, Cameco presented a paper suggesting uranium suppliers, including itself, were not ready for the impact that new reactor builds will have on the uranium market.
The paper assumed ten new reactors will be coming on-line each year, starting in 2010 for at least a 10-year period. Sprott believes current WNA forecasts do not take into account that these start-up reactors have to commence stocking uranium up to three years in advance – that is how long it takes to purchase the product and make it ready for usage in the reactor.
This means that some of the reactors scheduled for 2010 may already be in the market today trying to secure their first supplies. Sprott believes that as a result of this, critically low inventories at US utilities are likely to drop to even lower levels.
Other assumptions made in the report are: BHP Billiton’s (BHP) Olympic Dam expansion will not be finalised before 2012 (two year delay) and remediation of the flooded Cigar Lake project will probably take three to four years (versus the one year Cameco management has conceded so far). The latter will involve re-engineering the mine and the mining method.
The report also states that close to 85% of global production is currently already contracted through 2012.
As far as production is concerned it would seem that Kazachstan remains the industry’s main hope in the near term. Sprott believes state owned Kazatomprom and its partners should be able to quadruple production by 2010.
So where does all this leave the sector in the short term? Beyond this week’s widely anticipated price jump, Sprott has penciled in an average uranium spot price of US$85/lb in 2007, with a further rise to US$95/lb in 2008, though this is considered to be likely too conservative.
“If the [uranium spot price] appreciation already witnessed this year is any indication”, the report notes, “the uranium price could easily break US$100/lbs.” In fact, one of the chapter titles in the report spells it out loud and clear: “Uranium Fundamentals – US$100 On The Doorstep…”
However, the main theme for the sector throughout 2007 will be consolidation, the report suggests. Last week SXR Uranium One and UrAsia Energy announced merger plans to become the number two in the sector. Sprott believes “the acquisition parade has just begun and will become a common theme in 2007”.
Another major change is that the problems at the Cigar Lake project have cost the juggernaut in the sector, Canada’s Cameco, its bellwether status. Sprott believes Australia’s Paladin Resources (PDN), one of the few new major producers since many years, has now become the global bellwether for the industry.
Paladin is rated Buy. Until recently the stock carried the tag Top Pick but strong share price appreciation has caused a recommendation downgrade.
Sprott Securities anticipates a “robust” uranium market for the next few years, with plenty of opportunities for investors in the sector. However, gains are likely to be more modest from here on making stock picking necessary.
Sprott advocates investors should focus on three types of uranium stocks; producers, imminent producers and “development stories with fundamentally solid assets aggressively moving towards production”.
