Uranium Supply Disruptions Spell Opportunity for Investors: Interview with David Talbot
Dundee Capital Markets, V.P. and Senior Mining Analyst David Talbot worked for nine years as a geologist in the gold exploration industry in Northern Ontario. David joined Dundee's research department in May 2003, and in the summer of 2007 he took over the role of analyzing the fast-growing uranium sector. David is a member of the Prospectors & Developers Association of Canada, the Society of Economic Geologists and graduated with distinction from the University of Western Ontario, with an Honors Bachelor of Science degree in geology.
The Energy Report: David, welcome. Let's start with the big picture: What is the general outlook for uranium in 2014?
David Talbot: Thank you, Tom. The long-term outlook on the uranium market remains the same at US$65/pound ($65/lb) U3O8. I think a new reality in the near term has set in. The uranium price has dropped significantly and now appears stable at levels not seen for almost eight years. We believe much of this has to do with the lagging Japanese restarts, cash-strapped sellers impacting the market and probably most important, near-term demand is lacking. We do expect uranium prices to rise, and relatively quickly when they do, but for right now, uranium prices will remain leveraged to the news of the Japanese reactor restarts and a return to term contracting by utilities.
This thesis underpins our $42/lb price estimate for the year, with prices to about $48/lb by Q4/14. When restarts might occur remains the million-dollar question, perhaps starting mid-2014, but the indicators out of Japan are that the government is committed to bringing its nuclear fleet back online now as the 17th and 18th reactors have applied for their restarts. We've had ongoing reviews. They were expected to take about three to six months, and now we're in month eight. So when they start isn't quite certain, but they are moving in the right direction. Their return should actually coincide with the return in contracting, almost completely absent last year as massive uranium requirements loom. We're seeing about 180 million pounds (180 Mlb) due, expected by the 2016–2018 period.
TER: What are the major influences in the uranium market today?
DT: Supply remains a wild card and probably the most important factor, hence the focus of our recent comprehensive sector report. Mines are currently being taken offline, deferred or cancelled altogether. But long-term fundamentals underpin our belief that a uranium supply deficit starting in 2016 will likely increase by 2020, at which time we think we'll see a deficit of about 16 Mlb. So we remain adamant that uranium supply is threatened by current uranium prices, regardless of the difficulties of the mining industry and challenges in permitting. This continues to set the stage for the supply crisis, particularly in light of dwindling secondary supplies as the Highly-Enriched Uranium (HEU) Purchase Agreement has come to a close, taking 24 Mlb/year with it.
The other part of the story is timing. We anticipate Japanese restarts to be the catalyst to kick-start uranium buying and contracting, but the lack of deals in 2013 resulted in the elevated uranium requirements that utilities have mentioned. This means that once the pendulum shifts back, it will shift quickly, and prices will probably rise at quite a torrid pace.
TER: Do you expect that 16-Mlb deficit in 2020 to draw more explorers and producers to the industry, or just to create more opportunity for the current players?
DT: Once the 16-Mlb deficit comes closer, we would expect development for some projects to perhaps expedite on the back of stronger uranium prices. But most of the new supply we see over the next few years is from existing producers, mainly expansion of existing projects, Ranger 3 Deeps, for example, or Cigar Lake. We do model some marginal players coming on-line, like Toro Resources Corp.'s (TRK:TSX.V) Wiluna project, or perhaps with some of Energy Fuels Inc.'s (EFR:TSX; EFRFF:OTCQX; UUUU:NYSE.MKT) conventional assets in the U.S. But that's a relatively small amount of production and certainly not enough to close the gap. We do think that uranium prices are going to be what's required to incentivize investors. Certainly, there will be a new set of explorers set up as exploration funding comes in. Just look at the explosion of junior exploration companies around the Patterson Lake South discovery. So should uranium prices rise, we would expect investment in the sector and exploration spending to increase.
TER: What was the mood at the NEI Nuclear Fuel Supply Forum in Washington, D.C., in January?
DT: Remember that the Nuclear Energy Institute is an American association that promotes nuclear power to Congress, the White House, state policy forums and the general public. So its message is typically well scripted and relatively even-keeled, and delivered nonpromotionally. I think that feelings were mixed. There were a few uranium-sector participants. In late January, the sector was flying high, so sentiment was generally positive. This was also after the Uranium Participation Corp. (U:TSX) financing, which more than suggests that investors will be coming into the sector shortly as Uranium Participation is mandated to spend about 85% of its raise on purchasing uranium. So at that time, the stocks were doing quite well, and the fundamentals of supply and demand are generally unquestioned by that group of people.
Richard Myers discussed the U.S. nuclear program. He's vice president of policy development at NEI. His message was similar to the one he provided last year at the World Nuclear Association Symposium in London. He started by saying U.S. nuclear power plants are operating well at about 90% of their capacity factor.
Right now in the U.S., they are currently shutting five reactors. These are typically older, smaller, single units that are mostly at risk but, also, larger, multi-unit sites are struggling under current regulations. Essentially, electricity prices are being suppressed by state mandates and federal subsidies. So price signals right now are inadequate to support existing power plants and investment in new capacity. He suggested that all electricity should not be treated the same. Nuclear has some very important attributes that are not being monetized. It's baseload; it provides grid stability, price stability, clean-air compliance, technical and fuel diversity and a huge tax base. So failure to address the importance of nuclear as baseload electricity will compromise reliability, introduce price volatility and frustrate efforts to decrease carbon emissions. This, of course, could have a negative impact on the U.S. uranium requirements, currently in the 45–50-Mlb range.
TER: Dundee Capital Markets was expecting 87 Mlb new production from 22 uranium operations between 2007 and 2013, but only 17.8 Mlb materialized. What happened there?
DT: I think this is the trend in the industry. You'll see these plans to develop uranium projects and, ultimately, a fraction of that effort ever materializes. Many of those mines that we expected to come on-line in 2007 never started. In one or two instances, there were technical issues. The timing of that report also coincided with the global financial crisis in 2008, so that was certainly one of the main factors. Capital dried up. But in general, development is becoming much more expensive, with timelines for projects ranging up to 15 years or more between discovery and production. That's because of several challenges that face the uranium space. You have increasing environmental and regulatory constraints. Public perception has darkened post-Fukushima. Significant community consultation is now required, and stringent radiological and groundwater controls are being put in place. Detailed tailings management plans are required, and comprehensive decommissioning strategies with upfront financial commitments are now commonplace.
TER: You mentioned the high costs of development. What role does the Canadian Non-Resident Ownership Policy play in that?
DT: That policy states that a foreign company cannot own 50% of a uranium project. This hasn't concerned me too much in the past. It is just a policy. We have seen some companies get around that policy, not necessarily grandfathered but just moving toward the expectation that that policy will not be there when they need to go and get their licenses. For example, you have AREVA (AREVA:EPA) moving forward its Kiggavik development project in Nunavut Territory. You have Paladin Energy Ltd. (PDN:TSX; PDN:ASX) moving forward its big project in Labrador called Michelin, formerly an asset of Aurora Energy Resources Inc. More recently, we've seen Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK) come in and take out Hathor Exploration Ltd. for its Roughrider deposit. So there are foreign companies that are acting in Canada. They're acting as if this policy will be overturned and, certainly, the Saskatchewan government would like to have it overturned.
TER: Is the uranium market heading for a wave of mergers and acquisitions (M&A) to achieve efficiencies of scale and maybe increase production capability in a low-price market?
DT: We do expect further consolidation. Financing is more difficult than ever. Project timelines are lengthy and costly. With some companies unable to secure supplies to advance projects, we expect further delays and/or corporate insolvencies. What often happens is the predator comes in and takes out its prey at pennies on the dollar relative to its underlying net asset value (NAV).
Many certainly look at Cameco (CCO:TSX; CCJ:NYSE) as the top predator. With about 1 billion pounds (1 Blb) in resources and reserves, it says it doesn't need more pounds in the ground, but bolting on production makes a lot of sense to us. Cameco has long said it seeks more production growth in the U.S., and while some of that's happening through organic growth, newer companies like Uranerz Energy Corp. (URZ:TSX; URZ:NYSE.MKT) and Ur-Energy Inc. (URE:TSX; URG:NYSE.MKT) look exciting to us. You also can't count out Denison Mines Corp.'s (DML:TSX; DNN:NYSE.MKT) Phoenix project in the Athabasca Basin. Cameco is a partner there, but that's the world's third highest-grade project at 16% U3O8. There are about 60 Mlb there right now. Plus, Denison has interest in the McClean Lake mill, and I know Cameco would probably be interested in having a feed at the mill that is processing its own Cigar Lake ore.
TER: Energy Fuels is trading around CA$9.50 now, but your target is CA$17. Why is this company so undervalued?
DT: I think part of it has to do with the general downdraft in equities, but Energy Fuels, in particular, did have a few events leading into 2014 that put some pressure on the stock. That included a selloff after a four-month hold on its June 2013 private placement. Strathmore shareholders were selling post-deal, post-acquisition of Strathmore. There was also pressure after its 50:1 rollback, as expected. Another part of this could be just the general unfamiliarity with this name. This is a company that has a number of small-scale operations with different incentive price levels, all feeding into the White Mesa mill. So production is often not year-round, but happens in runs or batches. This combines with alternate feed material runs.
TER: What are Energy Fuels' strengths and its weaknesses?
DT: I think Energy Fuels has several strengths that make it one of our top picks. It is one of our favorite stocks in a low uranium price environment, as the company is effectively 100% hedged at around $60/lb uranium. But we also like it for its significant leverage to rising uranium prices, given its ability to easily turn on its brownfield projects at minimal cost. Primary standby mines—Pandora, Beaver, Daneros—all have potential to produce between 200–500 thousand pounds (200–500 Klb)/year. Canyon could add another 500 Klb/year once it's developed. So its White Mesa mill has a license capacity of 2,000 tons per day and can produce about 8 Mlb/year. Costs have also come down about 18% quarter over quarter to $32/lb.
But there are some risks, of course, with small, higher-cost conventional mines. The production profile hinges on milling and trucking costs. So with about 50% of our valuation dedicated to these projects and then 50% delegated to greenfield projects, development risks must also be taken into account. Those include permitting, financing, economics, timelines and so on.
TER: What is the significance of the Patterson Lake South discovery for Fission Uranium Corp. (FCU:TSX.V)?
DT: We believe the Patterson Lake South discovery is very significant, probably the largest since Hathor's Roughrider discovery, and we all know what happened with that one. It sold for $680 million ($680 M) to Rio Tinto. At that time, it wasn't much bigger than where we think Patterson Lake South is now. So we do have a Buy on Fission as a result of its Patterson Lake South project. It's shallow, high grade, thick; it has all the hallmarks of a great project. Not only that, but it's also located in the Athabasca Basin, which hosts a supportive government, excellent infrastructure, capacity at existing mills and a solid permitting framework.
At Patterson Lake South right now, all six zones lie at or near the surface, and they are only drill limited at this point; they're not cut off. We anticipate that several of these zones will probably tie together, creating a much larger, single deposit. It's still in the early stages of delineation. Aggressive drilling is underway in preparation for an initial resource. We speculate we might see that early next year. Right now, we estimate about 43 Mlb grading 2% uranium. The grade goes up significantly if we use a higher cutoff grade, but the pounds in the ground aren't impacted that much. So right now, it's looking like a great, high-grade uranium deposit.
TER: Does that make Fission Uranium a likely takeout target?
DT: We've always felt that Fission is a potential takeover target. Given its grades and shallow depth, Patterson Lake South has potential to become an economic deposit, capable of supporting not only construction of a mill. But, also, perhaps even more attractive is that this near-surface deposit may require relatively smaller upfront capital and could provide feed to an existing mill and be run at irregular intervals, essentially delivering high-value material over great distances when it's necessary. So we believe that Patterson Lake South and Fission, for that matter, make sense as a target for anybody that wants to set up shop in what is the underexplored western side of the Athabasca Basin.
TER: You changed your rating on UEX Corp. (UEX:TSX) very quickly. Why?
DT: We did an about-face on UEX not long after reducing our target and recommending it as a Neutral due to unexpected news of a slowdown and competition from fresh discoveries, like Patterson Lake South. But we now rate UEX as a Buy with an $8 target price. While we didn't change our discounted cash flow model, the new CEO, Roger Lemaitre, brings depth to this company that it hasn't seen before. With his vast industry experience as Cameco's exploration director and the fact that UEX has almost $9M in cash, I think he's going to turn the company's attention to new discoveries and potential M&A activity. His familiarity with Cameco is certainly an asset. But I think we still need to see some execution here by UEX to leverage its attributable 85 Mlb in resource plus its past exploration success into something new and accretive for shareholders. Meanwhile, Shea Creek is open in multiple directions. It does have a current resource of about 96 Mlb. As UEX decides to take its direction, I think it will remain focused on the Athabasca Basin. I think it will likely seek synergistic projects.
TER: Are you excited about any other uranium companies?
DT: There are two others. Ur-Energy—we have a Buy on this one. It has a $2.20 target price. Ur-Energy is our top pick in the sector right now. This is a U.S.-based, Wyoming-based, in-situ recovery producer. It officially entered production last year. Early indications are the well fields are performing exceptionally well. It produced 135 Klb last year. We expect about 1 Mlb this year, 1.2 Mlb next. Flow rates and front end are operating above expectations. The back end elution and precipitation circuits are performing as designed. Notably, head grades have been significantly above expectation, leading to less header houses and volumes that are required, pointing to lower costs. Right now, the company sells about 40% of its production forward at about $60/lb between 2014 and 2016, so it makes Ur-Energy less sensitive to spot price fluctuations than some of its peers. It's actually getting prices much, much higher than spot. It was in the $63/lb range for last quarter. Shirley Basin is another project it just purchased. That could be up next. It could come online by 2017, ramping up to 1 Mlb/year within a couple years there. Ur-Energy trades at a discount to its producer peers.
Another company here: We recently initiated full coverage on NexGen Energy Ltd. (NXE:TSX.V). We're recommending it as a Buy, no target price. The company has two high-quality assets in the right locations. Rook I is adjacent to Fission Uranium's Patterson Lake South discovery. NexGen could potentially have the best claims in the area aside from Fission itself. The second project is the Radio property. That's located on the Roughrider Midwest trend on the eastern side of the Athabasca Basin. That project is within 10 kilometers of 150 Mlb of uranium resources. First drilling at Rook I tested three conductors that lie directly east of Fission's Patterson Lake South discovery in the Athabasca. With 12 holes, it hit the right graphitic basement rocks, shallow structures and modest alteration, and elevated uranium mineralization was confirmed in three holes and somewhat significant in one of those. Follow-up drilling has made a potential uranium discovery (pending assays) that is not only a game-changer for NexGen, but for the western side of the Athabasca Basin. What's more impressive is that it was the first hole drilled into Target C, now called Arrow, that hit.
Further drilling is required and NexGen has suggested that it will commit more resources to follow up. The Radio project is essentially on hold with earn-in commitments delayed, allowing the company to focus on the Rook project. NexGen has experienced management and quite a deep technical team, including ex-Hathor and Rio Tinto geologists who really know the region.
TER: Do you have any parting thoughts to share on the uranium market generally?
DT: I think it all hinges on supply. Demand is relatively consistent. It's predictable, Japan restarts notwithstanding. But I believe it's the strengthening fundamentals based on supply that really drive this. Mines are closing. We've seen Zarechnoye close, La Sal, Beaver, Pandora, Daneros. Projects are being deferred, big projects including Olympic Dam, Trekkopje, Imouraren, Cameco's Double U, plus no more Kazakhstan production. The HEU agreement is gone, and we're getting unexpected disruptions, such as Ranger, Rossing, Cigar Lake and assets in Niger. So I think investors should focus on that. When uranium prices come back, I think they're going to come back quite quickly, not because Japan is going to come back seeking supply but because the other 90% of the world hasn't been buying like it should.
TER: Thanks for sharing your thoughts.
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( Companies Mentioned: DML:TSX; DNN:NYSE.MKT, EFR:TSX; EFRFF:OTCQX; UUUU:NYSE.MKT, FCU:TSX.V, NXE:TSX.V, TRK:TSX.V, UEX:TSX, URE:TSX; URG:NYSE.MKT, URZ:TSX; URZ:NYSE.MKT, U:TSX, )
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