The Energy Report: Does cheap oil depress uranium demand?
Rob Chang: It shouldn't, because uranium is feed for nuclear power,
whereas oil is more of a transportation energy source. Oil isn't commonly
used as a source of base-load power supply. However, we have noticed that
uranium equities seem to be greatly influenced by the oil price. For some
reason or another, it does occur. But I wouldn't attribute the decline in
uranium equities entirely to the decline in the oil price. There has been of
late a flight from all commodities.
TER: Would you say the price of oil serves as an index of the
strength of the world economy?
RC: Oh, absolutely. As global activity picks up, we see more
construction and a greater use of transportation. And you need oil to make
that happen.
TER: Do you expect nuclear power usage to grow despite the global
economic lull?
RC: I do. China is moving forward with determination on nuclear
power. Not so much for the power it needs now, but for the power it will need
to accommodate future growth. We could be seeing an economic slowdown in
China, but it remains robust compared to other countries. China will have a
voracious demand for uranium as the number of its nuclear reactors increases
from 36 today to 52 by 2020. It was also recently reported that the draft
version of the 13th five-year plan for China calls for eight reactor
approvals a year from 2016 to 2020. That's a far cry higher than our estimate
of about three per year.
In addition, the global push toward cleaner and greener energy is good for
nuclear power and uranium. Nuclear is the only form of base load energy that
emits zero carbon.
TER: Anti-nuclear sentiment remains high in North America and
Western Europe. Will the growth of nuclear power come entirely from Asia?
RC: The picture is more complicated than that. Public opinion in
Japan is still mostly anti-nuclear due to the Fukushima disaster. However,
the Japanese government appears very committed to restarting nuclear power,
as the country needs cheaper electricity than what it is importing to use now
due to the shutdown of nuclear to begin with. On the other hand, France,
Great Britain and Canada are still pro-nuclear, despite media agitation. And
keep in mind that the United States remains the premier consumer of nuclear
power in the world.
TER: The uranium spot price has fallen to $36 per pound ($36/lb).
Is this significant?
RC: Well, it's actually risen from $28/lb, if you want to look at
it from a different vantage point. We believe the current spot price is not
economic for most producers. The only reason producers continue to produce is
because they have long-term contracts that pay more than $50/lb. Those
contracts are scheduled to start rolling off in the next few years. That will
be the catalyst for greatly increased prices.
When utilities come looking for new contracts, the producers are not going
to reload at the $36–44/lb range because many are still probably losing
money, or at best breaking even, at $50/lb. Prices will probably move
violently higher within 6–12 months.
TER: If the contracts start rolling off in the next few years, why
should we expect price increases beginning six months from now?
RC: The uncovered requirements of the utilities. We recently took a
look at this issue again, and it seems the needs of utilities will become
about 20% uncovered sometime between 2017 and 2018. That means a significant
amount of material needs to be secured before then, otherwise their reactors
will be forced to operate below capacity, which is not ideal since there
still is strong demand for electricity globally. Utilities are currently
buying in the spot market, but that supply will be whittled down.
Uranium prices peaked a decade ago because many utilities saw a spiking
uranium price and were worried about security of supply, so they contracted
en masse, which pushed the price even higher. This led to a global
synchronization of contract timelines since many utilities contracted on
similar terms. As contracts start rolling off in bunches, utilities will be
buying on spot and aggressively contracting to shore up their needs. This
will coincide with very low production levels from producers, who have been
weathering a tough period of low prices. In addition to an environment with
little production growth, there has been relatively little exploration and
development work done in the uranium space over the past few years, since low
uranium prices provided little incentive.
TER: When you say "violently," how high do you think the
price will go?
RC: Utility demand is pretty easy to figure out because a nuclear
reactor is not something you can erect overnight. Reactors require long-term
planning, huge capital budgeting, and face long permitting processes. We
believe that most reactors currently in the development and construction
stage will become operational. We can foresee the demand, and the fact is
that a significant increase in uranium supply will be required for those
reactors to generate power.
The breakeven costs for planned uranium mines are $70–80/lb. Those mines
will not begin production until the price is north of that range. Mines won't
be built so they can break even; an incentive price is needed. We
conservatively predict that a price of $80/lb is the breakeven required for
global supply and demand to meet over the long term, and with incentive
pricing, that range will likely rise to $90–100/lb.
TER: Nuclear power plants are exceedingly expensive. How much does
the uranium price affect the total price?
RC: Uranium costs are probably somewhere between 1–3% of a
utility's total cost. For a utility, that's almost meaningless.
TER: How many nuclear reactors are operating now, and how many do
you expect by 2020?
RC: There are now 439 worldwide; by 2020 we expect 472.
TER: Is Japan fully committed to recommissioning its nuclear fleet?
RC: No. The federal government is, but approvals from the
prefectures (state governments) are still required. We recently chatted with
several nuclear experts and industry participants, and in their opinions, the
large majority of Japan's reactors will easily meet the required safety
protocols. After that, it's up to public opinion in the relevant prefectures,
which is a mix of those who want them restarted for economic reasons and
those who fear nuclear power. In our opinion, two-thirds of Japan's reactors
will be recommissioned.
TER: Let's talk about specific uranium companies. Why did the
merger of Denison
Mines Corp. (DML:TSX; DNN:NYSE.MKT) and Fission
Uranium Corp. (FCU:TSX) fail?
RC: They are two different types of companies. Fission is more of
an exploration upside story, while Denison is more of a near-term development
story. I believe the merger failed because Fission's shareholders preferred a
big takeout and weren't happy with the dilution that a merger with Denison
would entail.
TER: Does this failure hurt the reputations of the respective
managements?
RC: There will always be questions whenever a merger fails, and
we're seeing that play out for both companies now. All I can say is that I'm
certain both management teams thought the merger was in their shareholders'
best interests.
TER: Let's discuss the prospects for both companies in the wake of
the failed merger. Fission shares hit a 52-week low Nov. 30, but are up 13%
since then.
RC: We still like the Patterson Lake South (PLS) property in
Saskatchewan. Fission management may need to do some public relations work to
get investors back on the company's side. That said, facts are facts. Fission
will continue to explore and add pounds to what is already a world-class
project: 105.5 million pounds (105.5 Mlb) with a projected operating cost of
$14.02/lb. Fission and NexGen Energy Ltd. (NXE:TSX.V; NXGEF:OTCQX) are the two
best uranium stories we've seen in quite a while.
TER: How do you rate Fission?
RC: A Buy rating with a 12-month, $1.55/share price target.
[Editor's Note: On Dec. 21, Fission announced an agreement with CGN
Mining Company Ltd., which will acquire a 19.99% ownership stake in Fission.
In a research note Chang issued on Dec. 21, he wrote, "We view CGN’s
first foray into Canadian uranium as a positive for Fission Uranium and the
Canadian uranium industry in particular as the Chinese have finally pulled
the trigger in investing in a uranium project in Canada.]
TER: What are Denison's prospects?
RC: The company has made the very interesting decision to push its
Wheeler River project in Saskatchewan to production. Denison owns 60% of
Wheeler River, with Cameco owning 30% and Japan-Canada Uranium Co. Ltd. (JCU)
owning 10%. Denison's share of this project's indicated resource is 42.1 Mlb.
I think Denison has chosen well, as it has added shareholder value by no
longer being a pure-play exploration company.
Denison's decision has put it in Cameco's viewfinder. Cameco has been
sitting on the Athabasca Basin with the knowledge that it will likely be the
ultimate buyer of many of the local projects because of economies of scale
and synergies. Cameco has been rewarded for its caution as prices have
fallen, but now the landscape has changed. Wheeler River could add 7–10 Mlb
annually into the market once it begins production. That will force Cameco to
make a decision: Allow Denison to proceed on its own or take it out and hold
on to it.
TER: When would you expect Denison to go into production?
RC: Probably in six to seven years.
TER: Would Wheeler River production coincide with the
"violent" uranium price increases you expect?
RC: It should. I believe, however, that Denison expects the project
to be economic even under current prices. We do know that Wheeler River's
location signals a low-cost mine because of the grade. Cameco's costs are
probably in the high teens to twenties per pound. Given that Denison is in
the same area, it's possible it would achieve the same low cost. In that
scenario, the current $36/lb is profitable even considering a large capital
expenditure (capex) and the discounted cash flow and time value.
TER: How do you rate Denison?
RC: A Buy rating with a $1.60/share price target.
TER: Would it be safe to say you have a high opinion of Cameco?
RC: Indeed. It is the juggernaut in the space. It is high grade and
low cost. It is one of the largest producers in the world, and it effectively
owns the Athabasca Basin, easily the best jurisdiction in the world for
uranium production. Cameco also is easy to invest in. Some of my larger
clients tell me their multibillion-dollar funds can't reach down to the
hundred-million-dollar equities, because a meaningful position by the funds
would result in control positions in the smaller companies.
Read Rob Chang's Investment Ideas in The Gold Report
Cameco is the only uranium-focused equity with a market cap that is over a
billion dollars and is very liquid, and for that reason alone it will be the
frontrunner when the uranium price shoots upward. It has a great management
team. Usually, the best people in the smaller companies come from Cameco, so
it must be doing something right.
TER: How do you rate Cameco?
RC: A Buy rating with a target price of $26.05/share. Right now, it
is trading at $16.80/share, so I expect a $9/share upside. We've tracked this
company for quite a while. Cameco has historically traded from a forward
price-to-cash-flow basis of about 13x. It's currently trading in the 5–6x
range, which is a level that we have never seen. That's significant, and
reflects investors' general dislike of the commodities sector, as well as the
current disdain for uranium.
We believe that Cameco is greatly oversold and will be worth much, much
more. Also, in a higher-price environment, Cameco will probably deserve a
higher multiple because it's the preeminent company in the space. A $30
target price, perhaps.
TER: Given that Cameco is the 800-pound gorilla in Saskatchewan,
could the company become a monopoly in the province?
RC: Well, it effectively does have a monopoly because it already
owns pretty much everything that's notable except for the McClean Lake mill,
which AREVA
SA (AREVA:EPA) and Denison own the majority of. Beyond that, Cameco has
all the notable, high-quality assets in the Athabasca Basin except those
owned by Denison, Fission and NexGen.
TER: Which other uranium juniors do you like and why?
RC: I'll name four. The first is NexGen Energy. This is our top
pick across all commodities, and we believe investors have the opportunity to
buy an emerging world-class deposit in Arrow in its early stages of being
discovered. Based on released assay results to date, we already estimate a
resource size of 149 Mlb U3O8 with significant upside available. In fact,
based on the length of the intercepts we have seen, the grade of these
intercepts and the size of the potential mineralized areas, Arrow has the
potential to rival some of the largest uranium deposits in the world. We have
a Buy (Speculative) rating on NexGen with no target price since it does not
have an official resource yet. But we expect to see a maiden resource
estimate by mid-2016.
TER: What else?
RC: The second is Energy Fuels
Inc. (EFR:TSX; UUUU:NYSE.MKT; EFRFF:OTCQX). It is the only conventional
uranium producer in the U.S. and the second-largest producer overall. It has
the potential to become #1, given the projects and mines it has on standby or
that are close to being in development. At full ramp-up we expect the company
to be able to produce 5–7 Mlb/year, in a country currently producing 4–5
Mlb/year.
The U.S. consumes 55 Mlb/year, but only about 10% is supplied
domestically. U.S. utilities seeking security of supply will greatly prefer
U.S. producers over those from Kazakhstan, Russia or Africa. This company is
well positioned to benefit from higher uranium prices.
TER: How do you rate Energy Fuels?
RC: A Buy rating with a target price of $11.85/share.
TER: Do American producers have the advantage in the domestic
market vis-á-vis Canadian producers?
RC: That hasn't materialized yet, but they could enjoy a premium at
some point and I believe they should. Security of supply is of paramount
importance, especially when the alternative to not having uranium for a
utility is an idle reactor generating zero revenue.
TER: And the third uranium junior you like is?
RC: Azarga Uranium Corp. (AZZ:TSE), which is underfollowed.
It owns the Dewey Burdock project in South Dakota, which used to be owned by
Powertech Uranium Corp. It is located in a region that has several producing,
past producing, and developing in-situ recovery (ISR) uranium assets, and we
expect this project to start producing ~1 Mlb/year by 2018–19. Because it is
the highest-grade ISR deposit in the U.S., we believe it can attain all-in
sustaining costs (AISC) of $30–40/lb. That's not a sexy number now, but we
believe it soon will be.
Dewey Burdock has a current resource of 8.58 Mlb attributed and 3.53 Mlb
Inferred, and there is still a lot of exploration upside in the area. We
believe that Azarga can easily add many more pounds.
TER: Azarga also has projects in Colorado and Kyrgyzstan. Are they
significant?
RC: We expect that Centennial in Colorado will be the company's
next project to go into production after Dewey Burdock. By the beginning of
2020, we expect 700 Klb/year from that source. We haven't modeled any of
Azarga's other projects, because Dewey Burdock and Centennial are the ones
that have the best chance of going online and creating value for
shareholders.
TER: How do you rate Azarga?
RC: A Buy rating with a target price of $1.20/share.
TER: And the final uranium junior you wanted to mention?
RC: Ur-Energy Inc. (URG:NYSE.MKT; URE:TSX) has been producing
at Lost Creek via ISR in Wyoming for two years, and also has the Shirley
Basin project. This company has outperformed from both cost and production
standpoints almost since the start. We're pretty excited by what we see. The
company can also ramp up production. It will be producing more than 1
Mlb/year with AISC in the $20s. This is a proven low-cost producer that will
look even better when prices rise.
TER: How do you rate Ur-Energy?
RC: A Buy rating with a $2.15/share target price.
TER: Many uranium juniors have recently seen 52-week lows. Have we
reached the bottom? Should investors be getting into junior uranium stocks
now, or should they wait for uranium prices to rise?
RC: I find it difficult to imagine why uranium prices would make a
significant move downward, but I see many obvious reasons why uranium prices
would make a significant move upward. At the current spot price of $36/lb,
many, if not most, uranium producers are probably losing money. Should
uranium prices fall below $36/lb for a significant period of time, producers
would shut down, and then we'd have even less production relative to demand.
Beginning in 2017–18, the utilities will become increasingly uncovered,
and that problem will only worsen as more reactors come online. Unless new
contracts at much higher prices are signed, I expect utilities' uncovered
positions will rise to one-half to two-thirds of requirements. As I said
earlier, uranium is a tiny part of total expenditures, so it makes little
sense for them to drive hard bargains at the risk of not getting the
material. There might be a little more short-term pain for uranium due to
inventory levels and secondary supplies, but a violent price increase is
coming soon.
TER: Rob, thank you for your time and your insights.
Cantor Fitzgerald Canada's Senior Analyst, Managing Director and Head
of Metals and Mining Rob Chang has covered the metals and mining space for
over nine years for the sellside and the buyside. Prior to Cantor, Chang
served on the equity research teams at Versant Partners, Octagon Capital and
BMO Capital Markets. His buyside experience includes managing $3 billion in
assets as a director of research/portfolio manager at Middlefield Capital,
where his primary resource portfolio outperformed its direct peer and
benchmark by more than 28% and 18%, respectively. He was also on a
five-person multistrategy hedge fund team, where he specialized in equity and
derivative investments. He completed his master's degree in business
administration at the University of Toronto's Rotman School of Management.
