The Mining Report:
It's been a rough couple of years for uranium prices. Realistically, could
news of possible restarts of nuclear plants in Japan positively impact the
price of uranium, even if it's only psychologically?
Thomas Drolet: The psychology of Japan
restarts has been driving the spot price; perhaps it will start to move the
all-important long-term price, too. The long-term price is the signal that
the utilities are buying. It is paramount to core value investing.
Let's
talk about Japan. My observation, after having been there several times
post-Fukushima Daiichi, is that there is a giant tug-o-war going on. Pulling
on one end of the rope is Japanese industry, which is paying a high price for
fossil fuels replacement electricity, and the current government, which is
definitely for bringing the nuclear plants back on-line. Tugging on the other
end of the rope is a profoundly fearful public. Hanging onto the middle of
the rope is Japan's new nuclear regulatory agency. It will take time for this
stronger regulator to finish a series of mandated safety checks before it can
authorize bringing back some of the mothballed reactors.
Kyushu
Electric Power Co. Inc. (9508:TKY) plans to restart two reactors at Sendai in
the middle of Q1/15. This is sending a positive signal to the whole uranium
production and supply space. However, the inventory of fuel at the Japanese
reactors is very high; the utilities had long-term contracts when they were
shut down. And those contracts generally could not be terminated. The large,
existing inventory of fuel will be gradually eaten up as reactors restart
after wending their way through nuclear regulatory approvals, prefecture
approvals, local town approvals and, finally, national government approval.
TMR: Will the Japanese be building new
reactors, as well as bringing back the ones that were mothballed?
TD: The Japanese have announced the intent
to start building a couple of new reactors, but I do not see any real
progress yet on the early-stage design efforts. What I do see is that the
major reactor suppliers from Japan—Mitsubishi Corp. (MSBSHY:OTCPK), Toshiba
Corp. (TOSBF:OTC: 6502:TKY)—are actually doing the opposite; they are
concentrating overseas. They are doing deals in the United States, in Europe,
in Southeast Asia.
Two
years ago in the U.S., there were 104 working reactors. Six of them were
stilled for valid local or contractual reasons: i.e., the argument with a
supplier of new heat exchangers for San Onofre took two units out. And there
was significant displeasure in the Northeast with a couple of reactors, and
one in Wisconsin. Anyway, we are down to 98 reactors in the U.S. now.
In the
U.S., four new AP1000 reactors, each one delivering 1,200 megawatts, are
being built by Toshiba/Westinghouse Electric Co. Toshiba is the master
contractor, supervising Westinghouse and, among others, Chicago Bridge &
Iron Co. N.V. (CBI:NYSE). Until these four reactors are operating
successfully, roughly on schedule and roughly on budget, the U.S. is not
going to be a high-growth area for nuclear power. Waiting on the sidelines,
major utilities like Duke Energy Corp. (DUK:NYSE), Exelon Corp. (EXC:NYSE)
and Entergy Corp. (ETR:NYSE) are in the very early stages of applying for new
reactor builds.
TMR: Given this environment, how do spot
prices relate to long-term contracts in the uranium market?
TD: Spot is simply uranium put up by
suppliers for short-term cash needs. The price is almost certain to be taken
up further by a smart utility, or by the enrichers, the firms that enrich the
uranium that goes into the fuel fabrication process and eventually burns in
the reactors. Current activity in the spot market is a signal that a corner
is turning. Uranium fell to ~$30/pound ($30/lb) on the spot market in the
early fall. That is below the average cost of worldwide production by a good
US$10. The price obviously cannot stay there because people have to make money
to stay in business.
Although
an important corner has turned, I am not saying that there is massive upside
for all uranium companies as a result of what is happening on the spot side.
There will be a slow and steady climb driven by major utilities coming in on
buying cycles that meet their internal needs.
TMR: When the long-term prices shoot up,
who will benefit?
TD: The uptick will mostly benefit the
big producers and the current suppliers, such as Cameco Corp.
(CCO:TSX; CCJ:NYSE) and Denison
Mines Corp. (DML:TSX; DNN:NYSE.MKT). Juniors such as Ur-Energy
Inc. (URE:TSX; URG:NYSE.MKT) may catch a bit of that wave. Interestingly,
Ur-Energy has ramped up production to about 600,000 pounds (600,000 lbs) this
year at its Lost Creek operation in Wyoming. The company is very transparent.
According to its CEO, the firm's production cash costs are averaging
$22–23/lb. Ur-Energy is selling into the long-term market. It has 5 million
pounds under contract through 2021 at an average price of $50/lb. Targeting
the long-term users is a smart move. And, importantly, Ur-Energy's capital
and production costs are relatively low, because it does solution mining.
TMR: How does solution mining create cost
efficiencies?
TD: In the Athabasca Basin, by
counter-example, miners typically drill vertical mine shafts into a very
hard, but high-yielding uranium-rich rock. However, the capital cost of hard
rock mining is high.
The
solution miners, on the other hand, drill both vertical and horizontal holes
to introduce solutions. A solution is injected into the bore hole and, after
it sits for a while, it is pumped out and U3O8 yellowcake is then
precipitated out.
TMR: What are the components of the
solution?
TD: It depends on the chemistry of the
rock. It can be mildly acidic; it can be mildly basic. The solutions are not
toxic by any industry standards.
TMR: Are Ur-Energy's long-term contracts
economic? Is $50/lb going to hold up?
TD: Yes, the $50/lb is tied up until
2021. With an average production cost base of approximately $20–25/lb, that
is very economic. Ur-Energy is
solidifying its book for the next six years at a cost that is roughly half of
its average sale price. In short, solution mining is quick off the mark, it
is relatively low capital cost. Smart juniors, like Ur-Energy, are signing
long-term contracts.
TMR: Is Ur-Energy still exploring the
Lost Creek region?
TD: It has various properties around the
Lost Creek. But, I understand the managers want to create a steady cash flow
before investing capital in the other areas. When those other areas are
developed, there will be an economy of scale already in place, perhaps with a
precipitating mill and network of pipelines serving multiple extraction
sites.
TMR: Let's look at the Athabasca juniors.
Who are you following there?
TD: I am on the Advisory Committee with Lakeland
Resources Inc. (LK:TSX.V) and Skyharbour
Resources Ltd. (SYH:TSX.V). Lakeland and Skyharbour have agglomerated
properties around successful mid-cap developers like Fission
Uranium Corp. (FCU:TSX), and seniors like Denison and Cameco. In my
opinion they both have a high probability of finding high-yielding
uranium-bearing rock.
The
problem that all hard rock Athabasca juniors share is the time and money it
takes to develop a producing mine. Each junior has to survive this very
difficult market and still raise the required exploration and production funds.
The uranium spot and long-term price markets will continue to slowly improve.
This will enable the juniors access to capital markets. Right now, most
juniors in the Athabasca are supporting themselves by issuing equity, or
associating with capital groups or getting gobbled by the big guys, the
Camecos, the Denisons, the AREVA SAs (AREVA:EPA) of this world. That has been
the way of the oil and gas junior business, and that will ultimately be the
way in the uranium junior business, as well, in my opinion.
TMR: How is the stock market treating the
Athabasca juniors?
TD: The stock prices are down about 30%
from the peak of a year ago. Investors exited uranium mining en masse because Japan did not appear to
be coming back. And, not well reported, China's reactor program temporarily
slowed down after Fukushima Daiichi as well. Now, new Chinese reactor
developments are back with a vengeance. Both the spot and the long-term prices
will benefit from China's immediate and near-term nuclear fuel needs.
In the
Middle East, four reactors are being built by South Koreans for the United
Arab Emirates. These will need a reliable fuel stream. The Russians just
signed up for building two reactors, and maybe four more, in Iran. The
Russians have a particularly unique and clever marketing business
strategy—compared to majors like AREVAs and Westinghouse. They are doing
turnkey operations for their customers. The Russians will design the reactor,
build it, and either run it directly or train the client to operate it. They
will supply the fuel and, also, take it back for disposal.
TMR: Will Russia have to go into the
global market for uranium?
TD: Russia will supply the uranium,
enrich it and fabricate it within the boundaries of Russia. Also using the
Kazakhstani reserves, Russia will supply yellowcake for the reactors that it
builds, be they in Pakistan, Iran, Turkey, Indonesia or Bangladesh. Russia is
the most aggressive nuclear reactor exporting nation on the face of the earth
at the moment.
TMR: What kind of creative financing are
the uranium juniors using to keep moving ahead in this environment?
TD: Lakeland is backed by a capital group
called Zimtu
Capital Corp. (ZC:TSX.V). Zimtu holds preferential positions in a dozen
or so companies. It helps these firms to access other capital sources. Until
the share prices rebound somewhat for the juniors, there is not a lot that
the Athabasca juniors can do other than to make sound investments in new
properties, continue drilling their well positioned properties and
potentially associate with capital suppliers that are willing to take a
preferential position. Otherwise, a junior will fall into the spiral of the
dilution mode. Never good for shareholders.
TMR: Leaving uranium, what are the
driving forces affecting the price of oil and gas today?
TD: There are several forces driving
these prices. Nation states such as Venezuela, Saudi Arabia and Iran are
taking over the place of the international integrateds. Nation states with
large oil reserves are attending to their own needs and gradually blowing off
the integrateds.
Second,
the revolutionary advance of fracking and horizontal drilling has taken away
a lot of the uncertainty about future supply. There is indeed a large supply
of tight oils and shale gas, with the new technology to extract it. However,
the price is not going to stay down forever. There is a new and important
phenomenon emerging.
We will
soon start to run out of shallow, easy-to-access, reasonably permeable, low
decline rate tight oil and shale gas zones. President Obama has said that
fracking and horizontal drilling will provide a transitional fuel source for
the next 50 years. I personally doubt that that super supply will last that
long, simply because the decline rates are huge and have a long, low tail.
Frackers have been able to get their money back in one to two years, but as
production drops, I worry about the high, never ending, poke-a-new-hole
drilling cost syndrome.
TMR: How does the strong dollar affect
junior miners in Canada?
TD: The cost of operating a drill rig is
paid in Canadian dollars, which is substantially below the U.S. dollar. That
means that the capital and operating costs for oil and gas companies is
denominated in a currency that is 15% less than the currency tied to the sale
of the product!
TMR: What shale oil and gas firms are
poised to do well as the energy environment continues to evolve, as you say?
TD: The big guys: the Chevrons
(CVX:NYSE), the Exxon Mobils (XOM:NYSE), the big integrateds in North America
stand to last the longest in this necessary constant high cost drilling
environment.
TMR: Are oil and gas juniors doomed?
TD: Most of the juniors will survive.
Eventually, the good ones will be bought up because that is the way of the
world. The little ones get bought up by the big guys.
TMR: Is now a good time to invest in
major electrical utilities?
TD: Yes. A lot of them have been beaten down,
because we are still emerging from a difficult period in the U.S. But as the
U.S. economy picks up steam, the big, well-managed utilities—the Dukes, the
Exelons, the Entergys, the Pacific Gas and Electrics (PCG:NSYE)—are good
places to invest for the long term.
TMR: Thanks for your insights, Thomas.
TD: You are welcome, Peter.
Thomas Drolet is the principal of Drolet & Associates Energy
Services Inc. He has had a four-decade career in many phases of
energy—nuclear, coal, natural gas, geothermal and distributed generation,
with expertise in commercial aspects, research and development, engineering,
operations and consulting. He earned a bachelor's degree in chemical
engineering from Royal Military College of Canada, a master's of science
degree in nuclear technology/chemical engineering and a DIC from Imperial
College, University of London, England. He spent 26 years with North
America's largest nuclear utility, Ontario Hydro, in various nuclear
engineering, research and operations functions.
