The Mining Report: The spot price for uranium stayed below $30 per pound ($30/lb) in May through late July. Since then the price popped up above $36/lb before settling at around $35/lb. Is that the near-term floor?
Colin Healey: It's a difficult call. Two things give us hope that we may see support at current levels. We saw the return of non-discretionary buying to the spot market in Q3/14 after an absence of three consecutive quarters—something we haven't seen since 2005. We look for non-discretionary buying to thin the market of available material and underpin support for uranium prices at current levels. The return of non-discretionary buying is important.
"Fission Uranium Corp. has drilled over 260 holes into its significant discovery at Patterson Lake South."
We also look for greater activity in the term market where an increase in contracting activity should also increase the competition for material in the spot market. We expect a sustainable rally in the spot market to coincide with progressive increases in the term price over the next 24 months. As of this week we saw no new interest in the term market, but much of that is traded off-market. We're watching closely for anything that might move the term price. We saw the UxC Consulting Co. (UxC) weekly spot price come up $0.85 to $36.50/lb, which adds some confidence.
TMR: Are there signs that non-discretionary buying will continue?
CH: It's difficult to get transparent data on that. In the most recent quarter we saw the first return of non-discretionary buying as a small component of the total volume in the spot market. If that materializes into a trend, then we might have some evidence that it is returning in a meaningful way.
TMR: Why didn't the end of Russia's "Megatons to Megawatts" create greater price strength in the uranium space in 2014? And what's responsible for the overhang on uranium prices now?
CH: As a major source of secondary uranium supply, the loss of the Megatons to Megawatts program was a significant event. It shifted the balance in total supply in favor of primary sources—although any impact will be tempered in the near term by the fact that the market remains oversupplied. The program was structured with a defined timeline and as such its end was not a shock. There's a form of replacement agreement in place between the United States Enrichment Corp. (USEC) and Techsnabexport (TENEX), the commercial subsidiary of Russia's Ministry of Atomic Energy, for delivery of enriched uranium to the U.S. with the U.S. delivering natural uranium in return, which covers about half the deliveries received under the Megatons to Megawatts program. That agreement appears to include an option to double the initial volume at the option of the USEC. The agreement is effectively a separative work unit (SWU) purchase contract where USEC is paying for enrichment services embedded in the Low Enriched Uranium (LEU) product TENEX is supplying.
"Ur-Energy Inc.'s well fields have certainly been performing in excess of management expectations."
The good news is that this structure should mean that utilities are more reliant on primary uranium production than before and that should be ultimately bullish for uranium prices. Nevertheless, the market has been oversupplied for several years. Total supply in 2013 was about 207 million pounds (207 Mlb) versus demand of around 172 Mlb, reflecting a surplus of about 35 Mlb. In 2014, we estimate a surplus of 20 Mlb, which contributes to an overhang in prices.
TMR: Haywood forecasts the 2015 spot price at $39.50/lb, but in 2016 that jumps to $53/lb. What are the catalysts that are going to push the price 34% higher?
CH: We're looking for progressive growth in long-term and spot prices based on a more normalized demand-supply relationship. Prices remain low as the market continues to be oversupplied, and as a result, as much as 30% of current primary supply is thought to be uneconomic at current spot prices. Driving our appreciating forecast are the 71 reactors currently under construction globally, coupled with a rationalization on the production side, whereby benchmark uranium prices will begin to move toward the marginal cost of production, which itself will shift with eventual production atrophy.
The global reactor construction pipeline is important. New reactor fuel loadings require about three times more uranium than the average annual burn of the same reactor, so there's an increase in demand when a fixed pipeline of new reactors comes on-line. We also believe that a return to nuclear power in Japan will help the situation. We're looking for between two and six units to be restarted in 2015. Our price forecast is underpinned by an assumption of tight demand-supply balance in uranium markets by 2017 with the price coming up to a point that rationalizes the majority of current production, plus provides an incentive for new mines.
TMR: Your average price for 2016 is $65/lb. How much of that is based on more reactors restarting in Japan?
CH: The return of Japan to nuclear power isn't as significant as the construction pipeline. It's more of a sentiment indicator, which we believe could move uranium stocks. We believe that Japan has significant uranium inventory, which should support consumption during the restarts. It's really the pipeline of reactors under construction that is underpinning the majority of our bullishness on the uranium price.
Furthermore, we believe the term market will respond alongside the spot market to the catalysts I mentioned. The term market is a better gauge of the overall condition of the sector. In 2013, reported term market volumes were very low at just over 20 Mlb, versus 191 Mlb in 2012, and over 100 Mlb in 2011. We've seen a bit of a recovery in volume in 2014 at almost 70 Mlb. We expect term market volume to pick up steadily in the coming months as uncovered utility requirements grow. We expect 2015 to be even busier.
TMR: Despite a price run-up in August, most uranium equities, especially the producers, did not follow the spot price higher. How do you explain that?
CH: The resource sector has had a rough ride over the last two months with the TSX Venture Index down more than 20% since the end of August. Most uranium equities were not spared. Recent positive uranium spot price movements have failed to reverse the negative trend in the equities and, in the near term, equities will respond to macro news, such as in Japan where 19 of 26 assembly members recently voted in favor of nuclear reactor restarts. Another positive vote of the Prefectural Assembly, expected later this week, could mean reactor restarts in Japan in the first half of 2015. We are seeing reports in the press that only 8 of the 49 members of the Assembly oppose restarts.
TMR: Do you have any insight into the investor mindset on the commodity?
CH: We're looking beyond the spot market to the term market for material consecutive movements month-over-month to gauge the sector. A movement in long-term price indicators, say $3–4/lb, in consecutive months would reflect the beginning of a meaningful return to the term market by utilities. We believe that would wake up the broad market to the equities.
For the producers, there are few tradable pure-play uranium producers, some of which have limited gearing to spot market prices, such as Cameco Corp. (CCO:TSX; CCJ:NYSE), where term contracts represent a majority of sales. Paladin Energy Ltd.'s (PDN:TSX; PDN:ASX) sales correlate well to spot prices, but Paladin still has term-debt maturity issues it's trying to resolve by year-end. There's significant uncertainty surrounding how that will be managed. We have a $0.50 target and a Hold rating on Paladin.
TMR: What are those debt issues?
CH: In November 2015 Paladin has $300 million ($300M) in debt maturing, and it has to deal with it. Our concern is that the company has not been clear on a strategy to deal with it. Paladin has said that it could sell interests in assets but it has already sold 25% of its flagship Langer Heinrich mine in Namibia to the Chinese for $200M. With all that uncertainty, we aren't calling it a Buy at this time.
TMR: Research reports from Haywood suggest that near-term producers and select explorers are the uranium equities most likely to perform. Is that your view?
CH: We certainly saw the biggest response from the near-term producers and developers during the rally in uranium equities from late November 2013 to mid-March 2014. We would expect that group to lead the pack in the next rally as well. This group is preproduction and is not selling and depleting their resources into a weak market. In that regard their cash flows tend to be linked to their development budgets, and their general and administrative expenses, making their cash flow more predictable. They offer historic correlation to uranium price movement without the direct cash flow exposure to the uranium price that we get with the current producers.
TMR: What are some explorers that you're following?
CH: We cover Denison Mines Corp. (DML:TSX; DNN:NYSE.MKT) with a $2.10 target and a Buy rating. This is one of our favorite names for gaining exposure to the sector. Denison has an extremely high-grade and strategic exploration asset at its 60%-owned Wheeler River project in northern Saskatchewan; Cameco owns 30%. Denison also has a 22.5% stake in the McClean Lake mill, which has undergone significant upgrading in recent years. That was paid for by the Cigar Lake joint venture in preparation for processing ore from the Cigar Lake mine, which recently started production. Denison will realize some toll-milling revenue from its stake in the mill and its 2015 exploration plan is fully financed to explore a suite of exploration assets in the basin.
TMR: Denison extended the Gryphon zone at Wheeler River. Please tell our readers why that's meaningful.
CH: The Gryphon zone is important to Denison because the current resource of 70 Mlb at the Wheeler River project is approaching the critical mass required for development. Demonstrating the potential of the Gryphon zone to add pounds to that project's resource is critical. A resource of 90 Mlb or so would probably place Wheeler River in a position to be developed at our mid- to long-term uranium price forecast. The discovery and addition of the Gryphon zone has the potential to transform Wheeler River from a great discovery into something that really leap-frogs up the global development pipeline.
TMR: What are some other exploration stories?
CH: In the southwestern Athabasca Basin in Saskatchewan we have followed Fission Uranium Corp. (FCU:TSX) and NexGen Energy Ltd. (NXE:TSX.V) in our Junior Exploration Report for several consecutive quarters. Fission has drilled over 260 holes into its significant discovery at Patterson Lake South. The next major catalyst for Fission would be its maiden resource estimate, which is expected by year-end.
TMR: Fission climbed about 10% in late October. Was that sentiment driven or was there material news?
CH: Fission sold down from mid-September levels of $1.15/share or so to the mid-$0.60 range. It may have been just viewed as oversold and once the selling pressure disappeared it bounced back. We don't have a formal target on Fission.
TMR: What can you tell us about NexGen?
CH: NexGen's Arrow deposit at the Rook I project is a newer discovery on trend with Fission's Patterson Lake South. NexGen intersected some very high grades at Rook I during summer drilling. We expect NexGen to announce a significant winter drill program to continue to follow-up on summer work on the project. It recently arranged a $10M financing, which is set to close in early November. We don't have a formal target on NexGen.
TMR: How should investors view NexGen's $10M raise?
CH: In this market it's nice to have financing in place in excess of the budget for the next drill program. I would suspect the company raised only what it thought it needed, plus a small cushion, so that it could avoid any excess dilution. With the good results at the end of the winter program, hopefully NexGen will be able to do its next round of financing at a better price.
TMR: Let's move to the producers. Tell us about some compelling narratives in that space.
CH: We follow several of the newer U.S.-based in-situ recovery (ISR) producers, including Uranerz Energy Corp. (URZ:TSX; URZ:NYSE.MKT) and Ur-Energy Inc. (URE:TSX; URG:NYSE.MKT) with Buy ratings on both. We cover Energy Fuels Inc. (EFR:TSX; EFRFF:OTCQX; UUUU:NYSE.MKT) with a Buy rating as well; it is a conventional uranium producer in the U.S. We also follow Paladin and Uranium Energy Corp. (UEC:NYSE.MKT). We currently have Hold ratings on those.
Uranerz is a new producer and it's set to deliver its first financial results since the company registered first sales of uranium in September. When it releases its financials at some point in early November we expect to gain some insight into average realized pricing where Uranerz is selling into contract with U.S. utilities. We expect those prices to be at a significant premium to current market prices for uranium given that it signed those contracts a few years ago at higher prevailing benchmark prices. As of today, its sales remain in confidential contracts. We don't have initial operating data on Uranerz's well field in Wyoming, but we are hoping to get our first look at operating data from Uranerz with financial reporting over the next couple of weeks.
TMR: Uranerz sold its first concentrate from Nichols Ranch in Wyoming for about $4M. What's next?
CH: We estimated the sale at $4M for 75,000 lb uranium oxide, but we don't know the exact amount because the contracts are confidential. $4M would reflect an average realized price of just over $53/lb. The actual price could be upward of $56/lb, but we just don’t know yet. Our estimates are based on when the contracts were signed and prevailing prices at the time. Typically utilities are purchasing on average about 70+% of their material on term contracts for security of supply and budgeting purposes rather than playing around in the spot market.
We saw the price at $28/lb each week during the summer lows, and wondered why no one is clearing the spot market. Then we see someone trying to buy small amounts and the price shoots up to $35/lb and we understand why sophisticated buyers prefer term contracts. Spot market depth is difficult to judge and price discovery is weak. We have a $1.80 target and a Buy rating on Uranerz.
TMR: What about Ur-Energy?
CH: Ur-Energy is also expected to report quarterly results shortly. We expect the highlight to also be high average realized pricing on its uranium sales, possibly in excess of $60/lb. Based on company guidance, the average realized pricing for the remainder of 2014 should be quite favorable. We expect that to be the highlight there.
TMR: Ur-Energy's main asset is its Lost Creek ISR mine in Wyoming. How does it compare with assets in its peer group?
CH: Ur-Energy has a couple of quarters of production in the books and the company has had excellent initial well field head grades. With ISR uranium mines you don't really know until you launch production how a well field is going to perform. It has had above-budget head grades pretty much since it entered commercial production. In operating a well field, you want the uranium to be easily liberated from the deposit and that's what is happening at Lost Creek. In our view, it compares quite favorably to assets in its peer group.
Ur-Energy's well fields have certainly been performing in excess of management expectations. We had some earlier concerns about water disposal, but the company has addressed those issues and we reinstated our Buy rating on Ur-Energy and have a $1.70 target.
TMR: You mentioned Uranium Energy Corp. What's happening there?
CH: Uranium Energy has a hub-and-spoke strategy with the Hobson ISR processing plant at the center of that hub. Its flagship project—the Goliad project in South Texas—is not in production. The Palangana well fields that were in production are now more or less on care and maintenance. We don't have a lot of operational data on those assets, but they seemed to be underperforming before they were taken offline due to low uranium prices. We're waiting on a Goliad construction update from Uranium Energy before we make any further decisions about the company. We see better opportunity in our Buy-rated companies, like Uranerz and Ur-Energy. We have a $1.70 target and a Hold rating on Uranium Energy.
TMR: What about Energy Fuels?
CH: Energy Fuels' current strategy is to leverage its strong contracting book. The company is not expected to produce from processing of conventional ore at its White Mesa mill in 2015, rather it will sell into its favorably priced contract book from inventory. It will decide to produce more uranium once it believes there is price support well above current levels. We like the company because of that contract book and because it's in the position to respond to recovering uranium prices and make that production decision, yet still generate revenue from sales during 2015.
TMR: It's essentially 100% hedged. What are your thoughts on that strategy?
CH: You could interpret it as 100% hedged, but I wouldn't because it has the ability to produce and sell additional material into current prices, offering potential gearing to uranium price when justified. Energy Fuels decided to sell into its contracts because those contracts are priced in excess of current market prices. Its planned sales are all contract, which is by definition hedged, but the company can turn on the production switch and generate sales at the prevailing uranium price, though it would probably take six to nine months to ramp up production from mines; stockpiled ore could be processed sooner. We have a $12.50 target on Energy Fuels and a Buy rating.
TMR: Few, if any, uranium producers have outperformed the TSX Composite Index so far in 2014. Do you expect a similar story in 2015?
CH: It's a difficult call in the near term as uranium prices have proven very tricky to forecast and the short list of producers have diverse production methods, scales and capital structures. Our commodity price forecast for the next three years calls for a significant appreciation, as we highlighted. If our uranium price forecast proves to be accurate over the next few years, I would expect uranium producers to outperform the Composite, at least in terms of nominal returns and not attempting to compare the risk-adjusted returns of the TSX Composite Index.
TMR: Thank you for talking with us, Colin.
Colin Healey joined Haywood in 2008 as a mining associate focusing on the uranium, iron ore and coal sectors. Immediately prior to his arrival at Haywood, Healey worked at a major Canadian bank as an analyst structuring debt financing across a wide variety of industries. Prior to joining the finance industry seven years ago, he worked for eight years as quality manager in an ISO 17025-accredited laboratory that performed extensive assay and analysis work for major mining and precious metals refining companies. He holds a Master of Business Administration from the Schulich School of Business at York University, majoring in finance and investments, as well as a Bachelor of Commerce degree majoring in computer information systems and a technical diploma in mechanical engineering.
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DISCLOSURE:
1) Brian Sylvester conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
2) Colin Healey: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Denison Mines Corp., Energy Fuels Inc., Uranerz Energy Corp. and Uranium Energy Corp. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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