Uranium hots up

Background: Through 2006, speculation had been active in the nuclear fuel and stockmarkets as to where the spot uranium price would land by year end '” up or down?

TradeTech’s spot price punched through the $US60 a pound mark for the first time in the commercial nuclear fuel market’s 38-year history. Less than two months after surpassing the $US50 mark, TradeTech reported a spot price level of $60.25 a pound of uranium oxide (U308) in its October 27 issue of Nuclear Market Review, its weekly subscriber magazine.

On Monday, October 23, debate about uranium supply-demand imbalances was settled by a natural disaster. TradeTech reported in Nuclear Market Review, along with the new spot uranium price:

“The uranium market was sent reeling this week with the news of the flooding and resulting production startup delay at Cameco’s Cigar Lake project in Canada. The prospect that seven million pounds will not be available to the market in 2008 and possibly 12 million pounds in 2009 '¦ as previously expected, caused many buyers to begin the process of reassessing their purchasing strategies and potential entry into the market.”

By the time TradeTech reported the new weekly record spot price, market analysts were speculating whether the spot uranium price would end the year at $US70, $US80, $US90 or even $US100. Instead of counting the price in nickels, as was done in the 1990s, the market is counting price movements by ten-dollar bills.

StockInterview talked with Gene Clark, chief executive of TradeTech, the only company that calculates a spot uranium price every Friday.

The interview

StockInterview: Some mining stock analysts downplayed the mine flooding. Some took it seriously; others less so. But, it appears the utilities have taken the Cigar Lake flooding very seriously. Why?

Gene Clark: It wasn’t just that the fact of the mine flooding that created a near-panic in the market; this situation was spurred on by Cameco’s forewarning in its press release: “Cameco has supply interruption protection in its contracts providing the right to reduce, defer or cancel volumes on a pro rata basis if we experience a meaningful shortfall in planned production. This language protects about three-quarters of current contracted volumes. This percentage will rise as old contracts expire. All contracts also contain standard force majeure protection. The baseload contracts put in place to support the development of Cigar Lake also contain supply interruption language, which allows Cameco to reduce, defer or terminate Cigar Lake product deliveries in the event of any delay or shortfall in Cigar Lake production.”

Given the foregoing contractual protections, Cameco is adequately positioned to meet its contractual obligations.

In other words, Cameco chose to “protect the shareholders” ahead of their customers, the utilities?

This statement was clearly intended to allay the fears of its stockholders, and that's actually what you would expect prudent management to do; that is, to use every option it has to keep the company financially viable and to be up-front about it. But this statement sent chills down the spines of Cameco’s customers. Its customers must have known that Cameco had these termination rights '” after all, they signed the contracts. But they probably did not consider themselves to be at-risk, given that they were dealing with what most consider the world’s most reliable supplier.

In the long run, how will the Cigar Lake event impact the world’s supply-demand situation?

The answer depends on how long the production delay turns out to be, or if Cigar Lake has to be written off as a supply source. As the figure below shows, the years 2004 to 2008 show market deliveries larger than actual reactor requirements. This shows that buyers are building inventories. There appears to be enough production capacity from developing and planned projects to meet reactor requirements, and even to continue this inventory building process for a few more years beyond 2008.

When will utilities feel the pinch?

After 2010, it starts to get a little dicey. Some level of Cigar Lake production would be needed by then to meet reactor requirements for that period. And, after 2013 when supplies from the so-called Russian HEU Deal end, Cigar Lake ’s production is a “must-have” supply source.

How serious is the tight supply situation?

While the “sky has not fallen yet”, there is not much breathing room left in the system. Some of the key factors to watch will be the extent to which utilities are able to build inventory for supply-disruption mitigation, the success of bringing on new production capacity (especially the larger projects), and participation by the speculators in the market. As pricey as uranium is in today’s market, this speculator segment of the market may be able to command real premiums for what will be precious material at given times in the future market.

What is the real impact of the Cigar Lake flood aside from the anticipated supply disruption?

In spite of the immediate impact on the spot market, the real issue highlighted for utilities by this event is in the long-term market. Because of the swing from a buyer’s market to the current seller’s market, producers now have more market power. Not only can they command higher prices, but producers can shift some performance risk to the buyer side.

How does this event affect contracts between utilities and uranium producers?

Having a contract tied to a future mine adds an additional layer of risk, as aptly demonstrated by the two Cigar Lake mine floods. Operating mines could also be subject to production problems. But, having a supply contract with the world’s largest uranium producer should provide a high level of assurance. Unfortunately, if a utility has a contract, with the reduction or termination language found in the Cameco contracts, the utility doesn’t really have a supply contract. Instead, the document is, in essence, a “put option” by the uranium producer.

What does this mean for the spot and long-term uranium markets?

In the depressed uranium market of the 1990s, participants got into the habit of “counting by nickels” when anticipating month-to-month price movements. After the current price run-up began in 2004, the currency changed. First, it was “counting by quarters”, and then “counting by dollars”. How long the current mentality of “counting by ten-dollar increments” will last is not clear, but the high level of uncertainty in future uranium prices will undoubtedly make participation in the market much more of a strategic decision than a tactical one.

How does the future look to you?

One statement will ring true through the foreseeable future. If you’ve got uranium in your hands, you’re going to make some real money on it when you sell. The lesson underscored for the electric utility industry is how vulnerable their supply sources are to this type of problem.

(This interview first appeared on Monday October 30 on Stock Interview at www.stockinterview.com)