Uranium: Still too hot to handle

Uranium claimed another victim last week with the share-price collapse of Energy Resources of Australia confirming that the nuclear fuel remains an investment which can be hot to handle.

Failure to win the support of its major shareholder, Rio Tinto, for the expansion of the Ranger mine in the Northern Territory meant that ERA joined Paladin Energy as a uranium producer which has cost investors billions of dollars.

Ironically, the ERA flop did not deter speculators from supporting other uranium stocks, perhaps in the belief that the death of Ranger might create a market opening for alternative suppliers.

Nor did ERA's sharp price fall inflict much damage on Rio Tinto with uranium a minor asset compared with iron ore which accounts for 80 per cent of its annual profit.

Toro Energy, which plans to develop a mine near Wiluna in central WA and recently secured a fresh financing deal with a major shareholder, rose by 10 per cent to 7.5 cents after ERA announced plans to end production at Ranger once it has worked through stockpiled ore.

Paladin, which has made heavy weather with its mines in Africa, also added an initial 10 per cent to 31c before slipping back to 28c.

What attracts investors to uranium is a belief that it will, one day, shake off its negative image and emerge as a key element in meeting demand for reliable, carbon-pollution free, electricity.

That might happen because nuclear power remains popular in some countries, especially China which has embarked on a campaign to curb air pollution from burning coal, and India which has embarked on an economic race to catch up with China and needs to invest heavily in power generation.

But, waiting for uranium to deliver on its promise has been a frustrating experience with most forecasts suggesting that it could be another three to five years before the price recovers to a level which requires new mines to be developed.

Ranger, a mine with a chequered history of environmental, political and operational problems, was given its death sentence when Rio Tinto said it could not support a major cut-back (expansion) of the open pit without a longer lease on the land and without confidence that the uranium price would recover.

Because Rio Tinto owns 68 per cent and has management control of the ERA its financial support is essential for the mine to continue operating and while a lease extension beyond the 2020 expiry date is important it was the price of uranium which weighed just as heavily – and which remains a worry for everyone exposed to the fuel.

At its current short term price of $US35.75 a pound, what nuclear power stations pay for quick delivery, uranium is roughly half the price required to justify investment in most new mines.

Even the long-term price, for the sort of contracts power station owners prefer to ensure continuity of fuel supply, is at an unacceptably low $US46/lb.

Understanding the different ways uranium is priced is a first step unravelling the economics of the fuel which caused enormous investor excitement a decade ago when it ran from $US20/lb to $US138/lb in a three year burst, but which ended almost as quickly as it started.

The first blow to uranium came in the early days of 2008 global financial crisis when speculators were squeezed out of the market, followed by the 2011 melt-down of reactors at the Fukushima power station in Japan which caused that country to mothball its entire fleet of reactors.

Today, there are promoters of uranium as a fuel to replace coal who believe that a price recovery is inevitable and while they might be right it remains a commodity which is yet to convincingly overcome its political and environmental obstacles, or the challenge facing small companies trying to compete in a business dominated by giants.

Rio Tinto's decision not to support fresh investment in Ranger might signal a future shortfall of uranium supply but offsetting that is the potential for BHP Billiton to expand its big Olympic Dam copper mine in South Australia which produces uranium as a by-product.

The problem with any by-product in mining is that the mine owner isn't overly worried about the price received because, in the case of Olympic Dam, the real money comes from copper. So, whether the market wants more uranium from Olympic Dam, or not, it's going to get it – if the mine is expanded.

Another reason for uranium being a difficult commodity for small companies is the high costs associated with security and environmental protection. As Paladin chief executive John Borshoff has said many times, when you start producing uranium you leave the mining industry and enter the nuclear industry.

Paladin's awful experience is a case study of how difficult it can be to convert promises into profits in the uranium business.

At its peak in early 2007 Paladin shares traded up to $9.60. That was around the time the uranium price hit its $US138/lb peak. Its latest price of 28c comes after years of heavy losses and operational problems at its Langer Heinrich and Kayelekera mines.

ERA, a stock which hit $19 in early 2007 and was trading as high as $15 in late 2009, has been in decline for the past six years, before dropping off a cliff last week with a price plunge from $1.29 to 40c – and with one investment bank, UBS, tipping a 12-month price target of 16c.

Rio Tinto slipped 50c lower after ERA's Ranger decision was announced but is now back to roughly where it was at $56.04.

The performance of Paladin and ERA has been so bad that it can be hard to believe that a fresh crop of uranium hopefuls are emerging, some with heavyweight financial support.

One of those is Toro which last week secured a fresh financing deal with Sentient Group that enabled the early retirement of a $12 million debt owing to Macquarie Bank, clearing the way for a future mining decision on the Wiluna project.

In theory, Wiluna could become a fresh source of uranium but Toro's chief executive, Vanessa Guthrie, acknowledges that a uranium price of around $US70/lb is required before the company and its bankers will commit to the estimated $315 million capital cost at Wiluna.

Vimy, which is 25 per cent owned by iron ore billionaire Andrew Forrest, also needs a higher uranium price, along with the receipt of final government approvals, before it commits to developing its Mulga Rocks project in WA.

It is the history of the erratic uranium price, coupled with the failure of most uranium developments to deliver reasonable profits, which makes investing in the commodity a high-risk adventure.

The reason why uranium promoters shrug off the past troubles is a belief that uranium's future is just beginning with Japan returning to nuclear power, China's building boom (23 reactors under construction and 45 more in the planning stage), and India scheduled to expand its reactor fleet.

The challenge for investors is to weigh up the promise of what might happen with the history of what has happened.