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When is the Uranium Price Going Up? And Other Facts About the Physical Uranium Market You Didn’t Know…

James Winston

October 21st, 2008

Retail investors made hundreds of millions of dollars on junior uranium stocks from 2005 up until this past summer. Many of our readers have taken profits and are now holding shares for long term growth. But with the recent market meltdown, what does the future hold? Is the uranium bull market finished or will these beaten down stocks come back? I recently interviewed people in the physical uranium market to find out what is happening behind the scenes – and try to get a handle on where the uranium price might be going over the next year or two. What I found out is that the uranium market is very complex. The uranium price is not set from what I call a free market. There are few buyers and even fewer sellers. Both sides will tell you a much different story of what’s happening in the marketplace. Each side has their story and they try to sell you on their position. As a result, most analysts, newsletter gurus, and even uranium exploration companies are not clear on the market dynamics. Many mining analysts see uranium as one of the best metals going forward, but there is little consensus as to where the spot price will be or what the growth potential might be for the uranium stocks. I therefore interviewed a number of insiders to conduct my own research. The industry players are very guarded, and only one group of our three industry roundtable participants agreed to have their names used – Gene Clark and Treva Klingbiel of Tradetech, one of the two groups who publish the uranium price. Our second interviewee is a senior executive with a near term uranium producer – we’ll him Mr. Producer - and our third person is a uranium price expert in the U.S. – we’ll call him Mr. Expert. No utilities would speak to us, even not-for-attribution. Some of the information we uncovered startled me. Did you know that western utilities generally only have one year’s inventory? European utilities have two years, Asians generally want three. But nobody has five years, despite what many uranium promoters will tell you. I was stunned to hear how the producers and consumers of uranium have completely different interpretations of supply/demand data. Could India affect a big increase in demand in uranium? Will the US government release a swath of uranium on March 29, as they are then allowed to?

Our panel weighs in:

Q: What is the psychology of uranium buyers right now? How does that compare to a year ago? What are the two most important factors in buyers’ psychology?

Mr. Expert: Generally, I would say that the buyers have reached a point that they can live with a market that ranges between $60 and $85 per lb, and they are looking to diversify their suppliers to prevent the perceived crisis with the 2006 Cigar Lake flooding. A year ago, the fuel buyers were shocked by the price run up, and they were basically in a panic mode with the prospects of $200 numbers, and to add insult to injury, some of the uranium they had to purchase ended up being non-deliveries from Cigar Lake. That created quite a bit of resentment because the buyers were not going to meet their budget goals. What I hear from the buyers is that they are looking to shave the price as much as possible, figuring someone will take it, and that they need reliable suppliers. I believe the first factor is a stronger priority than the latter simply because most buyers negotiate longer term deals with a short term outlook.

Mr. Producer: I basically agree. Buyers were in shock from 2004 to 2007. Now they do appear to accept the market where it is. They are working hard to keep it in that price range. Two important factors 1) the buyers market ended in 2004. It took until last year for them to become proactive in trying to control the price at the next price level of 60+/- instead of $10-12, that was a very difficult adjustment for them. The psychology of the uranium buyers right now, is they think they’ve won the battle compared to a year ago. By the way, I can also speak to producer psychology. We have talked to some utilities. We were offered a contract for $80 a pound last year. And we said we won’t do it for that.

Gene Clark: In just my experience in dealing with the utilities is that they had shock and then there was anger that the price was too high. Now they’ve kind of settled in to. "... Well this is a new era." The price isn’t going to be $15 a pound anymore or even $20, you know, so I think they’re resolved to there needing to be a new price level to get new production in line as they see the value of having a larger number of suppliers, especially given the number of disruptions in the past couple of years. And we see the utilities really returning to the Spot Market now that we’ve hit $60 (per pound) and have been in the $50’s. So right there you have hard evidence they’re willing to put their money into this market at these price levels. If they had a problem with these prices they would still hold away and not buy because most of them still have inventories. These are not have-to buyers; they’re discretionary buyers. They’re willing to pay what they would call a reasonable, or a rational price. They didn’t consider something in the $80, $90, $100 or above price level to be something they considered reasonable or rational.

Q: Gene, are utilities increasing their inventories now – to what levels?

Gene Clark: I think the average inventory level for a utility in the US was like a one-year’s forward requirements. And the European Union was more like one to two years and Asia was more like two to three years. I think most utilities now are looking at raising their desired level of inventory maybe on the order of six months additional because of the experiences on the supply side of supply disruptions and under production.

Q: The market generally assumes that speculators drove up the spot market price last year, and are driving down the spot market price this year. How true is that really? How big a role are speculators playing now?

Mr. Expert: I believe that there is some truth to that statement, but I believe that it may be more perception than reality. The speculators were able to shake the market up because they would bid up the price on relatively small quantities, but the real buyers were the utilities that were forced to compete with the speculators for price points. The market declined for two reasons, the utility buyers stayed out of the market intentionally to force a perceived oversupply and the auction of surplus DOE (US gov’t Dept. of Energy – ed.) material fueled the perception that there was a significant amount of material from secondary sources from a seller (DOE) who was forced to take whatever price they could get. The speculators began liquidating their material later in the year as a response to the need for liquidity in addition to their normal behavior.

Gene Clark: I think it’s pretty true. It’s not the only factor that is driving down the price right now; you know, I would caution anybody to point to just speculators or investors as the sellers at these levels. We see all kinds of sellers whether it’s producers, whether it’s traditional traders, and also the investors and speculators selling at these levels. But I would agree that it is the investors and speculators that have sort of started it and now everybody’s sort of being pulled along.

Q: My research tells me that uranium producers and consumers are basing their uranium price forecasts on different assumptions – how true is that, in your opinion?

Mr. Expert: In reality, the fuel buyers are working from one supply/demand projection and the suppliers are working from another. The predictive curves are determined by the data that goes into them. In the low price scenario, it anticipates that there will not be a significant growth in demand due to limited build outs on new plants and it assumes that all of the projected production will actually occur. That is the scenario the fuel buyers use. Some suppliers will use the high price case, but we use the mid case scenario that is a composite. We know that demand is going to increase because new plants are being built and existing ones are getting extended lives. We also know that lately there have been several production shortfalls, and those are going to continue. With the loss of equity financing, some of the planned production may not even happen.

Mr. Producer: I just don’t think the buyers are aware really of how precarious the supply side is. The worldwide average production cost is on the order of $40/pound. A term price of $80/ pound is needed to support that cost level. With inflation that price is going up. Fuel, equipment, permitting, etc for the new operations is expensive and tough. The incremental cost of that last pound to feed the last utility in the market is going to be much higher than $100/lb.

Q: I keep hearing that physical uranium is a very small portion in the cost structure of a nuclear facility, so why do utilities care so much about the price?

Treva Klingbiel: I can speak to this because I was a fuel buyer at a utility and I can tell you what happens. And what happens is that these guys are expected each quarter to produce a budget variance report which means they’re looking at what’s the percentage change between what you budgeted and what you actually spent. So it doesn’t matter if we’re spending $1000 versus $2000 or $10 million versus $20 million. It’s the percentages they’re looking at and saying how could you have missed it by this great a margin? And for these guys, their jobs are on the line if they can’t predict, to a very close percentage, what their costs are going to be. And that feeds in to the whole financial system of the utility because they’re looking at predictable costs across the board whether it’s the fuel cost, whether it’s construction costs, whether it’s other O & M (operating and maintenance) costs associated with the utility.

Q: What do you see as potential inflection points for the uranium price – either up or down – over the next few years?

Mr. Producer: India. If everyone agrees that we can sell them uranium they are overnight going to suck up the excess inventory - because they want to get their nuclear plants that they already own and have built running at capacity. So that’ll pretty much consume the inventories that are available right now. From that point forward I think they’ll probably put in inventory at a minimum five more years additional supply so this doesn’t happen to them again. So that’s going to suck up probably close to 10 million pounds total from the market place. That’s when the uranium price will turn around. I think it’s a matter of months that all those agreements are going to fall into place for India. And again utilities – I think some will be caught short and the other thing is is no one is bringing on uranium like the WENA or NEI has forecast.

Gene Clark: I think the impact (of India) is going to be less than people think. I know that India right now is not running its domestic nuclear plants at full capacity because of lack of uranium. The requirements, any requirements for the fleet they have right now is about a thousand metric tons a year which is 2.6 million pounds. They’re able to run those at only about half capacity. So they’re going to need an extra 1.3 million pounds per year to add. That will be the demand to the market due to the Indians coming in. That’s not a whole lot. But I think some of the plants being built - like a Russian plant for example - and any new orders in the West are really going to be (the orders we see go through the market-ed) - not India directly in the market. But it will be like first cores (orders) and a couple of reloads probably will be provided by the Western reactor manufacturers.

Q: So uranium power plant builders are supplying uranium as part of the deal?

Gene Clark: As part of the deal. And that’s what’s happening in China for example. We keep trying to figure out why aren’t the Chinese out there buying a whole bunch of uranium? Well they’re looking very, very long-term and again it’s because of the first cores and I think the Westinghouse plants are supplying first cores and maybe five reloads. The Russian plants are, I don’t know, supplying more than five reloads even…

Q: What does that mean, you’re using lingo that I’m not quite familiar with.

TREVA: Well it means that the manufacturer who’s providing the reactor as part of the package is throwing in the fuel. A reload generally is about 18 months (worth of uranium-ed). So if we say five reloads, five times 18 months. So we’re talking many years into the future they’ve got the fuel provided for that particular reactor from the manufacturer. And we suspect, although we don’t really have any evidence to support this yet, that the same thing is happening in India whether it’s Areva; we know Areva has been talking to the Indians for many years about providing the reactors; Westinghouse, the Russians, they’re all in there talking to them in terms of providing the reactor. And we suspect that the same process is going on there that occurred with China in which the fuel will be thrown into the package. So India doesn’t have to come into the market. I mean the fact that they can buy it now gives them the freedom to go ahead and buy it as a package from the manufacturer but it doesn’t necessarily mean we’ll see them issue RFQ’s (Request for Qualifications)and come into the market in an open way. They may; we don’t know yet.

Q: Anything else in the future?

TREVA: One thing is if (Cameco) were to come out and say, you know, it’s over at Cigar Lake or whatever it might be. That certainly could be an inflexion point. But we don’t anticipate that they’ll do that. I guess the other inflexion point, is whether BHP Billiton would make an announcement about (the expansion of the huge) Olympic Dam (mine in Australia), whether they will expand or they won’t expand. Again, we suspect they won’t ever really make an official announcement.

Mr. Producer: The (US) government has always been a huge factor in the uranium supply chain. And they still could be in the future. If they started dismantling US nuclear weapons that would bring another huge supply into the marketplace. But are they going to dismantle nuclear weapons that literally cost millions of dollars per pound to make the fuel, are they going to dismantle that and sell it for $20 a pound when it cost them a million dollars to make it? I don’t know. The DOE is also sitting with huge inventories of partially depleted uranium. I think it’s maybe 160 million pounds equivalent. These numbers are all out there in various publications.

Gene Clark: Most of their inventory is actually embargoed from release into the market by legislation, USEC Privatization Act, that keeps some of the stuff off of the market until about March 2009. Going forward they have now a policy that’s been approved for the Department in which they would sell, they would target approximately 10% of the US market, so 5 to 6 million pounds a year of their excess inventory that they would sell. They haven’t revealed when or how they would sell it. That’s kind of the level at which I think most people have already kind of built in to their expectations.

Q: Gentlemen, Treva, that is a lot of information for everyone to digest. Thank you for giving us a window into the dark room of the physical uranium market.

Summary In today’s turbulent market, we as investors need to focus on future investment opportunities which are now selling at huge discounts. In reviewing the uranium market, it seems clear that there is little downside risk to the price of uranium short term. All other economic factors staying equal, I don’t see this changing as the cost of mining is too high to warrant a price decrease below $50. Going forward, if anything, it seems to me that there is greater potential for higher prices. New plants are being built which will increase demand further. The supply side is already tight with production shortfalls expected to continue. And due to the shrinking credit market, new mine production could be delayed indefinitely. The big wildcards which could change prices significantly either up or down over the next one to four years is the expected new production coming from Cigar Lake and Olympic Dam. A number of industry experts outside of the aforementioned panel are quietly saying the Cigar Lake flooding problem may never be resolved. As for the Olympic Dam project, the sheer size and cost of the project is so big, it may not get completed either. Never mind the current credit crunch problem. Any price projection that shows the uranium price coming off in three years time is because of the Olympic Dam and Cigar Lake projects. The buyers of uranium see these mines as saving their world. Rumors are that Olympic Dam will cost $28 billion to build. They’ll have to move a million tons of rock per day just to build a super pit. The mammoth Highland Valley mine in B.C., Canada moves 265,000 tons a day and its one of the biggest mines in the world. Just to give you an idea of the scope of the Olympic Dam project, just to have enough heavy equipment in place necessary to move a million tons per day would require an entire year’s worth of production from Caterpillar. I don’t know if these numbers are fact or fiction but these are the type of numbers that are being bandied about. So the likelihood of these new projects coming on line is not guaranteed. A lot of today’s new production is coming from older mines which have been re-activated like those around the White Mesa mill in Utah owned by Denison Mines. New discoveries by junior uranium exploration companies over the past 20 years have been a rarity. Only two notable significant new discoveries have been made, both of which we’ve been following in Winston’s Growth Stock Report since they started trading. One of those was by Hathor Exploration (HAT, TSXV) who have just received their first institutional research report by analyst Patrick Donnelly of Salman Partners. Donnelly reports that the Roughrider Zone at their Midwest NorthEast property is a "World class discovery!" Based on his discussions with management, he has estimated that the deposit has approximately 828,000 tonnes at an average grade of 2.4% U3O8, containing approximately 43.8 million pounds which could get much bigger as drilling continues. Donnelly has suggested a 12 month price target of $6.40 and expects Hathor to become a takeover target. "Given the Midwest NorthEast’s proximity to the McClean Lake mill, we expect that AREVA, Cameco or Denison Mines could attempt to take over Hathor." A second exploration company that has created a large and growing resource in Canada – 20 million pounds - is Uracan Resources (URC, TSXV). Managed by the team from the former Bema Gold and Endeavour Financial, their association with Endeavour means they will always have access to capital, even in this market. Their deposit is right at surface in Quebec with power and highway on the property, giving it a huge leg up on other development stage assets. Expect a new and larger resource in the next couple months. So in conclusion, I’m still very bullish on the uranium market. I believe the greatest capital gains will come from the junior explorers who are proving up resources, namely Hathor Exploration and Uracan Resources both of which are trading at deep discounts from their market caps this past summer.

James Winston

October 21st, 2008

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