well worth the read

Things Can Get A Lot Hotter For Uranium, Still


Rudi Filapek-Vandyck, editor of FNArena.com
http://www.fnarena.com




Everyone's entitled to his own opinion, but when you are a commodities analyst at Macquarie bank your opinion tends to attract a little bit more attention than others'. This week saw quite a few eyebrows raised throughout Australia as the resources team at Macquarie updated its thoughts on uranium.

In particular the forecast that spot uranium will gradually fall towards the broker's long term price assumption of US$35/lb is in sharp contrast with what market experts elsewhere have been putting through their models for the industry. Macquarie has penciled in an average spot price of US$46/lb by 2011.

This thus raises the question: How much is true of the anticipated surge in primary production as a result of unprecedented high U3O8 prices flagged by analysts Lee Bowers and Jim Copland in this week's research report?

We didn't even have to resort back to all the reports we amassed over the past few months on the industry to have our view confirmed that Macquarie analysts are a lone wolf in today's uranium environment (together with Citigroup's Alan Heap).

Resources specialists at GSJB Were updated their research on the industry this week as well confirming the trend that uranium is finally attracting the attention of the larger players in the financial sector. The GSJB Were report immediately shows why it has taken this long: long term contracts keep any noticeable earnings impact for industry heavyweights BHP Billiton (BHP) and Rio Tinto (RIO) limited until at least 2010.

What's more, GSJBW analysts Malcolm Southwood, Paul Gray and Marc Bonter agree with their colleagues at Macquarie that current record high prices for uranium will trigger increased efforts to ramp up projects across the globe. Thus the assumption that primary supply should rise over the next few years is not such a strange one to make.

Where GSJBW's view differs from Macquarie's is that the broker anticipates demand will accelerate as well while secondary supply will decline. The combination of these three key developments should still make for a very tight market in the years ahead.

Like other experts, GSJBW sees a big opportunity for Kazakhstan with the country accounting for 51% of projected additional production between now and 2015. However, it has to be noted that while Kazakhstan has undoubtedly a massive amount of uranium underneath its surface, the country's role in the industry is also seriously hampered by a lack of modern infrastructure and a highly corrupt political and business climate. You won't hear or read much about this in general, but that's because everyone who wants to do business over there knows that any proof of criticism cannot be bought off and is likely to backfire in a big way.

In addition, Kazakhstan is not immune to the lack of available experienced staff that is haunting the mining industry in general. And to make things even worse the Kazakh government currently requires in situ mines to have recovery rates of at least 80%. Existing mines of Cameco and Kazatomprom are struggling to meet this requirement, even after two years of test production.

This is not to say the Kazakh elite doesn't acknowledge the opportunity that lies on the table. It's just that any predictions should be viewed with a rather large risk factor attached to them.

The team at GSJBW seems to acknowledge all these risks. The broker has a long term price forecast of US$45/lb but the figure doesn't figure anywhere in the outlook for the next few years. Average U3O8 spot price forecast for calendar 2007 is US$90/lb, for next year it is US$95/lb, after which a gradual decline is assumed to US$80/lb. (2011 sees a rise to US$85/lb, however).

This is the broker's base case scenario.

Assuming things can get tighter than expected, and in case they will, the price forecasts for the next few years look a tad different: US$110/lb for 2007, US$130/lb for 2008 and US$100/lb for the following years. Mind you: these figures are estimated price averages, not peak forecasts.

What the above figures suggest is that things can still get a lot crazier in the uranium sector, a fact that is acknowledged by the Macquarie team as well. The broker notes nuclear reactors worldwide are likely to continue to struggle to secure sufficient primary supply as secondary supplies are in decline.

Maquarie forecasts spot U3O8 will peak at US$100/lb in mid-2007. Its average price forecast for the full year is US$90/lb.

GSJBW makes two interesting assumptions with regards to secondary supply. The analysts anticipate Russia will not renew the HEU agreement with the US and that Techsnabexport (Tenex) — representative of the Russian Federal Agency for Atomic Energy — might stop exporting uranium from Russia in 2008.

With regards to Western inventories which were built up pre-1990, the analysts believe the majority of this material has either been delivered, or is committed.

Resources analysts at Merrill Lynch updated their price forecasts this week as well. As the balance of power has shifted towards uranium producers which as a result seem to be able to negotiate new contracts at bottom prices of US$50/lb (and no ceiling), the analysts question the logic of keeping long term price forecasts beneath this level. Merrill Lynch raised its long term price forecast to US$50/lb this week.

The broker's average price forecast for the current calendar year was lifted to US$85/lb from US$75/lb previously. This is expected to drop to US$80/lb in calendar 2008, and further to US$60/lb the year after.

If you think those numbers seem a bit benign in the light of GSJBW's projections, we can confirm Merrill Lynch's price projections even seem overly conservative when matched with the fundamental comments made by its own analysts.

Consider, for instance, the following quote: "The outlook for [uranium] demand has never been stronger, with government support (around the globe) increasing by the day. Uranium appears in definite under-supply for the next 10 years. Risks to this view are Cigar Lake coming on line sooner than 2010 when we now expect it, and a quick turn-around into production of extra uranium from Australia if the ALP lifts its restrictive 3 mines policy."

Merrill Lynch analysts believe the market is currently under-estimating Russia's long term nuclear expansion plans. The report notes current government plans foresee an increase of the country's nuclear power capacity by 102% by 2020. (Whether this will be achieved is another issue, of course).

The analysts also believe Cameco's troubled Cigar Lake project won't be up and running until 3-4 years from now. They subtly hint at the fact that some experts believe the mine will never reach production.

The widely expected change in uranium policy by the major opposition the Australian Labour Party (ALP) at its April meeting could result in a quick end to Australia's current three mines policy, the broker believes. This could accelerate extra production coming on line, but Merrill Lynch remains sceptical whether this will make any noticeable changes to the market before 2010.

Of equal importance is that the US Department of Energy (DOE) is currently considering its future sales program of secondary uranium and related products. According to current plans the DOE could increase supply to 5 million pounds U3O8 equivalent per year for ten years but Merrill Lynch also notes the DOE has made it known it doesn't want to interrupt the normal market dynamics as well as that the Department wants to support the nuclear renaissance.


- Rudi Filapek-Vandyck


Cheers


Xan