The Mining Report: It's been a rough couple of years for uranium prices. Realistically, could news of possible restarts of nuclear plants in Japan positively impact the price of uranium, even if it's only psychologically?
Thomas Drolet: The psychology of Japan restarts has been driving the spot price; perhaps it will start to move the all-important long-term price, too. The long-term price is the signal that the utilities are buying. It is paramount to core value investing.
"Ur-Energy Inc. is solidifying its book for the next six years at a cost that is roughly half of its average sale price."
Let's talk about Japan. My observation, after having been there several times post-Fukushima Daiichi, is that there is a giant tug-o-war going on. Pulling on one end of the rope is Japanese industry, which is paying a high price for fossil fuels replacement electricity, and the current government, which is definitely for bringing the nuclear plants back on-line. Tugging on the other end of the rope is a profoundly fearful public. Hanging onto the middle of the rope is Japan's new nuclear regulatory agency. It will take time for this stronger regulator to finish a series of mandated safety checks before it can authorize bringing back some of the mothballed reactors.
Kyushu Electric Power Co. Inc. (9508:TKY) plans to restart two reactors at Sendai in the middle of Q1/15. This is sending a positive signal to the whole uranium production and supply space. However, the inventory of fuel at the Japanese reactors is very high; the utilities had long-term contracts when they were shut down. And those contracts generally could not be terminated. The large, existing inventory of fuel will be gradually eaten up as reactors restart after wending their way through nuclear regulatory approvals, prefecture approvals, local town approvals and, finally, national government approval.
TMR: Will the Japanese be building new reactors, as well as bringing back the ones that were mothballed?
TD: The Japanese have announced the intent to start building a couple of new reactors, but I do not see any real progress yet on the early-stage design efforts. What I do see is that the major reactor suppliers from Japan—Mitsubishi Corp. (MSBSHY:OTCPK), Toshiba Corp. (TOSBF:OTC: 6502:TKY)—are actually doing the opposite; they are concentrating overseas. They are doing deals in the United States, in Europe, in Southeast Asia.
Two years ago in the U.S., there were 104 working reactors. Six of them were stilled for valid local or contractual reasons: i.e., the argument with a supplier of new heat exchangers for San Onofre took two units out. And there was significant displeasure in the Northeast with a couple of reactors, and one in Wisconsin. Anyway, we are down to 98 reactors in the U.S. now.
In the U.S., four new AP1000 reactors, each one delivering 1,200 megawatts, are being built by Toshiba/Westinghouse Electric Co. Toshiba is the master contractor, supervising Westinghouse and, among others, Chicago Bridge & Iron Co. N.V. (CBI:NYSE). Until these four reactors are operating successfully, roughly on schedule and roughly on budget, the U.S. is not going to be a high-growth area for nuclear power. Waiting on the sidelines, major utilities like Duke Energy Corp. (DUK:NYSE), Exelon Corp. (EXC:NYSE) and Entergy Corp. (ETR:NYSE) are in the very early stages of applying for new reactor builds.
TMR: Given this environment, how do spot prices relate to long-term contracts in the uranium market?
TD: Spot is simply uranium put up by suppliers for short-term cash needs. The price is almost certain to be taken up further by a smart utility, or by the enrichers, the firms that enrich the uranium that goes into the fuel fabrication process and eventually burns in the reactors. Current activity in the spot market is a signal that a corner is turning. Uranium fell to ~$30/pound ($30/lb) on the spot market in the early fall. That is below the average cost of worldwide production by a good US$10. The price obviously cannot stay there because people have to make money to stay in business.
Although an important corner has turned, I am not saying that there is massive upside for all uranium companies as a result of what is happening on the spot side. There will be a slow and steady climb driven by major utilities coming in on buying cycles that meet their internal needs.
TMR: When the long-term prices shoot up, who will benefit?
TD: The uptick will mostly benefit the big producers and the current suppliers, such as Cameco Corp. (CCO:TSX; CCJ:NYSE) and Denison Mines Corp. (DML:TSX; DNN:NYSE.MKT). Juniors such as Ur-Energy Inc. (URE:TSX; URG:NYSE.MKT) may catch a bit of that wave. Interestingly, Ur-Energy has ramped up production to about 600,000 pounds (600,000 lbs) this year at its Lost Creek operation in Wyoming. The company is very transparent. According to its CEO, the firm's production cash costs are averaging $22–23/lb. Ur-Energy is selling into the long-term market. It has 5 million pounds under contract through 2021 at an average price of $50/lb. Targeting the long-term users is a smart move. And, importantly, Ur-Energy's capital and production costs are relatively low, because it does solution mining.
TMR: How does solution mining create cost efficiencies?
TD: In the Athabasca Basin, by counter-example, miners typically drill vertical mine shafts into a very hard, but high-yielding uranium-rich rock. However, the capital cost of hard rock mining is high.
The solution miners, on the other hand, drill both vertical and horizontal holes to introduce solutions. A solution is injected into the bore hole and, after it sits for a while, it is pumped out and U3O8 yellowcake is then precipitated out.
TMR: What are the components of the solution?
TD: It depends on the chemistry of the rock. It can be mildly acidic; it can be mildly basic. The solutions are not toxic by any industry standards.
TMR: Are Ur-Energy's long-term contracts economic? Is $50/lb going to hold up?
TD: Yes, the $50/lb is tied up until 2021. With an average production cost base of approximately $20–25/lb, that is very economic. Ur-Energy is solidifying its book for the next six years at a cost that is roughly half of its average sale price. In short, solution mining is quick off the mark, it is relatively low capital cost. Smart juniors, like Ur-Energy, are signing long-term contracts.
TMR: Is Ur-Energy still exploring the Lost Creek region?
TD: It has various properties around the Lost Creek. But, I understand the managers want to create a steady cash flow before investing capital in the other areas. When those other areas are developed, there will be an economy of scale already in place, perhaps with a precipitating mill and network of pipelines serving multiple extraction sites.
TMR: Let's look at the Athabasca juniors. Who are you following there?
TD: I am on the Advisory Committee with Lakeland Resources Inc. (LK:TSX.V) and Skyharbour Resources Ltd. (SYH:TSX.V). Lakeland and Skyharbour have agglomerated properties around successful mid-cap developers like Fission Uranium Corp. (FCU:TSX), and seniors like Denison and Cameco. In my opinion they both have a high probability of finding high-yielding uranium-bearing rock.
The problem that all hard rock Athabasca juniors share is the time and money it takes to develop a producing mine. Each junior has to survive this very difficult market and still raise the required exploration and production funds. The uranium spot and long-term price markets will continue to slowly improve. This will enable the juniors access to capital markets. Right now, most juniors in the Athabasca are supporting themselves by issuing equity, or associating with capital groups or getting gobbled by the big guys, the Camecos, the Denisons, the AREVA SAs (AREVA:EPA) of this world. That has been the way of the oil and gas junior business, and that will ultimately be the way in the uranium junior business, as well, in my opinion.
TMR: How is the stock market treating the Athabasca juniors?
TD: The stock prices are down about 30% from the peak of a year ago. Investors exited uranium mining en masse because Japan did not appear to be coming back. And, not well reported, China's reactor program temporarily slowed down after Fukushima Daiichi as well. Now, new Chinese reactor developments are back with a vengeance. Both the spot and the long-term prices will benefit from China's immediate and near-term nuclear fuel needs.
In the Middle East, four reactors are being built by South Koreans for the United Arab Emirates. These will need a reliable fuel stream. The Russians just signed up for building two reactors, and maybe four more, in Iran. The Russians have a particularly unique and clever marketing business strategy—compared to majors like AREVAs and Westinghouse. They are doing turnkey operations for their customers. The Russians will design the reactor, build it, and either run it directly or train the client to operate it. They will supply the fuel and, also, take it back for disposal.
TMR: Will Russia have to go into the global market for uranium?
TD: Russia will supply the uranium, enrich it and fabricate it within the boundaries of Russia. Also using the Kazakhstani reserves, Russia will supply yellowcake for the reactors that it builds, be they in Pakistan, Iran, Turkey, Indonesia or Bangladesh. Russia is the most aggressive nuclear reactor exporting nation on the face of the earth at the moment.
TMR: What kind of creative financing are the uranium juniors using to keep moving ahead in this environment?
TD: Lakeland is backed by a capital group called Zimtu Capital Corp. (ZC:TSX.V). Zimtu holds preferential positions in a dozen or so companies. It helps these firms to access other capital sources. Until the share prices rebound somewhat for the juniors, there is not a lot that the Athabasca juniors can do other than to make sound investments in new properties, continue drilling their well positioned properties and potentially associate with capital suppliers that are willing to take a preferential position. Otherwise, a junior will fall into the spiral of the dilution mode. Never good for shareholders.
TMR: Leaving uranium, what are the driving forces affecting the price of oil and gas today?
TD: There are several forces driving these prices. Nation states such as Venezuela, Saudi Arabia and Iran are taking over the place of the international integrateds. Nation states with large oil reserves are attending to their own needs and gradually blowing off the integrateds.
Second, the revolutionary advance of fracking and horizontal drilling has taken away a lot of the uncertainty about future supply. There is indeed a large supply of tight oils and shale gas, with the new technology to extract it. However, the price is not going to stay down forever. There is a new and important phenomenon emerging.
We will soon start to run out of shallow, easy-to-access, reasonably permeable, low decline rate tight oil and shale gas zones. President Obama has said that fracking and horizontal drilling will provide a transitional fuel source for the next 50 years. I personally doubt that that super supply will last that long, simply because the decline rates are huge and have a long, low tail. Frackers have been able to get their money back in one to two years, but as production drops, I worry about the high, never ending, poke-a-new-hole drilling cost syndrome.
TMR: How does the strong dollar affect junior miners in Canada?
TD: The cost of operating a drill rig is paid in Canadian dollars, which is substantially below the U.S. dollar. That means that the capital and operating costs for oil and gas companies is denominated in a currency that is 15% less than the currency tied to the sale of the product!
TMR: What shale oil and gas firms are poised to do well as the energy environment continues to evolve, as you say?
TD: The big guys: the Chevrons (CVX:NYSE), the Exxon Mobils (XOM:NYSE), the big integrateds in North America stand to last the longest in this necessary constant high cost drilling environment.
TMR: Are oil and gas juniors doomed?
TD: Most of the juniors will survive. Eventually, the good ones will be bought up because that is the way of the world. The little ones get bought up by the big guys.
TMR: Is now a good time to invest in major electrical utilities?
TD: Yes. A lot of them have been beaten down, because we are still emerging from a difficult period in the U.S. But as the U.S. economy picks up steam, the big, well-managed utilities—the Dukes, the Exelons, the Entergys, the Pacific Gas and Electrics (PCG:NSYE)—are good places to invest for the long term.
TMR: Thanks for your insights, Thomas.
TD: You are welcome, Peter.
Thomas Drolet is the principal of Drolet & Associates Energy Services Inc. He has had a four-decade career in many phases of energy—nuclear, coal, natural gas, geothermal and distributed generation, with expertise in commercial aspects, research and development, engineering, operations and consulting. He earned a bachelor's degree in chemical engineering from Royal Military College of Canada, a master's of science degree in nuclear technology/chemical engineering and a DIC from Imperial College, University of London, England. He spent 26 years with North America's largest nuclear utility, Ontario Hydro, in various nuclear engineering, research and operations functions.
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1) Peter Byrne 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) Thomas Drolet: 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 (options) with the following companies mentioned in this interview: Lakeland Resources Inc. and Skyharbour Resources Ltd. 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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