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$100 URANIUM BEFORE 2010
by Elliott H.
Gue
Editor, The Energy
Letter
October 30, 2006
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In the August
4 issue of The Energy Letter, I outlined my bullish case for
uranium prices. Simply put, the supply/demand balance for uranium is
tighter than for just about any other major commodity; supply of natural
uranium from mines just isn't enough to cover even current demand. And
with a global building boom for nuclear power plants underway, demand
for uranium is only going to rise. Consider that, in 2005, the world consumed roughly 175 million pounds of uranium while total mine production was just 110 million pounds. That 65 million pound deficit was covered by a combination of reprocessed nuclear warheads and inventories of uranium owned by utilities and the government. But inventories are now running low, and the deal with Russia to reprocess nuclear warheads into plant fuel is set to end soon. To make matters worse, two weeks ago the outlook for uranium supplies got even tighter. The world's largest uranium producer, Canadian mining giant Cameco, announced a problem with its Cigar Lake mine: A rock fall at the mine resulted in the rapid inflow of water. The reaction to this news highlights the fragility of uranium supply and the potential for a uranium supply squeeze during the next three years. The first step in producing uranium fuel is mining natural uranium. There are a few ways of doing this. Two of the more common methods are surface mining and in-situ leach production. The former is akin to strip-mining coal or any other mineral; the latter involves pumping acid down a hole and dissolving the uranium. Acid and liquid with dissolved uranium is known as pregnant liquid; this can then be pumped back to the surface and the natural uranium separated. As with any mining or drilling operation, producing uranium isn’t an exact science. Even after a particular mine has been well studied and the geology is well known, a host of events can delay production or reduce the rate at which uranium can be mined. Rock falls, equipment shortages and malfunctions, and even the lack of skilled available labor can all conspire to delay projects. Delays are particularly common for more technically complex underground operations. In the oil and gas market, the delay of a single project can certainly have a short-term effect on prices. But those moves tend to be short-lived; there are so many wells producing oil and gas worldwide, the delay of a single project or operation isn't likely to have a huge impact on global supply. That's not the case with uranium. A lot of hopes were riding on Cameco's Cigar Lake project. It's one of the largest and richest uranium mines anywhere in the world. In fact, this single mine is supposed to produce 18 million pounds of uranium per year at full production, equivalent to more than 10 percent of global uranium demand and more than 16 percent of 2005 global uranium production. Utilities had already contracted with Cameco to source uranium from this mine once it started producing. But Cameco announced that the rock slide has caused serious damage to this mine. Cameco workers tried to close two bulkhead doors to isolate the inflow, but one of those doors didn’t seal properly. The water, under tremendous geological pressure at a depth of nearly 500 meters (1,500 feet), rushed in at a rate of 1,500 cubic meters per hour. This was way too fast to be controlled by electric pumps installed in the shaft. In the end, Cameco was forced to close other bulkhead doors and allow a large section of the mine shaft to flood entirely. Cameco now believes it’s stemmed the inflow of water, and the current bulkheads are designed to handle the pressure effectively. But the damage is done. Given the flood, Cameco's management estimates the Cigar Lake project will be delayed by at least one year. Scheduled to start producing uranium in early 2008, it now looks like early to mid-2009 for this mine. And Cameco was careful to state that this is just a preliminary estimate; the delays could ultimately be far longer. This is a near-term negative for Cameco. The revenues it would’ve earned selling this uranium will now be delayed by at least one year. There has been some speculation that Cameco would experience major financial woes as it was forced to source uranium elsewhere to cover its supply contracts. In my view there's absolutely no evidence of that; Cameco is the most-experienced company in the uranium business and knows the potential for mining delays. Cameco made sure the contracts based on Cigar Lake production were written to allow Cameco to delay delivery in the event of just such an accident. In addition, Cameco has a large amount of uranium in inventory--enough to give it a cushion against further delays. Management made sure to highlight its contract coverage during the conference call immediately following the accident. But the far more interesting implication of the accident is the big supply squeeze now developing in the uranium market. By around 2008, some utilities will be running low on uranium inventories to fuel their existing reactors. Some of these companies were undoubtedly factoring in Cigar Lake production in their supply plans. With that production now delayed and uncertain, they'll need to look for alternative sources. There aren’t many other sources of uranium out there to fill the void. The spot market for uranium--the market for immediate delivery--is extraordinarily illiquid. Because there aren't many buyers and sellers, it would be next to impossible for a company to enter this market and make a huge purchase; such a move would undoubtedly be noticed and lead to a huge spot market price spike. There are a handful of mining companies--literally about four companies globally--that are scheduled to begin significant uranium production in the next two to three years. With Cameco's project at Cigar Lake delayed, the value of the production from these near producers just shot up immensely. There are few situations more profitable for a mining firm than the ability to bring significant new production online into a supply-constrained market. In addition, there are two publicly traded firms--one in London and one in Canada--that buy and hold physical stocks of uranium. They are in a closed-end fund or exchange traded fund that owns uranium. The price of these securities tends to rise and fall with the price of uranium itself. Both the near producers and the uranium holding firms shot higher on Cameco's announcement--most on the order of 15 to 25 percent last week. But that's only the beginning. The actual cost of uranium has very little effect on the cost of nuclear power. In fact, a doubling in uranium prices would likely only lead to a 7 to 9 percent rise in the cost of nuclear power. In contrast, if natural gas prices double, natural gas-fired power costs about 80 percent more. The result is that nuclear power producers aren't terribly price-sensitive when it comes to the cost of uranium. They're willing and able to pay up for supply; the prime consideration is just securing supply to keep the lights on. I can see a bidding war developing as utilities scramble to secure supply from the few companies that can actually bring supply to market. Bottom line: Uranium now costs around $55 to $56 per pound, and I expect to see a quote of more than $100 before 2010. At $100, some of the junior producers with significant production coming online in the next two to three years will be in the catbird's seat. Elliott H. Gue is editor of The Energy Letter.
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