Who Will Fill the 24 Million Pound Uranium Supply Gap?: David Talbot

Source: Zig Lambo of The Energy Report  (8/14/12)

http://www.theenergyreport.com/pub/na/14121

David Talbot of Dundee Securities sees the tides rising in uranium markets, but not every stock price will recover in-step. Talbot's strategy is to focus on a good story, and he has identified uranium exploration, development and production companies with compelling growth profiles. In this exclusive interview with The Energy Report, Talbot explains why investors should build positions while the spot price is still sluggish.

The Energy Report: In your last interview, "The Uranium Industry Is Alive and Well," Germany and Japan looked determined to shift away from nuclear power. Now, it looks like Germany is having second thoughts on its plans to shut down all nuclear plants by 2022, and Japan has restarted one reactor, with more to come. What's your general industry view at this time?

David Talbot: We are still bullish on the uranium sector because the nuclear power industry is moving forward and demand is behaving somewhat predictably. Supply will make all the difference in the world. The U.S./Russia Megatons to Megawatts program will go off-line in 2013, which will remove 24 million pounds (Mlb) of secondary supply from the equation. Meanwhile, there are five more reactors in the planning or construction phases globally than there were before the disaster at Fukushima occurred. There are 430 reactors currently in operation worldwide, and 160 reactors are being planned now. The trend is clear: There is still growth in nuclear power.

On the supply side, the world uses 176.7 Mlb of uranium each year, according to the World Nuclear Association. The reactors under construction alone will account for a 13% increase in demand, approaching 200 Mlb of uranium required annually. This does not factor in any reactors in the planning stages. Mining companies are not matching that in the short to mid-term-they need higher uranium prices to make larger-scale and typically low-grade projects economic, and miners are optimistic that will happen. Uranium exploration expenses rose to about $2 billion worldwide last year.

As for Germany, its demand accounts for only 9 Mlb a year, or about 3% of world demand by 2020. I believe its government did overreact, and it is apparently having second thoughts, based on economic realities. We don't think Germany's opinion on nuclear power has changed much. But the country is struggling with rising electricity prices and facing pressure from industry. Finally, China matters. Its 15 reactors now produce just 2% of its electricity, and there are 26 reactors under construction and 51 more planned. Last year, China produced only 10% of the electricity that the U.S. reactors produce. It already uses 17 Mlb per year, and that figure is climbing quickly and should be in line with U.S. figures in the next seven years. Chinese demand is a major force driving the industry. While we believe that renewables should be a growing part of the energy mix, they are intermittent generation sources and can't necessarily handle a large proportion of baseload demand. Many alternative energy sources are still in their infancy and expensive.

TER: So, despite the negative thoughts about nuclear power, it really is the only viable alternative to coal at this point, other than natural gas.

DT: I think so. We are seeing a lot more natural gas use these days, primarily in Japan, which is spending about $100 million (M) a day on energy imports. If Japan wants to maintain its way of life, it really must turn the reactors back on or risk losing jobs. A couple of reactors have started up and two more restarts are under discussion. I think this is going to help boost sentiment in the sector and ultimately increase uranium demand, which should improve spot prices from the current U.S. $49.50/lb level.

TER: What are your expectations for short-term uranium prices? Even major companies like BHP Billiton Ltd. (BHP:NYSE; BHPLF:OTCPK) and Cameco Corp. (CCO:TSX; CCJ:NYSE) are having trouble justifying their respective Olympic Dam and Kintyre projects.

DT: The supply/demand balance in the mid-to-near-term may impact pricing. BHP announced a decision to delay expansion at Olympic Dam, by at least a couple of years. The initial expected expansions would have brought production up to about 20 Mlb from about 8.8 Mlb currently. Recently, Cameco warned that rising costs and mediocre uranium prices have made its Kintyre Project in Australia uneconomic. Cameco is still pushing ahead but needs around $67/lb to break even by the planned production start in 2015. That's another 6 Mlb of uranium supply up in the air. Cameco needs to make some acquisitions to reach its Double U strategy production goal of 40 Mlb by 2018, which would partially replace its lost Megatons to Megawatts supply.

Earlier this year, Paladin Energy Ltd. (PDN:TSX; PDN:ASX) postponed its stage-four expansion of Langer Heinrich until prices rise. That expansion would nearly double mine production from 5.2 Mlb to about 10 Mlb annually. These three projects alone total about 23 Mlb, which is 64% more uranium than Cameco's Cigar Lake is scheduled to produce annually. Each of these reminds us that many projects simply are not economic at current uranium prices and something has to give.

The current supply deficit should put upward pressure on prices, eventually making projects like Kintyre more feasible. We'll be lucky if annual uranium production reaches 180 Mlb by 2020. And that would require sustained spot prices of $70-80/lb. Our current forecasts for next year and 2014 are $70/lb and $67/lb, with a long-term forecast is $65/lb.

TER: How have the uranium stocks performed this year?

DT: Equities in general have really dropped off since the beginning of the year. As a group, uranium stocks are down about 30% year-to-date and much of the downward action occurring within the last 3-months. These companies have been under the same pressure as the broader market, with low liquidity and European debt worries. In the long term, I think the producers will outperform developers. But over the past few weeks we've seen some movement in the smaller stocks, with no clear winner between producers, developers or explorers. But however harsh the market is, you have to pick good stories, and right now we have a couple of suggestions for each of those categories.

TER: Paladin Energy has been showing some pretty exciting production results, but the stock has continued to languish and now there are some takeover rumors floating around. What's the situation there?

DT: Paladin is our top producer pick. We have a Buy rating on the stock with a $2.65 target price. Right now, we like what we see. We think the company has really turned the corner with good production numbers, a strong outlook, resource growth, advancement of the pipeline, asset sales and strategic alliances that are expected shortly. Those alliances could not only improve the balance sheet, but it could also add value to the projects that are still in the pipeline.

A Bloomberg article last month suggested that Paladin is a takeover target at these levels. We think that potential acquirers could include Cameco, Rio Tinto Plc (RIO:NYSE; RIO:ASX; RIO:LSE; RTPPF:OTCPK), Uranium One Inc. (UUU:TSX) or other senior miners looking to get into the uranium space. We have a Buy rating on Uranium One and a $4.50 target price. But I think that Paladin is going to make the first move with strategic alliances before anything else happens.

TER: What do you think is the most likely strategic alliance?