Monday, October 8, 2007

Uranium to Head North of $500/Pound?

Legendary stock picker James Dines recently compared uranium stocks to the high-flying net stocks of the halcyon days of the Internet expansion era. While the much-hyped and fleeting Y2K crisis never materialized, the U.S. energy crisis for highly sought uranium has been developing for more than twenty years. Still early in the current bullish uranium cycle, investors are scoring triple-digit returns on what some are calling a renaissance in nuclear energy.

Just as investors caught the curve of a new paradigm in communications and commerce with Internet stocks, many early birds have already begun investing in the nuclear energy story. The nuclear story pitch is simple: How do you accommodate a massive rush for electrical power demand while faced with the dire threat of carbon dioxide emissions and its direct impact on global warming? The growing consensus is that fission-based nuclear power may become the significant stop-gap energy alternative for this century and possibly until reliable technologies can effectively provide the means for renewable-sourced energy.

Nearly 2 billion people across the planet have no electricity. The World Nuclear Association (WNA) believes nuclear energy could reduce the fossil fuel burden of generating the new demand for electricity. The WNA forecasts a 40-percent jump in worldwide electricity demand over the next five years. The worlds most populated countries, China and India, are in the process of creating the largest energy-consuming class in the history of earth. Both plan aggressive nuclear energy expansion programs. Dozens of lesser developed countries, from Turkey and Indonesia to Vietnam and Venezuela, have announced their eagerness to pursue a civilian nuclear policy to benefit power needs for their burgeoning middle classes.

In a nutshell, global utilities are going to need uranium to help feed the increasing number of nuclear power plants proposed over the next twenty years. Herein lays the crisis: the world has been living off rapidly dwindling inventories since the last uranium up cycle. Uranium is now in shorter available supply for civilian energy use than ever before. Over the next decade, as demand continues to outstrip supply, analysts are predicting utilities will snap up known uranium inventories sending spot uranium prices to record highs. During this launch phase, investors have taken notice, chasing up the stock prices of many uranium producers and exploration companies.

Uranium Prices May Reach Unbelievable Highs

Toronto-based Sprott Asset Management research analyst, Kevin Bambrough, told STOCKINTERVIEW.COM, There is a good possibility of a supply crunch that could drive uranium prices to unbelievable highs. Various analysts predict price targets for spot uranium, in the near-term, above $40. Canadian Augen Capital Corps managing director David Mason speculated, $100 (US) a pound is within reason within the next year or two. Sydney-based Resource Capital Research is half as generous, forecasting $50/pound by 2007, explaining another 40 percent jump in spot uranium prices will be driven by end users in the power generation market which is urgently trying to secure supply into the future.

How high could spot uranium prices run? Kevin Bambrough made a hypothetical case for uranium trading north of $500. Its a ridiculous price, Bambrough confided. Its hard to speculate if this is even going to happen. While he admits that price would not be sustainable, Bambrough makes an interesting point about the concerns facing utility companies, charged with providing us with our electricity. In his futuristic scenario, Bambrough speculated, Theres a chance that some facilities will have to choose shutting down their nuclear plants (if they can not obtain uranium to fuel the facility). On that basis, Bambrough calculated the operating costs of a nuclear facility versus the operating cost of a competing fuel. In his conjectural model, Bambrough used natural gas priced at $5.

Bambrough explained, Assuming that the coal-fired plants operating capacity, before you would basically shut down a nuclear facility, you would be comparing it to what you would have to bring on, which would be natural gas. If there is a shortage there (with natural gas), what price would it take before I am willing to shut down my nuclear facility? If you were to shut off the nuclear capacity, and fire up more gas to replace it, it would send gas prices through the stratosphere. And that doesnt factor in the cost of shutting down a nuclear facility, itself an exorbitant process. The analyst said he reached his calculation of north of $500/pound for spot uranium, under an extraordinary emergency supply crunch, by answering this question: How much would people pay before they shut it (a nuclear plant) down if there is a shortage of uranium?

Bambroughs point illustrates that, unlike coal or natural gas, the cost of uranium in the nuclear fuel cycle is minimal. Thus, uranium is subject to an ever greater price rise without the blowback of consumer panic found in rising fossil fuel prices. Uranium prices might have to approach the level of Bambroughs hypothetical forecast before even registering concern on an ordinary consumers radar.

Despite the recent parabolic rise in spot uranium prices, Bambrough doesnt foresee the uranium frenzy peaking until the years 2013-2015. What will happen then? Theres a good chance that the HEU agreement wont be renewed, said Bambrough. Russia may not be selling their uranium. The Russians may want to hold onto what they have. And if they do sell, they may not sell to the U.S. In 2004, U.S. utilities imported more than 80 percent of their uranium supplies from foreign sources. It could be that the Russians are interested in trying to build nuclear plants for other countries and be in that business, he suggested. That may go hand in hand with were going to build you the facility and we can guarantee you supply. And Russia would be using the balance of that uranium for their domestic needs. Bambrough also cited the problem of mines expiring in the face of a potential new demand.

He concluded, There are time lags to bring new production on versus what needs to be replaced in that 2013 period. The International Atomic Energy Agency forecast nuclear electrical generating capacity to soar by more than 40 percent by the year 2030, which may further drive demand for tight uranium resources, especially during the period of Bambroughs forecasted period.

Historical cycles support spot prices higher than $40/pound, a level above where uranium may hover for several years. The current cycle of rising uranium prices closely parallels the leap which occurred between February 1975 and April 1976. Spot uranium prices soared from $16 to $40/pound during that 15-month period. During the 1970s cycle, uranium steadily rose from $6.75/pound in November 1973, peaking in July 1978 at $43.40/pound. Uranium held above $40/pound for nearly four years from April 1976 through February 1980. In this cycle, uranium prices bottomed at $6.40 in January 2001, creeping higher into 2004. Since late last year, spot uranium prices soared with the same momentum seen thirty years ago. If history repeats itself, spot uranium prices should trade above $40/pound this year, and stay above that level until the end of this decade or perhaps for a longer stretch.

The key yardstick in determining how much higher uranium prices will climb is by keeping track of the number of new nuclear facilities being constructed or proposed. Estimates vary wildly, from as few as thirty by 2020 to more than 150 before 2050. A few years ago, when we first started investing in uranium, Bambrough explained. There were very few plants being proposed. The numbers have doubled for proposed facilities. And for every one you hear about, theres a lot more being planned. That puts uranium miners into an enviable position. Bambrough added that utilities have to secure their fuel supply for up to six years out, once they decide to build a nuclear facility. The fact is the supply is just not there, warned Bambrough.

According to the U.S. Energy Information Administration, Cumulative unfilled uranium requirements for U.S. civilian nuclear reactors for 2005 through 2014 were reported to be 365 million pounds U3O8e. The quantity of maximum deliveries of uranium for the same period under existing purchase contracts totaled 181 million pounds. Nearly 67 percent of the maximum anticipated market requirements for uranium lack a contract. Over the next decade, U.S. utilities will need to newly purchase more than 36 million pounds of uranium oxide each year, on average, in order to keep their nuclear power plants running. According to the Department of Energy website, contracted purchases from all suppliers precipitously falls in 2007 below 40 million pounds. By 2008, the amount of contracted uranium sinks below 20 million pounds.

In short, U.S. utilities may soon be scrambling for uranium inventory to fuel their nuclear reactors, or face the ridiculous price(s) research analyst Kevin Bambrough warned about. An excerpt from The International Atomic Energy Agencys booklet, Analysis of Uranium Supply to 2050, bears out Bambroughs thesis, As we look to the future, presently known resources fall short of demand. The deficit between newly mined uranium and reactor demand has averaged about 40 million pounds annually over the past decade, cannibalizing existing inventories. As we begin 2006, the supply/demand imbalance has reached a critical phase.

Where Will the Uranium Come From?

In his September 2004 presentation to the World Nuclear Association, Thomas L. Neff of MITs Center for International Studies, stated, The net result of nearly twenty years of inventory liquidation is that existing higher-cost suppliers were driven out of business, new mines were discovered from starting, and exploration was neglected. Neff warned in his conclusion, The problem is the one to two decades that will be needed to expand (production) capacity and build the flow of nuclear fuel that meet the expanding requirements horizon.

The 1970s price spike in uranium was limited because existing uranium mines were quickly ramped up to supply utilities with fuel. Neff noted, This is not the case today and a longer period of high prices could prevail. In Neffs analysis, uranium prices would have risen well above $100/pound in the mid 1970s, using constant 2004 US$. On that basis, Bambroughs hypothetical forecast above $500/pound may be not too far out of reach. Neff summarized why the problem has reached a critical stage, We are currently facing the consequences of what may be the largest sustained divergence between expectations and reality in the 60 year history of uranium.

Kevin Bambrough offered some slight relief for the uranium inventory problem, There are a number of mines coming on, and there are talks of expansion. He gave Australias Olympic Dam as one example, and added, Theres lots of talk about big production coming on in Kazakhstan, but Ive also heard reports saying thats very optimistic. The International Atomic Energy Agency (IAEA) is less sanguine, Lead times to bring major projects into operation are typically between eight and ten years from discovery to start of production. To this total, five or more years must be added for exploration and discovery. The IAEA doesnt foresee relief until 2015 to 2020.

For the time being, U.S. utilities are forced to bide their time while they continue to rely mainly upon newly mined uranium imported from Canada or Australia. Once the worlds largest uranium producer, the estimated recoverable reserves in the United States now ranks but eighth in the world with four percent of known global reserves. Those 125,000 tonnes of uranium would supply 250 million pounds of uranium, far less than the unfilled maximum requirement for U.S. utilities over the next decade. The majority of domestically mined uranium now comes mainly from Wyoming, Texas and Nebraska. Permitting operations are progressing in New Mexico, once the countrys largest producer of uranium, which may become a significant uranium supplier later this decade.

For people who want to bring on new (nuclear) facilities and contract for it, its very difficult to do that, said Bambrough. You have to go to mines that are not even there yet in order to try and contract supply. In this light, it appears the greatest opportunity will appear with the junior uranium companies, which obtained known uranium resources during the last down cycle, and whose operators abandoned such properties because of low prices. As Neff warned in his presentation, Uranium prices have recently reversed a twenty year decline, apparently surprising many buyers and sellers. Buyers will be combing the same company lists investors scan. Just as investors will be racing to find the best uranium juniors for investment purposes, utility buyers and uranium traders will be scrambling to identify which company could provide them with a long-term uranium supply.

How Can Investors Profit?

Bambrough recalled compiling a worldwide list, in 2003, of a mere 25 companies involving in uranium mining and exploration. I cut the list down to around ten that looked to be promising, said Bambrough. Id say that today there are still less than 30 uranium companies that present a good reward-to-risk ratio considering the massive move the sector has made. Depending upon whose list you believe, the number of companies now mining or exploring for uranium stretches to about 200. The majority trade on either the Canadian or Australian stock exchanges.

So how do you separate the potential winners from the also-rans? People in the industry sort of know whos real and whos not, said Bambrough. I think a lot of the pure exploration companies are more likely to fall on tough times. Bambrough cautioned, I think there will be a real separation between the haves and the have-nots, those who actually have uranium and economic deposits. A lot of exploration companies are more likely to fall on tough times. Those are the ones that will get hurt because they dont have anything to fall back upon. They have to go to market to keep raising money to do the expensive drilling that needs to be done. It costs so much. Miller added, It will take exploration funds, good geology, and some luck to find new uranium deposits in these frontier areas. The success rate of each individual prospect will be far less than 1 in 100.

What sort of companies has Sprott Asset Management invested in? Bambrough responded, We have preferred to invest in companies that have acquired properties that were once owned and were actively being worked by majors at the end of the 70s bull market. He added, The cost of uranium exploration is so large there is great value built into many of these properties. Specifically, millions of dollars worth of drilling work and data have been collected on some properties. In some cases, mining shafts have been built that only require rehabilitation at a fraction of the cost of starting fresh with a green fields project. Another example of what he does and doesnt like, The guys that picked up stuff in the last year, when they saw the uranium boom, they just said, Im going to go grab some land. I have greater confidence in the guys that have been there for a longer period of time, bought things when they were being thrown away at the lows, and waiting for the uranium price to rise.

Bambrough shared a few of his favorite uranium stocks. Of the companies that we own, we own a larger percentage of Strathmore Minerals (TSX: STM; Other OTC: STHJF) than almost any other company, said Bambrough. We think theyve got some great properties. They were guys who got into the game very early, and who have skills as they do with David Miller (president and chief operating officer of Strathmore Minerals) in understanding the uranium business. And they have a very large amount of databases, as does Energy Metals Corporation, which is extremely valuable in understanding the properties. Both Strathmore Minerals and Energy Metals have properties in New Mexico and Wyoming. I think the future for New Mexico is quite good, Bambrough noted, as well as ISLs in Texas and Wyoming. Said Strathmores president, David Miller, Strathmore is the only company to open an office up in New Mexico dedicated to bringing properties into production. The office is staffed by two veteran uranium men, John Dejoia, VP of Technical Services and Juan Velazquez, VP of Environmental and Government Affairs. They have a number of subcontractors doing various required work to bring projects forward to obtain permits to mine.

Another Sprott Asset Management favorite is Tournigan Gold Corp (TSX: TVC). You look at a past producing region, Bambrough pointed out. They went and got old mines. Tournigan recently drilled the historic Jahodna uranium resource in Slovakia, once drilled by the Russians. The company also holds uranium properties in Wyoming and recently acquired uranium properties in South Dakota. He also likes Western Prospector (TSX: WNP), saying, Western Prospector has gone through areas where in some cases, there are shafts there that were dug by the Russians. A lot of work was previously done. Others rounding out Bambroughs preferred list of juniors include Paladin Resources (TSE: PDN) and Aflease, now trading as SXR Uranium One (TSE: SXR). We also have a bit of investment in the Labrador area, and very small, mainly in Altius (TSX: ALS), added Bambrough. Its something were watching. We think its a promising area.

Where the Action Is

The more adventurous price action may be found in the ongoing consolidation within the uranium sector. Bambrough observed, There appear to be a few aggressive junior uranium companies that seem to be moving forward and working to build a major company. In November, one uranium exploration company, Energy Metals Corporation (TSX: EMC) began takeover procedures to acquire two other uranium juniors, Quincy (TSX: QUI) and Standard Uranium (TSX: URN). Standard Uranium has since traded nearly 70 percent higher. There are people who have neighboring properties, and it makes sense for them to come together, advised Bambrough.

In late December, another of Bambroughs favorite uranium companies, Strathmore Minerals (TSX: STM; Other OTC: STHJF), announced it had engaged National Bank Financial as its exclusive financial adviser to review transaction alternatives to maximize shareholder value from its uranium assets. Questioned about this news release, CEO Dev Randhawa told, National Bank has the best technical team and will help us reach the right decision to maximize the benefit to our shareholders. In a December 7th note to his subscribers, Canaccords David Pescod wrote, We talked to Dev Randhawa of Strathmore Minerals because Strathmore seemed to be the one company on most peoples list as an obvious take-out target. When we talked to Dev, obviously he wouldnt be adverse to a take-out as long as the price is right, and he even gives us a 50/50 bet that they wont be around in the next six to twelve months. In a 2005 research report, the Cohen Independent Research Group set a price target of C$4.29/share for Strathmore Minerals, based upon the current spot uranium price.

How does Bambrough envision the uranium bull market unfolding for investors? I think the market could really use more large cap uranium companies, since large fund managers currently can really only look to Cameco (NYSE: CCJ) and Energy Resources of Australia (ASX: ERA) to get exposure to the uranium market, said Bambrough. There are several junior companies that should come together to form large uranium companies to leverage their extremely valuable skilled personnel, lower the exorbitant costs of permitting and exploration, and achieving other economies of scale. How soon would it be before a larger company, combining some of these promising juniors, reaches listed status on the New York exchange? I would guess that a NYSE listing may not come until 2007 or 2008, responded Bambrough. I think that when the tap comes for a lot of these companies, it will come to those that are in production. Youll be able to see a nice production profile, several projects, diversification, cash flows, and a nice pipeline of projects.

As for the approximately 200 uranium exploration companies that have sprouted up in less than two years, Bambrough advised, I dont understand why people would put so much money into grassroots properties when there are properties that were (already) worked on, and you can continue on their work. The idea is we are continuing on those projects rather than going grassroots. Its the logical place to go for me. Bambrough is still enthusiastic about the uranium sector and closed his remarks, saying, I expect that we will see a great out performance by quality uranium companies as they move their projects forward. We still see some incredible values and are still actively investing in the space. We are still in the early days of the uranium bull market.

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James Finch contributes to and other publications. StockInterviews Investing in the Great Uranium Bull Market has become the most popular book ever published for uranium mining stock investors. Visit