First, a Primer on Uranium
The uranium market has a pulse again (look no further than the charts of Cameco (NYSE:CCJ), and Uranium One (OTC:SXRZF) for what look to be trend reversals). The recent LDP win in Japan, where Shinzo Abe has been shown to have a "realistic" stance on Japan's nuclear future, is the most recent data point suggesting that uranium cannot be ignored as a sector for much longer. Considering the looming expiry of the Russian HEU agreement, the deferral of BHP's Olympic Dam expansion plans, the closing of the open pit phase of ERA's Ranger Mine, and limited investment in projects capable of generating timely new uranium supply, it appears that the stage is set for uranium to glow once again (link here to The Energy Report for more detail).
Some quick history. After waking from a long slumber in the early 2000s, the uranium market had a sudden and speculative false start that ran from 2005-2007 with uranium prices topping out at around $135 per pound after starting that decade in sub-$10 per pound territory. That run probably did more harm than good in a lot of ways, as investors burned in the collapse of that 2007 bubble were reticent to come back, despite the fact that the fundamental arguments behind the bubble were sound, albeit a little early. With market outlook upgrades and increasing focus returning in late 2010, there was a wall of money coming back into the uranium sector in 2011 as analysts and investors acknowledged the looming supply gap just a few years out. Then Fukushima cut the legs out from under the uranium market overnight. It was back to square one, but the longer-term fundamentals remained the same (chart historical prices for yourself here).
Post-Fukushima, the market grappled with an abundance of headlines and uncertainty. Germany made pledges to shut down all nuclear power by 2022 (some interesting discussion here), though the fact that they are likely to make-up that power loss at least in part by importing power from Poland and France (generated by, you guessed it, nuclear) was generally not discussed. Italy banned nuclear altogether, which is not a surprising initial reaction for a country with so many active faults and a relatively small land area (details here). Japan shut down all of its reactors for safety inspections at the demands of a population gripped by fear in a crisis. Almost everyone had something to say on the matter, critics and proponents alike. Over the next 18 months, the price of uranium fell again (this time from about $75 per pound), bottoming at about $40 a pound in late 2012 as the physical market absorbed excess short-term supply created primarily by the Japanese shut down. Currently, uranium spot prices have ticked up to the $45 per pound range as a result of a variety of factors, including the points mentioned earlier in this article.
At the end of the day, after much posturing and analysis, we find ourselves back where we started... nuclear energy is here to stay as a primary global power source, right along side oil, coal, natural gas, and renewables. Nuclear power, much like an airplane, is safe if designed and maintained properly. Fukushima was an exceptional and extremely unfortunate set of circumstances, but to characterize an industry with one outlier event is simply not practical. Today, new reactor build projects incorporating next-generation designs are continuing around the world, with activity being particularly strong in Asia. The development of small modular reactor designs is being backed by the DOE in the United States. Japan looks set to begin a phased restart of idled reactors as LNG imports continue to weigh heavily on that country's economy. The world is carrying on with nuclear power, and the uranium producers are expected to struggle to meet demand in the coming years.
Fortunately for both uranium producers and consumers, reactor power supply costs are relatively insensitive to fuel input costs (a doubling in the uranium price might result in a (roughly) 10% rise in the cost of generating power). To put it another way, the uranium price could double or triple and nuclear power producers wouldn't lose sleep over it. This lack of price sensitivity is important because at current prices, uranium producers will have a very hard time justifying capital expenditures to increase supply. The other factor in the equation is that the market will need more supply to fill a supply gap that opens around 2014, depending on which forecasts you use (some commentary here). Put those two factors together and you're set for a rise in price. This is Economics 101.
In conjunction with a price rise, the world will also need new primary uranium supplies in the form of new discoveries in order to meet demand in the coming years. Along those lines, having watched, traded, and invested in the sector for 8 years now, early results from one project in particular have led me to the "Saudi Arabia of Uranium"... Saskatchewan's Athabasca Basin. A discovery is unfolding there much like you would read in a textbook, but you have to know how to interpret the data. It's early days, and not for the faint of heart, but this is a story worth hearing.
The Patterson Lake Discovery - Welcome to the Western Athabasca Basin
In a 50/50 JV, two Canadian companies, Alpha Minerals and Fission Energy (FSSIF.PK) have recently drilled a discovery hole grading 2.49% U308 (uranium) over 12.5m, starting at a depth of 65 meters (press release here). The hole was one of the last four of their 2012 fall drilling program. 3 other surrounding holes were also mineralized. The average grade of all the holes is about 1% U308. Again, these were literally the last 4 holes of the fall program. Drilling is expected to start up again in January 2013. A typical hole at Patterson Lake takes only 2 days to drill given the shallow depth. In my view, this is one of the most interesting holes to come out of the Athabasca Basin in recent years for two reasons: 1) the shallow depth, and 2) the size potential based on the available data.
Alpha's CEO is Ben Ainsworth, an industry veteran who was VP of Exploration at Hathor Exploration (HAT) when that company made their discovery. Garrett Ainsworth (it's a father-son team) is the VP Exploration at Alpha and is the "boots on the ground"... Garrett is a key player in the exploration program and knows every bit of the land and the data that comes out of it. Michael Gunning, also of Hathor fame, recently joined as a board member and lead technical advisor, so investors can take comfort that this is not this management team's first rodeo.
As an aside, most investors do not know how to interpret uranium grades in terms of what is "good". The average grade of hard-rock uranium mines ranges from 0.05% for large open pit operations in Africa to over 18% for high-grade underground freaks-of-nature like Cameco's Cigar Lake in Canada's Athabasca Basin. As with any mining operation, grade must always be considered in the context of depth. The most relevant recent comparable for the Patterson Lake discovery may be Hathor Exploration's Roughrider deposit, which was bought by Rio Tinto for about $650mm in 2011. Roughrider's average grade was 5% U308 at an average depth of about 250 meters. Without going into the math behind it (just a simple cone volume calculation), the volume of material you have to move for a 100m deep conical pit with a pit wall slope of 40 degrees is less than 1/10th of the material you have to move for a 250m deep pit with the same slope. So, in a nutshell, the stripping costs (the time and money you spend moving waste rock before you get to your ore) are far lower for a shallower deposit. Intuitively then, 1% U308 at 65m depth may not be all that different from 5% U308 at 250m. From another perspective, 1% U308 is equal to 22 pounds per tonne which, even at the current spot price, is over $900 per tonne of rock.
The Patterson Lake discovery is on the west side of the Athabasca Basin, in an area that is generally lightly explored. The project sits directly off an all-season highway (so access is good) that leads to the Cluff Lake mine site, where approximately 62 million pounds of uranium were mined at an average grade of just under 1% U308.
Patterson Lake is an interesting project in that it hosts one of the largest, if not the largest, radioactive boulder fields in the entire Athabasca Basin. These are boulders that were plucked from bedrock by glaciers during the last ice age and pushed along with the ice as those glaciers advanced. Logically, AMW/FIS have been exploring "up ice" of the present day boulder field where the boulders must have been sourced from. Believe it or not, for a variety of reasons best summarized as the project "falling through the cracks" under prior holders, the boulder field was never followed up on until the current JV partners came along. Think of it as following a trail of bread crumbs (the boulders) back to the loaf of bread (the deposit that the boulders were sourced from). The data so far is compelling (see Alpha's presentation here). Below is a map of the boulder field and the resistivity survey over the area:
Sources: Company reports, annotations by author
There are a few things to note:
1) There is a large conductive body (in blue) running ENE in the survey area. This is known to be a rock type conducive to uranium mineralization and there is evidence of fluid alteration throughout. Combine that with the fact that uranium mineralization has already been discovered on the western edge of that conductor, it's safe to say AMW/FIS are in a good fairway, with one already known mineralized area to delineate in the immediate vicinity of the discovery hole(s).
2) The high-grade uranium boulder field (boulders grade up to 39% U308) is "down-ice" of the conductor and the discovery area. When glaciers covered the area during the ice age, the ice "smeared" whatever was in the bedrock along their path, with the boulder field being the final limit of that smearing. Characteristics of the boulders suggest that they have not traveled far, perhaps 2-4 km, which put their likely source area right over that large geophysical conductor. Again, AMW/FIS appear to be in the right fairway. If the size of the boulder field is any indication of the size of the source, the source deposit(s) has the potential for big tonnage.
3) The discovery area is on the edge of low-resistivity "finger" that extends to the east. There is 600m of untested strike to the east along that thin red line which is a strong geophysical target. Hathor's 60 million pound deposit was contained along just a 300m strike length. AMW/FIS already know that the western edge of that "finger" is mineralized.
4) While the whole length of the blue conductor is a target, one other area of high interest is farther to the northeast, where the blue conductor clearly bends, setting up a second, textbook, high-priority target area. That area looks like there is structure, favourable geology, and a large heat source just to the east that is evident from aeromagnetic data. All of these factors are conducive to the formation of uranium deposits.
The pure play on the discovery is Alpha Minerals (AMW), so it is the easiest to focus on for valuation.
AMW, post-financing (they just raised $4mm in a non-brokered round at $1.50), will have about 16.7 million shares outstanding and about $4mm in the bank. Their burn is low, at about $60k/month. Capex for the winter program is likely to come in at $2-2.5mm (net) assuming a 6,000-8,000m program, which is a reasonable expectation based on discussions with management. Bottom line, they're funded to drill out their new discovery and test other high-priority targets along the same conductor, which has now been proven to be prospective for high-grade basement-hosted mineralization.
Fully diluted, AMW has approximately 24mm shares out and a fully diluted cash position of about $12-13mm. That warrant money is likely to come in quick, as all warrants are in the money and there is an accelerator on $3.2mm worth (exercise price at $1/sh) that will be triggered if/when the stock trades over $2 for 30 trading days.
The recent move has been parabolic as information and details spread regarding the developments and data at Patterson Lake. To put it in context, HAT is the only logical recent comparable that we can use as a reality check. Looking at the AMW chart, there was a "check back" on the first assays in early December as uninformed investors hoped for Hathor-like grades in the first 4 holes. The stock has been under accumulation since.
When HAT halted for the first assays from their "08-12" discovery hole in early 2008, the stock price was $1.30 on 68mm shares out. After the halt, the stock quickly traded to $2.40, again with 68mm shares out. That was on one hole... there were no other results pending at that time. The U308 spot price was about $60/lb (and falling) and we had just seen the "great uranium crash of 2007".
$2.40 x 68mm = $160mm... HAT had 90% of their project back then.
AMW/FIS have 50% each, so to adjust HAT's post assays market cap, multiply by 0.55.
That gives you $90mm for AMW's share of PLS in the "early" discovery stage (same for FIS) if you use HAT as a guide.
HAT was eventually bought for about $650 million after proving up just under a 60 million pound resource. It's early days, but with that kind of potential on the table and the data available to date, this is a story that believers in the uranium sector will find hard to ignore.
The ultimate size of the find remains to be seen, but the core encountered to date shows extensive alteration and the geophysical data suggests a large and long-lived mineralizing system. The boulder field, if its size is relative to the size of the source, also bodes well. One potential analogue deposit that has been suggested is Key Lake, which is a 200 million pound uranium deposit. In any case, at this depth, if January's drilling proves Patterson Lake has the size and grade potential that the data suggests it does, AMW's $24 million market cap will likely be a distant memory. These things can go either way, but this is a case where investors have to decide for themselves whether or not they buy into the data that supports what Alpha is seeking while those investors are seeking alpha!
While it takes an optimist to invest in a microcap, investing in microcaps is inherently risky given their lack of revenue and reliance on the public markets or industry partners for continual funding. It should also be noted that while the data thus far is highly supportive, its interpretation is also speculative, which is probably true of any microcap exploration story no matter how good the initial data looks. Significant additional drilling will be needed to determine whether or not a mineable resource exists on the Patterson Lake property and the results of the winter drill program (which is expected to begin in January) will be critical to the outlook of the project going forward.
Think of microcaps as bets at the racetrack: No matter how much you talk to the jockey, know the horse and track conditions, and what the odds should be, you just never know until the horse crosses the finish line. The financial risks are mitigated somewhat by the fact that the holes are shallow and therefore cheap, which is a nice situation to have when companies like these are dependent on external capital for continuing operations, but it is important to keep the high investment risk in mind when evaluating these types of opportunities.
Additional disclosure: I also have a position in Alpha Minerals (AMW on the TSX Venture) but I cannot find a US OTC ticker for that stock for disclosure purposes.