Uranium Market Overview - 2014 Q1
There is renewed optimism for uranium equities following a three-year bear market sparked by the infamous Fukushima Daiichi nuclear accident (Chart 1). On Feb 25th, the Japanese government, led by Shinzo Abe, reversed the previous government's decision to phase out nuclear energy. Instead, nuclear is set to regain its former stature as an integral component of Japan's electricity generation; although no timetable for reactor restarts was given (Map 1). The use of nuclear remains a heated topic with the Japanese public, as recent polls show the majority of respondents continue to oppose reactor restarts and a large majority harbour some degree of concern over reactor safety. Therefore, restarting idled Japanese reactors is likely to be contested, indicating the industry-wide completion of the process will be gradual, with reactors restarting in stages. Depending on the enforcement of new safety regulations and the degree of compromise from the Abe-led government, a sizable contingent of reactors may never restart.
Source: Yahoo Finance
Japan Reactor Restarts - Return of the Jedi
Our model suggests a base-case scenario of 28 eventual reactors restarting; though the confidence range is wide, reflecting the uncertain political environment. Alternatively, Cameco (NYSE:CCJ) had predicted 35 to 40 reactors would eventually restart. This seems optimistic, as we assume no BWR (boiling water reactor) with Mark 1 containment built in the 70s will restart. This was the model in operation at Fukushima Daiichi. Though utilities operating these reactors had made improvements prior to 2011, the design appears inadequate to deal with Japan's seismic threats (earthquakes, volcanic activity, and tsunamis) post-Fukushima. Even BWRs with Mark 2 containment may have a tough time receiving approval to restart without massive capital expenditure (capex) improvements depending on their geographic location. Japan has three BWRs with Mark 1 containment still listed as operational, and eleven BWRs with Mark 2 containment.
Source: National Report of Japan for the Fifth Review Meeting of the Convention on Nuclear Safety, Sep 2010, Government of Japan
It should be noted that the unlike its predecessor, Japan's National Regulatory Authority (NRA) has the legal authority to "back-fit" new rules and regulations onto existing nuclear power plants (NPPs). This has left the future of NPPs located at Tsuruga, Ohi, Higashidori, Mihama, and Shika up in the air due to their proximity to potentially active faults. New rules incorporating multi-layered protective measures will also increase one-time costs for NPPs exposed to tsunami risk along Japan's eastern seaboard and NPPs with active volcanoes within a 160 km radius. There are numerous potentially active faults and volcanoes in Japan, such that the definition of what is or should be considered active will have a material impact on utilities that own idled reactors. Regulatory uncertainty - and the subsequent costs - mixed with significant anti-nuclear public support makes predicting reactor restarts difficult and the timing next to impossible.
Due to the large amount of uncertainty, we use an ordinal ranking methodology based on an assigned score using the independent variables:
- Seismic safety
- Reactor age and model
- Proximity to major population densities
- Reputation of the operating utility
- Exposure to tsunami potential
- Concentration of reactors
- Access to consumer base
To determine seismic risk, we used mapping from the Japan Seismic Hazard Information Station (J-SHIS), which included information regarding:
- Probability of major seismic hazards within 30 years
- Major active fault zones
- Major subduction-zone earthquakes
- Occurrence region of subduction-zone earthquakes
Source: IAEA|PRIS, WNA (World Nuclear Association), and ZC estimates
We believe both reactors currently under construction will be completed, as both scored well and are modern, third-generation advanced reactors. Japan's referenced nuclear output under our best-case scenario could approach 32 GW of capacity, representing 75% of the country's currently listed operable net generating capacity.
The results of the model are encouraging, as the Sendai-2 and to a lesser extent Sendai-1 reactors were estimated to be amongst the first group to restart. The Sendai NPP has been shortlisted by the Japanese NRA clearing the way for the first potential NPP restart.
We use the 10-year average load factor for reactors worldwide prior to the Fukushima accident to determine what the expected load is for Japanese reactor restarts. Interestingly, it appears, in aggregate, Japan's NPPs' utilization was below the world average in 2010. Economically, Japan's nuclear industry, though not necessarily individual utilities, should be healthier, with fewer operating reactors running with increased efficiency once necessary write-downs are taken.
USA - The empire strikes back
In the US, the commercial nuclear industry may soon be able to arrest the recent declines experienced. Nuclear power consumption peaked in 2010, before declining year-on-year (yoy) in 2011 and 2012. Last year saw four reactors close prior to the expiration of their operating licences, and EDF announce its withdrawal from the US nuclear market due to unfavourable economics. Exelon (NYSE:EXC), the largest US utility of NPPs, has indicated possible closures of some reactors. And while there are four new reactors under construction in the US - the first to have broken ground in over thirty years - the expected completion dates are anything but certain. Construction of the Watts Bar-1 reactor, which was connected to the power grid in 1996, took over twenty-three years to complete; while construction of Watts Bar-2, expected to be commercially operable in 2016, started in 1972, before being suspended for almost twenty-two years in 1985. Therefore, little faith should be placed behind either project - Summer or Vogtle - reactor construction schedules. Both appear to be facing cost overruns and difficulties honouring their respective timetables.
However, a combination of factors should help the US commercial nuclear industry through 2015 to 2020:
- Coal - Routinely represents more than 40% of the annual US electricity generation, and was relied upon this winter due to consistently frigid temperatures. However, new environmental regulations will have a material impact on US coal consumption. The US Energy Information Administration (US EIA) estimates coal consumption to decrease by 3.1% in 2015, ahead of the implementation of the EPA's Mercury and Air Toxics Standards (MATS) in 2016. Further, the US EIA reference case projects the retirement of 60 GW of capacity by 2020, which was approximately 20% of the total US electricity generating capacity from coal in 2012.
- Gas - Represents approx. 27% of US electricity generation. Unlike NPPs, whose cost structure when operating is largely fixed, electricity generation from natural gas has significant variable costs. Any prolonged material increase in the price of natural gas from the mid-U$4/MMBtu range should cause the wholesale price of electricity to rise, improving the competitiveness of nuclear generation. Reasons for natural gas prices to likely rise in the US over the medium term are: ((i)) increased demand from utilities as coal plants retire, (ii) the adequacy of the natural gas transportation and storage network to handle greater-than-expected demand. Anecdotally, the Keystone XL application was filed 5.5 years ago, leading to the conclusion that lobbying by special interest groups will stifle necessary infrastructure investment. ((iii)) Potential relaxation of the rules surrounding the export of liquefied natural gas (LNG), which could lead to increased domestic natural gas prices.
- Wind - The recent expiry of the Production Tax Credit (PTC), which historically has had massive positive impacts on wind infrastructure investment dollars. A recent PwC global survey showed the majority of utilities expect onshore wind to be economic by 2030. However, without the ongoing renewal of the PTC, it is difficult to see how the US will achieve the administration's renewable energy targets by 2020.
Therefore, a reasonable case can be made for fewer reactor retirements throughout the forecast period than would otherwise be expected. Currently, there are no operational reactors older than 45 years in the US. Reactor retirements are likely to occur after the initial operating licence has been extended and before large fixed capital expenditures are incurred. During this stage, capex requirements are more likely to be greater than the expected net present value (NPV) of future cash flows due to much shorter time horizons. In the base-case scenario, we expect five BWRs with Mark 1 containment vessels to be retired along with the three oldest PWR reactors by 2020. The US currently has 23 BWRs with Mark 1 containment. However, none are situated along the Pacific coast, and the US does not face the same hazardous seismic risks as Japan. We discount the probability of current reactors under construction being commercially operational within the forecast period, anticipating only the Watts Bar-2 reactor to be connected to the grid. Our base case leads to the conclusion of 93 operational reactors by 2020.
Source: IAEA|PRIS, WNA, ZC estimates
It is important to note there are risks to the US commercial nuclear industry. Domestic natural gas prices remaining at current levels over the forecast period due to consistently mild weather and continued economic malaise would keep wholesale electricity prices low, hindering the competitiveness of NPPs. As well, increased scrutiny by the Nuclear Regulatory Commission (NRC), though unlikely, of older reactors could potentially increase capital and maintenance costs for utilities. The combination of these risks would lead to a rash of reactor retirements and our bear case assumption is of 82 operational reactors by 2020. For reasons listed above, we do not believe this scenario will come to fruition.
China - A new hope
China is a markedly different and refreshing story. Though the China General Nuclear Corporation (CGN) and China National Nuclear Corporation (CNNC) secured a large minority stake in the recently announced multi-billion dollar Hinkley C project in the UK, the real growth market for nuclear is in China. Given China's favourable nuclear power performance since 1996 and continued commitments, we anticipate 23.6 GW of capacity additional capacity by 2020. With air quality becoming a serious concern within China, and less opposition to the politburo policies, there is no reason to expect growth of nuclear generating capacity in China to slow. Even with more modest growth for Chinese electricity generation, the forecast total net 40.5-44.7 GW of nuclear capacity will likely represent approximately only 4% of total electricity generated in 2020.
Source: IAEA|PRIS, WNA, ZC estimates
Due to continued headwinds for the commercial nuclear industry throughout the OECD (Organisation for Economic Co-operation and Development), representing 79% of total nuclear consumption in 2012, we have revised down our future spot price estimates. Prodigious Chinese nuclear growth and Japanese reactor restarts will be partly offset by declining demand out of the US. Therefore, our base case growth forecast for aggregate annual NPP requirements from China, Japan, and the US is an additional 20.7 million pounds of U3O8 in 2020. Meanwhile, Cameco expects production from Cigar Lake to be at optimal capacity of close to 18 million pounds of U3O8 by 2018.
Source: IAEA|PRIS, WNA, ZC estimates
We believe the current spot price of U$34.70/lbs U3O8 continuing to languish under our 2014 bear case annual average price target of U$40.72/lbs is telling. The percentage of spot market transactions over the period 2011 to 2013 remains above the long-term trend. This situation is unlikely to reverse, and alleviate downward pressure on the spot price, until Japanese reactors officially begin to restart. We continue to believe the Athabasca Basin, as a low-cost producer, provides a certain measure of prolonged downside price risk, while offering significant upside potential. Given the uncertainty surrounding global uranium requirement for NPPs, and the likely scenario that most utilities have probably accumulated significant of fuel due to the heavy discount between the spot and long-term price, there is tremendous value in being a low-cost producer.
The Athabasca Basin - Update on our investment thesis
We have and continue to believe that the Athabasca Basin region is the best place to explore for and mine uranium. Grade is the number one reason. Additionally, Saskatchewan is an attractive place to build a mine, ranking 12 out of 112 jurisdictions worldwide in the recent Fraser Institute Global Mining Survey. There is necessary infrastructure (roads, power, mills, etc.) in much of the region, especially in the eastern side of the Basin, where CCO's McArthur River and Cigar Lake mines are situated. Infrastructure is a major factor that influences the economics of a potential mine; the less material that you have to physically mine, truck, and process, the more lucrative your operation.
The main risk in the Basin continues to be the inherent uncertainty in exploration, which can be compounded as depth increases. However, given uncertainty surrounding the future uranium price environment, the potential rewards for finding premium deposits will continue to further incentivise exploration in the Basin. Many believe that a long-term price of $60/lbs U3O8 is needed to properly incentivise investment and maintain production for close to 33% of the world's high-cost production; though our own analysis indicates this is closer to 25%. I believe the fact that Paladin Energy Ltd. (OTCPK:PALAF, TSX: (PDN)) is placing operations at its Kayelekera mine in Malawi on care and maintenance (after continued operating losses) illustrates the material difference in cost structures that exist for producers outside the Basin and a few pockets in the US. Recent business developments from Denison Mines (DNN, TSX: DML) - spinning off its African operations, bolstering the 2014 Basin exploration budget, and planning to acquire Enexco Limited (OTCQX:IEXCF) - upholds our investment thesis. Exploration companies focused in the Basin hold a lottery ticket to a massive deposit. Hathor Exploration is an excellent example of a company that in 2006 had a market cap of about $6M, discovered the world-class Roughrider deposit in 2008, and was bought by Rio Tinto (NYSE:RIO) in 2012 for $654M. As a low-cost producer, if the uranium price remains under distress, the Basin should attract both domestic and foreign exploration dollars.
Within Zimtu Capital's portfolio (OTC:ZTMUF), two uranium exploration companies focused in the Basin recently were able to raise capital in short order, both exercising the full over allotment option. NexGen Energy (OTCQX:NXGEF) announced a C$10 million bought deal on March 4, which closed on March 26 for gross proceeds of C$11.5 million, to advance ongoing exploration efforts. Lakeland Resources (OTCQX:LRESF, TSX: LK) announced a C$2 million brokered private placement on Feb 24, which closed on March 20 for gross proceeds of C$2.8 million. Using a small sample size to extrapolate over a much larger market is risky, and yet these financings do indicate increased investor risk appetite and optimism in the Basin.
Recapping our previous note on Lakeland Resources, the Company has a strong technical team with a clearly defined business strategy, and has added professional uranium and nuclear expertise to the advisory board. Lakeland has a large land package with historic data. LK's focus has been to enhance this historical data with modern at-surface geological and geophysical techniques, before partnering the individual projects for drilling. In this way, Lakeland is able to diversify some of the exploration risk by working on multiple targets. The large land package also allows Lakeland the freedom to act as a property vendor. Gibbon's Creek is the first target identified by the Company. The target property is in the north of the Basin, totals 12,711 hectares, and is less than 3 km from the closest community (Stoney Rapids).
Source: Lakeland Resources
Significant Corporate Updates - Timeline
Dec. 4 - Lakeland announced a joint venture with Declan Resources (CVE: LAN) on their Gibbon's Creek target, whereby LAN can earn up to 70% interest in the property given certain obligations are met, including annual cash and share payments, and exploration expenditures (Table 8). The recent appointment of Mr. David Miller, the former head of Strathmore Minerals Corp., to president, director, and CEO brings credibility and Athabasca Basin uranium focus to LAN. We believe LAN will be able to meet annual exploration requirements for Gibbon's Creek.
Jan 8 - Update on recent at-surface exploration work at Gibbons Creek. Both boulder prospecting and DC-Resistivity support historic data. Notably, RadonEx results were extremely positive, helping to define high-priority drill targets.
Mar 18 - JV partners' announcement of a modern electromagnetic ground survey to confirm historical data. The Phase I drill program is expected to include up to 15 holes totaling 2500 meters. Permits have been received to drill up to 52 holes on the property.
Mar 20 - Lakeland closed a brokered and non-brokered private placement for gross proceeds of C$2.83 million. The Company issues 5.885 million flow-through (FT) units and approximately 6.47 million ordinary shares (Table 6). The use of proceeds from the FT units will be used to cover qualified Canadian exploration expenses, while the proceeds from ordinary shares issued ("hard dollars") will be used for exploration of the Company's properties in the Basin.
Over the last twelve months, Lakeland has successfully transitioned into a junior uranium explorer focused in the Athabasca Basin. The company-building process was executed in measured increments, including the addition of a diverse group of professionals to the advisory board, changes to the board of directors, acquiring an impressive land package, and completing two successful financings. With the expected exploratory drilling set to begin in the near future on the Gibbons Creek property, Lakeland has shown successful skill at proving up potential uranium targets. If Lakeland can replicate its business model on additional properties, it will be well positioned to offer a diverse portfolio of uranium exploration targets and provide shareholders with value.
 The ASAHI SHIMBUN, "ASAHI POLL: 59% oppose restart of nuclear reactors", Mar 18, 2014
 Cameco Corp. Presentation at the Canaccord Resource Conference, Oct 2013
 Reuters, Japan reactor design caused GE engineer to quit, Mar 15, 2011
 Hitachi-GE Nuclear Energy, "Advanced Boiling Water Reactor", page 4
 Japanese NRA, "Enforcement of the New Regulatory Requirements for Commercial Nuclear Power Reactors", Jul 8, 2013
 Reuters, "UPDATE 3-EDF exits US nuclear, ups earnings outlook", Jul 30, 2013
 Direct Testimony of Steven C. Prenovitz on behalf of Nuclear Watch South | Docket 29849
 US EIA, "US Coal Consumption", Short-Term Energy Outlook, Mar 11, 2014
 North American Natural Gas Midstream Infrastructure Through 2035: A Secure Energy Future
 "Global Trends in Renewable Energy Investment 2013" Frankfurt School UNEP Centre & Bloomberg New Energy Finance
 Ux Weekly, "2013 Uranium Spot Market Review", Feb 3, 2014
 Fraser Institute, " Survey of Mining Companies: 2013", Cervantes, Miguel et al, Mar 3, 2014
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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