Short-term supply-demand dynamics are not supportive
While most investors expected two major tailwinds in 2014 (nuclear restarts in Japan and lower supplies in relation with the HEU expiry in 2013), the uranium price has been weak lately, sending uranium stocks and notably Cameco (NYSE:CCJ) lower.
Under the 20-year HEU agreement, the U.S. paid Russia to convert approximately 500 metric tons of highly enriched uranium warheads of the Soviet Union era into low-enriched uranium for use as a fuel in commercial nuclear reactors. The agreement expiry removed more than 20m pounds of annual supply from a market that only produces 140m pounds a year.
But it looks like there is still oversupply in the market. On the supply side, some long-term project have been delayed in recent quarters due to the weak price environment but other projects, driven by sovereign interests, have been given the go ahead leading mine production to keep growing.
On the demand side, it is well known that utilities are well covered until 2016 and that demand from Germany is gradually declining as the country is in the process of decommissioning 17 reactors by 2022. As for Japan, approvals for reactor restarts are taking longer than expected.
The restart process in Japan is taking longer than expected
Despite strong political support for nuclear energy in Japan, anti-nuclear activists won an important legal battle recently when a Fukui prefecture court ordered Kansai Electric Power not to restart two idled nuclear reactors at Ohi because of their earthquake vulnerability.
This is the first time that a lawsuit brought by anti-nuclear activists has been successful in Japan. But the ruling may not remain in force for long as the Osaka Court of Appeal has rejected similar suits brought by citizens' groups and has explained that it would be inappropriate for a court to stop the restart of reactors before the NRA's safety assessment.
Anyway, this shows that the restart process is more complex than initially expected: according to Cantor Fitzgerald LP, 6 units may resume this year, well below its 12 units January forecast.
In view of the large uranium stockpile in Japan (the country honored its purchase contracts post-Fukushima despite the reactor shutdowns), Japanese utilities are unlikely to buy uranium before one or two years. But the gradual restart of reactors could be a positive for sentiment and send both the uranium spot and term prices higher.
The mid- and long-term picture remains attractive
Even if the short-term remains uninspiring, we remain confident in the long-term nuclear power dynamics. First, Japan has no other choice than to restart its nuclear reactors as it cannot afford to pay high LNG prices (compounded by the JPY decline) for an extended period of time.
Second, China has to fix its pollution issues. The country burns 3.5bn tons of coal a year and nuclear power is obviously an attractive alternative thanks to its super-low life cycle carbon emissions.
In all, there are currently 73 reactors under construction around the world, according to the World Nuclear Association, including 29 in China alone. And 172 reactors are planned… These figures are in line with Cameco's expectation of a net increase of 93 reactors over the next 10 years. Importantly, Cameco forecasts that this will spark an increase in annual uranium consumption to 240m pounds from 170m, suggesting that a supply deficit is likely to develop soon.
Potential consolidation wave in the industry, Cameco likely to emerge as a winner
The current low price environment could make it difficult for junior miners to survive and this could spark a consolidation wave across the industry in our view. Cameco could emerge as a winner from this situation. The company, which is expected to make money even in this environment as it is the lowest cost major producer, could take the opportunity to buy assets at low valuations. And could consequently be in a comfortable position when uranium demand picks up and pricing improves, with a likely huge earnings leverage.
Note that the outcome of the C$800m tax litigation with the Canada Revenue Agency could have an impact on Cameco's stock price as it represents close to 10% of the stock's market cap. But we believe that's it's already largely factored in the stock price.
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