Cameco Should be a Big Player in Nuclear Renaissance

by: Michael Filloon

Like some rare earths, uranium is a common element. Surprisingly, it is more common than tin, forty times more common than silver and five hundred times more common than gold. I have been a uranium bull for some time.

Uranium, like vanadium and some of the rare earths, are not openly traded. This creates problems with transparency and can create volatility. I have completed overviews of many smaller uranium exploration and production companies like Denison Mines (NYSEMKT:DNN), here, Crosshair Exploration (CXZ), here, and Uranium Resources (NASDAQ:URRE), here. These companies see large valuation swings, so I will try to show why Cameco (NYSE:CCJ) is different.

These stocks are a traders dream with five percent moves being a frequent occurrence. The problem with these names is the everyday investor could lose a very large investment in a short time. There are ETFs that are fairly good with respect to lowering volatility such as Global X Uranium (NYSEARCA:URA), PowerShares Global Nuclear Energy (NYSEARCA:PKN), iShares S&P Global Nuclear Energy (NASDAQ:NUCL), and Market Vectors Uranium+Nuclear Energy (NYSEARCA:NLR). One stock long term is Cameco (CCJ). This has been a pure play in uranium exploration and production, since they sold their gold interests some time ago.

With accidents like Chernobyl and Five Mile Island, uranium has received bad press. Since those accidents, some of the negative rhetoric has passed. With China and India's energy needs expanding and countries like France and Japan that have a majority of their energy produced through nuclear means, this negativity has transmuted into a more accepting environment. These variables look to be the start of a growing interest in nuclear energy.

Currently, Canadian uranium offsets 700 million tonnes of CO2 emissions annually. Canadian uranium reserves are approximately equivalent to 17.5 billion barrels of oil, and 4.5 billion tonnes of coal. Saskatchewan uranium reserves have more energy than the entire Canadian conventional oil reserves (not including the Athabascan oil sands). Saskatchewan uranium reserves are expected to last 20 to 30 years and this does not include undiscovered reserves. To give an idea of how important Saskatchewan's uranium is as opposed to other reserves, we will look at average grade. The average grade is how concentrated the uranium is. The higher the concentration, the cheaper it is to mine. The McArthur River has an average grade of 19.53% of U3O8 and Cigar Lake has 17.04% of U3O8. Deposits like this have made Cameco profitable while other, smaller companies with lower concentrations go out of business.

Increased uranium prices have helped to get smaller companies in the game, so to speak. Looking at expenditures of uranium mining, there has been a substantial increase from 2003:

  • 2003 $49.4
  • 2004 $101.5
  • 2005 $215.6
  • 2006 $343.2
  • 2007 $347.2
  • 2008 $403.6
  • 2009 $288.3

*all numbers in millions

Since 1980, uranium companies have spent more than five billion dollars just in Saskatchewan. Being in this uranium hub has its advantages for Cameco. Cameco also is benefiting from the recent run-up in the uranium spot price.

Now that the spot price is at the point of crossing the long term price, we could see sellers holding out for higher numbers. This company believes that the fundamentals are stronger than in 2007 where speculation created a bubble. It seems Cameco is well positioned and prepared for this change in uranium prices.

The change in fundamental has a lot to do with China. They recently entered into long term contracts as opposed to buying on the spot market. They also increased their nuclear reactor build program. This metric has changed the supply and demand dynamic. China currently has 13 reactors on the grid and 27 in construction. China has 11 GW of nuclear produced electricity. They plan to expand this to 80 GW by 2020.

There is more upside to this equation. 80 GW would only produce 5% of China's electricity needs. To reach this number they would have to build an additional forty 1000 megawatt reactors. Before last year, China only required about 4.5 million pounds of uranium per year. This represents only 2% of the current global production. If the number of builds are correct, China would need at least 45 million pounds per year. This is about 17% of annual expected world consumption. This doesn't include the first uranium needed to load the reactors first cores. When a reactor is initially started, the core is loaded with about 1.2 million pounds per 1000 megawatts of electricity generated. Cameco believes that these new builds and their immediate uranium needs will outpace supply. Although we have considerable time to prepare, it seems pricing could increase significantly.

Cameco bases their calculations for this supply and demand disruption from the loss of the HEU agreement. This agreement ends in 2013 and Russia has stated they will not resume HEU under current terms. This exiting will cause a large hole in supply. Currently the world uses 180 million pounds of uranium. Current uranium production only makes up 140 million pounds. This remaining 40 million will need to be made up somewhere, and without a second round of HEU.

Other countries are also interested in nuclear. UAE, Vietnam, Turkey, South Korea, Japan, and India are also interested in expanding their nuclear interest. There are 19 reactors currently in India, and they plan to increase this to 31 total by 2019. South Korea will expand to a total of 30 reactors in that time frame. Some of these countries building reactors have not contracted for their future uranium needs. This could create some scrambling to attain their fuel. Germany has said it was going to phase out its nuclear program, but that has since changed. Germany has decided to run their reactors for at least another 12 years. Cameco thinks that the United States will build four to eight reactors in the next decade. With all countries included, the world will add 20% more reactors or an additional 86.

Cameco has signed two strategic contracts with China to provide them with Uranium. The first deal was signed with China Nuclear Energy Industry Corporation. 23 million pounds of uranium will be purchased by 2020. The second deal was signed in November of last year. China Guangdong Nuclear Power Holding Company will purchase 29 million pounds in a contract that will run through 2025. Cameco has announced they are currently working with India to sign a long term contract.

Over the next decade it has been estimated that uranium usage will increase 3% per year. In this model, 230 million pounds will be used in 2019. This means over two billion pounds will be used over the next ten years. It may be tough for companies to get mines running by that time, as it can take up to ten years of exploration and preparation.

Cameco has stated they will be able to double production by 2018. The very large increase in production will be coming from existing projects. So any new projects purchased over that time frame will be extra. Cameco will be relying heavily on Cigar Lake, so keep an eye on how that mine fares. It has had several possible production dates, which have been pushed back several times due to flooding. Cameco has had a very good couple of years. They have seen a 20% increase in U3O8 production 2009. In the first three quarters of 2010 they've seen a 17% increase in production.

Cigar Lake looks to be able to produce 18 million pounds of uranium per year at full capacity and it is the cornerstone with respect to doubling production. Cameco will keep 9 million pounds of that production. Cigar Lake is the largest undeveloped high grade uranium deposit in the world but this mine is in a sandstone environment and has had a history of flooding. The water has been removed from the well and work is underway to make Cigar Lake a developed project. Cameco believes this project will be on line by mid-2013.

Kazakhstan is another area Cameco has interest in. In the first three quarters of 2010 there was production of 2.1 million pounds from this region. The processing facilities are moving toward full capacity. Cameco is in talks to increase its share of production. This looks to be another area with huge potential, that would further increase production.

McArthur River is the center piece of Cameco's uranium production. It has currently the world's highest grade uranium ore source ever discovered, at an average 19.5%. Cameco is currently using freeze walls to begin working in mining zones.

There are several new projects on the horizon for Cameco. The currently own 70% of Kintyre, Australia. This location helps to diversify the company while adding low cost production. The Millennium project in Saskatchewan will add a significant uranium resource while being able to use the milling capacity at Key Lake. Rabbit Lake continues to produce for Cameco. This location has mined and milled over 180 million pounds. Cameco also has holdings in the United States at Smith Ranch-Highland in Wyoming and Crow Butte in Nebraska. These two locations are producing 2.5 million pounds of uranium per year. Although Cameco has a lot riding on its Cigar Lake project, it has diversified its assets enough to still have impressive growth in production even if it has to delay production yet more. Without the above mentioned programs, Cameco still has direct interest in almost 70 active exploration projects, in six countries.

Outside of direct uranium production, Cameco is investing in other areas of the nuclear fuel cycle. Conversion facilities and new technologies are also highlighted here. The conversion facilities aid in growth of their overall business. Cameco has also partnered with GE and Hitachi (HIT) to work on a new laser enrichment technology. They also have a 32% interest in four nuclear reactors servicing Ontario. Although there has been no word on new facilities being built, Cameco is working with Bruce Power, on extending the life of the reactors.

Over that last few years, Cameco has produced good results. Full year revenues have increased from 1.905 billion in 2007 to 2.315 billion in 2009. Although uranium prices have fluctuated, the price of fuel is very low and even when times are tough, this essential energy is reliable. Most uranium exploration and production companies have a very high beta. However, this price fluctuation is not seen in Cameco's stock. Its business relies on long term contracts that provide the company with downside protection if uranium price pulls back and the upside protection that has a ceiling around $100 per pound protecting the customer. This helps to level out pricing and help Cameco, the customer and the investor have a predictable outcome.

In summary, Cameco is a leader in the uranium market. Its assets at McArthur and Cigar Lake have very high concentrations of uranium. Due to this, its production costs are much lower then the competition. Cameco also has an ability to increase production, and do it cost effectively. All of this places Cameco in a unique position with respect to the upcoming nuclear renaissance.

Disclosure: I am long DNN, URRE.