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  • Hunting On The Backbone For Valuable Master Limited Partnerships With Hinds Howard

    Hinds Howard knows what makes a master limited partnership worth buying and holding for income and tax advantages. In this interview with The Energy Report, the head of MLP research for asset management firm CBRE Clarion Securities explains why the recent downturn in the sector was a practically meaningless dip, and describes why MLPs are an ever-strong growth proposition built on the energy resource backbone: drilling, pipelines and refineries.

    The Energy Report: In an interview last fall, Hinds, you noted that master limited partnerships [MLPs] had "massively outperformed the broader stock market" for several years previously. Then the MLP sector went into free fall. What's going on?

    Hinds Howard: During an eight-day period in October, the MLP index lost 13% of its value. We have not seen a streak like that since the beginning of 2008. Retail investors hold MLPs for a long time. There are tax consequences for trading in and out of an MLP; selling raises the tax bill. Retail investors were not the big sellers during the streak.

    There are reports that certain hedge funds had non-MLP trades that went against them, and they were forced to sell off their MLP winners. A large amount of total return swaps in the MLP space could have contributed to the sell-off. It's tricky to figure out, because the MLP sector is fully invested from an institutional standpoint. The big, dedicated MLP mutual funds are hit with negative tax consequences when they sell, too, so they tend to hold no matter what. Their cash is fully invested and not really available to buy MLPs on short notice, without additional inflows. Hedge fund selling seems to have caused the correction. The good news is that investors can buy names that sold off 15% plus. And during the past week, MLPs are back up.

    TER: Was October the first MLP market correction since 2008?

    HH: We had a correction of more than 10% last year. One day in August 2011, the MLP sector sold off 8.5%. Macro factors do impact liquidity across the overall stock market, and MLPs have limited liquidity trading volume. When the overall market sees less trading volume, MLP moves tend to be exaggerated.

    TER: Has the oil and gas surplus affected the valuation of energy MLPs?

    HH: Generally, the stock market valuations of MLPs are affected when oil prices fall below $90 per barrel. But the vast majority of an MLP's cash flow is not impacted by direct movements in commodity prices. Certainly a slowdown in production would be bad for MLPs, but that is not the case. The total return proposition remains quite attractive. It includes a 5-6% distribution yield and a 6-8% distribution growth rate on average.

    TER: Is now a good time to buy MLPs?

    HH: There has rarely been a bad time to invest in MLPs. The tailwinds that have historically supported the growth of this sector remain in place. The outlook for energy infrastructure investment continues to accelerate. We continue to need more pipelines, more processing facilities, more export terminals, more everything. MLP-operated infrastructure projects generate attractive returns because the returns from building a pipeline exceed the cost of capital. The intrinsic value of MLPs based on distribution discount models screens "attractive" because low interest rates are a key input to those valuation models.

    Obviously, if interest rates rise, that potentially goes against MLP returns. But even then, the valuation of MLPs remains compelling relative to bonds, which cannot grow their payments. MLP valuation remains attractive relative to real estate investment trusts [REITs], which can grow their dividends but probably not as fast as MLPS, and which have lower yields. Utilities can grow, but they tend to grow more slowly and act more defensively. MLPs are compelling relative to these other yield-based equities partly because MLPs focus on building out capacity, rather than growing through expensive acquisitions.

    TER: How does one judge the potential of a new MLP?

    HH: Many MLPs are spun off larger corporations, and that is a positive sign. Being tied to a strong parent helps with access to capital and limited debt. Cash flow in excess of current distribution is very important. Distribution coverage provides the cushion in a downturn. And having a large percentage of fee-based contracts is very important. Even more important is having a large percentage of take-or-pay contracts. On those deals, customers pay for access to a pipeline even when they are not using it. And the MLPs that really outperform are the dropdown MLPs, which buy assets from the parent company over time.

    TER: Does it matter whether an MLP is positioned downstream or upstream of the wellhead?

    HH: Downstream refining carries its own commodity price exposure. Being in the middle of the energy value chain is preferred.

    TER: Is there a risk to being upstream?

    HH: The closer an MLP is to the wellhead, the more susceptible it is to a downturn in energy prices. A long-haul pipeline is more insulated from risk as it serves a producing region comprised of many wellheads.

    TER: How are the MLP indexes performing?

    HH: The Alerian MLP Index (NYSEARCA:AMLP) is doing better than the Alerian MLP Equal Weight Index (AMZE) or the Cushing 30 MLP Index (NYSEARCA:MLPX) because it is a market cap-weighted index, and larger MLPs have outperformed this year. Kinder Morgan Energy Partners L.P. (NYSE:KMP) represents a very large portion of the Alerian MLP Index. The index performed well following the announcement of the acquisition of Kinder Morgan Energy Partners [an MLP] by Kinder Morgan Inc. (NYSE:KMI) [the original parent corporation]. The higher the weight of Kinder Morgan in an MLP index, the better that index performs. During the recent downturn, Kinder Morgan Energy Partners did not selloff as much as other MLPS. The larger-cap MLPs tend to do better during downturns.

    TER: How many MLPs are there in the Alerian MLP Index?

    HH: About 25% of the Alerian MLP Index is represented by Kinder Morgan Energy Partners and Enterprise Products Partners L.P. (NYSE:EPD). There are around 120 MLPs, but only 50 are listed in the Alerian MLP Index. There are a number of qualification requirements. There is no widely followed index that has all the MLPs in it. That is one of the problems with the space right now.

    TER: What qualifications does a company have to meet to be in the Alerian MLP Index?

    HH: Qualifications include having a partnership or LLC structure, a certain level of market capitalization, trading volume and consecutive distribution payments at the minimum quarterly distribution or above. Because general partners are not allowed in the Alerian MLP Index, Energy Transfer Equity L.P. (NYSE:ETE) is not part of the index. It gets most of its cash flow directly from MLPs and incentive distribution rights that it owns. These rules are subject to change by management of the index.

    Because Kinder Morgan is consolidating its pipeline business, Kinder Morgan Energy Partners will have to come out of that index based on the current rules. And so will El Paso Pipeline Partners L.P. (NYSE:EPB), which is also being acquired by Kinder Morgan Inc. Those two MLPs currently represent 11% of the Alerian MLP Index. The question is, what does Alerian plan to do? Taking that much market cap away from its index could drastically affect performance for exchange-traded funds and other market trackers. It will be great if Alerian decided to expand the number of names in the index to make up for losing that market cap.

    I do hope that Kinder Morgan Inc. is not left in the index as a corporation. It is important to keep the Alerian MLP Index for only MLPs. Putting a corporation in the index opens up the possibility for including other corporations, which would dilute the index and make it less clear. The Kinder Morgan deal is expected to close by Thanksgiving, so an announcement will be forthcoming.

    TER: What MLPs do you like?

    HH: MLPs that generally outperform in most environments are those that have high distribution growth rates, high distribution coverage, good balance sheets, fee-based business models, and operations focused in and around regions with a high level of producer activity. MLPs that meet those criteria include Western Gas Partners, L.P. (NYSE:WES), EQT Midstream Partners, LP (NYSE:EQM) and Summit Midstream Partners LP (NYSE:SMLP).

    Then there are MLPs with businesses that benefit from the growth in exports of energy commodities. Names that fall in that category include Targa Resources Partners L.P. (NYSE:NGLS), Sunoco Logistics Partners L.P. (NYSE:SXL) and Energy Transfer Partners L.P. (NYSE:ETP).

    TER: Let's talk about those MLPs.

    HH: Western Gas Partners has a very strong parent company that supports its growth, Anadarko Petroleum Corp. (NYSE:APC). Anadarko is very active in the DJ Basin in Colorado, and also in the Delaware Basin. We see those areas as very attractive for production activity. Western Gas is going to benefit from building infrastructure that Anadarko needs. It can also supply infrastructure to other customers. Western Gas has a great management team. It enjoys a solid distribution coverage ratio. It meets all the criteria that one looks for in a solid MLP.

    EQT Midstream has a great core asset: a natural gas pipeline asset in the Marcellus called the Equitrans system. Its parent company, EQT Corp. (NYSE:EQT), is a very active producer in the region, and it firmly supports the growth of EQT Midstream. The MLP is building a takeaway long-haul natural gas pipeline that reaches into the southeastern United States, where there is a lot of demand for gas from utilities. It's a very nice MLP.

    Summit Midstream Partners has gathered assets in the Marcellus and Utica Shales. These assets feed into processing facilities being built by Mark West Energy Partners L.P. (NYSE:MWE). Summit is a structurally sound MLP. It gets 90%-plus of its cash flow from fee-based contracts supported by minimum volume commitments. It is also expected to acquire additional assets in the Bakken Shale from its private equity-backed parent, Summit Midstream Partners LP (SMLP).

    Targa Resource Partners announced its acquisition of Atlas Pipeline Partners L.P. in October. Atlas Pipeline has a solid footprint in the Permian Basin that overlaps well with Targa's assets. Targa is active in propane exports on the Gulf Coast. It is a well-run partnership with a lot positive characteristics in terms of distribution coverage and balance sheet strength and growth factors.

    Sunoco Logistics is also going to benefit from exports. It is developing projects that will provide takeaway capacity for ethane and propane out of the Marcellus Shale area to markets in Canada and eventually abroad. It also has the Nederland terminal on the Gulf Coast, which will export natural gas liquids once online. And it has large crude oil pipeline expansion projects coming out of the Permian Basin. Sunoco Logistics' market valuation looks attractive on a distributable cash-flow basis, as does EQT Midstream's market valuation, relative to other fast-growing MLPs, despite low current yields for each.

    Energy Transfer Partners is involved in a number of large pipeline projects, and a liquefied natural gas export project. It is tied to a lot of the positive trends in the sector. Energy Transfer Partners trades at attractive distributable cash flow multiples relative to other large cap MLPs.

    TER: Thanks for your time, Hinds.

    This interview was conducted by Peter Byrne of The Energy Report and can be read in its entirety here.

    Hinds Howard leads CBRE Clarion's MLP investment team. CBRE Clarion is an asset management firm with more than $25B in assets under management. Prior to joining CBRE Clarion Securities in 2013, Howard was a portfolio manager and partner managing separate accounts with a MLP investment focus at Guzman Investment Strategies. While at Guzman, Howard managed client portfolios investing in MLPs and North American energy securities. He previously worked for Lehman Brothers, analyzing and modeling public and private energy MLPs, first in the investment banking division and subsequently for an investment fund investing in MLPs. He has more than 10 years of MLP investment experience. Howard earned a master's degree in business administration from Babson College, and a bachelor's degree in finance from Boston University [summa cum laude]. He has been the author of a blog on MLPs since 2009 [mlpguy.com].

    Want to read more Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

    DISCLOSURE:
    1) Peter Byrne conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
    2) The following companies mentioned in the interview are sponsors of Streetwise Reports: None. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
    3) Hinds Howard: I own, or my family owns, shares of the following companies mentioned in this interview: Targa Resources Inc. CBRE Clarion manages MLP investment funds that own the following companies mentioned in this interview: Energy Transfer Partners, Energy Transfer Equity, Western Gas Partners, Enterprise Products Partners, Sunoco Logistics Partners, Targa Resources Inc., Targa Resources Partners LP, Summit Midstream Partners, Mark West Energy Partners L.P., EQT Midstream Partners L.P. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
    4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
    5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.

    6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

    Streetwise - The Energy Report is Copyright © 2014 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part.

    Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported.

    Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.

    Participating companies provide the logos used in The Energy Report. These logos are trademarks and are the property of the individual companies.

    101 Second St., Suite 110
    Petaluma, CA 94952

    Tel.: (707) 981-8204
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    Nov 06 4:11 PM | Link | Comment!
  • Bob Moriarty: $80 Oil Is The New Normal Minimum

    Saudi Arabia has nothing to do with falling prices at the pump, argues Bob Moriarty. He sees falling demand as the culprit, driven by economic slowdown in China, Europe and the U.S. In this interview with The Energy Report, Moriarty explains why increased consumer spending won't solve our problems, and discusses why he's still a fan of North American energy stocks-even though he hates shale oil.

    The Energy Report: Bob, thanks for joining us again. In your recent interview with The Gold Report, you discussed U.S. involvement in the Middle East and how it could contribute to a financial crash. Today, oil is in the low eighties. A lot of focus is on Saudi Arabia and the fact that the country is not pulling back on its production. Is this a price war to squeeze out the North American shale oil plays?

    Bob Moriarty: No, that's not the case. The price of oil is going down because demand is going down. China is slowing down, and that's reflected in the price of platinum, silver, copper, iron and coal. It's perfectly natural for the price of oil to go down as well. I don't attribute falling prices to any malignant behavior on the part of Saudi Arabia. I'll tell you-Saudi Arabia doesn't give a damn about shale oil because shale oil is not economic. Anybody who can do basic math understands that. Everybody in the oil business is saying the math doesn't work. The majors are bailing out on shale as fast as they can. The wells are deep, expensive and last 2-3 years before depletion.

    TER: So, U.S. energy independence. . .

    BM: It's absolute rubbish. We are never going to have energy independence. We have much more coal than we have oil. Coal's been a disaster. Coal mines have been shutting down for the past several years.

    TER: Has new infrastructure or technology, like fracking or horizontal drilling, brought down the cost of extracting oil?

    BM: Exactly the opposite-it's increased the cost. It used to cost $30 per barrel [$30/bbl] to extract oil using conventional methods. Now it costs $80/bbl. No one is making money in fracking, not in North Dakota, Montana or Wyoming. They're all losing money because the cost of production has gone way up. Nobody talks about peak oil anymore, but peak oil is absolutely real. Below an oil price of $80/bbl, no one can afford to produce.

    TER: Yet you're still a giant fan of energy stocks. What value do you see in the energy sector?

    BM: I'm a giant fan of energy, food and water. The one thing we know is that cheap oil is over. The cost of energy is going to go up. The big opportunity in the next 15 years is going to be energy in any form. Food and water are analogs of energy.

    TER: Are there specific energy stocks that are more interesting to you?

    BM: Yeah, the ones that are well run, well financed and well managed.

    TER: Can you give us some of your favorites?

    BM: When I write about an energy stock, it's because I know the management. I met the people at Torchlight Energy Resources Inc. (OTCQB:TRCH) when I was out in L.A. at a conference a few months ago. They're raising money, and the company is going to have a lot of money when the cost of projects and the cost of drilling come down. Torchlight is drilling in Texas and Oklahoma.

    TER: Is the money being raised for drilling programs? The company recently bought a property in Texas.

    BM: I'd like to see Torchlight increase its acreage and do drilling. It's a very favorable time because things have slowed in the patch. I actually like corrections. Everybody else wants to buy stuff at new highs. I'm not a big fan of that.

    Another company I follow is Pan Orient Energy Corp. (OTCPK:POEFF) [POE:TSX.V]. That company is kind of a tripleheader. It has projects in Thailand, Indonesia and Canada. All Pan Orient has to do is succeed in any of them. The stock seems pretty cheap to me now.

    TER: You said that stock prices for most energy stocks have gone down, but you don't see them decreasing much further. Is that true for shale energy companies?

    BM: A lot of guys in shale are literally going to go out of business. I will make it crystal clear: I am not a shale fan. The idea that shale is the salvation of the United States, that we're going to be the net energy producer and that we're going to start exporting oil and natural gas-it's bullpucky. Anybody who knows energy knows it's bullpucky. It ain't gonna happen.

    We can expect oil from shale, but it's going to cost more money. I think that somewhere in the $75-80/bbl is the bottom for oil prices, but a lot of people are going to be hurt at that price. You want to look for companies that are well managed, with conventional oil in safe jurisdictions.

    TER: A counterargument could be that consumer spending could go up, because people are paying less for gas and have more disposable income. Do you buy into that theory?

    BM: Well, yeah. I mean, the natural way of economics is that over time, the cost of the things we consume should actually go down. Deflation is not a bad thing. Deflation is a good thing. If you look at the price of computers now compared to the price of computers 20 years ago, we get far more computer today at a fraction of the price. That's the way economies are supposed to work. Cheap oil hurts energy companies, but consumers obviously are better off.

    TER: Would an uptick in consumer spending then trigger a downturn in energy demand growth in China, the U.S. or Europe?

    BM: China has been on an orgy of inefficient spending for the last five to 10 years. There are millions of housing units in China that can't be sold. China needs a cleansing of its economy to restart natural growth. If China takes the same approach as the United States and Japan, and allows the government to micromanage, then that could turn into a full-blown depression. Governments never fix anything. Governments only screw stuff up. The idea that government is the solution to anything is a really flawed logic. We need the government to stay out of the economy as much as possible.

    TER: If we're seeing decreases in energy costs and increases in consumer spending, what's going to trigger the crash you discussed in your last interview?

    BM: We're not seeing an increase in consumer spending. We're seeing more efficient consumer spending. If you were spending $100 for a tank of gas and now it's $80, you don't necessarily go and spend that $20 difference. Hopefully you save it. Economies grow through saving, not through consumption. We created this idea that you could somehow consume your way to prosperity. Think about it for a minute. How are you better off by consuming? You're better off if you save.

    There is nothing sacred about economies growing. We need economies that spend money wisely and economies that are based on savings rather than consumption. Growing economies are not necessarily a good thing.

    TER: Anything else you want to mention in terms of trends and energy?

    BM: I think we are experiencing a natural correction, primarily due to slowdowns in Europe and China, and it's perfectly natural for the price of energy to go down. I think $80/bbl oil is probably the new normal minimum.

    TER: Thank you for joining us Bob.

    BM: My pleasure.

    This interview was conducted by Karen Roche of The Energy Report and can be read in its entirety here.

    Bob and Barb Moriarty brought 321gold.com to the Internet over 10 years ago. They later added 321energy.com to cover oil, natural gas, gasoline, coal, solar, wind and nuclear energy. Both sites feature articles, editorial opinions, pricing figures and updates on current events affecting both sectors. Previously, Moriarty was a Marine F-4B and O-1 pilot with more than 820 missions in Vietnam. He holds 14 international aviation records.

    Want to read more Energy Report interviews like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see a list of recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

    DISCLOSURE:
    1) Karen Roche conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. She owns, or her family owns, shares of the following companies mentioned in this interview: None.
    2) The following companies mentioned in the interview are sponsors of Streetwise Reports: Torchlight Energy Resources Inc., Pan Orient Energy Corp. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
    3) Bob Moriarty: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Torchlight Energy Resources Inc., Pan Orient Energy Corp. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
    4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts' statements without their consent.
    5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports' terms of use and full legal disclaimer.

    6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

    Streetwise - The Energy Report is Copyright © 2014 by Streetwise Reports LLC. All rights are reserved. Streetwise Reports LLC hereby grants an unrestricted license to use or disseminate this copyrighted material (i) only in whole (and always including this disclaimer), but (ii) never in part.

    Streetwise Reports LLC does not guarantee the accuracy or thoroughness of the information reported.

    Streetwise Reports LLC receives a fee from companies that are listed on the home page in the In This Issue section. Their sponsor pages may be considered advertising for the purposes of 18 U.S.C. 1734.

    Participating companies provide the logos used in The Energy Report. These logos are trademarks and are the property of the individual companies.

    101 Second St., Suite 110
    Petaluma, CA 94952

    Tel.: (707) 981-8204
    Fax: (707) 981-8998
    Email: jluther@streetwisereports.com

    Nov 06 3:33 PM | Link | Comment!
  • Colin Healey: Suppressed Uranium Price Shouldn't Keep Hedged Producers And Promising Explorers Down

    Near-term oversupply is suppressing uranium prices but there are signs of upside movement, says Colin Healey, research analyst with Haywood Securities. In this interview with The Mining Report, he notes that non-discretionary buying in the uranium spot market returned in Q3/14 after a lengthy absence and that the 71 reactors being built around the world should support Haywood's long-term $75/lb uranium forecast. Healey also discusses companies suited to perform in the current market and beyond.

    The Mining Report: The spot price for uranium stayed below $30 per pound [$30/lb] in May through late July. Since then the price popped up above $36/lb before settling at around $35/lb. Is that the near-term floor?

    Colin Healey: It's a difficult call. Two things give us hope that we may see support at current levels. We saw the return of non-discretionary buying to the spot market in Q3/14 after an absence of three consecutive quarters-something we haven't seen since 2005. We look for non-discretionary buying to thin the market of available material and underpin support for uranium prices at current levels. The return of non-discretionary buying is important.

    We also look for greater activity in the term market where an increase in contracting activity should also increase the competition for material in the spot market. We expect a sustainable rally in the spot market to coincide with progressive increases in the term price over the next 24 months. As of this week we saw no new interest in the term market, but much of that is traded off-market. We're watching closely for anything that might move the term price. We saw the UxC Consulting Co. [UxC] weekly spot price come up $0.85 to $36.50/lb, which adds some confidence.

    TMR: Are there signs that non-discretionary buying will continue?

    CH: It's difficult to get transparent data on that. In the most recent quarter we saw the first return of non-discretionary buying as a small component of the total volume in the spot market. If that materializes into a trend, then we might have some evidence that it is returning in a meaningful way.

    TMR: Why didn't the end of Russia's "Megatons to Megawatts" create greater price strength in the uranium space in 2014? And what's responsible for the overhang on uranium prices now?

    CH: As a major source of secondary uranium supply, the loss of the Megatons to Megawatts program was a significant event. It shifted the balance in total supply in favor of primary sources-although any impact will be tempered in the near term by the fact that the market remains oversupplied. The program was structured with a defined timeline and as such its end was not a shock. There's a form of replacement agreement in place between the United States Enrichment Corp. [USEC] and Techsnabexport [TENEX], the commercial subsidiary of Russia's Ministry of Atomic Energy, for delivery of enriched uranium to the U.S. with the U.S. delivering natural uranium in return, which covers about half the deliveries received under the Megatons to Megawatts program. That agreement appears to include an option to double the initial volume at the option of the USEC. The agreement is effectively a separative work unit [SWU] purchase contract where USEC is paying for enrichment services embedded in the Low Enriched Uranium [LEU] product TENEX is supplying.

    The good news is that this structure should mean that utilities are more reliant on primary uranium production than before and that should be ultimately bullish for uranium prices. Nevertheless, the market has been oversupplied for several years. Total supply in 2013 was about 207 million pounds [207 Mlb] versus demand of around 172 Mlb, reflecting a surplus of about 35 Mlb. In 2014, we estimate a surplus of 20 Mlb, which contributes to an overhang in prices.

    TMR: Haywood forecasts the 2015 spot price at $39.50/lb, but in 2016 that jumps to $53/lb. What are the catalysts that are going to push the price 34% higher?

    CH: We're looking for progressive growth in long-term and spot prices based on a more normalized demand-supply relationship. Prices remain low as the market continues to be oversupplied, and as a result, as much as 30% of current primary supply is thought to be uneconomic at current spot prices. Driving our appreciating forecast are the 71 reactors currently under construction globally, coupled with a rationalization on the production side, whereby benchmark uranium prices will begin to move toward the marginal cost of production, which itself will shift with eventual production atrophy.

    The global reactor construction pipeline is important. New reactor fuel loadings require about three times more uranium than the average annual burn of the same reactor, so there's an increase in demand when a fixed pipeline of new reactors comes on-line. We also believe that a return to nuclear power in Japan will help the situation. We're looking for between two and six units to be restarted in 2015. Our price forecast is underpinned by an assumption of tight demand-supply balance in uranium markets by 2017 with the price coming up to a point that rationalizes the majority of current production, plus provides an incentive for new mines.

    TMR: Your average price for 2016 is $65/lb. How much of that is based on more reactors restarting in Japan?

    CH: The return of Japan to nuclear power isn't as significant as the construction pipeline. It's more of a sentiment indicator, which we believe could move uranium stocks. We believe that Japan has significant uranium inventory, which should support consumption during the restarts. It's really the pipeline of reactors under construction that is underpinning the majority of our bullishness on the uranium price.

    Furthermore, we believe the term market will respond alongside the spot market to the catalysts I mentioned. The term market is a better gauge of the overall condition of the sector. In 2013, reported term market volumes were very low at just over 20 Mlb, versus 191 Mlb in 2012, and over 100 Mlb in 2011. We've seen a bit of a recovery in volume in 2014 at almost 70 Mlb. We expect term market volume to pick up steadily in the coming months as uncovered utility requirements grow. We expect 2015 to be even busier.

    TMR: Despite a price run-up in August, most uranium equities, especially the producers, did not follow the spot price higher. How do you explain that?

    CH: The resource sector has had a rough ride over the last two months with the TSX Venture Index down more than 20% since the end of August. Most uranium equities were not spared. Recent positive uranium spot price movements have failed to reverse the negative trend in the equities and, in the near term, equities will respond to macro news, such as in Japan where 19 of 26 assembly members recently voted in favor of nuclear reactor restarts. Another positive vote of the Prefectural Assembly, expected later this week, could mean reactor restarts in Japan in the first half of 2015. We are seeing reports in the press that only 8 of the 49 members of the Assembly oppose restarts.

    TMR: Do you have any insight into the investor mindset on the commodity?

    CH: We're looking beyond the spot market to the term market for material consecutive movements month-over-month to gauge the sector. A movement in long-term price indicators, say $3-4/lb, in consecutive months would reflect the beginning of a meaningful return to the term market by utilities. We believe that would wake up the broad market to the equities.

    For the producers, there are few tradable pure-play uranium producers, some of which have limited gearing to spot market prices, such as Cameco Corp. (NYSE:CCJ), where term contracts represent a majority of sales.

    TMR: Research reports from Haywood suggest that near-term producers and select explorers are the uranium equities most likely to perform. Is that your view?

    CH: We certainly saw the biggest response from the near-term producers and developers during the rally in uranium equities from late November 2013 to mid-March 2014. We would expect that group to lead the pack in the next rally as well. This group is preproduction and is not selling and depleting their resources into a weak market. In that regard their cash flows tend to be linked to their development budgets, and their general and administrative expenses, making their cash flow more predictable. They offer historic correlation to uranium price movement without the direct cash flow exposure to the uranium price that we get with the current producers.

    TMR: Let's move to the producers. Tell us about some compelling narratives in that space.

    CH: We cover Energy Fuels Inc. (OTC:UUUU) with a Buy rating; it is a conventional uranium producer in the U.S. We also follow Uranium Energy Corp. (NYSEMKT:UEC), which we currently have a Hold rating on.

    TMR: You mentioned Uranium Energy Corp. What's happening there?

    CH: Uranium Energy has a hub-and-spoke strategy with the Hobson ISR processing plant at the center of that hub. Its flagship project-the Goliad project in South Texas-is not in production. The Palangana well fields that were in production are now more or less on care and maintenance. We don't have a lot of operational data on those assets, but they seemed to be underperforming before they were taken offline due to low uranium prices. We're waiting on a Goliad construction update from Uranium Energy before we make any further decisions about the company. We have a $1.70 target and a Hold rating on Uranium Energy.

    TMR: What about Energy Fuels?

    CH: Energy Fuels' current strategy is to leverage its strong contracting book. The company is not expected to produce from processing of conventional ore at its White Mesa mill in 2015, rather it will sell into its favorably priced contract book from inventory. It will decide to produce more uranium once it believes there is price support well above current levels. We like the company because of that contract book and because it's in the position to respond to recovering uranium prices and make that production decision, yet still generate revenue from sales during 2015.

    TMR: It's essentially 100% hedged. What are your thoughts on that strategy?

    CH: You could interpret it as 100% hedged, but I wouldn't because it has the ability to produce and sell additional material into current prices, offering potential gearing to uranium price when justified. Energy Fuels decided to sell into its contracts because those contracts are priced in excess of current market prices. Its planned sales are all contract, which is by definition hedged, but the company can turn on the production switch and generate sales at the prevailing uranium price, though it would probably take six to nine months to ramp up production from mines; stockpiled ore could be processed sooner. We have a $12.50 target on Energy Fuels and a Buy rating.

    TMR: Few, if any, uranium producers have outperformed the TSX Composite Index so far in 2014. Do you expect a similar story in 2015?

    CH: It's a difficult call in the near term as uranium prices have proven very tricky to forecast and the short list of producers have diverse production methods, scales and capital structures. Our commodity price forecast for the next three years calls for a significant appreciation, as we highlighted. If our uranium price forecast proves to be accurate over the next few years, I would expect uranium producers to outperform the Composite, at least in terms of nominal returns and not attempting to compare the risk-adjusted returns of the TSX Composite Index.

    TMR: Thank you for talking with us, Colin.

    This interview was conducted by Brian Sylvester of The Mining Report and can be read in its entirety here.

    Colin Healey joined Haywood in 2008 as a mining associate focusing on the uranium, iron ore and coal sectors. Immediately prior to his arrival at Haywood, Healey worked at a major Canadian bank as an analyst structuring debt financing across a wide variety of industries. Prior to joining the finance industry seven years ago, he worked for eight years as quality manager in an ISO 17025-accredited laboratory that performed extensive assay and analysis work for major mining and precious metals refining companies. He holds a Master of Business Administration from the Schulich School of Business at York University, majoring in finance and investments, as well as a Bachelor of Commerce degree majoring in computer information systems and a technical diploma in mechanical engineering.

    Want to read more Mining Report articles like this? Sign up for our free e-newsletter, and you'll learn when new articles have been published. To see recent interviews with industry analysts and commentators, visit our Mining Report home page.

    DISCLOSURE:
    1) Brian Sylvester conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
    2) Colin Healey: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: Energy Fuels Inc. and Uranium Energy Corp. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
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