Mixed Views On Outlook For Uranium Prices

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By Chris Shaw

Uranium prices have fallen 57% over the past year as natural disasters and faults have seen a number of reactors around the world shut down, JP Morgan suggesting in the shorter-term at least the spot market is likely to remain quite volatile as the seasonally soft northern hemisphere summer begins and there are rumours the US Department of Energy is placing uranium on the secondary market.

Taking a longer-term view though both GSJB Were and major global producer Rio Tinto ((RIO)) reportedly expect uranium prices to recover, with expectations the price could rise by more than 50% to US$90 per pound in coming years on the back of increased global demand.

According to a report by Bloomberg, some fund managers expect the gains will be led initially by developing economies, but the rest of the world will play a major role as well given the International Energy Agency estimates the world will need 32 new nuclear plants each year if goals of cutting carbon emissions in half by 2050 are to be achieved.

Certainly India will be an early leader in lifting output as it is set to start up three reactors this year, while a further six will come on stream next year in Japan, Russia, India Canada and China. This is tipped to lift global uranium demand by 0.8%.

Macquarie estimates global uranium demand last year was 66,500 metric tonnes but this should increase to as much as 102,000 metric tonnes by 2020, meaning supply issues will continue to be a large part of the pricing equation. This is especially so as World Nuclear Association figures suggest global uranium usage is now almost 70% higher than the near 40,000 tonnes of material mined in 2006. To date the difference has been made up of inventories and reprocessed material from old nuclear warheads, though supply of the latter continues to decline.

The other issue with pricing is the cost of production as major Canadian producer Cameco had production costs of about C$45 per pound last year, meaning it actually lost money on its output given legacy contracts in place to sell material at about C$40 per pound. This suggests the uranium price must increase if production is to also increase by enough to meet global demand.

While agreeing there is longer-term upside for prices, JP Morgan sees little to push prices higher in the next year or two, the broker trimming its (average) uranium price estimates to US$69.60 per pound this year from US$87.20 previously and in 2009 to US$75 per pound from US$85 previously. The broker has also lowered its long-term price forecast to US$65 per pound from US$70 previously.

The reason is JP Morgan expects the market to remain in balance or slightly in oversupply in the medium-term, the one caveat being this assumes no disruptions to supply at existing and planned projects. Longer-term the broker sees the market as more supply constrained, but given long-term supply is important in the industry it continues to see the term uranium market as offering more attractive pricing than the spot market.

History bears this out as over the past 12 years the term market has averaged an 8% premium to the spot market, so while the broker expects the current pricing gap of significantly more than this average will narrow, the term market will continue to be favoured.

The broker also accepts longer-term the demand outlook for uranium remains favourable as IEA figures suggesting a doubling of world electricity demand by 2030 will drive buying, while the fact supply never manages to reach capacity means there will always be some supply side issues.

Throw in the need for security of supply in long-term contracts and the broker sees scope for spot prices to bottom at around current levels before slowly trending higher in coming years.

In terms of how to play the sector the broker rates emerging Australian producer Paladin ((PDN)) as Overweight, having initiated coverage on the stock today. It likes the combination of new developments and expected earnings growth, leaving the stock well placed to outperform within the sector in its view.

Similarly JP Morgan rates Energy Resources of Australia ((ERA)) as Overweight given the run-off of legacy contracts will mean greater exposure to spot uranium prices in coming years for the company, which in turn sets it up to generate solid earnings growth.

Others in the market are similarly positive on the outlook for the two companies as the FNArena database shows Paladin as scoring six Buys compared to two Holds and one Sell and ERA with six Buys and three Holds. The average price targets for the two stocks are $6.39 and $24.49, while JP Morgan’s price targets stand at $7.15 and $24.00 respectively.

Shares in both stocks are stronger today despite a weaker overall market and as at 2.00pm Paladin was up 48c or more than 8% to $5.91 and ERA was 25c higher at $22.27.

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