Cameco BOA Conference Transcript May14 2014

 

Bank of America/Merrill Lynch Global Metals, Mining & Steel Conference Cameco Corporation Presentation Transcript

Date:

Wednesday, May 14, 2014

Time:

9:00 AM ET

Presenter:

Grant Isaac, Senior Vice-President and Chief Financial Officer

 

Caution about forward-looking information This presentation includes forward-looking information or forward-looking statements under Canadian and U.S. securities laws, including our expectations regarding future world electricity consumption, the number of net new reactors we expect to be built, our expectations regarding future uranium supply and demand, our future uranium production targets and forecasts, and our forecasts relating to mining, mine life, production, development and other activities. This information involves risk and uncertainty, including the risk that we face unexpected development and operating risks, the risk of disruption of our operations, and the risk of changes in regulation or public perception of the safety of nuclear power plants. In addition, we have made assumptions in drawing the conclusions contained in these statements, including assumptions regarding future demand for uranium, production levels and costs, mining conditions and our ability to continue our operations without any significant disruptions. Additional information about the material factors that could cause the results to differ materially, and the material assumptions we have made, are contained in our current Annual Information Form and our current annual MD&A, which are available on SEDAR. Forward-looking information is designed to help you understand management’s current views of our near and longer-term prospects, and it may not be appropriate for other purposes. We will not necessarily update this information unless we are required to by securities laws.

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GRANT ISAAC (SENIOR VP AND CFO): Thank you very much. Obviously, delighted to be here, and thank you, Oscar. You do a great job following the uranium space. It’s not an easy space to follow and we certainly appreciate the work that you put into it and the lights you help shine on what can sometimes be a very tricky market. I don’t have very many slides today. There is a much longer handout available in the hallway and also on our website. I just have a handful that I want to go through, and really, these slides are oriented around three key messages. So, why don’t I put them out there now and then you can let me know if I’ve convinced you afterwards whether those three key messages hold? The first key message that we always want to emphasize is that there is a very positive long-term fundamental for uranium. The uranium market is truly in transition from what has historically been a supply-driven industry to what is becoming an exciting demand-driven industry. That’s not to say the short-term is not difficult. In fact, the second key message is that there is very much a challenging dynamic over the near-to medium-term in our space, but we would argue that this challenging dynamic is simply delaying, not preventing, just simply delaying the transition to an exciting demand-driven industry. Then the last key message that I would emphasize will not surprise you at all. I will argue that we’re very well positioned to weather the challenges that we see in the near- to medium-term, and to provide maximum leverage to what we think is a very positive long-term fundamental. 2

 

Just a very quick reminder that this presentation contains forward-looking information. This is based on a number of assumptions and results could differ materially, and the reminder to please read our recent MD&A and our AIF for further information.

So, if I’m going to say something bold about the robustness of our industry going forward in the long-term, I’d have to convince you that there’s a demand story out there. We’ve been using this slide for a number of years to help articulate the demand story. This slide is what we call our net new reactor slide. We break the world up into regions. We say that in some regions, they’re building reactors. They’re also shutting some older ones down. So really, it’s that net balance of reactor growth over the years that we like to focus on from a demand side. 3

 

Now, the backdrop or the drivers to this demand are very simple—a global population growing from seven billion to nine billion people by 2050. That coincides with growing demand for electricity. In fact, currently, two billion of the seven billion people on the planet do not have reliable access to electricity. Hundreds of millions of those, no access to electricity at all, so there really is a compelling case for more electricity growth. But within that electricity demand is obviously, a very strong demand for safe, for clean, reliable baseload power; that 24-hour power that you need for a healthcare system, an education system, transportation, communication; not intermittent power, but that 24-hour baseload power that does not negatively contribute to air quality. It’s a very strong driver and you see in this chart that the demand is really based in areas that are still facing the challenge of installing that baseload power. So, as we look out and follow these regions and apply our reactor count methodology, we view that there’s over 90 net new reactors to be added to the grid over the next 10 years, by 2023. Ninety seems like a really big number. Ours is an industry that hasn’t grown very much in the last couple of decades. Seventy of those 90 are under construction today. These are reactor programs where licensing, permitting has happened, vendor selection has occurred, construction has begun and we’re on a pathway to building those reactor—70 of the 90 under construction.

What we then have to do with this chart is translate it, obviously, into uranium consumption. If you go down—not sure why that jumped ahead—if you go down the column that says ‘Operable by 2014’, you see 433 reactors. That translates into about 170 million pounds of annual uranium consumption. If you add new reactors, net out the ones that have shut down, you get operable by 2023 of 526 reactors, and 4

  that coincides with about 240 million pounds of uranium consumption. So, the demand is very much growing. Growing at a rate of 4% per year. What we then want to do is kind of give you a sense of if there is certain and predictable growth happening in the industry, because these are real reactor construction programs that you can count, that you can visit; they don’t sneak up on anybody. They’re very long-lead projects. If that demand is certain and predictable, what is, in fact, happening to the supply? The supply is a much different story. We see a great deal of uncertainty around the supply of uranium. The taller bars there are simply tracking that demand number I talked about, growing from 170 million to 240 million pounds of annual production. Existing production, no surprise, is actually following a depletion curve and when no new projects are being added, that depletion basically translates into 140 million pounds of existing production. So, we have a situation where demand’s growing at a rate of 4% per year and existing production is actually diminishing, and to give you a sense how big that challenge is or how big that gap is, when you get out to 2023, that’s 100 million pound gap between the demand and the supply of uranium. McArthur River/Key Lake complex in northern Saskatchewan, the world’s largest uranium complex, produced a world record 20.5 million pounds of uranium last year. The world would need to discover, construct, ramp up five additional McArthur River/Key Lake complexes in the next 10 years in order to fill that gap. So obviously, as an existing producer, we’re very excited about that long-term story. This chart does, however, give you a sense of what the challenge is in the near-term, so I’ll come back to it but I want to flag it in this chart. You see the estimates for 2014; 170 million pounds of consumption that we already talked about, 160 million pounds of primary production and then there are secondary supplies in our market. There is enricher feeding, there’s strategic inventories that are coming from some of the state players in our industry. So, it is an oversupplied market in the short-term, but the existing production tracking low while demand is growing, but I will come back to that challenge in a second.

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This is another view of the same picture, this time a stock view, if you will, and we’ve added in two pieces. We’ve added into the demand stack the inventory building because, of course, each reactor comes with a strategic inventory. So, rather than just focus on that run rate number, let’s make some assumptions about the inventory that might be attached to it. Then, on the supply stack, we’ve added in the secondary supplies that we expect to continue to see in the market. By the way, nothing of the scale and scope of the HEU agreement, which was the agreement to down blend material from Russia and put it into the United States. But secondary supplies will still be in our industry so we’ve added that to the supply stack. This alternative view gives you a picture that the demand over the next 10 years, on a cumulative basis, is about 2.2 billion pounds of uranium, while the supply is about 1.9 billion pounds of uranium, requiring about 300 million pounds. And it’s important to understand the changing nature of that requirement. In the past, and I have said this earlier, that this is historically been a supply-driven industry, and what I meant by that is when the origins of nuclear power for commercial production began, there was a sense there were going to be thousands of reactors around the world producing power, and on the basis of that dream or on the basis of aspiration, a lot of uranium was explored for and it was discovered, and it wasn’t left in the ground as inventory. It was dug out of the ground and it was put into various forms of strategic inventories, and that secondary supply has been coming back to the market for many, many years and we’re finally seeing an end to that secondary supply with respect to significant scale and scope. So, that required supply of 300 million is going to require a lot more primary production than has been required in the past and primary production obviously carries with it a risk profile that secondary supplies don’t. Secondary supplies have already been dug out of the ground, mined, milled and are sitting in a can 6

  somewhere or a canister as UF6 gas. That’s not the case with the need in the market, which is to replace it with primary production, to incent that primary production and to understand the risk profile of that primary production.

I think it’s pretty fair, at this point, to ask a question that if the long-term supply and demand imbalance is so clear, then what’s happening with the uranium price today, because it doesn’t seem to be trading on the same information that I just provided. In other words, why is the uranium price so low that it’s destroying future supply when, in fact, it should be high and incenting future supply, not destroying it? What is going on in our market? There are a number of factors that are affecting our market right now. When you think about the near to medium-term, the next 12 and next 18 to 24 months, we were always in a period of discretion. A lot of contracting in our business happened through the 2007 price run-up and through the 2010 price run-up, and you see those two blips there on the orange spot price line. As a result of that contracting, the utilities have many of their requirements met over the next period, out to about 2016. Their requirements are well covered, so it puts the fuel buyers in a position where they can be discretionary with respect to their purchases. Many of the big producers also contracted forward their production, and so the big producers are being selective in the type of contracts that they would pursue in this period. So, we were already in a discretionary period and now we’ve added to it, some additional pressure. First of all, the construction program that I showed you earlier is just that; it’s still construction programs. Seventy net new reactors being constructed today, but they’re not consuming uranium, which then affords a bit more confidence. Yes, demand is coming but it’s not here yet. You add to that the Japanese situation, and Oscar referenced it earlier, Japan is a very large nuclear consumer when all of their 7

  reactors are running, but that’s not the case at the moment. Since the earthquake and tsunami in Japan, the—all the nuclear reactors in Japan are currently shut down. In anticipation of restarts, the Japanese customers are, by and large, taking delivery of the uranium they have under contract, but of course, they have no impetus to enter into new contracts. Also, just the sense of the stockpiling that’s going on is creating a perspective among the rest of the fuel buyers that perhaps at some point the Japanese might say, “We’re full up; we don’t need any more uranium at the moment,” and that might launch or propel deferral conversations with customers again, and deferral conversations would result in some producers ending up with material in their laps which they might put into the spot market. We also have the enrichment complex around the world providing natural uranium by underfeeding or underutilizing the capacity of their enrichment SWU capacity, and that allows for additional natural uranium to come into the market into an already oversupplied market. So, between the good production that we’ve seen on the primary side in the last few years, the fact that some of the producers do not have contract portfolios to put their material into—they’re putting it on the spot market—that’s coinciding with the material that’s coming from enrichers as they underfeed; and on the demand side, the lack of restarts in Japan, the fact that the construction programs are not consuming uranium yet, are all just creating a bit of a standoff in our market. Very little market activity because the fuel buyers believe it’s still a price off. They believe that these downward pressures that we’ve talked about will continue to have an impact on the spot price, and that will ultimately drag that term price lower—the term price $45 a pound today. The bet is perhaps they can push it lower through reduced activity. The producers, like Cameco, on the other hand, are taking the opposite bet. We’re taking the bet that a heck of a lot of uranium has to be incented to fill the supply/demand imbalance that we see, and that’s going to require a higher term price and we will wait that out and we will wait until that higher price is available in the marketplace before we enter into new contracts. So, what we have in our market is very little fundamental activity. We have small transactions at the margin in a price reporting environment that are causing the price drift—the price drift down and a bit of a standoff, a buyer’s and a seller’s strike, if you will. But what is interesting about this— and this is not unique to the uranium commodity space—this simply reinforces the favourable long-term picture because as prices fall, uranium supply is deferred, delayed, if not cancelled, exploration projects are put on hold and eventually, existing production goes into care and maintenance because it isn’t supported by today’s prices. So, like a lot of other commodities, we find ourselves in a pricing scenario where future supply is being destroyed at a time when, in fact, the opposite should be—should happen. And again, this is very positive for an existing producer like us. The other thing that I want to point out on this slide is the blue line at the bottom. That is Cameco’s average realized price. We have a contract portfolio which is a combination of term deals that have gone 8

  on for many, many years. That contract portfolio gives us incredible downside protection as a company and most obvious at the extreme of that chart, where you see we’re yielding a $50 price for the sale of our uranium in a $45 term market and a $29 spot market. This average realized price gives us the comfort, if you will, the protection, if you will, to say that we can wait out the market, to understand that a higher price needs to be incented and we will wait for that higher price to come before we enter into the market.

So, a number of things that we need to look for in order to determine when this market is going to turn around. These are pretty obvious. We’ve touched on all of them. The reactor restarts in Japan is an important first step. It’s not a—it wouldn’t be an actual tangible change to the demand profile because our expectation is that while reactors will restart, they won’t start all at once. There will be a few that restart, that—there will have to be a demonstration period to show that they’re safe, reliable operation in order to obtain the confidence that the new regulations are where they need to be. So, it provides a psychological start because it gives the sense that the Japanese fleet is coming back. But it is a necessary first condition. We’re watching what’s happening with some of the excess inventories. We’ve had some early shutdowns of some U.S. reactors, for example, and what happens with those excess inventories, whether they hit the spot market today or not. Certainly, that reactor construction piece is really important. We follow that very closely. It is robust, as we said earlier. Seventy of the 90 net new reactors we expect under construction today. We also need to see the fuel buyers starting to position for long-term contracting coming back to the market, making sure that their annual requirements, their run rate requirements in the 2016 and beyond period are met, and then obviously, supply performance on the production side matters in helping reset the market expectations.

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So, what we’re doing through all of this as a company is we’re pulling in, obviously exercising a lot of discipline. We were on a very aggressive growth strategy pre-Fukushima, a goal of doubling our annual uranium production. That does not make sense in today’s price environment. Those decisions are not being rewarded, they’re not being supported. We no longer have a growth target, if you will. We simply have said we will focus on our Tier 1 assets, those that produce, you know, the $20 life of mine operating costs in our industry. McArthur River expansion is still on our agenda, as well as ramping up the Cigar Lake project, which Oscar had talked about; that’s another high grade deposit in northern Saskatchewan. These are Tier 1 assets that leverage brownfield infrastructure, and we’ve parked our projects that would have been more greenfield—a high grade mine in northern Saskatchewan and two open pit mines in Western Australia. These are projects that we’ve put to the side and said that they need to be incented to come to the market. Because of our contract portfolio, we are a company that enjoys good revenue protection, as I said, our average realized price outperforming both the spot and the term price, and it’s a contract portfolio that leaves us well covered out to 2016 and into 2017. We believe that this is just the right leverage profile in terms of when the market turns around is precisely when we will need to find ourselves back in the market term contracting. Combine this with a very similar story that you’ll be hearing from others about controlling operating costs, reducing CapEx, really focusing on the sustaining replacement and growth capital, reducing general and administrative expenses. All of that very important work we undertook in 2013 to change the capital allocation within the company, and so we just believe that we are very well positioned

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  to withstand the short-term pressure that the market is under and to leverage not just the price, but operational leverage to the turnaround in the uranium space. So those are the three key messages we wanted to leave you with today, and I know that Oscar wanted to leave some time for questions, so why don’t we do that now?

OSCAR CABRERA (MODERATOR): Okay. Great. Thank you, Grant. There’s a question here.

AUDIENCE PARTICIPANT: Thank you. A big part of the demand story is clearly China’s reactor growth. Does your supply model for uranium—do you believe you have a good grasp on everything China’s doing from a supply perspective and sourcing uranium? I know there’s some uncertainty in terms of investments they’re making and inventories they may have. I’m just trying to get a sense of how much confidence you have in their future supply.

GRANT ISAAC (SENIOR VP AND CFO): Yes, the Chinese growth is impressive. It’s actually breathtaking. With the 19 reactors running now and the 29 under construction at the moment, obviously they have spent time building up the supply that they need for their growth profile. Their official growth profile—this was articulated at the World Nuclear Association meeting last September and it hasn’t changed at the moment—is 60 gigawatts of nuclear power by 2020, with another 30 gigawatts of nuclear power under construction at that time. So, very aggressive growth strategy. In 2010, the Chinese entered the long-term market, so prior to that, as they 11

  were building reactors, they were in the spot market quite a bit through the 2008, 2009, early 2010 period, acquiring the one-time volumes that you need for things like first cores. When you start a reactor the first time, you need to fill all three fuel chambers but your annual run rate is a third of that. So, those one-time volumes were being satisfied in the spot market, as well as building up a bit of a strategic inventory. In the summer of 2010—and that’s what drove that price spike in the 2010 period in the uranium space— you remember at that time, spot price kind of sitting at a $40 resistance floor, term price never having the courage to get above $50 went to—spot went to $70 and the term price went to $74 very rapidly in 2010 as the Chinese entered the term market, because their interest is now tying up the annual run rate material that they need. If the Chinese stopped all their growth today, our view is they would be well supplied because of those term contracts, plus the work that they did in the spot market prior to 2010. But when you layer on this growth profile and build in the notion that they’re going to at least 90 gigawatts sometime after 2020, the Chinese will not be left out of the next round of term contracting. They’ll have to be in there, and, in fact, it’s of considerable interest to us that, you know, the strategic—or security of supply issues in China—has now compelled them to actually be on the producing side of the business. One of the utilities, CGNPC, has acquired a property in Africa and, in fact, just last week was an announcement to kind of kick off that project. Some of our folks were there to celebrate with them. This is their intention, to have at least some supply, some supply indigenously, some supply they own around the world, but by and large, they will be a big purchaser off the uranium market and we intend to be there with them in a diversified portfolio, of course, not put all of our business there but be part of that business. So, China is a very impressive part of this demand story.

AUDIENCE PARTICIPANT: Just, in view of the chart where you guided, you know, the 2.2, I think, or the million—or 2.2 billion pounds by the end of the, by 2023 relative to the amount of supply, you know, you talk about just, in the footnote, you know, excluding projects under construction. If you were to include all the projects under construction, do you have a sense for what, you know, that imbalance would be? Then also just can you talk a little bit about how quickly the Kazakhs are able to sort of create production?

GRANT ISAAC (SENIOR VP AND CFO): Yes, so on the supply side, that footnote is actually not completely accurate. I mean, Cigar Lake is a project that’s still technically under construction because commercial production has not been declared. First ore has occurred at Cigar Lake, so we’ve added Cigar Lake in as its own block. The only other project that’s truly under construction is the one that I just mentioned, the Husab project in Africa. That appears to be full steam ahead. Everything else is on hold, or at least not being pushed as hard as it was 12

  pre-Fukushima. So really, that contribution of new production is just not clear and, in fact, the price is not incenting any of it at the moment. You asked about Kazakhstan. Kazakhstan was the very big surprise on the supply front through the early 2000s; really came out of nowhere, and now, 40% of the world’s supply of uranium comes out of Kazakhstan. So, one of the questions obviously is can they repeat that? I mean, you’re talking about a very robust demand profile, but if they simply can double their production, are they just going to take the wind out of that sail, and our view is that’s not a likely outcome. We’re there with a project. We do mine in Kazakhstan under a joint venture with Kazatomprom. There will be enough challenge on the production side sustaining at their current rate under today’s price environment. Not only that, the—you know, it’s pretty clear that not all ore is created the same in Kazakhstan. There’s a very good corridor, the Inkai corridor, if you will, that has tremendous resources, tremendous reserves but the profile is not uniform across the country. And there is a cost curve within Kazakhstan that needs to be incented and for them to double would require production on the very high end of the cost curve, which is going to require a much higher uranium price to get there. So, our view is that there’s enough challenge sustaining at their current rate because it is well field production and those ride depletion curves the day production begins.

AUDIENCE PARTICIPANT: Can you elaborate a little bit on Japanese reactors coming back into the production—to producing—I know it’s estimated a half to two thirds may come back, but can you speak to the regulatory process, how quickly they’re coming back? Is this a two-year event or a five-year event, as you see it?

GRANT ISAAC (SENIOR VP AND CFO): Yes, well we certainly see it as a multi-year event. The underlying data are positive. If we were talking this time last year, you know, there’s a number of positive indicators from an economic point of view. The competitiveness of the economy is the number one priority of the government. It’s a fact that Japan, export-driven industrial growth model, does not have a competitive economy without cheap baseload power. It’s also a fact that cheap baseload power requires the nuclear fleet to be running in Japan. Those are economic facts. The regulatory situation is more clear than it was. There is a true fourth arm regulator now set up. They do have a regulatory framework in place. They do have an approval process articulated and there are utilities and reactors in that approval process. That began last July. At the time, the regulator said it would take about six months. We’re well past that six-month window, but we know what the regulatory framework looks like, the work that’s required to go through it. In addition, the regulator has also indicated the first two reactors that will restart, the Kyūshū Sendai reactors. 13

  So, that is all very positive. What it hasn’t turned into yet is actually a ‘go’ decision on any reactors, and we do view this as a multi-year exercise. There would be no shotgun start and, quite frankly, it’s in nobody’s interest to rush the process if it’s not done right. What the industry needs is they need a safe, reliable restart process in Japan that builds confidence, and that’s going to take some reactors coming up, demonstrating this reliability period before the second wave are invited in for approval. So ultimately, we view about two thirds of the reactors that were in Japan prior to Fukushima as being operable but it’s a multi-year exercise to get up to that operating level. In the meantime, this adds to the challenge in the short- to medium-term market because as long as the Japanese customers are continuing to take delivery for those two thirds reactors, it creates this sense of overhang, this sense of stockpiling and this perspective, if you will, among the fuel buyers that perhaps they can wait and just see what’s going to happen with that big stockpile before they are compelled to worry about their future supply of uranium.

OSCAR CABRERA (MODERATOR): Okay. I’m sorry, in the interest of time, Grant, that was great. Thank you very much. Ladies and gentlemen, can you please help me thank Grant for a great presentation.

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