CCO BAML Transcript 05132015
Bank of America/Merrill Lynch Global Metals, Mining & Steel Conference 2015, Barcelona, Spain Cameco Corporation Presentation Transcript Date:
Wednesday, May 13, 2015
Time:
9:00 AM CES/3:00 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: Terrific, thank you very much, Oscar, and also thanks to Oscar for the time that he takes to learn the uranium market. It is not an easy market, it can be opaque even to us, and he takes the time, asks the right questions and puts out very good research, and occasionally gets our story right, so that’s always very helpful. So, thank you. We’re delighted to be here. This is not Saskatoon, so we will accept this invitation every single time.
I have a very short presentation. I’m most interested in your questions, so hopefully we’ll leave sufficient time for that. There is an Investor handout that has been provided and I’m going to steal about six slides from that presentation, and that’s about it. But, there are three main points to what we’re going to talk about today. So, if all you have time for is the first couple of minutes, here’s the punch line. I’m going to try to tell you and convince you that the long-term outlook is very constructive for uranium. I’m going to try to convince you that ours is truly a market in transition, from what has historically been a supply-driven industry to what is truly becoming a demand-driven industry, and I’m going to try to convince you of that, as I say.
The short-term, however, remains very challenging in our market. There’s absolutely no doubt about that. There are challenges that impact the ‘when’ of the transition—not the ‘if’, but the ‘when’—and certainly we have seen delays in the recovery of the uranium market because of the short-term challenges, and they are quite significant and we’ll go through some of those.
Obviously, and no surprise, I will then try to convince you that we’re very well positioned to not just deal with the challenges that we see in the short-term, but also to seize the opportunities that we see in the long-term.
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Obviously, the presentation will have some forward-looking information, so this caution applies. I know you’ve read it, so I’ll move on to the next slide.
If I’m going to try to convince you that this is a demand-driven story that’s emerging, then, obviously, we have to start with demand. What we’ve done for the last couple of years is moved away from trying to articulate the demand from a gigawatts basis and we’ve moved to this reactor count methodology. Now, obviously, there’s some problems with it. If you’re simply counting reactors and you have old, small reactors that have shut down and they’re being 3
replaced with new, bigger reactors, your count looks off on a gigawatts basis, but what is helpful is it’s showing a few key points.
One is there is truly growth happening in the uranium space, there’s truly demand in the form of reactors that are under construction today, but, even more importantly, is where that demand is occurring. We’re not talking about growth that’s in areas where there are established mature grids. We’re talking about significant growth in areas that are still trying to install baseload power—that 24-hour power you need for a modern healthcare/transportation/education system, jurisdictions like in China, like in India, places where this 24-hour power is an absolute necessity, there are a lot of people without access to reliable electricity, and clean air is a concern, so a solution to the power deficit that doesn’t contribute to poor air quality.
What we’ve done with this chart, very simply, is divided the world up into regions, except for two countries, which we draw out specifically, India and China. I want to give you a sense of what’s operable today, a sense of where we think new construction is happening—and this is a compilation of our own bottom-up work, as well as cross-referencing with groups like the World Nuclear Association and the Nuclear Energy Institute. There’s going to be some shutdowns, obviously, in this 10-year period, so we try to net off those, to give a sense of where the operable units are going to stand by 2024. We want to just then, obviously, calculate what the net change is, new minus the shutdowns.
One of the questions we often get is, “Well, how real is it? This is a 10-year view. You’re saying 81 net new reactors over the next 10 years.” I think a key point right now is that of those 81 reactors, 63 are under construction today. You can go around the world and you can see these sites, and there are real construction projects happening. This isn’t just in the planning stages.
Our reactor count methodology also tends to be a little bit conservative relative to some other analysts, because there’s a few things we require before we put a reactor in here. It’s not sufficient just to have a jurisdiction simply say that, “we’re going to build a reactor.” We, obviously, as a first principle, we like to see an atomic regulator in that country before we would count a reactor. We’d also like to see some site selection and some vendor selection, and a bit of a financing pathway, and only then does the reactor go into our count, and that chart is then meant to derive what we view as the demand going forward. So, if we simply take those 4
reactors, add it to the existing grid, we see demand that’s growing in a certain and predictable way. The 2015 estimate for uranium consumption, 165 million pounds, but by the time you add those 81 net new reactors to the grid, demand for uranium growing to 230 million pounds.
The question mark then becomes what about supply? In today’s environment, we see a supply picture that is far less certain and far less predictable. Investments in primary production are simply not happening. Outside of our Cigar Lake—I was just going to call it a project, but of course it’s a mine now in operation. Outside our Cigar Lake mine, which is a new production to come to the market, and a project by CGNPC in Africa, there really isn’t new growth investment in the uranium space of any size.
There’s also a lack of secondary supplies in the market of the scale and scope that we became accustomed to in the past. You’ll all recall the HEU Agreement, the Highly Enriched Uranium Agreement to downblend material in Russia and make it available to Western power producers. 500 metric tons of highly enriched UF6 translated into a 400-million-pound mine producing 24 million pounds a year for the market, and mine life was up at the end of 2013. So, we look around and we say, “What’s happening on the supply side?” and the answer is not very much.
What we’ve done with this chart here—and these are the lighter coloured bars, so not the 230, but the 140 line in the next 10 years, how is that derived. What we’ve done is we’ve simply taken all the existing primary production and we said, “It’ll continue to operate, so there’ll be no 5
shutdowns, but it will not receive the growth investment because the price is not there to incentivize it. If that were the case, what will happen?” Well, like any resource space, it will deplete. It won’t completely fall to zero, but it will have difficulties staying at its current estimate level of 155 million pounds for 2015. So, we see demand rising in a certain and predictable way and we see real question marks around supply, and, in fact, a supply profile that’s falling.
Now, ours is a commodity that’s measured in pounds, not tons. This might not sound like a very big gap, the 90 million pounds between demand and supply 10 years from now. How hard can that be to fill? We like to think about it in the context of the world’s biggest uranium mine, which is the McArthur River mine, high-grade mine in Northern Saskatchewan; we operate it. Think of it as a 20-million-pound-a-year producer of uranium. In that context, the world would need to explore for, discover, construct, ramp up to full production four-and-a-half McArthur Rivers. So, we just simply asked the question, “Who’s doing that work today?” Because, if it’s not underway today, it’s going to make it very difficult for that supply to be there in 2024, and that work just simply isn’t proceeding. So, it’s a big gap, it’s a big challenge for the market.
This slide just takes it from a flow to a stock view, and we just again try to emphasize that it is a market that’s transitioning to a demand-driven market. We see more demand in that stock than we see supply. We just don’t have line of sight to the supply like we used to.
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When we say that it has historically been a supply-driven industry, it really goes back to the roots of nuclear power production. When the concept of nuclear power for commercial production came about, there was this notion there were going to be thousands of reactors around the planet—not hundreds, but thousands—producing power that was too cheap to meter, and as a result, a lot of uranium was explored for and it was discovered, but it wasn’t left in the ground, it was dug up, so it was mined, it was milled, and it was put into all sorts of strategic inventories, and it’s those strategic inventories that have been coming back to the market over the years and have made it a supply-driven industry, not a demand-driven industry, an industry that actually hasn’t been motivated by the cost curve, like you would expect, but instead by the ample supply of these secondary sources. But, these secondary sources are finite; the big ones are gone. This chart will say that there are some secondary supplies that are available, but not of the scale and scope they have been in the past.
So, for us, as an existing producer, we obviously get very excited by this outlook. We see a world where there’s a tremendous opportunity for us and for our Tier 1 assets. It truly is an exciting time.
But, I don’t want to lose sight of the fact that this is a challenging market today. We get, I think a fair question, that we get when we outline this outlook that we have, is, “Okay, Cameco, if this supply gap is as clear and obvious as you think it is, then why is it not reflected in the uranium price today? Why are you the only ones who seem to be worried about this?” and I would argue 7
it’s not that our customers don’t see the lack of investment in uranium supply, it’s not that they’re not concerned about where uranium is coming from in the future, and it’s not that they don’t see the demand growing in places like India and China. It’s that we can’t agree at the moment on what price is required to make sure that supply is there, and, quite frankly, the fuel buyers have history on their side.
When there was talk about a deficit in uranium supply—go back 30 years, for example, uranium price began to make some moves, and out of nowhere came the HEU Agreement, supply coming out of Russia going into the United Sates, as I said earlier, 400 million pounds a year— or a 400-million-pound mine, 24 million pounds a year. The uranium just showed up. You go back to the price run that you see there in the early 2000s. This idea that there was going to be a demand growing faster than supply put momentum behind the uranium price, some supply disruptions along the way, including the flooding of our Cigar Lake mine, and the uranium price spiked, and it spiked heroically, but then the uranium just showed up. Kazakhstan came out of nowhere to become 40% of the world’s global supply of production.
So, the fuel buyers have history on their side when they say to us, “Yes, but every time you’ve talked about a scarcity of uranium, the uranium has just shown up, it’s been there.” So, we can’t agree on at what price is required. We simply just look at the scene and we say, “We don’t see the secondary supplies today. If you do, please tell us where you see them. We don’t.” We say, “We don’t see where the next Kazakhstan is coming from. If you see it, please tell us, but we don’t.” So, obviously, we have a view that this time is, in fact, different, that we just don’t see where that kind of scale and scope uranium supply is going to show up from, unless there’s a price incentive in order to make that happen.
The short-term is dominated by a couple of key factors, because it may seem odd that there’s such a disconnect between our view of supply and demand and where the price is lingering or languishing today, but the factors are real and I think they’re easy to comprehend.
When we think about the construction programs, they’re not consuming uranium yet. So, there’s a lot of construction going on, but the consumption isn’t there to match. There is truly market oversupply at the moment. You have existing production that’s been performing very well over the last handful of years, the last three years in particular. This year has started off with a few 8
notable supply disruptions, but nothing of a big enough scale to disrupt the over-supply that’s currently in the spot market.
There is enricher underfeeding going on, whereby the enrichers in our business have less SWU capacity that they need to place with customers because they’ve lost some customer demand. So, instead of introducing fresh UF6 into the front door of their enrichment facility, they make that material available in the spot market, they monetize it, so they add to a market where there’s already good primary production, and we continue to see the Department of Energy in the United States put some of its excess inventory in the market. The purpose of this is to pay bills. It’s to cover the cost of cleanup at places like Portsmouth and Paducah. This just, again, adds to what is already an oversupplied market.
We’ve also seen the early shutdown of a few smaller merchant reactors, especially in the United States, trying to compete with shale gas, trying to deal with the regulatory costs that have been added to the nuclear space post-Fukushima. This has released some material to the spot market, so again contributing to this oversupply, and, of course, we see that the market overhang that’s caused by Japan. Think of Japan as a 20-million-pound-a-year consumer of uranium. Normally, probably a three-year strategic inventory, so you would expect about 60 million pounds of uranium to be assigned to the various Japanese utilities. By about a year postFukushima, they just started to take deliveries of the uranium they have under contract, and they’ve continued to do that, so they’ve probably doubled what their strategic inventory would normally be, probably 120 million pounds of uranium assigned to the Japanese utilities today, and not a single reactor running.
So, this obviously creates a very significant overhang, not from the prospect that the Japanese utilities will sell their inventory, the material that they’ve already taken possession of, but the prospect that at some point there will be deferral conversations again, that a utility will say, “We’re full up, we don’t need to take delivery of any more uranium today,” and get back into some deferral conversations, whereby maybe tuck that volume of uranium on the back end of a supply contract when the reactors are running. The result, obviously, would be that some producers would end up with material in their laps today. Some producers may be able to hold that material or may be able to put it into their contract portfolio, we certainly would do that, but
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others might not be in that position, might have to monetize that material as soon as it returns to them, and there’s a bet, if you will, that some of this will happen.
All of these factors contribute to what we would call a price-off bias of the fuel buyers. They just look at these factors, they look at the supply-demand balance, and, in essence, they just determine that now is not the time to start worrying about the uranium price and uranium contracting.
So, as we think about the near-term, we are closely watching these factors around these compass points, because these are what are driving that bias, if you will, that price-off bias. Obviously, the pace of reactor restarts, we’d certainly like to see some restarts in Japan. On balance, it’s more positive than it was this time last year. This time last year there hadn’t been a single reactor to make it through the new regulatory provisions. Now there’s four, with another 20 reactors in behind. We also know that there’s some momentum building with respect to those approvals because the units, the utilities that are in behind that have not yet received approval have participated in the regulatory process of the first movers, so that they know what the questions are, so that they know what the answers should be, and they can accelerate that regulatory review process. So, on balance, it’s more positive in Japan than it was this time last year, but there are no reactors running yet in Japan.
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Obviously, the excess inventory position, especially as we see it in Japan, we need some clarity on that before I think there’s going to be real momentum for the fuel buyers to engage. Reactor constructions, we’ve seen obviously some very good announcements out of China about the resumption of a fairly aggressive reactor build program, following Fukushima. That’s positive. All of that is then going to lead to a return to long-term contracting.
On this front, there has been some good news. Early in the year, at the January Fuel Cycle Conference, the trade reporters came back and in their reports wrote about 50 million to 60 million pounds of stated term demand that they had identified walking around that conference, but I just would caution, it’s stated demand, it’s not yet revealed. We haven’t seen the RFPs in the market, the transactions haven’t occurred, but it is stated demand at a level we haven’t seen since Fukushima, so positive, if you will.
And, of course, supply performance. I think ours is a market where it wouldn’t take much, in terms of a supply disruption, in order to tip the balance. So, all of these are the factors that will change that price-off bias to one of a price-on, and, obviously, create the conditions for the term contracting.
So, what have we done through this process? Well, as a company, we’ve done a couple of things. Our strategy has been to deal with the short-term challenges. We moved off a very aggressive growth strategy that we had identified back in 2008, a strategy to double our 11
uranium production, at that time, from 20 million pounds to 40 million pounds, based upon a portfolio of assets that we had, but we obviously moved off that. There’s no incentive for that type of growth strategy, and no appetite for the type of expenditures that go along with that. So, we’ve taken a number of our projects in Western Australia, as well as some projects in Northern Saskatchewan, and we’ve just parked them. We just said, “These projects are not going ahead, there’s going to be no investment in them.” We’ve reduced significantly our operating costs. We’ve, essentially, peeled the operating costs of the company back down to 2010 levels and, happily, have held them there, which is obviously very useful for the margin protection you need in this type of environment. We made very significant changes to our G&A spend. We divested of a non-core asset, and that was our investment in Bruce Power, power generating in Ontario, Canada. All of this to make sure that we had the financial strength to weather the downturn that we saw in the market.
Yet, at the same time, we didn’t abandon all the opportunities. We continued to invest in our Cigar Lake project, which is now, happily, a mine. This is a Tier 1 asset, and for us, it is a true opportunity to gain some of that operating leverage that you always want at the turn of a cycle. Cigar Lake, last year, produced a meagre 300,000 pounds, on a 100% basis. This year, the forecast is for 6 million to 8 million pounds, on a 100% basis, going to 18 million pounds by 2018. This, for us, is that opportunity to have those unencumbered Tier 1 pounds to sell into a market that we think is going to be there for it, and pretty exciting for us.
We’ve also continued to find ways to expand our McArthur River operation; arguably, the best uranium mine in the world. A licence limit at 18.7 million pounds has now been moved up to 25 million pounds. We’re waiting for one last provincial approval to do that. Again, a Tier 1 asset, the best leverage for the opportunities that are coming.
Along the way, we’ve made a few acquisitions, too, in order to bolster what we think is our position for this upswing. We acquired the trading company NUKEM, probably the world’s best at identifying and sourcing unique, unconventional supplies of uranium. While in the past, our trading, if you will, was really in support of our long-term contract portfolio, the NUKEM folks work in the spot market, and it gives us that clear bridge from the spot market to the term market in a way that we didn’t have before. We acquired a project in Western Australia, the Yeelirrie project. We’re very pleased with this. This is one that obviously we’re not pushing 12
ahead today, but a very important project for uranium supply going forward. We also acquired a majority of the Millennium project, a high-grade mine in Northern Saskatchewan. Again, positioning ourselves for a recovery that we see in the uranium market.
So, we have been prudent, we haven’t abandoned all growth, but we certainly have been prudent through this cycle.
So, I hope I’ve gone some way to convince you of the three points we mentioned at the beginning: that the long term is, in fact, constructive in our business, we haven’t seen this kind of growth in 35 years in our business, since the French were building up their fleet and the Japanese were building up their fleet; and that a very exciting market transition is underway; that the short-term remains challenging, there are some real factors that are driving the challenge, but they’re sorting themselves out slowly but surely; and that I think we’ve taken all the necessary steps that are required through this down cycle.
Now, I see that I haven’t left a lot of time for your questions, Oscar, so I’ll stop there.
OSCAR CABRERA (BANK OF AMERICA/MERRILL LYNCH): Great, thank you, Grant. Are there any questions? There’s a question back there, please. Actually, no, Steve, please.
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STEVE (AUDIENCE PARTICIPANT): You talked a little bit about just sort of Japan and having high inventory levels. I guess the question is how much is the industry shipping to Japan at this time and how much visibility is there over the next few years as far as contracts, and I guess the question is, you know, think of a number, let’s say 50 million pounds, I mean, is there a risk that in 2018 that just goes away, you know, if the Japanese utilities say “I have several years of inventories?” Can you help us just think about that, and the risks related to it?
GRANT ISAAC: Yes, I think it’s a real risk. It’s, in part, what contributes to this overhang in the market. I said earlier think of them as a 20-million-pound-a-year consumer of uranium. They’re actually a little bit less than that. Post-Fukushima, you would expect maybe 30 to 35 of their reactors would be operable, or capable of restart under the new regulatory provisions. That’s down from the 54 pre-Fukushima. When the Japanese take delivery of their uranium today, they tell us it’s because uranium is cheap, it’s because they believe the reactors are coming back online, and they might as well build up their inventories now, but, quite frankly, we do not expect to see a Japanese fuel buyer in the market for a very long time.
You’re absolutely right, a real risk right now, and, in fact, we think driving part of this price-off bias, is this notion that the Japanese utilities will say, “We have enough, we don’t need to put anymore into our inventory,” and they’ll ask for deferrals from the producers that they’re supposed to take the material from today, and that that material will find its way into an already over-supplied market. That is a real risk and it’s why we have consistently said over the last couple of years that the near- to medium-term remains discretionary in our market. Despite how good this outlook is, there are factors that just really reinforce a price-off bias.
OSCAR CABRERA (BANK OF AMERICA/MERRILL LYNCH): We have time for one more question, please.
AUDIENCE PARTICIPANT: Since you have time for one question, I’ll ask two questions.
OSCAR CABRERA (BANK OF AMERICA/MERRILL LYNCH): 14
Okay.
AUDIENCE PARTICIPANT: The first is can you just describe a little bit what the path looks like from here to 2024, in terms of supply and demand, because you sort of have what it looks like today and in 2024, but just interesting to know what the path is?
Then, the second thing is, if that supply gap does open up the way you described, how do you see that scenario? Obviously, you’ll have a price spike, but reactors have to buy material, so don’t you think the US would supply the reactors, or, I mean, can’t you understand why customers do think that the supply will have to come, because, surely we’re not just going to have nuclear reactors around the world sitting idled or having to shut down after starting up a few years prior, right?
GRANT ISAAC: Yes, absolutely. What we’ve observed in our industry in the last 35 years, which we’re not observing today, is a bit of a trend to come to the market about five years before you need a fabricated fuel bundle, come to the market to start acquiring the U3O8. What we’re seeing right now is, in fact, a compression of that five-year runway. How far can it compress, I think is at the heart of the question that you asked. Clearly, they can compress within five years. I think that five years gives their supply chain lots of elbow room to get the uranium, have it refined, have it converted, have somebody enrich it, have it brought back into enriched UO2 and fabricate it, but can they compress into three years, we don’t know, but it’s a bet we’re, quite frankly, willing to take, because we look at the growing uncommitted requirements of the utilities. It’s not an issue today. UX Consulting would say 90% of the requirements, outside of China and Japan, are covered, and next year it’s probably 85, and it’s probably 80% the year after that, but by 2020, there’s about a 40% uncovered requirement among the utilities in Western Europe, the United States, South Korea.
This is pretty important, because if we were in typical times, we’d expect a lot of contracting today. Because, by 2020, according to this chart, we can expect about 200 million pounds of annual consumption of uranium; that means about 80 million pounds has not been contracted for the 2020 year. So, what we’re seeing is, in fact, that compression. We’re not seeing the 15
contracting this year, there’s a price-off bias, the utilities are holding out, but you are right in saying that at some point a price-sensitive fuel buyer gets a visit from a supply-sensitive Chief Nuclear Officer, who walks down the hallway and says, “If there’s not a fabricated fuel bundle for this reactor by August of 2019, then that’s your accountability.” We just haven’t seen that yet. We are seeing compression right now in that runway, if you will.
OSCAR CABRERA (BANK OF AMERICA/MERRILL LYNCH): Okay. Well, ladies and gentlemen, can you please help me thank Grant for his presentation. Thank you.
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