CCO GS2016Conf Transcript 11162016
Goldman Event Cameco Presentation Transcript Date:
November 16, 2016
Time:
11:15 AM EST / 10:15 AM CST
Presenter:
Grant Isaac Senior Vice President and Chief Financial Officer
ROB NORWOOD (GOLDMAN): All right, folks, thanks for coming. My name is Rob Norwood. I’m here with the metals and mining team at Goldman. Happy to present Grant Isaac from Cameco who’s going to lead it off today with a brief presentation and then we’ll take some Q&A. GRANT ISAAC: Great. Thank you very much. Thanks, folks, for giving a bit of time to us and letting us try to explain the uranium world through our eyes. Most interested in your questions, and so we’ll get to that, hopefully, really soon. But I do have a very quick PowerPoint presentation, just seven short slides, really oriented around most of the questions that we tend to get anyway, so hopefully can build up a bit of momentum and then get into some pretty detailed questions during the Q&A period, if that’s all right.
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It’s not going to surprise anybody in the room, but the conclusion of this presentation’s very simple. You know, we’re going to try to suggest to you that there is truly a demand story to pay attention to in the uranium space, it’s real, and one that gets us very excited. It gets us up in the morning. But, that’s not to suggest there aren’t real challenges in the market. There are some short-term pressures that we’ll continue to bear and need to work themselves through the market. Those would be the factors that keep us up at night, if what gets us up in the morning is the demand story. It’s the supply side and in particular the short-term supply side that keeps us up at night.
Then, ultimately I’m going to try to convince you that we’re really well placed to weather this short-term market transition and to capitalize on a demand shift. So, no real surprise there, I’m sure you’re hearing that kind of story over and over again, and let me just add to the list of people trying to convince you of that.
Forward-looking information caution; obviously have to put this up, but we’ll get through this one really quickly.
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At the heart of the demand story, is just the reactor rebuild that’s going around the planet. All we did with this slide was try to build the story up from, say, where we are in 2016 regionally, what we think is going to shut down. There will be reactors that will shut down; they run to the end of their life. There will be new reactors come to the grid, and what is that net change over the 10-year window that we’re looking at here, and then break it down by region as well.
You know, the first point in this slide is just to say there really is demand growth. If we translate it into uranium, it’s going from about 160 million pounds of annual consumption to about 220 million pounds of annual uranium consumption over this period, so. Fairly significant increase in annual demand as a consequence of these new reactors that are coming to the grid. You see in some regions, over-represented here obviously, China, really important part of the new build story. It has been, I would say, the most successful part of the new build story for the last several years. If we were at this conference chatting three years ago, we would have been talking about 13 reactors operating in China and some 20 under construction; today there’s 35 operating and 22 under construction. So, it really is about delivering on a commitment that they made, and it’s still an important part of the story going forward. But you see, our base load 3
regions maintain their position quite strongly through there as well: the Americas, Europe for example.
So, this demand growth translates into uranium growth. For us, the exciting part is, a lot of the uranium required to power this fleet over this 10-year window has not yet been bought. When we add up the uncovered requirements of the utilities represented in these regions, over the 10year period, we look at a wedge of about 500 million pounds of uranium they haven’t yet procured. A part of the problem is they don’t need it this year, they don’t need it next year, they don’t need it the year after; the wedge doesn’t really start to grow until you get out into early 2020s, but that’s 500 million pounds of uranium that’s required. Some of that’s coming our way. We’re a sovereign-safe, reliable supplier with Tier 1 assets and we know some of that demand is coming our direction. So, that obviously gets us pretty excited.
Of course, the demand side doesn’t mean anything unless there’s a supply side story to go with it. I’m just trying to advance this. It’s not seeming to want to respond. Perfect.
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So, the supply side over the same window, and just a slightly different look, this is just a stock diagram, also gets us pretty excited. We see demand represented there by actual consumption plus a bit of inventory build that will occur over that period. We then glance across and we say, “Where’s that uranium coming from?” Well there’s the part that we know, that we control through our existing mines; there are other mines that are producing around the world that will continue to produce. There’s certainly a bloc of secondary supply that will always be there: strategic inventories from governments, for example, or the willingness of enrichers to make uranium available through their facilities.
But it all results in a gap, a gap of about 200, in this case 210 million pounds of required supply that simply is not being incented today. At an $18.75 spot market and a $35 term market, there isn’t an incentive to fill this gap. There just isn’t the economic rationales to proceed with the development projects required to fill that. So, as an existing producer, that obviously gets us pretty excited. We see a long-term demand story that carries with it a certainty and a predictability that we don’t see matched on the longer-term supply story.
Now, one of the questions that I think is fair to ask—I’ll just get you to advance the slide again here—is, if this is so obvious, if this demand and supply imbalance is so clear and so obvious to everybody, then what’s wrong with the uranium price today? Why doesn’t it seem to be reflecting this reality? Because it’s not, it’s moving in a much much different direction. It’s a fair question. So, let me just take a bit of time to try to explain this current market uncertainty as we see it.
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Essentially we have very willing sellers, in fact in some cases panicked sellers of uranium right now, and matched up against really a buyers’ strike. So, we have an absence of the normal term demand that we enjoy in our market: that demand that comes where utilities come to the market to buy their run rate material for a five to 10-year window and layer in those volumes into their supply. We just have seen an absolute absence of that activity. Normally, we would expect kind of replacement rate term contracting. So, as I said earlier, if the world’s consuming 160 million pounds of uranium annually, you would expect somewhere around 160 million pounds to be contracted in the term market annually at the replacement rate, out over time, but layered in as replacement rate. Over the last 3½ years, we’ve seen fuel buyers consume over 600 million pounds of term contract material, and replace only 200 million pounds of that through term contracting.
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So, we’ve seen this delay in term contracting. Why? Because fuel buyers do not feel any panic to do any term buying right now. They glance across at a terribly over-supplied spot market, and they come to the conclusion that, if they have some early near-term demand, rather than provoking a term contract and going into the term market, they’re far better off just to duck into the spot market, pick up some small discretionary volumes, tuck that into the early part of their term demand, and essentially buy themselves more time. Why are they buying themselves more time? Because they want to see, like the rest of us, they want to see how Japan is going to unfold. Japan is a major consumer of uranium, down from about 20 million pounds on an annual basis to about 13 in a steady state post Fukushima, but not consuming really anything today. Two reactors running, and stockpiling, and therefore building an inventory overhang. Fuel buyers everywhere else want to see how this is going to play out. They want to buy themselves some time, and they’re effectively doing this with this oversupplied spot. The oversupplied spot is creating the delays and the deferrals to the term market. Where’s this oversupply coming from in the spot market? It’s coming from a bunch of different sources. 7
Number one, it’s coming from primary producers who wanted it to be spot-exposed. We’re not one of them; we sell all of our Tier 1 production into our contract portfolio; but there are others who wanted to be spot-exposed and enjoy the spot market in the uranium business; well, now they’re spot-exposed, and so they have material that needs to clear. There are also sources of uranium supply that aren’t really uranium supply-driven, and I think we can all fit into that category the Olympic Dam, BHP, I mean, as long as there’s copper and gold coming out of that mine, there’s uranium coming out, and that needs to go some place, and it finds its way into the spot market.
In addition, we have some strategic inventories that clear the spot market. In the U.S., here, the Department of Energy likes to make some of its strategic inventory available to pay bills, to pay clean-up bills at Portsmouth, Ohio, and Paducah, Kentucky, and that material clears the spot market.
In addition, enrichers, who have excess capacity because of reduced global enrichment requirements, due in particular to the Japanese fleet not running, have uranium, excess uranium that they can sell instead of producing SWU with. That hits the spot market.
In the last couple of weeks, couple of months, the extra gravity that we’ve seen on the spot market is driven by a very specific factor, and that is, there are intermediaries, traders and brokers in our business, who would have observed a $25 spot price over last fall and into early this year, and just deemed that an unsustainably low price of uranium; probably went long on uranium, bought a little more than they should. We’ve now been through two fairly negative conferences in our industry, once in September, one just recently, the NEI conference here in the U.S., which really didn’t send any strong demand signals, and we’ve seen the panicked unloading of those long positions into the spot market. That’s what’s created this extra gravity to the green line, just in the last couple weeks, so that the usual primary over-supply that’s hitting the spot, the enricher underfeeding, the strategic inventory mobilization, and now kind of this panicked deflationary mentality selling that we’re seeing, really pushing that spot price below, so. It’s real. It is pressure on the spot market. It could face—the spot market could face more pressure before year end here if we see any more of that panicked selling. On the other hand, we may see some year-end buying, some budget room from some fuel buyers for example might try to step in to pick up some of that demand, we’ll watch very closely how that plays out. So, I’ll get you to advance the slide again for me, thank you. 8
So, in terms of what changes this mentality, what flips it to a demand transition? We just tried to highlight on this slide some of the things we watch for. Obviously, it’s a return to term contracting. Until fuel buyers step into the market and start putting RFPs into the market more than one at a time, looking for material, 2020 and beyond, in significant volumes, we’re—we just—we’re not going to change this spot mentality. But for them to get there, we need to see a tightening of the spot market. We need to see either supply discipline from those who are selling into the spot market, or we need to see some disruption to those supplies that are hitting the spot market. On the demand side, we need to see some clarity and some certainty around Japan that will help offset some of the material that is putting pressure on the supply side— putting pressure on the spot market in terms of excess supply.
Obviously, the performance of reactor restarts in Japan is key to that demand picture, so all eyes remain on that. To the extent that the reactor construction programs continue a pace 9
around the planet, that’s going to help the demand eventually fill in the pothole, the lost demand of Japan over the last couple years, so we just kind of have to work through that.
All of this translating into a view of ours, that yes, the longer term is very constructive for Cameco, but we still have a near- to medium-term, in the absence of a shock, discretionary market that needs to be worked through.
The good news for us is we’re not seeing any competitors line up with supply, out in the window when we think demand is going to return, because they’re just not making those supply decisions.
So, if I move to the next slide, I would just say that we’re trying to handle this in a very specific way. If we had a balance sheet objective right now, it would read something like, “Our objective is to maximize our cash flow,” which everybody knows is code for cut OpEx, cut CapEx, cut 10
G&A, “subject to maintaining our investment-grade rating, making sure that we have the tools in the toolbox to deal with this low market and to ensure that we’re positioned for operating leverage.” That’s translated into us focusing on our Tier 1 assets. We’ve curtailed production from our Tier 2 assets, taken 7 million pounds out of the global supply stack, as a consequence of decisions we made in April. All of that to position us for weathering this storm and positioning for operating leverage when we come out of it.
Flexible production is something that we’ve been focused on. Flex means up, it also means down if the market doesn’t respond. Like everybody else, we’ve been on quite an aggressive cost control exercise.
I would just say a word about our contract portfolio: there’s been some attention to some contract cancellations that we’ve announced this year, two in particular. I would just say in general there’s a bit of context for those that needs to be considered. Because our average realized price from our contract portfolio is out-performing the market, we—no surprise, we have a lot of fuel buyers who are coming to us and saying, “Gosh, you know, I’m out of the market with the price I’m paying for Cameco uranium, can you help me out?” We of course remind them that it wasn’t very long ago they were paying a lot less for Cameco uranium under our contract portfolio than the market price, but we’ve forgotten about that period of time, obviously.
So, we take those customers that are approaching us and we really—we shift them into two buckets. There are customers that we have a pretty robust view about their long-term demand, and therefore their long-term value to our contract portfolio. We’re sensitive to the pressures they’re under to cut costs, and we’ll engage in, for example, “blend and extend”-type arrangements with them to lock in some of that value of the existing contract, give them a bit more relief in the near term, but ultimately give us value out into the future.
The contract cancellations fall into the other bucket. We have some customers where we don’t have as bullish view about their long-term demand. It could be a policy change in their region, it could be an economic decision, maybe in the face of shale gas prices or in the face of competition from feed-in tariffs for solar and wind, and all of that translating into some doubts about their long-term demand. In that case, it wouldn’t make sense for us to deal with those customers on a “blend and extend” basis. Why would we kick value out into an even more
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uncertain period? So, in those situations we are willing to translate or convert uncertain future value into certain present value, and those two contracts were an example of that.
The other thing I would just add, because I think there’s been a bit of misunderstanding, is these contract cancellations are not front-running announcements of early shutdowns. They’re a consequence of announcements that are already in the market, so.
The utilities, and we haven’t disclosed who they are, but they’ve already made their announcements to the market that they’re shutting down early and, as a consequence, have to deal with things like their uranium supply. We’ve detected there’s been some confusion that people think these contract cancellations are going to result in further announcements of early shutdowns. That’s not the right way to think about them.
So, if it makes sense, we will optimize our contract portfolio that way, and when it doesn’t we will stick to it and obviously fight for those contract provisions.
So, with that, it’s probably as far as I wanted to go with my comments today; opening it up for your questions, but just a quick reminder that we do think the market is very constructive going forward. There are real challenges that have to be worked through in the near to medium term. We think that we’ve taken the right actions to balance being prudent through this market pressure and ensuring that we have the price and operating leverage for the demand shift coming out the other side.
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So, with that, I’m happy to take questions. ROB NORWOOD (GOLDMAN): Thank you, Grant. We’ll open up to the audience first. MALE SPEAKER: Thanks, a lot. So, two quick questions. First, can you talk a little bit about reflexivity on the supply side? What I mean by that is, let’s say we all love the pitch, go out, buy uranium tomorrow, goes to $80 or $65; how quickly do you see additional incremental supply coming on? Is it mostly African assets, and at what price points, ballpark?
And then, I know that the U.S. market doesn’t necessarily drive demand but sometimes it does drive sentiment. If you could, any thoughts on a Trump presidency?
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GRANT ISAAC: So, I’ll start very briefly with the second point. I wouldn’t have any insights into that. I just am peering from across the border in what the Trump presidency can mean. You know, I think there’s a couple dimensions to think about, and one is, there have been some statements in the past about support for nuclear power, and that’s good, obviously received. There have also been some statements that don’t seem to support the renewables for—sorry, the subsidies for renewable energy that have come to really challenge the economics of base-load nuclear in merchant markets in the U.S. So, it’ll be interesting to see how that plays out, how those merchant markets react with their nuclear assets in the absence of those subsidies, which have been quite attractive and have created that situation where some of that power comes to the front of the line and it asks the nuclear plan to peak, to be a peak generator, and of course that’s not how you run nuclear assets. So, will it level the playing field from the base load point of view, I don’t know. More to come on that, obviously. So, that’s all I’ll say about the second one.
The first question is an important one. There’s a long answer and a medium answer. There isn’t really a short answer. If you look at the global supply of uranium, it really is going to come from essentially four jurisdictions in the world, represented by three mining types and really three cost tiers. The first tier of cost is either the high-grade mines in northern Saskatchewan, MacArthur River, Cigar Lake, or the In-Situ recovery mines in Kazakhstan. Not all Kazakhstan assets are created the same, but there certainly is a cluster of them that are Tier 1 assets. By Tier 1 I mean $20 and under life of mine operating costs. That represents about 40% of current primary production in the world, is that Tier 1 category. The second tier would be represented by loosely Australian production and some U.S. production. So, now you have a blend of lowgrade high-tonnage mining in Australia, plus In-Situ recovery mining in the U.S. Now you’re talking about a cost category that’s kind of in the $40 to $45 life of mine operating costs. So obviously under pressure in today’s price environment, under considerable pressure. That’s about 30% of primary production. The remaining is—and you’re going to have to take this with a very big grain of salt, because this might be the most self-serving thing you ever hear a Company say. We would just put the African production largely in that Tier 3 category. Now, it’s easy for us to do that because we’re not there. But, we’re not there because we’ve never been able to figure out how to make it Tier 1 or Tier 2. So, when we look at that production, that’s kind of in that $60 and up life of mine operating cost. But, it has a very considerable advantage in terms of coming to the market. It comes quickly. Because it’s such low grade, in truck and shovel operations, you don’t need ground freeze, you don’t need ventilation, you don’t 14
need radiation protection. So, high-grade mines, Tier 1, take a really long time to respond, 10years plus; the Tier 3 stuff can come on very quickly but the economics have to be right for it. So, that remaining 30% is not any investment decision you’d make today.
So, you might want a bit of a proof for that taxonomy that I just gave. If you follow the announcements post Fukushima, as the price came off, you would start with African projects, growth projects, being delayed and deferred; and then it would have moved into Australian growth projects being delayed and deferred. For example, our Kintyre project. Then, you started to see delays and deferrals in Tier 1 as the price fell further. So, that behaviour post Fukushima supports that view that that last marginal pound is going to come from a place like Africa and it needs a much higher price in order to incent it to be there.
But once the price is there, it doesn’t need the lead time of a high-grade mine in order to come on. It can come on quickly, of course the danger to that, and every mining company faces it, is the stickiness of supply. Once it’s in the market, it tends to just play itself out, it doesn’t disappear if the price falls. In part, we’re seeing some of that today, that stickiness, relentless supply, even though the price isn’t there to support it. So, in the event of a demand shift you could see the same thing: supply come on quickly from Tier 3 assets that then will be sticky and probably create the conditions for a little bit more price-off in the future. That’s the lack of equilibrium conditions we live with in the mining sector. ROB NORWOOD (GOLDMAN): Right here in the front?
MALE SPEAKER: Can you explain the—is there much of a forward curve in uranium? I don’t know uranium much. How do contracts typically get negotiated? You had a long-term price on one of the graphs; what does long term mean and where is that data coming from? GRANT ISAAC: That’s a great question, and sorry for not providing a bit more detail on that earlier. So, the spot market in our business is a non-fundamental market. It tends to be a discretionary market, it tends to be the market of relatively low volumes, used by fuel buyers for discretionary purchases, in order to acquire one-time material for first cores, in order to acquire one-time 15
volumes to shore up an inventory position. It’s not where their run rate material comes from. That’s typically the term market. So, if the spot market is any uranium that’s going to transact over the next 12 months, the term market is uranium that’s going to transact kind of starting three years out and beyond.
The term market is characterized by two types of contracts. You either have a base-escalated contract or you have a market-related contract, in general terms.
If you wanted a base-escalated contract today, you would come to the market, and we wouldn’t quarrel over the price you start with; we would both turn to today’s term price indicator, $35. Our entire fight would be over how it escalates, how it escalates between today and first deliveries, and then how it escalates from first deliveries to the end of the contract. I would submit to you that I need regulatory cost indicators, and I would need inflation—mining inflation cost indicators, and you would say, “Look at the market, buddy, you’re not getting anything better than inflation, in industrial inflation, and in fact I want you to discount industrial inflation, because by the way I have all the advantage today.” So, that would be the way you set up a base-escalated contract.
A market-related contract commits pounds in the same window, three years out and beyond, but now we argue over which price indicator we use, say, 30 days before delivery. You would argue for a spot price indicator, because you’d be looking at the contango today, you’d see the big gap between the spot price and the term price. I’d want a term price indicator; I wouldn’t want 100% term price indicators, because we can get backwardation in our market. So, we’d fight over which price indicator; and then along the way you might ask for a ceiling in a marketrelated contract, and as soon as you ask for a ceiling I’m going to ask for a floor, and then we’re going to have a debate over extensions and options and flexibility for deliveries within that.
But, those are the two general types of contracts. You asked about a forward curve? Essentially, there’s an immature mid-term market in uranium. Some people like to draw the forward curve as simply today’s spot price to today’s term price. But of course, that’s inaccurate, when you have a contango like between $18 and $35, others will draw it by today’s spot price escalated by just a carry trade cost, and in a low interest rate environment that becomes a pretty flat curve. But all that to say it’s a pretty immature market, and not one that we have good developed price reporting on. In part, it’s what’s allowing this situation where the 16
oversupplied spot is becoming the solution for the first couple years of term demand, along just a very cheap carry trade. Fuel buyers can stay out of the $35 term market, and instead be in the $18.75 spot market.
So, in general, that’s how we—how the contract can be so …
MALE SPEAKER: (Inaudible 26:34), you said like three years out only? GRANT ISAAC: Yes, generally, deliveries will start kind of three years out and beyond. When there’s a demand shift under way and there’s a lot of price pressure, fuel buyers like longer-term contracts. When we’re in a market today where they have a lot of power in the market, we see that shortening of the term window, maybe it’s—maybe 10 years is no longer the industry average, maybe it creeps back to like 5. But fuel buyers, by and large, still want certainty and predictability where their run rate material is coming from. We don’t have any customers who want just-in-time fuel purchases. The estimate in the U.S. is that a light water reactor that has to come down because of a fuel shortage is about $5 million to $7 million a day. So, it doesn’t make any sense to take that kind of risk.
Right now, in today’s price environment, fuel buyers can be very price-sensitive; but eventually they become “security of supply”-sensitive, and that’s what drives the spiking nature of our industry.
MALE SPEAKER: In a reasonable market, utility daily market, what is the fuel cost of uranium which reduce run rate (inaudible 27:47)? You could do it as a percentage of power price or (inaudible 27:52) no matter what (inaudible 27:54) GRANT ISAAC: So, the uranium component of the operating costs of a light water reactor would be less than 5%. The fabricated fuel cost would be somewhere between 8% and 10%. So, the uranium is a pretty small component, but it has to be turned into a fuel bundle to be used, and that still gets you kind of less than 10% of the overall operating costs. 17
Thank you. ROB NORWOOD (GOLDMAN): We have got one in the back?
FEMALE SPEAKER: (Inaudible 28:20–27), sorry, is this better?
With the roughly 200-million-pound gap between the supply that you see by 2020 and the demand that you see by 2020 with the reactors coming on, what you’re describing is essentially pent-up demand. What kind of market dynamics are you anticipating over the next basically three years at this point?
GRANT ISAAC: Well, I think there’s—let’s start with how the market has behaved in the past. In the past, we see an industry and if you follow the uranium price curve, and there was an example of it that went back, I think, to ’03 in my slides, but if you took that back 20 years, 40 years, what you see is an industry that spikes for very short periods of time and then it sags for prolonged periods of time. From that, you can kind of get a cumulative average growth rate of the uranium price over the commercial period of uranium. It spikes because the utilities kind of sit out the market together and then they all get into the market together.
An example would be in 2006, 2007, when the uranium price went to $136 a pound on the spot market. It did that on the basis of a supply event. That was the flooding of our Cigar Lake mine development. So, there had been lots of talk about a nuclear renaissance and the demand for uranium going up, but it was this prospect that 18 million pounds of high-grade uranium, that the world was starting to count on, was going to be lost. That really drove a spike. Then, once comfort set in that the uranium supply was going to be there, the price came off to essentially $40. So, it came a long way off and swung in that $40 window for a period of time measured in years.
The second price spike on that curve was 2010; that wasn’t a supply event, that was a demand event. So, the fuel buyers, very comfortable with supply coming off the 2007 price spike, were 18
not doing active term contracting; not layering in and staying in the market, they kind of just vacated the space, so we saw term contracting grind down like we are seeing today. But, what happened in the summer of 2010 was the Chinese stepped into the term market for the first time. Prior to that, they would buy uranium in the spot market. But they stepped into the term market, did term contracting with Cameco, Areva, and Kazatomprom, and this kind of made sense from the point of view of our industry; a major build program, where reactors were starting to come on line in 2015, five years before they need the fuel bundles, they’re in the market looking for the uranium. When they did, they sent a bit of a shockwave through the rest of the fuel buyers, because they were pretty happy with their uranium coverage, 2010 to 2015, but they watched the Chinese step in and gobble up volumes 2020, 2015 and beyond, and started to worry about their share of that supply, and they all moved into the market at the same time, uranium went from essentially $40 to $74, and that momentum was building until an earthquake and tsunami struck the shores of Japan, all the term buyers stepped out of the market, and we’ve just seen one of these familiar sags again in the market.
So, if the past is any indication of the future, we expect at some point term demand to all come to the market in one big bulge. That’s why we keep our eye on that wedge of uncovered requirements that I talked about earlier. Right now, they’re not material. They’re not driving any pressure. Even in—two years from now, they’re not material. But, you start to get out into the early 2020s, you’re starting to see uncovered requirements from utilities that you can’t satisfy in the spot market. It’s not big enough. So, that will require term contracting. Course, they’re not going to show up just in time, they’re going to show up a few years before, and so for us it’s about matching up our contract portfolio protection with their lead time on uranium production and saying essentially, who can wait longer? Do we need to be contracting in the market today, or can we wait for this demand to come? If the past is any indication of the future, it’s going to come at once. FEMALE SPEAKER: Sorry, just one follow-up question. In those two events, you’ve described in the past, what was the sort of supply gap to the demand that was present there? Is it on a scale similar to what you’re describing for 2020?
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GRANT ISAAC: That’s a good question. I don’t know the answer for 2007. In 2010 you would have had a very similar picture. You would have had—you would have reduced both of those stacks, but the gap between the consumption and the inventory build, as well as the line of sight to supply, would have probably been in the 200-million-pound range, which is in part what propelled the price from $40 to the mid seventies, because it now had to incent the production we talked about earlier, that last marginal pound to come out of assets in Africa. So, it had to discover that kind of price to see those investments being made. MALE SPEAKER: Just sort of following up your comment, so, in a sense if you got a constructive picture, let’s say 2020 forward, lot of long term contracting to come and presumably higher levels. How do you think about how much you should have contracted up in advance of that, and how much do you keep open for getting the better pricing down the road? How do you decide sort of the minimum level of pricing you have in place? GRANT ISAAC: That’s an excellent question. Right now, we are benefitting from a contract portfolio that we layered in through the ’07 run-up and again in 2010. That’s giving us an average realized price well above the market. Over the five-year window we have an average of 27 million pounds per year contracted; that’s above our level of Tier 1 production. So, for us it’s about matching up the opportunities we see in the market with the need to place business. At the moment, we just don’t see the need to be chasing this market down. We see our contract portfolio being a good home for our Tier 1 production. We won’t produce more than our contract portfolio, so that we don’t have to sell Tier 1 production into the spot market and put further pressure on it. So, we’ll watch that really closely. Right now, we feel quite comfortable that we don’t have to be chasing this market. As we roll out in time, it’ll be a trade-off between the prospects for a low market for longer versus a demand shift. So, obviously that compass point that I saw, we’ll be watching all of those factors; if we see a significant fact change in the industry to the negative, that would propel us to do some contracting today. What do I mean by that? Suppose the Abe government in Japan comes out and says, “You know what, we’ve tried to restart these reactors, we’ve been banging our heads against the wall, we’re not going to get them restarted, we’re done.” Well that would be a significant fact change. There would be some hundred million pounds of uranium that would have to be unlocked from Japan, that would have to come 20
to the market, over a period of time, but that would keep it low for longer, in which case we would then have to assess our current stubbornness around contracting. But at the moment, as we see the market playing out, that fact change isn’t before us, so we think we can wait, mine our current contract portfolio for more value, and not chase this market down.
MALE SPEAKER: Just your first slide there with the “where we’re going, it’s 2020.” Can we critique that a little bit? Is that assuming that we have the 17 reactors in Japan restarting? What are the upside and downside scenarios from that (inaudible 36:10)? GRANT ISAAC: So, that first slide, just make sure … ROB NORWOOD (GOLDMAN): Let me put that one back up. GRANT ISAAC: So, in that slide, you have Japan represented by the Asian bloc, of course China’s broken out and India’s broken out from the Asian bloc. You have a fairly significant reactor program in Korea, continuing through that period. The assumptions in Japan for 2025 for us would have them by 2025 achieving their current policy goal, which is 20% to 22% of power coming from nuclear. That’s the current policy goal of the Abe government. In order to get there, they need about 30 of their reactors running. Depending on which ones, because they’re not all the same size, let’s say 30 to 35 reactors. So, in other words, by 2025 that assumption would have about 13 million pounds of annual Japanese consumption in it. So, if you want to handicap the numbers for Japan, just take 13 million pounds out, and just assume they’re not coming back to the market. That would be the way to take the Japanese effect out. So, for our perspective, we view the commitment as being real, and we see that the opportunity is there and it is aligned with the current policy statements. Should those change, or should we see less commitment to getting those reactors restarted, then of course we would adjust those numbers accordingly. MALE SPEAKER: Okay. What were they consuming at the peak (inaudible 37:39)?
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GRANT ISAAC: They were at about 20 million pounds of annual consumption. Remember, when the earthquake and tsunami struck Japan, there were 54 operable reactors in Japan. As a result of that event, there has been a new regulator established; that new regulator has a bunch of new requirements that, quite frankly, older reactors are not going to meet. So reasonably most people have backed something around 20 to 24 reactors out of that number to come down to the 30 or so required to hit the 20% to 22% of nuclear power. So, you still see announcements about reactors going into decommissioning in Japan. It’s the reactors that are part of that older first generation stuff that’s not coming back under the new regulations. MALE SPEAKER: Okay, so in that gray part there for retirements is about 20 Japanese nuclear reactors. GRANT ISAAC: That’s where they would be, yes. MALE SPEAKER: Thank you. MALE SPEAKER: Grant, in regards to Japan, what’s the tone currently coming out of the government regulators, (inaudible 38:42) two reactors (inaudible 38:43) now?
GRANT ISAAC: Yes, that’s a great question. So, I was through Japan, and I met with 10 of our 11 customers in May, and actually our CEO was in Japan last week. So, we were just kind of comparing notes on the tone. The tone, I would just say the tone remains positive with the folks that we deal with. We see utilities that are truly making an investment commitment, an economic commitment to these reactors. They’re spending real money on them. They are trying to get them ready for the new regulations. I toured a reactor in May, couple of boiling water reactors, so they’re not the first in the line going through the queue for restarts. It’s at the Hamaoka plant, Chubu Electric, they built the mile-long seawall that wraps around the plant, that some of you have seen in photos. It truly is a massive industrial undertaking. The commitment seems to be there. We see the commitment through policy. I referenced the 20% to 22%. We see the 22
commitment also through the way our Japanese customers and partners are behaving on uranium development projects. The Japanese are partners in our Cigar Lake project. You can imagine we’ve asked them many many times if they’re interested in exiting the Cigar Lake project; they’re not. They’re partners of ours in advanced exploration projects. They’re not interested in abandoning those either. So, we’re seeing that commitment.
Don’t forget there are a couple of reactors under construction in Japan. Construction was ongoing when the earthquake and tsunami hit, and then the construction license was suspended, then reinstated. If you’re really done with a nuclear enterprise, the easiest ones to shut down are the ones you’ve never started, that you’ve never actually finished. We’re seeing that commitment there. So, the commitment is real. But that’s a different question than “is there any urgency?”. What we’re not seeing is a rush. We’re not seeing utilities that are trying to rush public sentiment, rush public confidence, rush the regulatory process. We may look back 5 or 10 years from now and say that that was shockingly prudent for them to do.
Right now, it’s frustrating, obviously, that we’re not seeing a faster restart process, but I would think—I would just summarize it by saying I think the commitment is real, I think the urgency doesn’t match certainly where ours would be, but, as I was reminded when I toured the Hamaoka facility, they have a responsibility to produce base load power for 40 to 50 years. If it takes them a few more years to get back operating, because that’s what’s required to build public confidence and public trust, so be it. ROB NORWOOD (GOLDMAN): Absolutely. Any—we have time for one more question.
All right, then I’ll give the last one. Just in regards to capital allocation, you mentioned the investment-grade rating, the commitment to that. I know on the 3Q call there were some questions around the dividend. What’s the thought process there? GRANT ISAAC: That’s a good question, and usually when you find yourselves in a market that rolls over and you get asked the boundary condition questions on things like your investment-grade rating.
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We treat our dividend as a commitment. We treat it as a commitment that was made to our owners. It’s a very serious commitment. So, when we take our capital allocation process, take our contract portfolio that gives us very good line of sight to our revenues; as long as we’re controlling our costs, it gives us very good line of sight to our cash from operations. But, that is not our investable capital to allocate. We then back out the dividend, because we treat it as a commitment, and then we back out the financing charges on our long-term interest. Then, that leaves us with a residual amount of capital to allocate. So, you see it has a primary role in our capital allocation.
Having said that, there are fact changes that would—that could provoke us to alter our current dividend. A fact change I described earlier would be an Abe government that said no to nuclear. Well that would be a fact change, that we’d go back to the table and ask about whether that’s an appropriate policy. A positive fact change might be, after the 1002nd time asking our partners if they’re ready to exit MacArthur or Cigar, if one of them said yes, well, that would be a very positive fact change for us that might get us to consider it, but that gives you an idea what the scale of fact change required to get us to shift off that commitment. ROB NORWOOD (GOLDMAN): All right, everyone, please join me in thanking Grant for his time today, and (inaudible 43:16).
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November 16, 2016
Time:
11:15 AM EST / 10:15 AM CST
Presenter:
Grant Isaac Senior Vice President and Chief Financial Officer
ROB NORWOOD (GOLDMAN): All right, folks, thanks for coming. My name is Rob Norwood. I’m here with the metals and mining team at Goldman. Happy to present Grant Isaac from Cameco who’s going to lead it off today with a brief presentation and then we’ll take some Q&A. GRANT ISAAC: Great. Thank you very much. Thanks, folks, for giving a bit of time to us and letting us try to explain the uranium world through our eyes. Most interested in your questions, and so we’ll get to that, hopefully, really soon. But I do have a very quick PowerPoint presentation, just seven short slides, really oriented around most of the questions that we tend to get anyway, so hopefully can build up a bit of momentum and then get into some pretty detailed questions during the Q&A period, if that’s all right.
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It’s not going to surprise anybody in the room, but the conclusion of this presentation’s very simple. You know, we’re going to try to suggest to you that there is truly a demand story to pay attention to in the uranium space, it’s real, and one that gets us very excited. It gets us up in the morning. But, that’s not to suggest there aren’t real challenges in the market. There are some short-term pressures that we’ll continue to bear and need to work themselves through the market. Those would be the factors that keep us up at night, if what gets us up in the morning is the demand story. It’s the supply side and in particular the short-term supply side that keeps us up at night.
Then, ultimately I’m going to try to convince you that we’re really well placed to weather this short-term market transition and to capitalize on a demand shift. So, no real surprise there, I’m sure you’re hearing that kind of story over and over again, and let me just add to the list of people trying to convince you of that.
Forward-looking information caution; obviously have to put this up, but we’ll get through this one really quickly.
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At the heart of the demand story, is just the reactor rebuild that’s going around the planet. All we did with this slide was try to build the story up from, say, where we are in 2016 regionally, what we think is going to shut down. There will be reactors that will shut down; they run to the end of their life. There will be new reactors come to the grid, and what is that net change over the 10-year window that we’re looking at here, and then break it down by region as well.
You know, the first point in this slide is just to say there really is demand growth. If we translate it into uranium, it’s going from about 160 million pounds of annual consumption to about 220 million pounds of annual uranium consumption over this period, so. Fairly significant increase in annual demand as a consequence of these new reactors that are coming to the grid. You see in some regions, over-represented here obviously, China, really important part of the new build story. It has been, I would say, the most successful part of the new build story for the last several years. If we were at this conference chatting three years ago, we would have been talking about 13 reactors operating in China and some 20 under construction; today there’s 35 operating and 22 under construction. So, it really is about delivering on a commitment that they made, and it’s still an important part of the story going forward. But you see, our base load 3
regions maintain their position quite strongly through there as well: the Americas, Europe for example.
So, this demand growth translates into uranium growth. For us, the exciting part is, a lot of the uranium required to power this fleet over this 10-year window has not yet been bought. When we add up the uncovered requirements of the utilities represented in these regions, over the 10year period, we look at a wedge of about 500 million pounds of uranium they haven’t yet procured. A part of the problem is they don’t need it this year, they don’t need it next year, they don’t need it the year after; the wedge doesn’t really start to grow until you get out into early 2020s, but that’s 500 million pounds of uranium that’s required. Some of that’s coming our way. We’re a sovereign-safe, reliable supplier with Tier 1 assets and we know some of that demand is coming our direction. So, that obviously gets us pretty excited.
Of course, the demand side doesn’t mean anything unless there’s a supply side story to go with it. I’m just trying to advance this. It’s not seeming to want to respond. Perfect.
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So, the supply side over the same window, and just a slightly different look, this is just a stock diagram, also gets us pretty excited. We see demand represented there by actual consumption plus a bit of inventory build that will occur over that period. We then glance across and we say, “Where’s that uranium coming from?” Well there’s the part that we know, that we control through our existing mines; there are other mines that are producing around the world that will continue to produce. There’s certainly a bloc of secondary supply that will always be there: strategic inventories from governments, for example, or the willingness of enrichers to make uranium available through their facilities.
But it all results in a gap, a gap of about 200, in this case 210 million pounds of required supply that simply is not being incented today. At an $18.75 spot market and a $35 term market, there isn’t an incentive to fill this gap. There just isn’t the economic rationales to proceed with the development projects required to fill that. So, as an existing producer, that obviously gets us pretty excited. We see a long-term demand story that carries with it a certainty and a predictability that we don’t see matched on the longer-term supply story.
Now, one of the questions that I think is fair to ask—I’ll just get you to advance the slide again here—is, if this is so obvious, if this demand and supply imbalance is so clear and so obvious to everybody, then what’s wrong with the uranium price today? Why doesn’t it seem to be reflecting this reality? Because it’s not, it’s moving in a much much different direction. It’s a fair question. So, let me just take a bit of time to try to explain this current market uncertainty as we see it.
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Essentially we have very willing sellers, in fact in some cases panicked sellers of uranium right now, and matched up against really a buyers’ strike. So, we have an absence of the normal term demand that we enjoy in our market: that demand that comes where utilities come to the market to buy their run rate material for a five to 10-year window and layer in those volumes into their supply. We just have seen an absolute absence of that activity. Normally, we would expect kind of replacement rate term contracting. So, as I said earlier, if the world’s consuming 160 million pounds of uranium annually, you would expect somewhere around 160 million pounds to be contracted in the term market annually at the replacement rate, out over time, but layered in as replacement rate. Over the last 3½ years, we’ve seen fuel buyers consume over 600 million pounds of term contract material, and replace only 200 million pounds of that through term contracting.
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So, we’ve seen this delay in term contracting. Why? Because fuel buyers do not feel any panic to do any term buying right now. They glance across at a terribly over-supplied spot market, and they come to the conclusion that, if they have some early near-term demand, rather than provoking a term contract and going into the term market, they’re far better off just to duck into the spot market, pick up some small discretionary volumes, tuck that into the early part of their term demand, and essentially buy themselves more time. Why are they buying themselves more time? Because they want to see, like the rest of us, they want to see how Japan is going to unfold. Japan is a major consumer of uranium, down from about 20 million pounds on an annual basis to about 13 in a steady state post Fukushima, but not consuming really anything today. Two reactors running, and stockpiling, and therefore building an inventory overhang. Fuel buyers everywhere else want to see how this is going to play out. They want to buy themselves some time, and they’re effectively doing this with this oversupplied spot. The oversupplied spot is creating the delays and the deferrals to the term market. Where’s this oversupply coming from in the spot market? It’s coming from a bunch of different sources. 7
Number one, it’s coming from primary producers who wanted it to be spot-exposed. We’re not one of them; we sell all of our Tier 1 production into our contract portfolio; but there are others who wanted to be spot-exposed and enjoy the spot market in the uranium business; well, now they’re spot-exposed, and so they have material that needs to clear. There are also sources of uranium supply that aren’t really uranium supply-driven, and I think we can all fit into that category the Olympic Dam, BHP, I mean, as long as there’s copper and gold coming out of that mine, there’s uranium coming out, and that needs to go some place, and it finds its way into the spot market.
In addition, we have some strategic inventories that clear the spot market. In the U.S., here, the Department of Energy likes to make some of its strategic inventory available to pay bills, to pay clean-up bills at Portsmouth, Ohio, and Paducah, Kentucky, and that material clears the spot market.
In addition, enrichers, who have excess capacity because of reduced global enrichment requirements, due in particular to the Japanese fleet not running, have uranium, excess uranium that they can sell instead of producing SWU with. That hits the spot market.
In the last couple of weeks, couple of months, the extra gravity that we’ve seen on the spot market is driven by a very specific factor, and that is, there are intermediaries, traders and brokers in our business, who would have observed a $25 spot price over last fall and into early this year, and just deemed that an unsustainably low price of uranium; probably went long on uranium, bought a little more than they should. We’ve now been through two fairly negative conferences in our industry, once in September, one just recently, the NEI conference here in the U.S., which really didn’t send any strong demand signals, and we’ve seen the panicked unloading of those long positions into the spot market. That’s what’s created this extra gravity to the green line, just in the last couple weeks, so that the usual primary over-supply that’s hitting the spot, the enricher underfeeding, the strategic inventory mobilization, and now kind of this panicked deflationary mentality selling that we’re seeing, really pushing that spot price below, so. It’s real. It is pressure on the spot market. It could face—the spot market could face more pressure before year end here if we see any more of that panicked selling. On the other hand, we may see some year-end buying, some budget room from some fuel buyers for example might try to step in to pick up some of that demand, we’ll watch very closely how that plays out. So, I’ll get you to advance the slide again for me, thank you. 8
So, in terms of what changes this mentality, what flips it to a demand transition? We just tried to highlight on this slide some of the things we watch for. Obviously, it’s a return to term contracting. Until fuel buyers step into the market and start putting RFPs into the market more than one at a time, looking for material, 2020 and beyond, in significant volumes, we’re—we just—we’re not going to change this spot mentality. But for them to get there, we need to see a tightening of the spot market. We need to see either supply discipline from those who are selling into the spot market, or we need to see some disruption to those supplies that are hitting the spot market. On the demand side, we need to see some clarity and some certainty around Japan that will help offset some of the material that is putting pressure on the supply side— putting pressure on the spot market in terms of excess supply.
Obviously, the performance of reactor restarts in Japan is key to that demand picture, so all eyes remain on that. To the extent that the reactor construction programs continue a pace 9
around the planet, that’s going to help the demand eventually fill in the pothole, the lost demand of Japan over the last couple years, so we just kind of have to work through that.
All of this translating into a view of ours, that yes, the longer term is very constructive for Cameco, but we still have a near- to medium-term, in the absence of a shock, discretionary market that needs to be worked through.
The good news for us is we’re not seeing any competitors line up with supply, out in the window when we think demand is going to return, because they’re just not making those supply decisions.
So, if I move to the next slide, I would just say that we’re trying to handle this in a very specific way. If we had a balance sheet objective right now, it would read something like, “Our objective is to maximize our cash flow,” which everybody knows is code for cut OpEx, cut CapEx, cut 10
G&A, “subject to maintaining our investment-grade rating, making sure that we have the tools in the toolbox to deal with this low market and to ensure that we’re positioned for operating leverage.” That’s translated into us focusing on our Tier 1 assets. We’ve curtailed production from our Tier 2 assets, taken 7 million pounds out of the global supply stack, as a consequence of decisions we made in April. All of that to position us for weathering this storm and positioning for operating leverage when we come out of it.
Flexible production is something that we’ve been focused on. Flex means up, it also means down if the market doesn’t respond. Like everybody else, we’ve been on quite an aggressive cost control exercise.
I would just say a word about our contract portfolio: there’s been some attention to some contract cancellations that we’ve announced this year, two in particular. I would just say in general there’s a bit of context for those that needs to be considered. Because our average realized price from our contract portfolio is out-performing the market, we—no surprise, we have a lot of fuel buyers who are coming to us and saying, “Gosh, you know, I’m out of the market with the price I’m paying for Cameco uranium, can you help me out?” We of course remind them that it wasn’t very long ago they were paying a lot less for Cameco uranium under our contract portfolio than the market price, but we’ve forgotten about that period of time, obviously.
So, we take those customers that are approaching us and we really—we shift them into two buckets. There are customers that we have a pretty robust view about their long-term demand, and therefore their long-term value to our contract portfolio. We’re sensitive to the pressures they’re under to cut costs, and we’ll engage in, for example, “blend and extend”-type arrangements with them to lock in some of that value of the existing contract, give them a bit more relief in the near term, but ultimately give us value out into the future.
The contract cancellations fall into the other bucket. We have some customers where we don’t have as bullish view about their long-term demand. It could be a policy change in their region, it could be an economic decision, maybe in the face of shale gas prices or in the face of competition from feed-in tariffs for solar and wind, and all of that translating into some doubts about their long-term demand. In that case, it wouldn’t make sense for us to deal with those customers on a “blend and extend” basis. Why would we kick value out into an even more
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uncertain period? So, in those situations we are willing to translate or convert uncertain future value into certain present value, and those two contracts were an example of that.
The other thing I would just add, because I think there’s been a bit of misunderstanding, is these contract cancellations are not front-running announcements of early shutdowns. They’re a consequence of announcements that are already in the market, so.
The utilities, and we haven’t disclosed who they are, but they’ve already made their announcements to the market that they’re shutting down early and, as a consequence, have to deal with things like their uranium supply. We’ve detected there’s been some confusion that people think these contract cancellations are going to result in further announcements of early shutdowns. That’s not the right way to think about them.
So, if it makes sense, we will optimize our contract portfolio that way, and when it doesn’t we will stick to it and obviously fight for those contract provisions.
So, with that, it’s probably as far as I wanted to go with my comments today; opening it up for your questions, but just a quick reminder that we do think the market is very constructive going forward. There are real challenges that have to be worked through in the near to medium term. We think that we’ve taken the right actions to balance being prudent through this market pressure and ensuring that we have the price and operating leverage for the demand shift coming out the other side.
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So, with that, I’m happy to take questions. ROB NORWOOD (GOLDMAN): Thank you, Grant. We’ll open up to the audience first. MALE SPEAKER: Thanks, a lot. So, two quick questions. First, can you talk a little bit about reflexivity on the supply side? What I mean by that is, let’s say we all love the pitch, go out, buy uranium tomorrow, goes to $80 or $65; how quickly do you see additional incremental supply coming on? Is it mostly African assets, and at what price points, ballpark?
And then, I know that the U.S. market doesn’t necessarily drive demand but sometimes it does drive sentiment. If you could, any thoughts on a Trump presidency?
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GRANT ISAAC: So, I’ll start very briefly with the second point. I wouldn’t have any insights into that. I just am peering from across the border in what the Trump presidency can mean. You know, I think there’s a couple dimensions to think about, and one is, there have been some statements in the past about support for nuclear power, and that’s good, obviously received. There have also been some statements that don’t seem to support the renewables for—sorry, the subsidies for renewable energy that have come to really challenge the economics of base-load nuclear in merchant markets in the U.S. So, it’ll be interesting to see how that plays out, how those merchant markets react with their nuclear assets in the absence of those subsidies, which have been quite attractive and have created that situation where some of that power comes to the front of the line and it asks the nuclear plan to peak, to be a peak generator, and of course that’s not how you run nuclear assets. So, will it level the playing field from the base load point of view, I don’t know. More to come on that, obviously. So, that’s all I’ll say about the second one.
The first question is an important one. There’s a long answer and a medium answer. There isn’t really a short answer. If you look at the global supply of uranium, it really is going to come from essentially four jurisdictions in the world, represented by three mining types and really three cost tiers. The first tier of cost is either the high-grade mines in northern Saskatchewan, MacArthur River, Cigar Lake, or the In-Situ recovery mines in Kazakhstan. Not all Kazakhstan assets are created the same, but there certainly is a cluster of them that are Tier 1 assets. By Tier 1 I mean $20 and under life of mine operating costs. That represents about 40% of current primary production in the world, is that Tier 1 category. The second tier would be represented by loosely Australian production and some U.S. production. So, now you have a blend of lowgrade high-tonnage mining in Australia, plus In-Situ recovery mining in the U.S. Now you’re talking about a cost category that’s kind of in the $40 to $45 life of mine operating costs. So obviously under pressure in today’s price environment, under considerable pressure. That’s about 30% of primary production. The remaining is—and you’re going to have to take this with a very big grain of salt, because this might be the most self-serving thing you ever hear a Company say. We would just put the African production largely in that Tier 3 category. Now, it’s easy for us to do that because we’re not there. But, we’re not there because we’ve never been able to figure out how to make it Tier 1 or Tier 2. So, when we look at that production, that’s kind of in that $60 and up life of mine operating cost. But, it has a very considerable advantage in terms of coming to the market. It comes quickly. Because it’s such low grade, in truck and shovel operations, you don’t need ground freeze, you don’t need ventilation, you don’t 14
need radiation protection. So, high-grade mines, Tier 1, take a really long time to respond, 10years plus; the Tier 3 stuff can come on very quickly but the economics have to be right for it. So, that remaining 30% is not any investment decision you’d make today.
So, you might want a bit of a proof for that taxonomy that I just gave. If you follow the announcements post Fukushima, as the price came off, you would start with African projects, growth projects, being delayed and deferred; and then it would have moved into Australian growth projects being delayed and deferred. For example, our Kintyre project. Then, you started to see delays and deferrals in Tier 1 as the price fell further. So, that behaviour post Fukushima supports that view that that last marginal pound is going to come from a place like Africa and it needs a much higher price in order to incent it to be there.
But once the price is there, it doesn’t need the lead time of a high-grade mine in order to come on. It can come on quickly, of course the danger to that, and every mining company faces it, is the stickiness of supply. Once it’s in the market, it tends to just play itself out, it doesn’t disappear if the price falls. In part, we’re seeing some of that today, that stickiness, relentless supply, even though the price isn’t there to support it. So, in the event of a demand shift you could see the same thing: supply come on quickly from Tier 3 assets that then will be sticky and probably create the conditions for a little bit more price-off in the future. That’s the lack of equilibrium conditions we live with in the mining sector. ROB NORWOOD (GOLDMAN): Right here in the front?
MALE SPEAKER: Can you explain the—is there much of a forward curve in uranium? I don’t know uranium much. How do contracts typically get negotiated? You had a long-term price on one of the graphs; what does long term mean and where is that data coming from? GRANT ISAAC: That’s a great question, and sorry for not providing a bit more detail on that earlier. So, the spot market in our business is a non-fundamental market. It tends to be a discretionary market, it tends to be the market of relatively low volumes, used by fuel buyers for discretionary purchases, in order to acquire one-time material for first cores, in order to acquire one-time 15
volumes to shore up an inventory position. It’s not where their run rate material comes from. That’s typically the term market. So, if the spot market is any uranium that’s going to transact over the next 12 months, the term market is uranium that’s going to transact kind of starting three years out and beyond.
The term market is characterized by two types of contracts. You either have a base-escalated contract or you have a market-related contract, in general terms.
If you wanted a base-escalated contract today, you would come to the market, and we wouldn’t quarrel over the price you start with; we would both turn to today’s term price indicator, $35. Our entire fight would be over how it escalates, how it escalates between today and first deliveries, and then how it escalates from first deliveries to the end of the contract. I would submit to you that I need regulatory cost indicators, and I would need inflation—mining inflation cost indicators, and you would say, “Look at the market, buddy, you’re not getting anything better than inflation, in industrial inflation, and in fact I want you to discount industrial inflation, because by the way I have all the advantage today.” So, that would be the way you set up a base-escalated contract.
A market-related contract commits pounds in the same window, three years out and beyond, but now we argue over which price indicator we use, say, 30 days before delivery. You would argue for a spot price indicator, because you’d be looking at the contango today, you’d see the big gap between the spot price and the term price. I’d want a term price indicator; I wouldn’t want 100% term price indicators, because we can get backwardation in our market. So, we’d fight over which price indicator; and then along the way you might ask for a ceiling in a marketrelated contract, and as soon as you ask for a ceiling I’m going to ask for a floor, and then we’re going to have a debate over extensions and options and flexibility for deliveries within that.
But, those are the two general types of contracts. You asked about a forward curve? Essentially, there’s an immature mid-term market in uranium. Some people like to draw the forward curve as simply today’s spot price to today’s term price. But of course, that’s inaccurate, when you have a contango like between $18 and $35, others will draw it by today’s spot price escalated by just a carry trade cost, and in a low interest rate environment that becomes a pretty flat curve. But all that to say it’s a pretty immature market, and not one that we have good developed price reporting on. In part, it’s what’s allowing this situation where the 16
oversupplied spot is becoming the solution for the first couple years of term demand, along just a very cheap carry trade. Fuel buyers can stay out of the $35 term market, and instead be in the $18.75 spot market.
So, in general, that’s how we—how the contract can be so …
MALE SPEAKER: (Inaudible 26:34), you said like three years out only? GRANT ISAAC: Yes, generally, deliveries will start kind of three years out and beyond. When there’s a demand shift under way and there’s a lot of price pressure, fuel buyers like longer-term contracts. When we’re in a market today where they have a lot of power in the market, we see that shortening of the term window, maybe it’s—maybe 10 years is no longer the industry average, maybe it creeps back to like 5. But fuel buyers, by and large, still want certainty and predictability where their run rate material is coming from. We don’t have any customers who want just-in-time fuel purchases. The estimate in the U.S. is that a light water reactor that has to come down because of a fuel shortage is about $5 million to $7 million a day. So, it doesn’t make any sense to take that kind of risk.
Right now, in today’s price environment, fuel buyers can be very price-sensitive; but eventually they become “security of supply”-sensitive, and that’s what drives the spiking nature of our industry.
MALE SPEAKER: In a reasonable market, utility daily market, what is the fuel cost of uranium which reduce run rate (inaudible 27:47)? You could do it as a percentage of power price or (inaudible 27:52) no matter what (inaudible 27:54) GRANT ISAAC: So, the uranium component of the operating costs of a light water reactor would be less than 5%. The fabricated fuel cost would be somewhere between 8% and 10%. So, the uranium is a pretty small component, but it has to be turned into a fuel bundle to be used, and that still gets you kind of less than 10% of the overall operating costs. 17
Thank you. ROB NORWOOD (GOLDMAN): We have got one in the back?
FEMALE SPEAKER: (Inaudible 28:20–27), sorry, is this better?
With the roughly 200-million-pound gap between the supply that you see by 2020 and the demand that you see by 2020 with the reactors coming on, what you’re describing is essentially pent-up demand. What kind of market dynamics are you anticipating over the next basically three years at this point?
GRANT ISAAC: Well, I think there’s—let’s start with how the market has behaved in the past. In the past, we see an industry and if you follow the uranium price curve, and there was an example of it that went back, I think, to ’03 in my slides, but if you took that back 20 years, 40 years, what you see is an industry that spikes for very short periods of time and then it sags for prolonged periods of time. From that, you can kind of get a cumulative average growth rate of the uranium price over the commercial period of uranium. It spikes because the utilities kind of sit out the market together and then they all get into the market together.
An example would be in 2006, 2007, when the uranium price went to $136 a pound on the spot market. It did that on the basis of a supply event. That was the flooding of our Cigar Lake mine development. So, there had been lots of talk about a nuclear renaissance and the demand for uranium going up, but it was this prospect that 18 million pounds of high-grade uranium, that the world was starting to count on, was going to be lost. That really drove a spike. Then, once comfort set in that the uranium supply was going to be there, the price came off to essentially $40. So, it came a long way off and swung in that $40 window for a period of time measured in years.
The second price spike on that curve was 2010; that wasn’t a supply event, that was a demand event. So, the fuel buyers, very comfortable with supply coming off the 2007 price spike, were 18
not doing active term contracting; not layering in and staying in the market, they kind of just vacated the space, so we saw term contracting grind down like we are seeing today. But, what happened in the summer of 2010 was the Chinese stepped into the term market for the first time. Prior to that, they would buy uranium in the spot market. But they stepped into the term market, did term contracting with Cameco, Areva, and Kazatomprom, and this kind of made sense from the point of view of our industry; a major build program, where reactors were starting to come on line in 2015, five years before they need the fuel bundles, they’re in the market looking for the uranium. When they did, they sent a bit of a shockwave through the rest of the fuel buyers, because they were pretty happy with their uranium coverage, 2010 to 2015, but they watched the Chinese step in and gobble up volumes 2020, 2015 and beyond, and started to worry about their share of that supply, and they all moved into the market at the same time, uranium went from essentially $40 to $74, and that momentum was building until an earthquake and tsunami struck the shores of Japan, all the term buyers stepped out of the market, and we’ve just seen one of these familiar sags again in the market.
So, if the past is any indication of the future, we expect at some point term demand to all come to the market in one big bulge. That’s why we keep our eye on that wedge of uncovered requirements that I talked about earlier. Right now, they’re not material. They’re not driving any pressure. Even in—two years from now, they’re not material. But, you start to get out into the early 2020s, you’re starting to see uncovered requirements from utilities that you can’t satisfy in the spot market. It’s not big enough. So, that will require term contracting. Course, they’re not going to show up just in time, they’re going to show up a few years before, and so for us it’s about matching up our contract portfolio protection with their lead time on uranium production and saying essentially, who can wait longer? Do we need to be contracting in the market today, or can we wait for this demand to come? If the past is any indication of the future, it’s going to come at once. FEMALE SPEAKER: Sorry, just one follow-up question. In those two events, you’ve described in the past, what was the sort of supply gap to the demand that was present there? Is it on a scale similar to what you’re describing for 2020?
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GRANT ISAAC: That’s a good question. I don’t know the answer for 2007. In 2010 you would have had a very similar picture. You would have had—you would have reduced both of those stacks, but the gap between the consumption and the inventory build, as well as the line of sight to supply, would have probably been in the 200-million-pound range, which is in part what propelled the price from $40 to the mid seventies, because it now had to incent the production we talked about earlier, that last marginal pound to come out of assets in Africa. So, it had to discover that kind of price to see those investments being made. MALE SPEAKER: Just sort of following up your comment, so, in a sense if you got a constructive picture, let’s say 2020 forward, lot of long term contracting to come and presumably higher levels. How do you think about how much you should have contracted up in advance of that, and how much do you keep open for getting the better pricing down the road? How do you decide sort of the minimum level of pricing you have in place? GRANT ISAAC: That’s an excellent question. Right now, we are benefitting from a contract portfolio that we layered in through the ’07 run-up and again in 2010. That’s giving us an average realized price well above the market. Over the five-year window we have an average of 27 million pounds per year contracted; that’s above our level of Tier 1 production. So, for us it’s about matching up the opportunities we see in the market with the need to place business. At the moment, we just don’t see the need to be chasing this market down. We see our contract portfolio being a good home for our Tier 1 production. We won’t produce more than our contract portfolio, so that we don’t have to sell Tier 1 production into the spot market and put further pressure on it. So, we’ll watch that really closely. Right now, we feel quite comfortable that we don’t have to be chasing this market. As we roll out in time, it’ll be a trade-off between the prospects for a low market for longer versus a demand shift. So, obviously that compass point that I saw, we’ll be watching all of those factors; if we see a significant fact change in the industry to the negative, that would propel us to do some contracting today. What do I mean by that? Suppose the Abe government in Japan comes out and says, “You know what, we’ve tried to restart these reactors, we’ve been banging our heads against the wall, we’re not going to get them restarted, we’re done.” Well that would be a significant fact change. There would be some hundred million pounds of uranium that would have to be unlocked from Japan, that would have to come 20
to the market, over a period of time, but that would keep it low for longer, in which case we would then have to assess our current stubbornness around contracting. But at the moment, as we see the market playing out, that fact change isn’t before us, so we think we can wait, mine our current contract portfolio for more value, and not chase this market down.
MALE SPEAKER: Just your first slide there with the “where we’re going, it’s 2020.” Can we critique that a little bit? Is that assuming that we have the 17 reactors in Japan restarting? What are the upside and downside scenarios from that (inaudible 36:10)? GRANT ISAAC: So, that first slide, just make sure … ROB NORWOOD (GOLDMAN): Let me put that one back up. GRANT ISAAC: So, in that slide, you have Japan represented by the Asian bloc, of course China’s broken out and India’s broken out from the Asian bloc. You have a fairly significant reactor program in Korea, continuing through that period. The assumptions in Japan for 2025 for us would have them by 2025 achieving their current policy goal, which is 20% to 22% of power coming from nuclear. That’s the current policy goal of the Abe government. In order to get there, they need about 30 of their reactors running. Depending on which ones, because they’re not all the same size, let’s say 30 to 35 reactors. So, in other words, by 2025 that assumption would have about 13 million pounds of annual Japanese consumption in it. So, if you want to handicap the numbers for Japan, just take 13 million pounds out, and just assume they’re not coming back to the market. That would be the way to take the Japanese effect out. So, for our perspective, we view the commitment as being real, and we see that the opportunity is there and it is aligned with the current policy statements. Should those change, or should we see less commitment to getting those reactors restarted, then of course we would adjust those numbers accordingly. MALE SPEAKER: Okay. What were they consuming at the peak (inaudible 37:39)?
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GRANT ISAAC: They were at about 20 million pounds of annual consumption. Remember, when the earthquake and tsunami struck Japan, there were 54 operable reactors in Japan. As a result of that event, there has been a new regulator established; that new regulator has a bunch of new requirements that, quite frankly, older reactors are not going to meet. So reasonably most people have backed something around 20 to 24 reactors out of that number to come down to the 30 or so required to hit the 20% to 22% of nuclear power. So, you still see announcements about reactors going into decommissioning in Japan. It’s the reactors that are part of that older first generation stuff that’s not coming back under the new regulations. MALE SPEAKER: Okay, so in that gray part there for retirements is about 20 Japanese nuclear reactors. GRANT ISAAC: That’s where they would be, yes. MALE SPEAKER: Thank you. MALE SPEAKER: Grant, in regards to Japan, what’s the tone currently coming out of the government regulators, (inaudible 38:42) two reactors (inaudible 38:43) now?
GRANT ISAAC: Yes, that’s a great question. So, I was through Japan, and I met with 10 of our 11 customers in May, and actually our CEO was in Japan last week. So, we were just kind of comparing notes on the tone. The tone, I would just say the tone remains positive with the folks that we deal with. We see utilities that are truly making an investment commitment, an economic commitment to these reactors. They’re spending real money on them. They are trying to get them ready for the new regulations. I toured a reactor in May, couple of boiling water reactors, so they’re not the first in the line going through the queue for restarts. It’s at the Hamaoka plant, Chubu Electric, they built the mile-long seawall that wraps around the plant, that some of you have seen in photos. It truly is a massive industrial undertaking. The commitment seems to be there. We see the commitment through policy. I referenced the 20% to 22%. We see the 22
commitment also through the way our Japanese customers and partners are behaving on uranium development projects. The Japanese are partners in our Cigar Lake project. You can imagine we’ve asked them many many times if they’re interested in exiting the Cigar Lake project; they’re not. They’re partners of ours in advanced exploration projects. They’re not interested in abandoning those either. So, we’re seeing that commitment.
Don’t forget there are a couple of reactors under construction in Japan. Construction was ongoing when the earthquake and tsunami hit, and then the construction license was suspended, then reinstated. If you’re really done with a nuclear enterprise, the easiest ones to shut down are the ones you’ve never started, that you’ve never actually finished. We’re seeing that commitment there. So, the commitment is real. But that’s a different question than “is there any urgency?”. What we’re not seeing is a rush. We’re not seeing utilities that are trying to rush public sentiment, rush public confidence, rush the regulatory process. We may look back 5 or 10 years from now and say that that was shockingly prudent for them to do.
Right now, it’s frustrating, obviously, that we’re not seeing a faster restart process, but I would think—I would just summarize it by saying I think the commitment is real, I think the urgency doesn’t match certainly where ours would be, but, as I was reminded when I toured the Hamaoka facility, they have a responsibility to produce base load power for 40 to 50 years. If it takes them a few more years to get back operating, because that’s what’s required to build public confidence and public trust, so be it. ROB NORWOOD (GOLDMAN): Absolutely. Any—we have time for one more question.
All right, then I’ll give the last one. Just in regards to capital allocation, you mentioned the investment-grade rating, the commitment to that. I know on the 3Q call there were some questions around the dividend. What’s the thought process there? GRANT ISAAC: That’s a good question, and usually when you find yourselves in a market that rolls over and you get asked the boundary condition questions on things like your investment-grade rating.
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We treat our dividend as a commitment. We treat it as a commitment that was made to our owners. It’s a very serious commitment. So, when we take our capital allocation process, take our contract portfolio that gives us very good line of sight to our revenues; as long as we’re controlling our costs, it gives us very good line of sight to our cash from operations. But, that is not our investable capital to allocate. We then back out the dividend, because we treat it as a commitment, and then we back out the financing charges on our long-term interest. Then, that leaves us with a residual amount of capital to allocate. So, you see it has a primary role in our capital allocation.
Having said that, there are fact changes that would—that could provoke us to alter our current dividend. A fact change I described earlier would be an Abe government that said no to nuclear. Well that would be a fact change, that we’d go back to the table and ask about whether that’s an appropriate policy. A positive fact change might be, after the 1002nd time asking our partners if they’re ready to exit MacArthur or Cigar, if one of them said yes, well, that would be a very positive fact change for us that might get us to consider it, but that gives you an idea what the scale of fact change required to get us to shift off that commitment. ROB NORWOOD (GOLDMAN): All right, everyone, please join me in thanking Grant for his time today, and (inaudible 43:16).
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