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Wednesday, March 14, 2007

poor quality Strathmore valuation (STM.V, STHJF)

I know that I've spent a lot of time on Strathmore Minerals lately, but it's for good reason. The stars are aligning for this particular industry.

This market commentary article was posted on U3O8.biz today. It whines about the price drops of uranium stocks. But the interesting part is a quote of analyst Graeme Currie:
"The perception of what one pound of uranium is worth [in the ground] has materially increased," concludes analyst Graeme Currie, whose analysis has bumped up the value for "measured and indicated" resources to $10 (U.S.) a pound from $8 and for "inferred" resources to $6 from $5.
First of all, we know that this is a meaningless measure for a lot of reasons which are all related to the question of "How much does it cost to extract that pound and when can we expect it to be extracted?" The answer can range from "$4"/"today" all the way to "$100"/"when hell freezes over" which produces a value of roughly $87 and $0 per pound respectively.

However, one thing we can say about Strathmore Minerals is that they've cherry picked properties based on a huge amount of historical database information before the whole uranium mania caught hold. So perhaps we can apply Currie's formula to Strathmore.

I'm taking the info from Strathmore's website here. Let's consider "historical demonstrated" in the same category as "measured and indicated" and let's consider "historical inferred" in the same category as "inferred" (I believe the categories are different due to whether they're NI 43-101 compliant and Strathmore's record is very good when it brings the info into compliance).

When I do this, and use the numbers above, here's what I get.

numbers are in millions of pounds of U3O8
MI means measured and indicated
IF means inferred
HD means historical demonstrated
HI means historical inferred
Church Rock: MI=11.8, IF=3.5
Roca Honda: MI=17.5, IF=15.8
Nose Rock: HD=18.2
Dalton Pass: HD=3.5, HI=0.8
Roca Honda North: HD=0.3
Copper Mtn,WY: HI=24.6
Sky, WY: HD=0.8
Pine Tree, WY: HD=2.6
Section 36 (Reno Creek), WY: HD=1.3
West (Reno Creek), WY: HD=4.0
SWD Claims Area, WY: HD=0.9
FMC Claim, WY: HD=3.7
Ketchum Buttes, WY: HD=1.4
Juniper Ridge, WY: HI=5.5
Gas Hills I, WY: MI=8.4
Gas Hills II, WY: HD=1.5
Gas Hills III, WY: HD=0.3
Chord, SD: HD=3.8
Dieter Lake, QB: IF=3.8
Duddridge Lake: IF=0.7

Total measured and indicated: 37.7 million pounds
Total inferred: 23.8 million pounds
Total historical demonstrated: 42.3 million pounds
Total historical inferred: 30.9 million pounds

Assuming dollars per pound specified by Mr. Currie
MI=10, IF=6, HD=10, HI=6
The total value would be $1.1 billion or about $14.65 per diluted share (@77 million shares)

Assuming dollars per pound
MI=10, IF=6, HD=5, HI=3
The total value would be $824 million or about $10.70 per diluted share

Assuming that 60% of everything listed gets extracted at an average cost of $40 per pound, sold for $80 per pound and split 50/50 in a joint venture, and then discounted another 50% due to time, the total value would be $10.50.

UPDATE same day:
Yellowcake announced that the joint venture agreement with Strathmore is done.
Yellowcake said it is paying US$100 thousand, and US$100 thousand on the subsequent anniversary dates for 4 years for a total obligation of US$500 thousand. The company is spending US$1.6 million per year for a period of 5 years for a total commitment of $8 million. Yellowcake will earn 50% of the optioned interest upon spending US$4 million and earn the remaining 50% optioned interest upon spending the additional US$4 million.
There were other details that I don't see here (Strathmore gets 9 million shares of Yellowcake stock which I think is around 20% of the company, Strathmore gets 3% royalty payments on Yellowcake's portion of ownership, Yellowcake pays for the Texas database evaluation). Juniper Ridge has 5.5 million pounds of historical inferred at a grade of 0.1% (2 pounds per ton), I don't know anything about the permeability/porosity/depth below water table/etc. and whether it can be mined via ISR methods, but given that Strathmore is pulling out this property early, it's probably pretty good (perhaps $30 per pound to extract?).

If I understand correctly that Yellowcake will be doing other mining development, I figure Strathmore ends up with something not far from 50% of the value of Juniper Ridge, but it's pretty convoluted.

UxC tells TradeTech, "I'll see your $90 and raise you a dollar." The spot price went up another dollar to $91.

Denison reported their results.
Future sales of the Company's uranium inventory and production will be under market related contracts with appropriate floor prices. In March 2007, one such contract was completed for the sale of 17% of the White Mesa mill production commencing in 2008 up to a maximum of 6.5 million pounds with a minimum of 2.5 million pounds by the end of 2011. The sales price is 95% of the published long-term price for the month prior to delivery with a floor price of $45.00.
That's a pretty low floor compared to what I've been reading.

They produced a lot less than the prior year:
Twelve month production at McClean for 2006 totaled 1,794,000 pounds compared with 5,490,000 for 2005.... The primary reasons for lower production in 2006 were lower-grade ore feed, the absence of higher-grade ore from the blind boring/jet boring operations, reduced throughput caused by variances in the arsenic concentration of the ore feed that resulted in elevated temperature in the leach circuit and a shortage of reagents due to road closure caused by forest fires.
There's production coming online, going into their Athabasca basin mill in 2010/2011 and ramping up to 9 million pounds per year. They were expected Cigar Lake to come online in 2008: "close but no cigar." There's other stuff coming online.

They're doing some serious exploration work in Athabasca basin. A possible project going forward in Mongolia (possible production in 2010).

Overall industry stuff:
Over the four-year period 2002-2005, global primary uranium production averaged 93.1 million pounds of uranium. In response to increasing uranium prices, worldwide uranium production rose to 104.6 million pounds in 2004 and to 108.1 million pounds in 2005, however, it dropped in 2006 to 104 million pounds as a result of production problems at several production centres [NOTE: this doesn't include Cigar Lake which wasn't expected to produce until 2008].
Based upon recent assessments of future secondary uranium supply, the scheduled uranium production forecast and forecasted nuclear generating capacity, there is a growing requirement for increased uranium production to meet the forecast needs of Western reactors. Based upon the most recent assessment of market trends published by the World Nuclear Association, "The Global Nuclear Fuel Market: Supply and Demand 2005-2030," (September 2005), under Reference Case conditions (uranium requirements, secondary supply) uranium production to support Western reactors will need to expand from its 2004 level of 93.2 million pounds, up to 123.0 million pounds in 2010 and reach 161.4 million pounds by 2015. These estimates are subject to a number of assumptions about future events and the anticipated deficit could change if the assumptions are incorrect.
And more perspective on uranium prices:
Over the period from 1996 through 2004, annual spot market demand averaged just under 20 million pounds U3O8 or about 12% of the annual world consumption, but has jumped to about 35 million pounds over the last two years as utility inventories commence to be rebuilt and investors and hedge funds have entered the market as significant buyers.
Historically, spot prices have been more volatile than long-term contract prices, increasing from $6.00 per pound in 1973 to $43.00 in 1977, and then declining from $40.00 in 1980 to a low of $7.25 in October of 1991. From this low in 1991, the spot price increased to $16.50 in June 1996. The primary reasons for this increase were trade restrictions limiting the free flow of uranium from the former CIS republics into the Western world markets, the Nuexco bankruptcy under Chapter 11 of the United States Bankruptcy Code and related defaults on deliveries, and the reluctance of uranium producers and inventory holders to sell at low spot price levels. The drop in spot demand in the following four years along with Russian HEU Feed sold under the USEC Privatization Act largely contributed to a relatively steady drop in prices to $7.40 in September 2000.

Prices remained depressed as a result of weak demand, falling to $7.10 in January 2001, but, due to moderate increases in demand and production problems at the McArthur River and Olympic Dam operations, prices rose to $12.25 by September 2003. Another major impact to the market occurred in early November 2003, as a result of Russia terminating a long term contract for the supply of HEU Feed with Globe Nuclear Services and Supply GNSS, Limited ("GNSS").

The uranium spot price started 2004 at $14.50 per pound U3O8 and has increased steadily since that date reaching $72.00 by the end of 2006.

The long-term uranium price has undergone an even more pronounced increase over the past several years, rising from just under $11.00 per pound U3O8, at the end of 2002, to $75.00 per pound at the end of 2006.

Future uranium prices will be influenced by increased demand from new reactors being constructed or planned in many parts of the world as well as the amount of incremental supply made available to the market from the remaining excess inventories, HEU feed supplies, other stockpiles and the availability of increased or new production from other uranium producers.

UPDATE March 15, 2007:
Ok, here's the official press release about Strathmore and Yellowcake, and it has all the details I was looking for.

UPDATE March 15, 2007:
China plans to hoard uranium.
China is building an emergency supply of crude oil and plans to expand that to metals and uranium.
UPDATE Fri, March 16, 2007: The uranium thesis in a nutshell
The chart at the top of this article is a great view of the production vs consumption of uranium over the years. There are two things that jump out from the chart. 1) Production dropped off a cliff in the late 1980s and hasn't really come back all that much. 2) Consumption continued climbing and has mostly climbed upwards over time.

We know that consumption is going to start rising faster with all the nuclear reactors being developed and planned. China alone plans 2 new reactors per year. Their energy needs are enormous and their pollution from burning coal is terrible. India is also adding a lot of nuclear reactors. Lots of other countries are, as well.

It takes many years to go from uranium exploration to actual production. Those companies who are farther along the curve will do well. It will be very difficult to get new production online very fast. If anything, production has suffered from long-term neglect and whatever increases in production that have occured have been the result of trying to squeeze more out of what's already in place, which eventually runs into problems and bottlenecks. There's a reason why Cigar Lake wasn't developed until just recently (the exploration was done a long time ago). The mine floods show why.

Compared to coal/oil/gas, fuel costs for nuclear are not the biggest costs to run the plant. If uranium prices rise to $200, nuclear plants are unlikely to consume less.

Inelastic demand + inelastic supply + huge demand/supply imbalance = higher prices

It's basic economics. It's also basic economics that whoever owns the cheaper production going forward will have great margins because, even when supply and demand equalize, the prices will be set by the costliest suppliers.

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