Uranium – Shift in Kazakh mindset may signal the long awaited market bottom

    Uranium – Shift in Kazakh mindset may signal the long awaited market bottom

    Kazatomprom starting to hint at increased sophistication and long-term approach
    Kazatomprom, the Kazakh-state uranium producer, has grown from a globally insignificant player to the largest producer in the world and constituted 39% of global mine production in 2015. In a series of interviews and public statements, Kazatomprom has shown an increasing level of sophistication and ambition with regards to marketing and increasing its position in the nuclear value chain. We believe that this foreshadows a shift in global uranium markets as the Kazakhs begin to move away from policies that enabled Kazatomprom to seize a significant level of market share yet exacerbated the global oversupply of U3O8.

    Kazatomprom’s establishment of Swiss marketing arm suggests that inventory management may become a policy tool.
    Beginning in October 2015, Kazatomprom announced, and has subsequently reiterated, the intention to establish a marketing company, based in Switzerland, to centrally coordinate the sale of uranium. The establishment of this structure has several implications for Kazatomprom’s uranium marketing that may have significant impact on the uranium spot price and supply/demand dynamics:

    ·  Inventory Management: The majority of Kazatomprom’s supply contracts have come in the form of asset level JVs or direct supply agreements which see mine production allocated for a specific utility customer from extraction through packaging and sale. An alternative strategy would see production from all mines pooled into a group inventory pool with sales drawn from the group pool for delivery. The benefit to the latter strategy over the former is that it would enable the group to incorporate an inventory policy and act as more of a swing producer or swing seller, using inventory and production levels to influence the uranium price.

    ·  Transfer Pricing: Kazakhstan has very detailed and comprehensive transfer pricing laws which restrict the sale of commodities to publicly verifiable prices where available (though these laws apply to non-commodity businesses also). The purpose of the laws is to restrict tax avoidance (generally by overseas companies) enabled by the shifting of profits out of country through subsidiary transfer pricing. However this has had the effect of restricting Kazatomprom to spot market sales. As the current spot price of ~US$18/lb is well below the long-term uranium contract price of ~US$38 negotiated between utilities and uranium suppliers, this has had a depressing effect on the market. Furthermore, it has enabled utilities to put off signing new supply contracts and rely on a more ‘just-in-time’ sourcing model.
    The establishment of the new Swiss marketing company enables Kazatomprom to sell U3O8 at spot to its Swiss marketing subsidiary and subsequently market uranium at higher prices abroad. In other words, it gives Kazatomprom the flexibility to contract at higher than spot price should it choose to. We expect that Kazatomprom will likely keep the bulk of its sales on the spot market to avoid locking in long term sales at low prices. Regardless, the option to contract gives Kazatomprom a tool to influence spot prices higher should Kazatomprom tire of selling at a persistently low spot price.

    ·  JV signed with Chinese partners to produce fuel assemblies: Kazatomprom signed cooperation agreements with China General Nuclear (CGN) regarding the development of uranium projects and JV construction of a fuel assembly plant located at the Ulba Metallurgical Plant. One of the stated goals of Kazatomprom’s transformation project is to increase the state company’s economic value add. The company has previously signed a fuel cooperation agreement with AREVA in 2008 and purchased a 10% stake in US-based nuclear supplier Westinghouse in 2007.

    ·  Kazatomprom now publically suggesting that it will halt production growth, is happy with current production and market share levels: Kazatomprom Chairman Askar Zhumagaliyev, in a recent interview with Kazpravda, stated that “the current market situation tells us there is no need to increase production significantly in the coming years.” Whilst Zhumagaliyev has not made any indications with regards to production cuts, the statement is a sign of Kazatomprom’s increased awareness of its position in the uranium market.

    ·  Kazatomprom is unlikely to passively sell at spot for much longer, will increase margin by upvaluing and managing sales to avoid flooding market: Kazatomprom’s initial strategy of rapid production increases and spot sales enabled the company to make tremendous market share gains. In our view, the next phase of Kazatomprom’s growth will see it focus more on margin, whilst maintaining its market share. In practice, this will see the development of a market based sales (and eventually production) strategy to improve margins on yellowcake with simultaneous efforts to move up in the supply value chain to more value added products. With increasing value add, these products include UF6 (hex), fuel pellets and eventually full fuel rod assemblies. This would follow the growth model, first demonstrated by Japanese and Korean industries, of establishing a large, low-cost market share of low value added products (eg. steel, copper, aluminium refining) which enable the growth of more value added industries (auto manufacturing, ship building, semiconductor production) later as the economy matures.

    ·  Utilities increasingly vulnerable to supply shocks as they have transitioned to ‘Just in Time’ supply model; majority of contracts roll off by 2020-2022: In our view, the current spot price reflects short term oversupply with the largest factor being the growth in Kazakh spot production. For the reasons we have outlined, we believe that this phase of the market is coming to an end. This may create a short squeeze situation as nuclear power generating utilities have increasingly relied on spot purchases to supplant contracts signed in the rush of the 2006-2009 uranium bull market. US utilities have less than 50% of their uranium supply under contract from 2020 onward while EU utilities will have less than 50% coverage from 2022. This resembles the supply dynamics of the early 2000s, when the spot market was oversupplied by de-enriched former weapons grade uranium made available by the ‘Megatons to Megawatts’ program. This situation was put into reverse by the unexpected flooding of Cigar Lake in 2006, which triggered a significant price reversal as utilities rushed to get their hands on supply, contracting volumes of material at higher prices that still form a large portion of their current supply agreements. Whilst we are not predicting another mine flood, we do believe that utilities have put themselves in a position with very little bargaining leverage. This may be decisive as Kazatomprom rethinks its marketing strategy and all major producers are unwilling to long term contract at price levels below the low US$40s/lb.

    Mehran Bagherzadeh  |  Investor Relations


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