Uranium's Next Phase - Strap In

What's coming may surprise even the bulls

The uranium bull market is starting its next phase, one that will involve even higher levels of volatility and, potentially, some defaults on delivery commitments to utilities. After Kazatomprom (KAP)’s recent announcement, there is a significant chance that there simply won’t be enough uranium for everyone who wants it over the near to mid-term. Prices will be dictated by the most desperate, marginal bidder.

I’m seeing very little coverage of the implications of KAP’s production issues in the mainstream media. Most journalists are focused on the geopolitical angle (potential Russia ban), the fact that uranium was the best performing commodity in 2023, and looking at past cycles as a blueprint for what happens next. There are very few journalists who are covering Kazakhstan well, and only a handful of financial analysts who cover KAP. It’s essential to dig deeper into KAP’s production issues to understand the bigger picture.

In September last year, KAP announced production guidance which indicated a gradual return to 100% of subsoil use agreement production level (the level that sets the +/- 20% range within which they can produce legally), from 80% in 2023 to 90% in 2024 and 100% in 2025. The middle of the range guidance was:

• 2023 - 21tU / 54.6mm lbs

• 2024 - 25tU / 65.8mm lbs

• 2025 - 31tU / 80.6mm lbs

I have previously expressed skepticism regarding these targets based on the Company’s track record and the ongoing supply chain issues in Kazakhstan, including a shortage of skilled labor, shortage of sulfuric acid, cost inflation etc. These are long-term structural issues that won’t magically disappear by 2024 or 2025. However, a number of utilities probably took the bait and signed LT contracts with KAP in Q4 of last year in wake of the production guidance announcement. Now, only 4 months later, these potential buyers are faced with the sobering reality that KAP may have over committed its production and is likely to be a buyer in the spot market to meet its delivery obligations.

It’s not only KAP’s customers who are impacted by this announcement. KAP has international JVs with uranium producers all around the world. Production issues in Kazakhstan reverberate globally, and JV partners like Cameco, Orano, CGN etc. might also be forced into the spot market to meet their delivery obligations. This is on top of all the logistical / transportation issues involved with getting uranium out of Kazakhstan’s borders to the West, which I have discussed previously.

We will learn more about why KAP is lowering its production forecast during the Company’s earnings call on February 1st, but a number of industry observers have surmised that the recurring sulfuric acid shortages are a symptom of something more sinister: KAP’s core inventory is depleting, making it harder to extract the same level of production with the given resources.

There is mathematical backing for this claim. In KAP’s 2018 IPO prospectus, the Company stated that it used 1.85m tonnes of sulfuric acid to produce 23.3 tU of uranium (on a 100% basis, i.e. including uranium produced under the JVs). A few weeks ago, a news article stated that KAP is using 2.2m tonnes of sulfuric acid to maintain its current production of 20.5-21.5 tU uranium, and that it would need 3m tonnes to meet its future production. In other words, KAP needed 79 tonnes of sulfuric acid to produce one tonne of U3O8 in 2017. This jumped +33% to 105 tonnes of sulfuric in 2023, and will need to further jump to 120 tonnes to meet the 2024 guidance, which is +51% higher than the 2017 level. This is a clear sign that the Company’s oft stated ‘sulfuric acid shortage’ problem, is really an asset decline problem. As tier-1 inventory is depleted, ISR mines requires more and more acid to produce the same amount of uranium.

There is additional evidence of production issues in Kazakhstan coming from China General Nuclear (CGN), which owns 49% of a KAP subsidiary Ortalyk. Based on an operational statement released yesterday, Ortalyk was expected to produce 1.28mm lbs of U3O8 in Q4 2023, but only produced 1.02mm lbs. While the full year production for Ortalyk missed guidance by only 5%, even small production issues are significant in light of a very tight market that desperately needs production growth from the world’s largest uranium producing region.

KAP’s struggles to grow production aren’t surprising looking at the Company’s history. To maintain current production, KAP has been using the mining road map laid out by the Soviets who originally drilled out the core asset and delineated the resource. In 1947, the USSR established the ‘Volkovskaya Geological Exploration Expedition’ which conducted exploration activities for many decades, discovering all of Kazkhstan’s major deposits. Since then, KAP hasn’t spent much time and resource on further exploration activities. For KAP to sustainably grow production from the current levels will require going past this legacy roadmap, and that will be a slow process. In ISR mining, you have to be very careful with exploration activities as you run the risk of oxidizing the rock / deposit, which can ruin it permanently.

What are the key takeaways from all of this? I don't think KAP’s production will suddenly drop off a cliff. However, I do think KAP’s ability to grow production over the next couple of years, and to market additional pounds to utilities, is likely hamstrung. I also think they have overcommitted their production to some degree, which means they will continue to be a spot buyer, and so will their JV partners. If there is not enough uranium available in the spot market, they may have to declare force majuere / default on some of their commitments. Western utilities will likely bear the brunt of this. KAP’s biggest customer, China, has more than sufficient inventory for their current consumption levels, so they are unlikely to squeeze KAP. However, China will need significantly more uranium in 10+ years, and it will wait for KAP to gradually increase its production capacity before signing new contracts. KAP is in process of building a sulfuric acid plant which will mitigate some of the production issues, but it won’t be online until 2026.

Over the last week, trading in the spot market has dried up as there seems to be a standoff between buyers and sellers. The sharp jump to triple digit prices has likely caught some buyers off-guard, and they are holding back in hopes of lower prices. I believe this will ultimately resolve to the upside, as the pressures on the spot market are continuing to increase based on the developments just discussed. It’s also important to note that the last ~$10 move up in the spot price has come on anemic trading volumes. Financial buyers have also been largely absent. Spot price velocity ($ move in spot price for every pound purchased) is currently in uncharted territory, based on the spot market trading data from the last few years. This suggests to me that the coming period will see a high degree of volatility as buyers are forced to re-enter an illiquid spot market. It’s time to strap in for a wild ride.