The Mining Report: It’s been a rough couple of years for uranium prices. Realistically, could news of possible restarts of nuclear plants in Japan positively impact the price of uranium, even if it’s only psychologically?

Thomas Drolet: The psychology of Japan restarts has been driving the spot price; perhaps it will start to move the all-important long-term price, too. The long-term price is the signal that the utilities are buying. It is paramount to core value investing.

Let’s talk about Japan. My observation, after having been there several times post-Fukushima Daiichi, is that there is a giant tug-o-war going on. Pulling on one end of the rope is Japanese industry, which is paying a high price for fossil fuels replacement electricity, and the current government, which is definitely for bringing the nuclear plants back on-line. Tugging on the other end of the rope is a profoundly fearful public. Hanging onto the middle of the rope is Japan’s new nuclear regulatory agency. It will take time for this stronger regulator to finish a series of mandated safety checks before it can authorize bringing back some of the mothballed reactors.

Kyushu Electric Power Co. Inc. (9508:TKY) plans to restart two reactors at Sendai in the middle of Q1/15. This is sending a positive signal to the whole uranium production and supply space. However, the inventory of fuel at the Japanese reactors is very high; the utilities had long-term contracts when they were shut down. And those contracts generally could not be terminated. The large, existing inventory of fuel will be gradually eaten up as reactors restart after wending their way through nuclear regulatory approvals, prefecture approvals, local town approvals and, finally, national government approval. 

TMR: Will the Japanese be building new reactors, as well as bringing back the ones that were mothballed?

TD: The Japanese have announced the intent to start building a couple of new reactors, but I do not see any real progress yet on the early-stage design efforts. What I do see is that the major reactor suppliers from Japan—Mitsubishi Corp. (MSBSHY:OTCPK), Toshiba Corp. (TOSBF:OTC: 6502:TKY)—are actually doing the opposite; they are concentrating overseas. They are doing deals in the United States, in Europe, in Southeast Asia. 

Two years ago in the U.S., there were 104 working reactors. Six of them were stilled for valid local or contractual reasons: i.e., the argument with a supplier of new heat exchangers for San Onofre took two units out. And there was significant displeasure in the Northeast with a couple of reactors, and one in Wisconsin. Anyway, we are down to 98 reactors in the U.S. now. 

In the U.S., four new AP1000 reactors, each one delivering 1,200 megawatts, are being built by Toshiba/Westinghouse Electric Co. Toshiba is the master contractor, supervising Westinghouse and, among others, Chicago Bridge & Iron Co. N.V. (CBI:NYSE). Until these four reactors are operating successfully, roughly on schedule and roughly on budget, the U.S. is not going to be a high-growth area for nuclear power. Waiting on the sidelines, major utilities like Duke Energy Corp. (DUK:NYSE), Exelon Corp. (EXC:NYSE) and Entergy Corp. (ETR:NYSE) are in the very early stages of applying for new reactor builds.

TMR: Given this environment, how do spot prices relate to long-term contracts in the uranium market?

TD: Spot is simply uranium put up by suppliers for short-term cash needs. The price is almost certain to be taken up further by a smart utility, or by the enrichers, the firms that enrich the uranium that goes into the fuel fabrication process and eventually burns in the reactors. Current activity in the spot market is a signal that a corner is turning. Uranium fell to ~$30/pound ($30/lb) on the spot market in the early fall. That is below the average cost of worldwide production by a good US$10. The price obviously cannot stay there because people have to make money to stay in business. 

Although an important corner has turned, I am not saying that there is massive upside for all uranium companies as a result of what is happening on the spot side. There will be a slow and steady climb driven by major utilities coming in on buying cycles that meet their internal needs. 

TMR: When the long-term prices shoot up, who will benefit? 

TD: The uptick will mostly benefit the big producers and the current suppliers, such as Cameco Corp. (CCO:TSX; CCJ:NYSE) and Denison Mines Corp. (DML:TSX; DNN:NYSE.MKT). Juniors such as Ur-Energy Inc. (URE:TSX; URG:NYSE.MKT) may catch a bit of that wave. Interestingly, Ur-Energy has ramped up production to about 600,000 pounds (600,000 lbs) this year at its Lost Creek operation in Wyoming. The company is very transparent. According to its CEO, the firm’s production cash costs are averaging $22–23/lb. Ur-Energy is selling into the long-term market. It has 5 million pounds under contract through 2021 at an average price of $50/lb. Targeting the long-term users is a smart move. And, importantly, Ur-Energy’s capital and production costs are relatively low, because it does solution mining. 

TMR: How does solution mining create cost efficiencies?

TD: In the Athabasca Basin, by counter-example, miners typically drill vertical mine shafts into a very hard, but high-yielding uranium-rich rock. However, the capital cost of hard rock mining is high.

The solution miners, on the other hand, drill both vertical and horizontal holes to introduce solutions. A solution is injected into the bore hole and, after it sits for a while, it is pumped out and U3O8 yellowcake is then precipitated out.

TMR: What are the components of the solution?

TD: It depends on the chemistry of the rock. It can be mildly acidic; it can be mildly basic. The solutions are not toxic by any industry standards.

TMR: Are Ur-Energy’s long-term contracts economic? Is $50/lb going to hold up?

TD: Yes, the $50/lb is tied up until 2021. With an average production cost base of approximately $20–25/lb, that is very economic. Ur-Energy is solidifying its book for the next six years at a cost that is roughly half of its average sale price. In short, solution mining is quick off the mark, it is relatively low capital cost. Smart juniors, like Ur-Energy, are signing long-term contracts.

TMR: Is Ur-Energy still exploring the Lost Creek region?

TD: It has various properties around the Lost Creek. But, I understand the managers want to create a steady cash flow before investing capital in the other areas. When those other areas are developed, there will be an economy of scale already in place, perhaps with a precipitating mill and network of pipelines serving multiple extraction sites.

TMR: Let’s look at the Athabasca juniors. Who are you following there?

TD: I am on the Advisory Committee with Lakeland Resources Inc. (LK:TSX.V) and Skyharbour Resources Ltd. (SYH:TSX.V). Lakeland and Skyharbour have agglomerated properties around successful mid-cap developers like Fission Uranium Corp. (FCU:TSX), and seniors like Denison and Cameco. In my opinion they both have a high probability of finding high-yielding uranium-bearing rock. 

The problem that all hard rock Athabasca juniors share is the time and money it takes to develop a producing mine. Each junior has to survive this very difficult market and still raise the required exploration and production funds. The uranium spot and long-term price markets will continue to slowly improve. This will enable the juniors access to capital markets. Right now, most juniors in the Athabasca are supporting themselves by issuing equity, or associating with capital groups or getting gobbled by the big guys, the Camecos, the Denisons, the AREVA SAs (AREVA:EPA) of this world. That has been the way of the oil and gas junior business, and that will ultimately be the way in the uranium junior business, as well, in my opinion.

TMR: How is the stock market treating the Athabasca juniors?

TD: The stock prices are down about 30% from the peak of a year ago. Investors exited uranium mining en masse because Japan did not appear to be coming back. And, not well reported, China’s reactor program temporarily slowed down after Fukushima Daiichi as well. Now, new Chinese reactor developments are back with a vengeance. Both the spot and the long-term prices will benefit from China’s immediate and near-term nuclear fuel needs. 

In the Middle East, four reactors are being built by South Koreans for the United Arab Emirates. These will need a reliable fuel stream. The Russians just signed up for building two reactors, and maybe four more, in Iran. The Russians have a particularly unique and clever marketing business strategy—compared to majors like AREVAs and Westinghouse. They are doing turnkey operations for their customers. The Russians will design the reactor, build it, and either run it directly or train the client to operate it. They will supply the fuel and, also, take it back for disposal. 

TMR: Will Russia have to go into the global market for uranium?

TD: Russia will supply the uranium, enrich it and fabricate it within the boundaries of Russia. Also using the Kazakhstani reserves, Russia will supply yellowcake for the reactors that it builds, be they in Pakistan, Iran, Turkey, Indonesia or Bangladesh. Russia is the most aggressive nuclear reactor exporting nation on the face of the earth at the moment.

TMR: What kind of creative financing are the uranium juniors using to keep moving ahead in this environment?

TD: Lakeland is backed by a capital group called Zimtu Capital Corp. (ZC:TSX.V). Zimtu holds preferential positions in a dozen or so companies. It helps these firms to access other capital sources. Until the share prices rebound somewhat for the juniors, there is not a lot that the Athabasca juniors can do other than to make sound investments in new properties, continue drilling their well positioned properties and potentially associate with capital suppliers that are willing to take a preferential position. Otherwise, a junior will fall into the spiral of the dilution mode. Never good for shareholders.

TMR: Leaving uranium, what are the driving forces affecting the price of oil and gas today?

TD: There are several forces driving these prices. Nation states such as Venezuela, Saudi Arabia and Iran are taking over the place of the international integrateds. Nation states with large oil reserves are attending to their own needs and gradually blowing off the integrateds.

Second, the revolutionary advance of fracking and horizontal drilling has taken away a lot of the uncertainty about future supply. There is indeed a large supply of tight oils and shale gas, with the new technology to extract it. However, the price is not going to stay down forever. There is a new and important phenomenon emerging.

We will soon start to run out of shallow, easy-to-access, reasonably permeable, low decline rate tight oil and shale gas zones. President Obama has said that fracking and horizontal drilling will provide a transitional fuel source for the next 50 years. I personally doubt that that super supply will last that long, simply because the decline rates are huge and have a long, low tail. Frackers have been able to get their money back in one to two years, but as production drops, I worry about the high, never ending, poke-a-new-hole drilling cost syndrome. 

TMR: How does the strong dollar affect junior miners in Canada?

TD: The cost of operating a drill rig is paid in Canadian dollars, which is substantially below the U.S. dollar. That means that the capital and operating costs for oil and gas companies is denominated in a currency that is 15% less than the currency tied to the sale of the product! 

TMR: What shale oil and gas firms are poised to do well as the energy environment continues to evolve, as you say?

TD: The big guys: the Chevrons (CVX:NYSE), the Exxon Mobils (XOM:NYSE), the big integrateds in North America stand to last the longest in this necessary constant high cost drilling environment.

TMR: Are oil and gas juniors doomed?

TD: Most of the juniors will survive. Eventually, the good ones will be bought up because that is the way of the world. The little ones get bought up by the big guys. 

TMR: Is now a good time to invest in major electrical utilities? 

TD: Yes. A lot of them have been beaten down, because we are still emerging from a difficult period in the U.S. But as the U.S. economy picks up steam, the big, well-managed utilities—the Dukes, the Exelons, the Entergys, the Pacific Gas and Electrics (PCG:NSYE)—are good places to invest for the long term.

TMR: Thanks for your insights, Thomas.

TD: You are welcome, Peter.

Thomas Drolet is the principal of Drolet & Associates Energy Services Inc. He has had a four-decade career in many phases of energy—nuclear, coal, natural gas, geothermal and distributed generation, with expertise in commercial aspects, research and development, engineering, operations and consulting. He earned a bachelor’s degree in chemical engineering from Royal Military College of Canada, a master’s of science degree in nuclear technology/chemical engineering and a DIC from Imperial College, University of London, England. He spent 26 years with North America’s largest nuclear utility, Ontario Hydro, in various nuclear engineering, research and operations functions.

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DISCLOSURE: 
1) Peter Byrne conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
2) Thomas Drolet: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship (options) with the following companies mentioned in this interview: Lakeland Resources Inc. and Skyharbour Resources Ltd. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I determined and had final say over which companies would be included in the interview based on my research, understanding of the sector and interview theme. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview.
3) The following companies mentioned in the interview are sponsors of Streetwise Reports: Ur-Energy Inc., Fission Uranium Corp. and Zimtu Capital Corp. The companies mentioned in this interview were not involved in any aspect of the interview preparation or post-interview editing so the expert could speak independently about the sector. Streetwise Reports does not accept stock in exchange for its services.
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts’ statements without their consent.
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports’ terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

The Energy Report: Is the energy sector undervalued?

Rudolf Hokanson: Energy is very undervalued. The market is not sure how to interpret what is going on in the world, and it runs scared of its own shadow. The market has a tendency to overreact to “The News,” and then to discount current pricing trends by focusing on near-term commodity valuations.

TER: What world news is implicated in the market’s overreaction?

RH: There have been significant interruptions to energy production in Africa, and to energy delivery capabilities in Eastern Europe. Libya is increasing production. The Saudis are selling into Asia, while positioning themselves to be competitive into the U.S. market. Supply issues are driving the markets, as U.S. production grows and Organization of the Petroleum Exporting Countries (OPEC) production finds new markets.

TER: Is there an oversupply of oil and gas in the U.S market?

RH: We are not oversupplied here. Our refiners are happy to take U.S. crude; it is light, sweet, inexpensive and easy to refine. We can keep our refiners busy servicing the domestic market. Our production influences the international markets. Of course, demand could fall, rather than just slow, if global growth rates decline or slow too much. The Brent and WTI differential should even out over time, and there is always a need for energy for growth.

TER: What role are new technological advances playing in developing energy resources?

RH: The oil patch does not like to adopt new technology just for the sake of new technology. High tech is costly, and nobody wants to be the guinea pig for testing new techniques. But we do keep making common sense technical improvements in hydraulic fracturing and methods of completions. One of America’s most important resources is human intelligence. For example, smart petroleum engineers have recognized that a smaller-size sand will penetrate fracked sediments more thoroughly, allowing more oil to flow in the patch. 

TER: How do oil patch service firms handle new technologies? 

RH: It is not necessary to have a brand-new widget to bring into the patch. Drillers are always looking to reduce costs by improving efficiency. For example, some of the more technologically advanced service firms are using seismic-linked computer programs to visualize the geometry of fracks. But the key to success in the oil well servicing sector is reducing costs, not spending precious capital on unproven technologies.

TER: What service firms do you like from an investment point of view?

RH: One of my favorite small-cap service companies is ENSERVCO Corp. (ENSV:NYSE.MKT). Its forte is heating up oil to improve flow. The company works with hot oil trucks, frack water heating units and acidizing. These technologies are not particularly new or complex, but ENSERVCO is very good at what it does, and it performs to customers’ timetables. I have listed ENSERVCO as a Speculative Buy, because a lot of small service companies have to fight hard to make their way in a competitive arena. But ENSERVCO’s trucks are servicing a lot of basins, and the company is building itself a good reputation, well by well. I have put a $4/share price target on it.

I am experiencing contrarian inclinations at the moment. I do believe that the seismic industry is critical to the energy program. To that end, I like ION Geophysical Corp. (IO:NYSE) and Dawson GeoPhysical Co. (DWSN:NASDAQ). Their stocks have been beaten up a bit of late, because many operators that need seismic are watching their budgets and going without. But, really, seismic technology is key to understanding where to drill, how to drill, and when to drill. It is an increasingly essential tool.

TER: Do you have target prices on those two seismic companies? 

RH: For 2015E, I have a $5/share target price for ION, and a $25/share target price for Dawson.

TER: Who do you like in the exploration and production (E&P) space?

RH: I recommend four high-quality companies in the E&P space. Each has a slightly different niche. 

On Whiting Petroleum Corp. (WLL:NYSE), I have a $122/share price target by 2015E. That target assumes that Whiting will acquire Kodiak Oil & Gas Corp. (KOG:NYSE.MKT). Its shareholders will vote on that acquisition in early December. Whiting’s managers are extremely sharp guys. They are focused on the Bakken, as is Kodiak. Acquiring Kodiak will strengthen Whiting’s overall position going forward. The company also has an important focus on the Redtail Niobrara Field. Focus is everything.

I recommend Continental Resources Inc. (CLR:NYSE), which is a large, independent E&P company. It is focused not only in the Bakken, but also in the SCOOP (South-Central Oklahoma Oil Province). I have an $85/share price target on Continental. Its managers really understand the energy market. Continental just sold its oil hedges, after the managers decided that oil is not going to drop any further. Some people have reacted negatively to that bold move. It is a gamble, but I trust the experience and instincts of the Continental managers. My own view is that oil is not going to stay below $80/barrel ($80/bbl) for long.

TER: What kind of experience does the Continental management team have?

RH: Harold Hamm started the company back in the 1960s as a small service company in a pickup truck. He gets very good results out of his wells, and he attracts good people. His managers are very smart people. 

Continental was among the first to start shipping its Bakken crude by rail to refiners that were closing on the East Coast. Those refiners could not process heavy overseas crude without investing many millions of dollars into new equipment. Now they are busy and profitable, using their older plants.

TER: Who else do you like in the oil patch?

RH: SM Energy Co. (SM:NYSE) has some Bakken properties, but its greatest exposure is to the Eagle Ford. It has a nice mix of oil and gas and liquids. The oil percentage is growing. It has a relatively short reserve-to-production life compared to the other companies I follow. Some of its Eagle Ford properties are viewed as three-year wells. Management is working on extending those profiles with different methods of completions. The company’s stock is going to react when prices fall, but when prices go up, SM Energy stock will rise faster because of the impact on its present value from its production capabilities. SM Energy has very smart, well-disciplined managers. The CEO is retiring in January, and the new, designated CEO came up through the company ranks. The firm is ramping up growth to 20% next year. I have listed a $102/share price target on SM Energy. 

Newfield Exploration Co. (NFX:NYSE) is very focused on its domestic oil and liquids holdings. It is selling off property in China and Malaysia. It is in the Bakken, and it has a play not far from Continental’s SCOOP called the STACK. Everybody gets into naming their plays, and if they can name it first, everybody else has to use it. I have a $47/share price target on Newfield.

None of the stocks I have mentioned are appreciated by the market at the moment. But the companies’ balance sheets are in good shape. The capital programs are disciplined. Growth is not projected at the expense of the companies’ health and balance sheets. Less well-capitalized companies will be stressed in a volatile commodity market, and their lenders may put pressure on them. Those poorly capitalized companies could then become acquisition candidates for companies like those that I am recommending.

TER: Thanks for talking with us today, Rudy.

RH: You’re welcome.

Read what other experts are saying about:

• ENSERVCO Corp.

Rudolf “Rudy” Hokanson joined Barrington Research in 2011 as managing director, research and senior investment analyst within the Equity Research group. His research focus is within the industrial and energy sectors, specializing in niches that primarily include exploration & production, oil equipment & services and other energy-related technologies. He was with UBS from 2005 to 2010 as a buyside analyst, covering energy companies. He served as an energy buyside analyst with US Bank from 2002 to 2005. He has also served as a sellside analyst with CIBC World Markets Corp., Deutsche Bank Securities, R.W. Baird, The Milwaukee Co. and Kemper Securities, providing research for both the energy and publishing/print & media industries, from 1981 to 2001. Other experience includes private consulting. Hokanson has over 30 years of experience within the investment industry, and is a former winner of The Wall Street Journal’s “Best on the Street” analyst survey. Additional accolades also include two 2013 Starmine Analyst Awards: “No. 5 Overall Earnings Estimator” and “No. 1 Earnings Estimator in Oil, Gas & Consumable Fuels.” Hokanson holds both an master’s degree in business administration and a master of divinity from Yale University, and dual bachelor’s degrees in philosophy and religion from DePauw University. He has also completed other business management certificate programs at Oxford University and the University of St. Thomas. He also holds the Chartered Financial Analyst (CFA) designation.

Want to read more Energy Report interviews like this? Sign up for our free e-newsletter, and you’ll learn when new articles have been published. To see recent interviews with industry analysts and commentators, visit our Streetwise Interviews page.

DISCLOSURE: 
1) Peter Byrne conducted this interview for Streetwise Reports LLC, publisher of The Gold Report, The Energy Report, The Life Sciences Report and The Mining Report, and provides services to Streetwise Reports as an independent contractor. He owns, or his family owns, shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of Streetwise Reports: ENSERVCO Corp. Streetwise Reports does not accept stock in exchange for its services. 
3) Rudolf Hokanson: I own, or my family owns, shares of the following companies mentioned in this interview: None. I personally am, or my family is, paid by the following companies mentioned in this interview: None. My company has a financial relationship with the following companies mentioned in this interview: None. I was not paid by Streetwise Reports for participating in this interview. Comments and opinions expressed are my own comments and opinions. I had the opportunity to review the interview for accuracy as of the date of the interview and am responsible for the content of the interview. 
4) Interviews are edited for clarity. Streetwise Reports does not make editorial comments or change experts’ statements without their consent. 
5) The interview does not constitute investment advice. Each reader is encouraged to consult with his or her individual financial professional and any action a reader takes as a result of information presented here is his or her own responsibility. By opening this page, each reader accepts and agrees to Streetwise Reports’ terms of use and full legal disclaimer.
6) From time to time, Streetwise Reports LLC and its directors, officers, employees or members of their families, as well as persons interviewed for articles and interviews on the site, may have a long or short position in securities mentioned. Directors, officers, employees or members of their families are prohibited from making purchases and/or sales of those securities in the open market or otherwise during the up-to-four-week interval from the time of the interview until after it publishes.

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