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Kazakhstan’s Surprising Logic In Cutting Uranium Production

Zoltan Ban 

Summary

  • Kazakhstan’s move to cut uranium production is widely seen as an attempt to lift prices ahead of privatization.
  • There is reason to believe that it is rather an uncommon decision to preserve a resource, keeping in mind the probability of it being more valuable in the future.
  • Uranium reserves and production patterns indicate that one country, Australia will become the dominant uranium supplier of the future, which will give it pricing power, meaning higher uranium prices.

When making an assessment in regards to production levels for a non-renewable commodity, a company or a country has to take a few considerations into account when making its decisions. The shorter term considerations include an outlook on what everyone else might be doing, therefore how it might affect the market. In other words, if everyone else is looking to increase production, will the price remain such that it is still worth increasing production, and if so for how long? For some dominant producers of a certain resource, such as OPEC, it can also be a matter of managing prices. It is thought that Kazakhstan’s current efforts to cut uranium production may also be such an attempt. For the longer-term horizon, one of the main questions is whether a resource left in the ground today will become more or less valuable tomorrow, or better said, about a decade from now. If the answer is that it will likely be less valuable in the future, then the decision-making process becomes really simple, given that the only answer is to produce the resource as fast as possible. If however the answer is that the resource in question is likely to be considerably more valuable in the future, the answer in regards to what to do today becomes far more complicated. I do believe that Kazakhstan’s latest decision to limit production may have more than just short term considerations involved in the decision. I believe that it is making the politically-hard choice for the shorter term, in the interest of longer term economic advantage, which is not common, but not unheard of either.

Whether it is a company, or a country which needs to make such a longer-term call, it is evident that making the right decision for the longer term when it comes to commodities exploration is very hard to do. For instance, shale producers actually responded to the post-2014 oil & gas price environment by producing exclusively the top grade resources, which might have been far more profitable when the price of oil & gas will once again increase to levels that will make the top and mid-quality acreage profitable. Instead, they opted to produce those top resources at a loss. At government level, making such decisions is equally hard. Democratic states think in terms of electoral cycles when it comes to temporal strategy length. Resource exploration today means jobs, government revenues, an improved trade balance and so on. Those resources may indeed become more valuable into the next electoral cycle, but giving up on those above-mentioned economic benefits today, may easily lead to another government enjoying those benefits. For authoritarian states, it is equally important to provide those economic benefits today in order to survive to see tomorrow. But there is also the rare case where a government can make the hard decision of sacrifice today for a better tomorrow, and it usually involves its ability to reference a more disastrous past.

Russia is an example where the current government can simply point to the hardships of the previous government when asking people to accept the hard road today, for a better tomorrow. It is up to debate whether the current government is making good use of that asset. Hungary’s current government is a classic example of how this can play out. The 2002-2010 period was so obviously disastrous from an economic point of view, that Hungary ended up being the first country in the EU to need an IMF loan when the global financial crisis started. The new government that was elected in 2010 turned its back on that agreement, which involved considerable shorter-term sacrifice, and yet it was re-elected in 2014, simply because the alternative was so discredited by its performance in the past that people decided to stick with hope for a better future, despite the hardships involved. Those sacrifices are starting to now pay dividend, with Hungary’s ten year note currently yielding 2.15%, which in my view is saving that government a few billion dollars per year, compared to where things would be if it would have chosen the easy path in 2010. As a point of reference, Romania which also got an IMF loan, even though it did not face as severe of a financial situation as Hungary did, currently sells its ten year bonds, with a yield of 4.5%. Unlike Hungary, it stuck with the IMF agreement. So, it can be done, but only under a certain rare circumstance.

I am not as certain in regards to what kind of persuasion power Kazakhstan has in terms of being able to convince people of the merits of some sacrifice today in the interest of a brighter tomorrow. I suspect that they see the current cut as a way of bolstering uranium prices in the shorter term, which it sees as providing for a partial counter-balance to the economic losses involved in cutting uranium production by 20% for the next three years. It may not be a net gain in this regard, but still not a total loss of short term advantage either. Kazakhstan can count on being able to affect uranium prices, given that it accounted for 39% of production in 2015.

While Kazakhstan has been the top uranium producer for a number of years now, it is by no means on the top spot when it comes to uranium reserves. That title goes to Australia and it is undisputed in this case.

Source: World Nuclear Association.

As we can see, Kazakhstan has only the world’s third largest uranium reserves, with about 13% of the world’s total. Australia has about 30% of the world’s economically-recoverable uranium endowment. Yet, when it comes to global production, it is a very different picture compared with the reserve situation.

Data source: U3O8.biz.

Keeping in mind the fact that the uranium reserve data is from 2009, Kazakhstan is now most likely seriously looking at producing itself into severe depletion. This, while uranium prices have been depressed for more than a decade now, in part due to its own production boom, meaning that Kazakhstan has been missing out on maximizing its potential benefit from exploring this resource later, when prices will recover, probably in the interest of the considerations that I listed as being the general driver of such a seemingly illogical decision. The efforts it is now making to cut production, which will most likely lead to higher uranium prices are in part an effort to correct this longer term investment mistake in my view.

It is also true that the shorter-term considerations, such as the fact that Kazakhstan wants to privatize its state-run uranium mining business, also probably play a role. Cutting production might arguably produce better company results just before the privatization starts. Then again, it might not, because the cut is only about 6-7% of global supply, and uranium is not like oil in terms of elasticity. Most nuclear power producers store significant reserves of the fuel, and there are other secondary sources of supply, aside from mined production. It is entirely possible that the 20% cut in Kazakhstan’s uranium production will not result in a 20% increase in uranium prices next year, therefore there will be a significant net loss in revenue, even if profitability will likely improve. I therefore do not think that this is the main aim of Kazakhstan’s government.

Looking back at the chart on the reserve situation and the price viability of those reserves, it seems to me that Kazakhstan is rethinking its longer-term uranium exploitation strategy. It is thinking correctly that it would be worth saving some of that resource for the day when many of the countries that are over-producing the cheaper uranium, given their resource base endowment, will end up entering production decline, leaving Australia as the dominant future supplier of uranium. The fact that Australia will gain this global advantage is a near-certainty, given that it has by far the largest reserves, while its production is nowhere near what Kazakhstan is producing from a far lower resource base. Having a long-term dominant supplier for an indispensable resource will inevitably give that country some pricing power, even though the extraction will be done by private enterprise. Kazakhstan wants to stick around as a significant uranium producer for those times, which is I believe the real reason why it is currently cutting production. I believe they are doing the right thing for the longer term. As for the uranium market, it should provide some much-needed price suport in the shorter term, while also providing a further reason to expect the Nov, 2016 spot price bottom to continue to hold and prices to move further up from here in the longer run.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Source: Seeking Alpha

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