Kazatomprom (LSE: KAP) 2Q20 Operations & Trading Update

The dominant player in the uranium sector, Kazatomprom, quietly confirmed yesterday that they had been a buyer in the spot market. The last paragraph of their 2Q20 Operations and Trading Update read:

“The Company continues to target an ongoing inventory level of approximately six to seven months of annual attributable production. However, inventory levels are expected to fall below these levels in 2020 and 2021 with no opportunity to catch up production losses in these periods. As such the Company will continue to monitor market conditions for opportunities to optimise its inventory levels and has purchased some volumes in the spot market at the end of the second quarter.”

Whilst there is a lot we still don’t know – for instance, how much is “some volumes” – it is important signalling from the world’s largest producer of a commodity that has been plunged into deep deficit by COVID-19 disruption.

Ponder this for a moment:

1. Kazatomprom acknowledged that Kazakh “production levels for the second half of the year are expected to be severely impacted” by the four month shut down of well field development activities across all of Kazakhstan’s uranium production. Not a “significant”, “substantial”, or “major” impact - but severe impact.
2. Kazakh production is ~40% of global uranium supply. And uranium is the un-substitutable power source for more than 10% of the world’s electricity.
3. Meanwhile Cameco/Orano have lost 6 months' production from the world’s largest single uranium mine, Cigar Lake, and several other operations around the world have been unable to operate at full capacity under the strain of COVID-19 restrictions.
4. Both Kazatomprom and Cameco have flagged that the production hangover from 2020 disruption will carry on into 2021 (the lag effect from Kazakh disruption can last up to 9 months – ie into May 2021).
5. Although Cameco plans to restart Cigar Lake production in September and Kazatomprom hopes to be operating at full staff by mid-September, there are many “ifs and buts” associated with those plans. Both companies have stressed that the health and safety of their employees, families and communities will trump production guidance. 
6. Both Kazatomprom and Cameco have confirmed publicly that they will honour all contracted delivery and will not use COVID-19 disruption of their production as a force majeure excuse with their customers

A situation where the two largest producers in a market become buyers over an extended period is unprecedented - not only in uranium but in any traded metal.

So, back to the spot market. Cameco have been aggressively buying in the spot market to deliver into contracts that were written back in the days when McArthur River was in production. Last week Cameco said that year-to-date purchasing of 19.3Mlbs was from the spot market before adding, rather ominously, that they could not be the only producer buying in the market. To add to the competition, there are also smaller players such as Peninsula and UR-Energy buying from spot to deliver into contracts. And Orano (the world’s third largest uranium producer) must be wondering when to time their entry into the spot market, given they have lost much of their share of production from Cigar Lake and Kazakhstan, will lose production from Cominak in 2021 and can’t ignore the 5.4Mlbs uranium loan from Cameco that is due in 2023.

What is interesting about Kazatomprom’s news is not that they need to buy from spot – this has been signposted in interviews by Galymzhan Pirmatov and Riaz Rizvi - but rather that they have started purchasing so early. Their Q1 production was hardly affected by COVID-19 disruption (because their ISR mines could continue to extract uranium by pumping from ore bodies that were acidified before April). Nonetheless, they chose to top up in spot – in the $30s – rather than run down inventory. That tells me something – and it ain’t that Kazatomprom reckon there will be plentiful or cheap pounds available over the next half year.

The second half spot market will be characterised as much by decreased supply as it will from increased producer demand. Of the “main culprits” often accused of selling primary production into spot, only BHP (Olympic Dam) and Navoi Mining (Uzbek production) are unaffected, so far, by COVID-19. The others have lost most of the cheap Kazakh pounds they enjoyed tossing into the spot market. Traders will think twice about selling into a market that looks ready to rise and, on the contrary, are more likely to become net buyers as utilities look for mid term delivery via the carry trade. In fact, given a "spot" transaction can be for delivery up to 12 months forward, it is quite possible that sellers could be caught short if they forward-sold pounds before the uranium world was turned upside down by COVID-19. 

We should not forget to mention financial buyers. The established players have been dealing with their own issues – mainly deep discounts to NAV caused as much by broader equity markets as poor uranium sentiment – which have led them to implement share buy-backs funded by uranium sales. But this could turn quickly. Should Yellowcake win back investor confidence and trade above the magical NAV line, then they will be holding aces via their option to demand around 3Mlbs from Kazatomprom before December. But more immediate is potential action from hedge funds and banks. The most reliable rumours of Kazatomprom spot buying emerged from Wall Street chat forums, where so much money is looking for a theme that the desired outcome could be forced on a relatively illiquid market.

And we might even see an increase in utility buying – if there is any room left for them in a market that is becoming increasingly surreal.

Company Website: https://www.kazatomprom.kz/en