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The date is December 17, 2021. Our families sit in adjacent rooms spreading holiday cheer while the Segra team puts the final punctuation on Kazatomprom: Golden Slumbers. With any luck our last missive of 2021 will bookend a banner year for the nuclear investment community, bringing a few weeks of calm during the holidays and into 2022.
…We make plans and markets laugh. The ensuing weeks have been anything but quiet. December’s Fed induced macro volatility and aggressive tax distribution selling from all uranium-related ETFs were the opening act to January’s main attraction: Kazakhstan’s most significant geopolitical event in a decade. By most initial media reports, the Kazakh people, rising up against long-simmering injustices, sparked unrest at such scale that the Kazakh government requested assistance from Russian armed forces via the CSTO. While initial protests seemed to be a genuine populist response to increases in consumer energy costs, the scale of coordination and violence – along with recent arrests of formerly senior officials for treason and a broad government reshuffling – has made clear that the power struggle within the Kazakh government was deeper than initially thought. While uncertainty will likely exist for some time, today Tokayev’s administration has restored order and followed the classic roadmap for heads of state consolidating power after an uprising – promising severe punishments for those responsible while pivoting to more populist measures at home regarding human rights and wealth re-distribution.
Left in the balance hangs questions about Kazakh uranium supply disruption, utilities’ counterparty diversification/risk management and what all these developments mean for the nuclear fuel supply chain going forward. Given the somewhat unfortunate timing of our last post, we thought a short update might help frame our views while we wipe the egg(nog) from our collective face.
While it is never fun to acknowledge geopolitical risk factors in a stock only to have a major geopolitical risk event present itself a short time thereafter, to a certain extent the “margin of safety” in KAP’s valuation has been proven (so far). The trading session following our post, KAP closed at $35.60. At the time of writing, the stock remains in the ~$35 range. Despite what many market participants likely feared as a worst-case scenario – or close to it – the company valuation is relatively steady as she goes. Barring full nationalization and subjugation of minority shareholders (which we think is very unlikely given what we know today), the stock was thrown a knockout punch and stayed standing. Should the political situation continue to stabilize with an improving macro backdrop perhaps KAP just had its Rocky Balboa moment.
To be clear, we do not believe the events of the last week are without ripple effects. Whether the impacts are mostly felt in the short versus long-term very much depends on how things develop from here. As we monitor the situation, here are some thoughts on how the uranium market may be impacted:
A Forced Supply Disruption
Without a re-escalation of violent unrest, we do not believe it is likely that mine output will be endangered in a material way. However, we do believe these events combined with an already challenged supply chain could end up impacting 2022 annual production – we are watching some of the following:
- Most mine sites only keep a week or two of leaching acid on site. To the extent roads and rail are compromised (currently or again in the future), there could be a rolling shortage
- Ditto mine workers. Shifts at the mine generally go two to three weeks, to the extent a new workforce can’t be mobilized the company may experience short pauses in operations
- Ditto food at site and COVID testing supplies
- Kazakh material is still exported to the boarders via road and rail (no air), so again, the state of domestic infrastructure is important
A Shift in Country Risk Premium for Utility Fuel Buyers
It goes without saying that over the last decade plus, the emergence of low-cost Kazakh pounds has been a major benefit to global utilities. In kind, counterparty risk and geographic concentration has also increased. While we are not concerned about KAP’s existing sales book, we find it hard to believe that recent events won’t impact utility procurement strategies going forward.
As we told the Wall Street Journal last week, the problem with a concentrated market like uranium is that if geopolitical instability causes a major supplier to stumble, there just aren’t many alternatives for utility buyers. To be clear – western utilities will continue to buy pounds from Kazakhstan and Kazatomprom, but they will likely further prioritize access to material from markets like Canada, Australia and the United States. For Kazatomprom, one possible result may be that on margin the customer mix may shift towards financial players, Russia, China and India (to name a few). While a bit early to make any hard and fast calls, we could see this dynamic impacting total Kazakh production levels but not in the way most think.
We have always been of the view that Kazakh production cuts in 2018 were driven by two factors: (1) the desire to create shareholder value (and realization that spot market selling was destroying long term value for the country) and (2) realizing that diversification needs from customers meant that gaining market share above their current levels of ~40-45% would be increasingly difficult (the company has said this directly on several earnings calls and conferences). Their pivot toward a more commercially minded, customer focused business (selling more material directly to utilities in longer term contracts rather than traders in the spot market) would shift their customer mix toward U.S. and European markets, take material out of the spot market and help rebalance the cycle. How could recent events impact that strategy? While many commentators have voiced concern that the government overhaul could result in uncontrolled production increases, we believe that management understands such a strategy would be self-defeating. The fact that Samruk-Kazyna’s board representative for Kazatomprom, Bolat Akchulakov (an individual who likely understands the value of KAP’s current strategy) was just appointed Minister of Energy is a very positive sign. Admittedly, this is pure speculation on our part, but if we do see a slowdown in the U.S. and European portion of Kazatomprom’s sales book we believe it could actually push any ramp in production further out into the future (the company has said repeatedly that production increases would be driven more by contracting success and “having a home” for material than by price). While the market, understandably, assumes the worst from a volatile situation, we are not so sure…Speaking of delays in production increases…
Bargaining Power Puts Cameco in Pole Position
If you believe that western utilities (in particular) will begin to shift a portion of their Kazakh exposure to other geographies, Cameco is the giant left standing (we believe Russian, Uzbek and China-controlled Namibian pounds will be given the same risk treatment as the Kazakh bucket). Brownfield C&M assets and high-quality development projects in favorable jurisdictions should get a boost… but we know where utilities are going first and in the near term. We won’t go so far as to say that Cameco will monopolize the western market, but their negotiating position is extremely strong today.
Quite opposite to the cherry-picked and highly misleading Reuters headlines about Cameco’s intention to ramp mothballed assets, we think management knows the benefits of their current position and will treat a McArthur River startup as subject to an increasingly high hurdle of right price and contracting mix. We see a macro win-win scenario whereby either contracting picks up in a material way at Cameco’s terms (emboldened by recent events), or various restart timelines remain intentionally and increasingly vague amidst a backdrop where customers increasingly overweight western suppliers on a go forward basis. The company has long emphasized ESG standards, counterparty diversification and an eventual return to the mutually beneficial dynamics of long-term contracting. The events in Kazakhstan this month underscore all of these points. If we were in Cameco management’s seat, the increase in bargaining power would be exploited to the maximum extent possible.
The politics of the situation are evolving and complex. To reiterate, the exceptional left tail risk is nationalization/Russian annexation, and we do not believe the likelihood is high. We expect there to be significant changes at Samruk-Kazyna and would not be surprised to see mild adjustments to the existing tax regime. With that being said, there are ways to restructure government ownership in domestic enterprise to give the people a more direct stake in Kazakhstan’s growth without impairing minority shareholders (see Romania’s Fondul Proprietatea as a possible comparable). The country has gone to significant lengths to court western capital, maintains a relatively deep IPO pipeline and has the best chance of redistributing domestic wealth by continuing to use global capital markets as an outlet.
In short, despite lots of nervous energy on the topic, KAP won’t be Back in the USSR. The macro implications are more nuanced than a simple expectation that 40%+ of global supply is endangered. The micro takeaway is that there was significant valuation margin baked into the stock. As always, the market keeps us on our toes.
Thank you for reading,
Segra Capital Management