Brent Cook & Rick Rule: Clean Energy Smart Investments
Source: Karen Roche of The Energy Report (6/14/11)
Are there viable options to nuclear power for clean energy? Is another uranium boom on the horizon? Or should we invest our resource dollars in thorium? If you've been pondering these questions, join The Energy Report in this exclusive interview with a pair of the resource sector's most highly regarded experts, Global Resource Investors Founder Rick Rule and Exploration Insights Author Brent Cook. The Energy Report caught up with them during Cambridge House's recent World Resource Investment Conference in Vancouver.
The Energy Report: It may be too soon after Japan's crisis at Fukushima to judge, but at this point, what's your take on the worldwide infrastructure for nuclear energy and demand for uranium?
Brent Cook: Uranium's interesting right now and certainly a contrarian play. Global warming is a fact and the overwhelming majority of the legitimate research, and I mean legitimate peer-reviewed scientific research, points to anthropogenic CO2 as the primary cause of global climate change. So we have a serious environmental issue, and none of the green energy alternatives will solve it on their own. They can produce only a relatively small fraction of the energy we're going to need. Nuclear power is the only non-CO2 emitting energy source out there that can significantly offset large-scale hydrocarbon-based energy sources.
Nuclear power is a real and viable, albeit imperfect, solution and I don't think it or the demand for uranium is going to go away. We've had three major nuclear accidents with a greater than five ranking that I can think of-Three Mile Island, where there are no documented deaths and it was pretty well contained; Chernobyl, which was a disaster in a backward totalitarian country; and Fukushima, which we are still watching but which appears to be contained. If you pit the damage and deaths from nuclear incidents against the damage caused by CO2 gases, there's no real comparison. Nuclear energy just has this irrational phobia associated with it.
TER: Are the current nuclear facilities' needs for uranium enough to elevate the uranium price? Or do we need new facilities to increase demand?
Rick Rule: On a global basis, we use about 150 million pounds (Mlb.) of uranium and we make 90 Mlb. We're living off historical surpluses. When those surpluses are gone, one of two things will happen-the lights go out or we produce more power. It's as simple as that.
TER: Even assuming that manmade CO2 is the biggest cause of global warming, the fear factor of nuclear fallout from a disaster seems greater than the fear factor of more CO2. There's talk about taking some plants offline in Europe.
BC: It's true. Germany says they plan to take nearly all of their nuclear facilities offline by 2022, which I think amounts to somewhere in the order of 3% of global energy production, so it's not that big a hit to uranium demand. There's no way we can get the power we need from coal and fossil fuels without continuing to add to the CO2 problem. The earth and its inhabitants are feeling the effects of that right now and it's bound to get worse. I have to assume a more rational energy policy will emerge in time that will include nuclear.
RR: Germany has said they're going to bring all of their plants down in 14 years. As Brent described, that's 3% of current demand. It's 1.5% of scheduled demand 15 years out. That's irrelevant in the context of the uranium price and nuclear demand. But more importantly, I suspect that Germany's announcement is a well-meaning sop to the greens. I don't believe they'll bring down their nuclear power industry because if they do, they eliminate 19% of the power in the country, and the lights go out. What will the German public say about the lights going out?
If you want to see protests in Western countries, wait until people's refrigerators and air conditioners stop running or the manufacturing base shuts down because there's no power. Then I think you'll see popular protest on a truly spectacular scale.
In the immediate reaction to the events in Japan, the discussion about our nuclear power plants in California centered on two things. One was bringing down American nuclear power. Because the U.S. gets 20% of its energy from nuclear power, the chances of taking our nuclear capacity down are zero. The second argument pertained to California, where our governors have said that green sources will provide 30% of the State's energy by 2020. That's up from 3% now and California's broke. Another point. There was a lot of discussion in the popular media about what would happen with the San Onofre nuclear plant in the context of a Richter 9 (R9) event in Southern California. That's two orders of magnitude greater than any earthquake we've suffered in Southern California. I don't know what would happen to San Onofre, but I do know that a collapse in the natural gas distribution system in Southern California in an R9 event would probably kill 150,000 people. The impact on the refining complexes in South Los Angeles, North Orange County, Long Beach and other places like that probably would kill another 15,000.
TER: Isn't thorium a safer alternative to uranium in producing nuclear energy?
BC: That's an option, but the technology isn't developed enough for it to come into the production scenario. It's at least 10 years down the road and we really need to see economic working examples of this to convince the power companies of its value.
RR: Thorium appears to particularly excite the subscription-driven newsletter business. A total of 63 nuclear power plants are under construction worldwide, with an average price tag of $4B per plant. This means that the power industry, not the newsletter industry, is betting $250B on uranium-and, as far as I know, nothing on thorium. In terms of producing power, you have to decide whether the power industry or the newsletter industry is better-versed on the economic efficacy of technology.
TER: Nuclear plants require a great deal of permitting. With the protests, fear-mongering in the media and a lot of politicians on the anti-nuclear bandwagon, what's the chance that the government will bar permits for nuclear?
RR: I think it depends on the government. In the immediate aftermath of the Japanese incident, the Chinese government said that China's nuclear power industry was going to be under review. The review is about 60% complete, and it goes something like this: Those were old, bad Japanese reactors built on a tectonic subduction zone. Ours are new, good Chinese reactors built on the Asian plate. That's the series of political processes that will occur around the world.
A whole range of people-some well-intentioned, others Luddites-are demonstrating about nuclear. Irrespective of your feelings about global warming, there's a whole series of environmental risks associated with non-nuclear energy.
TER: We can all sit here and agree with that logic, and point to all the people killed in mining coal. But that's not what the populations seem to be thinking about. Even Japan is talking about decreasing reliance on nuclear energy in favor of LNG.
RR: If I were a betting man (and I am) and I could find somebody to take the back side of the bet, I would bet that Japan changes course within a decade. People say, Well, my investing horizon is 90 days, so what they do a decade from now doesn't matter. But it does matter because Japan slowing things down doesn't change the demand outlook for uranium in the near term. And if they don't change, it doesn't change it in the long term. The only thing that's happened is that people have allowed their reaction to a boogey man called nuclear power to influence their response to investing without looking very deeply at the fundamentals.
My own suspicion is that the Japanese have no choice but to stay with nuclear. The Japanese themselves have said that the advantage of nuclear power for them was that it was the densest fuel in the world. They can import uranium and have it on Japanese soil so that they have a geopolitically secure source of energy in a world where there's less and less security. You can't store hydropower. You can't store the sun. You can't store enough natural gas or coal to make a difference. But uranium is such a dense fuel that Japan could easily store five years' supply.
You can understand the interest that places like Korea, Japan, Taiwan and Singapore have had for nuclear energy and the advantage of uranium's density relative to other sources of energy if you imagine a deeper schism between Sunnis and Shiites that snaps the Straits of Hormuz shut and cuts off supplies of export crude from the Persian Gulf and LNG from the fields in Qatar, Kuwait and Saudi Arabia.
TER: You've both said that we still need to mine more uranium as we don't produce enough supply to meet the demand of currently operating plants, let alone any new ones. What are the risks with uranium exploration and mining?
BC: The same with exploration and mining of anything else on top of a much more difficult permitting process, particularly if you're looking at a high-grade deposit. Even in Saskatchewan, if Hathor Exploration Ltd. (TSX.V:HAT) tries to get a mine permitted, it could be 7 to 10 years before the company could even start digging that first hole.
TER: That's an impossible timeline if demand already exceeds supply.
BC: Oh, other places in the world have much larger deposits, although they're lower grade, that are ready to go. In Namibia in particular, Paladin Energy Ltd. (TSX:PDN; ASX:PDN) is already in production. Extract Resources Ltd. (TSX:EXT; ASX:EXT) has its Husab Uranium Project, the fifth-largest uranium-only deposit in the world. Rio Tinto (NYSE:RIO; ASX:RIO) has a huge deposit that's in production and expanding.
TER: Suppose that the U.S. government decommissions some nuclear weapons, creating a surplus of enriched uranium that nuclear power plants could use. Would that additional supply be a black swan that someone investing in uranium should worry about?
BC: That's a good point. And, yes it's a possibility.
TER: Russia did it for years.
RR: We've done a bit of it too, and I hope it increases. The idea that we need enough bombs to kill the world's population 1,500 times over seems like excessive security to me. I'd love to see that stuff blended down as fast as we can. Although I think the Strangelove argument is a great one, we're going to need to burn de-fissionable material to keep our reactors open until such time as we can increase production enough to sustain current demand and meet future demand.
The risk we run is not having too much but having too little, because having too little makes nuclear a less secure source of power. For me, the real question is, can we develop a uranium industry that can produce 200 Mlb. a year? We need to demonstrate to the people who finance nuclear power plants that they'll have some uranium to burn in those plants so they get their loans paid back.
TER: So, what's the opportunity for investment in uranium?
BC: The Paladins and others such as Extract Resources and Rockgate Capital Corp. (TSX:RGT) have projects drilled out and ready to go. In the U.S., Uranium Energy Corp (NYSE.A:UEC) and Uranerz Energy Corp. (TSX:URZ; NYSE.A:URZ) have good deposits in South Texas and Wyoming going into production with good margins. So I wouldn't go out and fund a junior uranium exploration company right now.
TER: Want to weigh in, Rick?
RR: I would certainly fund a generative uranium exploration business in the same fashion that I'd fund sand and gravel. I'm commodity-neutral. If a really good team came to me with a really good idea in the uranium exploration space, would I finance it? Absolutely, because I believe in the exploration process and I believe in the ability of earth scientists to generate money. They've done it for me in the past.
Events in the last few months have reduced the price of existing uranium deposits to the extent that an exploration proposal put to me would have to be overwhelmingly attractive because some existing deposits that have been de-risked are selling for a third of what they're worth. Somebody has to put a truly extraordinary exploration proposal to me to overcome the discount that exists in already drilled-off deposits. But I wouldn't be afraid to look for uranium if the right person put the right proposal to me.
TER: With gold, the underlying equities haven't increased at nearly the same rate as the commodity itself, in part because investors have an alternative in gold ETFs. Because that's not the case with uranium, should we expect uranium equity prices to reflect increases consistent with the commodity price as it recovers?
BC: Yeah, I think we'll see some good price increases in the uranium-producing companies. Rick pointed out the uranium equities have been hammered pretty hard. They're selling at decent valuations if you're willing to come in and wait it out.
TER: How much volatility will uranium see?
RR: You've seen it. They're uniformly off about 50%. The corollary to what Brent said is that in the brief uranium boom from 2002 to 2006, the number of junior explorers in the uranium business increased from 5 to 500. The problem with that was that we had 20 competent teams, so the probability of having a good management team was a function of dividing 20 by 500.
I don't think we'll see an across-the-board sector recovery, though, because investors lost 95% of their money last time. My hope is that investors will be pickier and show a greater degree of selectivity than in the last boom.
TER: So is this really a speculator's market in uranium?
RR: Maybe an informed speculator's market. Most speculators are truly punters who confuse speculation with gambling and prefer to feel rather than think. Those people, sadly, just don't stand a chance in any market.
TER: Early on, Brent, you said that nuclear power is the only clean energy that's going to help solve the CO2 problem. Help solve implies a continuing need for other clean energy sources. What else looks interesting to you?
BC: There really are no good alternatives. They all have issues. With solar, it's night. It's not always windy. The turbines are very expensive to build and someday will be seen as eyesores that chop birds into little pieces. Even geothermal, which is a great source of energy, is a tiny piece of our whole energy budget and carries the added risk of exploration drilling.
TER: But if governments put the same amount of money needed for a nuclear facility toward building up geothermal capacity, could it take on a bigger percentage?
BC: No. There are thousands of volcanoes but a very small fraction of them have the right hydrology to trap the heat in such a way that it could be used in a geothermal plant. A lot of unique things have to happen for a geothermal reservoir to actually produce geothermal energy, much the same as a mineral deposit.
TER: So if this industry will always be a niche, where's the investment upside?
RR: You don't have to change the world to get stupid rich. Remember pet rocks? They didn't change the world but they made $20 million for the guy who created them. I'm not trying to present a threat to the nuclear industry nor am I trying to deal with global warming with my own investments in geothermal energy. Will it make a difference to worldwide energy supply if I develop 1,000 Megawatts (MW)? No. Will it make a difference to me? Immeasurable.
If I am able to build out a resource at $4M/MW that has a net present value at a reasonable discount when completed at $7M/MW, that's a good business to me. It doesn't matter to the world, but it matters to my clients
TER: Could more exploration identify additional geothermal resources?
BC: Yes. A lot more exploration could be done, and there are many areas to look. There's also deep enhanced geothermal, an idea they're exploring in Australia. It's not associated with volcanism but rather with slightly radioactive intrusives at depth, five to eight kilometers down, that trap the heat. That's a potential source that may prove successful and could represent a major energy source. But while there are certainly lots of places to look, we're talking exploration again-and 95% of the projects are going to be busts.
TER: We've seen a lot of consolidation in the industry, too. Would you expect consolidators such asMagma Energy Corp. (TSX:MXY) and Ram Power Corp. (TSX:RPG) to be doing the exploration? Or will they wait for explorers to succeed before they buy them?
RR: The lessons I've learned in geothermal are lessons I learned in other industries-it's about people. It's a spectacular business and people can wreck it. I suspect that speculators will cease to exist in four years because power producers will buy up the successful efforts. The very long lead times to success and the industry's extraordinary capital requirements make the geothermal business less suited to exploration speculators than other businesses. And the speculators haven't climbed the learning curve fast enough. Most resource investors look at ounces per ton, which doesn't translate particularly well in geothermal companies that report results in calories or gigajoules or megawatts.
TER: So are you backing away from geothermal?
RR: No. I'm doubling. The more I've come to know the geothermal business, the more I've learned that the downside can be ameliorated. It's seven years from slim hole to production, and in the geothermal junior business we've used up half of those seven years so the time risk is now halved and the prices are off by 80%. The geothermal junior industry is now a billion dollars into the capital-spend stage, and capital is coming in at a fraction of the prices paid earlier, so it's extraordinarily efficient capital.
TER: Can the companies make money by continuing with the geothermal they've found already, building it up with the cheaper capital? Or do they need to find new projects?
RR: This is one of the sexy parts of the story for me. We haven't had to explore for geothermal for 30 years, not since the oil companies led a geothermal exploration boom in the '70s, when they were looking for other sources of energy and they had too much money. So we've had only to explore the files for the last 10 years.
The public junior companies in the geothermal business now are opportunity-rich. And, what's wonderful, if they get to the point where EBITDA is self-sustaining, the opportunity to reinvest the capital they generate at high, predictable internal rates of return (IRR) will make them look like the very best junior royal companies, where you can invest at 15% or 16% unleveraged IRR, 70% leveraged with a 7% cost of capital, and you're generating 22% to 24% leveraged IRR. You're able to redeploy that capital-into geothermal resources that you already have on your own books that you don't have to discover-with the same leverage to generate the same margins for 6 to 10 years. That's extraordinary internal compounding unavailable in any other resource industry I know.
TER: Any parting thoughts?
RR: I'd like to reiterate my general energy thesis, which is simply that the oil markets drive energy prices. The oil markets will be chaotic but secularly higher-potentially catastrophically higher. Secularly higher in part due to increasing demand at the bottom of the demographic pyramid, where increases in disposable income are energy dense. A much more important reason, though, is that on a worldwide basis, oil is produced not by oil companies but by governments that can't deliver mail or educate kids. On top of that, major producing countries-Venezuela, Mexico, Ecuador, Peru, Indonesia, Iran-are diverting way too much free cash-flow from their oil industries to politically expedient domestic spending programs. This will impair their industries' ability to produce for decades.
As a result, I expect worldwide export crude availability to decline by at least 20% within five years. With import demand increasing by 2% compounded, if you understand that prices are set in the margin, that imbalance between supply and demand could lead to catastrophically high oil prices. I hope I'm wrong, but . . .
Brent Cook, a renowned exploration analyst, geologist and author of the weekly Exploration Insights-has devoted 30-plus years to providing economic and geologic evaluations to major mining companies, resource funds and investors. A 1978 graduate of Utah State University (BS in geology), he's worked in more than 60 countries on virtually every mineral deposit type and on projects from the conceptual stage through to detailed technical and financial modeling related to mine development and production. Brent was principal mining and exploration analyst to Global Resource Investments from 1997 until 2002, and since that time has served as an outside analyst and advisor to several investment funds and high net worth individuals.
Rick Rule, founder of Global Resource Investments Ltd., is a well-recognized expert whose company has built a stellar reputation on providing investment advice and brokerage services to high net worth individuals, institutional investors and corporate entities worldwide and on taking advantage of global opportunities in the oil and gas, mining, alternative energy, agriculture, forest products, and water industries. Rick has been principally involved in natural resource security investments from the start of his career in the securities business in 1974. Since establishing Global in 1994, he's also been particularly active in private placement markets, having originated and participated in hundreds of debt and equity transactions with public, pre-public and private companies. Earlier this year, Rick closed a landmark deal with Eric Sprott, another famous powerhouse in the natural resources arena. With GRI now a wholly owned subsidiary, Sprott, Inc. manages a portfolio of small-cap resource investments worth more than CAD$8 billion and boasts a workforce of more than 130 professionals in Canada and the U.S.
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1) Karen Roche of The Energy Report conducted this interview. She personally and/or her family own shares of the following companies mentioned in this interview: None.
2) The following companies mentioned in the interview are sponsors of The Energy Report: Ram Power, Uranium Energy and Uranerz Energy.
3) Brent Cook: I personally and/or my family own shares of the following companies mentioned in this interview: None. I personally and/or my family am paid by the following companies mentioned in this interview: None.
4) Rick Rule: I have accounts under my control that own shares of Ram Power and Rockgate Capital.
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