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TABLE OF CONTENTS Mar 3 - 9, 2014 Volume 100 Number 3 - 0 comments

Paladin suspends production at Kayelekera

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VANCOUVER — In the most significant curtailment of today’s uranium cycle, Paladin Energy (TSX: PDN) is suspending production its Kayelekera mine in Malawi until the uranium price recovers.

Kayelekera, a large open-pit resin-in-pulp operation in northern Malawi, has been producing 3.3 million lb. uranium oxide (U3O8) annually since it started operating in 2009.

Two years later, the tsunami-induced disaster at the Fukushima nuclear facility in Japan sent uranium prices into a tailspin.

Kayelekera has been operating at a loss ever since, despite Paladin’s efforts to reduce operating costs. During the 2012–2013 fiscal year the production cost at Kayelekera fell by 24% to US$39.20 per lb. However, the uranium spot price fell 32% in the same period, declining from US$50.75 per lb. to US$34.50.

“The Kayelekera mine has performed exceptionally well technically, with production levels recorded at or near nameplate capacity over the past 12 months and significant achievements made in Paladin’s cost-reduction program,” said Paladin CEO John Borshoff in a statement. “Nevertheless, despite these considerable efforts Kayelekera continues to operate at a loss due to the low prevailing uranium price. By placing Kayelekera on care and maintenance now, we are preserving the remaining value of the orebody until it can be mined profitably.”

Low prices have forced uranium miners around the world to cut costs and defer expansions.

Kayelekera, however, “represents the most significant mine currently in production to shut due to weak spot uranium prices, which sit near eight-year lows of US$35.50 per lb.,” Raymond James analyst David Sadowski said in a note. He estimates Kayelekera represented 2.2% of world uranium production.

Paladin worked hard to make Kayelekera profitable, advancing two cost-cutting initiatives at the mine. The first was adding a nano-filtration acid-recovery plant, which is now operational and deserves credit for much of the reduction in operating costs.

Unfortunately the company has not been able to complete the second cost-cutting initiative, which involves connecting Kayelekera to Malawi’s national power grid. During the 18 months Paladin spent negotiating with Malawian authorities about the power connection, the uranium price kept falling, eventually reaching a level where even grid power would not make Kayelekera profitable.

As analyst Colin Healey of Haywood Securities noted in his response to the news, it cost more to produce a pound of uranium oxide at Kayelekera than a pound was worth on the spot market in every quarter of 2013. Until September, though, Paladin had a small buffer in place: the company was still selling some of its output into higher-priced term sales contracts.

“Kayelekera delivered its last product under these contracts in September 2013,” Paladin wrote in its release. “Subsequent uranium produced from KM is now fully exposed to the depressed uranium spot market. The very low continuing uranium spot price . . . makes continued operation at KM unsustainable in both current market conditions and in conditions projected in the medium term.”

Indeed, analysts resoundingly agreed Paladin had to suspend Kayelekera — and none expect the mine to resume operations soon.

“We believe restarting the mine is highly unlikely any time soon,” wrote Sadowski. “Not only is the price required to resume operations much higher than current levels (above US$55 per lb., in our view), but we anticipate the company may experience some blowback from the government of Malawi, one of the world’s poorest nations.”

Kayelekera is a joint venture between Paladin, which owns 85% of the mine, and the government of Malawi. Kayelekera is the largest mine in Malawi and represents about 10% of the country’s gross domestic product. As Sadowski notes, there have been increasing calls in recent years around raising royalty rates or even expropriating the mine. Such talk could now intensify.

In an effort to soften the blow, Paladin is giving laid-off employees an average payout equivalent to almost 11 months of salary. The company also plans to retain 194 Malawi national employees and 27 expatriate staff to maintain the site and ensure security. These efforts would cost US$12 million annually.

That cost pales compared to the amount saved by shutting the mine down. Based on a US$35 per lb. uranium price, Paladin says it would have had to inject US$20 million to US$25 million into Kayelekera in each of the next two years to maintain the mine.

With the operation suspended, Paladin expects its cash flow to improve by US$7 million to US$10 million in 2014 and by US$20 million to US$25 million in 2015.

“Kayelekera is one of numerous uranium mines currently operating at or below break-even,” Paladin wrote. “Paladin’s decision to place KM on care and maintenance is the latest in a sequence of closures, production suspensions and deferrals of major planned greenfield and brownfield expansions in the uranium sector.”

Analyst David Talbot of Dundee Capital Markets Research agrees. In a mid-January uranium update, Talbot notes that a commodity bear market usually cycles through phases — and uranium is partway through the cycle.

“It usually starts with discussions of cost-cutting and capital deferrals,” Talbot wrote. “Then we start seeing expansions and new projects deferred or cancelled altogether, which we have seen plenty of in the past few months alone, and finally it’s a significant shut down of a current operation.”

He pointed out that in the U.S., Uranium Energy (NYSE-MKT: UEC) and Uranium One (TSX: UUU; US-OTC: SXRZF) deferred well construction at their in-situ operations while Energy Fuels (TSX: EFR; NYSE-MKT: UUUU) announced plans to stop processing conventional ore at its White Mesa mill.

Expansions have also been cancelled, including Paladin’s 2012 decision to abandon a major expansion of its Langer Heinrich mine in Namibia and BHP Billiton’s (NYSE: BHP) decision to defer a major expansion of its Olympic Dam mine in South Australia.

(Talbot wrote the note before Paladin’s Kayelekera news, but the shutdown fulfills the final phase of the cycle.)

Mining operations at Kayelekera are already halted, but processing will continue until all reagents and consumables on-site have been depleted and the production circuit emptied, a process expected to last until April or May.

Paladin expects to produce 7.8 million to 8 million lb. U3O8 in 2014. When Kayelekera was still in the picture, the company had forecast 2014 production of 8.3 million to 8.7 million lb. The company does not expect the shutdown to impact its balance sheet, as the mine’s value had already been written down to zero.

“Electing to take Kayelekera off-line at this time is a prudent and sensible step to preserve shareholder value and position Paladin to take best advantage of the opportunities that will present to the company when the uranium sector enters its next exciting phase of growth and profitability,” Borshoff said.

Borshoff is not alone in anticipating an impending surge in the uranium sector. Most analysts expect the uranium market to be undersupplied within a few years, which should push prices up.

Dundee’s Talbot, for example, foresees an initial uranium market deficit in 2016. By 2020 he expects to see only 207 million lb. of supply versus 223 million lb. of demand, which means a deficit of 16 million lb. U3O8.

As such Talbot expects the uranium oxide price to rise to US$65 per lb. in the long-term. However, he recently reduced his near-term price forecasts to account for the market’s continued softness. In 2014 he expects the spot price of uranium oxide to average US$42 per lb., rising to US$52 per lb. in 2015 and US$60 per lb. in 2016.

“Investors, miners, fuel-cycle participants and utilities are all waiting for the same catalyst — Japan nuclear restarts,” Talbot wrote. “Japanese restarts are the single largest catalyst to a rebound in uranium prices, followed by Chinese new builds . . . not because restarts will change uranium demand all that much, especially in the short-term, as Japan likely has three to four years of nuclear fuel inventories. But we believe the restarts will signal to the rest of the world — the other 90% of uranium users — that Japan is maintaining its long-term view that nuclear must be part of its energy mix.”

Like most analysts, Talbot believes Japan has to return to that perspective. With its 50 reactors shut down, the country is importing 84% of its energy needs at a cost of US$40 billion a year. But bad press and a slow restart-approval process has seriously impacted the restart timeline. Talbot predicts 10 to 15 restarts in 2014.

On news of the Kayelekera suspension, Paladin’s share price gained 1.5¢ to close at 49.5¢ — an improvement over its November 52-week low of 37.5¢. A year ago  shares were worth $1.30.

Paladin has 964 million shares outstanding.

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Paladin Energy has suspended production at its Kayelekera uranium mine in Malawi (above). It had been operating at a loss due to low uranium prices. Credit: Paladin Energy
Paladin Energy has suspended production at its Kayeleke...

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