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BHP - BHP Billiton

Cameco was the disaster for the week. Cameco announced on Monday that a rock fall in one of their under construction mines had sprung a leak and filled the mine with water. Cameco said it would eventually recover the mine but they would have to begin remediation from the surface down. A seal on a watertight door failed and the entire mine was flooded. Cameco initially said it could take up to a year to resolve the leak and continue construction on the mine but later reports indicated it could take longer. This was the second time water had caused a work stoppage. This was not a producing mine but Cameco had planned on beginning production sometime in 2008. The mine is expected to produce 18 million pounds of uranium at full capacity sometime near the end of the decade. An analyst at Salman Partners said they had estimated demand would exceed supply by 25 million pounds in 2008 and with the mine delay they raised that estimate to a shortage of 32 million pounds. Uranium has risen from $42 a pound in March to $56 a pound today. Cameco still maintains it has enough production in other mines to meet its contractual obligations. Cameco owns 50% of the Cigar Lake mine, Areva 37%, Idemitsu Uranium Exploration 8% and TEPCO Resources 5%.

Cameco fell from $38 to $33 on the news but has since recovered to the mid $35 range. Losing Cigar Lake until 2009 or later is a major blow to Cameco (18 million pounds x $60 = $1,080,000,000) and uranium prices are only going to go higher. One analyst said losing Cigar Lake was like losing Saudi Arabia to the oil sector. I disagree somewhat but it is a blow, especially to Cameco. Cameco may be able to fulfill its contracts but those contracts are a old prices. New production is always sold at the higher current price.

This uranium shortfall is only going to get worse. The world is on a crash course to add nuclear plants with more than 150 on the drawing boards. In the US there are 31 plants in the application process and expected to be approved by 2008. The Energy Policy Act established some benefits and government subsidies for plants with completed applications submitted to the NRC by Dec-31st 2008. Part of these subsidies included $2 billion in standby insurance to help plants cross hurdles both financial and regulatory. The bottom line is a veritable flood of nuclear plants will begin construction later this decade. With the 12 plants in planning stages or under construction in France, 30 more in China, etc, it will take every scrap of uranium on the planet to feed them. Russia is planning at least 42 and as many as 58 plants. Several countries are already stockpiling uranium in anticipation of having plants in the future. With that additional 18 million pounds of new Cameco production out of the picture until at lease 2010 that opens the door for others in the sector. Uranium is expected to exceed $70 by the end of 2007 and I believe it will be even higher. Mine production supplies only 62% of current demand. The rest is met by destruction of nuclear weapons. The nuclear material is de-enriched, basically watered down to 1/100th of its current purity in order to be turned into fuel mild enough for reactors. That program will end by 2013. At that point the world will have to depend on mine production for future uranium needs. Basically it boils down to "if you don't own the mine now you are already out of luck." China is trying to lock up all the available supplies around the world and is accomplishing it one deposit at a time.

Because of Cameco's problems and their locked in prices for current production I am going to recommend we move out of Cameco and into BHP Billiton. BHP is an Australian miner of many different metals including uranium. BHP owns a property called the Olympic Dam mine, which is the biggest uranium deposit on the planet. It contains something in the range of 40% of all known reserves. Current contracts delivering uranium in the high $teens expire in 2008 and BHP will be in the drivers seat. Future contracts will have escalation clauses to reward BHP for its dwindling asset and rising demand. BHP produced YTD profits of more than $10 billion through last quarter and announced a $3 billion stock buyback. BHP has 10x the market cap of Cameco. Business is good and the breadth of mining for different metals should give us some diversification in addition to the uranium exposure we need.

BUY 2009 $40 LEAP Call ZPK-AH

I went with the $40 LEAP with BHP at $42.35 due to price. The $50 LEAP is $7 compared to $11.10 for the $40 strike. Subtract the $2.35 in the money and the real premium is $8.75. I am willing to pay $1.75 more for a $10 lower strike. It will pay off down the road. If you want a higher strike that is certainly your prerogative.


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