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Nuclear reaction

There are no crowds rushing to get into nuclear power, but it's a
sweet fit - a money machine, even - for Cameco, the world's top uranium miner

By Martin Mittelstaedt
Friday, Feb. 28, 2003

There are business deals that seem too good to be true, where one side comes out so far ahead it's a surprise such a lopsided arrangement was ever consummated.

Cameco Corp. looks like it's on the sunny side of such a transaction in its deft moves to buy nearly a third of Bruce Power LP, the world's largest atomic power complex. It's a transforming event for Cameco, the little-known Saskatoon company that is the world's biggest producer of uranium for power reactors.

By changing itself into a hybrid of miner and power generator, Cameco is embracing a business model-vertical integration-that has never been tried before in the mining business. And nuclear power, after all, is a business whose long-term future is perpetually clouded by environmental and technical concerns. Can Cameco make it fly?

The company's core asset is a string of uranium mines-the richest ever discovered-deep under the boreal forest of Northern Saskatchewan. It has two processing plants in Ontario that turn the uranium into a form that can be used by utilities. The company also owns a pair of rich gold mines at the other end of the world, in Kyrgyzstan and Mongolia.

Analysts generally view Cameco as well run. Apart from being the world's lowest-cost uranium producer, it is that rarity in Canada's mining industry, a consistently profitable company. It even sports a coveted A credit rating.

All of this success has been engineered by a company-formerly co-owned by both the federal and Saskatchewan governments-that gets conspicuously little notice. Partly this is due to the product. A copper producer "makes sheets of copper or copper wire and whatever, and so you get something tangible," says Gerald Grandey, Cameco's new CEO. "Our final product is energy, an electron. It's a little bit ephemeral."

But corporate culture has dampened the profile too. Cameco executives cultivate a plain-folks-from-Saskatoon image, although the disarming manner belies a hard-nosed business edge. Most company leaders would extol the vision and financial acumen Cameco demonstrated through the Bruce negotiations, which includes bringing two heavy-hitting partners into the deal: the Ontario Municipal Employees Retirement System and TransCanada
PipeLines. (Each of the three lead partners has a 31.6% stake; the remainder is held by the plant's unions.) But bragging is not the Cameco style. Bernard Michel, the company's CEO until Grandey took over in January, won't discuss his role in the $950-million deal (Cameco's investment was $198 million). An aide says Michel doesn't want to take too much credit (now Cameco's chairman, Michel steps down on March 31).

The eight reactors at Bruce have enough readily available capacity to pump more than 20% of the juice in what is shaping up to be one of the most power-short parts of North America. Ontario narrowly avoided blackouts last summer after residents innocently began to turn on air conditioners during a heat wave.  Soaring prices and a
maxed-out system revealed the precariousness of the province's electricity market. With little in the way of new power supply underconstruction, consumers will be clamouring again this year for everywatt that can be pumped out of the Bruce. That all but guarantees lush profits for Cameco and company.

"It's a money machine," grouses David Martin, policy adviser for theSierra Club of Canada. And a money machine that until recently was owned by the public. "The issue here, of course, is the deal-this sweetheart deal for Bruce and Cameco."

The big slice of Bruce fell into Cameco's lap because of the misfortunes of British Energy, the plant's former majority owner. Last year, British Energy was veering toward insolvency, the victim of declining U.K. wholesale power prices. It was forced to sell some of its choice assets to raise cash. British Energy was not only a
motivated seller, but it was selling something-a used nuclear plant-for which there were few potential buyers. Advantage Cameco.

Cameco initially bought into Bruce in 2001 alongside British Energy, paying a mere $100 million for a 15% stake in the facility. The two companies bought from an even more motivated seller, Ontario Power Generation (OPG), the Ontario government- owned utility that had been ordered by the province to create a competitive electricity market by reducing its near monopoly on power generation.

The original deal with the province was toothache-sweet for British Energy and Cameco. OPG agreed to lease the plant for more than 40 years at a low cost. The province agreed to keep the liability for nuclear's biggest headache: the scary and unknown costs of decommissioning old reactors and disposing of their deadly
radioactive waste.

But there's more. Half the plant's reactors were then idle, and no value was assigned to them. But this year, two of the idled reactors that Cameco essentially got for free are scheduled to come back on stream, raising the facility's capacity by nearly 50%. Add the fact that the Bruce is probably the lowest-cost producer of electricity in North America apart from the cheapest of hydroelectric sites (Niagara Falls, for instance), and you've got "a very, very attractive opportunity," Cameco CEO Grandey says. The low cost "makes a very interesting story to shareholders."

Analysts believe the Bruce plant will generate profits of about $55 million (translating into $1 a share) for Cameco this year, a return of more than 15%, which is excellent for a stable, utility-like investment.

Still, that's not the end of the story. Next year, the company will make about the same as in 2003 because the increased output from the two reactors returning to service will be offset by the other four reactors being taken off line for routine maintenance. But in 2005, profits should jump higher, as all six reactors will be pumping juice
into the system for most of the year, and the heavy investments in getting the nukes back on line will have ended.

Given that Cameco's lease on the Bruce runs for 40 more years, it could also find itself in an enviable financial situation if inflation returns to high levels; if concerns over global warming give nuclear plants an edge over coal-fired plants; or if supply shortages undermine the economics of natural- gas-fired plants. That's a lot of
potential upside for Cameco.

But in every story, there is, of course, a potential downside. In the United Kingdom, after years of an open electricity market, competition from new suppliers drove prices down and created a glut. This is what nearly bankrupted British Energy, and led to the Bruce sale.

Ontario is probably in a better position to avoid falling power prices because new power plant construction has virtually ground to a halt, a reaction by the market to Premier Ernie Eves's erratic moves to deregulate the electricity business. And Ontario's transmission ties to the U.S. are limited, which means that even if power prices drop in nearby deregulated markets such as New York, Ohio or Michigan, these price declines won't be fully transmitted in the province. In any case, Bruce Power tries to mitigate risk by selling more than half its
electricity under long-term contracts at fixed prices, so it has some protection from price volatility.

With Ontario's oftentimes cantankerous CANDU nuclear plants, there is also the chance of something going wrong at one of the reactors. The Bruce reactors that are about to be reopened are the second-oldest in the province, and nuclear plants generally have increasing problems as they age. The reactors were mothballed in
1998 for poor performance, among other reasons.

Dave Martin of the Sierra Club contends that running them is a big risk. "They seem to have this attitude, well, we'll run them until something goes bang.'' But the federal nuclear regulator, the Canadian Nuclear Safety Commission, deemed the risk of reopening the Bruce reactors so small that it applied only a low-level
review, rather than ordering a full-scale environmental assessment.

The weak point in CANDU reactors is their pressure tubes, the heart of the power plant, where high water pressures and radioactivity from the atomic reactions can make parts brittle and vulnerable to
failure. At some point, the tubes have to be torn out and replaced to reduce the risks of a severe accident or meltdown. It's an extremely costly job that Bruce Power believes won't be required for years.
The company did a spot check on 81 of the 960 pressure tubes, and determined through this partial review that they are in good enough shape for many more years of operation. Martin contends the partial inspection isn't good enough.

Duncan Hawthorne, Bruce Power's CEO, disputes this view, saying that critics of the restart don't know much about nuclear power. He says the tubes checked were the ones deep in the reactors, and subject to the most stresses and strains. If they are fine, it's safe to assume the rest are in good shape too.

Bruce spent $30 million evaluating whether the reactors were safe to reopen, and it will spend $400 million to bring them back to service. Hawthorne says the company has no reason to do sloppy work. "We'd lose our entire investment if we didn't bring these plants back safely," he says. "We don't want any hiccups as the units come back."

Cameco has another potentialLy big moneymaker: the improving outlook for uranium prices. In recent years, a global supply glut has made uranium dirt cheap, hardly worth the bother of digging it out of the ground. Prices, which had been as high as $17 per pound in the late 1980s, fell to as little as $7 in 2001. But by the end of last year, they'd crept back up to $10, which is considered a breakthrough in the industry.

What drove prices down was excessive mine production in the 1980s and the recycling of old nuclear bombs into reactor fuel in the late 1990s. Thanks to these factors, the West has used two billion pounds of uranium to run power reactors in the past 15 years, but has had to mine only 1.1 billion pounds. "That can't be sustained
forever," observes Grandey.

But this bullish story about an upturn in prices has been going around for a long time now. "A lot of analysts have been saying for years now that it's going to happen some time soon," says Nick Carter, a vice-president of Ux Consulting Co., an Atlanta company that tracks uranium prices. Even though analysts have been wrong
up to now, Carter says depletion of inventory will finally make a difference. "Prices really could increase substantially," he says. Grandey thinks they could even reach $20.

Cameco has been underestimated throughout its life as a public company. It went public in 1991 at $12.50 and is now close to $40-quite an achievement, considering that basic commodity producers haven't exactly been market darlings, and that the federal and Saskatchewan governments have been steadily selling their stakes, recently eliminating their positions. Saskatchewan still owns one special class B share, but its only purpose is to force the
company to keep its headquarters in the province.

"I think if you looked at it over the 10-year period, the trebling of one's investment is pretty good," says Grandey.
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