Well-known and highly regarded throughout the mining and exploration community, Mercenary Geologist Mickey Fulp returns to tell The Energy Report readers about his growing Primer for the Lay Investor and share his musings on plays taking shape in uranium (Athabasca, Wyoming and New Mexico) and natural gas (southern U.S. and central Texas).

The Energy Report: The third installment in your Primer for the Lay Investor series, “ The Good, the Bad, and the Butt Ugly ” appeared in our precious metals website, The Gold Report, on February 24. What’s the short story there?

Mickey Fulp: The piece deals with junior resource companies, metal commodities and flagship projects. The gist is that certain metal commodities are conducive to success for a junior resource company, and some metal commodities are not. Carrying that a bit further and bringing in the geology aspect, certain deposit types within these specific commodities are good, bad or ugly for juniors to have as flagship projects.

I then give examples of each: three examples of good types of projects and deposit types, three examples of what I consider bad commodities and/or deposit types, and three examples of the ugly (or the butt ugly as I say)—commodities and projects I think juniors and investors should avoid at all cost.

TER: When you’re qualifying the good, the bad, and the ugly, are you looking from a cost of mining point of view, a yield in the mine point of view or all of the above?

MF: All of the above. It’s based on the idea that juniors have limited financing capabilities and limited life spans. The average life of a junior resource stock is probably on the order of five to seven years. A junior needs to select projects that have a good chance of success within a time period of three to five years, it needs to look at something where the production costs are in the lowest quartile, ultimate capital expenditures are within its financing capabilities, and there are multiple exit strategies, whether it’s to develop a mine or get taken out, or even pay the exploration costs to get to the point that it can become a takeover candidate without diluting the share structure so much that it becomes a financial nightmare.

Many juniors select projects that are way too big for their britches. An example would be big porphyry copper deposits. It takes 10 years or more to explore, permit, and develop and you need a minimum of $2-$3 billion in debt and equity financing to put a mine into production. That is beyond the capability of any junior resource company. The exit strategy is limited too: Sell out to a multi-national integrated mining company or a sovereign company looking for smelter feed. So nearly all of these companies fail.

TER: What do the first two installments in your Primer focus on?

MF: Bear in mind, there is no sequential nature to these things. Whatever I am inspired to write at a particular time becomes a chapter in this series. The first one (August 25, 2008) dealt with “Reserves and Resources,” and I was motivated to write that because it became very apparent to me that many investors, investment advisors, brokers—even geologists and engineers—did not understand the difference between reserves and resources. So this piece laid out the Canadian Institute of Metallurgy’s 43-101 definitions in layman’s terms.

The second in the series was “Share Structure, People and Projects” (December 15, 2008). Those are my three key criteria for evaluating companies. I have plans to do “What Do Drill Results Mean?” and actually posted a couple of others that will fit into this series.

It’s in the back of my mind that sometime this is going to be a book; so when I have 10 or 15 chapters, I may bundle them up and rework them to become less time-sensitive and perhaps publish a little book.

TER: Your third one—“The Good, the Bad and the Butt Ugly”—deals with geology in a way that you are to be applauded for. It makes sense; even non-geologists can understand what you were saying. Would investors find all three installments on your website?

MF: First of all thanks for the compliment, the idea is to make them understandable to the average investor; and yes, they are available in Mercenary Musings, a tab on my website (MercenaryGeologist.com). All my newsletters appear on the Musings page. Just scroll down until you find the one you want to read.

TER: You’re a fan of the uranium sector, which we discussed in our last interview a few months ago. At the time, you called uranium “the canary in the coal mine” for the commodities collapse but also noted that it had recovered fairly well. What is your thinking nowadays?

MF: I like certain segments of the uranium industry for speculation in junior resource stocks. I like the Athabasca Basin, which we have talked about before and where Hathor (November 24, 2008) made its discovery. I also like the Western U.S., specifically areas that have had significant historic production. For me that would be Wyoming and New Mexico, particularly the in situ recovery (ISR) techniques being employed in Wyoming. Several juniors have projects in the permit stage right now. The ISR deposits are basically solution mining. They establish well fields, inject oxygen, baking soda, and club soda down the holes, dissolve the uranium and then recover it in small extraction plants. In some ways—in that you’re developing well fields—it’s analogous to coal-bed methane. It’s relatively cheap to do and environmentally benign. So yes, I’m bullish on uranium in the mid-term, for say, the next 10 years. I see a supply crunch in the uranium business.

TER: It’s interesting that Obama never seems mention nuclear when he talks about energy.

MF: I think that’s a mistake.

TER: So should we expect any government funding to be advancing nuclear facilities, either building, expanding or upgrading them?

MF: I don’t care to predict what the government might do. The U.S. has expanded its nuclear power plant capabilities significantly since Three Mile Island. It’s been under the radar screen, but we are consuming many, many more pounds of uranium than in the 1980s when the bottom fell out of the U.S. uranium business. We currently consume about 55 million pounds a year, and we’re producing about four million. About half of that supply shortfall is presently being filled by the Russians in their Megatons to Megawatts Program, but that’s all going to end in 2013.

U.S. nuclear power plants are going to continue to use 55 to 60 million pounds of uranium a year, and that supply has to come from somewhere. Whether government supports the expansion of nuclear power plants or not, that supply shortfall still exists.

TER: And what about Hathor Exploration Ltd. (TSX.V:HAT)? Many people are talking about Hathor, and the Athabasca region has a lot of fans. Is it group-think or do we really have a play there?

MF: It’s group-think, and it scares me because it is group-think. By nature, I’m a contrarian; but all my buddies and all the analysts in the business—we’re all onto this, and we’re all into this play. So, although it makes me a little bit uncomfortable to be in a crowd, Hathor is a very good play, an interesting play.

I recently crunched some numbers on Hathor and will run you through my simple scenario: There are 95 million shares fully diluted—86 million outstanding, but we’ll use the fully diluted because the warrants were in the money until recently. I haven’t calculated numbers on the resource because I don’t think there’s enough drilling to put good numbers on it, but lots of analysts have played around with it and have come out with about 35-40 million pounds U3O8. Using current peer valuations for, let’s say Forsys Metals Corp. (TSX:FSY), which operates in Namibia and is being taken over by a Belgian company or the Uranium One (TSX:UUU) sale of half of Honeymoon in South Australia, we’re looking at $7–$9.50 per pound in the ground. Based on that comparison, you have somewhere between a $245 to $380 million market cap for a resource of 35-40 million pounds.

That adds up to a fair market value somewhere between $2.60 and $4.00 a share. With recent weakness in the uranium sector and Hathor’s first results from this winter’s drilling, which for some reason that I don’t understand were negatively received by the market, it is currently trading at about $1.90. I would say it’s undervalued at that price. The thing about Hathor is that it trades a lot of shares. And it’s cyclical, too, so people play both the liquid nature and the cyclical nature. I know players in Hathor who have a core position they don’t trade, and then a portion of their Hathor ownings that they trade between $2.50 and $3.50. You can see a cyclical pattern to Hathor’s price over the past three months, ranging somewhere from $2.50 to $3.50 per share. It’s now broken thru on the downside of that trading range.

With current guess-timates of pounds in the ground—say that 35 million or 40 million pounds—and in a previous trading range of $2.50 to $3.50, it was not undervalued. The play, and why analysts are so bullish, is premised on growing this resource.

TER: And what’s the basis for that expectation?

MF: Analysts think that the resource is going to be much bigger than it is currently. There are good geologic reasons to think that, because they have yet to hit mineralization where the structure hits the unconformity. I know this is geology speak, but let me try to explain.

These deposits are fed by basement faults, the basement being the underlying rocks. A series of flat-lying sedimentary rocks lies atop that basement at the so-called unconformity. Where the basement faults, i.e., the feeder zones hit the unconformity, is where bonanza-grade uranium ore bodies occur. Hathor has yet to announce results from current drilling that test that unconformity.

So the deposit could grow much bigger; there is also good geophysical evidence that it could grow bigger. Everybody has analyzed and recommended Hathor based on the theory that it’s going to get much bigger than it is. That’s really a crapshoot; all drilling is a crapshoot, so we’ll see.

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