Uranium

Key Points

  • Uranium demand is expected to outstrip supply due to the green energy revolution, global electrification, and nuclear reactor buildout.
  • Uranium is coming off the bottom of a 10-year bear market and there are several potential short-term catalysts which could drive the price significantly higher.
  • Exposure to uranium can be achieved in multiple ways, but the higher returns are expected from the right uranium mining and development companies due to their operational leverage, albeit with higher company specific risk.

We believe uranium to be one of the most asymmetric investment opportunities available at present.

Uranium Price (Futures)

Introduction

Uranium is one of the least followed and understood commodities; it is truly ‘niche’ and trades primarily via opaque term contracts.  It is, however, reasonably simple to understand given that the entire supply chain results in a single output to a concentrated user base.

Uranium represents a unique opportunity as uranium-related investments are unlikely to be held by generalist investors (both retail and institutional).  However, many opportunities are available to absorb significant capital once mainstream and momentum investors take notice and begin to allocate funds, yet the market remains small enough for such allocations to move the market dramatically.

As an example of this, at the start of 2006 there were c. 20 uranium companies worldwide.  By the end of the bull market in 2007, there were c. 600 uranium companies worldwide, and the market capitalisation of the uranium mining industry rose from c. $10bn to >$150bn within two years.

We believe that this is a short-to-medium-term investment thesis, and the drivers appear to be aligning.  The most recent long-term bear market makes the supply and demand case compelling as there is currently insufficient supply to meet long-term current-level demand – not including expected growth in demand due to global reactor buildout.

Global demand is c. 180m lb/year, with global supply c. 125m lb/year, resulting in a structural deficit at c. $40/lb uranium prices.  The United States uses 45m to 50m lb, and in 2020 around 120m lb was removed from the market due to production suspensions and shutdowns.  Secondary sources of supply is around 20 to 25m lb, much of it coming from under feeding from the enrichment process.  Even with above ground inventory, current known supply options will be stretched over the next 5 to 10 years. 

Expected future demand requirements of c. 200 to 300 m lb/year due to new reactor build out, along with the start of a new utilities’ contracting cycle, and the backdrop of megatrends of electrification, decarbonisation, and population growth, are all considerable tailwinds expected to drive substantially higher prices.

There are indications that whilst the spot market remains around $45/lb (Q3 2021) there is some tightness in the term market, with consumers are paying significantly more that the spot price to secure longer-term supply at a reasonable price.  If the indicated strength in the term market is true, this should begin to be reflected in the spot price relatively soon.

Furthermore, encouraging signs appear in 2021 from the behaviour of smaller uranium mining companies. At least four junior producers took advantage of their Q4 2020 to Q1 2021 strong share price run up to raise capital and, rather than developing new capacity, purchased uranium in the spot market which becomes a liquid balance sheet current asset.

This kind of activity, in addition to buying in the spot market at a lower price than their cost of production, and so preserving their assets in the ground, creates a strategic inventory.  Once demand picks up this allows the companies to accelerate cash flow, and supply utilities more quickly giving them a head start on market positioning.

The storage of liquid capital in the companys’ own primary product, and not in cash, is very rare for a commodity producer and indicates much about what industry insiders consider to be the likely short-to-medium term price movement of the underlying.  A comparable example would be gold miners buying gold in 2015 when gold was c. $1,000/oz, but which certainly did not happen.  Uranium miners were more confident in their product at $30/lb than gold miners were at $1,000/oz.

Uranium Mining

Uranium mining is typically either hard rock (open pit or underground), or “in situ recovery” (ISR).  ISR is more cost effective as it does not require significant earth moving equipment, and the 1st and 2nd tier cost curve producers globally are primarily ISR producers as this method lowers both the up-front CapEx and operating costs.  ISR accounts for >40% of global production.

The main ISR sites in the US are the South Texas Uranium Belt in Texas and the Powder River Basin in Wyoming (which have been mined for over 30 years with the geology well understood), and Kazakhstan.

Over 75% of volume is transacted in the contract or term market, by way of long-term contracts with specified price, volume, and delivery dates.  These contracts are entered into by end users (i.e., utilities) to secure longer-term supply at a pre-determined price to hedge their input cost.  This contract term market is typically for contracts spanning 5-to-7-year terms, running in ‘utility contracting cycles’, and is highly opaque due to its bilateral nature and the lack of contract standardisation.

Uranium miners typically sell either through brokers or directly to consumers.  The spot uranium market accounts for c. 15% to 25% of global transaction in the uranium business.  Although the price in the spot market is a key barometer, and the only direct way to price supply and demand, spot market transaction volume is not truly representative of market transactions and pricing, which leads to a somewhat bifurcated market.

Investment Case

We expect the uranium price to increase substantially [updated] from c. $45/lb to $75/lb, and include a likely overshoot to a reasonable temporary target of $80/lb. Given the operating leverage of many uranium producers, and the optionality of large high-quality deposits in the ground, we believe the right uranium equities to be good investments for the medium term.

Such a price increase would be the consequence of supply and demand imbalances, as well as prices below c. $60/lb being too low to incentivise significant additional supply and the criticality of uranium in supplying global baseload energy supply.

Earlier signs of interest in uranium are apparent from the behaviour of higher quality uranium producers and juniors, buying their underlying product whilst maintaining their assets in the ground.

Furthermore, the recent launch (Q3 2021) of the Sprott Physical Uranium trust is expected to raise interest and offer a highly liquid way for institutional participants to gain exposure to the uranium market.

Demand characteristics:

  • Demand is mainly driven by utilities to produce electricity, and the push to produce cleaner (carbon-neutral) energy.
  • Demand is highly inelastic as uranium input costs for nuclear power plants are a small component over of the overall costs, and the costs of suspending operations due to any fuel shortages are very high, so security of supply is dominant over price considerations.
  • There are few short-to-medium term substitutes for clean and reliable baseload power supply.

Supply characteristics:

  • Supply is currently constrained by mining capacity and the lack of investment in developing new fields during the recent long-term bear market.
  • Current prices (c. $45/lb) are insufficient to incentivise both current supply (hence mines remaining on care and maintenance) and development of future supply, given that the global average total costs of mining are between $60 and $65/lb.

Drivers for a New Secular Uptrend

The uncovered reactor requirements gap (how much uranium is not contracted for by utilities) is consequently expected to widen in the coming years, and likely to manifest itself in increasing utility contracting from 2021 onwards.

When Cigar Lake in Canada was shuttered due to Covid there were no producing uranium mines in North America.  This contrasts with much of the previous 50 years where both the US and Canada were major producers, with the US leading the world in uranium mining in the 1970’s and 1980’s and Canada’s Athabasca basin one of the world’s premier mining jurisdictions.

Uranium is required for the US Navy, which is required by congress to maintain a minimum number of, for example, aircraft carries, and use only US-sourced uranium for this purpose.  Consequently, in the future there may be a premium for US production.  The US government is also committed to establishing a strategic uranium reserve and purchasing 1.5 billion dollars of uranium over the 2020’s decade.

This could lead to a bifurcated market with the domestic uranium supply commanding a premium, and the US uranium producers likely seek to be able to capture that premium (from inventory) whilst freeing up production for utility sales and other market opportunities.

The relatively recent decarbonisation and green energy drive puts nuclear power plants and owners in a strong position as nuclear energy is the largest source of non-emission / carbon-free emission electric generation.  The US is the largest uranium demand market, and there is impetus easily to 2050 (e.g., government emission target goals) that renewable power generation sources alone (i.e., wind and solar) will not be able to satisfy.

Furthermore, renewable sources of power generation, without significant energy storage infrastructure, are highly dependent on environmental conditions.  Other than fossil fuels, nuclear energy is the only other substantial way of securing baseload energy supply, and this energy supply is more important that cost. 

c. 1/5th of homes in the US are supplied with energy originating from uranium, and the start of the supply chain is not in the US.  Supply chains matter, particularly in the increasingly nationalistic global political environments.  There is, unusually, bipartisan support for uranium in the US government, not least as nuclear power has an important place in the solution for meeting the US’s decarbonisation goals.

The US is also leading the world in the design and development of “small modular reactors”.

US utilities are running at 5-to-10-year lows in inventory, with c. 2 years of average inventory remaining, and that is over the whole fuel cycle not just the end-state fabricated material.  EU utilities typically require themselves to have >3 years inventory.

China has entered its 14th “5-year plan”.  Previously this included a 100GW nuclear power generation requirement by 2030, which was revised in April 2021 to 120GW.  Currently China is outputting c. 48GW, with another 12 reactors under construction which would add around another 18GW.  Therefore, to meet their goals, another c. 35 reactors would need to be built.

Economic & Market Backdrop

Uranium is widely available in the earth’s crust.  However, to justify mine capital expenditure, the key requirements are finding:

  • large enough deposits;
  • in accessible/minable areas;
  • near enough to existing infrastructure;
  • in permittable locations;
  • with sufficient economics / return on capital.

Reactors last for 80 to 100 years, and so both reactor and mining development needs long-term capital commitment.

There are far more permitting layers required than to approve other types of mines (e.g., gold or silver).  This leads to longer times to production and therefore higher required internal rate of return hurdles from investors to justify the CapEx investment.

For example, in Mexican law, it is not permitted for the private sector either to search for uranium deposits or to mine for uranium; these activities are under Federal government control, and it is the same for Brazil.  Such political factors add additional constraints to future supply.

There are relatively few jurisdictions that understand uranium mining well enough and have the regional intellectual capital to facilitate mine development.  Historically, other than some regions in Canada, the south-western US states are the most favourable jurisdictions; this includes Texas, Wyoming, Nebraska, Colorado, Utah, and Arizona, and even in Texas and Wyoming it takes 5 to 7 years to permit a new mine. The other key mining jurisdiction is in Kazakhstan, which is under the prerogative of one of the top three producers globally, Kazatomprom.

Last Cycle Price Drivers

The previous bull market in uranium was driven by both the contracting cycle and other dynamics such as supply and demand.  In 2006 & 2007 a new contracting cycle began, which, in addition to the flooding of Cameco’s Cigar Lake mine, caused the uranium price to rise above $100/lb, before falling back to below $40/lb.

Whilst in 2010 there was no major supply destruction, global utilities came to market again pushing the price back to $40/lb to $70/lb.

In 2020 and 2021 safety concerns around Covid were bigger priorities for uranium plants than sourcing supply, especially as the cost of uranium is a small component of overall cost.  Once the industry sees stronger contracting for larger volume the price is expected to continue to rise significantly.

Another factor which likely pushed out the contracting cycle, exacerbating the structural supply and demand imbalance, was that during the Trump administration there was almost three years of potential uncertainty due to pending decisions around quotas and tariffs which would have impacted the US utilities.  As US utilities represent c. 25% of global demand their activity has a global effect which kept buying and contracting at bay pending the outcome of this ‘Section 232’ resolution.

These distractions caused the focus of utilities away from securing uranium supply.

As of Q3 2021, current spot price is c. $45/lb.  This time, the market has recently exited a historically decade-long uranium bear market and the coiled supply and demand imbalance has already shown itself in the relatively quick run from $30/lb to $45/lb. The supply side is tighter, and producers have been more disciplined shuttering mines to preserve assets in the ground.

Risks & Issues

Every power source has advantages and disadvantages.  There is a lot of fear and misunderstanding around nuclear power, which both time and necessity will likely change.

Chernobyl, Three Mile Island, Fukushima are three major nuclear ‘accidents’ that are infamous.  However, if one compares the annual equivalent deaths from pollution, emissions contributing to extreme weather events (e.g. hurricanes), accidents in coal mining, etc… on balance nuclear power is one of the safest options.

History of Fukushima

In Fukushima, for example, an earthquake and the ensuring tsunami destroyed population centres and infrastructure causing many direct deaths.  One of the only sets of infrastructure left standing was the nuclear power plants.  There has not been (yet) a single recorded death due to the failure of the backup power generation that caused the Fukushima shutdowns.

It’s also worth noting that the nuclear reactors themselves were not breached.  The incident was caused by the failure of backup conventional power generators. 

On detection of the earthquake the reactors automatically shut down.  Because of this, and other electrical grid supply issues, the electricity supply to the pumps that circulated coolant through the reactor cores failed and this supply was replaced by backup diesel generators. However, the subsequent tsunami flooding caused the failure of the backup diesel generators which resulted in overheating and high-pressure explosions which release radioactive contamination.

The plant owners were already aware of recommendations to relocate the backup generators away from the plants but chose not to do so for cost reasons.  Had the owners and operators acted on previously known safety concerns this incident would not have occurred. So, Fukushima, along with Chernobyl and Three Mile Island, and all other nuclear incidents, are attributable primarily to human failure and not failures of the underlying technology.  Once again, the industry has learned and improved.  This does not, of course, guarantee no further incidents in the future, but does significantly reduce both the likelihood and potential impact of any future failures.

Counter Thesis – What Could Go Wrong?

We see four main risks to the investment rationale.

1) Another disaster, like Fukushima.

This is possible, but a lot has been learned and new safety regulations make this increasingly unlikely.  However, it is always possible that an event that has not been accounted for occurs, and if there is another significant incident it could turn public and political sentiment against uranium-based nuclear power for another generation.

Whether or not this would significantly affect reactor buildout in China and India is less certain, so the general supply and demand fundamental thesis could remain intact albeit with a diminished level of conviction.

2) Regulatory moves away from uranium.

This has been seen in France, where the ‘green’ party pushed for a reduction in uranium energy supply in favour of fossil fuels.  Although France, under current legislation, will move from c. 75% energy supply to 50% over time this appears to be a countertrend to the current global picture.

3) Large scale replacement with thorium (or similar) reactors.

This would likely be a great positive for society, as such (high temperature rather than high pressure) reactors would fundamentally be much safer, the thorium decay chains have short half-lives compared to uranium, and thorium reactors can recycle ‘spent’ fuel which has to be stored indefinitely with uranium.

Long-term this may occur but is unlikely to materially affect supply & demand within 15 years or even longer-term due to the expected 80-to-100-year lifetimes for new uranium reactors coming online.

4) Unknown new technology.

This could affect mining efficiency and output, or, more critically for the thesis, energy supply.

5) A strong and persistent economic downturn.

An economic downturn would reduce industrial demand for energy, and likely supress uranium prices in the short-to-medium term. However, it would likely also lead to reduced CapEx and potentially contribute to an even tighter long-term supply picture.


Originally published in Q1 2021, where the uranium prices was c. $30/lb.

Last updated: May 1, 2022

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