Uranium: Electrifying the Low-Carbon Future (Part 1 Supply)
Nuclear power is the fastest growing traditional energy source, and is essential to any low-carbon future. Unlike renewable energy, investor apathy is extraordinarily high for nuclear. Once capital-intensive nuclear reactors are built, they operate 24/7 all year long. Uranium, the most common fission fuel source, accounts for only 2% to 4% of the cost of nuclear power. Thus, unlike other commodities, substitution and conservation are not relevant for uranium. Demand is extremely inelastic. Meanwhile, enduring low prices have set in motion a future supply deficit. In this letter we explore the supply characteristics of this unique resource which partially explains our excitement for uranium holdings and developers. We will address other aspects of the thesis, like accelerating demand and utility need to sign contracts subsequently.
Exhibit 1: Uranium recoveries can be meteoric. Source: Uranium Energ Corp, Ux Consulting
Present uranium prices are materially below the marginal cost of production. Many producers are bleeding cash. Most new mines will not be developed unless uranium (U3O8) prices exceed $60/lb. Currently, the long-term contract price is ~$44/lb and the ‘spot’ market for marginal trading and inventories hovers around $28/lb (Exhibit 1). Bear markets for commodities end in one of two ways: demand creation or supply destruction. Demand creation is happening for nuclear power, but is not driven by cheap uranium. Supply destruction takes longer, but has been underway since 2011. A similar crunch occurred in the 2000’s following a 20-year bear market. Spot uranium prices bottomed at $7/lb in 1997 when production costs were $20/lb. As prices rose, supply security concerns drove utilities to compete for contracts. Prices skyrocketed to $138/lb by 2007. During this period, companies that owned quality resources, permits and production, operated by value-creating management, had their shares multiply ten- to thousand-fold from forgotten ‘penny stock’ levels.
While the near-term outlook for uranium producers is far from rosy, the forsaken equities of these companies offer fertile hunting ground for the patient contrarian. We are dusting off the old records and meeting some the most extraordinary company managers with whom to partner for the inevitable recovery.
Supply: Higher Prices Required
The uranium market has been in a state of imbalance for more than a decade and a half, with ‘primary’ mine production serving only 60-70% of consumption. The balance was met through drawdown of stockpiles, down-blending Russian and U.S. highly-enriched uranium (HEU) and other ‘secondary’ sources. The 20-year ‘Megatons to Megawatts’ program to recycle HEU from Soviet warheads came to an end in 2013. This program energized 1-in-10 U.S. homes, and satiated 12% of global demand for nuclear fuel. While overall uranium inventories remain high, most are unusable in their present form – highly-enriched, depleted or contaminated – and need billion dollar investments to become usable fuel. Secondary supply will continue to decline from 2016 level (18% of demand). Therefore, mine supply will have to grow faster than nuclear power demand.
As existing mines deplete their finite resources, the onus of incremental production falls on projects yet to be commissioned. Uranium is at the tail end of a technology shock to the supply curve. In situ recovery (ISR) is a low-impact method that has lowered the cost and development timeframes. In lieu of mining uranium-bearing rock to extract the fuel source, ISR reverses the natural process that deposited the uranium in sandstone deposits. Fortified water is pumped through injection wells into the reservoir to dissolve uranium and then brought to surface through production wells. Due to the phenomenal success in Kazakhstan, ISR now accounts for 51% of primary production. Kazakh production multiplied 12x between 2001 and 2015 to reach 62 Mlb/a (41% of world supply). However, the shallow and high-grade ISR mines in the north are being depleted and Kazakh production looks to plateau for the next 5 years. Production is increasingly moving to deeper, lower grade and more difficult southern districts, which will halt cost deflation.
Exhibit 2 explores the breakeven cost analysis of uranium projects in the development pipeline. Utilities need to sign long-term contracts for project development. For each project, the height of the bar represents the price threshold needed for investment. Very little production is available below $60/lb.
Exhibit 2:
Each bar represents a planned or potential project. The height shows
the uranium price needed to incentivize the developer to generate
minimum returns, and the thickness denotes that annual productive
capacity.
Source: Raymond James Ltd, Radiant Value Management
The permit process for uranium extraction takes longer than for other mining ventures due to potential health and security concerns. Traditional hard rock mines take many years to build. These activities typically take 5–10 years. Once produced, uranium needs to be enriched and fabricated into fuel rods, a process that takes another 1–2 years. In light of the declining supply profile, unless development projects are sanctioned in a timely fashion, scarcity concerns will reemerge.
