Description

The most overlooked ESG investment is currently the uranium sector. In a world that is de-carbonizing, there needs to be a carbon-free baseload power complement to wind and solar power. Uranium is the fuel that powers nuclear reactors, which provide clean, safe, and reliable energy. The investment proposition is rather simple: demand is increasing, supply is decreasing and the buyer is indifferent to the price that it pays. While uranium prices have increased from $25/lb last year to approximately $29/lb currently, prices need to rise to at least $60 to bring equilibrium to the market. Earlier this year, during the "two sessions" meeting of China's National People's Congress has been told that the country has to build six nuclear reactors a year if it hopes to meet its 2060 deadline to become carbon neutral. To put this into context of the current uranium market, in 2040 China will consume more uranium than is mined globally today.  

Current uranium demand is roughly 175-180 million lbs annually and mine supply is 130-140 million lbs. Over the rest of the decade, depletion from existing mines will reduce supply by 10-20 million lbs while demand is expected to grow to 220 million lbs. Unlike when the last price spike occurred, the uranium market is expected to remain in deficit thru the end of this decade and beyond. Last cycle, the deficit was made up when production from Olympic Dam came on and Khazakstan aggressively ramped up its production. At this point, there is no credible plan to meet the supply gap.

A factor that has limited the construction of nuclear power plants is that they cost significantly more to build than wind and solar farms. A lot of research has gone towards Small Modular Reactors (SMR). SMRs offer many advantages, such as relatively small physical footprints, reduced capital investment, ability to be sited in locations no possible for larger nuclear plants, and provisions for incremental power additions. SMRs also offer distinct safeguards, security and nonproliferation advantages. The Department of Energy is working with the Nuclear Regulatory Council to test a few concepts which they hope could be deployable in the late 2020s to early 2030s. Bill Gates has an investment in TerraPower, which is one of the advanced SMR concepts. 

Why are spot prices languishing in the face of an inevitable market deficit? The answer goes all the way back to 2011 when Japan shut down all of its reactors following the Fukushima accident. Japan began selling part of its uranium inventory at this time as well. Following Fukushima, Germany, Spain and Belgium announced that they would be shutting down all of their existing reactors. During this time period, Kazakhstan was ramping up its production. In 2000, Kazakhstan was responsible for less than 10% of the global uranium supply, and now it’s approximately 40%. Kazatomprom went public 2 years ago. Management is very cognizant of the fact that the best way to maximize profits is to restrict production. Going forward, it has 90% of its sales tied to the spot market and is incentivized to maximize market prices.

In addition to the ramp up of Kazakh production, there were other temporary factors impacting the markets. Russia and the US were engaged in the Megatons to Megawatts program, where Russia was dismantling part of its nuclear arsenal, down blending the highly-enriched uranium, and selling it to the US. This program ended in 2013. Another factor that has been an overhang in the market is a phenomenon known as underfeeding. Centrifuges are used to enrich uranium, or increase the content from .7% to 3-5% uranium. Centrifuges are constantly spinning. When there is lack of demand from utilities, centrifuges are incentivized to “make more of less” given their fixed cost structure. In other words, they can make more usable fuel from less uranium. Industry experts claim that supply from underfeeding will decrease from 11% of supply to as low as 2% beginning in 2021.

Following Fukashima utilities became spoiled. There was a lot of material available in the marketplace so they did not need to buy for the long term. The largest suppliers in the market, Cameco and Kazatomprom are intent on entering into long-term contracts at prices substantially higher than spot prices today. Buyers look at the spot price and are reluctant to enter into contracts at prices 50-100%  higher. We are at a point where the majority of long-term contracts have expired from 2025 onwards and need to be renewed at least a couple of years in advance. Utilities are suffering from a recency bias and when they begin to contract over the next couple of years, they will be surprised.  

The supply picture for uranium is really challenging. In 2028, Cameco’s Cigar Lake, which produces 13% of global uranium, will be depleted. According to UxC, the deficit will be approaching 100 million lbs by 2035. As the Cameco CEO said on their recent earnings call, the world will need six new Cigar Lakes by the middle of the next decade. Bringing on a new uranium mine is extremely difficult to find the pounds and permit and commission the mine.  It takes more than 10 years in the developed world. Marginal assets have been mothballed and require north of $45-60 per lb. to come back online. 

There are a handful of skanky junior mining companies which will probably all work over the next 5 years. I don't understand why anyone would waste their time when you can buy the largest producer with the lowest costs and a debt free balance sheet. Assuming uranium prices appreciate to $60/lb, the company will generate $6.40 in free cash flow. The company has pledged to pay out greater than 75% of its free cash flow as a dividend. Assuming the company pays out 75% of this and trades at a 5% dividend yield, the stock would appreciate to $96 per share.

Catalyst

Sprott Asset Management took over management of Uranium Participation Corp. This will help the uranium market achieve price discovery much quicker than it would otherwise. Sprott will purchase all excess inventory until the uranium price starts to respond. The company will issue $300 million of equity to buy uranium in the open market.