Description

Nobody cares about uranium right now, but before long I think people will care a whole lot.  In the meantime, you can buy yellowcake in-a-can near cash cost of ~$40/lb.  In a year or two a wave of new reactor construction in Asia should start to boost demand and push the market back into deficit.  You don't need any new reactors in the U.S. or the E.U. for this to happen.  Meanwhile, the uranium market remains tight and prone to disruptions that could send prices higher at any time.  I'm hoping for 60% upside based on $75/lb uranium.

I'm recommend buying uranium via Uranium Participation Corp.  Check out the writeup by yarak775 from Dec. '08, as well as the one by tyler939 on Nufcor, a similar name that UPC just acquired at a discount to NAV.  UPC just hoards yellowcake (U3O8) and slightly more refined yellowcake (UF6).  Expenses are largely covered by income from loaning some of the uranium out to the market.  It's pretty simple.  In good times it has traded north of 40% over NAV, in bad times as much as 20% below.  Maybe you get lucky and they issue more shares at a premium.

It's sort of strange that this commodity should be trading at cash cost, since:

• demand is growing
• global inventory coverage is near all-time lows (excluding surplus gov't inventory, market was in deficit until 2009/10)
• supply is tight and has a history of disruptions
• it's only a small (<10% now) portion of nuclear energy's total cost (i.e. buyers can/will pay a lot more)
• incremental capacity is needed, and it's unclear how much of this will get built at current prices

To explain, let me first note that uranium is only trading at cost (~$40/lb) in the spot market.  Roughly 85% of end-user demand is sold in what's known as the term market, where prices are higher.  Since nuclear is baseload (always-on) power, future needs are highly predictable well into the future.  Thus, utilities normally enter term contracts for deliveries many years into the future.  These usually specify floor prices with upside tied to future market prices.  The lowest floor prices in contracts being signed today are at $60/lb. 

Historically, spot prices have been much closer to the floors in term contracts.  Today's wide spread has been seen before on a handful of occasions when near-term supply has surprised to the upside.  In the late '90s, some supply from the Megatons-to-Megawatts (M2M) program hit the market earlier than expected.  Shortly after that, USEC dumped some unexpectedly large inventories.  But once that was absorbed, spot returned to levels much closer to term - historically within a couple years.

Today it's similar, except that now the "surprise" is coming from new mines.  A quick history:  this market was in deficit for decades as it worked off excess inventories that arose due to factors no longer present today.  Meanwhile, demand grew steadily, and by the early 2000's the world's miners could no longer rely on existing mines to meet demand just a couple years hence.  Upon hearing this, many utilities balked.  After 20 years of sliding prices I guess they just couldn't believe it.  But the miners weren't bluffing.  Supply suffered a series of setbacks over 2003 - 2008 as aging infrastructure struggled to keep pace with demand.   Having refused to renew their term coverage, they were now heavily exposed to these supply shocks.  The ensuing panic sent prices into the stratosphere.

Determined to lower their exposure, utilities signed term deals for pretty much every pound they could get, right up through the spring of 2007.  So for the past few years nearly all their requirements have been covered - no need to worry about spot prices.  (Of course, this security came at a steep price:  floor prices went as high as $95/lb.)

2009 was the first year in a long time that we didn't see any major setbacks in supply growth.  I'm calling that a surprise, given how setbacks had almost become the norm.  This rising supply coupled with hefty term coverage has left utilities in no rush to buy.

But term coverage starts to loosen up in 2011.  More importantly, M2M comes to an end in 2013, which means the largest single source of supply will disappear.  Meanwhile, there's a wave of new reactor construction in Asia, the brunt of which will start to come online in 2014.   The initial fuel loads (aka initial cores) for these will require about 50% more yellowcake than reloads, so 18 - 36 months of fuel, assuming reload cycles of 1-2 years.  Uranium for initial cores is ordered many years prior to startup.  Assuming a three year average lead-time, the reactors going online in 2014 bulge will boost demand around 2011. 

I think supply will be slow in rising to the challenge for a few reasons.  The first is timing.  The bull market in uranium collapsed before the boom in Asian reactor construction really started to accelerate.  It takes longer to set up a mine than it takes to build a reactor in Asia, so expect supply to lag for a while.  Moreover, the financial crisis has curbed funding for new mines more so than for new reactors.  For example, almost half of new generation capacity through 2016 will come from China, where they already have the cash. 

The second reason is costs.  We know the deposits for which new mine planning is well underway, and given long lead-times these are the only ones likely to produce anything in the next 4+ years.  Given current uranium prices, only so much can be brought online so fast and I think it will fall short of demand for a while.  I forecast a gap starting in 2011 and extending at least through YE2013.  (Applying a 3-year lead time for initial cores to estimated capacity through 2016 = total demand through 2013.)

By the way, forget about new discoveries.  Rossing South is the only big, currently-economic discovery to come out of the 2004-2008 exploration cycle.  While it's a very nice find, I'd say the industry was hoping to find a lot more given the $3.3B spent.  Since then, exploration budgets have largely collapsed.

This gap will have to be filled from inventory.  I'm not predicting a bull market like the last one since utilities will likely have better term coverage this time around.  But it could be substantial, since the inventory available will be much smaller.  As I said, M2M ends 2013 and supply from military inventories will slow to a trickle.  Moreover, civilian inventories were shrinking up until sometime last year. 

The Asian utilities see all this and are preparing by investing directly in miners, new mines and getting off-take agreements.  China entered the spot market in a big way last year and also bought quite a lot last January.  But so far this has been offset by a lack of activity from Western utilities.  While I can only speculate as to why, I think the quotes below shed some insight:

    "Another analyst noted that in normal commodity markets, buyers purchase small lots as the price is falling - and still get a lower average price - rather than waiting until it hits bottom. But in the uranium market, he said, buyers wait for the 'inflection point,' meaning the point when the price changes direction and they're sure it won't go any lower. Then all the buyers come in at the same time, pushing the price up, he said."  Nuclear Fuel  3/9/09

    "While 2009 was a relatively active year for term contracting, a substantial number of utilities, particularly in the USA, continue to wait in hopes of catching the market at the absolute bottom before securing supplies for the longer term,"  TradeTech 1/7/10 

    "While many have the budget if they wanted to approach the market, 'Who wants to buy today if its going to be two bucks cheaper in a couple of weeks?' asked one [U.S.] utility buyer."  Uranium Intelligence Weekly  2/1/10

    "Old time uranium traders often claimed utilities would jump to buy 'like a flock of sheep following the first sheep out of the gate'  ... [they] will chase supplies if they think others making purchases are on to something (e.g. production cutbacks)"  http://www.uraniumseek.com/news/UraniumSeek/1250193204.php

So it sounds to me like a big herd where everyone tries to do what everyone else is doing.  Buyers are complacent until they aren't, then they all rush in to buy at the same time (sounds like a lot of money managers, doesn't it?). 


How low could it go?
My guess is not much below marginal cost of $40/lb.  2009 saw a number of projects in the U.S. put on standby, and closures will likely continue if spot goes lower.  Still in production are Areva's mines in Niger (6.2% of primary supply), which I estimate to have cash costs of about $40/lb.  These mines are old enough to sell into the term market, and that keeps them running for now.  New mines usually must sell at spot until proving their abilities.   By the way, note that "cash cost" typically excludes royalties and ongoing capex.  Counting that stuff, I get costs of $41/lb for Rio Tinto's Rossing mine (7% of primary supply), $30-40 for Cameco's McArthur River mine (15%), and $33/lb for ARMZ's Priargunsky mine (6%).  Point is, lots of big mines have costs close to this spot price, so just think how many small ones do too.  

Moreover, current prices are pushing back plans for new mines.  Just last week, Areva announced that it was pushing back its giant Imouaren mine by 1-2 years.  Likewise, it appears prices have helped to delay Quasar's Four Mile mine by one year.  Frankly, these are only two of a long list that won't go forward at current prices, but I think their owners are keeping quiet so as not to spook the capital markets.

But in the short-run anything is possible.  Have-to sellers can always push prices into the $30s if they're desperate enough.  That could come from new mines as they sell their first production.  It could also come from hedge funds in distress for whatever reason.  Right now the consensus seems to be for continued weakness through 2010.


How high could it go?
Tough to say.  I think term prices need to get up around $75/lb in a few years so as to offer an IRR of ~15% on the new mines we'll need.  (Not that I'd fund a new mine in the Congo for 15%, but hopefully someone will.)  This translates into about 60% upside on UPC assuming no increase in premium to NAV.  History suggests, however, that spot uranium prices will overshoot fundamentals, and that UPC will trade at a frothy premium to this frothy new NAV.  (But history also suggests that I'll sell way too soon.)

Estimating demand:
We know plans for shutdowns and uprates (increases in capacity at existing plants).  Supply is a little bit trickier, but I think you can look to a number of reasonable estimates to support the conclusion that today's market surplus is likely to be short-lived.

If we know capacity we can estimate demand, and the outlook for capacity is fairly clear through 2016.  Plans for shutdowns and uprates (increases in capacity at existing plants) are announced well in advance.  We probably know the high-end for new construction, since newly-announced plans now seem to target start dates in 2017+. 

My forecast uses the latest start dates I've seen published for each reactor.  Of the 106 GWe I see coming online by YE2016, 56 are already under construction.  Believe it or not, I don't expect many start-dates to slip beyond this timeframe.  While delays and cost overruns have historically been common in the U.S. and E.U., they have only 3 reactors totaling 4.4 GWe under construction the U.S. and the E.U. today.  The only recent major delays I've read about concern the E.U. (building two of the world's first Generation III reactors - first-of-a-kind construction is always tough) and Russia (financial crisis has delayed new build program).

The situation in Asia is very different.  For example, in China, Japan, and South Korea, construction times have been 4-5 years versus roughly 7-10 in the West.  Costs have been around $2,000/KWe versus ... well, let's just say $7,000/KWe is not out of the question.  This also explains why I'm including the other 51 GWe of planned reactors that have not yet begun construction.  Of these, 40 GWe are from China, Japan and South Korea.  None are from the U.S. and E.U.

Yes, delays could lower my estimates.  Demand could surprise to the upside as well: China, India and the Ukraine all want to build strategic fuel reserves and none of that is in my model.

Generation capacity (GWe): (new/restarts, decommissioned, uprates, YE total)

2000 3.2 (0.5) 0.2 351
2001 2.7 (1.1) 1.1 353
2002 5.0 (1.0) 0.4 358
2003 1.6 (1.4) 2.0 360
2004 4.8 (1.2) 1.2 365
2005 3.8 (0.9) 0.6 368
2006 1.5 (2.2) 2.3 370
2007 1.8 - 0.3 372
2008 - (0.4) 0.2 372
2009 1.1 (1.6) 0.5 371
2010 7.1 (1.4) 1.9 379
2011 9.1 (0.0) 1.6 390
2012 11.9 (0.7) 1.6 402
2013 12.9 (3.2) 2.0 414
2014 22.0 (3.4) 1.1 434
2015 20.0 (2.9) 1.1 452

The U.S. and E.U. have mostly added to future demand by extending the lifespans of existing plant.  In the U.S. all but a handful of our 104 operating reactors will likely be approved for 20 year extensions to the original 40 year planned lives.  In Europe it's similar.  Also, a number of Western European countries have reversed previous plans to phase out nuclear power.

I adjust my capacity numbers for downtime (for reloading fuel, repairs, etc.) and multiply by the average uranium requirement per GWe to arrive at final demand numbers.  To be conservative, I've assumed that anyone planning to start a new reactor prior to 2013 already has uranium for the initial core(s).

Yellowcake demand (M lbs): (initial cores, reloads, total)

2000 2 166 168
2001 6 168 174
2002 5 179 184
2003 2 179 180
2004 2 166 168
2005 0 178 178
2006 1 172 173
2007 9 169 178
2008 0 168 168
2009 4 168 172
2010 17 178 194
2011 28 190 218
2012 26 194 220
2013 27 199 226

Estimating supply:
Supply comes from both mining (primary) and recycling (secondary).  Let's look at secondary:  most of this comes from M2M, which explains why the numbers drop off after 2013.  I doubt the markets will see much more supply from military uranium, aside from the small amounts already planned and in my forecast.  M2M has been a great success, but the environment that got Russia to do it no longer exists.  The U.S. has tried and tried to get Russia to convert more warheads into fuel, but the answer is always no.

Rest of secondary is various forms of recycling (MOX, reprocessed uranium, enriched tails) which are generally more expensive than primary supply.  This is done largely to reduce nuclear waste and the political battles over its disposal - not to save money.  Moreover, growing this supply requires significant investments in new infrastructure.

As for primary supply, I've tried to be as generous as reasonably possible to each mine.  Note that this assumes today's prices throughout the forecast period.  The first question you should ask when looking at anyone's production forecast is "what prices are assumed?"  Miners love to talk up their own outlooks, but when you look hard at the costs you'll find that a lot of projects are just not viable at today's prices.  In my opinion, that includes giant projects such as Imouaren in Niger and Elkon in Russia.  It also includes a lot of talked-about projects in Namibia and Australia, as well as just about anything in Canada not named "Cigar Lake."  Finally, some upcoming projects in Kazakhstan are a bit out-of-the-money, but I've kept them in just to be conservative.

As far as I know, my numbers are pretty close to the latest forecasts from the likes of UxC, Energy Resources International, WNA, Credit Suisse and Deutche Bank.  Usually I'm a bit higher, although the WNA is a bit higher than me over the next several years.

Supply, etc. (M lbs): (primary, secondary, (deficit)/surplus)

2000 91 58 -18
2001 93 52 -28
2002 94 55 -34
2003 93 48 -39
2004 105 45 -19
2005 109 49 -21
2006 104 53 -17
2007 108 47 -23
2008 114 47 -7
2009 127 47 2
2010 139 45 -11
2011 147 38 -33
2012 161 37 -22
2013 171 35 -20

Inventories:
Today, Western utilities hold about 1.5 years worth of forward requirements, while their Asian counterparts hold about 3 years worth.  That might sound like a lot, but consider that the process of turning yellowcake into usable fuel can take more than a year, and initial cores can take even longer.  Thus, much of those amounts are permanently tied up in the pipeline.  Coverage at U.S. utilities is up from an all time low of 0.7 years in 2003, wheras the E.U. hit a similar low around 2004.  This improvement was only possible because suppliers (miners, converters, enrichers, and fabricators) sold most of their excess inventory at high prices during the last bull market 2004-2008, and some of that has been used already.  Thus, global inventories are basically at all-time lows.  My model assumes that utilities will simply buy what the mines produce and let their inventories run down, bringing the U.S. and E.U. back to their all-time lows within 4 years. 

I don't really believe in that scenario, of course.  I'm just trying to show that we're likely to see demand above my forecast as Western utilities try to defend their inventory coverage.   Industry experts were sounding alarm bells back in 2003/2004.  It's highly unlikely they'll get even close to those levels.  I think the only reason they ever did was the extraordinary market psychology that arose from 20+ years of falling prices.  Buyers today might be relaxed, but they're not that relaxed.   

Also, it's not just average coverage levels that matter.  The variance matters too.  As one buyer said recently, "There are a couple of people walking the tightrope.  If you're that guy, you're screwed."  Uranium Intelligence Weekly  10/26/09


Bad news as a catalyst:
Almost half of mine production from the largest six mines, meaning that a single disruption can have a large impact on supply.  Canada's McArthur River is an underground mine with a unique geology that is at constant risk of flooding.  The last flood in 2003 halted production for 3 months - a relatively short delay, but scary nonetheless as McArthur is the world's largest mine at nearly 15% of primary supply.  Beginning last year, most of McArthur production started coming from a new zone that is more challenging than anything mined before.  Canada's Cigar Lake has a similar, but even more difficult geology that will require a new mining technique (boxhole boring) that has never been used in large-scale production.  The mine was originally to enter production in 2006, but it flooded in that year, and flooded again in 2008.  This really caused a panic, as the market was counting on Cigar Lake to reach production levels nearly as high as McArthur.  Cameco (the operator) is now targeting a 2013 startup, and my model says 2014.  But frankly, no one really knows since Cameco couldn't start assessing the damage until recently.  There's also Ranger, an open-pit mine in Australia's Northern Territory (10% of primary supply) that was temporarily flooded due to tropical storms in 2007, and Olympic Dam in South Australia (normally 6-7% of primary) that halted 75% of its production due to an accident in a mine shaft last fall. 

Supply could also be delayed further downstream.  After leaving mines as yellowcake, uranium goes through conversion, enrichment, and finally fabrication before being loaded into reactors.  Of these, the conversion and enrichment markets are both very tight, meaning that any disruption could delay supply there as well.  Two conversion facilities were temporarily shut in 2003 and 2004 - the first due to fire, the second due to a strike.  Disruptions in the pipeline cause utilities to want more finished-product inventory, which boosts demand for yellowcake since many of them don't have much of that either.

Political risk is significant.  In Kazakhstan (28% of primary supply), the government recently declared that the deals through which many foreigners had entered mining ventures were illegal.  In Niger (6% of primary supply), the president recently dissolved the parliament, and was later ousted by a coup.  In Western Australia, a recent election overturned the previous ban on uranium mining, and my model includes a lot of production coming online from this region.  But future elections could re-establish the ban before these new mines get going.  In fact, that's exactly what happened in 1983 and 2002 - involving the very same deposits as today.

Western Australia primary supply (M lbs):
2011 0.0
2012 0.4
2013 1.8
2014 4.5
2015 6.9

Risks to my forecast:
My biggest worry is underestimating supply growth from new mines. New reactors could be delayed. Another
accident (e.g. Chernobyl) would obviously hurt demand. Finally, there's the technological risk that someone
invents a cheap way to store large amounts of electricity, meaning solar and wind could provide baseload
power. I don't, however, see much tech risk from within the nuclear industry. There are plenty of ideas that
could greatly lower the need for uranium (e.g. fast breeder reactors, thorium-powered reactors), but none of
these are likely to be commercial for decades.

Catalyst

Demand from new reactors in Asia tightens market, putting the fear-of-God back into the hearts of uranium buyers at Western utilities.  (But it might not happen this year!)

Murphy's Law continues to hold as per the mining industry, resulting supply shocks have similar effect on buyers