The Bullish Case For Uranium

Deck: 

Higher prices to come?

Fortnightly Magazine - December 2010

One of the main features of the uranium market historically has been a fairly low price. Mining and extracting companies, processors and utility operators could build their business models with a reasonable degree of confidence that prices would be in the $20 to $40 range year in and year out. However, a quantum change in the uranium market has begun, and for the foreseeable future, the prospects of rising prices will affect market participants—some to a great degree, some only marginally.

Uranium Supply

As we all learned in Economics 101, price is a function of supply and demand. An examination of these two factors in the market for uranium illustrates that the price in coming years is quite likely to rise.

Looking at potential supply in the ground, uranium is considered ubiquitous. Scientific consensus puts its natural occurrence at about 2 to 4 parts per million, making it more common than tin or silver.1

The quality of the mines (i.e., grade) and the geological type of formation are more of an economic issue than anything else. At $10 a pound, there are fewer profitable, quality mines than there are when uranium is priced at $45 a pound. At the same time, discovery costs stand at $4 to $5 per pound, and they are rising because the easy uranium has been found already. This will weigh on supply.2

In the post-Cold War era, an additional source of nuclear fuel has come from the destruction of nuclear weapons. The United States and Russia in 1993 established a 20-year agreement that created the regime for beating these nuclear swords into plowshares. Highly enriched uranium (HEU) for bombs is 90 percent or so U-235. Blending that down to 5 percent to make low-enriched uranium (LEU) results in the raw material for fuel rods. Overall, the blending down of 500 tons of Russian weapons HEU will give the industry about 25,000 tons of LEU over 20 years. This is equivalent to about 225,000 tons of natural uranium, slightly less than 3 years of global uranium demand.3

Despite this substantial quantity of fuel, the release of diluted military uranium to nuclear utilities hasn’t disrupted prices and likely won’t in the future. In fact, prices rose appreciably during the 2004 through 2007 time period, and probably would have risen more if this material hadn’t been available to the commercial nuclear fuel market . When this source runs out, tighter supply might pressure prices upward.4

Uranium Demand

Prior to the discovery of its radioactive properties in 1896 by Antoine Becquerel, uranium’s main use was in ceramic glazes, creating a yellowish hue in glass and pottery. Following World War II, uranium had two uses, both of which relied on its fissile nature. The first, obviously, was weaponry. The second was its use in nuclear power plants, the first of which was the EBR-I experimental station near Arco, Idaho, which initially produced about 100 kW and which started operations on December 20, 1951.

Since then, nuclear power has grown dramatically. As of June 30, 2010, about 372 GW of installed electric net capacity is operating at 438 nuclear power plants in 30 countries. Of these, the overwhelming majority are 20 years old or more. A further 61 plants in 16 countries are under construction that will add 59 GW of net nuclear capacity.

From 1951 to the end 2009, the world’s total nuclear electricity production is 64,600 billion kWh. By June 2010, the industry had logged 14,092 years of the cumulative operating experience. Current usage is about 80,000 tons of uranium per year.5

Since the initial nuclear reactors that were designed to produce electricity came on line, uranium prices have been largely stable, usually below $20 a pound, with two exceptions. The first uranium spike came in the wake of the 1973 oil embargo, when all energy resources saw an increase in price. Adjusted for inflation, this was the highest price uranium ever reached. Then, from 1976 to 1980, the price was level, although historically high at slightly more than $40 a pound in nominal dollars. From 1980 to 2004, the price dropped back to the $10 to $20 per pound range and remained there until 2004.

Starting in 2005, uranium prices began increasing as supply concerns arose (see Figure 1). Very few new mines had been developed and brought into production because of the persistently low price. Then, oil took off for $140 a barrel, and like 1973 through 1976, other energy sources followed suit.

Adding to the pressure from the oil complex, the Cigar Lake flood disaster pushed the market into excessive exuberance. Cameco, the largest uranium producer in the world, had the Cigar Lake mine targeted for production in 2007, and it was supposed to change everything, adding 18 percent to global uranium production. With the price of uranium at $60 a pound, that extra 18 percent would’ve brought prices back down, and in the meanwhile, Cameco was going to make billions.6

However, that’s not what happened. In 2006, a retaining wall in the mine collapsed and a flood ensued. Cameco announced that not a single ounce of uranium would come out of the mine for at least five years. As the summer wore on, uranium prices eventually hit $138 a pound in mid-2007.

When oil prices declined, and as the first liquidity issues from the subprime lending market hit Wall Street, the bubble in uranium finally burst. The price is now around $60 a pound, up 50 percent from the March 2010 low of $40, and the question is what happens next? Will the price continue to move? How fast and for how long?

The market appears to be biased toward higher prices, but the timing of the move is far less certain because the knowledge is dated regarding deposits and technology, and permitting regulations have gotten tougher. There has been no broad development for the last 25 years, so updating and renewing that information is vital.

Uranium exploration comprises many different activities, technologies and procedures, and the developments in mining over the last generation leave a great many areas of uncertainty. Moreover, the speed of research and exploration will be a function of price; the higher the price, the more spending will happen, thereby accelerating the process.7

That said, market analysts have made some forecasts about supply, demand and future prices that appear to hold water. For example, RBC Capital Markets reports: “We foresee uranium demand growing by an average of 4.2 percent per year during the next 20 years, in line with our previous forecast, but weighted to the 2018-2025 timeframe.”

At the same time the same analysts say, “We forecast the supply of uranium to grow by an average of 3.9 percent annually until 2015, but falling thereafter as reserves are exhausted. The uranium bull market of 2006 and 2007 stimulated the development of new supply, but we do not think it is enough. In our opinion, the prevailing uranium price is too low to stimulate sufficient supply to cover future reactor requirements… [T]here is not enough uranium production, either current or planned, to satisfy reactor needs, initial core requirements and inventories.”8

What’s driving this assessment? Four factors enter into it. First, the Cold War stockpiles are continuing to be drawn down. Second, China is embarking on a massive nuclear plant drive, with India moving in the same direction. Also, American politics have changed so that nuclear is enjoying greater support. And finally, financial markets are taking notice of uranium as a commodity.

Thus far, China’s economic development has been fueled largely by coal and oil. However, China is building 24 nuclear reactors right now and plans to have 200 GW of installed nuclear capacity by 2030.9 Furthermore, China recently announced an increase to the 2020 nuclear capacity target from 70 GW to 112 GW. Clearly, the ramp-up is accelerating and all expectations point to upward revisions of future growth targets beyond 2020. The reason for this nuclear drive is quite simple. Coal can’t keep pace with China’s growth and the energy demands of its growing middle class. This summer the Tibet-Beijing Expressway experienced traffic jams that lasted days; many of the stuck vehicles were hauling coal from the Himalayas to the coast.

While it hasn’t yet announced a program as ambitious as China’s, India’s 1.1 billion people also are consuming more energy. Nuclear power supplied 2.5 percent of India’s electricity in 2007, and this will increase as imported uranium becomes available and new plants come on line. The target is a 25 percent nuclear contribution by 2030, nearly 10 times the 2002 percentage.10

Another significant factor in the increase in demand is the likelihood of new U.S. plants being built in the next decade or two, stemming from a shift in the political landscape. From the 1970s through the 1990s, the Democratic Party was strongly anti-nuclear. However, global warming has caused a re-assessment of nuclear power’s value, given that it produces no greenhouse gases.11

The Obama Administration has earmarked approximately $54 billion for federal loan guarantees for new nuclear reactors. And it has granted the first $8 billion in loan guarantees to Southern Company for the construction of two reactors in Georgia.

Traditionally, investors could only really invest in uranium by buying or shorting mining stocks. Unlike other industrial metals, such as copper or nickel, the uranium exchange-traded futures market is relatively new and not especially successful. Some 85 percent of all uranium is sold under long-term, multi-year contracts, with deliveries starting one to three years after signing. These contracts range from two to 10 years duration, with most running three to five years.

The uranium landscape might be changing however. Uranium exchange traded funds (ETFs) have hit the financial press. These would allow retail investors to get in on the action as never before. More significantly, media reports suggested that Goldman Sachs’ purchase of the commodity trading side of Constellation Energy Group, part of which were uranium stockpiles, signaled increasing interest in the metal as an investment vehicle. And Deutsche Bank also continues to monitor and participate in the physical uranium market, as do hedge funds that choose to remain anonymous.

Goldman’s interest raises the issue of speculation. Speculation represents a two-edged sword in the market. On the one hand, speculators add liquidity, but at the same time, they can increase volatility and, by definition, increase demand. Every financial bubble since the Dutch tulip fiasco was the result of speculators overextending themselves.

A further source of heightened demand might be uprating—the process of increasing the licensed power level of a commercial nuclear power plant. One way of increasing the thermal output from a reactor is to increase the amount of fissile material in use. The NRC says, “As of January 2008, the NRC has approved 116 uprates, resulting in a gain of approximately 15,600 MWt (megawatts thermal) or 5,200 MWe (megawatts electric) at existing plants… Collectively, these uprates have added generating capacity at existing plants that is equivalent to more than five new reactors.”12 In a world of increasing demand for electricity, uprating likely might become more common, boosting demand.

Market Effects

Having established that the price will trend higher as time goes on, the discussion now turns to the effects this new pricing environment will have on each class of market participant: mining and extracting firms, processors, utilities and substantial numbers of investors and speculators.

As a general proposition, higher prices are good for mining and extracting firms in the near and medium term. Revenues from existing operations rise, deposits that were uneconomic at a low price can become viable at a higher price, and more cash coming in means a greater ability to explore new locations. In the longer-term, price increases bring more competition as new parties enter the market in search of profits. However because it takes years to bring a new mine into production, higher prices seem unlikely to increase competition greatly for years to come.

Uranium processors occupy a position similar to that of oil refineries in the petroleum business. They process the ore into usable nuclear fuel. Like oil refineries, higher prices force them to pay more for their inputs, but they can also charge more for the finished product. If the oil precedent holds, higher prices should mean more money for processors at the end of the day.

Interestingly, higher prices will have minimal impact on operators of nuclear power plants. The cost of fuel in a nuclear plant is almost a rounding error compared to the other costs—such as initial capital expenditures and ongoing O&M costs. Indeed, this insensitivity to fuel prices is one of the factors that makes nuclear power generation so attractive.

Finally, speculators and investors are often attracted to markets where prices are rising, and with the expected upward trend in uranium prices, their market participation can be expected to increase.

 

Endnotes:

1. “Uranium,” The McGraw-Hill Science and Technology Encyclopedia (5th ed.), McGraw-Hill.

2. International Atomic Energy Agency, Uranium Production Cycle.

3. World Nuclear Association, Military Warheads as a Source of Nuclear Fuel, October 200.

4. European Nuclear Society, Nuclear Power Plants, World Wide, 2010.

5. World Nuclear Association, Supply of Uranium, Updated August 2010.

6. Andrew Mickey, “Uranium Has Bottomed: Two Uranium Bulls to Jump on Now,” Uraniumseek.com, August 22, 2008.

7. International Atomic Energy Agency, Uranium Production Cycle.

8. Adam Schatzker, RBC Capital Markets, “Metal Prospects,” Uranium Market Outlook—Third Quarter 2010, p.1.

9. World Nuclear Association, China’s Nuclear Fuel Cycle, Updated 1 September 2010.

10. World Nuclear Association, Nuclear Power in India, Updated 6 September 2010.

11. US Energy Information Administration, Nuclear Power and the Environment, 2010.

12. US Nuclear Regulatoy Commission, “Power Uprates for Nuclear Plants.” February 16, 2010.