Uranium going Nuclear: The Uranium Bull Thesis
Introduction
Nuclear power, and therefore uranium, generates approximately 10% of the world’s electricity. Yet the combined market cap of the entire uranium sector is a mere $25 billion. To put that into context, $AMC, a dying cinema company in a dying industry has a market cap of over $30 billion. Not only is the uranium sector’s market cap laughable compared to that of a cinema company, but it’s also staggeringly lower than it was only a decade ago. According to ‘Cambridge House’, in 2011 when the uranium price was nowhere near all-time highs the sectors market cap was still upwards of $150 billion, 6 times higher than it is today.
I believe that due to a structural supply deficit caused by historic underproduction and rising demand, the uranium market is wildly undervalued and offers the most asymmetric investment opportunity available in the market today.
Background
Unsurprisingly, creating nuclear energy isn’t as easy as taking a yellow rock from the ground and throwing it into a reactor. In fact, uranium, despite being nicknamed ‘Yellowcake’, isn’t even yellow anymore. Nowadays it’s more of a dark brown or black but those nicknames are far less enticing. Uranium can’t just be pulled straight from the ground and shipped to a reactor. Instead, uranium ore is mined, milled into Yellowcake and then undergoes a half-dozen further processes before being usable in a reactor. For the purpose of this analysis, and uranium investing in general, the uranium we refer to is U3O8/YellowCake and is created by milling mined uranium iron ore.
For all extensive purposes, uranium is solely used by utility companies. They need it to power their nuclear reactors. Hence, the demand for uranium is inelastic in that the utilities are going to buy it no matter the cost. They simply cannot decide it’s too expensive and shut down the reactor until uranium has a Black Friday sale. Obviously, utilities know this and therefore they sign contracts for years worth of uranium far in advance guaranteeing their vital supply. These contracts are signed with miners and involve utilities either agreeing to pay a set price for the uranium or paying spot price on each delivery, depending on the contract. Long term contracts make up the source of the majority of uranium with the rest being covered by the secondary supply and utilities individual inventories.
The price of uranium, as with all other commodities, is driven by supply and demand. The price falls when supply is increased or demand is decreased and the price rises as supply dries up or demand grows.
Despite its perhaps scary reputation, uranium is very cheap. The current spot price is slightly above $30 per pound. This hasn’t always been the case though. As the below chart demonstrates, uranium has gone through two massive bull runs in the past. Sparked by fears of the Oil Crisis in 1973, the uranium spot price reached an inflation-adjusted $173 per pound in the mid-’70s as utilities rushed to buy and contract any available current or future inventory. Once the crisis subsided, yellowcake’s price crashed back down to the $20 range where it remained for almost 3 decades. Fueled by floods in two of the worlds largest uranium mines, Cigar Lake and McArthur River, coupled with China strongly promoting nuclear energy the uranium price gained momentum in the early 2000s eventually topping out an inflation-adjusted $160 per pound in 2007. Again, almost as if history repeats itself, the price cratered as the Great Recession hit. Then as the price began to recover the Fukushima Disaster struck and put the final nail in uranium’s short term price prospects.
That doesn’t sound like a particularly efficient market, does it? Well, it’s not. Miners have an all-in cost per pound of uranium which depends on various factors including mines, capital and exploration. So when the price of uranium is low, specifically below a mine’s cost per pound, a lot of mines simply don’t produce uranium. Why would they? By signing a long term contract to supply below their cost basis a miner would be guaranteeing a loss. Instead, mines will cease production until the spot price rises and when it does they will sign contracts for years worth of supply at a profitable price per pound. This results in the huge downward swings we see once uranium prices skyrocket as vast amounts of yellowcake flood the market. Now the reason that the price can even get that high in the first place is that mines can’t simply switch back on the minute they sign a contract, it takes years. Not only does it take years for a mine to resume uranium deliveries, but uranium also isn’t usable in its current form. It must undergo a half dozen of processes which take over a year, in order to be usable in reactors. Therefore there can be, and have been, times where there is immense supply uncertainty in the market causing utilities (and speculators) to buy and contract uranium at any price they can. Think of it as a short squeeze.
The Setup
Until recently, uranium had been in a bear market since the Fukushima disaster in 2011 which caused Japan to close 54 reactors and severely damaged the global sentiment towards nuclear energy. Uranium’s spot price bottomed out at $18 in 2018 and remained in the low $20 range until the COVID-19 pandemic. This bear market had a huge impact on the industry. Estimates state that there were over 600 uranium mining companies a decade ago, today there are 50. Evidently, the reduction in the number of miners reduces the uranium supply. This is then compounded by the miners who still exist either reducing their production or not producing at all due to uranium’s low price. During this period utilities have been drawing from the secondary supply far more than historically. The secondary supply is made up of uranium which comes from various sources including uranium used for military purposes in the past and reprocessed uranium. For various reasons, the supply had been inflated however the last decade of utilities under contracting has all but dried it up. The International Atomic Energy Agency estimate the secondary supply to only be 22 million pounds which is around 15% of total annual uranium consumption and yet utilities continue to draw from the secondary/spot market more than ever before.
Many long term contracts, the majority of which were signed in the early 2010’s, have already or will be coming to an end soon. With utilities drawing from secondary supply at historic rates and refusing or being unable to sign substantial long term contracts, their contracted volumes are extremely limited as demonstrated by the below chart.
Not only has supply dwindled over the past decade but demand has begun to increase and is projected to do so further. The world’s superpowers are all heavily reliant on nuclear energy. Overall, nuclear power provides about 11% of global electricity output. Worldwide, there are upwards of 450 nuclear reactors while another 50 are under construction. Many reactors lifespans have also been extended with the US and Japan among countries to have extended select reactors lifespans by over 20 years.
The United States get 20% of their electricity from nuclear reactors, the UK gets 15%. China plans to increase their nuclear energy output by 50% in the next 5 years and they aim to have 4 times as much by 2035. India are also pushing for nuclear energy with half a dozen reactors currently under production.
Furthermore, the worldwide move towards clean energy heavily favours nuclear energy. Energy sources traditionally considered ‘green’ simply cannot scale fast enough to cover the gap that fossil fuels will leave. The EU Commission recently endorsed nuclear energy in their drive towards lowering emissions claiming “nuclear energy has near to zero greenhouse gas emissions”. President Biden echoed this rhetoric with his climate advisor stating nuclear energy is essential for emissions goals. Biden further solidified his stance with the release of his budget proposal which features $9.75 billion in credits for ‘electricity generation from nuclear facilities’ alongside a further $5 billion aimed at developing nuclear power. Biden’s predecessor, Donald Trump was also pro-nuclear and passed an act which set aside $75 million for a US uranium reserve which to date has not been filled.
Overall, the number of new reactors is expected to outpace shutdowns, and as a result, the demand for uranium is projected to increase by 1–3% per year in the coming decades.
We’ve established that utilities have very little uranium contracted and the secondary supply of uranium is sitting at the lowest levels since the turn of the millennium. Furthermore, demand is rising and fast. The US, China and other superpowers are making a major push toward nuclear energy to meet emission goals and provide for growing populations and energy consumption. We’ve also seen that uranium demand is inelastic and that utilities will buy uranium no matter the price, especially during times of supply-side risk such as 2007. With the spot price of uranium at $32, no new mines will come online as their all-in cost of production is in the $50 to $60 range. There is, without a doubt, a major structural deficit forming in the uranium market.
So it’s pretty simple, the uranium price must rise. It must rise soon and by a lot. Either utilities will realise this and slowly begin bidding the price up as they sign contracts at profitable prices for currently idle mines or they will be left with a massive deficit which will in effect cause a squeeze on the uranium price as everybody rushes to get their hands on the remaining yellowcake. The below chart illustrates the looming deficit in the uranium market. Note that this chart does not factor in supply decreases due to COVID-19 related mine closures and therefore the deficit is even worse than illustrated.
We see that even with prospective & planned mines, mines under development and restarted mines there is already a production deficit and utilities are burning through their inventories. By 2023 there will be an approximately 10 million pound deficit, which only increases as time passes. Cameco, the worlds second-largest uranium miner, stated in a recent earnings call “given the timelines it takes, we should be investing now to replace that lost production, but at today’s prices, that makes zero sense.” Cameco are referencing the fact that to make up this deficit, the uranium sector needs huge investment in building mines, restarting production and even exploration for new mines. Yet with the price so low, due to utilities under contracting, no sane miner is willing to make that investment without signing contracts at a profitable price point. The longer the utilities refuse to come to the table, the higher the uranium price will eventually overshoot resulting in even higher equity prices which rise (and fall) faster than uranium itself.
Catalysts
If you’ve ever heard of the uranium bull thesis, you’ll know it’s not a new thesis. Industry experts and investors have been calling for and predicting a uranium bull market for the past few years. So why invest now? There have been numerous catalysts over the past year which have pushed the spot price upwards and in turn, the uranium equity market has entered a bull market.
Prior to the COVID-19 pandemic, the uranium spot price had been stuck below $30 since 2016. As the pandemic took hold, supply-side risk caused the spot price to jump with strong uncertainty in the market as mines were forced to close. Cameco’s Cigar Lake which accounts for over a tenth of annual production was closed while the world’s largest producer, Kazatomprom, reduced production by 10 million pounds. Fueled by this, the spot price jumped 40% in March to the mid 30’s. Despite this, the uranium equity market barely moved likely caused by market-wide uncertainty surrounding COVID-19.
Then in early December that all changed as a bullish uranium focused ‘Bear Traps Report’ was sent to institutions, hedge funds and money managers worldwide causing a massive buying pressure of uranium miners’ shares. Due to the tiny market cap of the industry, even relatively small inflows into the equities cause large price increases. This momentum has continued throughout 2021 as uranium equities have hit their highest levels in at least half a decade.
Instead of uranium producers and developers selling uranium into the market, many have actually been buying. This seems counterintuitive but is hugely bullish. Uranium companies are so convinced of the impending bull run, they are going into the market and buying millions of pounds which they know they can sell for far more in the future. In the past 3 months alone Australia’s Boss Resources purchased 1.25 million pounds, Denison Mines purchased 2.5 million pounds, Uranium Energy Corp purchased 2.1 million pounds while Cameco will be buying over 10 million pounds in 2021 to fulfil their contracts rather than produce it themselves at current low prices. This further depletes the secondary supply. Interestingly, many of the above purchases cannot be physically delivered until mid to late 2022 while the Denison Mines purchase took 17 separate purchases to complete indicating the secondary supply and spot market is running incredibly thin.
In late April, Sprott Asset Management announced they would be taking over ‘Uranium Participation’ to form the ‘Sprott Physical Uranium Trust’. This fund will hold physical uranium similar to $PSLV for silver. Despite funds similar to this already existing, notably Yellow Cake PLC and Uranium Participation Corp itself, they are hard to purchase as they trade on foreign exchanges, usually have high premiums and are illiquid. Sprott are a renowned asset management team who plan to list the fund on the NYSE and will provide an accessible and liquid vehicle for investors and funds looking to hold physical uranium. The looming Sprott takeover is one of the most important upcoming catalysts for the uranium market.
As most uranium companies, alongside the sector as a whole, have low market caps any investment from large funds or money managers could trigger sizeable upswings in the equities. This happened prior to the 2007 bull run where hedge funds recognised the opportunity and decided to front-run utilities by buying uranium from the spot market alongside uranium companies. While there has been some institutional investment, notably New York hedge fund Anchorage Capital Group LLC amassing a few million pounds of uranium in the past week according to the WSJ, we only anticipate this to grow as the cycle progresses. These inflows will place strong upward pressure on low volume and market capitalization equities.
In my eyes, the most important upcoming catalyst is utilities returning to the negotiating table. We’ve seen the secondary supply is nearing depletion, utilities have massive needs completely uncovered by their long-term contracts and they are burning through their own inventories. Not to mention utilities can’t just buy uranium and use it immediately, it takes over a year to convert, enrich and fabricate alongside the two years it takes for the first delivery of uranium after a contract is signed. Therefore, utilities are running out of time to begin signing major long term contracts. Once they come to the table, utilities will realize there is insufficient supply and will be obligated to offer miners prices above $50 or $60 to incentivise them to resume production, driving the spot price upwards andvin turn dragging uranium equity prices with it.
Bear Cases
While uranium is one of the, if not the best, opportunities on the market today, it would be imprudent to ignore the various risks or bear cases:
Supply Miscalculations — There is no oracle of truth in the uranium market and so we have no guaranteed way of knowing how much uranium is available on the secondary market or utilities currently have in their inventories. Despite this, we have estimates from organizations who specialise in the uranium and nuclear sector and therefore can expect these to be relatively accurate. In a worst-case scenario where these estimates are way off, I believe that this will only delay the inevitable however this does bring up concerns regarding opportunity cost.
Equities detached from the spot price — Most uranium companies stocks are up at least 50% in the past year with many of the smaller players rising over 100%. In the same period, the uranium spot price hasn’t moved. While there are reasons for this including the sectors low market capitalization and equities not moving while uranium prices jumped 40% during the COVID-19 crash, it is a potential cause for concern and we may see a correction in uranium stocks before the bull market resumes.
Why aren’t utilities contracting? — There’s an argument to be made that if the bull thesis is so
obvious why haven’t individual utility companies started signing long term contracts at current prices before they inevitably rise. Initially, this was my biggest qualm with the thesis. Utility purchasers are professionals and simply assuming they’re ignorant to the very industry they operate in isn’t smart. However, numerous facts disprove this argument. Utilities are still able to draw from their inventories, purchase from the spot market and use their, albeit ending, long term contracted supply for or at below current prices. If they want to sign a long term contract, there simply aren’t any producers or developers willing to sell or contract below $50 or $60 per pound so the utilities are delaying the inevitable in the hope the market slows. Furthermore, purchasing U3O8 is only a tiny fraction (4–6%) of the cost of producing nuclear energy and in such utilities can afford to pay higher prices if and when it becomes necessary. Finally, utilities have been caught out before. In both the 70’s and 2007 utilities left themselves vulnerable to supply and demand risks and paid the price as the spot price skyrocketed. I have personally heard anecdotes of utility purchasers claiming there is not and will not be a supply shortage which are reminiscent of several scenes from ‘The Big Short’.
Black Swan event — No matter what, nuclear energy is nuclear energy. The risks that come with investing in an industry responsible for events such as Chernobyl and the Fukushima Disaster should not be understated. A disaster of those proportions would almost certainly destroy the uranium market. Nonetheless, the industry is safer than ever following massive investment in safety in the decade since the Fukushima disaster. Just today, there were reports of a performance issue at a Chinese nuclear reactor which, despite being overblown, caused the uranium sector to correct over 5%. This incident will not affect the long term thesis however a real disaster unconditionally would. In my opinion, a nuclear catastrophe is the only real threat to the thesis.
Conclusion
At its core, the uranium thesis is simple. Uranium supply is rapidly diminishing through reduced production and depleting secondary supply while inelastic demand is growing annually. These factors have created a structural deficit in the uranium market and the uranium price must at least double to incentivise miners to resume production to satisfy future demand. The longer it takes for this to happen, the higher the price will eventually overshoot.
The uranium market’s structural supply deficit combined with a historically minuscule sector market capitalization presents one of the most asymmetric investment long term opportunities in the market.
Although I believe most if not all uranium equities will outperform the market in the coming years, diversification is key in a volatile and risky industry. The North Shore Global Uranium Mining ETF ($URNM), is a pure uranium play holding solely producers, developers, explorers and physical uranium funds. $URNM currently trades at $66.52 and provides ample exposure and diversification to those looking to take advantage of one of the asymmetric risk-return opportunities in today’s market.
To conclude with a quote from Mike Alkins of Sachem Cove Partners;
“There’s nothing to wonder day to day. Do the math, the math is the math. Go and understand the historical context of this and put it in context of where today is. Stop trying to guess every day; ‘oh, the spot price has moved a nickel today, a dime…’. Who gives a shit, it doesn’t matter. The horse has left the barn. There’s not enough supply, utilities are going to get run over.”
