- After the Fukushima accident in 2011, the world started to resent nuclear energy once more. The whole industry experienced a near-death situation and finds itself at 10-year lows.
- Now, the global situation shows us a nice opportunity. Japan will have to restart at least some of its idle reactors, as it understands the economic need for the reactors.
- A number of obstacles were encountered, but none of them changed the resolute stance of the Japanese government, and we could see the global demand for uranium increase in 2014/15.
- Ur-Energy is the top pick in the junior section, and will provide sufficient exposure to the boom in the markets after the gap between supply and demand increases further.
- The downside is limited almost only to Japan, as it will act as a psychological catalyst for the renaissance, which will happen sooner or later. The spot price creates a self-reinforcing process.
History is the main catalyst for my interest
After the unfortunate accident at the Fukushima-Daiichi plant in the year 2011, the whole world started to resent nuclear power again. This led to the closure of every reactor in Japan, and consequently, the ones in Germany as well. This set of events was, of course, followed by a huge sell-off in the commodity. The downturn was exacerbated, as it saw radical gains pre-Fukushima. In the chart below, we can see that the peak is around $72 per pound of U3O8, uranium oxide, or in other words, the pure commodity which is sold to the reactors.
The black line shows the date of the aforementioned Fukushima, and the green and red lines are acting as support and resistance, respectively. As of now, uranium is selling at a distressed price of $31 per pound, down almost 57% from three years ago. But recently, the spot price saw some positive action, which could signal a subtle wind of change in the perception of the uranium market.
Now the decline of U3O8 is, of course, driven by the closure of reactors in Japan (around 12% of the global demand), which distorted the supply-demand relationship, but definitely more psychologically than physically. The whole market now sits on lows seen back in 2005, and with little volume, it can be revived quickly when Japan restarts its reactors.
Near-term condition for the market renaissance
We need to understand that the psychological impact of Japan is crucial, and in order to transform itself, the uranium market needs to restart. Although it may seem like a life or death situation (restart or not), the reality is not that bleak at all.
With almost a third of their electricity supply gone, Japan had to resort to more expensive fossil fuels and started to look for alternatives in the long term. But even though it may be feasible to try to diversify Japan's energy supply, they certainly cannot do so now in the near future, and will have to get back to their reactors.
Moreover, the Japanese economy has been trapped in a deadly deflation environment since the 90s, and has yet to recover since. The government which was elected last year certainly took some drastic measures in order to get rid of the deflation, and asserted that it will take as many steps as possible to get the economy on the "right" track.
Mr. Shinzo Abe, the prime minister, set out his three economical arrows and now finds himself in a precarious situation of the transition period, which always turns out to be the most difficult one. People do not see any major improvements, but the tough policies are already underway. The situation was worsened by Fukushima, as the price of energy has risen. There was a need for increased imports of fossil fuels, which hit Japan's trade deficit as well. Therefore, Mr. Abe has to support the restarting of the reactors, as it will ameliorate the situation hardened by his policies.
The logical assumption holds, as Mr. Abe has himself reassured us quite a few times, that nuclear energy is in the essential energy mix for Japan. Important steps were taken to speed up the restart process, such as the foundation of the NRA (Nuclear Regulation Authority), which has been operating under strict rules from last year. The requirements for the restarts are very rigorous. As a result, Japan will have the safest reactors in the whole world, but naturally you cannot predict everything, and that's why public opinion is rather unsupportive.
Lately, we have seen a positive development, as on the 16th of July, the NRA has granted permission to restart the first two reactors (Sendai I and II).
To sum it up, we see that there is an obvious need for the nuclear energy in Japan, and while expecting it to be the same as before Fukushima is a bit of a fantasy (mainly because of the safety requirements - some reactors will have to stay closed), we will certainly see a significant return of Japanese demand on the global U3O8 market in the near future (2H of 2014 and early 2015).
Obstacles in Japanese restarts
Although we have seen significant steps towards the restarts and will probably see few of them as early as October 2014, there are some factors which could hurt the resolute stance of the Japanese government, and thus the restarts.
Firstly, as stated above, the public opinion is not the most supportive of the cause. People are afraid of another disaster and try to point out that the government is led by some kind of nuclear lobby and that the government disregards the majority of the population (you can read loads of public comments on JapanToday, for eg., this one). Although there is a likelihood of potential future protests, they are not likely to change the view of the government, as a lot of them have already happened. While there is a strong opposition, it is certainly not a decisive majority, as the rest of the society supports the restarts due to the fact that it would significantly lower the price of energy. They operate on the same presumption as the government.
A second possible obstacle could be the local governments, which have an unofficial say in the restarts, and most of them are leaning towards the opposition. While this will stall the process, ultimately they cannot do anything about it, as they will be overruled by the government. In the end, the restart of the reactors will fail only if the government policy changes. The aforementioned obstacles will only prolong the process, but not end it.
Bottom line from Japan: The restarts will happen in 2H of 2014 and in the start of 2015, thus reviving the confidence in the U3O8 market and pushing the spot price upward.
Global supply-demand gap and the perspective of nuclear energy
Although Japan can provide a short-term spike in confidence, we need to look at the most important aspect when considering investing in a commodity or a company related to one: the supply and demand relationship. This is what the commodity market always boils down to, no matter what amount of speculation is involved.
As of early 2014, the global market saw a supply-demand gap of almost 8% (demand exceeding supply). The following chart shows us the relationship until 2012.
Mine production has been significantly growing after 2011 (matching demand in 2016, ceteris paribus), but on the other hand, the inventory of each country has been going down. USA is an excellent example of diminishing military reserves of U3O8. USA had an agreement with Russia over the supply of U3O8 from leftover nuclear weapons, but this has ended in 2013, and thus, will continue to drive the US demand up.
Another strong point for widening of the gap is the fact that the energy demand will be moving higher (fuelled mainly by Japan in the short term) and the mines will not be able to handle such an increase. The following chart explains the situation:
China could prove to be the main driver of the demand in the long term as they try to focus on nuclear energy, because fossil fuels cannot be proliferated, mainly thanks to the health impact and alternatives are not that efficient yet to serve the huge Chinese energy market. They have 28 nuclear reactors currently under construction (compared to 21 active), and will raise this number, as they want to increase the amount of electricity produced by the nuclear reactors by three times (from 2% to 6%). But not only China is focusing on nuclear energy, India could become a major player in the future as well. All the data is taken from up-to-date research.
Finally, the fact that the whole industry is overlooked and caught in the doldrums of low profits will serve to widen the gap as well. It creates a self-reinforcing process. Uranium mines are struggling, and they certainly do not have much capital to spare for research. They will not be producing excess of U3O8, and all this will result in a smaller supply, while the demand will be picking up, the gap will widen further until the mines catch up again; a demonstration of a simple economic relationship in action.
Introduction to Ur-Energy - Competition and alternatives
After my interest grew in the prospects of the commodity, I started to look for the best way to exploit the opportunity. Getting into U3O8 itself could be interesting but more long-term, as the spot price will start to react slower to the news than stocks, and there are limited possibilities to get prime exposure to the commodity as well. Individual investors can invest in Uranium Participation Corporation (on the Canadian Stock Exchange), which buys uranium outright on the spot market and therefore shadows the spot price, but that's about it.
Therefore, I started to look into the best mines available. Kazakhstan is the largest producer, with a high-quality grade of U3O8 (in other words, quality of the mined rock - solid grade is around 0.10%, more interesting mines have a grade over 0.15%), but most of the mines are state-owned, which prevents any sort of exposure.
Next up would be Cameco (NYSE:CCJ), which is the second-largest producer; and it needs especially to be stated that it is a profitable one as well, even during such low spot prices. Situated in Canada, it has the exposure to the Athabasca basin, which is the next "Bakken" in the uranium world, as it has some of the best grade of U3O8 (16%) available in the world. CCJ is an established company, and therefore, can be a good pick for investors who are more conservative and do not want to open themselves to a larger risk (but larger profits as well), as CCJ has a broader and more diversified financial base. Although recently, CCJ had problems communicating with the unions.
From the chart, we can again deduce easily the Fukushima accident, as well as the stable price movement since then.
Other major producers are either private or act as a part of a broader corporation, and therefore, have only limited exposure to the potential rise of uranium.
That is why I became interested in researching the junior mines, which operate in high-quality areas and provide me with potentially higher gains and clear exposure. From the pack of juniors, Ur-Energy (NYSEMKT:URG) struck me as a definite and clear winner.
It is located in Wyoming, US, and since December 2013, it actively produces U3O8 from the Lost Creek complex. It extracts the uranium by using a modern in-situ method. Instead of conventionally mining the whole rock, in-situ uses pipes to dismantle the product from a rock by using special liquids, and therefore, is more efficient and prevents major deterioration of the grade.
Positive side of URG
The company definitely has strong financing. No imminent need of a stock offering is visible, even though it needs to service a debt. It is no longer burning significant amounts of cash, as production has already started. Although no short-term need for the offering is visible, the company did file an SEC Form S-3, which is about a $100 million mixed securities offering.
This is forming a nice hedge for the company, but could potentially affect the stock price in the near term, although it depends on how much of the amount will be brought about by common shares and when exactly it wants to exercise this right (both not stated in the filing).
As seen on the recent Q1 and Q2 fillings, sales have been going well. In the first quarter of the year, it was able to sell 200 thousand pounds to secured long-term agreements. These long-term contracts are priced way above the actual spot price, and are now standing at an average of $51.4 per pound ($20 premium); while the costs of producing a pound is $29, almost identical to the spot price, which is a huge advantage as well, as the spot price should be very near the bottom.
URG stated that it will produce another 200 thousand pounds in Q3, which again will increase its cash positions. Moreover, it is certain to sell it in order to honour the contracts, and by the end of the year, it could see a profit on its income statement.
The update from Q2 does not change the picture much. Production stalled a bit, as it had to strategically allocate the supply in accordance with its contracts, and it also delivered U3O8 to a lower-priced contract. That is why the average price fell down, but 2H of 2014 will be a lot better in the sense of income and the average sell price of pound of U3O8.
Most of the agreements will expire in the year 2016, so the next two years should not pose a threat to the balance sheet of the company either. Moreover, URG has been able to secure two more agreements for the next two years, and can continue to do so repeatedly, as it produces a high-quality grade uranium (average of 0.179%).
But what is most attractive about the company is definitely its chart.
The fact that the stock was trading at almost $3.30 a share in 2011 is magnificent. At that time, investors were buying only the prospect of the mine. URG was not producing anything and had a long way to go, but was incredibly popular despite the uncertain future. The downturn after Fukushima was severe, but the price action stabilized afterwards, and recently, we are starting to experience higher volume and some volatility.
We can see that since December, the stock almost doubled, but as the spot price of U3O8 did not improve and the speculation took over, the stock was eventually hammered. This presents us with a valuable buying opportunity.
Now we stand at the same price as in December, and I do not see a reason why the stock would not be propelled to the $2 mark again if the catalyst (Japanese restarts) is sufficiently strong, as I think it is.
Possible downturn scenario
There are some possible risks that could prove fatal to the company or the stock. The most dangerous one is the change of the governmental policy in Japan, because that would make uranium even more despised and it would lose a market-defining catalyst. The spot price would stagnate and URG would start to struggle to provide a profit, and all that would be incorporated into the stock price very quickly. So any negative news from Japan can hurt the prospects of the stock in a major way.
The second biggest downturn would be if the company did not secure any more long-term agreements and would have to sell at the spot price, which will take a while to increase.
In the end, the last major risk is the spot price. Even if Japan restarts its reactors and everything looks fine with the market, the spot price will not see a substantial movement and the stock of URG will not react positively, although this would create, to use a very popular term, a "screaming buy".
Lastly, I want to provide a short-term glance at the chart, the stock price action, an enter and exit scenario and possible hedges.
Enter and exit scenario, and possible hedges
Now, if we look at the stock price, we can see it has been oscillating between $1.30 and $1.00, and recently got hurt by the news about the S-3 offering, and therefore, created a great buying opportunity. I would enter the position now at $1.07 with at least 25% of the targeted investment. In the near future (days), we could see the stock price go even lower. Therefore, we could lower our average price by using the rest of the targeted investment, but the stock price should hold the support of $1. Whenever the price becomes depressed after a short-term spike (like the one in the beginning of July), I would buy more.
Now to exiting the position. I would sell off only if the fundamentals change (Japan not restarting, URG cannot make profit etc.). Alternatively, I would sell off a portion at the $2 mark, and then continue to scrutinize the future prospects very closely.
To hedge the trade, I would use at-the-money (or at least near) puts on Cameco, which would get hurt a lot if any of the downside problems were to occur. Apart from the fact that URG would not be able to secure any new contracts, which would render the investment unprofitable and you could start shorting the stock.
Thanks for reading, and do not forget to comment! Long URG.