Uranium As A Commodity

| About: Cameco Corporation (CCJ)

Summary

The nuclear power industry is slowly healing. This will eventually lead to growth in uranium consumption.

Uranium prices are very low, probably under the cost of production of almost all producers.

The emerging bull market will take a very long time. I am only trading tactically at this time.

If I had a dollar for every bullish article I've seen on uranium in the last five years, I would have, well, a lot of dollars. I blew off virtually all of these because they were largely a collection of qualitative platitudes (nuclear energy is a vital part of preventing climate change, power plants are uncovered, etc.) And of course, the inevitable copy and paste from company presentations.

All the while, uranium prices have continued to decline. They are now at their lowest since 2004, and even lower if inflation is taken into account (more on that later). Here's a graph on a log scale of the industry-standard NUEXCO price:

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I'm going to write yet another (somewhat) bullish article on uranium, but the argument is more complicated than for the typical commodity. So this will be somewhat long, be warned....

Since almost the only commercial use for uranium is as a fuel for nuclear reactors, any analysis of the market has to start with the nuclear power industry. The industry was doing fairly well for a time until the Fukushima disaster of 2011. After that, Japan and Germany decided to shut down all their nuclear facilities. At the same time many planned reactors were delayed or stopped. Here's a table of the potential use of uranium from the World Nuclear Association.

2010

68,646

2011 62,552
2012 67,990
2013 64,979
2014 65,908
2015 66,883
2016 63,404
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Data is in tonnes. This is not quite actual use because of various outages, but it represents potential demand.

Going back over the historical data, nuclear power seems to be an incredibly overoptimistic industry. It's the way of the future and always will be. Note the decline in usage from 2012 to 2016. This has to do with the permanent decommissioning of a number of reactors for both safety and cost reasons.

In the absence of another disaster, it's fairly easy to predict uranium usage by counting the number of installed and planned reactors. Here's a graph of installed:

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Note: this data is also from the World Nuclear Association. You can see how things were doing OK until 2011, and seem to be coming back now. There are 60 reactors currently under construction. Many of these are in China and Russia, where you can be fairly certain they will not face serious delays:

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If all these are built, it would add about 13% to the world reactor base. However, there is also permanent reactor decommissioning. So far there have been 158 of these. Many of them were of older and smaller reactors in the US, but some were major installations in Germany and Japan. My guess is that absent another Fukushima, there will not be too many more of these.

Finally, let's look at the operating performance of nuclear. Here we can find some definite improvement. One measure of performance is the percent of time the reactors are down. Here's a graph of that worldwide:

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The line goes down steeply after 2011 as new attention was given to safe operations. This is a major plus, both because it improves the economics and because it reduces the chance of another disaster.

My best guess is that demand will rise by a little over 10% in the next five years. This is pretty good for any commodity. Additionally, the market will shift even more to EM countries like China and India. Neither of these nations are big league uranium miners, so they will likely continue import. I doubt there will be any new reactors in low-gas cost countries like the US or Canada.

Supply

The largest producer of U3O8 by far is Kazakhstan. Behind that is Canada, Australia and Namibia. I feel that all of these are reliable suppliers. Kazakhstan and Namibia rely on this industry for a sizable part of their economy, and Canada and Australia have a rule of law.

Future production increases will depend on the price, and here is where it gets interesting. Taking inflation into account, U3O8 prices are at very attractive levels. Here's a graph I put into every commodity analysis I do. It measures the 2016$ price of U3O8 on the X-axis vs. the 10-year forward price change of U3O8 on the Y-axis.

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The red line is where we are now. So just reading off the graph, it looks like U3O8 prices will about double in ten years, excluding inflation. Along with a fairly good demand situation, that looks exciting!

Physical Stocks of Uranium

Compared to fossil fuels stations, nuclear reactors have a high fixed cost and a low variable (FUEL) cost. Thus it makes sense for operators to keep large uranium stockpiles to ensure there is no break in supply. Additionally, uranium has obvious strategic importance. Several nations have government-owned strategic stockpiles. To me, this is the key to the uranium market. No one knows what the demand for stocks is or even how large world stocks are. Here is a quote from the World Nuclear Association:

"The following graph gives an historical perspective, showing how early production went first into military inventories and then, in the early 1980s, into civil stockpiles. It is this early production which has made up the shortfall in supply from mines since the mid 1980s. However, the shortfall is diminishing towards the level of continuing secondary supplies."

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In other words, we probably have to shut down some high cost production to really get a bull market going. I expect this will happen, but it will take awhile.

It is important to mention that China, Russia and eventually India have negotiated out-of-market supply deals with major producers. At the current low prices, it pays for them to lock up future stocks, even if they are paying above market prices. This will reduce the market potential of companies in the market like Cameco.

How to Play It

Readers of my posts know that I normally advise investing in the equity or debt of a commodity producer rather than in the commodity itself. In this case I think the commodity itself is OK. U3O8 is easy to store, so the costs of carry are not high. There is a futures market for it, but I prefer the Toronto-listed investment vehicle Uranium Participation Corp (OTCPK:URPTF). It's only (non-cash) asset is actual uranium. It sometimes lends out some of it's uranium for a fee, but it is basically a pure play. Fees are reasonable, and the market is quite liquid. The only negative is that right now it is selling for a 12% premium, as vehicles like this sometimes do. If the premium gets too great, they issue more shares and buy back on the flipside.

If you prefer to invest in corporate equity, the two companies I would target are Cameco (NYSE:CCJ) and Uranium One (A9Y in Russia). CCJ is the class of the uranium stocks. It is active through the entire cycle, including processing and marketing. It is positive in operational cash flow even now, although that is probably because of long term contracts. If U3O8 prices were to stay where they are now for several years, it might become very dicey.

If you are willing to accept the country and governance risk (I'm not), Uranium One is probably a better bet. My guess is that it has the lowest cost of production in the world, aided by a very cheap currency. It also has close financial and strategic ties to China, the major growing market. Since mining is pretty much the Kazakhstani economy, I doubt they would want to jeopardize it.

I would stay away from all the smaller and junior miners. Unless the price rebound comes sooner than I expect, most of them will go broke or need to be recapitalized. It's true there is an inexhaustible supply of suckers in the Canadian and Australian markets to do this, but it leads to dilution.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in URANIUM PARTICIPATION CORP over the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

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