Energy Diversification

Nuclear Power Is in Demand

Its important that we are finally highlighting that nuclear power is clearly not an emission-free, or CO2-free energy source. The plant construction and uranium mining produce various pollutants and leave mine tailings.

This does not invalidate the nuclear energy proposition, but its clearly an issue worth evaluating in light of the climate change arguments.

From an investment standpoint, the single largest exposure to all aspects of the value chain from uranium exploration and production to nuclear plant construction and management is Areva (CEI.PA / ARVCF.PK). For a more diversified energy and infrastructure play, but with clear exposure to nuclear plant development, Shaw Group (SGR) is a good opportunity. Energy Solutions (ES) is a back-end play on the management of nuclear sites & waste.

Its important not to buy a basket of any old equities with nuclear attached to them. The utilities mentioned above are going to be the ones paying to develop nuclear plants, so its a capital drain for them for a long time. And with the latest estimates of plants costs at $5 billion to $12 (twelve!) billion, even with loan guarantees, this is a distant way to play nuclear.

Denison Mines (DML.TO / DNN) should clearly have been mentioned alongside Cameco and Uranium One. The point I would focus on here is a very strategic one: CHINA is likely to be both the nearest-term AND largest nuclear developer. Why? It can make it happen faster (for better or worse) because NIMBY concerns can be ignored. More importantly, remember that the Chinese lose 5,000 coal miners every year! These direct deaths coupled with the indirect health issues are a clear concern in China -- the government is aware and cares about these issues.

Many uranium-watchers claim China will try to tie up strategic uranium reserves by buying public explorers and producers. China has no reason to publicly announce this, but it has recently confirmed that its nuclear development is much further along that was expected. China also reportedly met with Cameco recently.

If China were to buy uranium companies, it would go for geographically accessible nations -- and ones without the finger-wagging they get from Australia (for example) about weapons proliferation. India is also going to have the same issues, given that even America will not sign a nuclear agreement with the largest democracy in the world!

Uranium One has operations in Kazhakstan -- very accessible to China and India. Despite its recent logistics challenges operating there, UUU.TO is a logical target, if you like this strategic reserve argument. The American and Canadian producers are not logical targets. Africa is a logical choice, although it a true energy crisis, the Chinese may feel safer having a source closer to home.

I'd steer clear of USEC -- the growth opportunity here has never been clear, and US uranium demand is years away from a significant increase. In fact, the biggest risk to US uranium supply is the Russia agreement being cut back -- but down-blending Russian HEU is a major revenue source for USEC, so it could even negatively affect them.

Finally, hedge funds enjoyed a huge run-up in both physical uranium and uranium explorers. They have reportedly been running from this sector, so the bubble in these shares could still be deflating for a while. Remember there are over 500 public uranium explorers -- clear indication of a bubble within this small sector of the market.

Uranium on the Rise

Although I believe in the long term promise of nuclear power - especially in China - it continues to amaze me that the only so-called "analysis" that anyone wants to do for uranium producers and explorers consists of drawing lines and talking about "uptrends".

On the one hand, we have very valid arguments that China will need (and in my view, already has much more massive plans than we have been informed of) to build nuclear plants. However, even in regulatory-lite China, these plants will not be online for at least a decade. And even if China were to double the build-rate of nuclear reactors that the world achieved during the building boom in the 70s-80s, its going to be a long, long time before this drives uranium demand.

Now of course investors are right to try to position themselves for this future demand increase. But the reality is (the analysis that is always skipped) is that there is a lot of production coming on line, from the very companies mentioned here - Uranium One, Denison, etc.

Over the next few years, we are looking at an OVER supply issue, not a shortage. Even with Uranium One's sulfuric acid problems in Kazakhstan, they still expect massive production ramp ups.

There is a contradiction when we talk about the growth prospects for all the companies - based on their production expectations - but then we don't address the broad supply/demand situation for uranium. If these guys meet their targets, we will have an oversupply for years. This is a long time to ride out from an investment perspective.

Moreover, no one is analyzing the true production cost of uranium. And you're going to need to, because even if you don't believe this is a problem, the anti-nuclear side is coming out with a host of well-reasoned arguments that large-scale mining of somewhat lower-grade uranium is going to cost a lot more -- and may even have a negative EROIE! This message will impact the market because the popular press will repeat it, reinforcing its own anti-nuclear bias for a few more years.

Finally -- if you truly believe the nuclear story, why not play the engineering firms that will be booking business from this buildout -- SGR, MDR, FLR, FWLT and of course CEI.PA (AREVA)?

Perhaps this is because the majority of uranium stock traders are basically inept analysts feverishly drawing "trend lines" to try to justify their way out of the hole they are in for chasing uranium equities to unreasonable heights last Spring?