SILEX AND TERRESTRIAL ENERGY: TWO NUCLEAR INNOVATORS
I am an investor in Silex, Terrestrial Energy, Cameco, GE, and Royal Dutch Shell.
I have no intention of trading these investments in the next month.
Public Companies Discussed:
Silex (OTCQX:SILXY), GE, Hitachi (HIT), Cameco (NYSE:CCJ), E.ON SE (OTCPK:EONGY), RWE AG (OTCPK:RWEOY), Areva (OTCPK:ARVCF), Suncor Energy (NYSE:SU), Imperial Oil (NYSEMKT:IMO), Exxon (NYSE:XOM), and Royal Dutch Shell (RDSA, RDSB)
by Levis Kochin April 8, 2014
Silex - a public company - is an attractive investment opportunity. Its technology for laser enrichment of uranium is markedly lower cost than the centrifuge enrichment technology of its competitors. Its licensee Global Laser Enrichment will over time take over the Uranium enrichment market and Silex is likely to receive royalties which are a multiple of the cap value of Silex. But the disruptive effect of laser enrichment is narrow. The prospects of nuclear power are only marginally affected because uranium enrichment is a small portion of nuclear power costs. Terrestrial Energy is attacking the main costs of nuclear power- capital costs, safety and waste disposal. If Terrestrial Energy succeeds, a substantial number of important public companies in nuclear reactor construction and coal will lose much of their capital value. The value of companies exploiting the oil sands will, on the other hand, be substantially enhanced.
Natural uranium has to be enriched in the fissile isotope U235 in order to be used as a fuel in almost all the world's nuclear reactors. Enrichment represents about 30% of the cost of nuclear fuel. But nuclear fuel represents only 10% of the total cost of nuclear power. The total value of nuclear electricity in the world at wholesale is about $200 Billion per year. The total value of nuclear fuel is about $20 Billion per year. (All valuations in this article are stated in U.S. dollars.)The world enrichment market is worth about $7 billion per year. Two manufacturers of centrifuges, one Russian (Rosatom) and one West European (Enrichment Technology Company) both manufacturing centrifuges designed by Gernot Zippe while a prisoner in the Soviet Union, have over 90% of the uranium enrichment centrifuge market.
In North Carolina, the first commercial laser cascade to enrich uranium is under construction by Global Laser Enrichment (GLE) under a license from Silex of Australia. In 2012 GLE obtained U.S. Government permission to build a six million SWU per year plant. GLE is building the first cascade of enrichment devices. If that works as projected, the plant will be completed and supply 10% of the world enrichment market. At current forward prices of about $120 per SWU, Silex's royalty will be between 5% and 12% depending on the cost of enrichment at the plant. At current forward prices for enrichment, Silex would collect about $75 million per year at a 10% royalty rate when the plant is completed (projected for 2020). Since GLE's costs per SWU will be about $60, GLE could (and probably would) obtain additional revenues by "underfeeding" their enrichment contracts, that is by using more SWU and less uranium to make the low-enriched uranium they deliver to their utility customers.
GLE is in exclusive talks with the U.S. Energy Department to build an enrichment plant in Kentucky to "mine" 50 million pounds of uranium by re-enriching the 110,000 tons of tails which accumulated in 60 years of operation of the obsolete and recently closed Paducah Kentucky enrichment plant. The 50 million pounds of natural uranium equivalent in the form of uranium hexafluoride that Silex would produce over the life of the enrichment plant are worth $3 Billion at current uranium forward prices. This would over time yield additional royalties of $300 million to Silex.
GLE's commercial opportunity for the sale of SWU is limited to the growth in the market for enrichment as almost all the cost of uranium enrichment comes from capital costs and current enrichment needs are covered by current SWU capacity and centrifuge enrichment plants currently under construction in New Mexico and France. GLE would have to cut the contract price from the current $120 per SWU to the operating costs of centrifuge enrichment which are almost certainly less than $30 per SWU in order to force the closure of existing centrifuge plants. What GLE is more likely to do is to set a SWU price enough lower than existing prices to make it uneconomic for Urenco to construct new centrifuge enrichment capacity. Nuclear power generation is expected to rise about 30% over the next decade as new plants under construction and planned in China, India, Russia, South Korea, France, Finland and the UAR have a larger generating capacity than the plants likely to close in the US, Japan and Germany so the additional demand for laser enrichment over the next decade is not insignificant.
Enrichment firms sell the service of enriching uranium. Enrichment firms swap low-enriched uranium for natural uranium and cash supplied by their customers. With lower costs for SWU, GLE can deliver a given quantity of low-enriched uranium while using less than all of the uranium supplied by the customer and selling the extra uranium to another customer. When an enrichment firm "underfeeds" uranium it is adding not to the supply of SWU but to the supply of uranium. With a much lower cost of SWU such underfeeding will be a far more important source of cash flow for GLE than for other uranium enrichment plants.
GE owns 51 percent of GLE. Even a prosperous future for GLE will have little impact on the returns to shareholders of GE. GE has a market cap of $500 Billion so the $4 Billion investment in GLE now planned will not have a material effect on the GE investor. For minority partners Hitachi (HIT) and Cameco their investment in GLE will total about 10% of their total plant and equipment investment if GLE's plants in North Carolina and Kentucky are completed. Even a GLE strategy that lowers SWU prices enough to foreclose all new commercial competition for uranium enrichment will have only a small effect on the prospects of nuclear power as enrichment is about 3% of the cost of nuclear power. Thus even if uranium enrichment were free, the demand for the products of nuclear plant suppliers and operators and most other firms in the nuclear power industry will be only slightly affected. Uranium miners will be more affected by a fall in the price of enrichment as enrichment is a substitute for natural uranium in producing low-enriched uranium. If the cost of enrichment falls, then more enrichment and less natural uranium will be used in producing uranium.
GLE's pricing strategy will have an important effect on the commercial prospects of the producers and operators of uranium enrichment centrifuges. USU is the one currently public company other than Silex whose principal business is uranium enrichment. USU has shut down its obsolescent enrichment plants in Ohio and Kentucky and declared bankruptcy. USU has spent over a billion dollars designing and making prototypes of a uranium enrichment centrifuge which even if USU's estimates are accepted will cost much more per unit of separating capacity than Urenco or Rosatom centrifuges. Rosatom is owned by the Russian Government. Urenco is owned one third each by the British and Dutch governments and one sixth each by the German utilities E.ON SE (EONGY on US pink sheets ) with a market cap of $35 Billion and RWE AG (RWEOY on US pink sheets ) with a market cap of $23 Billion. Urenco's current owners have agreed to sell Urenco. They are anticipating receiving between $11 Billion and $15 Billion for Urenco. Part of this value derives from the enrichment plants in Europe and New Mexico and part of it derives from Urenco's half interest in Enrichment Technology Company (ETC). E.ON SE and RWE shares of Urenco would be worth about $2 Billion at that valuation. Bidders for Urenco would trim their bids if they are aware of the competitive threat of GLE which is possibly the reason why the existing owners are selling . The other half interest in ETC is owned by Areva, a French company which has a sizable centrifuge enrichment plant now operating in France. Areva is building George Besse II a 7.5 million SWU centrifuge enrichment plant which began commercial production of SWU in 2011 and is scheduled to be completed in 2016. Areva is now the only substantial publicly traded company for which uranium enrichment is an important current business. But Areva has other nuclear businesses in designing and building nuclear power plants, in mining uranium, in reprocessing nuclear waste and in renewable energy . Areva's total market cap is about $11 Billion, of that more than 90% is owned by the French government.
In 2020 and after, Silex would receive $100 million in annual royalties or about $75 million after tax. The present value of $75 million a year would be $1 Billion in 2020 at a 7.5 % discount rate and $647 million now which exceeds the $270 million enterprise value of Silex. On the upside, Silex has hopes for follow up plants which would yield additional royalties. I have not included these more speculative royalties in my valuation of Silex but I have also not made an allowance for the chance that the GLE plant will not be constructed or will have much higher costs than Silex now projects lowering royalties. In my evaluation of Silex I have assumed that the royalty proceeds will be either returned to Silex shareholders or invested in projects yielding benefits to them. Silex executives will control the disposition of the royalty payments from GLE. Silex is spending a net $9 million on ongoing projects in solar energy.
Silex has a market cap of about $330 million. Silex has about $80million in current assets and about $15 million in total liabilities. The market is valuing the commercial operations of Silex at $265 million. Most Silex trades occur in Australia (under the symbol SLX.AX). On average 1152 ADRs worth $11,000 trade per day on Nasdaq. Each Silex US ADR is a deposit receipt for 5 Australian shares. SILXY recently traded at $9.6 per ADR and traded as high as $20 per ADR in the past year. SLX.AX has recently traded at about $2 Australian per share.
Silex's control of its technology does not end when its patents expire as Silex's technology has been put under a security blanket by an agreement between the Australian and US governments. Imitators will not be able to copy Silex's key innovations by reading patent documents. Silex can therefore look to a stream of royalties potentially extending to uranium enrichment plants not yet planned. The value of the Silex intellectual property depends on the long run demand for uranium enrichment and thus on the prospects of the commercialization of conceptual designs for nuclear power plants which would increase the demand for enrichment by substantially lowering the main (capital) cost of nuclear power plants.
Canadian startup Terrestrial Energy Incorporated plans to design and build Integral Molten Salt Reactors (IMSRs) powered by low-enriched uranium. In molten salt reactors the nuclear fuel is dissolved in a molten salt. The Terrestrial Energy emphasis is on cutting capital costs which are 80% of levelized cost of conventional nuclear power. The new (Generation IV) reactors being designed by others and the bulk of government funding for new reactor designs are focused on reducing fuel costs which are 5% of levelized costs. Reactors in which the fuel is dissolved in molten salt were first designed and constructed in prototype as aircraft engines and current designs (while unsuited to be aircraft engines) are far more compact than other reactors. Terrestrial Energy plans to have all its reactors factory built and truck transportable. The Terrestrial Energy emphasis is on reducing capital costs by simplicity of design and economies of scale in serial factory production.
Existing reactors have not been able to penetrate the industrial heat market because they are too large and operate at too low a temperature to supply most industrial demand. Heat cannot be transported more than a few miles and no industrial heat application has a demand for anything near the 3000 thermal megawatts (1000 electrical megawatts) of most reactors within a one mile radius. Other firms are designing small nuclear reactors but their projected capital costs per kilowatt are multiples of those of Terrestrial Energy's reactor design at small sizes.
The central reactor core of an IMSR reactor would be cheap enough that it would pay to extract the core of the reactor as a module after seven years when the graphite moderator needs to be replaced rather than removing the graphite moderator for replacement. All molten salt reactors have inherent safety advantages as consequences of physical law which enable them to avoid the costs of elaborately engineered safety systems . The elaborately engineered safety systems needed by all conventional reactors make small conventional reactors extremely expensive per unit of power produced. Terrestrial Energy is designing three version of its IMSR. Its prototype and initial commercial reactor is sized (80 megawatts thermal, 29 megawatts electrical) to produce electricity and heat for isolated communities on islands or in the Arctic. It could provide heat and cogenerated power to large industrial plants where natural gas is not available at North American prices. The middle sized reactor is sized (300 Megawatts thermal, 121 Megawatts electrical) for use in the oil sands or other extremely large users of heat. This size of reactor would be ideally suited to provide base power, for example, on New Providence Island in The Bahamas which has an average power demand of about 200 megawatts and a base load of about 150 megawatts . Economies of scale (as compared to the 80 MW thermal design) enable this (300 MW thermal) reactor to be a somewhat cheaper source of heat in the oil sands than natural gas. The largest reactor design (600 megawatts thermal, 288 megawatts electrical ) is for use on large grids and is projected to be a cheaper source of heat and electricity than coal. Even the largest IMSR reactor would provide about one fifth the power at one half the cost per KWH (Kilo Watt Hour) as the EPR reactors Areva is now constructing in Finland and France (4500 MW Thermal and 1650 MW Electrical). Fleets of 288 MW IMSR would be added over time to electrical grids without any individual reactor being a bet the company decision.
The Alberta oil sands are the largest market for industrial heat on the planet . In Alberta, Terrestrial Energy faces competition from what is usually the cheapest natural gas in North America. Each barrel of oil produced by existing oil sands plants uses 1000 cubic feet of natural gas to heat the heavy oil to a temperature high enough to make the heavy oil flow. Burning this natural gas is the source of the extra CO2 emitted by producers of heavy oil over and above the CO2 emitted in the process of producing light oil. This extra CO2 is the source of most of the opposition to oil sands production and to anything such as the Keystone XL pipeline which would facilitate that oil sands production. There are 2 Trillion barrels of heavy oil in the Alberta oil sands about 10% of which could be economically produced with current technology at current oil prices. In Alberta natural gas currently has forward prices of about $4 per thousand cubic feet. In addition the CO2 charge imposed by Alberta adds 60 cents per thousand cubic foot cost to the use of natural gas in the oil sands. This is Terrestrial Energy's maximum target cost of heat if it is to market its reactors in the oil sands as a replacement for natural gas. Industrial heat customers in other places offer an easier target as almost everywhere else on Earth natural gas is more expensive than in Alberta. The oil sands are a sizable commercial opportunity by themselves. The total value of the natural gas at current forward prices which could be displaced by Terrestrial Power's nuclear plants would be $920 Billion-assuming that only 10% of the heavy oil is extracted from the oil sands.
At existing forward natural gas prices and projected costs of the heat generated by the Terrestrial Energy 300 Megawatt IMSR reactor, the reactor would be somewhat but not much cheaper than burning natural gas is the oil sands. But there are other advantages both to Terrestrial Energy and to the oil sands industry in installing some of the first commercial Terrestrial Energy reactors in the oil sands. Reactors would operate at oil sands production sites distant even from the modest population centers of northern Alberta minimizing the NIMBY factor. Natural gas prices in North America have been very volatile over the last 50 years. Even if the best guess is that future natural gas prices in Alberta will not be significantly greater than today, there is a serious chance that natural gas prices will be double the price expected now. A tested Terrestrial Energy reactor would give the industry an option if natural gas prices make a major move upward.
The oil sands industry is under heavy pressure from activists who have emphasized the much higher CO2 emission levels from oil sands oil production (per barrel) as compared with the CO2 emission level from most (but not all) other oil production. Production of heavy oil in Venezuela is just as CO2 intensive without attracting similar attention. In response to this pressure, the Alberta government has one of the world's few taxes on CO2 emission. The Alberta tax on carbon dioxide emissions in large scale industry is $15 per ton of carbon dioxide emitted over and above 88% of carbon dioxide emissions on a business as usual basis. The tax had as of early last year yielded $181 million which was used to fund projects to cut emissions of CO2 in Alberta by seven million tons over the next decade. The Government of Alberta proposed last year to raise this tax to $40 per ton and to increase the base to 60% of business as usual emissions of carbon dioxide. Such a tax is estimated to amount to $1.50 per barrel of oil sands oil or a total of $1 Billion per year. The revenue from such a tax could easily fund the design and operation of a molten salt reactor optimally sized for the oil sands industry. This investment would if successful greatly reduce the pressure from activists on the oil sands industry.
In Europe and East Asia natural gas is expected to cost at least about twice as much as in the US or Canada. This difference is expected to continue. Applicants are lining up at the permit offices of the US and Canadian governments to build plants to make liquid natural gas (NYSEMKT:LNG) for export to Europe and Asia. If natural gas prices were not expected to be double or more the North American level in Europe and Asia, no one would be interested in building LNG export plants in North America. Those firms which have approved plants have been able to sell their services forward to overseas purchasers of natural gas for high enough prices to justify the multi-billion dollar cost of the plants. The process of producing, transporting and gasifying LNG is estimated to cost about $4 per 1000 cubic feet so the forward price of North American natural gas delivered in Europe or Asia is at least $8 per 1000 cubic feet. One target market for Terrestrial Energy is the industrial heat and electrical power market in the UK. The UK has a nuclear friendly government and will soon have 160 tons of reactor grade plutonium in storage. Each ton of plutonium used in a Terrestrial Energy reactor (together with five tons of thorium costing $300,000) could produce as much electricity as 600 tons of natural uranium (in the form of enriched UF6) costing over $100 million.
Terrestrial Energy's molten salt reactor would enable the oil sands industry to be viewed not as a villain in the global warming narrative but as a savior of the planet from global warming. Each barrel of oil sands oil which displaced other oil would be a step toward a solution to the problem of global warming. If Terrestrial Energy can build a reactor producing heat at a cost lower than burning natural gas in Alberta where natural gas is cheap, Terrestrial Energy will have built a reactor capable of producing electricity at a cost lower than the full private cost of coal fired power. There is a famous quote, "The stone age didn't end because they had run out of rocks." So the solution to global warming is not necessarily a new and rigorous Kyoto Treaty but a low CO2 power system cheaper than coal. A zero CO2 emissions nuclear power plant cheaper than coal fired power will lower worldwide CO2 emissions in the same way that the increased natural gas production in the US (the shale gale) has enabled the US to reduce the emission of CO2 without ratifying the Kyoto Protocol. At the same time, the European Union has increased its CO2 emissions despite many costly policies nominally aimed at global warming. Such a shift in reputation would be a major gain to those companies such as Suncor Energy and Imperial Oil which are specialized in producing and refining oil sands oil and to the Province of Alberta. It would provide a significant gain to the many other companies that have invested in the oil sands such as Exxon and Royal Dutch Shell (RDSA and RDSB) and to the energy security of the North American continent.
Molten Salt Reactors have good prospects of being substantially cheaper to build BECAUSE they are inherently safer than existing water cooled reactors. As Dr. David Leblanc writes on Terrestrial Energy's website:
"Molten Salt Reactors (MSRs) are very, VERY, safe reactors In contrast to the LWR, the MSR does not achieve this enhanced safety through elaborate system redundancies. This safety comes from the fundamental properties of the MSR - it uses a chemically unreactive, liquid salt fuel and operates at atmospheric pressure as compared with the very high operating pressures (70 - 175 atmospheres) of the LWR. In the 1960's, when the MSR was first proposed and built, the MSR represented a paradigm shift in reactor design. The MSR's design is fundamentally different from the LWR and so the risk profile is also fundamentally different. A MSR is inherently stable and responds passively to equipment or power failures. This leads to a key commercial implication: the MSR can deliver superior safety at a materially lower cost. The safety-cost relationship is entirely different for a MSR for it is an entirely different reactor."
The cost of nuclear fuel would not limit Terrestrial Energy's capability of displacing coal . Terrestrial Energy's reactor when fueled exclusively by uranium would have a cost of fuel to generate electric power about one third that of existing reactors. That saving in uranium is caused first by the greater efficiency at transforming heat to electric power of Terrestrial Energy's 700 C. reactor as compared to the much lower efficiency of a conventional reactor operating at 300 C. Secondly, the Terrestrial Energy reactor system is capable of using as nuclear fuel almost all of the plutonium it generates without ever isolating plutonium. This burning of plutonium has an additional advantage as plutonium produces considerable radioactivity for tens of thousands of years while the nuclear fragments produced by fission lose almost all their radioactivity in a few centuries. Conventional reactors must discharge as waste most of the plutonium they generate because their solid fuel is damaged beyond repair by fission product gases within a few years. These fission product gases can easily be extracted from a molten salt reactor. Plutonium's high level of radioactivity makes solid nuclear fuel made with plutonium so expensive to manufacture that the MIT study of nuclear fuel options estimates the net value of plutonium at - $16,000 per kilogram IF that plutonium is from spent nuclear fuel recently discharged. If the reactor grade plutonium is from used fuel which was removed from a reactor 20 years ago, much of the original plutonium (from plutonium 241 which has a 14 year half life) will have converted to americium which is useless in Mixed Oxide fuel and which can be removed from the plutonium only at heavy cost. The UK is holding over 100 tons of separated reactor grade plutonium from spent nuclear fuel much of which is heavily contaminated with americium. The Terrestrial Energy reactor does not use solid fuel elements so a Terrestrial Energy molten salt reactor could be able to fission both plutonium and americium to generate power. The Terrestrial Energy reactor's ability to fission almost all the plutonium it generates would make the Terrestrial Energy's reactor's waste decay much more rapidly than the waste of a conventional reactor. After 50 years most and after 200 years almost all the radioactivity in a conventional reactor's high level waste comes from plutonium and americium. Within 300 years the waste from a Terrestrial Energy reactor would produce less radioactivity than the uranium ore which was mined to produce its fuel would have produced if it had never been mined.
Plutonium is used in the form of Mixed Oxide Fuel (MOX) to fuel European and Japanese reactors but at a significant cost penalty. Plutonium's high level of radioactivity makes the cost of manufacturing solid fuel elements 10 to 30 times as expensive as manufacturing fuel elements from uranium which has a much lower level of radioactivity. Also the process of isolating plutonium to put in solid fuel elements makes bomb material potentially available to anyone who can interrupt plutonium shipments which sometimes extend over more than 10,000 miles. By contrast, the plutonium in a Terrestrial Energy Incorporated reactor would always be mixed with fission products and never isolated but always dissolved in salt from which it is difficult to extract. This plutonium would be less tempting for diversion to produce bombs than the plutonium produced in conventional reactors. In the US plutonium is removed from conventional reactors as part of high level waste and can be stolen when shipped to and deposited in waste repositories which will become potential bomb grade plutonium mines in the distant future when the radioactivity of the fission products has sharply diminished. Over time the proportion of plutonium composed of fissionable plutonium 239 rises. In 25000 years, initially reactor grade plutonium will be transformed by the faster decay of plutonium 240 than of plutonium 239 into bomb grade plutonium. The waste from a TEI reactor would never be able to be used to make an atomic bomb.
Terrestrial Energy's reactors could use thorium to extend the low-enriched uranium which is their original fuel. By using thorium to supplement a continuing injection of low-enriched uranium, Terrestrial Energy reactors could reduce their use of uranium per kilo watt hour to 1/6th the level in conventional reactors. Terrestrial Energy's reactors would be capable of generating all the world's power with the current level of production of uranium with the addition of two million pounds of thorium costing less than $100 million per year to mine or to separate from the waste piles of existing rare earth refineries.
Molten Salt Reactors were developed in the 1960s to be breeder reactors breeding more U233 for fuel from thorium than the uranium or plutonium fuel that was used to start them. Such molten salt breeder reactors would cost far more to design and to build than the reactors Terrestrial Energy plans to build. The saving in fuel cost would be much less than the increased capital cost of designing and building such reactors. The uranium fuel cost of Terrestrial Energy reactors using supplemental thorium would be about .1 cents per kilowatt hour. There are a number of competitive projects to design and build molten salt reactors. All of these molten salt reactor designs (in the US, India, France and China) are aimed at saving the cost of fuel (3% of levelized cost) by breeding reactor fuel from thorium rather than saving capital costs (80% of levelized cost)
Terrestrial Energy's reactors are a threat to all existing nuclear reactor manufacturers. Even before Terrestrial Energy reactors are ready for the market, the shadow of these cheap, safe and fuel efficient reactors will make utilities more reluctant to order current designs which cost twice as much. The most affected company would be Areva much of whose market value is attributable to possible future profits from the construction of its EPR (European Pressurized Reactor). Hitachi (HIT) as a partner in GE's boiling water reactor business is responsible for an appreciable percentage of its market cap of $34 Billion. GE has a market cap of $250 Billion. GE shares are much less tied to its nuclear business than are Hitachi shares.
I am an Associate Professor of Economics at the University of Washington, Seattle Campus. I earned my Ph.D. in economics from the University of Chicago in 1975. Lester Telser and Milton Friedman were my advisors. I have taught at the University of Washington since 1973. I have also worked for the Federal Reserve Bank of New York, the Federal Reserve Bank of St. Louis, the Bank of Israel, and the Hoover Institution of Stanford University.
Disclosure: I am long SILXY. 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.
Additional disclosure: I have shares in Terrestrial Energy - A private Canadian company