Value Investing In Uranium

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Includes: CCJ, UEC
by: Pontus Granlund

Summary

This article is aimed at giving investors insight into the uranium market and uranium as a commodity.

Recent price volatility of uranium producers makes this information valuable to investors looking to invest in uranium producing companies.

At the current uranium price, no new investments in uranium production are made and many projects are put on hold. This will widen the supply/demand gap going forward.

Uranium presents a good investment at current price levels. Demand for uranium is stable and growing while supply lags demand by 10%. High inventory levels and the Fukushima disaster in 2011 have helped push down the price of uranium to its current levels. Now, with an increased demand for uranium, inventories are being emptied in order for the demand to be met. New nuclear plants are being constructed and many more are planned. At the settlement price in the low $20s, the price of uranium is below its average extraction cost. The price of uranium will likely converge toward its average extraction cost of $31. A focused investor could either buy and hold uranium futures or invest in some of the listed uranium producers, such as Cameco (NYSE:CCJ) or Uranium Energy Corp. (NYSEMKT:UEC).

Uranium is a silvery white radioactive metal and chemical element in its pure form. It has a density 70% higher than that of lead. It occurs naturally in the Earth's crust and is commercially extracted from minerals such as uraninite. One kilogram of refined uranium can theoretically provide the same amount of energy as 1,500 tonnes of coal. Commercially enriched uranium fuel contains around 3%-5% uranium and comes in the form of pellets to be used in reactors.

The basis of uranium futures contracts is triuranium octoxide (U3O8), which is the most popular form of "yellowcake" (contrary to its name, it's often grey or black) -- the form of uranium gained through chemically refining the uranium ore. The triuranium octoxide is an intermediate form between raw uranium ore and the later-stage uranium hexafluoride (aka "Hex"). Industry-grade uranium is enriched from uranium hexafluoride through a gas-centrifuge process. The U3O8 can, contrary to common belief, be easily stored and is moderately safe to handle (radiation one meter from a drum containing the dust is about half of that experienced from cosmic rays during a commercial jet flight), which is why it is preferred as a storage form to hex (which is highly toxic). This, however, implies that the cost of carry is negative, which is why we observe rising settlement prices for contracts in the future. These settlement prices have a steeper curve than those of zinc and other metals.

The main producing countries of uranium are Kazakhstan (39%), Canada (22%), and Australia (9%). Australia has the highest amount of recoverable uranium, amounting to 29% of the world's resources, while Kazakhstan has 12%, Russia has 9%, and Canada has 8%. In 2015, the company producing the most uranium was Cameco, which supplied 22%-26% of world production, followed by Areva (OTCPK:ARVCY) at 14%, and a joint venture between Uranium One and Kazatomprom at around 10%. The top 15 mines produced a total of 66% of world production. Total production has been steadily increasing since 2007 from 48686 tU (tonnes uranium, uranium being U3O8). Currently, there are 11 facilities that can convert the yellowcake into functioning nuclear fuel with a total capacity for 81870 tU. The total amount of uranium supply from mines amounted to 71343 tU in 2015, which covered 90% of world demand, with the remaining 10% being made up from inventories.

The demand levels for uranium are driven by the number of nuclear reactors in operation. As of March 2016, there were 440 reactors in operation in 30 countries. These reactors supply around 11% of the world's demand for electricity. Countries have different energy policies; France, for example, gets around 40% of its energy from nuclear power generation. As of now, 65 reactors are being built, 238 reactors are planned, and an additional 337 are being proposed with the potential of being operational by 2030. From Cameco's latest annual report, the estimation of the number of reactors operable by 2025 will be 497, an increase of 57.

A characteristic of newly built reactors is a rapid increase in strategic inventory levels, which has the potential of boosting demand for uranium rapidly. Energy demand for the entire world is projected to increase from around 530 Btu to 740Btu by 2030, with the main growth coming from non-OECD countries. The demand for uranium in 2015 amounted to 79,270 tU; this means that 8,000 tU were taken from inventories that year. With a world concerned about carbon emissions, the outlook for nuclear power looks bright.

The current level of inventory comes from either normal inventories, the deconstruction of nuclear warheads, or the re-enrichment of used fuel. The re-enrichment of used fuel is less cost effective than the enrichment of hex, but overall the re-enrichment process is simple: grind down used fuel and re-run it in the centrifuges. Because of the supply/demand gap, inventory levels have been decreasing since 2007. Mined uranium provided 64% of world demand in 2007, ramping up to 90% in 2015. The supply of uranium, without new extraction capacity, will struggle to keep pace with increasing demand.

At current levels, supply will be at around 60% of consumption by 2025. According to CRU, an independent commodity research firm, the extraction cost of uranium averages $31/lb. In 2007, an all-time high was recorded for uranium spot prices, which reached $136 in June 2007. On Nov. 18, a 12-year low was recorded on the uranium prices at $18/lb, forcing new projects in uranium extraction to be cancelled -- and investments in new projects are currently not happening. This drop can be traced to the worries surrounding the Fukushima disaster in 2011, after which 50 reactors were closed in Japan. The industry has yet to recover from this impact, but Japan is scheduled to open its reactors again.

As uranium is a politically strategic resource, and the subject of international debate spurred by environmental concerns, this poses some risks for investors. The benefit of uranium vs. sources of energy, especially renewable energy, is that it provides a stable flow of electricity uncorrelated to weather and sunshine. Germany gives us an example of a policy shift that could pose a threat to uranium as a power source. Germany has decided to close all of its nuclear factories by 2022. Ironically, during the foreclosing process of its power plants, the country has been forced to buy nuclear power from France.

It's worth noting that German nuclear power generation constitutes a small part of the world's total nuclear generation. The main threats to nuclear power generation are groundbreaking development of energy storage, such as batteries, and efficient renewable energy sources that, in combination, could pose a large threat to any investment made in the resource. With the main growth in nuclear reactors being underdeveloped countries, these risk factors pose little threat to nuclear power generation as alternative solutions are relatively more expensive.

Uranium prices have recently reached their lowest level in 12 years following oversupply. Companies currently extracting the resource struggle to stay afloat, while the numbers tell a story of increased demand going forward. At the same time, new investments in extraction are not being made. Supply is decreasing while demand is increasing, and inventory levels continue to be drained. Uranium prices reached a point in February 2016 where the cost of producing the commodity became lower than its price. It is therefore highly likely, by the basic principles of supply/demand economics, for the price to converge toward the average extraction cost of $31/lb.

At uranium's current price in the low $20s, investors might realize attractive returns investing in the commodity's futures should the price start converging toward extraction costs. The price of uranium has become unhinged from its value, presenting value investors with an opportunity.

Supporting Documents

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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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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