Uranium Spot Might Hit $51-$54 In 2018

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Includes: ARVCF, BHP, CCJ, PALAY, RIO, URA
by: Michael Bryant

Summary

Uranium price graph adjusted to inflation points to spot price of $35-$41 in near future.

Minimum AISC seems to be about $60.

Models point to shortage in uranium in 2017-2018.

Natural uranium, or triuranium octoxide (U3O8), prices have soared to $138 per pound in mid-2007 and plunged to $18 per pound December of 2016. Now it is about $25 per pound. Uranium, which is 84.8% of triuranium octoxide, follows closely to the price of natural uranium. The March 11, 2011 Japanese earthquake and subsequent meltdown created a massive oversupply of uranium and helped push the price of the metal lower. But will uranium recover? When? And how high can it go?

Academia has developed several formulas to value stocks, with the one used most often in graduate business school and introductory CFA programs for companies other than financial institutions and REITs is: Price = Present value of future free cash flow. Valuing a commodity seems to take a little more work. In Joe Ponzio's 2009 article, he showed that the value of copper follows the inflation-adjusted price and supply and demand. In my October 7, 2016 article, I attempted to value gold based on supply and demand, AISC (all-in sustaining production cost), interest rates, and opportunity cost. And followers of Avi Gilburt know that he uses sentiment to help value gold. Since uranium is primarily used for energy and nuclear weapons, I assume that the value of uranium follows much like copper, meaning its value follows the inflation-adjusted price, AISC, and supply and demand.

Inflation-Adjusted Price

Below is the graph of swap futures sentiment prices of natural uranium (U3O8). Since 2011, the futures price has been falling by about $7 per pound each year. It bottomed in December 2016, which was also the lowest since 2004. The futures price has bounced off that support line and could head up to the $35 resistance line. As of March 15, 2017, the futures price was $24.50 per pound.

Source: Indexmundi.com

But as Cameco (NYSE:CCJ), "one of the world's largest uranium producers providing about 18% of the world's production," states, "uranium does not trade on an open market like other commodities. Buyers and sellers negotiate contracts privately." Thus, the spot price is an estimate of the "immediate purchase of a single pound or kilogram of uranium." The long-term price, an estimate based on the several long-term contracts, is where most uranium business is conducted. Two analytics companies, TradeTech and Ux Consulting Company, calculate the spot and long-term prices. According to Cameco's CEO, in June of 2016, utilities were not signing many long-term 10-year contracts, and were instead signing more "mid-term 2-year contracts" as prices could go lower. Also, producers seem hesitant to sign long-term fixed contracts at current prices, preferring variable long-term contracts. The spot price shown below very closely matches the futures price shown above. It seems that the long-term price moves about $7-10 above the spot price. The December 2016 long-term price was the lowest since 2006. Long-term prices have bounced off that support line and could head up to the $50 resistance line. As of March 6, 2017, the spot price was $25.50 per pound, and the long-term price was $33.00 per pound.

Source: Cameco: Uranium Price

In a March 26th, 2007 Seeking Alpha article, the spot price of uranium from 1947-2007 was adjusted for inflation. Extending the graph from 2007 to present and adjusting to inflation yielded a 2007 annual high of about $115, the same high hit in the late 1970s. Resistance lines are at $41 and $61. Thus, it seems that the spot price of natural uranium may have a hard time rising above the $35-41 level in the near future.

Source: Seeking Alpha: March 26th, 2007 and Created From Above Data

AISC (all-in sustaining production cost)

Just like rare earth metals, uranium is a common metal, and its supply depends on how much can be extracted economically. As of November 2016, the marginal cost of production, the cost to produce one additional unit of output, of uranium miners was estimated to be about $40-50 per pound. About the same time, the Husab mine in Namibia, the second largest uranium mine in the world, had an AISC slightly higher than $60 per pound. AISC includes general and administrative (G&A) expenses, exploration expenses, and sustaining capital, which is not included in the marginal cost of production. In March of 2016, the long-term AISC of uranium was estimated about $80 per pound. But a few producers can mine at much lower costs. As of August of 2016, Australian mining company Paladin Energy (OTC:PALAY), which "owns 75% of Langer Heinrich, the world's fourth largest open pit uranium mine located in Namibia," achieved a record low cost of production of $25.88 per pound of uranium and an AISC of $38.75 per pound of uranium. Thus, I will assume $60 is the minimum average AISC.

Supply From Nuclear Weapons

Source: World Nuclear Association

Uranium is used as fuel in nuclear power plants and nuclear-powered ships and used in nuclear weapons. The graph above shows that up till about 1988, supply of uranium from mining was greater than demand, causing a surplus in uranium. That surplus was largely used in the development of nuclear weapons, which peaked in the mid-1980s. The combination of a surplus and a peak in nuclear weapon development seemed to have caused a dramatic fall in supply of mined uranium from 1988-1993. But was there a shortage in uranium from 1988-2012? There was no shortage due to the presence of a "secondary uranium supply." Uranium from mining is considered "primary supply." Uranium secondary sources are "commercial stockpiles, nuclear weapons stockpiles, recycled plutonium and uranium from reprocessing used fuel, and some from re-enrichment of depleted uranium tails (left over from original enrichment)."

The conversion of nuclear fuel from nuclear weapons started in the 1980s, and countries around the world agreed to reduce their nuclear arsenal by approximately 80%. Total stockpiles were about 61,662 nuclear weapons in 1985, meaning that the world would need to deplete its nuclear weapons stockpile to about 12,332 nuclear weapons. As of March 31, 2016, there were over 15,000 nuclear weapons in the world. Russia and the United States have the bulk of the world's nuclear arsenal, with about 7,300 and 6,970 nuclear weapons respectively. If we assume that the world had about 15,000 nuclear weapons in 2016, about 1,505 nuclear weapons were depleted each year. This yielded about 8,850 tons of natural uranium (U3O8) each year, or 7504.4 tons of uranium. Thus, each nuclear weapon yielded about 5.88 tons of U3O8, or 4.99 tons of uranium.

Assuming straight line depletion, it would take only about 1.77 years from March 31, 2016 for the world to deplete its stockpile to about 12,332 nuclear weapons. Worldwide nuclear stockpiles are expected to be further cut to about 9,795 nuclear weapons by 2022 at a rate of about 634 nuclear weapons per year. Below is a graph of how depletion of nuclear weapons would affect supply.

Source: Created From Above Data

The wild card is if President Trump's denouncing of the 2010 New START treaty will cause an end to depletion and an increase in nuclear stockpiles. The treaty "caps U.S. and Russian deployment of nuclear warheads." If this does happen, uranium demand would possibly spike, and secondary supply would possibly plunge. If depletion goes as planned, secondary supply would still drop dramatically in about 2018.

Estimated Future Demand and Supply From Uranium Production

As shown in the graphs below, demand of uranium over the last several years has been nearly flat as mining production started growing in a nearly linear line from 2007-2015. But in 2015, Ux Consulting estimated that uranium demand would "increase by 53% through 2030." Assuming a 53% increase, demand could hit 102,843 tons of uranium by 2030, an increase of 35,625 tons from 2015 levels. This would mean that from 2015-2030, uranium demand would increase by 2375.03 tons (3.53%) per year. The trendline of current production shown below from 2007-2015 forecasts production would hit 94,402 tons of uranium by 2030, an increase of 33,906 tons from 2015 levels. Thus, 8,441.2 tons of additional uranium would be needed to meet demand. This could be satisfied by increasing production by 562.75 tons to 2823.15 tons per year, which is shown as a green line in graph on the right.

Source: Created from World Uranium Mining Production Data

Cameco "estimates world uranium consumption will increase from 160 million pounds (80,000 tons) today to about 220 million pounds (110,000 tons) by 2025," or an increase of 30,000 tons (37.5%). Taking 2823.15 tons per year from above and calculating the increase from 2015-2025 (10 years) yields 28,231.5 tons, slightly lower than Cameco's estimate for an increase of 30,000 tons.

Uranium Electricity Demand

Uranium demand is expected to increase largely due to increasing energy demand. Despite past recessions and slowdowns, world electricity demand has rose almost every year. Electricity demand is usually about 10% greater than consumption. The best fit polynomial trendline from 1968-2012 was added to historical electricity consumption data.

Source: Historical World Electricity Consumption

In 2012, electricity production by the world was 22,752 TWh (terawatt-hours), and about 10.8% was satisfied by nuclear power plants. In 2008, world electricity production was 20,279 TWh. The World Energy Council predicts world electricity consumption would increase to more than 40,000 TWh in 2040. But the IEA (International Energy Agency) predicts that nuclear energy will only increase from 10.8% in 2012 to about 12% of worldwide electricity production by 2040. Below is a table of calculated electricity consumption values using the trendline. Conversion used is one ton of uranium produces 0.0419 TWh.

Currently, there are 447 operational nuclear reactors in 31 countries, and 61 new nuclear reactors are under construction. Cameco expects about 480 reactors in operation worldwide by 2025. A typical 1000 megawatt reactor consumes about 200 tons of uranium per year. That yields about 96,000 tons of uranium consumed for electricity in 2025, not too much higher than the 92,495 tons calculated in the table above.

Naval and Ship Demand of Uranium

Based on the world uranium production and demand graph, the uranium demand for naval vessels and other ships have declined in recent years. It seems that such uranium demand was slightly higher than 2,500 tons in 2012.

Combined Uranium Model

Japan is the third largest consumer of uranium in the world. The 2011 Tōhoku earthquake and tsunami caused Japanese nuclear power plants to shut down, and utilities stockpiled "about 120 million pounds (60,000 tons) of uranium." In the graphs below, this caused a huge spike in uranium supply starting in 2011. Japan started two reactors in 2015, and plans to have 24 operating by 2017. The graph on the left shows that if production stays the same as projected earlier, it will take till 2030 for Japan to exhaust their excess uranium capacity (assuming Japan keeps 24 reactors operating each year) and for supply to equal demand. But the graph on the right show that if production drops to zero in 2017 due to uranium prices being far below the AISC and gradually increasing to about equal supply from 2018-2030, there would be a small shortage in 2017-2018. This could lead to a temporary spike in uranium prices.

Source: Created from above data

The graph below is "an adjusted uranium production forecast assuming uranium prices remain at US$40/lb for the foreseeable future." The model was created by Cantor Fitzgerald Canada Research. It also shows a shortage (deficit) starting 2017-2018. The difference is that the model predicts the deficit to grow, while the above right graph assumes that uranium miners will work to close the deficit. But either way, uranium prices seems to be heading higher in 2017-2018. Taking the minimum AISC ($60) and the projected yearly growth in demand (3.53%), the long-term price should hit $61 in 2018.

Source: Uranium Fundamentals Remain

Conclusion

Since long-term price is predicted to hit $61 in 2018, spot prices should hit $51-$54 in 2018. Besides investing in Cameco and Paladin Energy , the two miners mentioned in the article, Areva SA (OTCPK:ARVCF), BHP Billiton (NYSE:BHP), and Rio Tinto (NYSE:RIO) are three other big miners, although uranium makes up less than 40% of BHP's and RIO's revenue. The Global X Uranium ETF (NYSEARCA:URA), which is designed to track the Solactive Global Uranium Total Return Index, may be the safest way to play uranium.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in CCJ, BHP, RIO 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.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

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