Have We Reached An Inflection Point With Uranium Prices?

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Includes: CCJ, URA, URPTF
by: Dennis Berzhanin

Summary

Uranium investors have welcomed recent production cuts from Cameco and Kazatomprom.

The ever-increasing construction of nuclear reactors will cause demand to keep rising.

Political climate is the most favorable to uranium producers, since at least the Bush Administration.

Both Uranium Participation Corp. and Global X Uranium ETF are compelling ways to create exposure to the uranium market.

Introduction

Uranium has been one of the more controversial and important commodities in the last 10 years. Scientifically speaking, this element has the highest atomic weight of the primordially occurring elements. The primary uses of uranium are in nuclear power plants and developing nuclear weapons. One kilogram of uranium-235 (the only naturally occurring fissile isotope) can theoretically produce about 20 trillion joules of energy, as much energy as 1500 tonnes of coal.

As with other commodities, an important factor contributing to price behavior for uranium is the balance of supply and demand. This commodity had a huge run-up in mid-2000s, crashing during the financial crisis and heading lower after the Fukushima disaster in 2011. Since the accident, the price of uranium has plummeted by around 70%.

Source: Cameco

One of the biggest catalysts for the price decline was the closure of nuclear power plants, which lowered the demand for uranium. After Fukushima, the shut-down of Japan’s nuclear power industry eliminated 13% from global uranium demand.

In the last few years, many analysts have called for the bottom, but to no avail. Certain events in the last year, however, have signaled for the uranium price to stabilize. There are now major reasons why bull market should be around the corner.

We believe that we are now at the turning point for uranium. This article will provide reasons for our bullish sentiment by outlining recent developments, discussing the industry outlook and investment opportunities.

Supply

Earlier this month, uranium investors have been gifted with one of the most positive catalysts in recent memory. Cameco (NYSE:CCJ) (the world's largest publicly traded uranium company) surprised the market with an announcement that the company will suspend production of uranium from McArthur River and Key Lake Operations. Tim Gitzel said:

With the continued state of oversupply in the uranium market and no expectation of change on the immediate horizon, it does not make economic sense for us to continue producing at McArthur River and Key Lake when we are holding a large inventory, or paying dividends out of proportion with our earnings

The impact of this announcement is huge because it drastically reduces the supply of uranium. McArthur River is the world's largest uranium mine. Its closure will take 12% of global supplies off the market, significantly reducing the gap between production and demand.

This wasn't the first major reduction in the global production of uranium. Back in January of this year, Kazatomprom, Kazakhstan's state uranium producer, announced a 10% reduction in production for 2017, taking off 3% of the global market. As a country, Kazakhstan is an undisputed leader in production, accounting for 41% of uranium in the world.

The major contraction in the supply of uranium is clearly a strong bullish signal for uranium, but what about demand?

Demand

There are major catalysts on the demand side. Japan has shut down all of its 54 nuclear reactors post-Fukushima. Of 42 operable reactors, 3 are currently operating. Japan has little choice but to reopen at least some of their reactors, because the country does not have enough space to store all of the coal and liquefied natural gas that it needs to fuel itself. By the end of 2018, Japan plans to have 19 reactors running, representing a significant potential demand within a year from now.

Outside of Japan, the construction of nuclear reactors is on the rise. There were 60 reactors in construction in 2016, compared to only 23 reactors in 2004:

Source: The Stock Catalyst Report

Out of the 60 reactors in construction, close to half are in China and Russia. In the last two years, global construction of reactors has been booming with expectations for the strong trend to continue:

China in particular is focusing strongly on constructing nuclear power plants, planning to build 108 reactors by 2030. As their economy continues to grow mid to high single digits annually, the increasing need for more power production keeps rising.

At the same time, pollution has been a major concern for the Chinese. Shifting to nuclear power generation will help China to take steps to reduce carbon emission and improve its global image.

Source: The Stock Catalyst Report

Coming back to the supply side briefly, Russian-speaking/Russian-friendly countries outside the U.S. control nearly 70% of world uranium supply. U.S. directly imported 45% of its uranium needs from those countries.

Source: The Stock Catalyst Report

Nuclear reactors generate about 20% of U.S. electricity needs.

Source: The Stock Catalyst Report

Any further political complications between Russia and U.S. could further constrict the supply of uranium for the western markets. Without getting too much into the conflict, the current situation between those two superpowers could give rise to more sanctions and embargos. Uranium use by the Russians is a major bargaining chip, and any potential disruption in the supply could send the uranium price a lot higher.

During the Obama administration, Russia had gained significant advantages in uranium production. Back in 2013, Russia took Uranium One, a miner that is based in Wyoming, private. Post-acquisition, Russia became responsible for 20% of U.S. production. We believe in the current "America First" political environment, the current administration will be inclined to reverse that trend. One would imagine policies that would be put forth to incentivize more American production. For this to happen, of course, there must be an economic incentive that would occur primarily for a higher price in uranium.

While future legislations are uncertain, we can look whether there have been recent bills passed to indicate whether the political climate is favorable. Indeed in March of this year, U.S. Senator John Barrasso (R-WY) helped to deliver bipartisan legislation to promote innovation in the nuclear sector by enabling processes for licensing new reactors. This was all part of the U.S. Senate Bill 512. Mr. Barrasso prepared remarks to the President, stating:

The Energy Information Administration reports that uranium production in 2016 was at its lowest level since way back in 2005. It is crucial that we restore our American uranium sector and preserve these important jobs. Our bipartisan legislation is going to enable the development of innovative reactors with bold, new technologies. Now, as a nation we can either lead this technology revolution or we can defer to our competitors. Mr. President, China and Russia are developing advanced technologies regardless of what we do here in the United States. America needs to be a leader of nuclear development

U.S. government can sometimes respond slowly to changing economic trends. Up until Trump administration took power, the political climate for nuclear energy has not been favorable, especially to U.S. producers. It appears now the pendulum has swung the other way. Two months ago, President Trump and Energy Secretary Rick Perry proposed a mandate that coal, nuclear and hydroelectric power plants get paid higher prices than they are currently receiving. Perry has made saving nuclear plants a top concern. We believe the recent mandate and Bill 512 are the beginning of a pro-U.S. nuclear political stance, which Rick Perry and President Trump will no doubt continue to support. The rise of new nuclear reactors will increase the demand for uranium, which will boost prices.

So how should an investor take advantage of these incredibly positive industry trends on both the supply and demand side?

Investment Vehicles

There are many ways to play the uranium market. One way is to buy stock from uranium producers, whether it is Cameco or smaller producers and miners. For an average investor this may not be the most prudent way. Although there may be a higher upside, these companies have other risks, namely major expenses and high capital expenditures that could continue sending those stocks lower if the price of uranium does not continue to head higher. Big producers, such as Cameco, may cut more production while still generating losses.

Junior minors are even more volatile. We would advise only industry professionals and those who have intimate knowledge of the companies and science (ex. geologists) to consider those names. It would be critical to have the ability to actually visit the mining operations, since even sophisticated industry leaders have been victims of fraud.

Instead of investing in the companies themselves, we recommend considering Uranium Participation Corp. (OTCPK: URPTF) and Global X Uranium ETF (URA).

Uranium Participation Corp.

Managed by Denison Mines, Uranium Participation Corp. (Market cap of ~$434 million) invests substantially all of its assets in uranium oxide in concentrates ("U3O8") and uranium hexafluoride ("UF6"), with the primary investment objective of achieving appreciation in the value of its uranium holdings through increases in the uranium price. This security is not an ETF or an open-end or closed fund, but rather an actual publicly traded company.

The benefit of investing in this company is that an investor is essentially buying an exposure to uranium as a commodity (more direct exposure vs. buying a miner). About 2/3 of the uranium assets are in U3O8:

Source: Uranium Participation Corp.

The company has recently traded at a slight premium, which makes sense given the positive developments.

Source: Uranium Participation Corp.

Given major catalysts described in this article, we believe the company will trade at a greater premium going forward together with higher net asset values, should uranium prices continue to increase.

Global X Uranium ETF

Another way to play the uranium market is by purchasing URA, an ETF which has about $270 million of assets under management. The fund invests at least 80% of its total assets in the securities of the underlying index and in American Depositary Receipts and Global Depositary Receipts, based on the securities in the underlying Solactive Global Uranium Total Return Index.

The expense ratio is fairly low at 0.7%. Yet, there is substantial dividend of 0.94, translating into 6.7%. We believe that the high dividend yield makes this ETF very compelling and a good alternative to URPTF. MarketEdge currently recommends URA as Strong Buy.

Taking a look at how both investments have performed side by side, we see that as expected both securities move together; however, URPTF outperformed as of late:

Chart URA data by YCharts

Let's take a look at some of the risks before making an investment.

Risks

There are a number of risks to consider before investing in uranium. In the last 10 years, the industry has been brutal for investors and several risks still remain:

  • Global growth has been slow, which is not a bullish catalyst for the energy market as a whole
  • Cheaper alternatives, especially natural gas, are a headwind for nuclear energy
  • Another Fukushima-like event could shut down existing reactors and drastically reduce future construction of reactors, causing demand to plummet
  • More energy-efficient technology in both energy production and energy use will lower energy needs overall
  • Wind and solar, although not a significant threat, provide a clean alternative to nuclear energy

Conclusion

For many years, companies were producing uranium at below cost, losing money in the process. Finally, now they are starting to take major actions, taking supply off the market, which will boost the upward price move in uranium. Demand for nuclear energy is on the rise again, as major construction of reactors is underway. The political situation is now favorable for U.S. production to rebound.

Current uranium prices at around $30 per pound do not make sense in the current market environment. The price at which producers would break even is about $50-60. Until the uranium price doubles, we do not see any new production, thus little resistance for an upward move.

We recommend investors to take small exposure (no more than 10% of portfolio) to uranium via URPTF or URA, which are less risky securities than producers and miners. We believe the exposure to uranium should be maintained until the uranium prices double from current levels, which should happen within the next 18 months.

Disclosure: I am/we are long URPTF.

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 discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.

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