To the Uranus [Part 1]
Disclosure: I am a generalist, recently graduated retail investor who seriously entered markets in 2021. ALL of my research is borrowed from others (see references), I claim no credit for it, and merely intend to consolidate it for others to learn more about a sector.
Commodity bull markets are like rodeos, with violent ups and downs. Of all the rodeos, Uranium may be one of the hardest to ride: in the Uranium bubble from 2003-2007, companies like Paladin Energy went from lows of 0.01 AUD to highs of 9.14 AUD (914x) before crashing below 0.1 AUD, whilst Uranium equities had no less than 7 pullbacks in the 30-70% range on the way up.
A Uranium bull market is underway, and we are in the midst of one of these pullbacks. Despite the momentary lull, there hangs an air of inevitability over the market.
In this post, I will detail why we are in a Uranium bull market and how equities will benefit going forward. The TLDR is that supply falls far short of requirements for the next decade, Uranium trades below the marginal cost of production to service those needs, and fund flows to Uranium are likely to squeeze commodity and equity prices to very high levels. Uranium equities are not pricing in this fully, and have significant upside.
We will break down the components of this thesis. Post have 2 parts due to length (It’s hard to explain a whole industry).
Contents (Part 1):
Industry basics
Economics of Uranium: Why the boom-busts?
Fukushima Blues: How did we get here
Growing demand
Contents (Part 2):
Dismal supply
Summary and when/how much we will see Uranium prices move
When/how much we will see Uranium equities move
The bear case
How to play the sector: divergences between individual stocks
Closing thoughts
References
Industry basics:
In this section, I explain some basics necessary to understand the market: 1) what Uranium is used for, 2) the nuclear fuel cycle, 3) how Uranium is purchased and 4) Uranium supply overview.
Uranium is the fuel for nuclear reactors (which supply nuclear energy) and material for nuclear warheads. We will focus on the former, but will discuss the latter when relevant. Uranium demand tracks nuclear energy demand.
The nuclear fuel cycle is the process that turns Uranium into reactor fuel. Uranium ore is mined, then milled into U3O8 concentrate (Mining & Milling). U3O8 is then converted into UF6 (Conversion). The converted UF6 is of too low a concentration to be used as fuel, so it is enriched, with UF6 separated into 2 streams of higher and lower concentrations (Enrichment). The higher concentrates are fabricated into fuel rods (Fabrication), while the lower concentrates are stored or used in miscellaneous uses. From mine to fuel rod takes about 18-24 months.
Uranium is purchased via 2 markets, the spot and the term market. Most Uranium is sold on the term market, via 3-15 year term contracts between producers and utilities. Some material is sold in the spot market, defined as material purchased for delivery within 1 year. The spot market is relevant to the term market as contracts are often related to spot at the time of delivery (Fig 1). Producers, utilities and miners constitute 30-40% of the market, and the rest are traders and financial intermediaries. The importance of this will be discussed later.
Uranium supply can be divided into primary and secondary. Primary supply refers to mined Uranium. Kazakhstan is by far the world’s largest producer, with ~42% of global production, while Australia, Namibia and Canada are also major producers. Secondary supply is all non mined Uranium used to satisfy reactor requirements, estimated in recent years to be ~20-25% of global supply. It has a few sources: inventories held by utilities and governments, military warheads blended down for rectors (~15% of global requirements until 2013), recycled Uranium (~3% of global demand), lower concentrates depleted Uranium as detailed above (~3% of global demand), and underfeeding (~20M lbs or ~11.5% of global demand). Each of these are their importance will be explained later.
Economics of Uranium: Why the boom-busts?
Uranium prices exhibit extreme volatility (Fig 1). While it’s partially event driven, it’s also because Uranium demand and supply are both inelastic, and Uranium demand is procyclical.
Uranium demand is inelastic because Uranium is a small percentage of the nuclear electricity cost. Levelized cost of energy (LCOE), which is lifetime generation cost divided by lifetime electricity generated, is used for energy cost comparisons. Nuclear reactors are highly capital intensive, and capital costs constitute at least 60% of LCOE, with interest rates and construction charges important variables for capital cost. Fuel costs constitute 34% of operating costs, and Uranium constitutes 41% of fuel costs (Fig 2, but note it is from 2017, and Uranium spot price bottomed in 2017). Thus, Uranium constitutes at most 0.41 x 0.34 x 0.4 = ~5.6% of total cost. For some reactors, this figure is closer to 3%. Uranium price could increase greatly with a limited impact on fuel costs (Fig 3). Fuel costs can vary greatly with limited impact on LCOE (Fig 4). That said, for reactors where much of the fixed cost is paid off, operating costs become increasingly dominant. For plants in highly competitive energy markets where they are price takers, reactors can become uneconomical, such as Exelon that required subsidies to compete against cheap natural gas in 2021. However, even as a % of operating costs, Uranium is lower than most fuel sources at 0.41 x 0.34 = ~14% (Fig 2), with some estimates going as low as ~10%, meaning greater leeway to rise vs fossil fuels.
Uranium demand is also procyclical. A forced shutdown of a nuclear reactor due to fuel unavailability is catastrophic (21:30). Firstly, nuclear plants are huge sources of baseload energy, and their loss could destabilise the grid. Plant operators have to inform grid operators and provision for outages years in advance. Secondly, plant shutdowns are very uneconomic. Nuclear power plants are capex heavy, opex light, and run at high capacity-factors. Hence, fuel related outages are very costly, especially since outed plants have high maintenance costs as well, and take time and resources to restart. Thus, demand is scarcity driven rather than price driven. When Uranium prices rise as supply tightens, utilities rush in together to secure supply, and increase their inventories to insure against shortage. During the Uranium bubble of 2007, speculation of supply shortage due to the growing Chinese and Indian nuclear programs, a reduction in supply from weapon grade uranium, low inventories (23:00) and flooding of Cigar Lake mine (the largest undeveloped high-grade uranium ore deposit in 2006) led to massive contracting at all time highs. There is a principal agent problem as well; fuel buyers have no incentives (53:00) to buy cheap fuel, but are severely penalised for fuel related outages.
Uranium supply, like most of mining, is inelastic. New mines take 100s of millions of billions to build, and are not built without ample proof of demand. The entire process of starting a new mine can take 10-15 years. Even restarting a mine (many miners shut down during the bear market) can take significant time and resources. Paladin energy recently raised 282M to fund exploration and restart mines, including Langer Heinrich, which was idled a decade ago. Macarthur river’s restart process would take a year to 18 months to complete, and even then will not ramp to full production immediately.
Hence, Uranium prices are volatile. In a rising bull market, this creates the potential for outsized gains in both the commodity and equities.
Fukushima Blues: How did we get here
Before moving on to discuss demand and supply in depth, some brief history on the Uranium market:
Mid-1960s to mid-1980s: Rapidly expanding civil nuclear power in North America, Japan and Western Europe saw uranium production pick up. Western production peaked in 1980 and stayed above annual reactor requirements until 1985.
Mid-1980s to 2002: Accidents like three mile island (1979) and Chernobyl (1986) led to severe cutbacks in civilian nuclear programs, while utilities still had substantial long term contracts. Utilities satisfied requirements by tapping into significant inventories rather than new production. The supply overhang was extended due to uranium supply from the former Soviet Union starting in 1993. 20 year bear market.
Early 2000s to 2011: New dawn. An anticipated renaissance in nuclear growth, utility inventories drawn down, 2006 flooding of Cigar lake, etc. started a contracting cycle after a 20 year bear market. Uranium prices 13xed between 2003 and mid 2007. Prices cooled from peaks but remained elevated until 2011.
2011 to 2020: Fukushima blues. Fukushima caused Japan to shut its nuclear fleet and nuclear programs around the world to be cut back. Meanwhile, Kazakhstan emerged as the world’s largest low cost Uranium producer, leading to a supply glut. A brutal bear market ensues. Investment in exploration stops. Major mines are closed. MacArthur river, the largest high-grade uranium deposit, shuts down in 2017. Langer Heinrich shuts down in 2018. Cigar lake, the second largest high grade Uranium deposit, shuts down in 2020. Uranium equities bottom during the March 2020 covid sell off.
2020 to present: New dawn 2.0. With the decarbonization and energy security (due to structural supply issues and Russia Ukraine war) concerns, countries recommit to nuclear. Meanwhile, excess supply that had been worked through for a decade show signs of ending, with no replenishment in sight. Major mines like Cigar Lake, Langer Heinrich, and Macarthur river begin restarts. URA, a Uranium ETF, increases from $7.40 Covid lows to a local peak of $30.14 in Nov 2021.
It is the last phase we will focus on. It is key to understand the impending mismatch between supply and demand. According to nuclear fuel consultants Tradetech (Fig 5) and UxC (Fig 6), we enter 2022 with 200M lbs of Uranium demand versus only 135M lbs of mined supply for a 65M lbs deficit. This deficit looks to widen in the coming years.
Growing demand
Figures provided by industry specialists like fuel consultants can often differ (Fig 5, Fig 6). I am a generalist and obviously know less, but the purpose of this section is to examine the components of demand to 1) provide a sanity check and 2) ascertain that we are directionally correct with ample margin of safety.
The key idea is that demand for Uranium is set to increase over the next decade, due to:
Increase in primary demand for reactors
Increase in secondary demand from overfeeding
Increase in secondary demand from inventory building
Increase in financial demand from speculators
Increase in primary demand for reactors
Post Fukushima, many nuclear programs were cut back. However, the recent energy crisis, driven by structural issues and the Russia Ukraine war, as well as the need to decarbonize, have renewed commitments to nuclear energy. We will go through major nuclear producing countries and their nuclear programs. It is impossible to go through all developments, but the main ones will be covered. 2021 WNA reactor requirements will be used as ground truth. Note that tU is converted into U3O8 pounds via WNA conversion factor.
WNA estimates 2021 global reactor demand to be 162M lbs. A scan of all regions shows that demand will maintain or increase greatly, with huge growth coming from China.
United States (Largest nuclear producer)
The US has 93 reactors with 95.5 GW capacity consuming 45.7M lbs of Uranium annually. The US story is not a growth, but prevention of decline story. Post Fukushima, support for nuclear new builds and plant extensions was rescinded. Increased regulations increased costs by ~50%. Competition from cheap natural gas and shale oil made nuclear plants even more uneconomic. 12 nuclear power plants have been closed since 2012, following a 14 year period with no closures.
However, political stance on nuclear has reversed. Jennifer Granholm, US secretary of energy, stated in 2021 that “US needs nuclear to achieve net zero”. New policies at state and federal level are savings plants from closure. In 2022, Biden extends a 6B lifeline to save nuclear plants. Illinois Senate passed a bill in Sep 2021 for 700M in subsidies to save Exelon’s Byron and Dresden, which supply 20% of Illinois’s electricity (planned closure 2021). California is seeking subsidies to save Diablo Canyon, which supplies 8.6% of California’s electricity (planned closure 2022). As the US nuclear fleet approaches 40 years old, there has been a re-evaluation and desire to extend their lifespans. 88 of 93 reactors have already received 20 year extensions to their lifespan.
Popular opinion is shifting, as these tweets and this movie suggest.
For new builds, the administration is supportive of advanced nuclear designs, such as small modular reactors (SMRs), and invested 61M in nuclear research in 2021. Notable entrepreneurs like Bill Gates have invested heavily in nuclear innovation and are prototyping it.. However, building traditional reactors remains intractable. US’s only new traditional reactor being built, Georgia’s Vogtle, has been delayed from 2016 to 2023, with costs overruning from 14B to 30B. Regulations and the US nuclear supply chain issues means that traditional nuclear reactor fleet will likely not expand.
Overall, plant extensions will likely see US Uranium demand declining very mildly from 45.7M up to 2030. Any new growth will likely be far off and based on new technology. A conservative case may be 42M lbs annually by 2030.
China (Second largest nuclear producer)
China has 54 reactors with 52 GW of capacity consuming ~24.9M lbs of Uranium annually. It has 19 reactors under construction with 19.5 GW of capacity. The Chinese story is a growth story. China does not face the same issues of cost and time in building nuclear reactors, with 5B and 2 years per reactor (~1 GW) being standard. The plants are half or less of the cost in US, UK and France. Cost of power is competitive with coal, which China is by far the world’s largest producer of, and which supplies ~60% of Chinese power. With goals to be net zero by 2060 and energy security concerns, China is planning 150 new reactors, reaching between 120-150 GW by 2030, and adding ~150 GW of capacity by 2035. Proportionally, 2030 consumption of Uranium at 120GW would be 57.5M lbs annually. In calculating 2035 fuel requirements, it is not mentioned if builds are newer designs, and if they are optimised for fuel efficiency, but any changes are likely incremental in next 13 years. Applying a 10% discount for new fuel needs, we are looking at 24.9/52 x 150 x 0.9 = ~64.6M lbs of additional annual demand by 2035. Furthermore, the initial load of a nuclear reactor is 2-3x annual demand, coming to ~161.5M initial load requirements. Even if China misses their target and produces 100 reactors, we are still looking at ~43M lbs of additional annual demand (total 67.9M lbs) and ~107.5M lbs initial load requirements.
A conservative case may be 50M lbs by 2030, 67.9M lbs by 2035, not including one time reactor initial load of 107.5M lbs.
European Union + Switzerland+Ukraine+UK (“EU+”, largest nuclear producer as a region, France is world’s third largest nuclear producer)
EU+ has 135 reactors with a capacity of 121.5 GW. consuming 46.1M lbs of Uranium annually. EU+ is both a prevention of decline and modest growth story. Different members have different energy policies, but the broad trajectory has been similar to US. Post 2011, nuclear programs were slowed/halted/reversed (Germany will completely exit nuclear by 2022. France, third largest nuclear producer in the world, debated a partial nuclear phase out. Etc.). However, this is reversing in the face of an energy crisis and greater urgency for the green transition:
EU: The EU taxonomy, which establishes a list of environmentally friendly activities, is moving to accept nuclear, which would open the regulatory and financing gates for nuclear in the future. It’s a done deal, as opposition falls far short of what is needed to exclude nuclear.
France: Macron has committed ~50B Euros to building new reactors, with 6 confirmed by 2050 and an option for another eight. Macron also seeks to “extend the lives of all existing French nuclear plants where it was safe to do so”. France’s nuclear safety authority agreed in 2021 to extend the operational lifetime of the country’s 32 oldest nuclear reactors by a decade.
Belgium: Belgium pledged to close all nuclear plants by 2025 post Fukushima, but Doel 4 and Tihange 3 received extensions to 2035 in 2022. They supply ~50% of Belgium’s electricity needs.
Poland: France’s EDF has submitted an initial, non-binding offer to build four to six EPR nuclear reactors in Poland that would add 6.6-9.9 GW.
Netherlands: Netherlands pledges 5B Euros to new nuclear plants.
UK: Boris Johnson pledged to build 8 new reactors in the next 20 years. Rolls-Royce has also been engaged to make SMRs.
Overall, 8 EU+ countries have concrete plans to build new reactors: France, Finland, Slovakia, UK, Poland, Hungary, Romania, Czech Republic, Ukraine (pre-war). There are detractors like Germany, Austria, Spain, etc., but net there will be modest growth, with 14 reactors constructing/planned, and 18 proposed. This is not without challenges: in 2022, half of France’s 56 reactors are in outage, with 12 due to corrosion issues that could take years to fix. However, technical challenges are delays, and in the long run, nuclear energy will likely grow modestly.
A conservative case may be maintaining 46.1M lbs annual Uranium demand up to 2030.
Russia (Fourth largest nuclear producer)
Russia currently has 37 reactors with 27.7 GW capacity consuming ~15.4M lbs of Uranium annually. Russia is a modest growth story. Rosatom is targeting 24 new reactor units in Russia by 2045. Nuclear energy exports are also a major Russian policy. Over 20 nuclear power reactors are confirmed/planned for export. Foreign orders totalled $133 billion in late 2017.
A conservative case may be maintenance of 15.4M lbs of domestic Uranium demand up to 2030.
South Korea (Fifth largest nuclear producer)
South Korea has 24 reactors with 23 GW of capacity consuming ~11.1M lbs of Uranium annually. It is a reversal story. In 2017, the standing president introduced a nuclear phase out, but his successor in 2022 has scrapped the policy. Instead, the 4 reactors under construction will be completed, 2 proposed reactors will begin construction in 2022. South Korea is also an exporter of nuclear technology, and the president has pledge to export 10 nuclear power plants by 2030. Uranium demand is likely to grow modestly.
A conservative case may be maintenance of 11.1M lbs of domestic Uranium demand up to 2030.
Japan (Would be fourth largest nuclear producer if restarts occur)
Japan is a reversal story. Japan had 54 reactors which were all shut down after 2011. 33 of these remain operable and represent 31.5 GW capacity. Only 10 have been restarted since 2011. In a stunning reversal, Japan’s PM pledged in 2022 to an emergency restart of all nuclear reactors. It’s not always smooth, with local opposition, but 53% of the public is in support and political will is strong.
A conservative case would see a restart of 15 of remaining 23 reactors, which would be ~11.4M lbs of annual demand.
Rest of World
Impossible to cover everything, but many countries, such as UAE, Saudi Arabia, India, Vietnam, Philippines are constructing/planning nuclear power plants. Overall Uranium demand in the rest of the world is likely to increase (especially since many are growing from a low base).
Increase in secondary demand from overfeeding
This is both a supply and demand point, but we will discuss it here.
Uranium demand increases with nuclear usage, but is also a function of the economics of the nuclear cycle. There is a likely increased demand coming from overfeeding.
What is overfeeding? Enrichment has two inputs: unenriched UF6 and enrichment capacity, which is measured in Separative Work Units (SWU). They are substitutes. When feed is expensive relative to SWU, enrichers lower the concentration of the tails, extracting more Uranium out of the current feed (Fig 7). Thus, for a given amount of enriched output, less UF6 is used. This is called underfeeding. The opposite, when feed is cheap and more UF6 is used, is called overfeeding. Underfeeding is secondary supply as enrichers sell excess feedstock into the market, while overfeeding is secondary demand as enrichers purchase more feedstock.
The market is currently underfeeding 18-20M lbs of secondary supply per year. This is due to large excess SWU capacity built up but underutilized after Fukushima. SWU prices peaked at $160 in 2010 but crashed to ~$35 in 2018 (Fig 8). Enrichment has been in a bear market, with Urenco (30% of global enrichment) having “written off billions of dollars worth of assets”. Although excess capacity still exists (66700 vs 57456 required), increased enrichment demand had spot price recover to $51 and long term price recover to $61 (Fig 9) in 2021.
That said, WNA estimates surplus will remain until mid 2020s. Where will overfeeding demand come from? The black swan is Russia. Russia holds 43% of the world’s enrichment capacity. After the Ukraine invasion, both US and EU are discussing banning Russian Uranium. If 43% of enrichment capacity is sanctioned, enrichers will flip from underfeeding to overfeeding. Even if sanctions are not passed, security of supply from Russia is already greatly threatened. As discussed, utilities are willing to pay a high premium for security, this time with western enrichers. The market has confirmed this: Spot SWU is at $84, long term SWU at $130 (Fig 10) and looking to continue its upward trajectory.
What is the potential demand increase? Urenco is underfeeding 2000 tons currently, with 8000 tons overfeeding capacity. Orano is also underfeeding to a smaller extent. If we assume that Urenco and Orano, at 30% and 12.5% of global enrichment capacity, account for 30% and 6% of 20M lbs of secondary supply (likely underestimate as Chinese enrichment underfeeds less), and that flips to equivalent overfeeding, we are removing 7.2M lbs of secondary supply and increasing 7.2M lbs of secondary demand, a delta of 14.4M lbs.
Increase in secondary demand from inventory building
When there is perceived threat to security of supply, utilities build inventories in excess of normal levels, creating a surge in secondary demand. In the Uranium bubble of 2007, utilities accumulated huge surplus inventories, which have allowed them to sustain operations despite Uranium mine production undersupplying world reactor needs from 2011-2020 (up to 26%).
The nuclear industry is opaque, and it would be a fool’s errand for a generalist to estimate inventory levels, but the consensus among credible experts is that whilst not dangerously low, Uranium inventory levels are getting low. WNA estimates US inventories in 2021 to be 141.7M lbs, ~3x annual demand, a figure backed up by industry veterans like Jim Pelchat (a nuclear engineer with 25+ years in the industry) and Mike Alkin (highly credible fund manager that has spent thousands of hours studying Uranium demand and supply), among others. IAEA estimates 16 months for US utilities and just above 2 years for European utilities, which they described as “precariously low”, although this is unlikely to refer to total inventories.
With an impending supply shortage (Fig 5, Fig 6) and geopolitical risks, 3 years of inventory looks fragile. Procyclical spikes in inventory levels are likely. Even an increase in inventory levels by 1x 2021 annual requirement (less than previous inventory build ups) delivered over a 10 year contract can create 16.2M lbs of annual demand to 2030.
Increase in financial demand from speculators
The Uranium market is small and volatile relative to other commodities, and tends to suck in speculators. From 2004-2007, many hedge funds were instrumental in squeezing Uranium to higher prices. This time, the same thing is repeated on a larger scale. On July 2021, Sprott acquired UPC, a Uranium holding company. The new company, Sprott Physical Uranium Trust (SPUT), is intended to track the spot price of Uranium by buying and holding it. Everyday, its market cap is compared to its net asset value (lbs of Uranium held x spot price). If premium to NAV >1%, shares will be issued to raise cash to buy Uranium. SPUT is a closed end investment trust that cannot sell uranium or buy back its own units. This means for the foreseeable future, all lbs of Uranium bought will not return to market. It also provides access to retail, something that did not exist in the previous cycle.
The impact of SPUT has been breathtaking: it acquired UPC with ~16M lbs in Jul 2021, but as of 2 Jun 2022, holds 55.6M lbs, at a NAV discount of 0.31%. It holds 85.4M in cash for further purchases. Thats ~40M lbs, or 25% of GLOBAL 2021 reactor requirements sequestered in a year. As the Uranium bull market continues, further speculation is likely to drive this figure higher, although it’s impossible to pin exactly how much, as manias are hard to predict.
While SPUT is by far the largest physical fund, there are others. Yellowcake has increased Uranium holdings from 13.3M lbs in July 2021 to 18.8M lbs in May 2022, an increase of 5.5M lbs. In Nov 2021, Kazatomprom launched ANU, a physical fund “to store physical uranium as a long-term investment”. While it only has 74M raised, it’s significance cannot be understated. Sprott was successful because of it was able to promote heavily to it’s large western retail and institutional base, convincing entities like Goldman to invest. ANU, while new, markets to an entirely new base of ex-western investors. And last I checked, Asians are no strangers to degenerate gambling.
The collective effect of financial speculation has already been profound, and I believe there is room for much greater absurdity down the road.
Summary
Across all major regions, primary Uranium demand is likely to maintain or increase greatly. Flipping from underfeeding to overfeeding at western enrichers, as well as inventory buildup, provides significant secondary demand. Financial demand has and looks to be a wild card for this cycle that could tighten the market.
Equally bullish to the demand picture is the supply picture, which we will cover in the second post.
Very helpful overview ... thanks !
Nice overview. Thanks.