Natural Resources

A hated commodity with huge upside

There’s one commodity that’s down three quarters from its 2011 level, and even more from its 2007 peak. But it appears to have found a base, moving sideways for the last year. With supply being slashed and steadily growing demand, it has the potential to rocket in future. The commodity in question is uranium.

A number of year back, my eyes were first opened to the potential for nuclear energy. That was when I read a book called “The Revenge of Gaia”, written by a renowned British scientist and environmentalist called James Lovelock.

Lovelock had concluded that nuclear power, fuelled by uranium, was the only practical, large-scale solution for cutting global emissions of carbon dioxide and slowing climate change. He was castigated and ostracised by much of the environmentalist community for his troubles. This made his change of heart all the more credible, at least to me.

So why is nuclear power production set to grow? First, some background. Global electricity consumption is growing at around 2.5% a year, and this growth is expected to continue for decades. A reliable source of electricity is the hallmark of a civilised society and the foundation of any economy.

I live in Argentina, a country that had regular power cuts until 2016 due to underinvestment in power infrastructure. Take it from me: it’s seriously tedious when the lights go out and the wifi is cut. Reading a book by candlelight is no picnic.

Many appliances are becoming more energy efficient, like fridges and TVs. But a lot more people are buying them each year, especially in the world’s vast and growing emerging markets. On top of that, the switch to battery electric vehicles has barely started, and they’re all going to need power.

At the same time, most governments are seeking to cut (or at least slow the growth of) emissions of carbon dioxide. The principal sources of carbon-free power generation are nuclear, hydroelectric, solar and wind.

Hydroelectric power is already widely exploited, and there is a finite number of suitable rivers that can be dammed. Both solar and wind power have huge growth potential, but they also have their limitations.

In the case of solar power, not everywhere in the world is especially suited to it. The sun doesn’t always shine, especially at night! Similarly, not everywhere is consistently windy, and even windy places have lulls. Finally, solar and wind power currently make up a tiny combined percentage of total global power production. They simply don’t have the scale to keep up with overall needs, even though both are still growing strongly.

This leaves nuclear power as the only carbon-free power source that’s easily scalable to meet growing overall electricity demand, and make up for falling production from the dirtier fossil fuels such as coal.

Nuclear power also has a key advantage over solar and wind power. It’s constant, and nuclear power plants can run 24 hours a day. This makes it ideal to provide the base load power for any country’s electricity grid.

As of 2016, according to a September 2017 report by the International Atomic Energy Agency (IAEA), nuclear power contributed 11% of global electricity production. The most committed country is France, where 73% of power comes from nuclear plants. But numbers are high in several other developed countries including Sweden (40%), Switzerland (34%), South Korea (29%), and the USA and UK (each 20%).

But most of the growth in electricity demand comes from huge emerging markets, and this is where the potential for nuclear power becomes really interesting. In China, less than 4% of electricity comes from nuclear power. In India, it’s less than 3%. These percentages are expected to grow substantially in future.

According to a January 2018 report from the World Nuclear Association (WNA), there are currently 440 nuclear reactors operating in 30 countries. At the end of 2017 there were 57 new reactors under construction, which represents an increase of 13%. There are over 100 more planned, and even more still at the proposal stage.

China alone has 38 operational reactors and 20 more under construction, with “many more” planned in future. India has 22 operational reactors, is currently building six, and has a further 19 planned. In fact, there’s a long list of countries currently building nuclear reactors. I counted 24 in a WNA report, from Argentina to Pakistan to the US.

Of course, nuclear power isn’t without its problems, such as occasional reactor meltdowns and the storage of spent fuel rods, which are highly radioactive.

You’ll probably remember the Fukushima Daiichi disaster that happened in March 2011. A huge, undersea earthquake off the east coast of Japan caused a devastating tsunami that hit the Japanese coast. Unfortunately, this flooded the Fukushima Daiichi nuclear plant.

Back-up power systems failed, causing reactor cooling pumps to fail. This resulted in reactor meltdowns and a major release of radioactive material. Yet, despite the catastrophe, even Japan currently has two new reactors under construction.

No doubt some severe safety lessons were learned. In the aftermath, countries such as Germany announced plans to completely phase out nuclear power. But it says a lot about the indispensable nature of nuclear power that the country at the epicentre of this disaster, Japan, is now constructing new reactors.

The IAEA’s bases case is for global nuclear capacity to increase by 42% by 2030, even taking account of the decommissioning of old reactors. That said, the high case is up 78% and the low case is up just 8%.

The ongoing growth of nuclear power means increasing demand for nuclear fuel, which, of course, is uranium. But there are two sides to every commodity coin. Price moves are determined by both demand and supply.

Uranium is most commonly found in nature in a compound called triuranium octoxide, or U3O8. It’s a yellow, powdery substance, and what’s dug up by uranium mining companies. The U3O8 is processed, eventually resulting in uranium-235, which is used in nuclear reactors.

Here’s a chart which shows the U3O8 price going all the way back to 1988:

You can clearly see how the price rocketed from less than $10 per pound in the early 2000s to over $135 per pound in 2007, during the commodity price boom. That was clearly a speculative bubble, after which the price collapsed to $40 per pound in 2009. It then shot back up to around $75 until the disaster in Japan, before steadily falling to today’s level around $20 per pound.

Commodity expert Rick Rule – from Sprott Global Resource Investments and who I’ve worked with in the past – reckons that the typical production cost for U3O8 is $60 per pound. This means miners are making a huge loss at current prices.

It also means the price has to triple for the industry to reach breakeven. This must happen at some point, and the price may go much higher.

Despite this, the uranium market remained in huge oversupply for many years. That was partly a hangover from excessive investment in new mines during the bubble years, but also due to supply from decommissioned nuclear weapons.

However, mined supply has recently been slashed dramatically. Kazakhstan used to make up over 40% of global production. But, according to my friend Nick Giambruno at Casey Research, Kazatomprom – the state-owned mining company – has reduced production significantly due to the low prices. It cut production by the equivalent of 3% of the global total in January 2017 and a further 8% in January 2018.

On top of that, Canadian miner Cameco Corporation, by far the largest privately owned miner, suspended around half of its production for 10 months, starting in October 2017. That took out another 12% or so of global production. Despite this, the stock price actually rose on the news, since it meant losing less money for now while the company waits for better prices.

This means that between a fifth and a quarter of global uranium production has been suspended for the time being, until prices become more economical for miners. That’s a massive supply shock, and must eventually drive prices higher as existing stockpiles run out.

Another thing to bear in mind is that nuclear power producers are relatively insensitive to the price of uranium. Over the life of a nuclear power plant, it’s reckoned that only 2-3% of the total cost is from the fuel.

Most of the money is spent on the plant itself, built to very high safety standards. This means, whether the price of uranium is $20 or $120 per pound, it will still be bought by end-users and doesn’t make much difference to the overall cost of power production.

Summary

Uranium production has been cut drastically, and is likely to fall further unless prices recover and miners can make a profit again. Meanwhile, demand from nuclear power plants is growing steadily.

At the same time, speculative investor interest is practically nonexistent. If a bull market in uranium gets rolling again, speculators could light a fire under uranium prices, just as they did in the 1970s, 2007 and 2010.

Because uranium is a commodity – and despite the long bear market – it’s still relatively speculative. So I recommend taking a position, but taking it in a relatively low-risk way.

That means avoiding higher-risk, junior miners and going for the most established ones. In this case, that means investing in Cameco Corporation (Toronto:CCO / NYSE:CCJ).

If you want to take a position on this hated commodity, with huge potential upside, I recommend you buy some Cameco stock. Tuck it away in your proverbial “bottom drawer”. Then forget about it until the headlines and TV bulletins are full of stories about the new uranium bull market and investors are desperately scrambling for a piece of the action.

It may take a few years to work out, but the profit upside could be spectacular.

Stay tuned OfWealthers,

Rob Marstrand

robmarstrand@ofwealth.com


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Rob is the founder of OfWealth, a service that aims to explain to private investors, in simple terms, how to maximise their investment success in world markets. Before that he spent 15 years working for investment bank UBS, the world’s largest wealth manager and stock trader with headquarters in Switzerland. During that time he was based in London, Zurich and Hong Kong and worked in many countries, especially throughout Asia. After that he was Chief Investment Strategist for the Bonner & Partners Family Office for four years, a project set up by Agora founder Bill Bonner that focuses on successful inter-generational wealth transfer and long term investment. Rob has lived in Buenos Aires, Argentina for the past eight years, which is the perfect place to learn about financial crises.