Uraniums Big Future

Hugo de Ville - Thu 19 Jul, 2007

Jeffrey Immelt, the CEO of General Electric, once said green is green. He was referring to how investing in clean energy could be profitable. Well it appears the nuclear renaissance is making uranium very green. The fever gripping commodity markets of late has now turned to uranium. In June the spot price of uranium hit $138/lb, a 200% increase on the same period just a year ago. In 2002 the average monthly spot price was just under $10/lb, by 2006 it was close to $50/lb. Are we reaching the end of the bull run? I think not. A couple of years ago, Goldman Sachs forecast oil prices could hit $100/bbl. This was the kind of dramatic headline newspapers crave for. In the end it peaked at $78/bbl. As for uranium I think the $200/lb threshold is realistic and likely to be hit over the next 18-24 months. So there is still time for potential investors in uranium stock to make a decent return.

Jeffrey Immelt, the CEO of General Electric, once said
‘green is green’. He was referring to how investing in
clean energy could be profitable. Well it appears the
nuclear renaissance is making uranium very ‘green’. The
fever gripping commodity markets of late has now turned
to uranium. In June the spot price of uranium hit
$138/lb, a 200% increase on the same period just a year
ago. In 2002 the average monthly spot price was just
under $10/lb, by 2006 it was close to $50/lb. Are we
reaching the end of the bull run? I think not. A couple
of years ago, Goldman Sachs forecast oil prices could hit
$100/bbl. This was the kind of dramatic headline
newspapers crave for. In the end it peaked at $78/bbl. As
for uranium I think the $200/lb threshold is realistic
and likely to be hit over the next 18-24 months. So there
is still time for potential investors in uranium stock to
make a decent return.

So what are the forces driving uranium prices to these
historic highs? As always it is the fundamentals of
supply and demand. On the demand side, global electricity
consumption is forecast to grow significantly. According
to the International Energy Agency world demand for
electricity will increase by a staggering 95% by 2030
compared to 2004. Given that nearly three quarters of
global power generation is from fossil fuels (oil,
coal and gas) this does not bode well for our future
carbon footprint.

The heightened focus on rising carbon emissions and
global warming, coupled with fears about security of
supply are the main drivers behind nuclear power’s
renaissance. The promise of clean carbon free energy
which is not dependent on energy imports from politically
unstable regions is encouraging many heads of state to
reconsider nuclear energy. As a result nuclear build is
back on the political agenda. There are presently 437
nuclear reactors operating worldwide, generating some
370,000MW of electricity. If all the reactors in the
process of being built, planned or proposed come online,
this would add another 286 reactors and contribute an
additional 70% of current generation capacity. Political
and regulatory hurdles may hinder some of this projected
new capacity. However, it is clear significant demand for
uranium is building up to feed these new reactors.

As for the supply side of the equation, this is when
things get really interesting. There is simply not enough
uranium to meet current demand. In 2006 demand for
uranium was around 146m lbs. Supply (that is mined
uranium) was only some 91m lbs. To bridge the gap the
industry resorts to secondary sources, such as strategic
national stockpiles and decommissioned nuclear weapons.

Historically, the industry invested little in growing new
sources of supply (Paladin Resources only recently
commissioned the world’s first uranium mine in over a
decade in Namibia). While secondary sources have baled
out the industry in the past, these stockpiles are now
close to exhaustion and suddenly the onus is on new
supplies. The supply picture has also been complicated by
two further factors.

Firstly, the industry is dominated by a core group
players (including Cameco, KazAtomProm, Rio Tinto plc and
Arreva) who represent some 77% of global production, any
supply disruption among this group suddenly has
significant ramifications for the global industry. Such
was the case of Cameco’s Cigar Lake mine, which as the
second largest uranium deposit in the world would
represent 10% of global production capacity. The project
was hit by flooding in October 2006 and is unlikely to
come onstream until at least 2010, further weakening the
supply picture.

Secondly, speculative activity by hedge funds is
exacerbating the supply context. Players are buying
physical supplies of uranium with some market estimates
suggesting they now own between 10-20% of global supply.
While it is difficult to confirm their exact share, it is
clear their activity is driving up the price of uranium.

So what does a bullish uranium price mean for those
companies that produce ‘yellowcake’? Well, as illustrated
in the chart below, share prices have certainly been
dragged upwards by uranium spot prices. Players such as
Cameco, Denison and Energy Fuels and SXR have all
benefited from the rising price especially since January
2006. Admittedly, the drag effect has been mitigated by
the fact the spot price reflects only a small proportion
of the market. The vast majority of uranium production is
bought by utilities on long term contracts of five to ten
years in length with a fixed price.

As with any rising commodity price, there are potentially
a few wild cards that could derail the uranium train. A
nuclear accident along the lines of Chernobyl would rally
popular opinion against nuclear and crush the
renaissance. However, given the industry’s safety record
since then, this is unlikely. Equally an unanticipated
release of uranium, such as from the US Department of
Defense might dampen prices. Nonetheless, the latter has
assured the industry it will not flood the market with
excessive volumes. Project risk will continue to play
either way. Unexpected delays in new supply will push up
the price, projects coming onstream as predicted will
soften prices.
As for the threat of product substitution this is
limited in the medium term. Thorium is often touted as a
‘greener’ alternative to uranium. It is more abundant
than uranium and produces less plutonium which could
subsequently be used for nuclear weapons grade material.
The hitch with using thorium as a fuel is that ‘breeding’
(thorium is not fissile in its own right) must occur
before any power can be extracted from it - and that
requires neutrons. Some engineers have proposed using
particle accelerators to generate the needed neutrons,
but this process is costly, and the only practical scheme
at the moment is to combine the thorium with conventional
nuclear fuels (made up of either plutonium or enriched
uranium or both), the fissioning of which provides the
neutrons to start things off. Several nations have
explored thorium based fuels but only India with its
large indigenous reserves has maintained an interest in
this area. A thorium-driven power plant is yet to be
developed, and advocates of the technology argue that
such reactors will be introduced within 20 years. So no
pressure on uranium for the time being.

In addition to all these factors, the uranium industry is
not the most transparent, which makes it hard to know
exactly what is going on. Uranium is not an openly traded
commodity on an exchange. Instead there are private
auctions with prices reported by a handful of
consultants. A futures exchange in uranium was launched
in May 2007 but this is still in its infancy. This lack
of data and transparency makes it difficult to assess
accurately the profile of this industry.

Having said all this, what is the prognosis for uranium
prices? Demand for electricity is growing with the onus
to deliver it cleanly ever greater. Nuclear energy is
going through a revival with a wave of new investment
coming online in the medium term which will require more
fuel. On the supply side, historically low uranium prices
have stifled investment in sources. New supplies are due
to come on stream but they will be subject to project
risk and the market will remain short on uranium for the
next couple of years. In view of all this there is still
an upside to the uranium price and the stock of the major
uranium players. All in all, the $200/lb threshold is
likely to be touched over the next 18-24 months, making
some investors ‘greener’ and others green with envy!

Regards,

Hugo de Ville
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