• Jonathan Jackson

Fuel For Your Portfolio

Updated: Apr 23, 2020

Why we Like the Uranium Market.

Although there is widespread concern over climate change, it widely accepted that the world needs more energy – global demand for electricity is expected to roughly double by 2050, driven by continued population growth, increased urbanisation, and higher living standards in emerging markets.

Nuclear power currently provides around 10% of the world’s electricity, and despite concerns over high construction costs, safety, and waste disposal, it is expected to remain an important part of the world’s long-term energy mix. This is because it produces a clean and, importantly, constant source of electricity, while helping to ease concerns over air quality and security of energy supply. The OECD International Energy Agency agrees – in its World Energy Outlook 2019, its decarbonisation scenario predicts energy generation from nuclear increasing by almost two-thirds by 2040.

The fuel used in a nuclear reactor is enriched uranium. As with all commodities, the uranium price is driven by the balance of supply and demand.

Demand collapsed in the wake of the 2011 Japanese earthquake, which saw Japan’s reactors taken offline, and decisions taken by a number of countries to either phase out nuclear power, ban the construction of new reactors, or slow down development plans. At the same time, new uranium production came onstream and the commodity price collapsed from a 2007 peak of almost $150/lb to a low point of around $18/lb at the end of 2016.

Looking forward, we believe the uranium demand outlook is positive. At present, there are around 55 nuclear reactors under construction globally (compared to 440 or so in operation), a further 110 or so in the planning stage, and an additional 328 or so proposed. The majority of the global pipeline of new reactors is in the developing world where one of the main drivers is the desire to improve air quality. In China, for example, where the ultimate goal is for nuclear power to generate 15% of the country’s electricity needs, compared to 4% today, uranium demand could quadruple. Elsewhere, Japan is aiming to generate 20%-22% of its electricity from nuclear in 2030. Although this is lower than the 30% level pre-Fukushima, it will require many of the country’s 33 operable reactors to be brought back onstream.

On the supply side, since 2017, and in response to the low commodity price, the world’s largest producers have cut production levels. More recently, the supply side pressures have been exacerbated by the effects of the Covid-19 pandemic, which has resulted in mine closures and further downward pressure on uranium production.

With around half of the world’s supply operating at a cash loss, we believe the current uranium price is unsustainable in the long term. There is little incentive to invest in new exploration and production and, as a result, insufficient capital is being invested in future supply. This is at a time when a World Nuclear Association report shows that, under all demand scenarios, the industry needs to at least double projected primary uranium production by 2040.

Although uranium represents only a small proportion of the cost of a nuclear power station, it is an essential component. As a result, customers do not come to the market right before they need to load uranium into their reactors. Instead they purchase their requirement years in advance, allowing time for a number of processing steps before it arrives at the power plant as a finished fuel bundle. For that reason, uranium doesn’t trade on an open market like other commodities; instead, buyers and sellers negotiate contracts privately.

At the peak of the last cycle, the long-term contract price was around $95/lb; today, according to Cameco, it has fallen to around $32/lb. As existing contracts struck at higher prices begin to roll off, the level of uncovered demand will increase further. It is estimated that US contracted coverage rates will fall to c. 50% by 2022, while the coverage level in Europe will fall to c. 70% by 2025. As the market begins to tighten, there will be increased pressure for buyers to return to long-term contracting, with new agreements expected to be struck at prices much higher than current spot levels.

Although the spot price of uranium has bounced in recent weeks from $24/lb to $32/lb, as a result of COVID-19 induced mine closures, we believe it has further to go over the medium term. Although there is little visibility over the timing of a pick-up in the commodity price, when the cycle does turn, history suggests it will do so very quickly and sharply. We note that between 2002 to 2007, the price increased 16-fold from $9/lb to almost $150/lb.

As a result, we believe, at this stage in the cycle, it is makes sense to have some long-term exposure to uranium in a diversified portfolio given its low correlation to other asset classes and the potential for a high level of capital growth when pricing improves.

In order to gain exposure to uranium, we would highlight three investments:

- Cameco, the Canadian-listed company, is the largest independent producer in the world, with high-grade reserves and low-cost operations.

- Yellow Cake is an AIM-listed company focused on buying and holding physical uranium. The company offers shareholders exposure to the uranium spot price, without the risks associated with exploring and mining.

- The Global X Uranium ETF tracks an index of companies involved in uranium mining and the production of nuclear components.

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