Cheapo Stock #1: Uranium
If somehow you’ve been living under a rock and haven’t heard about uranium’s wild ride, I’m here to fill you in. I would like to brag that I was *early* on the uranium bandwagon. I say that to buy some credibility for when I post an idea that flops. Let’s get into it.
Nuclear Power
Nuclear accounts for 20% of electricity in the U.S. and 17% in OECD countries. Nuclear reactors are fueled by uranium and supply baseload power the world relies on. As countries like China and India develop and grow, more energy will be needed to meet new demand.
Heavy public pressure to curtail carbon emissions globally cannot be overlooked. Nuclear power is one of the greenest energy forms when it comes to carbon emissions. It’s second only to wind and emits less carbon than other renewables such as hydro and solar. The graph below shows the environmental benefits of nuclear as a baseload power source in a green future.
If the world wants to reduce emissions, why haven’t we already pushed toward nuclear power? Well, a couple huge disasters, mainly Fukushima in Japan in 2011, have given nuclear a dirty reputation. It used to be political suicide to suggest nuclear over solar, wind, or even natural gas. However, that is changing recently with the public and lawmakers starting to warm up to nuclear.
Supply and Demand
In 2019, global supply of uranium (U3O8) was 143 million pounds, or 84% of demand. Supply was down to around 130 million pounds in 2020, while demand held firm at 170 million pounds. This supply shortage has been the trend for the past few years. Uranium spot prices have remained low since Fukushima in 2011. They got as low as $18/lb in 2016 and have been mostly hovering between $24-$30/lb the past few years. For reference, prices surpassed $100/lb in 2007 during the last bull market.
Uranium Production
Very few mines are profitable at current prices. The average cost of production is well north of $40/lb around the world.
Pay attention, this is the most important part. Producers have slashed production dramatically because spot prices have remained lower than the cost of production. It’s basic economics. Losing money? Stop mining until you start making it again. Cameco and Kazatomprom control the majority of global uranium supply, roughly 40% when they’re producing at full capacity. Both cut production beginning in 2016 and won’t ramp it up again until prices recover. Listening to Cameco’s earnings calls, they are committed to being patient until prices move higher. Their actions have backed it up, too. The same goes for Kazatomprom. Their production forecasts remain well below full capacity. If the two entities that control nearly half of world uranium production want a higher price, the price is going to go higher.
Cameco has the capacity to produce over 35 million pounds of uranium annually but produced only 10 million pounds in 2019 and even less in 2020. Beginning in March 2020, Cameco and others have shut down mines temporarily due to COVID-19. Cameco’s Cigar Lake is the highest grade mine in the world and was shut down temporarily in 2020, further complicating the supply picture.
These producers have been buying from the spot market to fulfill their long-term contracts. Cameco alone has purchased 50 million pounds over the past several years. Uranium prices can’t be below the cost of production in the long-term. They will have to move higher or else producers won’t have an incentive to restart production and supply will continue to be at a deficit to demand.
New Demand
New demand for uranium is reliant on new nuclear reactors coming online. Currently, there are about 440 active nuclear reactors in the world, and 50 or so under construction. Each new reactor adds roughly 500,000 pounds of uranium demand annually. If all reactors currently under construction make it to market, they would add 25 million pounds of uranium demand annually and widen the already large gap between production and consumption. Many of these reactors are due to get connected to the grid by the end of 2023. Additionally, there are over 100 reactors planned and another 330 proposed. Reactors coming online will get partially offset by reactors getting retired, but it will still be a net increase in demand.
Nuclear power plant uprates - modifications made to increase the electricity produced – are common and increase the amount of uranium each reactor consumes. There have been 165 uprates in the U.S. since 1977. The life of a power plant can also get extended, which has been happening frequently as countries are realizing the value of the clean energy nuclear plants produce. Read the news and you’ll notice countries like France extending reactors.
Industry Conclusion
The key factor is that average cost of production is greater than the uranium spot price. And if you remember anything from Econ 101, you should know this can’t be sustained in the long term. Producers have cut production dramatically and will wait patiently for the price to rise well above the cost of production in order for mining to be worth it. Cameco and Kazatomprom are committed to raising the uranium price. Read their earnings calls and see for yourself. The question is not “if” but “when” will prices go higher?
Utilities will soon need to secure long-term supply. Producers won’t be willing to restart production and sign these contracts at prices below their cost of production. Uranium makes up less than 5% of the cost of operating a nuclear plant. Because of this, utilities will secure supply almost regardless of price or else they can’t operate. They don’t bother to buy a ton when the price is low - they buy when they need it. This is what happened in the last uranium bull market and caused prices to rise quickly. The combination of these factors is setting up for a potential dramatic increase in uranium prices.
Sprott - A Gift From Above
Every investment needs a catalyst, something to set it on fire or else it will stay cheap for longer than you can hold it. The Sprott Physical Uranium Trust (TSX: U.UN) has been that and much more. The sole purpose of the trust is to buy physical uranium (U308). They began buying in mid-August and have purchased over 14 million pounds, an average of around 350,000 pounds per day. I’ll say that again for the people in the back - they have purchased over 10% of annual global uranium supply in less than two months. The best part is Sprott is not allowed to sell the uranium at any point, it’s removed from the market forever. They’re a permanent vacuum sucking up uranium and squeezing the price higher.
What has the price done? Spot uranium has gone from $30 to as high as $50 during the reign of Sprott. They still have $54 million in cash on hand to buy more and will continue to issue units whenever the trust trades for a greater than a 1.5% premium to NAV. A possible NYSE listing is also looming for 2022, which could mean big money flowing into the trust.
It’s a wonderful thing as a value investor to see something with both strong fundamentals and technicals. The fundamentals have been strong for a while, but it took Sprott getting involved to trigger the rally.
What Inning Of The Rally Are We In?
I have no clue. But I decided to post this because we’ve seen a pullback recently that I think new investors could use as an entry point. The price of Sprott reached C$17 in late September but now sits below C$15 even after rallying this past week. In my unexperienced opinion, there’s still solid risk/reward at these levels.
Not investment advice.