Going Nuclear - How Uranium will be Vital to the Clean Energy Transition
Before I begin this week’s article, I wanted to let you know that I am on holiday next week and therefore will not be publishing an article. Be sure to check out The Spark’s Instagram page for any market updates each day though!
There has been a lot of noise over the past number of years about the severity of climate change and the need for every nation to change the way it produces, stores, and uses energy. There has been a big push for a switch to renewables, not least through US President Biden’s recent $1.2trn Infrastructure Bill. Also, the recent COP26 climate conference held in Glasgow was a great way for the elites to plot their commitments for the energy transition and their own carbon-neutral goals. Over the past few years, the stock market has caught wind of this, and many renewable energy stocks have boomed.
To meet the energy needs of a complete transition to electric vehicles, smart cities, and so on, we need to expand our current electricity supply and make it more efficient. We cannot get to net-zero and meet our energy needs by shutting down our hydrocarbon and fossil fuel sources and relying solely on renewables, as they are inefficient. About 40% of the energy produced by an offshore wind turbine actually makes it to the grid. Also, we need sun for solar energy, an obvious problem for many countries such as the UK, and once again its efficiency is poor at around 20%. Further, many countries don’t have the water facilities to mass-produce hydroelectric power. For example, California has had a rain drought for years, and 80% of the state is currently classified as in ‘extreme drought’ (the second-highest rating). Pumping water from the sea to generate hydroelectric power would be extremely costly and again, inefficient.
Recently, the UK has had to switch coal-fired plants back on to supply the nation’s energy needs. Price surges, lack of wind, and the current energy crisis have caused mayhem globally. The electricity grid in California is unstable. Residents are being told not to charge their Electric Vehicles between 5-7pm as it would destabilise the grid. The infrastructure bills being passed as law around the world will hopefully improve the storage and capabilities of our nation’s grids. However, we need a cleaner, more efficient form of energy to supply our ever-increasing electrical needs.
Uranium is the answer
So, what is the ideal source of energy? In my view, the following features must exist in any potential solution:
- Zero emissions produced
- Capacity to generate a large amount of energy
- Ability to be stored for extended periods with ease
- Extremely efficient (80% or higher)
- The price of the raw asset doesn’t affect production substantially
Let me introduce Uranium, the only true form of clean energy. Uranium is mined out of the ground in places such as Kazakhstan, and transported to nuclear reactors, where nuclear fission occurs to produce raw energy, with no toxic emissions. In a nuclear reactor, the uranium fuel is assembled in such a way that a controlled fission chain reaction can be generated. The heat created by splitting the Uranium atoms is then used to make steam which spins a turbine to drive a generator, producing electricity. These chains use uranium rods and a single uranium rod lasts 6 years in a reactor, meaning there is no over-reliance on uranium demand for energy supply in the short term. Also, reactors last 80 years, and uranium fuel can be stored safely for decades, making it extremely efficient.
In addition, the cost of raw uranium isn’t the key cost for nuclear power. If the cost of raw mined uranium was to double, it would only add about 10% to the cost of the electricity produced, a key consideration that many don’t consider. With that said, obviously the rising cost of the commodity will affect the net profit for nuclear plants, but who is to say governments won’t subsidise these cost rises should uranium become one of the main sources of power in our new green world? President Biden’s $1.2trn Infrastructure Bill, which became law on Monday, includes $6bn in grants for the US’ 93 nuclear reactors. The US is also proposing a $15 per megawatt-hour tax credit for nuclear energy suppliers.
This fuel solves the green problem, in terms of cost and energy crises, and governments are starting to come around.
Current uranium production by country, Source: World Nuclear Association
Smelling the coffee
Countries around the world are planning to produce more nuclear energy. Whether you hate them or love them, there is no denying that China is the best country at seeking long-term improvement over short-term gains, unlike many western nations. China is currently building a dozen nuclear facilities, with 50 planned and a further 200 reactors proposed. It is also expanding its nuclear weapons supply, a hot topic at present.
In the west, French President Emmanuel Macron recently unveiled a 5-year plan worth €30bn aimed at reducing its dependence on other countries. His ‘France 2030’ plan will include investment in low-carbon emitting aircraft and the development of small modular reactors (SMRs – more below). France is keen on nuclear energy and acknowledges the opportunity that exists, building a ‘pro-nuclear European alliance’ of countries that will help make nuclear power adoption widespread. Rising natural gas prices and overreliance on other nations for their energy needs will further encourage such adoption.
All of these factors are leading to rising demand. So, what has happened in the uranium market and why is such a bullish case not leading to huge growth for the industry?
Am I missing something?
Safety is the stigma surrounding nuclear energy. Many think back to Fukushima. For anyone that doesn’t know, a huge earthquake occurred in Japan in 2011, and as a result of this earthquake, a nuclear plant located in Fukushima exploded, releasing radioactive material into the atmosphere. Although no one died, many were concerned about this after the events of Chernobyl years before. However, nuclear energy has the best safety record of any energy technology.
Previously disposal of waste products produced was another large problem, as although they were not damaging to the atmosphere, they were damaging to the earth, where they were stored in the ground. Thankfully the advancements of recent years mean the disposal of such toxic substances is no longer an environmental threat.
Some may also make the argument that it is mined from the ground and therefore isn’t environmentally friendly. But by the same token, we cannot say an electric car is clean if it was built or run using fossil fuel burned to generate the electricity needed for it. I understand uranium must be mined, but with 9bn people in the world by 2040, we will need commodities, and western miners are becoming more environmentally friendly as technology continues to advance.
So, what happened in the last bull market, and will the price crash happen again?
The market
There was a huge bull market for uranium stocks from 2004-2007, where the uranium spot price peaked at $134 p/lb. This corrected and started to recover with the strong fundamental story which I have outlined above. Then Fukushima happened. This hurt sentiment toward uranium. This event prompted Japan to close 54 reactors (10% of global demand), and Germany followed suit, closing three of its nuclear facilities. This led to a sharp decline in demand, but because these multi-million dollar production facilities were hard to shut down, they kept producing and the spot price continued to tank.
Uranium Spot price, Source: Bloomberg
Supply and demand is off-balance
Fast forward to today, however, and this oversupply has now been fully used, and the nuclear energy market is starting to boom again. We currently consume 200m lb of uranium globally per year, but only produce 120mn lb. Many uranium miners enter into multi-year contracts, and as the price continued to fall, uranium miners were becoming less and less profitable. They then refused to enter into new contracts, placing many of their mines in ‘care and maintenance’ until the price rises again. The breakeven price for a lot of miners is around $60 p/lb. It takes years and millions of dollars to build and operate uranium mines, and therefore the price of uranium would need to remain above $60 p/lb for a sustained period for a lot of miners to come back online. This has led to a supply deficit.
Historical and forecast Uranium Supply/Demand, Source: BMO
Alongside this supply glut, demand is continuing to increase, not only from countries in the longer term but also due to financial instruments that have recently entered the market. An Exchange Traded Fund (ETF) is a financial instrument that tracks the price of a basket (or individual) of assets. Several uranium ETFs have recently been listed on stock markets such as the Toronto Stock Exchange, for example, SPROTT Physical Uranium Trust. This is a closed-ended trust which aims to allow investors to gain exposure to the price of uranium. This Trust has an obligation to buy and store uranium as money pours into its fund. This is because, as money pours in, the share price of the Trust rises. However, this creates a differential between the value of the physical uranium held and the value of its shares. In order to maintain a tight spread between the two, SPROTT must go into the physical market and purchase uranium with the money investors have placed into their Trust, therefore raising the net asset value (NAV) of the Trust and closing the gap. This is sucking further supply out of the uranium market.
In the first four weeks of SPROTT’s IPO, the Trust purchased over 10mn lb of uranium and the spot price has boomed upwards from $32 to $52 p/lb. The price has now pulled back and sits at $43 p/lb. The crazy thing is, SPROTT alone is currently buying more than Kazatoprom, the world’s largest uranium miner, is producing annually.
There is huge potential for a continued up-cycle in Uranium at present. As the price continues to rise toward $60 (the breakeven price for miners), more investors will buy SPROTT and other such ETFs, which have to buy more uranium, leading to a virtuous cycle of buying leading to more buying. This is a huge short-term catalyst for uranium. Another shorter-term catalyst is if an ETF such as SPROTT were to list on the New York Stock Exchange (NYSE). Listing on the NYSE, where liquidity and money flow is roughly 13 times the size of Toronto, would lead to a huge boom in Uranium as institutions jump on board. There is also clearly longevity in the market, with many countries expanding their nuclear capacities to meet energy needs and climate targets.
Cameco PLC price chart, Source: TradingView
Adding modest exposure
One of the most exciting ways to get exposure to the Uranium market is through SMRs (above). SMRs have been used in submarines and aircraft for years but are now being used in nuclear reactors to generate electricity. They are: small; energy output can be controlled to match demand at different times of the day or seasons of the year; and they require far less land with little impact on the landscape, compared to many other renewable energy sources. SMRs are also used to power Elon Musk’s SpaceX rockets to Mars, showing the power these devices have. Unfortunately, many SMR companies are still private, but two involved in this market are Rolls Royce (RR) and Flour Corporation (FLR). RR is riddled with debt and has gone through a rights issue (Where a company issues more shares, diluting current shareholders) in November 2020, so I would tend to lean towards the engineering group FLR if I was to gain exposure. FLR is the majority shareholder in an SMR company and will give me modest exposure since this is not their only source of revenue.
In the mining industry, there are several ways I could gain exposure. In the TSX, I could buy the SPROTT Physical Uranium Trust (U.UN), but going for a miner means I gain leveraged exposure without having to pay fees to the Trust. MegaUranium (MGA) seems interesting. This is a risky option, but it holds equity stakes in a number of other miners, and its equity value is in the price for free, creating an arbitrage. In the UK, Yellowcake (YCA) plays the same role as SPROTT, buying and storing physical uranium. Most miners can be found in the US market, with one of the biggest players being Cameco (CCJ). Other options are Uranium Energy Corp. (UEC) or Denison Mines (DNN). These are smaller, more speculative plays, and may not have the liquidity to survive to be profitable, so be careful with position sizing and ensure to analyse the liquidity of the miner. UEC is promising because the CEO is very truthful regarding the outlook for the Uranium market and has been negative since 2013. There have been many false dawns in the market since 2013, but only now he is turning bullish, which gives me additional confidence in my recommendation.
Uranium is clearly an exciting opportunity. However, there are a number of potential threats lying ahead. The US Dollar is rising, which will put pressure on commodities. A rising dollar can also suggest two other things. One, that the market believes rate rises are coming sooner than the Federal Reserve is suggesting, and two, markets are worried. The US Dollar as the world reserve currency is a safe haven for investors when recessions or uncertainty hits. You will have seen in March 2020, after an initial drop, the US Dollar exploded higher as investors raced to it. Also, as I explained last week, the yield curve is flattening, suggesting the bond market believes the economy is heading for a downturn. I will take a 3.1% position in Cameco (CCJ) at $25.40 which I aim to add to should the macro-outlook improve.
Until next time,
Peter
Disclaimer
This communication is for informational and educational purposes only and should not be taken nor used as investment advice, as a personal recommendation, or solicitation to buy or sell any financial instrument. This material has been prepared without considering any particular recipient’s investment objectives or financial situation and has not been prepared in accordance with the legal and regulatory requirements to promote independent research. Any references to past or future performance of a financial instrument, index or structured product are not, and should not be taken as, a reliable indicator of future performance. I assume no liability as to the accuracy or completeness of the content of this publication.