While most people are aware of the huge rise in many commodity prices during the boom “super-cycle” that started at the turn of the millennia, there was one particular commodity that the crowd and mainstream public was unaware of (but nonetheless saw an astronomical rise in prices as well).
That commodity is Uranium (U, 92). Yes, uranium from the actinide series of the periodic table. It is used mainly in nuclear technology due to its fissile isotopes, generating heat in nuclear power reactors and providing the fissile material for nuclear weapons.
While commodities like crude oil, gold, copper and many more took the limelight in the past decade, the boom in uranium prices wasn’t so obvious to the general public. Uranium prices exploded upwards from 2003 onwards, moving from under USD 20/pound to more than USD 120/pound in 2007!
Like every commodity boom and bust cycle in history, a combination of the uncertainty of future supply as well as speculation of skyrocketing prices (triggered by expectations of nuclear programmes in emerging markets) have led to the five-fold increase in prices back then. Suppliers like uranium miners were also caught off guard initially, and began to expand capacity and ramp up production in response. However, the correction in prices after mid-2007 coincided with the start of the Global Financial Crisis, and uranium prices crashed more than -70% from its all-time high!
The deflating of the ‘2007 uranium bubble’ had a small impact on global nuclear power generation as the price of uranium supplies constitutes only a small portion of their overall operating costs and most power plants secure long-term delivery for their supplies.
However, the fallout from the crash in prices in 2008 and 2009 had a huge impact on companies focused on exploration and production (E&P), and this particular industry is said to have shrunk by more than -90% as a wave of bankruptcies and consolidation gripped the industry. In fact, some of the survivors are only kept afloat by those long-term contracts and deals made in 2005 and 2006.
Then, in 2011, the tragic accident in Fukushima Daiichi, Japan, led to another setback in the uranium industry as Japan shut down its fleet of nuclear reactors, dealing another blow to producers. To add salt to the wound, Germany’s politicians rather unexpectedly and somewhat illogically shut down its own nuclear power plants (and now they are struggling to obtain cleaner energy sources again). The developments in 2011 led to a further slump in uranium prices in both the spot and futures markets (dipping below USD 30/pound in 2014). According to The Economist’s data on nuclear reactors across the globe, the shutdowns in 2011 stood out rather obviously, making it the industry’s worst blow.
Five years on into 2016, with the continued gradual slide in prices, producers are in preservation mode as many have held back production. Optimism is low among many investors, and Main Street is generally unaware of this segment.
While Japan may not return to nuclear power, there is already an expected deficit in the supply and demand dynamic of the uranium market. According to the World Nuclear Association and data from Raymond James, the expected demand over the next 8 years is expected to outstrip potential available supply, which could lead to a recovery and surge in prices of the metal. A large part of the expected demand comes from emerging markets like China, India, Russia as well as Vietnam and Indonesia. Additionally, demand for nuclear power remains strong in the western nations like the US, which could lent support to prices of uranium moving forward.
While the expected deficit will not occur until 2020, a revival in prices could begin as soon as this year or next, as nuclear companies need to secure fuel way in advance prior to utilisation. This is firstly because they cannot afford to run out of supplies (that would cause a nuclear meltdown) and secondly; uranium supplies have to be processed into fuel rods (U3O8 ) before they are placed into reactors. The processing takes between 12 and 18 months according to industry experts.
Operators cover their expected uranium requirements at least three years out, and working backwards, this puts the expected time where operators start to secure supplies around late-2016 to 2017. Additionally, during the 2006-2007 price surge, many nuclear operators rushed with one another to close supply deals out of fear that prices would continue to surge. Many of these deals were 10-year deals – this puts the expiry date of these deals around now! This means that a whole bunch of contracts will run out by end-2017.
This leaves the industry now in a rather uncomfortable situation, with many operators slow in securing new deals because they have been able to load up on cheap uranium in the spot market over the past 5 years.
Many producers know a supply gap is imminent. However, higher prices are needed in order to incentivise future production. A surge in prices will be good news to many uranium producers, and it may not be a huge concern to operators as uranium represent an insignificant portion of their overall operating expenses.
Die-hard contrarian investors have all been fatigued waiting for this rather niche market segment to regain its glory, and while nuclear power competes with fossil fuels as well as other forms of renewable energy at present, the current situation of expected deficits have already taken into consideration a low oil price environment, given the fact that there is a general, perhaps even secular, shift away from relying on fossil fuels’ across the world. Many countries have projected nuclear power as a small proportion of their overall energy source mix over the next few decades, alongside wind, solar and hydropower.
Even Hong Kong’s business magnate Li Ka-Shing has made his move, perhaps in an attempt to go upstream for his companies’ utilities…
So, is it time for uranium to finally regain its glow?
Uranium equities have been on a constant downtrend in prices – the Global X Uranium ETF (which tracks the Solactive Global Uranium Index) remains at all-time lows relative to its history. This ETF is a great way of expressing a view on the entire uranium E&P industry, as the share prices have a high statistical relationship with the direction of uranium prices. Additionally, one essentially diversifies away company specific risks via an ETF.
Stock picking in this segment would be difficult, as many producers have raised/refinanced debt and diluted equity over the past 5 years in order just to stay afloat in anticipation of higher prices. Sticking to companies with strong sponsorships/backers and healthy balance sheets would be a way to navigate this segment. Additionally, companies that have lower break-even costs relative to the industry would be better positioned and could benefit more when uranium prices eventually recover upwards.
*I have long exposure to the above segment*