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Biennial uranium market review -- uranium still underpriced

22 Aug 2012 by Jim Fickett. (23 Jun 2013, biannual corrected to biennial.)

Demand for uranium is likely to continue growing, after a pause due to Fukushima. There is no issue with supply, given the right price, but the current price is probably too low to support necessary mine development. Uranium remains a good value.

The OECD Nuclear Energy Agency and the International Atomic Energy Agency recently produced their biennial joint publication, Uranium 2011: Resources, Production and Demand, a weighty (489 pages, $137) report on the state of the uranium market. Although Uranium 2011 avoids making market predictions, the report provides an indispensable backdrop for understanding market forces.

Demand

The report was first prepared with data as of 1 Jan 2011 but, after the accident at Fukushima in Mar 2011, projected demand for each country was revised with any official changes in policy up to 1 Sep 2011. Note that only official changes were recognized, not sentiment. Belgium, Germany, Italy, Switzerland have made official reductions in their planned use of nuclear power, and these are reflected in the projections, but since the Japanese government's official position was (and is) still that all reactors will be restarted, that is what is shown in the projections.

The price of uranium has been depressed since the Fukushima accident, in part due to a genuine slowing of purchases, as nuclear power operators delayed buying until the political fallout was clear, and in part due to speculative selling by investors. Here is a price history from a recent conference presentation, showing both long-term contract prices and spot prices (I am not endorsing all the other interpretive information on the graph):

Many news articles give the impression that with the negative public reaction in Japan, Germany, and a few other places, the nuclear power sector is on its way out. In fact, Uranium 2011 finds, after an exhaustive survey of the plans in every nation on earth, that nuclear power is likely to grow steadily for a long time. If we see another major nuclear accident, all bets are off but, presuming business as usual, long-term demand is likely to be at least approximately as projected by this report:

Here is the short overview:

At the end of 2010, a total of 440 commercial nuclear reactors were connected to the grid with a net generating capacity of 375 GWe [gigawatts of electric output] requiring some 63 875 tU [tons of uranium], as measured by uranium acquisitions. By the year 2035, world nuclear capacity, taking into account the current understanding of policies announced by some countries (e.g. Belgium, Germany, Italy and Switzerland) following the Fukushima accident, has been projected by the Secretariat to grow to between about 540 GWe net in the low demand case and 746 GWe net in the high demand case, increases of 44% and 99%, respectively. Accordingly, world annual reactor-related uranium requirements are projected to rise to between 97 645 tU and 136 385 tU by 2035.

Note that even if Japan were to abandon nuclear power, the low and high electric generation numbers would be 489 GWe and 681 GWe, giving increases over current generation of 30% in the low case and 82% in the high case. Further, arguments for jobs will win over fears of further accidents in at least some areas of Japan.

It is useful to see a careful projection, based on the best available data worldwide, of uranium demand. However as an investor, I do not place too much faith in any of the details. For the investment argument, all I take from this analysis is that uranium demand is quite likely to grow, requiring development of new mines over time.

Resources

A primary purpose of this report is to survey known and inferred deposits worldwide, and to estimate the total amount of uranium in the ground that is likely to be available in the future, at various price points. (The price points are in terms of cash costs, including current production costs, amortization of debt, and reserve replacement, but not new exploration for expansion of reserves, nor costs already completely paid. For reference, the current spot price is about $50 per pound of U3O8, or $130 per kilogram of uranium).

The two most interesting conclusions of the resource analysis are:

  1. If one includes identified resources that can be produced at costs up to about $260/kgU (double the current price), resources are more than 100 times current annual reactor requirements. The $260/kgU price point is worth considering because capital costs greatly outweigh fuel costs for nuclear power plants, and electricity could still be produced at competitive rates with uranium at this price. Even with projected growth in demand, this means that there is plenty of uranium for many decades.
  2. Even at a price point well below the current one ($80/kgU), there is probably enough uranium to meet demand for a few decades. The cheap uranium will not all be produced first, so this does not mean the current price is too high. It does mean that (a) prices will be determined at the margin of the cost curve, by the most expensive mines (more on this below), and (b) companies sitting on the best resources will make good profits for a long time.

Supply and cost

The price of uranium will be determined by the balance of supply and demand and, since demand is likely to grow fairly smoothly, the more interesting part of the price analysis is on the supply side.

There are two parts to supply – primary, which is new production from mines, and secondary, which is mainly re-purposing old nuclear warheads to make them into reactor fuel.

Secondary supply is often oversimplified. The “Megatons to megawatts” program, which for 20 years provided a significant fraction of total world supply from old Soviet bomb material, ends in 2013. This could result in a supply shock, and many who are new to the uranium market put forward a supply shock as a sure thing (I have made this mistake myself). However some military material will continue to be converted after 2013, and no one really knows how much. Further, there is almost no data available on commercial stocks. So it is possible that Japan, for example, could have a large stock of reactor fuel and could release some of it to the market if the nation does, indeed, scale back nuclear power significantly. After considering all the various sources of secondary material, and whatever data is available on when it may come to market, the Uranium 2011 report comes to the conclusion that secondary supply will very likely be somewhat smaller starting in 2014, but that it is very hard to tell exactly how much smaller.

So far, then, we have that demand will likely rise and secondary supply will likely fall. The question, then, is whether primary supply will rise fast enough to meet demand. There are certainly enough planned mining operations to theoretically meet demand, as is made clear by the second figure above. But to try to get a little more quantitative, we need a business analysis.

Recall from an old 2010 post (Uranium price: long-term upward trend and short term spike likely) the concept of the supply cost curve:

This plots the cost of producing uranium, at some point in time, in increasing order from the cheapest to the most expensive mines. If you go out along the curve to the concurrent level of demand, and read up to price, you find the mine price which will, at the margin, determine market price.

A very helpful analyst report from JP Morgan (Uranium: Project deferrals likely to see the market in deficit for four years, by Mark Busuttil, Fraser Jamieson, Joseph Kim, Luke Nelson, Andrew Muir, and dated 10 Jan 2012), attempts to predict when various planned mines will actually come on line. They calculate the price needed for each project to provide a decent return to its backers, and assume that projects will not actually be initiated until the price rises to an appropriate level. They then calculate a series of future supply cost curves and, throwing in some volatility due to the bumpiness of supply, predict future prices. Here is a summary of their results:

2011 was a challenging year for the uranium sector, following the incident at the Fukushima power plant. However, 2011 also saw a number of announced delays to uranium project development. We estimate the incentive price for medium-term uranium projects is >50% above the current spot uranium price which will lead to supply being pushed out and the market moving into deficit. On that basis we foresee a tight market for several years and have increased our uranium price forecasts by 5% in 2012, 17% in 2013, and 21% in 2014.

  • Planned production growth is likely to exceed demand forecasts: We had previously written about the substantial new supply that is planned to come online over the next five to ten years. In aggregate, this new supply exceeds projected demand growth (even before Fukushima). However, there were several announcements of project delays or cancellations in 2011, with the proponents citing unsupportive spot prices. This suggests that supply could take longer to arrive than current projections by the developers.
  • We estimate the incentive price is ~US$80/lb: We have estimated the incentive prices for 20 greenfield projects that are expected to come online over the next 10 years. These projects represent total capacity of 66kt U3O8 versus current global mine production of ~62kt U3O8. The analysis indicates that the average incentive price for these projects is ~US$80/lb, versus the current spot price of US$53/lb. We would also note that, of these projects, not one has an incentive price lower than the current spot price.
  • We estimate the market will be in deficit for the next four years: We have modified our supply/demand forecasts to account for delays and/or cancellations to project development. We have only allowed projects to start if their estimated incentive price is lower than the forecast spot price in year one. The analysis suggests that the market will be in an aggregate deficit over the next four years, implying that spot prices are likely to increase.
  • Higher forecast uranium prices: We are increasing our 2012 uranium price forecast by 5% to US$63/lb, our 2013 forecast by 17% to US$70/lb, our 2014 forecast by 21% to US$85/lb and our 2015 forecast by 25% to US$70/lb. We have also lifted our 2016-17 price forecasts to US$60-$70/lb. …

as uranium prices have faltered in recent years, there has been evidence that the producers generally expect higher prices to support their expansion projects: [list of 7 big projects put on hold in 2010 and 2011] …

Based on industry data, we have estimated the incentive prices required to achieve a 15% nominal rate of return for a selection of 20 greenfield projects. These projects are expected to come online over the next ten years and represent total capacity of ~66kt U3O8 (compared to current global mine production of ~62 kt U3O8).

Many details of this analysis will no doubt turn out to be wrong. Some CEOs will be optimistic about the future price, and start mining before the price rises enough to guarantee a good return. Some projects will be initiated but run into technical problems. And so on. But the basic fact that the current price is too low to justify any of the major planned projects strongly suggests that the price will need to rise in order for supply to meet demand.

The analysis is supported internally by a list of seven big projects put on hold in 2010 and 2011. Furthermore, several more projects have been delayed since. Bannerman admitted in April that the large Etango project would be uneconomic at current prices. In July BHP Billiton announced that it would delay an expansion of the Olympic Dam mine, and Cameco announced it would delay the Kintyre project.

These are large projects, that make a big difference for supply. From the Bleu Blog in Switzerland:

In a recent JPMorgan Chase & Co. research publication, analyst Mark Busuttil said growth in Chinese uranium imports is expected to raise uranium prices as early as this year, reaching $85/lb within two years. “China will likely continue to import more uranium than its existing reactors require with the expectation of a significant roll-out of capacity,” said Busuttil.

Analysts at Raymond James are also betting on U3O8 spot prices rising later this year to reach as high as $75/lb once supply tightens in 2014 to 2016.

After this weekend's announcements, analysts may revise their forecasts toward an even rosier picture as both the Olympic Dam mine and the Kintyre project were expected to put hundreds of millions of pounds of uranium supply into the market in the coming decade.

The expansion of BHP's Olympic Dam was anticipated to yield 40.6 million pounds of U3O8 a year, or 17 percent of forecast global mine output in 2020. Cameco's 70 percent-owned Kintyre project, heralded as one of the world's biggest undeveloped uranium deposits, is expected to produce 40 million pounds of U3O8 over a seven-year mine life.

Delaying the Olympic Dam expansion by two years will remove more than one million pounds of annual uranium production from 2013 to 2014. More than 10 million pounds of uranium production from the second phase of the expansion will be pushed back to 2020, along with another nearly 22 million pounds from phase three not seeing production until 2027.

Once again, I am not willing to trust any particular timing prediction very much, but I think the case is quite strong that if demand holds up the price must rise in order for an adequate supply to materialize.

I consider uranium a solid, fairly safe, long-term investment, likely to at least preserve value and probably provide a decent return.