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Uranium price: long-term upward trend and short term spike likely [ClearOnMoney]
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Uranium price: long-term upward trend and short term spike likely

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Investment

Uranium price: long-term upward trend and short term spike likely

2 Aug 2010 by Jim Fickett.

Low-cost resources are more limited than had been thought, and the fraction of supply coming from such resources will decrease over the next 20 years; this will likely push prices gradually higher. Many experts expect some shortage in the next few years, with a resulting short-term price spike. Supply and demand are both lumpy; we can expect volatility. I am holding at my 3% position in U.TO, but may also buy some mining shares.

In what follows the “Red Book” refers to a joint publication of the Nuclear Energy Agency and the International Atomic Energy Agency, entitled Uranium 2009: Resources, Production and Demand. This publication provides the most comprehensive and authoritative view available of, as they say, resources, production, and demand.

Recent prices

There is no comprehensive, public, overview of uranium costs and market prices. But piecing together a number of sources can give a pretty good idea.

The 2008 cost of production was in the neighborhood of $15/lb U3O8. More specifically, comparing 2008 production, according to the Red Book, of 44 thousand tons of uranium (52 thousands tons of U3O8), to a supply cost curve in a 2008 presentation by BHP Billiton, we see that most mine production in that year was at a cost of between about $12 and $18/lb.

(Click for larger image. Reproduced by permission.)

Some costs have certainly risen since then. For example the Red Book explains that a new tax was imposed in 2009 in Kazakhstan, one of the lowest-cost producers. However the development of mines, the main issue, is a slow process, and presumably the cost curve does not change very much in two years.

There are two important selling prices, the spot price and the long-term contract price, with the latter covering most of the market. There is no exchange, and incomplete transparency for the lay investor, but specialist consultancies provide spot prices with some delay. The spot price bottomed at about $40/lb recently and on 28 July stood at $46/lb, according to The Ux Consulting Company. The long-term price stood at about $60/lb in June, according to Cameco, one of the large miners.

During the period 1997-2006 the spot price and long-term price were rarely very far apart. It seems likely that they will converge again.

The current spot price may be a little low. In January, Gene Clark, head of consultancy TradeTech, projected a spot price range of $45-60 during 2010 and 2011. On 27 July Uranium investing news reported that “Many analysts have been forecasting price projections of $50 to $55 per pound for next year”.

The cliff at the end of the cost curve

In the supply cost curve above, prices are fairly flat most of the way out the curve, and then rise steeply at the end. This is an important feature of the uranium market. It means that small changes in supply or demand can strongly affect prices. The matter was explained well in May 2009 by Dave Forest, a consulting geologist.

The Athabasca Basin … produces 20 million pounds of uranium yearly. That's 25% of total world output. …

The uranium here is remarkably high grade. Look at a few numbers for comparison. Ore reserves at the Cigar Lake deposit grade 17.5% U3O8. McArthur River reserves grade 14.6%. Now look at the rest of the world. Ranger, Australia is the world's second largest deposit, after McArthur River. Ranger grades 0.2%. Nearly 100 times lower grade than the Athabasca giants! In fact, the highest grade for major uranium mines outside of the Athabasca Basin is a meager 0.5% (for the Arlit and Akouta mines in Niger). …

… uranium is unique (relatively) because high-grade Athabasca deposits account for such a large share of global production. McArthur River alone produces 20% of the world's uranium. If Cigar Lake is developed (not a certainty following the recent flood), it could provide another 20% of world production. That's two-fifths of world output potentially coming from the most high-grade mines. …

[unlike for most metals] the uranium cost “curve” looks more like a hockey stick. … A staggering 95% of production can be had for less than $25 per pound. …

Most of the curve is relatively flat thanks to low-cost production from the high-grade Athabasca Basin (and a few other large deposits like Australia's Olympic Dam). This is the hockey stick's “handle”. But the blade of the stick comes at the very far end of the curve. Outside of the Athabasca Basin, Olympic Dam, and a few other low-cost mines, most of the world's uranium is held in relatively low-grade deposits. And these deposits cost a lot more to produce. Remember we said 95% of world uranium can be produced for less than $25 per pound. But the final 5% of global uranium production costs as much as $50 per pound. …

Suppose demand [is at] 95% of potential world supply … This level of production can be supported at a price of $30 per pound. Now suppose a few new uranium buyers enter the market. Global demand rises only slightly. Perhaps by a few million pounds yearly, or 1-2% of overall demand. But now we need to bring on the final 5% of global mine supply to deliver these extra pounds. And the final 5% of mines are high-cost compared to the rest of the world. In order for these mines to operate, we need prices to rise to $50 per pound. A 65% increase from our previous $30 price. And this increase needs to happen very quickly.

[A price spike can be] caused by a single, aggressive buyer looking for a few hundred thousand extra pounds of supply. …

Cameco's development plan for Cigar foresees eventual output of 18 million pounds yearly. That would increase the world's potential uranium supply by 20%. More importantly, this would be low cost production. Having 20% more cheap uranium would allow demand to expand without pushing the market into the “red zone” of high cost production and causing price spikes. The market would have a much easier time staying on the “handle” of the hockey stick. Stability would reign. This is why the flooding of Cigar Lake in 2006 was such a seismic event (no pun intended).

The upshot is that as the need for output from more expensive mines comes and goes at the margin, the price can be quite volatile. The large peak of uranium prices in 2007 was mostly due to speculation. But speculation always needs good stories, and the flooding of Cigar Lake provided one.

The low-cost resources will not last forever

Although the long term view is uncertain, it is useful to set the stage.

In most of what follows, I'll only discuss what the Red Book calls “Identified Resources”. These are the uranium deposits that have been at least partially characterized by exploration and are quite likely to actually exist more or less as described. As the Red Book describes it, Identified Resources “refer to uranium deposits delineated by sufficient direct measurement to conduct pre-feasibility and sometimes feasibility studies.” This is in contrast to Undiscovered Resources, that are based mainly on educated guesses working from a geological characterization of an area and parallels to known deposits. The main reason for restricting attention to Identified Resources is that mining companies naturally pursue the best deposits first, so the Undiscovered Resources, besides being much less certain, are likely, on average, to be lower quality and more expensive to mine, and hence to be somewhat less important for the price outlook.

One of the most interesting results in this year's Red Book was that Identified Resources in the lowest price category shrank considerably, partly as easier deposits were used up, but mainly because mining cost projections were raised higher.

For example, Cameco reported that, after three mine floodings and a significant overhaul of mining plans, their projected lifetime costs at the Cigar Lake mine rose from a 2007 estimate of $14.40/lb to a 2009 estimate of $23.14/lb.

(By the way, Cameco's technical report on the Cigar Lake mine makes fascinating reading. They are now in a three year period of pumping calcium chloride solution at -300 C through a system of boreholes, in order to freeze solid the whole mass of wet, unstable sandstone above the ore body. They will then conduct the mining by remote control in -100 to -200 C conditions, and replace each block of ore removed with concrete to maintain stability of the sandstone.)

Here are the Red Book cost classification results. Cost categories are cumulative; the highest cost category was used in 2009 but not 2007. Resources are in thousands of tons of uranium.

Cost category Identified Resources 2007 Identified Resources 2009 Change
< $100/lb U3O8 (> 5469) > 6306 +837
< $50/lb U3O8 5469 5404 -65
< $30/lb U3O8 > 4456 3742 -715
< $15/lb U3O8 2970 > 796 -2174

In the top cost category, the increase for 2009 is relative to the second cost category of 2007, which was then the top one.

The lowest price category, $15/lb, overlaps significantly with current production. The fact that the lowest cost category has shrunk substantially in the last two years is very significant for the price outlook.

If most low-cost deposits are indeed already known, and if the above estimate of about 800 thousand tons of low-cost material is about right, how long might it last? Reactor requirements, which are partly met by old stockpiles now, will probably largely be met by newly mined material after 2013. Reactor demand is expected to rise from 65-69 thousand tons in 2010 to 77-91 thousand tons in 2020.

If all the lowest-cost resources were used first, the 800 thousand tons in the low-cost category could be expected to run out in the early 2020s. Of course the real world is more complicated. For example, Cigar Lake is scheduled to start production in 2014 and produce (at fairly low cost, despite the difficulties) for 15 years. What we can say is that, as the low-cost resources are used up in the next 20 years or so, the cliff at the end of the cost curve will draw inwards, at the same time that production expands outwards. So the very long-term trend in prices is up.

I'll bring in two price projections by experts. But first, a look at the end of the main military surplus supply.

The end of Megatons to Megawatts

The 3-year price horizon is particularly important because (1) currently about 13% of supply comes from excess military material, but (2) the main agreement under which military material comes to market, “Megatons to Megawatts”, expires in 2013. Thus a significant ramp-up in mine production is needed in the next three years.

Here is the Red Book's summary graph for supply and demand projections through 2035 (click for larger image):

The key year to look at is 2014. If we look first at existing and committed production capacity, this is projected to rise to about 90 thousand tons of uranium. Actual production is normally somewhere around 80% of capacity, so that would suggest something like 72 thousand tons of production. Reactor requirements look to be in the neighborhood of 75 thousand tons. All these are rough estimates, and there will be some supply not from mining, so all we can say is that supply and demand look to be in approximate balance, based on existing and committed production.

If we take the higher estimate of production capacity, including planned and prospective production, then supply definitely looks adequate. However this broader measure of capacity includes all production supported by Identified Resources with cost up to $50/lb U3O8, implying that the market price would probably have to rise.

All in all, we can conclude, on the basis of rough, aggregate market data, that spot prices in 2014 may not be under pressure to rise if all goes as planned but, on the other hand, may indeed rise in the not unlikely case that demand outstrips the supply from low-cost mines. The markets will be somewhat on edge as Megatons to Megawatts runs down, and so small imbalances could cause outsized reactions.

Two projections

I have mentioned before a Fall 2008 analysis by the Macquarie Research commodities team. In it, they make more detailed projections of supply from particular mines, and demand from the reactors in each country, and project the overall supply-demand balance in each year 2008 to 2016. Their projection shows an excess of demand over supply in each year 2011 to 2013. Their guess, as of 2008, was that the spot price could rise to $90/lb in 2011, dropping back to $50 in 2016.

Cameco, in the technical report mentioned above, estimates their realized sales price in each year of mine production (2014-2028). This is only partly a reflection of market price projections. Cameco's pricing strategy is to sell about half of planned production several years in advance, at a conservative price estimate, to guarantee cash flow. The rest of production is sold either on the spot market or in more flexible contracts that have some element of market pricing. Still, in the end, the projections of realized sales prices reflect contracts negotiated by people intimately familiar with the market, and do say something interesting about likely trends in prices. Here are the projections:

Again, this is not a direct forecast of market price. However it suggests a price spike in the next 3 years, consistent with the Macquarie analysis. And it suggests gradually rising prices in the longer term, consistent with the Red Book's view of lower cost deposits being used up.

Conclusions

Both supply and demand are unpredictable in detail. Nevertheless, three things are fairly clear:

  • The lower cost resources are much smaller in volume than had been thought, and the fraction of supply coming from such resources will decrease over the next 20 years; this will likely push prices gradually higher
  • Most experts expect some shortage in the next few years, with a resulting short-term price spike
  • There will always be unpredictable changes in supply (technical and regulatory difficulties at mines) and demand (e.g. recent stockpiling purchases by China); due to the shape of the uranium cost curve, this means we can expect volatility

I will be looking into Cameco more thoroughly. They own a significant share of the remaining low-cost resources. That means that as prices rise they will have guaranteed profits for a long time.