The fantastic world of uranium

The fantastic world of

Uranium

The fantastic world of

Uranium

24/04/2020

INTRODUCTION

The quick thesis on uranium is that the world will need at least 700 million pounds of uranium in the coming years and there are only 500 million pounds available from current producers. The difference must be met by new mines that will need much higher uranium prices in order to start production.

What does this mean to us, investors? It means that there is money to be made. Hopefully, a lot of it.

In the last uranium cycle, the worst companies went up 10 times while the single best one went up 1000 times. That’s O N E – T H O U S A N D times. Those who have gone through it say that a uranium cycle makes Bitcoin enthusiasts feel like choir boys.

The way you invest in cyclical companies is when nobody wants them, when you start seeing shutdowns and bankruptcies, ideally right before an inflection point. And that’s where we are at right now.

But going against the crowd is easier said than done since everyone will be telling you that you should be investing in Apple instead of buying that lousy cyclical company. The opposite will happen when you sell them. That’s also the reason why you can make a ton of money in these companies, if you know how to “play” them correctly.

Cyclical companies are an attestman to human stupidity. Be it uranium, shipping, business real estate or any other.

When commodity prices are low, no one wants to build a new mine or a tanker or an office building. When prices start to rise, people start to take notice, some players will come into the market, but since no one really knows for sure if prices will keep rising, there won’t be a lot of new supply right away… which will make the prices rise even more. Then you start to see everyone wanting a piece of the pie.

But building a new mine or a new tanker takes time (about 7 years for a mine and 2 years for a tanker). Suddenly, after a few years, all of this new supply comes into the market at the same time creating a situation of oversupply which will lead the prices back down again, which will in turn force the weaker companies out of the business… and so it all starts again.

Now, I know what you might be thinking. Isn’t nuclear energy dead? Well, no. In fact, today uranium fuels 10% of the world’s energy. Nuclear power is actually a growing industry, expected to grow at 1,5% annually for the foreseeable future.

Take for instance the USA. Nuclear accounts for 20% of the country’s energy generation. Solar, wind and biomass collectively are about 3% of US energy supply and none of it can be regarded as baseload. Baseload power is that minimum energy needed to power a country. It has to be constant, reliable and cheap.

Nuclear is actually a clean form of energy. Apart from some mining operations, it emits very little CO2. But I’m not here to discuss the merits of the technology. I’m here to tell you about the investment opportunity.

I’m going to take you on a step by step journey through the fantastic world of uranium as I wish someone had done for me. After reading this, you will (hopefully) be able to dazzle your friends with your deep knowledge about uranium on the next time you get together for a beer.

The first thing we’ll be learning about is the Unarium Cycle. Then we’ll proceed to the industry analysis and to the reasons why I believe this can be a great investment opportunity.

URANIUM CYCLE

The Uranium Cycle is composed of 5 phases:

Mining (or Extraction)
Conversion
Enrichment
Fabrication
Reactor

1- Mining

Uranium mines can be Open Pit, Underground or In Situ Leaching.

Open Pit mines are common when the ore is relatively close to the surface. These are the mines with the greatest environmental footprint. They don’t require as much capital expenditures as the underground mines but they’re more expensive than the In Situ mines.

Underground mines have a smaller footprint (at least at the surface level), but they require much more cash, work and time and they’re much harder to mine.

Note that the mine’s floor on the picture below is flooded with water. McArthur River mine (one of the largest in the world) is situated underneath a river. Cameco – the company that owns it – has to constantly be pumping the water out of the mine.

In Situ Leaching seems to be the Holy Graal of uranium mining given that it’s a low cost method and its environmental impact is very limited. You drill several small holes in the ground until you reach the uranium ore, you pump an acidic mix through those injection wells and then you pump that solution back up to the surface.

Yes, there are some people worried about pumping acidic stuff into the ground and contaminating the groundwater.

After the extraction, the ore goes into specialized mills where the uranium is separated mechanically and chemically. What you get is U3O8 or yellowcake (it’s called this way due to its yellowish color, although most of the times it isn’t even yellow).

By the way, if you thought uranium was rare, it isn’t. There’s a lot of uranium out there in the world.

2- Conversion

After the extraction, the yellowcake is shipped into another facility where the solid uranium is converted into a gas (UF6) through a chemical process (I find it amazing that we can turn a solid into a gas). After being turned into a gas, it is put inside special canisters like the one below.

3- Enrichment

Now comes the cool part. The one that we hear about in the news when the US accuses Iran of enriching uranium for military purposes. The uranium – which is now a gas – goes into vertical centrifuge tubes, each spinning on its axis at speeds greater than 2x the speed of sound.

At these speeds, the molecules are separated. The heavier gas molecules (U-238) move to the outer part of the tube while the lighter gas molecules (U-235) stay in the center. The U-235 is the radioactive stuff. You take the U-238 out and keep the good stuff, the U-235.

Enrichment centrifuges work in a cascade of vertical tubes. After the gas goes through the first one, it passes into the second one, and then into the third and so on until the uranium is enriched up to 3%-5% (low enriched). This is the uranium used to power the reactors. The uranium used for weapons will be enriched up to more than 90%.

As most facilities can technically enrich uranium up to the grade they want, and it’s quite “easy” to enrich it a little more, it’s very hard to know if a country is enriching uranium for electricity purposes or for weaponry.

4- Fabrication

After the enrichment process, the uranium is transformed back into a solid in the form of pellets which then get assembled into rods which in turn are bundled in Fuel bundles and it’s those bundles that you see here that go into the fuel core at a nuclear reactor.

It takes anywhere between 18 and 24 months from the moment the uranium is mined to the delivery of the fuel bundles.

Bear in mind that each of these steps is usually performed by a different company. So a miner doesn’t usually convert uranium nor will an enricher mine the ore. Each to its own. The power utilities will buy the yellow cake from the miners, then they will contract the conversion, then they will send the uranium gas to the enrichment facility, etc, etc.

5- Reactor

New reactors require an initial fuel load that is 3 times the regular fuel load. After about 18 months, the reactor will pause and one third of the fuel will be replaced. Why one third? Because inside the core, the fuel rods “burn” unevenly depending on where they’re placed. The core is like a beehive… wait! It’s better if I show you one. Here’s a small one. Those “needles” are the fuel rods (or fuel bundles in the big ones).

There is even a discipline in physics that deals with the optimization of the rearrangement of the fuel rods to “burn” fuel more efficiently.

INDUSTRY

Now that you know more about uranium than anyone else you know, let’s understand the industry.

Spot Market and Long-Term Market

Uranium can be traded in the Spot Market or in the Long-Term market (also known as the Term Market).

The Spot Market is where “small” amounts of uranium can be purchased for immediate delivery. You buy it there, “on the spot”. There can be several different players acting in the Spot Market. From miners to financial traders, to the utilities themselves, to governments, etc to anyone that needs uranium immediately, although recent trades in the Spot Market are suspected to have happened between financial traders who don’t have a use for it other then reselling on a later date (thus tricking everyone into thinking that there is plenty of uranium out there when people see that uranium has been traded).

The Long-Term market is the “regular” market. Utilities negotiate the contract terms with the miners for deliveries of uranium over the span of several years. These contracts can last anywhere between 5 to 10 years, the average one being 7 years and prices are then published by independent market consultants (UxC and Tradetech). Bear in mind that after a contract is signed, the utilities don’t take delivery immediately. It will take at least 2 years before they see the first pound of uranium.

Just so you understand the complexity of this contracting, the negotiation process alone can go on for months. Many pieces must fit into place. No miner will start a new mine with one client alone, so when the first client comes to these miners asking for uranium, they will negotiate with him and then they will negotiate with others and then come back to the first one and so on… (yes, there are a lot of mines that are closed right now and many more that don’t even exist yet)

When you hear someone say that the price of uranium is $33 per pound, that is usually the price at which the last transaction in the Spot Market occured, not the price at which long term contracts were signed.

But the Spot Market is thin. What do I mean by this? I mean that most of the uranium that is bought and sold all around the world is through long term contracts. It’s the Long-term market that holds the industry together. Still, it’s the Spot price that investors focus on and it’s the Spot price that informs the whole industry.

John Borshoff (a living legend in the uranium world) said recently that the spot price “doesn’t matter but it authenticates long term pricing“. This means that both Spot and Long-Term prices feed each other off. If the spot price is lower than the cost to extract uranium (as it’s happening right now), utilities will buy in the spot. But this can’t last forever. At some point utilities will have to sign Long-Term contracts with the miners at higher prices. Then the spot price will have to go up (as it’s already happening).

So, both the Spot price and the reported Long-Term price have their shortcomings… but hey! This is how the industry works.

As we can see from the chart below, the spot price as come up a lot since the beginning of the year, but it’s still not enough.

Demand

Nuclear energy accounts for 10% of the world’s energy production. There are currently 442 nuclear reactors in operation (USA: 96, France: 57, China: 48) and 53 under construction (China:10, India: 7). An additional 107 reactors will be added by the end of 2030.

The nuclear fuel contracting happens in cycles. Not because it should but because things turned out that way. The last cycle happened right before the Fukushima accident. That was in 2011, exactly 9 years ago (remember when I said that contracts usually last between 5 and 10 years?). After the accident, the 54 Japanese nuclear reactors were shut down. That’s about 15% of the global demand. Not only that, but the Japanese utilities, who always keep around 2 years worth of inventory, had spare inventory that came into the market because they had no use for it.

Utilities are the main uranium buyers. They like to keep 2 to 5 years of Uranium (depending on if they’re western or Asian utilities) so they need to buy 2 years in advance.

They have been able to delay contracting by drawing down their inventories and buying uranium on the spot market.What does all of this mean? It means that contracts are expiring and utilities should come into the market and start contracting in mass. This is the basis for the whole uranium thesis. In a minute, we will see how this went in the last cycle.

The image below shows us 2 things. The future demand that is covered by the existing mines and the future demand that requires for new mines to come online. As we can see, in 2030, more than half of the world demand won’t be covered by the current mines. And at this point you might say “But 2030 is a long way from here”. Not in the uranium world. A new mine can easily take 10 years to come online. There’s pre-feasibility studies, feasibility studies, financing to be guaranteed, permitting, developing of infrastructure (bear in mind that these mines are usually in the middle of nowhere), profit sharing agreements with local governments, etc, etc, etc.

For the new mines to come online in 2030, you need to start working on them today. But no one will do it at the current uranium prices. When “the world” (aka utilities and the financial world) realises this, everyone will try to secure their uranium. It’s the perfect storm.

Supply

This is the time when I introduce you to KazAtomProm and Cameco, the two most important uranium mining companies in the world.

Kazatomprom (from Kazakhstan) is the lowest cost producer and accounts for 22% of the world supply. Kazakhstan itself accounts for 40% of the world supply.

Cameco (from Canada) is the other giant. It accounts for 9% of the world supply and it owns the largest and highest-grade uranium mines in the world.

I’m not going to write about specific companies in this analysis apart from these two, which are the most important ones. I will be looking into specific companies in the coming weeks.

Let’s look at the next chart together, shall we? (you can click on it to enlarge)

It represents all the mines that must come online to meet uranium demand in 2030. “come online” means “start producing.

The boxes along the x-axis represent mines, the width of the box reflects the size of production, the height is the costs of production. The white ones are the ones that were producing just before the coronavirus and the red ones are the ones that were offline or yet to be created.

The mines on the left side of the red vertical line are mines that are economical at the current price ($33) and that meet today’s demand. All the other mines on the right side of the red line are mines that must come online between now and 2030.

For instance, Cameco will need a sustained price of around $40 to put McArthur River (the first red one) back online. Then there’s Arrow at the same price and then the others will need higher prices.

The horizontal red line is an estimate of the price at which uranium has to be traded for to justify the start of production for all of those red mines. You see, if the uranium prices reach $40 next week, no one will build the mines that need to come online, even if that’s the price at which their operations would be economical. Higher prices are needed to secure funding and start things.

On this chart, the incentive price is at $60 but there are experts that point to $70. With the uranium price at $33 right now (up from $18 in January), it needs to double.

I know what you’re thinking right now. It seems that the uranium price could just rise steadily in order to allow for all of these mines to come online in a civilized manner.

That’s right. But it doesn’t work that way. As all other things uranium, even some of the prices shown in this chart by Redcloud aren’t consensual and are said to be too optimistic by several experts. On top of that, there is human behaviour and irrationality that will make the uranium prices shoot up. It has happened before, it will happen again.

The miners are considered to be the Primary Supply. Then there’s the Secondary Supply.

There have been several different sources of secondary supply over the years. After the Soviet Union collapsed, the US and Russia got into a deal to decommission the Soviet nuclear warheads, transform the highly enriched uranium into low-enriched uranium and sell it to the USA so it could be use in its nuclear plants. The USA got its much needed cheap energy and Russia got the much needed money. This was called the Megatons to Megawatts Program and it lasted for 20 years between 1993 and 2013. It accounted for about 20% of the world uranium needs per year.

As we’ve seen previously, after the Fukushima accident there was also uranium coming into the market after the closing of the Japanese nuclear power plants.

There are also other sources of secondary supply like government inventories and “underfeeding“. I won’t bother you with the technicals of underfeeding. I’ll just say that the enrichment facilities can squeeze more U-235 like if it was an orange and thus sell it into the market for a profit.

Unlike all the other commodity industries, the uranium industry is very opaque. Not even the guys that have been mining and selling uranium for their whole lives know exactly how much uranium is out there and who owns what. They have an idea, but they don’t know for sure. It’s fascinating.

PAST CYCLE

To understand what can happen this time, we need to understand what happened in the last time a similar situation took place. Let’s go back to the first chart on this write-up.

In 2003, McArthur River, the second largest uranium mine in the world was flooded. This created a supply shortage that rushed utilities into the market to secure their much needed fuel. But the financial players smelled the opportunity and also came into the space by buying a lot of uranium. The utilities panicked and that’s how the prices went through the roof. The price of uranium went from $8 to $140. It was madness.

You see, utilities are price insensitive because fuel (uranium) is just a small part of their cost (5%). Can you imagine 20% of households in the USA being out of electricity? Naaa! Utilities will pay any price to secure their fuel. That’s what happened before when they sensed that they could run out of fuel and that’s what’s expected to happen again. The last thing a CEO of a utility wants in his curriculum is to be held accountable for not having bought enough fuel.

Miners have a huge operating leverage which allows them to earn much more than the correspondent increase in uranium prices. “Operating leverage” means that they have high fixed costs in comparison to their variable costs. So a 10% hike in revenue can lead to 50% higher profits and thus higher stock prices (the opposite happens in the way down).

Here’s two examples from the last uranium cycle. I would say that these two are the extremes. Between these two there were countless multibaggers. The first one is Cameco, the most “conservative” company. It went up 7 to 10x depending on where you start to count.

And here’s Paladin Energy. It went up 1000 times!!!

The legendary Rick Rule had this to say about it: “it was the single most important financial event of my career“.

CURRENT SITUATION

So where do we stand today? We stand at what I believe to be the inflexion point everyone in the uranium world has been waiting for for the last 10 years. I’m not the only one thinking this way. The majority of the uranium experts (including all CEO’s) are saying the same. You can watch many interviews to all of the CEO’s here.

Around 90% of the Long-Term contracts are expiring in 2020. The utilities must come back to the negotiation table to secure their energy. There’s no other way around it.

As if all of this wasn’t enough, there have been several catalysts to the already pressing need for contracting:

In July 2018, Cameco announced that it was putting its McArthur River mine in “Care & Maintenance” (aka suspend it). McArthur River can produce 18M pounds of the highest grade uranium in the world. For the highest grade mine in the world to be shut down, this means that the current situation will have to change.

On March 23 of 2020, Cameco announced that it was suspending production at Cigar Lake (the largest mine in the world). Rossing and Husab, other important mines owned by the chinese have suspended production on March 28. Kazatomprom has also suspended all operations on Abril 7. Although no one knows for how long all of these mines will be shut, this is undoubtedly a serious event that will certainly worry utilities.

By now you might be asking yourself why have utilities let things get to this point? It’s hard to believe this, but they didn’t know what was happening. It took Mike Alkin and some other guys to go to their events and explain things to them. They were clueless. Mike Alkin is THE guy you should watch to understand all of this. Here’s a great video.

Section 232

I couldn’t end this analysis without talking about Section 232 and the Nuclear Fuel Working Group. The whole uranium world has been holding its breath until yesterday because of this. What happened yesterday?

In January 2018 , two of the few American uranium miners that are still alive, namely Energy Fuels (UUUU) and Ur-Energy (URG), have filed a petition with the Department of Commerce that asked for a mandatory requirement for US utilities to purchase a minimum of 25% of the uranium from US producers. Right now, they purchase a very small percentage from the US miners. 40% of it comes from Russian friendly countries. How can the USA rely on Russian friendly countries for about 8% of its power generation? Don’t ask me.

Well, this petition and the Working Group went back and forth for more than 2 years and yesterday the final report came out and it was…. an anticlimax. America is restoring its nuclear industry and this and that, but there were no concrete measures on it. Trump left it all to the 2021 budget. And since there will be elections this year, this might change.

The thing is, this was holding back utilities from coming into the market. If they had signed contracts with Russia or its friends and then Trump came and said that they couldn’t do it, they would be screwed. So the utilities just paused and waited for the resolutions to come out. It has finally happened to the relief of everyone.

Risks (or just things to bear in mind)

The bull thesis has been around for years. Each time it has failed whether because there was extra inventory in the world or because enrichers started to underfeed or something else.
Enrichment facilities continuing to “underfeed”. Underfeeding is something I must understand better because it’s a major risk.
Nuclear accident: This would definitely blow it. Having said that, after the Fukushima accident, reactors around the world have undergone major safety checks and the new reactors that are being built or planned have incorporated the latest safety measures.
Production increase from Kazatomprom
Existing inventory is bigger than expected (doesn’t seem so).

Conclusion: Prices are low and they must rise.

“We think the increased uncertainty of future supply along with rising price indicators will give the fuel buyers justification to sign contracts at price levels necessary to balance the market.” Brian Laks, Old West Capital Management

To sum it all up, the world produces less uranium than what it needs and the uranium prices must rise for several mines to come online.

There is no doubt in anyone’s mind that uranium prices have to go up. It’s just a question of when, not if. There is no “if”. Everyone in the industry knows it. And when it goes up (as it’s already happening), stocks will overshoot.

When will this be? It should happen soon but no one knows for sure. Everyone has been waiting for it for several years and that’s part of the reason why prices are so low (both uranium and stocks). Investors got tired of waiting. That’s exactly when you want to be investing in this industry.

So here it is. You’ve just gone through my uranium crash-course. If you’re still reading this, I must congratulate you. Many thing were left out but I think this is enough for you to get the big picture, right? In the coming weeks I’ll be doing a deep dive on the uranium companies to hand pick a basket with the best of the best. Those that can make an investor talk about them for the rest of his life. Cheers.

Selected material for further research:

Crux Investor (Youtube channel): Matt is a real classy guy who has interviewed almost every CEO in the industry.

Videos one and two of Mike Alkin. This is the guy that first discovered all of this. He’s like the Michael Burry of uranium (from the movie The Big Short). He runs his own fund and spent 2 years deep in the uranium world. He studied which mines are working, how long it will take for the new mines to come online, what are the costs of each-single-one of those, he studied every single nuclear reactor in the world, how much fuel it uses, etc, etc.

Cameco Conference Calls (Google them. They’re a great source of information)

Could you have made a fortune in Uranium? Excellent story about the last uranium supercycle.

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