Investment Matters

Uranium: too low for too long

Clients will note that in October we took a position in Paladin, a uranium producer.  Uranium is the primary commodity used to fuel nuclear reactors.

Our position in Paladin reflects our view that there will be a sustained rise in the price of uranium in the near future.

Does nuclear power have a future?

Nuclear power has the distinct advantage of being able to provide a reliable amount of base-load power with relatively low greenhouse gas emissions. (some 66 grams per KWH, compared with up to 1,050 grams per KWH for coal). 

Fig 1

As a result, we see that while the cost of renewable energy is rapidly declining, nuclear energy will continue to have a place in the global energy mix. This view is re-iterated in forecasts by a number of authorities, including the International Energy Agency (IEA).

  Fig 22

 Unsustainable prices

 The price of uranium hit multi-year lows at the beginning of this year, reaching prices of $19/pound.

 

Fig 33

In our view, these prices are not sustainable in the long term, simply because they are significantly lower than the cost of production.

The full cost* of even the lowest cost producers range between $20-$30/pound (note – full cost is a measure that looks at a recovery of costs spent to deliver supply – it does not factor in the return on capital or spending required to fund future exploration and development).

A sustained depression of prices

Prices have been depressed as a result of a flood of secondary supply (already mined uranium - such as inventories) onto the market. This has been a consequence of the sell-down of Japanese inventories post-Fukushima, excess enrichment capacity and the sale of surplus military stockpiles.

Furthermore, nuclear power utilities have been able to use inventory, which has allowed them to delay re-contracting with uranium producers.

A contraction in supply

It is our view that the above factors have changed recently:

  • The US has ceased sales of excess military stockpiles (early this year).

  • Japan has begun to restart its idled reactors.

  • Utility inventories are reaching critically low levels.

Furthermore, as a result of depressed prices, production has recently been cut to a level where supply will struggle to meet future demand:

  • A large number of producers plan to take their mines offline with approximately a quarter of total production (in 2017) being put into care and maintenance
  • Even the lowest cost producers in the market, Cameco and Kazatomprom, have had to make significant cuts to production, with Cameco choosing to fulfill existing contracts via uranium purchased on market rather than depleting its reserves

So, a rise in prices is on the horizon. 

As a result, we expect utilities will need to re-contract with uranium producers in the near term for future supply.

We expect future annual demand for uranium to range between 170-190 million pounds. As can be seen below, the costs of a majority of producers are well above the current market price of uranium ($29/pound).

Supply at current levels will not be sufficient for future demand, thus new contracts will have to be at prices that incentivise existing producers to come back online. It is therefore probable that the price of uranium will have to rise significantly.

Fig 4

The law of supply and demand dictates that the price of a commodity cannot stay below the cost of the lowest cost producer for long, meaning it is unlikely prices will head lower.

In our view an investment in uranium therefore provides an investment with an asymmetric risk profile: there is a significantly higher probability that prices will rise than fall.

Our investment in Paladin

Paladin has a Tier 1 producing asset in its flagship Langer-Heinrich mine. The mine is currently on care and maintenance, however, it can quickly be brought back into production once there is a sustained increase in the uranium price.

Furthermore, an analysis of its share price (based on comparable companies) reveals that Paladin is likely undervalued based on the implied price of its deposits:

Fig 7

Additionally, unlike the majority of other listed players, it has a producing mine and track record of operational performance.  We therefore see Paladin as the best way for clients to gain exposure to a future rise in the uranium price.

*Full cost = Operating cost + Capital cost. (Operating cost = Mining Cost + Hauling Cost + Milling Cost + Production/Property Tax + Environmental Tax + Royalty/Severance Tax. Capital cost = Acquisition/Exploration Costs + Mine Development Cost + Mill Construction Cost + Environmental/ Infrastructure Cost + General  & Administrative).

- Paul Grace