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| Brought to you by The Oxford Club | Saturday, July 2, 2016 |
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Is Uranium Set to Double?
 It's been a while since I've written about nuclear power and uranium. Because the typical utility runs on a number of different fuels, there really isn't a pure nuclear play to invest in.
Instead, many energy investors are drawn to uranium as a proxy investment. That said, uranium prices are in the dumper, and U.S. utilities announced the closure of six nuclear plants in the last month.
But a number of analysts feel uranium prices are set to double over the next two or three years. And a number of big hedge funds are betting big on an upswing in the price of uranium.
So I gave my friend Rick Rule a call. Rick - like my colleague Sean Brodrick - is one of the top natural resource mining and investment experts in the world.
Rick is the president and CEO of Sprott U.S. Holdings Inc. He leads a highly skilled team of earth science and finance professionals who enjoy a worldwide reputation for resource investment management.
He's made hundreds of millions of dollars investing in natural resources. If anyone knows whether this is a good time to jump into the uranium market, he does.
What follows is an abbreviated version of a conversation Rick and I had on Wednesday.
Dave: Rick, let's start with the big picture. What are your thoughts on the uranium market?
Rick: Given that the all-in costs to produce uranium are about $60 per pound, I would expect its price to at least double from its current $30 level over the next three to four years.
The bull case for uranium is pretty simple. It's the densest form of energy in the world. So if you're Japan or Taiwan or South Korea and you need energy security, there's nothing like uranium.
You can, in a fairly small warehouse, store enough raw material to keep your economy going for five years. The price of the fuel, relative to the value of the power, is so small, it almost doesn't matter. The fuel cost makes up between 2% and 3% of the operating budget of an old small plant... and far less in the total cost structure of a million-pound plant.
[Editor's Note: A million-pound plant means the plant uses 1 million pounds of uranium per year.]
Dave: The biggest cost is building the plant itself, right?
Rick: Amortizing capital, that's right. The ongoing compliance, material storage, handling and legal expenses are big, big, big, failsafe costs. Insurance and bonding, on an annual basis, cost more than fuel.
The second part of the bull case is simply the current market share that uranium has in the world's baseload capacity. In the U.S., which can afford to be anti-nuke, 16% of the baseload capacity is nuclear.
Which means that in the near term, we have no choice but to continue it. On a systemwide basis, 2% to 3% involuntary dips in power generating capacity are a threat to the grid; they could shut it down. Imagine the effect of a 16% drop.
And finally, both the International Energy Agency and Cameco Corporation (NYSE: CCJ) believe that the median cost of production worldwide in uranium (including the cost of capital, not just cash costs) is about $60 a pound.
So you make the stuff for $60, and you sell it for $27. You lose $33 a pound and try to make it up on volume. That obviously doesn't work. In order for the lights to stay on in a four- to five-year time frame, the price of uranium has to double in a four- to five-year time frame.
Dave: But there's another side to this equation, right?
Rick: Right. Here's the other side of the equation, the downside: Worldwide economic growth is very slow and doesn't seem to be making any upturns.
Secondly, one consequence of high energy prices of all types in the last decade has been that there is increasing efficiency in energy production and in energy use in a lot of energy-intensive industries. This has reduced demand for uranium. The avoided cost of uranium has fallen as a consequence of the fact that seaborne LNG prices have fallen by 60% over five years.
So, with natural gas priced at $15 per million Btus, the Japanese could easily make the case for restarting their nuclear power plant fleet. At $7.50 per million Btus, they can afford to wait if they're willing to take the political risk and postpone the inevitable for a while. Because now their natural gas fuel cost is only five times what it would be if they were running their grid from uranium as opposed to 11 or 12 times, which it was only four years ago.
The third issue evolves around the whole political and social concern, which is the fact that uranium is a pariah. And increasingly, the places that can afford to won't make the decision based on technology or economics. Rather, they'll make the decision based on politics and social preference.
Dave: So what's the most common bearish case for uranium that you hear?
Rick: The problems that are widely stated by the people who have a bearish investment thesis on uranium, ironically, are wrong. Their primary suggestion is that forms of alternative energy will back nuclear out of the equation, and I think that's a real falsehood.
I don't think, even with the increasing nonsubsidized economics of solar in warm climates, that it has the probability of going from 2% of total consumed electricity to 15%. The greater risk is how much cheaper natural gas and coal are than they used to be. And how much more energy-efficient big industrial users of electricity are.
An example would be that the building I'm in right now in Vancouver is now 50% more energy-efficient than it was 15 years ago as a consequence of retrofitting. That's pretty astonishing. And you would know this because you're an energy technologist, but most people in the market don't understand that the greatest source of energy in the world is efficiency.
Dave: You're right, Rick. I was trying to explain to someone not too long ago that the greatest source of energy is efficiency. They had trouble visualizing that.
I keep reading about U.S. nuclear plant closings. Six have been announced in just the past month. I'm having trouble seeing a doubling of the price of uranium as U.S. plants continue to close.
In the U.S., the problem seems to be that these nuclear operators aren't being properly compensated for their carbon-free generation. What are your thoughts on the global nuclear power sector as a whole? Is the U.S. closure of plants unique to this country?
Rick: Globally, they're closing old 250,000-pound plants that are pretty inefficient. If you compare the efficiency of the plants being closed (ingloriously called "firecrackers" by the way)...
Dave: They are some of the earliest designs from 40 years ago, correct?
Rick: That's right, and those plants are being replaced on a global basis by 1.25 million-pound Chinese and Emirati plants. From a U.S. point of view, we're in the process of permitting the building of two plants, which are million-pound plants, and we're closing six 250,000- to 300,000-pound plants.
Dave: So the net loss isn't going to be that great.
Rick: It's not going to matter. Now, the truth is, the future of the nuclear energy industry probably isn't in places like the U.S., where we have a lot of alternatives that we can afford. The future of the nuclear power industry, if it occurs, is going to be in places like Japan, in particular, which has a stated political policy of energy security.
There's just no way you can store five years' worth of LNG or coal. You can't do it. It takes too much space. There are probably 50 different facilities in Japan that could store five years' supply of enriched uranium.
LNG has fallen by 60% in nominal terms and more in real terms.
They understand in the Emirates and in Saudi Arabia that reducing the domestic demand for natural gas for power generation allows them to use that same natural gas for exports as LNG, or as feedstock for fertilizer or chemical production. In other words, the highest and best use of natural gas, ironically, in areas where they have a lot of it, isn't to generate electricity but to substitute nuclear power and use that natural gas for higher and better uses.
Dave: Rick, I'd like to thank you for taking the time to talk to me today. I always find it insightful, and this conversation was no exception. I'll speak with you again soon.
And we have our answer. Uranium is set for a double. I like Cameco. It is the world's largest uranium producer.
But there are certainly others out there. Sean recently profiled Cameco and Uranium Energy Corp. (NYSE: UEC). Both will certainly benefit when uranium starts to move.
Good investing,
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