Tuesday, January 3, 2017

Uranium

Introduction

The price of uranium has been going down forever.  For 5 years, since the 2011 Fukushima disaster.  Or for 10 years on a longer term chart:

Source: Cameco

Although uranium use has been falling since 2011, 60 new reactors are now under construction, mostly in Asia:


Source: IAEA.  See World Nuclear Association for an updated & detailed table.

This is a 13% increase in the current 450 operational reactors.  The bull case for uranium is that an overreaction to Fukushima and the multi year slump in prices has undermined sentiment in the industry, halting exploration and curtailing mining.  And prices should see a massive jump when new demand comes online.

Economics of Nuclear Plants

Nuclear fission makes up 11% of the world's electricity.

Nuclear plants have high fixed costs, but have low operational costs and run for a minimum of 30 years.  It is hard to vary their energy output, so they are best suited to base-load power plants.

To startup (or restart) a reactor, you need twice as much uranium in the first year.  Most reactors will stockpile 7 years of fuel before starting.

Nuclear plants need water for cooling, so can only be operated in costal areas.

In the US, cheap natural gas may make nuclear plants uneconomical.  Exelon came close to closing 2 Illinois plants which were losing cash on an operating basis.  Even though the 2 plants were saved, I think its unlikely many new plants will be build in North America, due to the high upfront cost.  This won't affect nuclear plants in Asia - cheap natural gas cannot be exported from the US to Asia - once you do its no longer cheap1.

Solar and wind power are getting cheaper and may already be a parity.  But they don't provide electricity throughout the day unless we get improvements in battery storage.  So the alternatives for base-load production are nuclear (expensive, risky), coal (cheap, dirty) or natural gas (clean, expensive in Asia) or oil (expensive).  So I'd expect that nuclear plants will continue to be used for base-load power generation where cheap piped natural gas is unavailable, water is plentiful, and air pollution is a concern.


Uranium Demand, Supply and Stockpiles

Demand is straightforward as the only commercial use of uranium is for fuel.  The number of reactors operating, under construction and planned is known.  Forecast uranium demand is from up 10% over five years to 26% over 10 years.

Mines supplied 60,469 tonnes of Uranium Oxide concentrate in 2015.  The amount required was estimated at 63,404 tonnes in 20162.    The difference was made up by drawing down stockpiles.

No one knows how much is stockpiled.  Early uranium production first went into military stockpiles, then later on in to civil stockpiles.  Since the 80's, these stockpiles have made up the difference between demand and mine output:


Source: World Nuclear Association

Even the size of civilian stockpiles is uncertain.  It is suggested that China has stockpiled more than one worldwide year's supply of uranium.  Japan has been selling off its stockpile since 2011, and nobody knows how much they have.  Global inventory estimates are all over the place.  Nobody knows.

Cost Curve

The latest cost curve I can find is here, but its not labelled.  The article says that most mines were cashflow positive in 2015, due the falling currencies of commodity producing countries.  Long-term contract prices fell by around 30% in 2016, so some may be losing cash now.

The lowest cost producers are ISL mines in Kazakhstan, and Cameco's mines in Canada.

Cameco (NYSE:CCJ)

The textbook strategy while awaiting a commodity price turnaround is to buy the lowest cost producer.  Cameco is the lowest cost (listed) producer - its two biggest mines, McArthur River and Cigar Lake have ore grades of 16-17%.  Most other mines have grades of less than 1%.

Some quick back-of-the-envelope numbers for Cameco:
  • Profits in 2014, 2015 and 9-months 2016 were CAD 183m, 63m and 85m respectively.
  • You could add another 40m to 9-month 2016 profit, due to one-off costs in winding down Rabbit Lake 3
  • Debt is around 1.5bn.  Long term notes, mostly due between 2019 and 2025.

The trouble with Cameco is their massive tax dispute with the Canada Revenue Agency (CRA).  They are alleged to have engaged in transfer-pricing from 2003 to 2015, by selling to Swiss subsidiary at below market prices.  They may receive tax expenses of up to 1.7bn (maybe more 4), plus interest and penalties.  The case for years 2003, 2005, and 2006 is under trial now with a result is expected in 2H17 - the company says the amounts claimed for these 3 years are 'modest' and can be covered by cash.  But the results may be later applied by the court to the other years.  Cameco says they have not broken the law, and have only recorded a provision of $54 million (as of 3Q16).  The case is too complex for a layman to understand (1) (2).

The possibility of such a large payment adds an unknown binary element to investing in Cameco.  There's a small possibility the company is screwed.  In the worst case for example, having to issue 1.7bn in bonds at a 6% interest gives an expense of 100m, raising doubts about their ability to survive when uranium prices are so low.  Or issuing more shares, which would dilute shareholders, and come close to nationalising the company.


Global X Uranium ETF (URA)

Due to Cameco's potential tax problems, its may be better to buy the URA ETF instead.  It holds:
  • 22%: Cameco
  • 39%: Other Uranium E&P companies, that are currently producing.
  • 24%: Uranium exploration companies, not currently producing - more speculative.
  • 8%: Nuclear companies (involved in mining, processing and building/running reactors).
  • 7%: Uranium ETF (holding actual uranium)
Around 50% of their holdings operate primarily in North America, 10% in China/Kazakistan/Mongolia, and 8% in Europe.

Risks

Risks to the bull case are:
  • China's nuclear plans do not work out, perhaps due to economic problems.
  • Advances in battery technology make solar feasible for base-load generation.
  • We may simply still be in the downward part of the cycle - people have been saying that uranium will recover for years.  There still may be years more to go, especially since the size of stockpiles is unknown.
  • Cheap supply from Kazakhstan.
                 ___________________________________________

1 Majority of LNG price is from liquefaction - see the third slide here.
2 This was not actual demand, as it excludes some outages, but it was potential demand.
3 See question by Greg Barnes in 3Q16 Transcript.  Care and maintenance for shutting down the mine is immediately expensed from COGS, not capitalised over time.
4 Its unclear, see page 11

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