The case for uranium

In recent months, I have continued to make the investment case for particular “energy metals”, or those metals used in the generation or storage of energy. Our central investment thesis centres on the idea that throughout history no middle class has either sustained itself or grown without access to reliable and affordable energy….and a growing middle class is the backbone of any society. Despite the uncertainties surrounding the global economy today, I continue to believe that this thesis holds true and bodes well for metals demand in the future.

With the global economy essentially “treading water” and Central Bank largesse responsible for much of the economic growth we see in the world today, commodity demand in general has suffered. Mining shares, particularly junior mining shares, have also taken the brunt of this downturn as the “risk off” mentality has taken hold. This presents a dilemma for those who invest in commodities: sit on the sidelines until sustainable organic growth returns to the global economy, or invest now with the viewpoint that we are witnessing a great contrarian opportunity?

If you’re of the belief that now is the time to be conducting due diligence on various commodities, the question becomes, “which one or ones to invest in and how?” This obviously has much to do with your own personal preference, and in my case there are four metals in particular that I am watching closely. They are scandium, cobalt, tungsten and uranium.

There’s a great buzz surrounding uranium in the mainstream press. I continue to hear talk of another “uranium renaissance” now upon us. I don’t dispute that uranium demand is going to increase likely faster than supply can come on stream, but I’m not sure if it’s going to happen this fast as many of us would like. I see a couple of different reasons to be thinking hard about uranium right now. Some of these reasons we’ve heard before and some of them aren’t as well known, at least in my opinion.

Why uranium now?

First and foremost, when I look out across the entire energy metals complex today, I don’t see many truly contrarian opportunities. Typically, the “crowd” will tend to read a headline or look at a price chart in a downtrend and assume that the doom and gloom is justified and will continue indefinitely. Headlines such as these:

“Nuclear industry in the US withers as wind pummels prices” – Bloomberg, 11 March 2013

“Cost overruns embolden Vogtle foes” – Newnan Times Herald, 16 April 2013

…are the types that pique my interest. Is the nuclear industry really “withering” in the United States? Are all 100+ reactors just going to shut down in favour of other sources of energy? Is wind power really going to supplant nuclear energy? If so, when and at what cost? What about the global reactor fleet? The size of the fleet (approximately 435 reactors) dictates that the industry just can’t “wither” away. Any change in energy generation will take a great deal of time and money.

These are questions to be debated another time but, nonetheless, crowd psychology has played a role in denigrating nuclear power as a source of electricity.

Additionally, when we look at a spot price chart of U3O8, if you’re a true “bottom fisher” wouldn’t this indicate to you that perhaps some additional due diligence is warranted?

I think the answer is yes. Asking questions such as, “Why has the price of uranium fallen?” “What are the forces that have pushed it down?” or “Are these forces permanent or are they temporary?” is a sound analytical strategy. Answering these questions within the context of uranium says a great deal, again in my opinion.

A final note with respect to uranium as a contrarian play concerns Japan. Much has been written about Japan’s need to bring the bulk of its reactor fleet back online. I do not doubt that this will happen, but it will be much slower and more methodical than many investors hope for. Though the newly elected government in Japan is decidedly pro-nuclear, there appears to be substantial resistance to nuclear power in Japan and this resistance will hamper efforts to quickly restart many of the reactors that have passed adequate safety inspections.

Existing nuclear infrastructure

Another reason to be optimistic on uranium demand has to do with the fact that much of the infrastructure for nuclear and its integration into the electricity grid is already in place. Substituting another form of base load power for nuclear is not an easy task from an engineering perspective and also calls into question the economics of such a move. The decommissioning and deconstruction of a nuclear reactor is a long-term expensive proposition fraught with challenges.

According to the Nuclear Energy Institute, the decommissioning of a nuclear reactor can cost anywhere from US$500 million to $1 billion and last for years. Who will pay for this? The operator? The taxpayer?

In an age of fiscal austerity and budget sequestration, the path of least resistance is likely the optimal one. This would indicate that the re-licensing of the existing nuclear infrastructure, rather than decommissioning reactors, is the path forward.   

To be clear, there are many challenges with nuclear power including waste storage, NIMBYism, the shale gas revolution, high up-front costs and the threat of another Fukushima-type event based on old nuclear technology. These cannot be denied, but again the necessity to “keep the lights on” outweighs these concerns for now. Thorium and other modular reactor technologies hold promise and will no doubt play a part in future electricity generation as well.

EROEI

Energy Returned on Energy Invested (EROEI) is a metric more and more people are using to try and get a sense for how economically viable disparate sources of energy are. I want to introduce this topic because it appears that nuclear power compares favourably when paired against other sources.

EROEI is defined as the amount of energy returned divided by the amount of energy invested, or:

EROEI = EReturned / EInvested

Essentially, how much “bang for the buck” do you get?

As more and more join the global middle class and as energy providers have to “dig deeper” for energy sources, this metric is declining, forcing those in charge of providing energy to look harder for low-cost sources of energy. Otherwise, energy prices rise and quality of life declines, hurting the poorest among us the most.

It has been claimed that certain renewable sources of energy have a higher EROEI than that of nuclear. The intermittency associated with most renewables, typically not factored in to the EROEI equation, puts nuclear power ahead of many of these sources of energy (except hydropower) based on my analysis. To be sure, there are many additional factors to be taken into account in this analysis, including the type of reactor and whether or not one accounts for the entire nuclear fuel cycle. I merely introduce this concept as it’s another way to judge the validity of nuclear power.  Below is a depiction of the nuclear fuel cycle to get a sense of how much energy is “invested”.

The global build-out continues

Though many are aware of this fact, I want to just reiterate a point on the scale and scope of the current nuclear reactor build-out across the globe. These numbers can always change, but as they currently stand there are 60 reactors under construction (in 13 countries), 160 planned and 320 proposed. This does not look like an industry “in retreat”.

Although it’s difficult to quantify just how much additional uranium will be needed and by when, many experts are forecasting a 3% per year growth rate in uranium demand out to 2022 which would put global demand by then at roughly 220,000lb U3O8 up from approximately 170,000lb today. Given the current depressed spot price and growth plans in the industry, you can begin to see why many are predicting a looming supply and demand imbalance in the coming years.

In addition to this, many of the existing plants are either being upgraded or are planned to be upgraded.

In short, the uranium sector is poised for growth, but this will happen most likely through consolidation. As major producers such as AREVA, Cameco and BHP look to lower production costs and have shelved expansion plans due to the current unfavourable spot price, those near-term production stories with sound management teams and low all-in production costs should become increasingly rare as investment opportunities.

Now that we’re clear on why, where to invest?

Given what I’ve discussed thus far, in an age of volatility and increasingly brazen resource nationalism, where is/are the optimal destination(s) to take advantage of any upside in uranium?

Which area allows you to mitigate against resource nationalism, concerns over low ore grades, and permitting risk amongst others? Would you rather invest in an area of the world dominated by authoritarian rule, or an area governed by a constitutional monarchy? These are just a few of the issues and questions that investors need to address when evaluating opportunities. Here is a list, courtesy of the World Nuclear Association, of the top ten uranium producing countries in 2012:

Of the countries listed above, where would you prefer to invest? I offer these choices not as recommendations either way, rather merely to demonstrate the choices you have.

Another consideration surrounds the type of uranium mining a company is involved in or considering. There are several, all with their own cost profiles:

Generally speaking, in-situ leaching offers the lowest production cost (ceteris paribus), so it is not a surprise to see 45% of uranium mining operations utilising this method of mining.

Summary

There are additional issues I have not discussed here that promise to affect the supply and demand dynamics of uranium in the future, including the looming end of the Megatons to Megawatts agreement between the US and Russia. This article was written to highlight some of the more unconventional reasons for considering uranium mining and exploration shares for your portfolio. Nuclear energy is today responsible for roughly 14% of global electricity generation. As millions aspire for a better life in the emerging world, I think it is clear that nuclear power will remain an important and viable part of global power generation well into the future. Now is the time to be evaluating opportunities in the space.

Disclaimer: The material herein is for informational purposes only and is not intended to and does not constitute the rendering of investment advice or the solicitation of an offer to buy securities. The foregoing discussion contains forward-looking statements within the meaning of the Private Securities Litigation Reform Act of 1995 (The Act).  In particular when used in the preceding discussion the words “plan,” confident that, believe, scheduled, expect, or intend to, and similar conditional expressions are intended to identify forward-looking statements subject to the safe harbor created by the ACT.  Such statements are subject to certain risks and uncertainties and actual results could differ materially from those expressed in any of the forward-looking statements.  Such risks and uncertainties include, but are not limited to future events and financial performance of the company which are inherently uncertain and actual events and / or results may differ materially.  In addition, I may review investments that are not registered in the US. I cannot attest to nor certify the correctness of any information in this note. Please consult your financial advisor and perform your own due diligence before considering any companies mentioned in this informational bulletin. I own no shares in any companies mentioned.

By Chris Berry

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