Fundamentals Signal a Looming Spike in the Price of Uranium
Exclusive to Sightline|U3O8 – Analysts and miners alike are predicting a smooth and steady comeback in uranium prices over the next 12-36 months… a prudent and conservative outlook. The reality, however, is that uranium prices have never moved quietly or slowly.
After sitting at a price of approximately $10/lb for 20 years, the spot price of uranium took off in January 2003 topping out at $136.00/lb in June of 2007 and delivering an average return over that time period of 5% PER MONTH! Over the following 12 months, the price toppled by 50% and ended 2008 at just over $50.00/lb.
Again, near the end of 2010, uranium took off running from $45.00/lb to $73.00/lb in just 6 months only to be halted by the shutdown of Japan’s nuclear reactor fleet.
As the $20 spot price of uranium now languishes at 13-year lows, investors are watching it like a ticking time bomb, waiting for its next explosive move.
That move may come sooner than expected as two events come together to ignite the next bull uranium market:
- While Japan shut down over 10% of the world’s nuclear power generation capacity in 2011, other countries did not slow down their nuclear expansion. As of 2017, the world has replaced Japan’s lost capacity. Not only is the current nuclear fleet generating as much electricity as it did prior to the Fukushima meltdown but more reactors are powering up at an increasing pace.
- In response to the low prices, the world’s major uranium miners have finally reduced the production of U3O8 by over 7% in 2017, a trend expected to continue well into 2018 and beyond.
Today, for the first time in over 35 years, nuclear power generation is rapidly rising while the production of nuclear fuel is swiftly falling signaling a tipping point for investors!
The Price Inelasticity of Uranium Demand
Investors should understand what allows the price of uranium to rise so violently. Quite simply – upward movements in price have no effect on demand. When operating a multi-billion dollar nuclear reactor, the uranium fuel represents only 2-4% of the overall cost of power generation.
When gas prices rise, people use less gas. The sale of big cars fall and commuters park their cars and take the bus. But when uranium prices rise from $20 to $100 it is a small adjustment to the ultimate cost of a kilowatt hour of electricity. The utilities keep the reactors running and continue to purchase the fuel at any cost without a second thought.
The Inventory Effects of Fukushima
When the tsunami struck Japan in March 2011, it resulted in the destruction of the Fukushima nuclear reactor. As a precaution, Japan shut down all 45 of that country’s nuclear reactors for inspection. That shutdown immediately eliminated over 10% of the world’s nuclear generating capacity.
Meanwhile, mining companies around the world were in the midst of a ramp up of uranium production necessary to meet the pending construction of 100’s of new reactors. Moving these large uranium mines into production represented years of effort and billions of dollars of investment. Putting the brakes on that freight train would take years.
The combination of an immediate drop in demand, an unknown timetable to turn Japanese reactors back on and unstoppable production resulted in a growing volume of excess uranium fuel.
The market has three levers it can use to reduce and rebalance its inventory:
- Increase Demand – as pointed out, reactor construction has continued unabated, not only increasing the amount of fuel extracted from inventory but also increasing the inventory required within the fuel cycle pipeline. What many do not realize is that as of 2017, demand has returned to pre-Fukushima levels. As reactor construction continues to grow on top of the continuing Japanese reactor re-starts and the re-election of Japan’s pro-nuclear Prime Minister Shinzo Abe, the demand curve can only get steeper.
- Reduce Price – Dropping the price of a product is the quickest and easiest method of clearing out inventory. In the case of uranium, it allows countries with massive nuclear plans (such as China or India) to stockpile fuel at low prices in order to protect against future price spikes or supply shortages. What we have witnessed over the past 5 years is a “liquidation price” for uranium bottoming out at about $20/lb. – 50-75% lower than the manufacturing cost of the product.
- Reduce Production – This, of course, is the most difficult lever to pull as decisions to reduce or stop production are very costly exercises and can only be reversed with a reinvestment of significant time and money. That being said, miners can only afford to sell uranium at a loss for so long and those difficult decisions to reduce production have finally been made.
Over the past year, the world’s largest producers including Kazakhstan, Cameco, BHP Billiton, Rio Tinto and Paladin announced the closure of mines and reduced productions across the board resulting in a supply drop in excess of 7%. With AREVA’s recent announcement to shut down production in Niger (the 4th largest producing country) we expect to see production drops continue into 2018.
If we look at supply and demand numbers in 2011 (Pre-Fukushima) and follow their change over the last 7 years we see a rare event occurring – the lines are crossing right now! Supply and demand are steeply heading in the exact opposite directions.
As we cross this tipping point, we expect to see uranium prices rise back to profitable levels, however, it is unlikely that prices will move in the smooth flowing manner most pricing models would typically calculate.
- With no resistance from demand, the price of uranium is free to soar up as high as it likes from its current price of $20/lb.;
- As miners require a profit, the price is unlikely to stop at the marginal cost of production (currently around $40/lb.); and
- If history is any indication, the price will move quickly and well overshoot its natural equilibrium.
Investors like to get in at the bottom of a cycle, and uranium investors in particular have been watching the price of U3O8 skip along that bottom for many years now – waiting for the appropriate time to re-enter.
As all of the variables line up to kick off uranium’s journey back to normal price levels, investors should be preparing themselves to board the train before it abruptly leaves the station one more time.