EXCLUSIVE TO SOURCELINE U3O8 – Since 2007, U3O8 prices have largely been moving in one direction – down. With long-term and spot prices languishing at 12-year lows, the uranium sector has been struggling over the past few years.
Many analysts will cite uranium underfeeding and the subsequent sale of additional enriched uranium on the spot market as one of the key drivers behind the fall of U3O8 prices. Low SWU (separative work unit) prices (down 65%) since 2011 and excess capacity are the common culprits cited to explain the drastic increase in secondary supply from underfeeding.
However, the underlying drivers behind underfeeding activity must be examined to truly understand its overall impact on U3O8 prices. This month we discuss the economics of enrichment and the relationship between utilities, enrichers, miners, and U3O8 prices. In Part 2, we will look at the impact underfeeding has had and discuss its future anticipated impact.
Generally, natural uranium (U3O8) is converted to UF6, enriched from 0.711% U-235 to ~4.0% U-235, called enriched uranium, then fabricated into fuel rods to be used by a reactor. Uranium under 20% U-235 content is called low-enriched uranium or LEU. High enriched uranium or HEU has 20% or greater concentration of U-235. At 85% or higher U-235 content, HEU becomes weapon-grade. All commercial reactors take enriched uranium anywhere from 3.5-5.5% U-235 content or LEU.
The bi-product of the enrichment process is tails assays which have a lower concentration of U-235 than U3O8. Tails assays can either be stored, disposed of, or re-enriched to ~4.0% U-235. The latter being referred to as underfeeding.
SWU or separative work unit, is the effort necessary to enrich natural uranium to ~4.0% U-235. Enrichment capacity is measured in tonnes of SWU per year. In 2008, world SWU capacity was ~55,300 tSWU. Little capacity has come offline or been taken online since then while nuclear generated electricity has suffered comparatively severe fluctuations.
Analysts will point to the disparity between world capacity for enrichment and LEU requirements as the driver behind increased underfeeding activity. While total demand for LEU dropped to ~60% of the world’s enrichment capacity after Fukushima, excess capacity is not a sufficient driver to prompt increased underfeeding activity.
Enrichers are a Profit Center
Nuclear power plants can either contract separately at each stage of the uranium process or directly purchase enriched product.
The majority of U3O8 suppliers do not have in house enrichment capacity (Areva excluded), which helps restrict some of the potential for weapons grade enrichment and makes it easier for the IAEA to monitor enrichment activity. Countries with the largest enrichment capacity (in descending order) are: Russia, Germany, France, USA, and China. Together accounting for over 90% of the world’s enrichment capacity.
Rather than leaving the enrichment price negotiation to miners and enrichers, most utilities will contract at each step of the nuclear cycle. Thus, when considering the LEU supply chain, enrichers act as a profit center whose goals are to maximize returns by minimizing input costs and maximizing revenue generating activity.
How Enrichers Generate Profit
An enricher has two ways to generate revenue: enrichment services where SWU price is charged to nuclear power plants for the service rendered or sale of enriched uranium on the spot market.
For services rendered, SWU prices represent revenue. SWU costs are company specific and are largely based on the type of enrichment plant used. The difference between SWU cost and SWU prices represents the gross profit of an enrichment plant. Recall, since utilities are contracting at each stage of the uranium process, enrichers do not bear the U3O8 cost.
For underfeeding sales, LEU prices represent revenue. The difference between LEU price and SWU cost is gross profit. The cost of tails assay conversion and storage is saved if an enricher chooses to underfeed.
With limited enrichment capacity in one year, an enricher must prioritize how much SWU to spend enriching natural uranium versus enriching tails assays. They cannot enrich two concentrations of U-235 simultaneously and cannot exceed their annual tSWU. Excess capacity reduces the opportunity cost of that choice but underfeeding still must make economic sense.
Enrichment Contracts and Average Cost of Enrichment
A utility’s cost of LEU can be summarized as follows: U3O8 + UF6 Conversion Cost + SWU costs + transport costs. As mentioned above, a utility will engage different key players at each stage of the fuel cycle. More importantly, while over 70% of U3O8 purchases are contract based, almost all enrichment is contracted due to the importance of a steady stream of LEU.
While SWU prices have been dropping, enrichers are price protected by the contracts signed in previous years when SWU was more expensive. Similar to how miners are protected against falling U3O8 prices, enrichers are able to weather falling SWU prices. Analysists will often cite the currently depressed SWU prices as incentive to increase underfeeding and LEU spot market sales, however that analysis is ignoring a major part of the profit generating equation.
The average SWU price an enricher is paid is much higher than the current long term SWU because the average price will include previous, more profitable contracts. Only new contracts signed at a lower SWU price and contract renegotiations will bring an enricher’s average SWU price down.
The Switch to Centrifuge Production
The switch by most enrichers from Gaseous Diffusion Plants to Centrifuge Plants was done to save on SWU cost and increase gross profit. This change was done in a period of LEU demand growth (pre-2011) when the drop in demand was not anticipated.
While Centrifuge Plants save on enrichment costs, they are significantly less responsive to changes in production and scaling back centrifuge production is very costly, similar to scaling back U3O8 production for miners. Turning off a centrifuge runs the risk of giving business to the competition and failing to secure new contracts from any demand pick up. Thus, enrichment plants will stay online as long as they are marginally profitable.
With a low cost of production, high cost of underutilization, and even higher cost of closure, many enrichment plants have remained online. Increasing projected reactor growth and enrichment fulfillment prices greater than current long term SWU add further reasons for current enrichers to keep their plants online.
Currently weak long term SWU prices however, have also prevented new enrichment capacity from coming online. Part 2 will address the effects of transitioning from an enrichment over-capacity environment to one of potential under-capacity as new reactors come online.
Continue to: Uranium Underfeeding – Big Price Factor? (Part 2)