EXCLUSIVE TO SIGHTLINE U3O8 – As discussed last month in Part 1, many analysts will cite uranium underfeeding (enrichment of tail assays) and subsequent sale of low-enriched uranium (LEU) on the spot market as one of the key drivers behind the fall of U3O8 prices.
Lower demand drove enrichers to increase underfeeding to prop up their bottom line creating incremental secondary supply. Increases in demand and SWU prices will reduce the viability of underfeeding and create a “secondary demand” for natural uranium as buyers move to optimize the cost of their fuel mix.
Enrichment centers are profit centers with goals of minimizing costs and maximizing revenues.
- Enrichers must strike a balance between revenue from enrichment services or secondary sales of LEU on the spot market as their total yearly capacity (measured in tSWU) is fixed
- Enrichment services are largely purchased on a contractual basis resulting in an average SWU price greater than market SWU price
- Most enrichment facilities use centrifuge technology making it costly for them to change LEU output and adjust production to market demand
- No significant new enrichment capacity has come online since 2008 because of LEU demand fluctuations and falling SWU price
Enrichment Cost – Higher for Tails Assays vs. Natural Uranium
The amount of effort (measured in SWU) necessary to enrich natural uranium (U3O8) to LEU is not linear. It is exponential with the inflection point sitting somewhere between 6 to 7% U-235 concentration, depending on the efficiency of the enrichment plant in question.
Contrary to what one might expect, the SWU necessary to enrich natural uranium (~0.711% U-235) to LEU (~4% U-235) is more than the SWU necessary to enrich LEU to highly enriched uranium (HEU – 90%+ U-235).
More importantly, the SWU necessary to enrich tail assays to LEU is significantly more than the SWU necessary to enrich natural U3O8 to LEU, especially when considering that tail assays are only around 0.5% lower in U-235 concentration compared to U3O8.
As such, enriching tail assays to create underfeeding revenues is not a simple decision. It means diverting resources from natural uranium enrichment operations to a more expensive process.
Balancing LEU Input Between Natural Uranium and Tail Assays
As discussed last month enrichers can pick between: 1) selling LEU on the spot market (from enriched tail assays) or 2) selling LEU to utilities (charging SWU prices for their service). Enrichers are usually responsible for storage, disposal, or enriching of any tail assays not utilized.
Utilities receive their LEU from a combination of enriched natural uranium (U3O8) and tail assays. On contract signing, they can specify the percentage of LEU from U3O8 and from tail assays (called contracted/ transactional assays). This is also when they will lock in the price per SWU they will pay.
Since tail assays need more SWU to enrich, a LEU mix that is heavier on tail assays will incur greater SWU costs but lower U3O8 costs. Enrichers will utilize their capacity (option 2), but will have less tails assays to enrich and sell on the open market (option 1).
Vice versa, a LEU mix that is heavier on natural uranium will incur greater U3O8 costs but lower SWU costs. The enrichers will make more money from selling on the open market (option 1) and less money from their service (option 2).
Buyers will contract for a mix that they believe will result in a lower cost over the period of contract signed (usually 3 to 5 years) balancing SWU and U3O8 price outlooks. Ignoring speculative buying, these choices affect total U3O8 purchases and determine the degree of underfeeding possible.
Inventory of Depleted Tails
The bad news is there is evidence to support an inventory of depleted tails. Long-term U3O8 prices were at their peak until Q1 2008 while long-term SWU prices remained high until the start of 2010. By the start of 2012 long term U3O8 prices were down 34% while long term SWU prices were only down 10%.
This means contracts signed around the 2009 to 2011 period were more likely to feature a higher natural uranium mix, taking advantage of the dropping prices.
This is reflected in a slight uptick in long term natural uranium prices from mid 2010 to mid 2011 and increasing contract volumes for U3O8 producers during that time. These higher contract volumes are part of the reason why miners have been able to weather the post-Fukushima slump.
The left-over tail assays remained with enrichers and were used to supplement income once demand for enrichment dropped and there was over-supply. Enrichers found themselves with excess capacity, competing for fewer contracts worth less money and some extra tail assays they could convert to supplement their gross profit.
Enrichers Can’t Bear the Low SWU Prices Forever
Like miners, enrichers are price protected by the contracts signed in previous years. However, all contracts mature and must be renegotiated.
With SWU prices at historically depressed rates, the total number of new sales made in the last few years are well below deliveries made during the year as no enricher is keen to lock in bottomed SWU prices when there is demand growth on the horizon.
While enrichers can underfeed and sell LEU for marginal gain on the spot market, even this strategy has an end as tail assay inventories dwindle and margins on LEU fall due to oversupply.
Eventually, SWU prices must rise or enrichment capacity will start going offline. No company can make money selling at a loss.
The Bottom Line
The connection between the enrichment process, SWU prices and ultimately U3O8 prices is not a simple concept. Here are a couple of things to keep in mind:
- Overall enrichment capacity has not materially changed since 2008. Nuclear power generation, however, has now surpassed pre-Fukushima levels (March 2011) and is steadily increasing.
- U3O8 production is now decreasing for the first time in two decades. With less product coming in, there will be more reliance on tail assays in new contracts and a reduction in the tail inventory growth.
- Fixed capacity and increasing demand will ultimately result in higher SWU prices.
- The only way to increase LEU output from fixed SWU capacity is to increase the proportion of natural uranium in the mix.
Lower demand drove enrichers to increase underfeeding to prop up their bottom line and create incremental secondary supply. As demand increases and SWU prices rise, however, it becomes more costly to underfeed. Utilities have to increase the proportion of natural uranium in their mix to reduce their cost thus creating a “secondary demand” for natural uranium as they move to optimize their fuel creation throughput.
The result should accelerate the improvement of U3O8 prices from what most analysts now see as a clear bottom.