Uranium: COVID-19 Brings Supply Deficit To A Head

After a decade long bear market, the time to invest in uranium has finally arrived. The largest uranium miners, Cameco (CCJ) and Kazataprom, began cutting production in 2018, leading to market with a supply deficit as a new contracting cycle approached. Then COVID-19 happened, causing further cuts in supply and shining a spotlight on the need for higher prices to encourage more supply. Finally, in late 2019 the North Shore Global Uranium Mining ETF (URNM) created a simple and high quality way for investors to get broad exposure to the companies most likely to benefit from a rise in the uranium price.

Demand

The demand for uranium comes from one source – nuclear power plants, which generate ~10% of the world’s electricity, and show consistent and steadily increasing demand. Since the Fukushima tsunami in 2011, the trend in the US & Europe had been towards closing nuclear power plants leading to a belief (and lots of press articles!) that nuclear was being phased out. Since I started investing in uranium this has changed, with existing plants seeing extensions and projects being planned. The change has been driven by a recent focus on ‘clean energy’ (vs. ‘green’ energy) that values nuclear’s carbon-free, safe (!) and low cost provision of base power, coupled with the beginning of the development of small and advanced modular nuclear reactors.While the Western world and press was focused on the decline of nuclear, the same was not true in Asia where countries, led by India and China, continued to plan and construct nuclear power plants.

Source: Visual Capitalist – Mapped: Visualizing the World’s Nuclear Reactor Landscape

Finally, nuclear utilities typically purchase uranium through primarily through long-term contacts and the cost of uranium is a small % of their total costs. The chart below shows the long-term contracting boom of the last cycle, with the recontracting phase expected to be begin in the next 18 months.

Supply Side

While demand for uranium has been a nice gentle incline, the attractiveness of the opportunity reflects that supply is constrained! Almost 2.5 years ago, the 2 largest miners – Cameco (through its Mcarthur River/Key Lake mine) and Kazataprom – both cut supply by a combined 20% in an economically rational attempt to help bring the market back towards balance. The magnitude of these supply cuts has seen the Uranium market shift from being oversupplied to a supply deficit of ~20mn lbs (or 15% of global production) before COVID-19! COVID-19 had a major impact on uranium mining with Cameco closing its remaining flagship Cigar Lake mine (12% of primary uranium supply!), and Kazataprom having to reduce both its production targets (by 10mn lbs, or 8% of annual primary supply) and its 2020 wellfield development (which will reduce its 2021 production capacity). This led to fears of a potential supply shortfall of ~40mn lbs in 2020! The cutbacks also led to both Cameco (especially in Q2) and Kazatprom (beginning in late Q2) entering the spot market to fulfill existing contracts.

This short video from Purepoint Uranium shows the impact of the cuts.

Eagle-eyed readers will have noted (i) the importance of Kazataprom and Cameco (Cigar Lake & McArthur River) due to both their size and as the lowest cost producers and (II) that almost half of the existing & idled production is uneconomic at today’s prices. While Cigar Lake will start coming back online in September 2020, the market is expected to remain in significant deficit, which is exacerbated by major mines (Ranger in Australia & COMINAK in Niger, which are a combined >5% of primary supply) permanently closing at the start of 2021 and Kazataprom confirming low 2022 production levels (i.e. no attempt at trying to recover from 2020/21 production losses).

Why Now?

Earlier this year, before the impacts of COVID were fully felt, the World Nuclear Association published its biennial “Nuclear Fuel Report”, and for the first time made the Expanded Summary available publicly. For those who don’t follow the space, charts such as the below helped codify the supply gap.

Source: World Nuclear Association – The Nuclear Fuel Report Expanded Summary

However, even the WNA report was overshadowed by the impacts of COVID-19 – demand for nuclear power remained largely unchanged, while the impact on supply pulled everything forwards. The Uranium spot price jumped ~50% after Cameco started purchasing in the open market, and both Cameco & Kazataprom will be doing so in the second half. OM suspects Cameco is re-opening Cigar Lake, both due to the costs of keeping it in care & maintenance but also for security of supply (to meeting existing contracts) given the limited inventory in spot markets, and Kazataprom needing to buy.

This combination has made clear that after the decade long bear market Uranium trades below its cost of supply limiting the incentive for new mines to be built. COVID-19 has exacerbated and highlighted the supply deficit. For utilities (and the primary consultant that advises them) security of supply is a vital factor. I believe that the upcoming contracting cycle will bring the problem to a head and lead to materially higher prices to encourage new uranium mining development.

Major Risks

The risks to the thesis are primarily on the supply-side. For much of the last half-dozen years, Utilities were able to meet their demand through the spot market where traders and/or secondary supply could fullfil their needs. Some have a hope that this will continue to be the case, or that idled supply will rush back, or that Kazataprom will return to its 2014-era behaviour of maximizing supply.

While these beliefs are understandable, they reflect and expectation that a market that’s now in supply deficit will look the same as the market that was in supply surplus. Nowhere is this clearer than the expectations around Kazataprom’s anticipated behaviour – those who expect the firm to go back to its 2014-era role are overlooking the changes since the company IPO’d in 2018. While talk is easy, since becoming a public company Kazataprom has also done what it’s said – and it’s saying that it’s buying in the spot market in H2-2020, that its supply in 2021 will be impacted and offered conservative production guidance through 2022.

The demand-side is more predictable given the time taken to construct a nuclear plant – and investors can track the news to see the continued plant builds. Should these track towards the WNA’s lower scenario for reactor requirements due to fewer nuclear reactors being built, it will become clear years in advance. Finally, while another Fukushima is a possibility and would certainly change public opinion, we should not invest based on acts of God!

Conclusion

After a long bear market, the time to invest in Uranium has finally arrived. COVID-19 has exacerbated and highlighted the move from excess supply to a supply deficit, and current prices mean its uneconomic for new supply to come on line. The upcoming 18 months should offer numerous signposts for investors movement in spot prices, increased interest in the sector (i.e. increased share counts in the two ETFs – URNM and URA – in the space), and long-term contracts being agreed at higher prices.