- Uranium is the critical commodity for nuclear energy production, and it is hot in the news recently.
- The market lives in a perpetual mining supply/utility demand imbalance and relies on non-conventional, secondary supply to survive.
- Recently Sprott Physical Trust entered the market and generated chaos with frenetic buy.
- With the proper government backing, the uranium and nuclear industry could begin a new super-bullish cycle.
Understanding the Uranium market and its players
Unlike other widely-known commodities (gold, silver, copper, etc), uranium is supplied and demanded by a limited number of players. The high regulation, intensive costs, and cyclical demand act as natural deterrents for new entries. There is also a perpetual supply/demand imbalance, with limited raw uranium coming from mines and the unmet need for utilities for more fuel. This structure is sustained by using recycled fuel, ex-military weapons uranium, and civil stockpiles (secondary supply). Aware of this particular setting for this commodity, Sprott Asset management started the Physical Uranium Trust (OTCPK:SRUUF) with the clear intent of buying physical uranium ore and holding it. The goal is to give investors the unique opportunity to cheaply gain exposure to this commodity, and so far, has been widely successful, here’s why.
The global production of uranium comes from three main countries: Kazakhstan, Canada, and Australia. Together, they account for more than 65% of global Uranium production and thus have a significant weight on the global supply chain of this commodity.
(Source: World Nuclear Association)
As shown in the chart, the amount of ore supplied by these countries is not enough to meet demand. The chart is about 6 years old, but things didn’t change a lot, and in 2019 less than 80% of the demand for the fuel was supplied by miners. The remaining was left to “secondary supply”, which is a synonym for “unpredictable and unsecured source of uranium”. When utilities can’t find the fuel at a reasonable price in the spot market, they start looking for depleted uranium from ex-military weapons. There are many processes to reduce the enrichment level and use the new fuel to make energy, as well as reprocessing plants that produce fuel from used uranium. While in a normal and not-stressed market this could work well, in case of prolonged demand expansion secondary supply wouldn’t be enough, and the price would skyrocket.
(Source: Statista on Nuclear fuel demand)
This is the forecasted demand/supply imbalance now to 2035. It’s really simple math. If existing mines continue to operate at the current price, margins and FCF will continue to be stressed. Instead of building up supply for the (rising) demand, they will start shutting down, especially in Western countries. Otherwise, if Uranium prices will rise at more reasonable levels there is a chance that they could eventually expand the production fast enough. With nuclear energy at the center of climate change actions, the number of reactors in the US will probably start to rise again. In case this happens, there will be a huge demand to satisfy and secondary supply would simply vanish in a couple of years.
The other big story is the relationship between the spot market and the “long-term” market (i.e. Uranium bought under long-term agreements with miners). On Cameco’s (one of the largest miners worldwide) website, there is an interesting chart published.
(Source: Cameco Website)
As shown, in the last years utilities dropped long-term contracts and returned to the spot market, like in the 2001-2005 period. Again, this works out well if prices stay low, as they have done in the last 5 years, but a short-term shock could have a disruptive impact on the market. After 2005, demand started growing more rapidly and the result is a huge increase in the average spot price between 2005 and 2008. Now, the same pattern is repeating itself, and the final results could be the same.
What is Sprott doing and why it matters
In the last weeks, a rally on Uranium stocks took place. From producers to enrichers and even sellers (like LEU), experienced big and fat gains, all because of the steady rise in the Uranium spot price. Again, this increase had a fundamental reason: Sprott Physical Uranium Trust buying up to 850,000 lbs of Uranium ore per day(!). In about a month they reached more than 24 million lbs of this commodity, and they are not planning to stop (yet). Just to give some perspective on what that number means: it is enough uranium to satisfy France’s entire demand for Uranium for one year, or it is the equivalent of 20% of the global uranium mining capacity in 12 months. The fact that it has been bought in a short period of time explains why everyone, from utilities to traders, is freaking out about this commodity.
(Source: Cameco Website, Uranium Current Spot Price)
After a quiet period between the Covid crisis and Summer 2021, the price is now at several years’ highs and seems to have no plan to stop. The big deal here is actually about self-fulfilling prophecies, Sprott buying tons of Uranium is leading Utilities to rush to the market too, because they fear future higher prices. This eventually generates the actual higher prices that they feared (same game as inflation expectations). As previously shown, the market is fragile because of the lack of long-term agreements between producers (miners) and utilities, leaving much more flexibility to short-term fluctuations. Basically, what Sprott is doing is generating an artificial crunch of supply by buying Uranium ore and holding it. As long as this fund has enough liquidity it will simply continue buying, at any price. Why? Because it is part of their legal status, as a physical trust of commodities.
What will happen next?
The interesting question is always about the future, not the past. What’s next? Let’s summarize the facts: this market is in a constant supply/demand imbalance, demand is expected to rise (rapidly) and now there is a big player buying everything he can until he finishes the money. Recently the Trust launched the “At-the-market equity program” (ATM). With this tool, they aim to collect up to $300 million by simply issuing new units of the trust to the market. Just to give some perspective, these additional funds are enough to buy about 9 million lbs of Uranium ore.
(Source: Cameco website, Uranium spot price)
This is how the recent two bullish cycles looked like. The first one, started in 2005 by the overall rise in commodity prices, saw the price rising more than 370%. Then, the Great Financial Crisis hit and a long recession disrupted the markets. The second one, in 2010-2011 saw the price almost doubling before Fukushima hit in March 2011. Assuming we have entered a new cycle, the price rose by a mere 60% from 2020 lows and not even doubled from the two-decades low of 2016. If it’s true that history doesn’t repeat itself but it rhymes, we’re well-positioned to see the Uranium price generating good returns in the following months and possibly even years.
Explaining risks and discussing buying
As many things could go right, many others could not. From a steady decline in the number of reactors to another nuclear disaster, risks are numerous. In the last two cycles, external and macro events showed how much they weigh on the pricing of this strategic commodity. If the US does not support new reactors construction or fails to keep the existing ones in function, demand for Uranium could take a hit, even with China building at the speed of light. Then, if reactors continue increasing their efficiency (less fuel required for the same output), demand will be negatively impacted. And last but not least, a new Fukushima or Chernobyl would disrupt the market.
So, is the Sprott Trust a buy? The odds are in its favor and probabilities are set more to benefit Uranium prices. But the fund trades at a premium, making it quite expensive.
(Source: Sprott Physical Uranium Trust Website)
Since Inception, it traded above NAV most of the time, but now this premium is more than 16%. Considering that the price of this commodity rose fast, a conservative way to play this game is waiting for the least difference between NAV and market price. Buying at a discount is always the best but considering the momentum, it would be hard.
The market setup is definitely in favor of a sustained bull cycle for Uranium. Many different things could contribute to a persistent rise in the spot price: utilities panicking and entering the market quickly or Sprott not stopping buying. History showed how much strength there was in the last cycles. There are risks too, and they are real, but benefits outweigh them by a lot. Last but not least, waiting for the Trust to take a rest and returning towards NAV is probably the best way to play this game.