Perseid Capital - Uranium Long Thesis

Perseid Capital

One small player striking its own path through the markets

Uranium Long Thesis

The core of the uranium miners long thesis is quite simple:

In a classic cyclical bottom, the price of uranium has been depressed below cost of production, leading to supply destruction, which will persist until the market dynamics support profitability.

The rest of this post and the series I’m writing on uranium can all be considered a very long set of footnotes to that one point.

Let’s dig in.

The Energy Use S-Curve

The American standard of living is one that requires a high amount of energy per capita, nearly 7000kg of oil in 2014. To provide a comparison, Portugal used 2,045kg of oil per capita, and at the low end, South Sudan used only 61kg of oil per capita.

In fact, a “higher standard of living” is pretty much synonymous with “higher energy use per person”. Post-WW2 history has shown that, as countries become more wealthy, their energy use skyrockets—going through a period of incredibly fast increases. Two salient examples: Japan and South Korea.

As can bee seen in the chart below from World Bank Group, in the 13 years from 1960 to 1973, Japanese consumption of energy nearly quadrupled. South Korean energy use doubled between 1971 and 1981, and then grew by an additional 356% from 1981 to 1997. South Koreans now use nearly 10 times the energy per capita as they did just 45 years before.

And a lot of the world has been going through the same process since 2002. Take a look at the top 10 countries by population in 2019:

Out of the top 10, only the US and Russia have stable or declining energy use per capita. All of the rest—a combined 3.8B people—51% of the world’s population—are going through the S-curve right now.

If all of these countries were to achieve the same average standard of living as Poland, they would demand twice as much energy as they did in 2014.

Advantages of Nuclear Power

While there have been many proponents of “renewable” energy sources like solar, wind, hydro, etc., nuclear power has proven to be superior on multiple fronts:

  • Proven scale
    • None of the other sources have been successfully scaled up to support a modern economy
  • Low cost
    • While the initial investment is high, the amortized cost per kWh of electricity is quite low
  • Constant production
    • Unlike renewables, nuclear power produces electricity at a constant rate, simplifying the build out and operation of the electrical grid
  • Geographically agnostic
    • You can put a nuclear power plant where you need it, as opposed to where the environment dictates
  • Few externalities
    • While there have been many concerns about the storage of nuclear waste, all other forms of energy production impact the environment in some way as well
    • Nuclear power allows the most control and mitigation of its impact
  • Harnessing the power of the atom
    • This geeky point is totally irrelevant to the immediate uranium miner long thesis
    • However, as an investor monitoring energy trends over the next decades, it’s incredibly important (I’ll save the discussion for another post)

We can have a discussion about how fossil fuels, renewables, and nuclear might all contribute to meeting the growing demand for energy—but given the advantages listed, I think it’s clear that nuclear power will be part of the world’s energy strategy for quite some time.

This can already be seen in the actions of countries across the globe.

Worldwide Nuclear Energy Production

The primary use of uranium is as the fuel for nuclear reactors to generate electricity.

The US is currently the largest producer or nuclear power, generating about 30% of the world total—though many other countries are turning to nuclear to meet their growing energy needs. The US generates about 20% of its electricity using nuclear power, making the industry a critical part of our energy policy.

Beyond the US, nuclear power is an important and growing power source across the globe.

Japan has long been a leader in nuclear power, though they recently took a hiatus. After the Fukushima accident in 2011, Japan shut down almost all of their plants over safety concerns. By March of 2012, only 1 of Japan’s 54 reactors was still running. As of February 2019, 37 reactors had restarted, with the other 17 in the process of restart approval.

China recently re-committed to growing its nuclear generation capacity, announcing plans to invest $12B to complete 4 new reactors. China plans to reach 58 GW of nuclear production capacity by 2020 (up from 34.5GW).’

India is planning to to increase its nuclear power generation capacity to 22.5GW by 2031 up from 7GW in 2016.

France had planned to reduced nuclear power production over the next two decades, but has recently delayed those plans. The example of Germany is likely why. Germany dedicated itself to producing electricity via “renewable” sources, and ended up with electricity rates nearly twice as high as France.

Overall, worldwide nuclear power generation capacity is projected to be over 46% higher in 2040 compared the output in 2016.

This represents a huge tailwind for uranium miners, who feed this growing demand for nuclear energy.

Uranium as a Source of Energy

The process of mining uranium, converting it into usable fuel, and using it to generate power is one of the most complex, sophisticated technological achievements of mankind. Putting on my science/engineer/historian hats, it’s nothing short of awe-inspiring.

It makes sense that it’s daunting to try to understand the opportunities in the field. Also—as is often the case when highly trained engineers work with advanced technology—the people in the field don’t make it any easier for the layperson.

Just look at this diagram of the nuclear fuel cycle from the World Nuclear Association:

Not exactly inviting, is it?

I may do a series of posts on the details of the steps above, but when it comes to evaluating the current opportunity in uranium mining, here are the most important pieces:

  1. Uranium Mining
  2. Uranium Processing
  3. Uranium Demand & Purchasing

1. Uranium Mining

The mining step is much the same as any other mining endeavor. Different mines have different costs of production, different total volumes, etc. The additional complications are:

  • Permits are often much harder to get due political considerations
  • The engineering demands of mining are a bit more complicated
  • So, it’s harder to start a nuclear mine and more problematic to stop and restart production on an existing mine

This is actually a huge advantage to us as investors, since it means that supplies are both highly predictable and slow to respond to shocks—the perfect setup for us to predict and ride bull runs.

2. Uranium Processing

Like most things related to uranium, the processing of uranium is complicated and involves multiple steps—but the most important aspects can be easily summarized:

  • Uranium goes through a multi-step process to prepare it for use in a reactor
  • Each reactor has very specific technical requirements, so processed uranium is not easily used by other reactors—the inventory becomes bespoke fuel
  • The process takes time: about 18–24 months pass between signing a contract to first delivery

3. Uranium Demand & Purchasing

Because of the long-term nature of the nuclear power business, the future demand for uranium is quite visible about 10 years out:

Given these constraints, it’s not hard to create a projection for uranium consumption over the next 10 years. While there could be some surprises due to unexpected events (Fukushima), the current trend is far more likely generate positive shocks than negative ones. For example, France is delaying planned closures as countries are realizing how poor the alternatives are.

I’ll explore the supply and demand projections in detail in a future post. For now, suffice to say, the demand for nuclear power is growing and uranium supplies are not projected to keep up. To make things worse, uranium prices have yet to recover from an 8-year bear market—meaning that supply will remain constrained until price recovers.

Purchasing

Uranium can be bought on the spot market and through long-term contracts. Most uranium is purchased through long term contracts, since the time horizons covered are quite long and each reactor requires such bespoke fuel.

We already covered how it takes 18+ months to go from contract signing to first delivery. The other “most important” thing about uranium purchasing is that the purchasing contracts tend to go through cycles where many contracts need to be renewed around the same time. As Mike Alkin discuss in this episode of his podcast, utilities operating nuclear reactors are going to start needing to take delivering from new contracts in late 2020.

This means the latest contracting cycle should have already started! (It hasn’t.) The entire industry has been put on hold due to the Section 232 investigation process started in the US.

Section 232

A Section 232 investigation is a process where an industry member can ask the US government to review the national security implications of imports in that industry. On January 16, 2018, two uranium miners (Energy Fuels and Ur-Energy) filed a Section 232 petition to have Department of Commerce investigate uranium imports.

I’ll discuss the national security implications in detail in another post, but the key point here is that petition kicked off an 18-month investigation period—which just ended.

On April 15, 2019, the US Department of Commerce delivered their report to the White House. The Section 232 process gives President Trump 90 days to review the report and make a decision (though he may act before). That means we should have a resolution by July 15.

The petitioners asked for an import quota. Trump may consider tariffs. Maybe the decision will only include US-based mines or US-controlled mines, or maybe it’ll include the mines controlled by the US and certain allies. Or, he may do nothing at all.

The interesting thing here is: it doesn’t matter what Trump decides.

The underlying fundamentals are so strong, that the uranium bull market just needs the US government to get out of the way. Once that happens, the utilities will know what kinds of contracts they can enter—and they’ll have a shortened window to get those contracts signed.

The second half of 2019 should see the real start of uranium bull market as the utilities rush to secure their uranium supply for 2021 and beyond.

Summary

That’s the 30,000-foot view of the coming uranium bull market:

  • Long term, demographic tailwinds driving energy consumption growth
  • Nuclear power is an attractive option for meeting energy needs
  • Uranium supply and demand are easily projected 5–10 years out
  • Current supply is less than demand (which is projected to grow)
  • Current prices are too low to support cost of production and development of new supply
  • The real rush to buy uranium will start as soon as a Trump makes a decision on the active Section 232 petition

Disclaimer: Perseid Capital is long a number of positions in uranium mining sector.