Yellow cake industry – uranium as investing opportunity

Niche, esoteric, and undervalued are three words describing one of the most exciting investment opportunities of the decade.

I am talking about the uranium mining and processing industry. It is highly cryptic for most investors for several reasons:

·??????The size of its physical market is less than $10 billion.

·??????The market capitalization of public companies mining and processing uranium is only $36 billion.

·??????The physical uranium market is different from the rest of the commodity markets in structure.

·??????The most prominent players are the state's and corporations' partnerships; many are not public companies.

·??????Uranium is a strategic material not only for energy but also for defense.

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As you can see, the uranium market size is cents compared to other industries. With Apple’s cash, it can buy all the companies in the sector several times over. Even compared to other energy commodities like oil and coal, uranium is a dwarf.

Separately, a handful of companies and states control the supply. And the fact that a large part of them is private leads to strong information asymmetry.

The uranium market is so tiny that it makes any supply-demand imbalance a powerful catalyst leading to epic peaks and valleys in its prices and the companies that mine and process it.

Over the past decade, a supply-demand imbalance has been building up on both sides – increasing demand and shrinking supply.

Demand is slowly but steadily increasing, while supply is stagnating due to the depletion of uranium reserves. The latter is due to a need for more investment in discovering and developing new deposits.

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Today’s article will explore the main factors that create higher demand and limit uranium supply.

The Big Picture

I will divide the macro factors into two groups according to whether they influence the demand or supply side.

Supply:

Geopolitical fragmentation – the unipolar world dominated by the United States faces challenges from various countries, such as China, Russia, and the Global South. This does not necessarily mean the end of the United States, but it does mean that conflicts of all kinds, economic, political, and possibly military, are becoming more acute.

Sanctions are one of the instruments of economic warfare, and the ones imposed on Russia seriously affected the prices of all raw materials. Uranium is currently an exception and is not subject to sanctions. I say "currently" because this could change. The consequences of such a decision would be multifaceted. It will create an epic supply squeeze, which would provoke a sharp increase in the price of uranium. In short, one signature could lead to the disappearance of more than a third of the supply.

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Tangible assets versus intangible assets – the CAPEX cycle and supply destruction sow the seeds of a new supercycle of raw materials. Uranium is no exception. After the Fukushima accident, investments in the development of new deposits plummeted. For the whole world, only $200 million was invested for this purpose in 2022. The supply of uranium is in complete stagnation.

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Demand:

The Green Deal – the path to zero carbon emissions goes through base metals and energy raw materials. Nuclear energy is the cleanest of all energy sources, even compared to renewable energy. Over the past year, even the ESG lobby has begun to acknowledge the benefits of nuclear power. Oliver Stone's film Nuclear was presented at the last meeting of the Technocrats' Club of Ecologists in Davos. This indicates a narrative shift that will be promoted in the coming years.

Demographics – the population of developed economies, except the United States, is stagnating. Countries like India, Brazil, and Sub-Saharan Africa are on the other end of the spectrum. This population will have energy needs that must be met. Nuclear energy is part of the solution. In other words, more required energy leads to mode uranium demand.

Political and economic fragmentation – as with supply, the emerging new geopolitical order impacts demand. State sovereignty is becoming an increasingly important factor, and it is directly related to energy independence. A country's ability to meet its energy needs independently changes its role in the geopolitical game. The more energy-independent a country is, the more freedom it has in making political and economic decisions.

Demand and supply are in a noticeable imbalance, and it will become more acute over time and could ignite a new bull market in uranium at some point.

The primary uranium users are nuclear energy and the defense sector. However, the former is the factor that determines demand because the quantities of uranium it consumes are significantly more than those consumed by the defense industry.

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Nuclear energy – demand

At this point, I will describe nuclear energy. It is the main factor driving the increasing demand for uranium. Nuclear power plants consume a much more significant portion of mined uranium than the defense industry.

Nuclear energy has several advantages:

• It provides the base load for the power grid – the base load is essential for its functioning, as it maintains a constant load on the grid regardless of atmospheric conditions and electricity consumption at any given moment.
• Almost zero carbon emissions compared to other sources of electricity.

• Nuclear energy is the safest, measured in deaths per terawatt hour.

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For several reasons not addressed in this article, nuclear energy was persona non grata for ecologists until last year. However, this trend began to change.

State sovereignty goes through energy independence. No energy-poor country is prosperous, and it is no coincidence that the most successful countries are energy-secure.

Despite the Green Deal and strong anti-nuclear lobbies, interest in nuclear energy has revived in the past year. The tide has turned even in countries like Japan, which were until recently vehemently opposed to nuclear power.

In addition, countries from the Global South are actively investing in developing new nuclear capacities.

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As we can see, the number of nuclear reactors will increase. This means rising demand for uranium, whose supply, as we have seen, is limited.

Unlike other fuels, uranium is needed in minimal quantities to provide vast power.

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The above illustration shows how energy-dense uranium is. Unlike fossil fuel power plants, where fuel costs are a large percentage of the final price per kilowatt-hour, for nuclear energy, it is precisely the opposite.

As a percentage of the final value for one kilowatt-hour, the cost of the necessary uranium is around one percent.

Even for brand-new nuclear power plants, the cost of the necessary uranium for the first refueling is at most 3 percent of the total investment in constructing and commissioning the power plant.

To summarize:

• The supply of uranium is limited due to supply destruction and political-economic fragmentation.
• Its demand is increasing, first due to the transition to zero carbon emissions and second because more and more countries want to be energy-independent.
• Its price is a small fraction of the total cost of a nuclear power plant.
• There is no alternative.

The above conclusion can be illustrated with the following graph:

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As can be seen, we are in a supply deficit mode.

Long-term, no market can function like this. To balance demand and supply, one of the following three things must happen:

·??????Compensation for the missing supply - in practice, it is impossible because a new working deposit of the caliber of Cigar Lake (a mine producing 10% of the world's uranium) would have to appear suddenly. It is technically impossible to happen within a few years.

·??????Sharp decrease in demand - a political decision to shut down nuclear power plants, which would reduce demand. This means power rationing in many parts of the world. Economically and politically unacceptable.

·??????Increase in the price of uranium to motivate most producers to invest in new developments. Most companies involved in uranium extraction have AISC above the uranium price. Prices above 65-70 $/lbs will motivate them to invest in CAPEX. This will compensate for this deficit - market principles in action, which is the most likely scenario.

Using the theory of constraints, the first two scenarios are (almost) impossible due to technical, economic, and political conditions. The third scenario is most likely because it follows the supply and demand market principles.

The topic of the imbalance between supply and demand is an excellent transition to the next point - the countries and companies that dominate the sector.

Supply

A few countries and a handful of companies dominate the uranium mining and processing industry. This is an advantage because the equation has relatively few variables.

Kazakhstan (40%), Namibia (12%), and Canada (10%) extract 62% of the world's uranium. Imagine the impact on the uranium market if a crisis resulted in the closure of mines in one of these countries.

The situation is similar with companies - they are concentrated in the same countries. If one of them has problems and suffers mine closure, the supply will immediately contract and be unable to meet demand.

In the following paragraphs, I will give you a map showing the leading players in the industry.

Geography of uranium

Uranium is a chemical element that is widely distributed in nature. Due to technological limitations, its extraction is limited to certain types of deposits. Geology predetermines metallurgy, and metallurgy, in turn, determines the necessary extraction equipment.

There are several zones in the world with suitable geology, and the largest uranium mines are concentrated in these areas. The following charts show the industry's most significant players: countries, mines, and companies.

The graphs are from two years ago, but that doesn't make them invalid. Unlike the high-tech sector, where leaders can change within a year, shifts in the commodity sector, especially in uranium, are prolonged.

A few of the above-listed companies are publicly traded corporations on stock exchanges. Most, even if listed on a stock exchange, are public-private partnerships between a state-owned enterprise and a private corporation.

Another characteristic is that private and public companies are concentrated in a few countries - Canada, Russia, China, Kazakhstan, and Australia.

A determining factor for future supply is an investment in discovering and developing new deposits. The following chart clearly shows the trends over the past decade:

Only $200 million has been spent on discovering new deposits worldwide.

If the trend of building nuclear power plants continues, the existing deficit will become impossible to cover.

The shortages are covered by recycling spent nuclear fuel and decommissioned nuclear weapons. However, this is a temporary solution, and new deposits are needed, which will only be found with investment.

At the bottom of the supply destruction cycle lie the foundations of a new bull market. This heuristic applies not only to uranium but to any other commodity.

The big picture can be summarized as follows:

·??????Stagnating supply - minimal investments in discovering and developing new deposits and political-economic fragmentation will increasingly affect supply. Even without direct sanctions, many countries have gradually started to look for uranium from sources other than Russia. This takes a significant portion of the supply out of the equation.

·??????Sustainably rising demand - nuclear power is increasingly accepted as an alternative to fossil fuels, making it an essential element of the green transition. The population of India and much of Africa is growing exponentially, and the only way to meet the needs of more people is to build more energy capacity. As India climbs the S-shaped wealth curve (GDP per capita passing above $3,300), it means increasingly higher consumption of goods and services, which requires electricity. Lastly, energy independence is becoming more critical due to the increasing polarization of the world.

·??????Potential booster - Sanctions against Russian uranium. The deficit between supply and demand is a fact, and it will slowly and steadily influence uranium prices. Should sanctions be imposed on Russian uranium, the described process will be accelerated manifold, and the uranium shortage will take on epic proportions.

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Asymmetric investment opportunities take work to find, and they are often outside the mainstream focus. The uranium market is one such market - too small, quite opaque, and dominated by a few companies.

Despite these reasons, or perhaps because of them, the scenario I described falls into the probable category on the plausibility scale. The reason for this is the apparent disequilibrium between demand and supply.

Applying the Theory of Constraints of the three variants - increasing supply, reducing demand, or raising the price of uranium - the first two are unacceptable. There are several technical, economic, and political obstacles in their way. As inappropriate as it may seem, the third option will have the least undesirable consequences in the long run.

The fuel costs of a nuclear power plant are less than 3% of the total budget per year, and this low percentage provides a large buffer for companies operating nuclear power plants. Even if the price of uranium doubles, it will not impact their budgets.

The uranium mining and processing industry offers two things:

·??????Exceptional asymmetry of the stake

·??????High plausibility of the hypothesis

A rare combination of profit potential with relatively high probability.

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