Uranium: Potential Trade Of The Decade (SRUUF & URNM)

Investment Thesis

The uranium industry is emerging from a decade long bear market and period of uranium oversupply. There is a significant supply/demand mismatch that is projected to worsen over the coming decade as nuclear energy is the cleanest, most reliable, and safest form of baseload energy. Catalysts are in place first as financial players have entered the uranium space and are serving to catalyze uranium price appreciation towards the marginal cost of production and second as utilities step in to initiate a new long term contracting cycle over the coming 1-2 years. Despite this, the price of physical uranium remains below the marginal cost of production, functionally backstopping downside for investors today. I expect uranium prices as well as those of many producers and explorers to appreciate significantly over the coming 1-3+ year time frame.

Why Uranium?

Uranium is the critical fuel required for nuclear power reactors. While research is underway to identify other elements capable of serving in nuclear reactors, as of yet, there are none that are commercially viable. With nuclear energy supplying 10% of the world’s electricity and a higher proportion of global baseload energy, uranium is an absolutely, 100% critical energy source.

What’s more, uranium is the critical element at the core of the world’s green energy transition. While wind and solar are cute, let there be no doubt: the world’s clean energy future is nuclear.

Nuclear is:

– The cleanest energy source

– Safe

– Reliable

– The best source of baseload power.

– Growing wildly in demand as more and more countries and economies embrace the fact that our energy future is nuclear.

(Author’s note: nuclear reactors take a long time to build and come online; so, while this is a long-term tailwind on uranium prices, do not expect to see demand from new reactors overnight.)

Frankly, I think this is the least complicated part of the thesis. It is very simple: if the world wants to go green despite globally increasing energy use per capita, we are going to be using a lot of nuclear energy in the future.

Supply/Demand Mismatch

With new reactors set to come online and global energy use rising, it seems clear uranium demand is set to increase.

However, things get really interesting on the supply side.

With uranium prices as low as the 20s for much of the last decade, there has been essentially no investment in bringing new production capacity online. That price is simply not even close to high enough to incentivize new production, with the marginal cost of production somewhere in the $60-80 range. Large players such as Cameco (CCJ) and Kazatomprom have decreased production. Juniors have halted or slowed development. And utilities have been happy to dip into the oversupplied spot market for uranium uncovered needs rather than enter into new, more expensive long term contracts.

With so much excess supply in the market, this hasn’t been a problem. Over the last year, however, financial players have begun to scale in the uranium space, and I believe that they are accelerating the rate at which the supply/demand mismatch causes prices to inflect.

The Financial Players

First, heavy kudos to Kuppy for being one of the first to point this out.

With prices so low over the last decade, nuclear power generators could simply buy pounds they needed out of the spot market rather than having to engage in more expensive long term contracting. With enormous oversupply, there was essentially nothing uranium producers could do about it.

However, in 2021, financial players significantly escalated their role in the uranium market, in particular, the Sprott Physical Uranium Trust (OTCPK:SRUUF). This trust exists to provide investors exposure to physical uranium, but in so doing, they take and sequester physical pounds from the market. Note that Yellow Cake plc (OTCPK:YLLXF) is a similar trust for UK based investors, although it is much less active in purchasing uranium.

I won’t dive too deep into some of the finer elements of this process such as the carry trade, but the short version is simple: when these trusts buy pounds of uranium, those pounds of uranium are removed from the excess supply, hastening the point at which the supply/demand mismatch will cause prices to inflect.

This process really took off in August of 2021 when SRUUF launched an ATM share issuance program. When shares of SRUUF trade at a 1% premium to NAV or greater, Sprott is able to issue units to the market in return for cash. The trust is then able to buy pounds of uranium with said cash, ostensibly to offer more investors exposure as well as to increase their revenue via the expense ratio… but functionally for us, sequestering pounds from the uranium market. Sprott has filed for a total $3.5bn capacity in its ATM program with a considerable runway to go.

See if you can spot where SRUUF started buying uranium:

Since initiating the program, Sprott has bought up somewhere around 26 million pounds of uranium, averaging a little over 200K lbs per day and with about $1.5 billion left in their ATM runway before they would need to file for expansion.

The other financial players remain active, and Yellow Cake purchased another 2 million pounds as recently as August 2021. Additionally, Kazatomprom recently announced initiation of another physical uranium trust that will further sequester pounds from the market. The initial raise for Kazatomprom’s trust is set to be for $50 million but with plans to later raise another $500 million from institutional investors.

While we have clearly seen the effect of these financial players on uranium prices, it remains to be seen just how far they might be able to push the market. Some investors think that it could cause the uranium market to become ultra tight and flip over into a bubble of epic proportions. While I am happy to enjoy said upside if it comes to pass, it is abundantly clear that these financial players have served and will continue to serve to accelerate the rate at which uranium prices normalize relative to the supply/demand mismatch previously described.

While it is inevitable that new supply will come online in response to rising prices, the development of production capacity is likely to lag behind need for several years. Experts indicate that mine restarts are likely to take years, and many of the larger projects in development are even further away.

Long-Term Contracting Cycle

The last piece of the puzzle, and the second catalyst, is the initiation of a new long-term contracting cycle for utilities.

I am again going to try to briefly summarize a complex issue. Utilities contract with producers for long term uranium delivery. Contracts are set somewhat above spot prices (or else producers would sell straight into the spot market). Over the last decade or so, there has been little incentive for utilities to enter into new long-term contracts as spot prices have been so depressed, they can comfortably get uranium from the spot market when they are uncovered.

You can see how this has played out below (link):

However, with spot prices beginning to rise and more and more long-term contracts coming off, it is likely that utilities will begin to initiate a new contracting cycle. The absolute imperative for utilities is to ensure power generation, not to ensure good uranium prices. Thus, when prices rise even as their volume of uranium secured through contracts dips, they panic and form new contracts, even at higher prices. This then drives prices up further as pounds are sequestered from the spot market into carry trades for future delivery.

The volume of uncovered utility requirements is set to rise significantly over the next handful of years:

With spot prices rising, I very much expect utilities to start making deals which will further serve to catalyze an increase in uranium prices.

Could Things Get Crazy?

It’s worth noting that uranium is a sector with a storied history of things getting… crazy. Just look at the last bull cycle:

The uranium price bubble was partially spurred by a supply/demand based commodity super cycle but was also further set off by flooding at Cameco’s McArthur River.

Will things get this crazy this time?

Well, I am not going to bet on it. I am betting on a bull cycle due to the fundamentals previously described. But… I sure wouldn’t mind if things went nuts again.

Other Good News

A few other bits of positive sector news that I noticed recently:

– China plans to build 150 nuclear reactors in the next two decades – this will obviously represent an extraordinary plus on the demand side, and you can probably expect China to accumulate ahead of time.

– Cameco earnings today indicate the long term contracting cycle is restarting.

– The EU is likely to include nuclear in its sustainable energy taxonomy opening the door for more ESG investment.

– Elon Musk wants Diablo Canyon to stay open as sentiment in the US shifts decidedly pro-nuclear.

– An SMR developer is going public via SPAC; this is a tremendously exciting technology.

– Global sentiment is moving pro-nuclear as we watch Europe and in particular Germany hamstring themselves by closing nuclear power plants and increasing reliance on Russian fossil fuel right on the door of a global political crisis.

Risks

If there is another nuclear disaster, you are going to see uranium stocks get nerfed. There is no way around that one.

Second, as prices rise, there is always the risk that a more opaque supply source (likely from China or Russia) shows up and dumps pounds into the market. I don’t think that is a big risk from these levels but could come into play when uranium prices are higher.

Third, there is the risk that Kazatomprom could expand supply more quickly than anticipated and before prices have the opportunity to rise to the marginal cost of production for other players. This could have a meaningful suppressive effect on uranium prices over the 2-7 year time frame (although likely not beyond as more reactors come online) and keep many of the juniors from enjoying the bull market. Kazatomprom has previously indicated a desire to “defend” uranium prices of ~$70 per pound, but with the unrest, it is difficult to say exactly how this will play out.

How To Play It

For US investors seeking broad coverage and plenty of upside to a bullish cycle in uranium and related equities, I suggest URNM, the North Shore Global Uranium Mining ETF.

Its top 10 holdings are as follows:

This ETF offers ~33% exposure to the two titans of the industry, Cameco and Kazatomprom. The latter of these is somewhat difficult for US based investors to buy, is the largest producer of uranium, and has the lowest cost to produce of all miners. Second, it offers ~16% exposure to physical uranium between Yellow Cake PLC and Sprott Physical Uranium Trust, while allowing US based investors to avoid PFIC tax issues. From there, it offers exposure to a slew of second tier and junior miners as well as some explorers.

URA, the Global X Uranium ETF is another option but is less of a “pure play” compared to URNM.

For more risk-averse investors willing to accept PFIC tax headaches, Sprott’s Physical Uranium Trust likely offers the best risk/reward. If you consider that uranium prices are overwhelmingly likely to rise to the marginal cost of production in the $60-80 range over the next 1-3 years, you are looking at about a double. If prices significantly overshoot, you could imagine a triple. Compare that, however, to the max downside of… I don’t know 20-30%? Maybe? Frankly, it’s hard to even imagine spot prices sustainably moving back down to the 20s with all the tailwinds for uranium prices.

More risk-on investors might look to some of the explorers or junior miners that functionally trade like call options on the price of uranium but carry significant idiosyncratic risks. I will leave the primary research on that end to readers (and maybe a future article or two…).

Conclusion

The uranium industry is emerging from a decade long bear market and period of uranium oversupply. There is a significant supply/demand mismatch that is projected to worsen over the coming decade as nuclear energy is the cleanest, most reliable, and safest form of baseload energy. Catalysts are in place first as financial players have entered the uranium space and are serving to catalyze uranium price appreciation towards the marginal cost of production and second as utilities step in to initiate a new long term contracting cycle over the coming 1-2 years. Despite this, the price of physical uranium remains below the marginal cost of production, functionally backstopping downside for investors today. I expect uranium prices as well as those of many producers and explorers to appreciate significantly over the coming 1-3+ year time frame.