Nuclear energy is back in the headlines.
The spot price of uranium jumped 19 per cent to $113 a pound at a recent auction only six years ago the metal traded at just $7 a pound!
The British Government is expected next month to scrap its ban on construction of atomic power stations, clearing the way for a phalanx of new plants.
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In the US the nuclear fuel company Urenco has got the go-ahead to invest $1 billion in the nation's second uranium enrichment facility.
Does all this activity signal investment opportunities?
Uranium investment: supply shortages
Sprott Securities of Canada says in a new research report that global supply of uranium, the fuel of nuclear power stations, is "very tight, with primary and secondary sources just meeting demand."
Any disruption in supply, unexpected delay in planned production increases, political conflicts between major players even just continued demand from investment funds, which have been buying a quarter of uranium available on the spot market "could drive the market into an immediate deficit position."
Even without such occurrences, there's likely to be a shortage in three to five years' time as mine output isn't planned to grow enough to meet increasing demand from nuclear power stations and to offset decline in supply from secondary sources.
Sprott predicts that uranium prices will continue to strengthen "over the next 20 years."
RBC Capital Markets, who have also just produced a fat report on investing in the sector, reckons that "we are in the middle of a uranium bull market" and "the current market deficit, which is exacerbated by supply disruptions, continues to point to higher prices."
Although mining giants such as Comeco, BHP Billiton and Rio Tinto own large ore bodies in Canada and Australia, and while they and smaller groups are opening up resources in Africa, Central Asia and North America, it's a struggle to bring new production on line.
Because uranium can be used to make nuclear weapons, its production and trade, by international agreement, is subject to tight regulation -- which blocks or slows new ventures.
Capital costs are soaring because of worldwide shortages of mining resources experienced managers, geologists and engineers, skilled construction workers, equipment and transport capacity. BHP Billiton says it expects expansion of its Olympic Dam mine in Australia to cost $10 billion and pessimists say the eventual cost is likely to be much greater.
As with other kinds of mining, there are the physical risks. Flooding of the Cigar Lake venture in Canada, planned to add 10 per cent to world supply of primary metal, delayed by several years its coming into production. After-effects of flooding at the Ranger mine in Australia will cut world supply by 2 or 3 per cent next year.
For more than 20 years demand for uranium has exceeded mine output, the deficit being met from secondary sources. Stockpiles of "yellowcake" uranium oxide, or U3O8 were accumulated when prices were depressed. Weapons-grade material, no longer needed with the ending of the cold war, is diluted and used to make fuel rods. But most of those sources are running out.
Meanwhile, demand for nuclear fuels is growing. Currently there are 28 new atomic power stations under construction, nearly all of them in Asia, with 64 more in the planning stage and a further 158 proposed.
Uranium investment: new demand about to hit the market
Cameco estimates that as from 2010 about ten new reactors will be coming on line every year. Sprott Securities suggests that each will need 17 to 22 million pounds of uranium before start-up, with a reload of half-a-million every eight to 14 months thereafter, depending on the size and type of reactor.
"For the fuel rods to be fully fabricated and tooled for use, the uranium must be purchased/mined, converted, enriched and fabricated." As that process will take at best 2 to three years, the additional uranium demand needed for reactors scheduled to start generating in 2010 could hit the market as early as this year.
The world's top ten uranium producers are already "having difficulty meeting demand of today, let alone preparing for the demand of tomorrow."
A further complication is increasing demand from investment funds, which are buying uranium and withholding it from the market. It's estimated that over the past two years that's been soaking up 5 to 7 per cent of global production.
Although nuclear power has long faced strong political opposition because of its perceived risks, that opposition is eroding, preparing the way for construction of new reactors outside Asia.
The climate change hysteria favours nuclear power, which doesn't produce greenhouse gases. And, unlike alternatives such as ethanol and biodiesel, it doesn't divert farm output from food to fuel, forcing up food prices.
The high costs of fossil fuels, low interest rates on borrowed capital and design efficiencies have made nuclear power a commercially attractive alternative to other major energy sources.
Nuclear power also reduces dependence on imported oil and gas, as uranium is a small proportion of total costs (about 7 per cent), and most of it comes from politically "safe" countries Canada, Australia, the US.
The industry is winning the public relations war as safety fears fade -- there haven't been any dangerous accidents for decades and it becomes clear that there are safe ways to dispose of radioactive waste. The new atomic plant under construction in Finland will encase high-level waste in steel and copper containers to be buried in hard granite that has been geologically stable for a billion years.
Uranium investment: eleven ways to cash in
If you want to buy into the nuclear energy story, how should you do so?
Sprott Securities suggests that investors "should remain focused on three sub-sets of uranium stocks producers, imminent producers, and those development stories with fundamentally solid assets aggressively moving towards production."
One problem with the established producers is that most of their output is tied up in long-term contracts to supply nuclear power stations at prices now very low compared to those on the spot market. In the fourth quarter of last year, for example, Cameco realized only $22 a pound on its sales although the spot price averaged $65.
For the next five years, 85 per cent of global mine production is locked into such low-price contracts.
The good news, of course, is that the established producers have low costs, yet own the highest-grade deposits Cameco's mines in Canada have ore grades as high as 25 per cent, compared to less than 1 per cent in the case of some new open-cast mines. So they should experience huge earnings growth in future years as sales are made at higher prices.
The bad news for investors is that many of the best uranium assets are owned by the two mining giants BHP-Billiton and Rio Tinto, whose other interests are so huge that their shares provide minimal exposure to the nuclear fuel.
The big pure play is Toronto-listed Cameco (CCO), the world's largest producer, with four operating mines in Canada and the US, major ventures also in Canada and in Kazakhstan, and even a stake in nuclear power generation.
It has enormous high-grade ore deposits and managerial/technical expertise, and Sprott Securities is forecasting earnings per share to triple, to $3.15, over the next couple of years. It offers good upside potential at lower risk than most other options. It's RBC Capital Markets' "top pick" uranium stock.
Other mining companies deserving consideration include:
Denison Mines (DML, Toronto), with a seasoned management team, production in North America and a large portfolio of exploration prospects. It plans to ramp up its output five-fold over the next four years and is Sprott Securities' "top pick."
Paladin Resources (PDN, Sydney) has started production at its Langer Heinrich mine in Namibia and has an equally substantial prospect, Kayelekera, in Malawi. Soaring profits should raise its earnings-per-share ratio to 15 times (the same as projected Cameco levels) in a couple of years.
Uranium One (UUU, Toronto) is a newly-formed combine with actual or incipient production in Kazakhstan, South Africa and Australia. Ambitious development plans could ramp its output to 12 million pounds a year (the same target as Paladin's) in five years' time.
Uramin (UMN, AIM London) expects its Trekkopje open-cast mine in Namibia to come into production next year and has other African interests.
Energy Metals (EMC, Toronto) is perhaps the most interesting speculative stock, with a large portfolio of ore deposits in the US. It expects to start production next year.
Justin Reid, analyst at Sprott Securities, suggests that "US-focused companies with solid assets" that have started the process to get operating permits and are "backed by good operating teams" could be takeover targets.
Other interesting investment possibilities include:
Geiger Counter (GCL, London), a new fund with a diversified spread of about 50 holdings in physical metal and the shares of producers, developers, explorers and service providers.
There are several other funds that only invest in uranium itself, such as Uranium Participation Corp. (U, Toronto), and Nufcor Uranium (NU., AIM London). They tend to trade at high premiums on net asset value.
Areva (CEI, Paris) is the world's biggest nuclear engineering group. It mines uranium, designs and builds power stations, makes fuel rods and processes nuclear waste. Although 95 per cent owned by the French government, the remaining 5 per cent is in listed non-voting shares.
There are high risks of various kinds in all uranium investments. The spot market is so thin that it could collapse should bullish sentiment evaporate for any reason. Mother Nature can turn nasty, as it did with the devastating floods at Cigar Lake and Ranger. A reactor accident could trigger a renewed upsurge in public hostility to nuclear power.
Yet it's hard not to be bullish about a resource sector where supply is likely to remain under stress for years to come, relative to steadily rising demand.
By Martin Spring in On Target, a private newsletter on global strategy
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