How to generate profits from nuclear power

As concerns over climate change gather momentum, nuclear energy is undergoing a revival. We reveal which stocks are most likely to benefit - and a nuclear fuel to rival uranium.

It may turn out to be a white elephant, but it still made for an excellent PR opportunity.

As politicians from around the globe gathered in Paris last week to finalise the ITER nuclear fusion project, the hyperbole flew thick and fast. "If nothing changes, humanity will have devoured in 200 years the basic fossil fuels accumulated during hundreds of millions of years, triggering a climactic earthquake," said Jacques Chirac. "We are duty bound to take these steps."

There's just one small problem with this grand vision of ITER saving the world. The reactor is just a research project. It's nowhere close to being a commercial design. And it won't be operational until 2016. Even if everything goes according to plan, the first commercial fusion reactor won't get under way until a couple of decades after that.

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In other words, fusion is still three decades away. And that's a best-case scenario; as fusion sceptics frequently point out, it has been three decades away for the last five decades. The problem? We no longer have decades to wait: a major new nuclear energy programme is needed now, based on the nuclear fission technology we already have.

Why is nuclear power set to make a comeback?

The case for reducing our dependence on fossil fuels is overwhelming.

Climate is an important part of the picture. Whether global warming is real or not is an irrelevance; the political consensus is shifting behind the view that it is, and this means that the push towards lower-carbon energy sources looks unstoppable.

Nuclear isn't carbon-free fossil fuels are still consumed in mining uranium, for example but it's still an improvement over most other forms of energy production. However, the need to invest in nuclear isn't just about climate change.

Equally compellingly, there are supply and demand issues. We live in an increasingly plugged-in' world, where access to electricity is vital and where, as countries such as China and India industrialise, we are going to need more and more of it. Demand for electricity will double between now and 2030, according to International Energy Agency (IEA) estimates.

Meeting that demand from non-nuclear sources would be difficult and costly. Spiralling prices for oil and gas in recent years show how tight the supply situation is for these commodities.

Coal will play an important part, but the pollution that coal-powered plants produce is a major handicap. Newer, cleaner-burning technology can reduce this, but it comes at a cost. Renewables such as wind and solar are even more expensive and are, in any case, only capable of meeting a small part of the extra demand.

The fact is that with the current level of energy prices, nuclear is already cheaper than gas, almost as cheap as coal and far cheaper than renewables, according to the IEA.

Finally we have to take into account the security of supply considerations.

Most countries would like to reduce their dependence on the politically unstable parts of the world that control most of the world's oil and gas (there are often suggestions that gas is a safer thing to be dependent on than oil, but who wants to end up relying on Russia's benevolence to keep the lights on?).

Most of the major uranium resources needed to produce nuclear power are located in friendly, stable countries such as Australia, Canada and the US, and that's a huge bonus.

On all of these grounds, nuclear looks very compelling and this is something governments are finally recognising. Around 30 new reactors are under construction in 13 countries, while others such as the UK and the US are working on ways to encourage plans for even more.

And this should be just the start, given that China talks about building two new reactors a year for the next 15 or so years. The companies that build nuclear plants are certainly optimistic; Toshiba forecasts that 130 gigawatts of new capacity will be built by 2020, for example (that's equal to about 90 to 130 new reactors at modern plant sizes).

How can investors profit from nuclear power?

A boom such as this would mean a major investment opportunity construction costs alone will be around $1.5bn per reactor. So what's the best way to profit? Well, MoneyWeek is inclined to ignore the limited number of listed companies that actually operate nuclear power plants, since the economics of nuclear are not always compelling for private companies.

Construction accounts for around 75% of the cost of nuclear generation, which means that companies are highly exposed to changes in the price of electricity. The fluctuating fortunes of the UK's British Energy (BGY), which was haemorrhaging cash a few years ago as power prices tanked, demonstrates this only too well.

This means that companies running new plants will be highly dependent on governments offering them deals that will reduce the risks inherent in their exposure to shifting electricity prices, perhaps by giving them subsidies or letting them sign long-term offtake agreements at fixed prices.

This will probably happen, since few businessmen will want to build new plants without such deals. But still we think it might be better to look at opportunities in the nuclear area that aren't tied to a single country and so have less political risk.

Uranium stocks set to benefit

Firstly, investors might look at the companies that will be supplying the reactors with their fuel. Because nuclear power was out of favour for so long, uranium exploration work has been extremely limited, and consequently not enough is being produced. There is a severe shortfall in supply both now and for the foreseeable future. At present, the shortfall is made up by reprocessing warheads from the ex-Soviet weapons stockpile, but this is likely to run out within a few years.

Meanwhile, the flooding of Cameco's Cigar Lake project has made a bad situation worse. The mine was supposed to supply around 15% of world production from 2010, but the project may now have to be abandoned.

A number of analysts have described this as being akin to the oil world losing Saudi Arabia.

So what's the best way to profit from this? We've long favoured Cameco, (CCJ) but with the future of Cigar Lake uncertain, this is not the time to buy or add to holdings. Any further bad news could spark a sell-off, so we would wait to see how the situation develops.

Among the mining majors, BHP Billiton and Rio Tinto both have uranium interests, but they only account for around 1% of earnings. However, Rio's uranium operations are held in a separate, 68%-owned company Energy Resources of Australia (ASX:ERA), which is the world's second-largest uranium miner and the purest listed mining play (Cameco also has processing operations). With a very low price/uranium resource ratio of just 3.3 (or a still-reasonable ten excluding the politically-sensitive Jabiluka deposit), it looks the best value company in the sector.

Others worth investigating include UrAsia Energy, which has interests in three Kazakhstani assets, operated in conjunction with the

state-owned Kazatomprom. Dension Mines (TSX:DEN) has interests in two important Canadian projects, include the producing McLean Lake facility, while Paladin Resources (PDN) and SXR Uranium One (UUU) are nearing production with assets in Australia and South Africa.

Update: UrAsia Energy was aquired by SXR Uranium One in 2007.

But if uranium prices were to rise sharply, the producers will probably not be the big winners in the short term. "With investors now riveted on the uranium sector, we believe that a mania phase is possible," says Doug Casey in the Casey Energy Speculator. If this is the case, the big gains will be made from speculative junior exploration companies.

Casey suggests buying a basket of small speculative uranium stocks such as Abaddon (TSX:ABN), Azimut (TSX:AZM), Hathor (TSX:HAT),

JNR (TSX:JNN) and Triex (TSX:TXM), which should

see their shares rocket if the boom develops into a mania. This strategy potentially offers high returns, but at high risk. It should only be a small part of a portfolio, and investors must be prepared to get out quickly once the mania subsides.

Unfortunately, there are no direct ways of taking a punt on the uranium price it's not traded on futures exchanges in the way that most commodities are.

The closest you can get is Uranium Participation (TSX:U) and Nufcor Uranium (Aim:NU), which are stockpiling uranium in the hope of price rises. Be aware that these are not exchange traded funds, so the share price does not directly reflect the value of the uranium owned.

Nuclear plays in the construction sector

But the big profits won't just be in mining. Hundreds of billions of

dollars will be spent on building new reactors and on decommissioning old ones, such as the UK's ageing Magnox fleet. However, it's harder to get undiluted exposure to this market. Most of the big construction and engineering firms are a small part of industrial conglomerates.

For example, GE Energy, which includes nuclear as well as other electricity generation technologies, accounts for around 10% of GE's revenues, while Westinghouse is now part of Toshiba. You might want to consider these shares, but their nuclear prospects are just one factor to weigh up.

However, France's Areva (FP:CEI) offers a fairly pure nuclear play, covering reactor design and construction, as well as fuel supply and reprocessing. The downside? It's controlled by the French government with a small share float (around 6%) and is heavily subject to political interference. Last year, politicians forced it to abandon a share sale that would have raised funds to expand its processing arm. But if you believe that the glacial French privatisation programme will eventually creak forward, Areva is a promising bet.

The only UK-listed pure nuclear play is International Nuclear Solutions (Aim:INS), which provides a range of construction, design and engineering services. The international' is a little misleading since it's UK-focused at present, but it is looking at opportunities to expand in North America. The business is still at an early stage, but the order book is growing strongly and it clearly has potential.

Many of the diversified engineering, construction and consultancy groups should also benefit from the nuclear boom. One play that stands out is Costain (COST), which is aiming to be one of the top players in the UK decommissioning market. Costain is significantly smaller than groups such as Amec and Carillion, so success would have a much bigger impact on its performance.

Small, specialist engineer Redhall (Aim:RHL) could also do very well through its Jordon Nuclear division, which specialises in containers for radioactive waste.

Investors should also bear in mind that the nuclear industry has huge potential for both new technologies and new approaches. Most of these are not yet open to private investment, but one small company called Thorium Power (THPW), which recently floated in the US, has the potential to revolutionise the industry with its new fuel systems. We have looked at this stock in detail on the previous pages; it's a risky one, but it could be the best bet in the sector.

Thorium is it better than uranium?

Most people have never heard of thorium, a mildly radioactive metal with similarities to uranium. But many who have say that if we were building the nuclear industry from scratch, we wouldn't use uranium, we'd use thorium instead.

Thorium has two major advantages over uranium. One is that it's much more abundant. Surveys suggest that global thorium reserves may be ten times greater than uranium reserves. As with uranium, these are mostly concentrated in stable countries, with Australia and India having the largest deposits.

The other is that the waste produced from burning thorium in a reactor is far easier to deal with than that produced from burning uranium. Not only is there less of it, but it's considerably less radioactive, with a half-life of just 500 years instead of tens of thousands.

So why was the nuclear industry based around uranium instead of thorium? Two reasons are generally cited. Technologically, it's harder to produce a sustained nuclear reaction with thorium than with uranium, so uranium-based fuel was easier to develop. And politically, when the first reactor programmes got under way, governments were keen to produce as much plutonium as possible for their Cold War weapons programmes, so the waste products from uranium (which include plutonium) were considered desirable.

But nowadays we have the opposite problem disposing of

ex-weapons plutonium stockpiles to prevent them from falling into the hands of terrorists and rogue states. And it is this which should provide the crucial impetus for the development of thorium fuels, since Thorium comes with another very useful property. If ex-weapons plutonium is combined with thorium in a reactor, around 85% of the plutonium is burned up, and what's left is in a form that cannot be used in weapons.

The only listed firm dedicated to thorium technology is Thorium Power (THPW), a small US company that is developing fuel designs to take advantage of this property. The company has been testing its technology at Russia's Kurchatov Institute for around three years and should have it at a commercial stage in another three, says chief executive Seth Grae.

Once it is commercialised, Grae hopes to license the technology for both ex-weapons plutonium and power-station waste disposal, giving the company a substantial royalty stream from the multi-billion dollar nuclear fuels market.

For weapons disposal purposes, Thorium Power's design faces competition from Areva's MOX (mixed oxides) technology and from another approach called vitrification, which is essentially sealing the waste in large glass bricks and burying it.

Grae says that his company's approach is by far the best one it's both more efficient than MOX and it gets value from the plutonium by using it for generating electricity rather than just dumping it.

A review by nuclear-engineering company Westinghouse backs this conclusion and says that on the evidence it has seen "the technology is well founded and has a good prospect for success".

One factor that may work in Thorium Power's favour is that its technology would bring enormous benefits, but wouldn't need a major upheaval in the industry to be accepted. The fuel designs will be usable in existing reactors such as the Russian VVER-1000 with only minor modifications, miners can easily mine thorium instead of or as well as uranium, and the company aims to license its technology to existing fuel processors such as Westinghouse, rather than go into competition against them.

There will undoubtedly be a good deal of political fighting ahead to get Thorium Power's technology adopted, but the company has some influential support on its advisory board, including former Westinghouse chief executive Charles Pryor.

As an over-the-counter, high-tech stock, this is an investment that clearly comes with big risks. However, it also has enormous potential and looks to us to be a very worthwhile addition to any nuclear portfolio.

First published 1/12/06

Cris Sholto Heaton

Cris Sholto Heaton is an investment analyst and writer who has been contributing to MoneyWeek since 2006 and was managing editor of the magazine between 2016 and 2018. He is especially interested in international investing, believing many investors still focus too much on their home markets and that it pays to take advantage of all the opportunities the world offers. He often writes about Asian equities, international income and global asset allocation.

Cris began his career in financial services consultancy at PwC and Lane Clark & Peacock, before an abrupt change of direction into oil, gas and energy at Petroleum Economist and Platts and subsequently into investment research and writing. In addition to his articles for MoneyWeek, he also works with a number of asset managers, consultancies and financial information providers.

He holds the Chartered Financial Analyst designation and the Investment Management Certificate, as well as degrees in finance and mathematics. He has also studied acting, film-making and photography, and strongly suspects that an awareness of what makes a compelling story is just as important for understanding markets as any amount of qualifications.