A mini-meltdown in the uranium market

The uranium market is a quieter cousin to the larger global markets for gas and coal.  But despite the post Fukushima shift in public opinion away from nuclear generation, there are still 152 operational nuclear power plants in Europe (ex Russia) totalling 138 GW of capacity.  So uranium is a key source of fuel for European power generation.

The uranium market has had a wild ride over the last decade, buffeted by the commodity supercycle, a push for a new generation of nuclear plant and the Fukushima disaster.   A precipitous decline in prices in the last year has resulted in price levels well below the long run production costs of new mines.  We do not pretend to be experts in the uranium market.  But there a few interesting top down observations that can be drawn as to the current state of play.

Uranium market 101

The most liquid traded form of uranium is U308.  This is a uranium compound that has undergone initial processing into the most common form of yellowcake (uranium concentrate powder) for shipping to nuclear power stations.  The market for U308 (which from here on we refer to as uranium) consists of both spot and long term transactions.  Spot commonly refers to deals for delivery within a three month horizon.  The long term market typically focused on deals with delivery over a two year horizon or longer.

Given the long term stable nature of nuclear plant output and fuel usage, the focus of market liquidity is firmly on long term contracts.  The uranium spot market typically exhibits low levels of liquidity and can deviate significantly from the term market depending on shorter term supply/demand balance of market participants.

Current supply/demand balance

Like most commodities, uranium was caught up in the exuberance of the commodities ‘supercycle’ bubble of 2006-07 with spot prices soaring to above 130 USD/lb.  Production costs rose and demand projections were strong on the presumption that a new generation of nuclear power stations would be developed as part of a global fight against climate change.

Much like the US gas market, the uranium market faced a near perfect storm from 2008-11:

• The financial crisis popped the commodities bubble, reducing production costs and power demand projections.
• The development of a commercially viable next generation nuclear technology suffered a number of setbacks with project delays, costs overruns and cancellations.
• Fukushima saw Japanese demand for uranium erased almost overnight and a global shift in public sentiment away from nuclear generation (e.g. Germany’s decision to accelerate nuclear closures).

The evolution of price over this period is illustrated in Chart 1

The decline of uranium prices has left several newer, higher cost uranium producers in a precarious position.  Cash strapped and struggling to find term buyers at healthy price levels, they have been forced to unload product in the spot market.  This appears to be creating a positive feedback loop in acting to further drive down term prices.

Risk vs reward at current prices?

What is interesting to note over the last 5 years is the sharp recovery of uranium prices in 2010. This brief period of market tightness prior to Fukushima reflects the increasing production cost structure of incremental uranium supply.  Long run costs for new production are currently estimated to be around 70 USD/lb.

It is a consistent feature of commodity markets that the link between prices and long run production costs can breakdown over long periods.  This is particularly the case during periods of spot market stress.  But long run costs tend to exert an influence on prices during periods when a market anticipates a requirement to deliver incremental supply.

That impact was felt in 2010 in the uranium market, although it dissipated quickly as global demand was revised downward after the Fukushima crisis.  But there are a number of demand side drivers that may act to draw prices back towards long run production costs over the medium term:

• The Russia-U.S. ‘Megatons to Megawatts’ program ends this year and is unlikely to be renewed.  That removes 24 million pounds per year of secondary supply from the market, around 15% of global supply.
• There are 60 nuclear power plant currently under construction globally, focused in China and Russia.  Nuclear generation remains the only large scale baseload form of low carbon production.
• Despite recent delays, Japan is progressing slowly towards restarting its fleet of 50 nuclear plant (~45GW).

None of these factors will necessarily cause a near term recovery in prices.  Indeed stress in the market currently appears to be firmly on cash strapped producers.  But downside cleanouts that cause producers to fail or consolidate often mark turning points in commodity market price cycles.  Given the structural demand drivers at work, there does not appear to be a very compelling risk/reward trade-off from positioning for further price falls.