Going nuclear in search for better yields

Michael Alsalem, Azvalor’s Head of UK Office, on deriving investment opportunities from long-suffering industries. Here, he makes a case for going nuclear in the portfolio.

Azvalor believes that some of the best investment opportunities are derived from industries that have suffered from a significant period of upheaval.

Intuitively, these industries have suffered a vast period of demand erosion, which has led to forced restructuring and radical shifts in supply curves which, in turn, favourably reshape industry economics. Such is the case today with the nuclear industry.

Nuclear power is the lowest cost and cleanest form of energy production. Nuclear power generates at a cost of $50-100/MWh which is extremely competitive to renewables where unit costs remain as high as $250/MWh while its negligible carbon emissions compare to oil at 800 gCO2/kWh or coal which emits 900 gCO2/kWh. The MIT Energy Initiative reported that nuclear power is integral to the emissions reductions target of less than 50 gCO2/kWh by 2050, which corresponds to a ten-fold reduction from current levels. The Initiative also concluded that to deliver the required 45% global demand growth for power by 2040 nuclear power generation must be employed, of necessity.

There is no alternative if society aims to achieve aspirational decarbonisation targets and deliver the means to globally advance electrification, which empowers the digital economy.

Nuclear power is reliable and safe. Nuclear plants typically operate at greater than 80% capacity factors with no intermittency issues which is a key drawback of renewables given the lack of economic battery storage solutions to satisfy a world where consistency of production and grid stability remains ever more important.

Nuclear power generation is a growing industry.

There are 440 operable reactors in the world today, which represents about 10% of worldwide generation with a further 55 reactors currently under construction. Coal and gas today represent 60% of global electricity generation, which provides some context for an addressable market to substitute clean for dirty baseload generation. Indeed, the World Nuclear Association (WNA) advises that some 25% of global power production could be provided by nuclear power by 2050, a bold prognosis which would require 1000 GW of incremental capacity, with each plant providing on average 1.0 to 1.5 GW per unit. This informs the pathway to a much larger count of operable reactors driven chiefly by emerging markets where economies are dirigiste, capital costs are lower and nuclear power is embraced, not feared.

Worries about de-commissioning and politically, not scientifically, motivated policy to displace nuclear power plants are exaggerated. The US has the world’s largest nuclear fleet standing at 98 plants in 30 states; many of these have enjoyed lifetime extensions for up to 80 years from 40 years and policy support has been recently codified in a very supportive report issued by the DOE, confirming federal support for nuclear generation including small modular reactor (SMR) investment and covering all aspects of the nuclear fuel cycle.

France, which relies on nuclear power for 75% of its power generation has pushed back nuclear decommissioning to 2035 and will likely also rule favourably on lifetime extensions before the end of 2020. Elsewhere, Japan which has overcome its post-Fukushima hysteria, has restarted 9 nuclear power plants, currently running 8.7 GW , while reiterating its target to re-establish nuclear generation to 20% of its mix by 2030 which would require another incremental 21 re-activations.

As these critical nuclear power embracing countries achieve their targets of producing cheap, reliable and clean energy….

Germany continues its policy to shut down all nuclear plants.

Germany has consequently realised no emissions reductions since 2009 and its consumers pay double retail electricity prices versus France to subsidise its renewables programmes.

This is a telling indictment of policy formed out of political expediency rather than sober analysis of facts and science.

The post-Fukushima dynamic has been a challenging period for players involved in the nuclear fuel cycle. Uranium prices crashed as the Japanese nuclear fleet was put offline post-accident which created an enormous glut of material from a starting price point well above the global cost curve. This painful experience has resulted in a nine-year bear market in Uranium as utilities, traders and producers were forced to retrench and liquidate inventory. This has put operators and mines out of business as prices dipped below operating cost for nearly the entire cost curve. As producers entered into high priced term contracts at reasonable levels, they have been partly insulated, but many of those contracts are falling off presently, which represents a threat to remaining producers who are nearly all unprofitable at the current price deck.

Industry dynamics have also greatly been impacted by the emergence of Kazakhstan which enjoys a 40pct market share in primary production today driven by its low costs and a 60pct devaluation in its currency. Very competitive mines in the high-grade Athabasca region in Canada have even put on care and maintenance as operator Cameco correctly sees more value in keeping the pounds in the ground awaiting an inevitable pickup in the term market and to help cope with Covid-19 related challenges. The US, meanwhile, has conceded its domestic production capacity in near totality.

The US employs only 48 miners, down from 20,000 in Uranium in the early 80s and is producing domestically at a run-rate of 32,000 lbs versus its 45m lbs requirements.

Each operating reactor at a 1 GW rating requires approximately 400-500k lbs of U3O8 annually with a maiden loading three to four time this number. A chief uranium consultancy, UxC, estimates that 2020 reactor demand will amount to 190m lbs of U3O8. This implies that we will be seeing a yawning gap between primary production, which could reduce by over 25m lbs this year, and demand. Though the Uranium market has relied on secondary sources of supply to balance the market since the 1990s, it is increasingly unclear whether there will be sufficient mobile inventories, excess natural uranium borne of enrichment, or sources from governmental programmes to satisfy these secondary requirements. This was true prior to the pandemic related shutdowns and is even more true now. It follows that the tragedy of the Covid-19 pandemic has been an unlikely elixir to rapidly rebalance a market that had already been drawing inventories and curtailing production for nearly a decade.

Currently, there are no operating mines in North America or Europe for arguably the most important mineral in the world.

As trends related to on-shoring and security of supply as it relates to provenance of minerals continue to gain in importance, it is very likely that support for all aspects of the nuclear value chain will continue with the recent DOE report a mere taste of what is likely to come. As producers down tools, inventory draws and financial and producer buying in the market has firmed up spot prices to $34/lb. The term market, however, remains relatively unchanged though some business is being written in the low $40s. Given long-term demand expectations, prices to need to move much further, however, to incentivise low cost tier-1 production to restart let alone to induce brownfield or greenfield players to advance their projects. This will be aggrieved by extremely long Uranium permitting cycles, measured in the decades, and challenges of access to capital inveterate to global mining today. The total market cap of all listed Uranium miners today is less than $10bn which is astonishing given the importance of nuclear baseload generation, the energy density that Uranium enjoys versus other fuels, and the obvious barriers to competition be it capital, expertise or time.

Cameco (CCJ US Equity) is the largest producer in the West and owns two of the best uranium mines in the world, McArthur River and Cigar Lake. Cameco is also present across the fuel cycle with strong positions in downstream fuel services, which are enjoying healthy economics owing to the previous suppression of investment and demand which creates a winner of attrition dynamic. Assuming Uranium prices move to $60/lb, Azvalor believe that Cameco equity value could be worth at least $17 per share with upside leverage to Uranium prices of about $2-3 per share for every $10/lb move in Uranium prices. Listed physical ETFs including UPC (U CN Equity) and Yellow Cake (YCA LN) offer investors direct exposure to spot uranium prices and currently trade at material discounts which implies effective bottom of cycles prices in the mid $20s.