What makes a 10X bull market possible

via deepvaluespeculator.com

I have gone over some interviews with Sachem Cove Partners (with Mike Alkin & Timothy Chilleri) to see what happened in the last bull market, and what has laid the groundwork for the coming bull market. These interviews are publicly available already, and I have listened to them several times. However, I get something different out of listening, reading or writing on a subject. I therefore hope you get something out of this post, if you have listened to these interviews already.

The last Bull Market in Uranium

As a history buff I believe that history repeats, in some way or another, because people do not learn, or are educated enough about it. A good place to start is therefore to go back to the early 2000s and see how the uranium market behaved then. The price of uranium was at the time $10-14/lb. Long term contract coverage had been sitting in the 31-38% range as a percentage of utilities yearly demand for many years, and you had lived through 15 years of oversupply (and a narrative of that the oversupply would continue). The price of Cameco from 1996 to 2000 can be seen as an example of this narrative. There was not a lot of faith in the market improving anytime soon.

Where was this oversupply coming from? In the late 80s you had supply coming from the Soviet Union and the Megatons to Megawatts program. (The program had bomb-grade uranium from dismantled Russian nuclear warheads recycled into low enriched uranium (LEU). From there the LEU was used to produce fuel for US nuclear power plants). You also had the Olympic Dam mine coming online in Australia in 1988. (The Olympic Dam mine is the fourth largest copper deposit in the world. More importantly to us, it is the largest known single deposit of uranium in the world. The underground mine is a giant made up of more than 450 kilometres of underground roads and tunnels. Copper production accounts for approximately 70% of the revenue, with the remaining 25% from uranium, and around 5% from silver and gold). Last but not least, McArthur River, the richest uranium deposit in the world, began production in 1999. (Olympic Dam is a much bigger mine, while the grade of uranium at McArthur River is a lot higher. This means you have to move a lot less earth at McArthur to get the same amount of uranium from the ground). When in production, McArthur River was the world’s largest producing uranium mine, accounting for 13% of world mine production. With uranium mining entering the new century, you had seen a plethora of supply coming online with prices staying low.

With prices staying low there was less exploration, development and production from producers. However, the saying of “Low prices is the cure for low prices” was starting to work itself out. In the early 2000s you saw that there was a tremendous amount of under contracting, with utilities not contracting their annual consumption needs. Because of this, inventory was down right before the uranium bull market of 2004.

I have seen presentations from Sachem Cove Partners that have shown this under contracting, and I have compared this to the numbers Kazatomprom has been given by UxC. (UxC is, according to their web page, the industry’s leading source of Publications, Data Services, Market Research, and Analysis, on the Global Nuclear Fuel Cycle Markets). Sachem Cove have done the graph in percentage of yearly consumption, and Kazatomprom have been given the amounts in million lbs. Even though the graphs do not match 100% the picture is very similar. When I took the numbers from Kazatomprom over a simplified assumption of 180 million pounds consumption per year, I got a graph very close to the one Sachem Cove Partners have been using.

In the early 2000s you had a much higher supplier/producer inventory compared to 2021, and lower utilities inventory compared to 2021. However, when you add both of those together, the inventories are lower in 2021 than they were then. (People who cherry pick data will focus on utilities inventory, and say they are well covered now and do not look at the total). The longer we wait, the more these utilities inventories will be drawn down. With a lot less readily available supply from producers when utilities run out, you do not want to be the last one to contract. You do not want to be the one without a chair to sit on when the music stops.

We can continue our story and look at what happened when the prices started to tick up:

Back in the early 2000s there were a host of factors that had an influence on the market. First of all there was a narrative of increasing demand from planned nuclear plants around the world. Nuclear was going through a bit of a Renaissance and several countries looked to nuclear as the solution for their energy needs. Experts in the sector therefore saw that there was a bigger probability of a supply deficit in the future.

At the same time the sector was experiencing supply shocks. There had been a flood at McArthur River. There had been a fire at the Olympic Dam mine. There was a failed delivery of uranium with a ship carrying uranium that had run aground. Inventories were already low and the market was tightening. This was because you had all this under contracting in the years before. If you want to know what was being said back then, the UxC Winter Survey is a good place to start. In the February 2003 issue they had a quote saying: «This perennial optimism actually makes the future imbalance between supply and demand worse. Buyers don’t believe there’s a problem, so they delay contracting, failing to send the needed signals to producers. For their part, producers have been burnt so many times in the past that they are not about to invest more on the mere promise of an improving market. Consequently, nothing gets done.» (UxC does not have all its work public, but I found it republished in their November 3, 2003 issue of The Ux Weekly).

Price of uranium was in 2003 at about $10-14/lb. Even with all these supply shocks and a bright future the spot market was still not responding. In the more forward looking stock market, the price of Cameco had started a run from under $3 in 2002 and was between $6-7 in November 2003.

The ingredients were low inventory levels, underinvestment by suppliers (exactly like we have seen the last couple of years) and supply shocks. The difference today is that you have an even better demand story and there is no new mine supply coming online before at least $45/lb. (Last bull market we already had McArthur River coming online at the bottom of the market, before the turn up towards $137/lb).

Why has the market been horrible for the last 10 years?

Uranium has inelastic demand. This is both an advantage and disadvantage. There is no substitute when it comes to fuel for the nuclear plants. You need uranium to be converted to enriched uranium and fabricated into fuel pellets to wind up in a nuclear reactor. Whether it drops or is rising in price, utilities have to buy it. The nature of the market is one that is characterised by very long term contracts between nuclear utilities and uranium mining companies. The reason for that is that it provides the utilities the security of supply (because there is no substitute for uranium).

Typically you see long term contracts (which by definition according to the industry is a contract that’s signed today but delivery is in the future) and they typically last seven to ten years. That is how it historically has worked. What happens with those contracts is that it gives utilities security of knowing they have supply, but it also gives (when you have changes in supply and demand that are natural to any business cycle) uranium miners a false sense of security when prices are dropping.

After Fukushima in March 2011 the price of uranium was in the 72-73/lb range before it started its march down to $18/lb. Today (in May 2021) the price is off the bottom around 30/lb. Before Fukushima had its meltdown, Japan was 13% of world nuclear power generation, and it was a significant buyer of uranium. Within 18 months all the Japanese nuclear plants were shut down (54 in total). That took a big chunk of demand out of the market. What you started to see was the price being adjusted. Like in any market that works off regular spot pricing, it adjusts very quickly. When price starts to go below the marginal cost of production, you would tend to see supply come offline. You don’t do it immediately because these are long lived assets that cost a fortune to build. If you expect demand to come back you are not going to just shut them down because price dips below $45-50 per pound. However, when it stays around, and below, these levels for a fairly long time, you’ve got to start thinking about cutting production.

Well, the uranium mining industry didn’t cut production so a lot of where the price is today is self afflicted. The reason why is because they had the security of those long term contracts. So as the price was dipping in the mid-teens in the 2014-2016 period, miners were saying the Japanese have to come back to their nuclear power. It’s a third of their electricity generation (just around the time LNG was really ramping up). The population was still adjusting to the perception of Fukushima.

The miners kept producing, they kept exploring, they kept expanding their businesses while prices were plummeting because they had the security of supply (from long contracts). We also had Kazatomprom ramping up production in this period and emerging as the world’s biggest producer of uranium. You finally got to a point where you still saw production growth into a declining price market and as those contracts rolled off you started to see a bleak picture. Most producers could not sell at those prices. If they announce tomorrow that they will start up, it will take time to get their production rate back up.

Conclusion

In broad strokes this explains how the sector has come to where it is today. (This is not an exhaustive list of all the factors. For that I would need the post to be a lot longer, and dive even further down into the rabbit hole). The stock market has up until 2020 priced the sector as it is in a liquidation phase. When a sector is priced this way there is a great potential with just a handful of positive news.

With several years of production cuts, utilities drawing down their inventories, this surplus has been worked off. Uncovered demand is getting bigger and bigger and we have experienced supply shocks with close downs of mines from Covid-19. We are seeing extensions of nuclear plants and big new build programs in the East. The spot price has still not moved, but just like in 2003 the stock market is forward looking. If we exclude the March 2020 sell off, Cameco is up more than 100% from $8-9 early 2020 to almost $20 in May 2020. If the market will continue as it did the last time still remains to be seen, but there are arguments that the conditions are just as positive as they were then.