Uranium - A New Bull Market is Dawning with Mike Alkin
Published in July 18, 2017on
00:09 I’m Mike Alkin. For a little bit of background, for the last 20 years I was an analyst, hedge fund manager, and partner at a few multibillion dollar hedge funds. I recently decided that I wanted to share my learnings from running some hedge funds, and share that with the investing public, and start a newsletter. It just launched. I’m here to talk about one of the industries that I know a little bit about, and have spent a lot of time, and that’s the uranium space. So anyone own uranium stocks here? So this chart looks familiar. It has been a tough grind. Down 85 percent. That’s where I start to get interested.
00:51 When I look at deeply cyclical industries, when you start to get price moves like this, that’s where you really need to start paying attention. I mean it’s in crisis right now. I’m probably not telling you anything you don’t know. But if you look at it, you’ve got a brutal six year bear market. The commodities have declined 85 percent, equities have declined even more, and the number of miners have gone from over 500 down to about 40 right now. What precipitated this? Fukushima. March 2011, tidal wave off the coast of Japan. A tsunami caused a meltdown. What was 13 percent of world uranium demand came offline as 54 reactors shut down. The market thought they would come on a lot sooner, but it has taken a long time. You only have five approvals, four up and running, and there’s only one more to come. By the end of 2018 we think there will be about 18 up and running. But still it has had a tremendous drag on the price of uranium as you look down.
01:47 So what’s the existing narrative? Well the miners are getting killed. Nuclear power is declining. Natural gas is going to take over. Japan is still not up and running. There’s way too much secondary supply, and there’s way too much inventory. We’re going to address all of that, and we’re going to knock each part of that narrative down, and why I think the bear case is rather weak right now. So it’s commonly said that a bear market sews the seeds for a bull market. If you think about mining right now, if you’re a global uranium miner, it costs you on average about $50 a pound to pull it out of the ground, and you’re selling it for $20 in the spot market. As Rick Rule likes to say, those economics don’t work.
02:29 If you look right now at what’s going on, the price of uranium, it simply has to go up. The nuclear field is 12 percent of global electricity production, it’s 20 percent of the US production, and the miners aren’t making money. Kazakhstan, the number one producer in the world at 40 percent market share just announced a ten percent cut. They actually cut 12 percent at the end of the first quarter. There’s likely another one coming down the pike. When you also think about the cycles in uranium, we’ve seen this before. In the 50s you had a massive move up. In the 70s you have a massive move up again. From ‘01 to 2011 you had another massive move. Now some of these moves have been longer than others, and we’re going to talk about that. We’re going to talk about why it’s so important that when you think about the bull case for uranium, that you have to focus on the difference between a narrative and the arithmetic. It’s the nuances of supply and demand that make a real difference here.
03:25 As I look across the landscape, and I look at the people who comment on uranium, this is where I think they’re missing the story. Because the narrative is where the losses already have occurred. The arithmetic of supply and demand is where I think the profits stand to come. I’m in Canada, I think it’s okay to use a Wayne Gretzky reference. His success, he wasn’t the biggest, he wasn’t the smallest, but he always skated the puck to where the puck was going and not to where it is. The puck right now is 8,700 miles away in Astana, Kazakhstan. That’s where that puck is sitting, and very few people are focusing on it. The other place the puck is is sitting in Russia. Russia has cornered the global uranium market. Russian or Russian influenced uranium is 60 percent of the global uranium market. They have total dominance on the uranium market, and they also have total dominance on the global enrichment market. Uranium by itself can’t enrich anything, it has to go through an enrichment process, and they own half of that capacity. Nobody is talking about it, and paying attention to it.
04:30 As I said, I spent 20 years managing a hedge fund, being an analyst at a hedge fund, a partner at a hedge fund. I’ve managed hundreds of millions of dollars. I’ve never seen a better risk reward in my investing career. It’s asymmetrical for those who have somewhat of a time horizon. But when you think of the downside versus the upside, I can’t find a better risk, reward anywhere in the investing landscape. So let’s talk about this. I promise I’m not going to get too heavy on the math. The world consumes about 180 million pounds a year of uranium. Primary mine production is about 160 million pounds. So there’s a natural shortfall, and it has been that way for a couple of decades now. What makes up the difference is secondary supply. Since Japan went offline, you’ve had secondary supply that has come online.
05:15 Right now you’re seeing a surplus in the market of about 23 million pounds. So you have 180 million pounds demand, 160 of primary supply, but 45 million pounds of secondary supply that’s causing that 23 million pound surplus. That secondary supply has devastated the market, and it comes in three forms. The first one is obviously the Japanese inventories. They’ve been taking, for the most part, delivery of those contracts. But they can also sell those into the open market, which they’ve been doing. But now that the reactors are scheduled to start coming online, they’re going to have to start keeping some of that inventory in hand.
05:53 The second one is something called under feeding. This is one of the biggest sources that has put pricing pressure on this market, and it’s another one that you don’t hear a lot about, and we’re going to talk about that in a minute. Then the third leg of that stool on secondary supply has been the United States Department of Energy. What the USDOE has done is during a dramatic downturn they’ve exacerbated the downturn in pricing by selling some uranium into the market to pay for some environmental cleanups, and that has hurt the market. But all three of those are starting to change.
06:28 Very quickly, I’m not going to take you through fuel cycle 101, but uranium comes out of the ground. It then gets converted to UF6, a gaseous form. Its gets sent to the enrichment facility, which then gets sent to a fabricator, and then onto the fuel plant. That takes 18 to 24 months. The under feeding though is where you’ve seen tremendous pressure taking place. What happens is they take the converted uranium, and they put it through centrifuges that are spinning at very high speed. Very high cost to build those facilities, but very low cost to operate them. Just like any business that has capacity, they’re sitting on around 48 million pounds of demand, but they have 57 million pounds of capacity. The way the uranium fuel cycle works is the order is placed with the miner, and then it goes through that conversion an enrichment process. The enrichers, when those centrifuges, they have excess capacity, they can keep spinning that uranium in there, and pull out some extra uranium. Their only obligation is to deliver the amount of pounds that that nuclear facility has ordered. So they wind up with some excess uranium.
07:35 So what do they do? The have excess uranium that they can sell into the open market, and they sell it to the nuclear power plants. That’s like adding an extra mine into the market. They don’t care about the economics of the miner, they care about the economics of themselves, and they’re trying to generate their cash flow. If you look at that chart on the right, that’s what their units were selling for not too long ago, $90 a unit. Those units today are selling for about $47 a unit. It’s called SWU, separative work unit. Well that’s an important unit, that $47, because that’s about the point where they start to lose money. They’re not in the business of selling, just like the miners aren’t. You can’t produce and sell at a loss, they’re doing the same.
08:18 Urenco, the second largest enricher, shut down some mines that they had in December around this price level. So that kind of gave us a baseline for where you’re going to start to see some enrichment capacity come offline. We’re starting to see that. I was at the Nuclear Fuel Conference a couple of weeks ago in Toronto, and Urenco said on stage that they’re very cognizant of where these price points are. So that will take a tremendous amount. Now of that 45 million pounds of secondary supply, there could be 15 to 20 million pounds of supply that comes from under feeding, so it could be quite dramatic. The Department of Energy has a Trump friendly administration. Whatever you think of Trump, we’ll debate that another time. But they are very pro nuclear power. Rick Perry is the Secretary of Energy. He’s from the state of Texas, a very nuclear friendly state. He came in and overturned the number of pounds after selling it to the market just recently, and reduced that by half. That’s going to take some pricing pressure off the market.
09:17 Now you can’t have a conversation about a deeply cyclical industry without talking about inventories. So when we look at inventories, again, what’s the narrative? The narrative is there’s 1.4 billion pounds of uranium in the market. When you think about a market that’s 180 million pounds it’s very easy to go, wow, that’s a lot. But again, you have to peel the onion back, and look at that, and get past the narrative. You have to wrap some context around it. The reality is the inventory has been at this level since 1985. They were twice that level in 1991, and at the start of the last market they were meaningfully higher.
09:52 When you break those numbers back even further, of that 1.4 billion pounds, a couple hundred million pounds sit at the governments around the world. 400 million pounds of that are sitting in China, because they are going through a massive expansion in nuclear power. So when you X out what won’t come into the market from the governments, and you X out China, there’s 800 million pounds of supply sitting in the global utilities. That’s about 2.9 years worth of supply. The typical supply for a nuclear fuel plant is two to three years. So it’s right at the very edge, but it’s right within historical means as well. So we don’t think that inventory at all is a problem, but it’s a big part of the narrative.
10:32 So why nuclear? It’s a growth industry. I know nobody who has sat here and known uranium stocks in the last couple of years, or several years feels that way, but it is. There’s 450 operating reactors around the world. There’s 60 reactors under construction, and another almost 170 in the planning stages. It’s clean. Regardless of what the environmentalists say, it’s the safest form of energy on the planet. It’s carbon free, it’s cost effective. There’s 750 billion dollars around the world in capital being committed to it. It’s consistent, dependable, base load power. You can’t substitute wind or solar. The storage capacity isn’t there. Wind doesn’t always blow, and the sun doesn’t always shine. You look at countries like China, they suffer up to a million deaths a year just from emissions poisoning, and it’s a real issue. In the developing world, you’re seeing a great growth driver there.
11:24 China, as I said, they have 35 reactors in operation right now. 22 under construction, 40 planned, and 136 proposed. The account for over ⅔ of the nuclear growth that’s coming down the pike. The US. I live in New York. I talk to people. I ask, what percentage of the US runs on nuclear power? I’ll sometimes get, two percent, three percent, five percent. It’s 20 percent. It lights 23 million homes in the country. One out of every five homes in the US are running off of nuclear power. It’s not going anywhere. They can’t afford to shut it down. The Japanese reactors, as I mentioned, are restarting.
12:02 But just having an industry where you have a supply demand in balance, and you have an obvious bull case, doesn’t mean it’s the time to own the stocks. You have to find catalysts. For my 20 years, if you don’t have catalysts, you’re going to get run over, and you’re just going to sit there with dead money. So the dominoes are starting to fall right now. If you go back to what I said, you look at that black line, that’s demand. There’s a natural inherent shortfall between production and new production coming online. But where it starts to get interesting is in the contracting cycle, the customer.
12:36 The utilities buy about 20 percent of their uranium on the spot market, historically. Now it’s higher because pricing is low. But they typically buy in seven to ten year cycles. Those cycles right now, they bought at the peak of the last cycle. So in 2009, 2010, 2011, when uranium was at $120, $130 a pound, they were out like crazy locking it in, not knowing where it would go. The reality is the price of uranium shouldn’t matter to them. The uranium is only about three percent of the cost of operating a facility. But there’s a herd like mentality. They’re no different than investors sometimes. When things are going up, they want to get it, they learn to lock it in.
13:17 So they’re coming to the end of a contracting cycle, and they have a problem. Because there’s a billion pounds of uranium that’s unaccounted for. There’s not demand. They don’t have it contracted yet. So they have to go into the market and buy. Earlier I said it’s a two year cycle. They need to start buying a couple of years ahead of time. By 2020, 40 percent of the global power companies who provide nuclear power are not contracted for uranium. If they want to keep the lights on, they have to come into the market right now. The second part of the catalyst is production cuts. So you have an inherent shortfall. You have secondary supply that’s coming off of the market. You have a customer who has to come into the market, and you have mine production coming offline.
14:09 Now Kazakhstan has, and we’re going to talk about that briefly in a moment. They have 40 percent of global production. Now think about that. Saudi Arabia has 12 percent of oil production. When they announce a few percentage point cuts, the price of oil goes parabolic. Kazakhstan under Russian influence controls 40 percent of the uranium market. They took ten percent offline. Camco, the second biggest player, has taken capacity offline, and more are coming. That’s a big deal. With no new production coming, this isn’t oil and gas, you can’t put a drill in the ground, and come out with oil or gas in a month. When the capital is not being spent, you have seven to ten year time lags before the time you go look for it, you find it, you permit it, license it, and open it. So you’re coming into a period where demand is accelerating, secondary supply is coming offline, and no new major production is coming.
15:06 Now in the last bull market that started, there were 24 reactors under construction. Today there are 60. There were three major new mines coming into production. Today there are none. The price of uranium went from $8 a pound to $137 a pound with far less appealing demand dynamics. The prices are unsustainable. Like I said earlier, as Rick Rule always says, you can’t mine it for $50 and sell it for $20. That math doesn’t work, I don’t care how good a manager you are. Production comes offline while demand is coming in. So you’ve got a supply shortage on its way.
15:44 But I want to talk about Kazakhstan, because this is what I think people just don’t pay attention to. We just found Gretzky again, he just showed up in Astana. 40 percent of global production...If you look at the red versus blue, red is what’s Russian or Russian influenced. If you don’t think that Kazakhstan is going to take direction from Russia, and those tanks don’t roll, if something is going to happen, then that’s a topic for a different conversation. But the reality is right now that we are at or near Cold War tensions again. Kazakhstan has gone from a nine percent market share in 2004, to 40 percent right now. If you look at the rest of the world that’s under Russian influence, it’s over 60 percent. As I mentioned, they have half the capacity. But the two critical parts of the uranium story that are the catalysts that are the reason to own the stocks now are two things. Number one is the Kazakh set up, a Swiss marketing arm. Number two, they’re going public in 2018.
16:44 Here’s where this gets important. Starting back in 2015, they started talking about setting up a marketing arm. 2016, the Kazakh newspaper talks about the pricing of uranium is going to soar based up on that. How did the uranium market react? Nada, nothing, paid no attention to it. What does that mean? Their transfer pricing laws in Kazakhstan are very simple. To avoid money laundering what happens is when you pull a commodity out of the ground, you have to have a known customer, at a known spot price, at a public price. That’s the spot market. Remember, only 20 percent of the contracting takes place there.
17:24 This marketing arm they’re establishing in Switzerland allows them to pull uranium out of the ground, and sell it to that marketing arm. Why is that important? Because now they can pool those inventories together, and they overnight become a swing seller of inventory into the market. They don’t have to dump it into the market. As they’ve gone on this land grab, which I think has been orchestrated to get a monopoly on the market, they’ve been dumping it into the market post Fukushima selling it. But they’ve cut production now, because at $20 even they don’t make money. So now you have the number one producer taking supply offline, setting up a marketing arm that is opening up this summer, that enables them to control the flow of inventory into the market. If you don’t think that’s going to take the price of uranium higher, I’m not sure what else will.
18:18 Another reason Kazakhstan is doing it. A few years ago when they went on this privatization spree, they brought in McKinsey, they brought in 40 consultants to say, okay, turn us into a western company that people want to come in and buy some of our stock. Well they’re going public in 2018. On May 26th they announced that they found a banker for that. Why does that matter? Because you can’t, you have to have dramatically improved cash flows from $20 uranium right now. So they’ve gone on a market share land grab. They have a Swiss marketing arm that allows them to control the flow of inventory into the market. They need those cash flows to look better for when they set up that IPO. That’s I think a perfectly orchestrated way for them with major influence over the market to control what happens.
19:04 Another catalyst, a geopolitical wild card, which is Russia. I mentioned earlier, Russia produces five percent of the uranium. But those who are very friendly towards Russia, or Russia can influence, controls over 60 percent of the market. Now let’s think about this math from a US security energy risk. The US uses 50 million pounds of uranium every year. It produces 2.9 million pounds. That’s all they make. The US mining industry is absolutely devastated. So they import half of their uranium from Russian and Russian friendly countries. They import 95 percent, but half of that is Russian friendly.
19:43 At the tensions that are right now, it takes one sanction against Russia for uranium not to come in. I think it’s a huge risk. People talk about, I see all the time on the news, they talk about the Europeans, and natural gas, and how the Russians can shut off, and put them in a crisis. They can shut down ⅕ of the US energy grid if they decide not to ship. That’s the production level. You can’t go to Canada, you can’t go to Australia who are our friends. They have long term contracts committed to China and India. So Russian enrichment dominance. Uranium by itself can enrich everything. It has to be enriched to four percent. Like I said, they own half the enrichment capacity in the world.
20:21 So right now the Americans are playing a game of chess with the Russian government, a game of uranium chess that there’s no chance they’re going to win. ⅕ of their electric grid is dependent upon it. There’s very high political tensions right now. You’ve got the Kazakhs in a perfect position to take pricing up. Who benefits from that? Everyone who is invested in the uranium space. Because as the Kazakhs control the market, it’s bad for the US. As an American, I worry about that. But as an investor, it makes me salivate. Because I know that once that price of uranium starts higher, these investors are going to have animal spirits. Because if you look back to the last bull market, you had stocks return 10 to 100 times their money. Right now where this price is sitting for uranium, it’s very hard to see that it goes much lower.
21:09 So how does the US avoid checkmate? Well they can incent US utilities through tax incentives. They can reduce the uranium that gets sold into the market. There’s a host of things they can do, you can see it up there. But the reality is uranium is a growth industry. It’s growing two to three percent. You have temporary supply and balance that has been exacerbated by some secondary supply. The economics of that secondary supply are not conducive to the people who have been providing that supply. That’s starting to wane. You have the number one producer in the world establishing a business that can absolutely control the flow of inventories into the market. That’s why I think you have to be patient over a 12 to 24 month time horizon. You don’t pile in. But I think now is the time to really start getting very interested in uranium. Thank you.