Likewise, as far as demand growth is concerned. Demand coming from new, nuclear power stations is also highly predictable which is a function of the long lead time. In OECD countries, it typically takes 7-8 years from the decision is made to build a reactor until the first power can be added to the grid. Although China has been able to reduce the lead time by 2-3 years, you know fairly precisely how much more uranium shall be required for at least the next five years.  The only variable factor of any significance is inventory adjustments.

Talking about China,  that is where most of the growth is coming from. As you can see in Exhibit 1 below, the Chinese pipeline is bigger than the pipeline in the rest of the world put together. 228 reactors are in the pipeline in China – more than have been built in the rest of the world over the past 35 years. The new reactors will, as you can see, be able to deliver 245.6 GW to the Chinese grid. By comparison, the entire electricity generation capacity in Germany is 225 GW.

Worldwide, there are 440 nuclear reactors up and running today. The Chinese expansion programme is therefore significant but often overlooked by investors, as the nuclear industry is widely considered a sick industry in our part of the world. As you can see in Exhibit 2 below, the industry grew fast in the 1970s, 1980s and 1990s, but various accidents took the stint out of the growth rate.

It is only recently that political leaders have begun to look at nuclear with friendlier eyes again, and the reason is climate change and the fact that nuclear is as climate friendly as wind and solar. Today, I will argue that, given the nuclear expansion plans in China and other EM countries, it is only a question of time before the flattish curve in Exhibit 2 will begin to turn up again.

And that brings me to the supply side of the story. According to the World Nuclear Association, Kazakhstan accounted for 43.4% of worldwide uranium production last year, making them by far the biggest supplier of uranium worldwide. That is important because of Putin’s declared ambition to re-establish the Soviet Union and make it a global superpower again.

Russia’s invasion of Ukraine came as a shock in Kazakhstan – a country already plagued by internal unrest. It has consistently distanced itself from the aggressive tactics of Russia and is keen to diversify its international relationships but, at the same time, it has been careful not to step too much on Putin’s toes. After all, it depends massively on Russia for foreign trade (Source: European Council on Foreign Relations). My concern is that, should the Russians succeed with their aggressive tactics in Ukraine, Kazakhstan could be next on the list.

Another important point to do with the supply side of the story has to do with the cost of producing uranium, and the impact the cost structure is likely to have on the supply side. As it stands, uranium spot is trading around $58/lb. Only about ten countries can produce uranium at a cost meaningfully below $58/lb. The global average production cost is about $45/lb but only because of the extraordinarily low costs in Kazakhstan (less than $15/lb). Most countries endure much higher costs. And, of the ten countries that make a profit at $58/lb, only three – Canada, Kazakhstan and Uzbekistan – can produce uranium in volume.

And that is not the whole story. Although the global average cost of production is around $45/lb, the incentive price to add new mining capacity is at least $65/lb, and much higher in some countries, i.e. with the price hovering around $58/lb, many mining companies continue to draw on inventories to meet demand rather than adding new capacity to existing production lines.

Take a look at Exhibit 3 below. At the very bottom of the chart, you can see mining levels as a percentage of demand. Because of the issue just referred to, i.e. that the uranium price is well below the incentive price required to increase production, uranium miners are drawing on inventories instead and have done so for years. This is a powerful indication that it is an unprofitable proposition to increase the mining capacity when the price is about $58/lb, even when costs, when measured in cash terms, are much lower.

I should point out that it is supplier-controlled inventories I am referring to, and they are indeed very low. Inventories under the control of owners/operators are higher than they have been for many years. This probably reflects operators’ concerns with the issues mentioned in this paper. Therefore, our investment thesis boils down to a simple point – that mining companies’ uranium inventories are being run down, and that the price will be forced up to incentivise miners to increase production.

The gap between worldwide uranium production and demand from nuclear power stations has been rising steadily since 2015 (Exhibit 4) and will almost certainly continue to do so. Last time demand dramatically exceeded supply, the uranium price peaked at $148 (in May 2007). With 228 new reactors coming onstream in China alone and almost twice that many worldwide over the next few years, the uranium price can only go one way.

Sceptics will argue that the price rise will come to an abrupt halt, once the next accident happens, but a couple of facts suggest a different reaction pattern, should another Chernobyl occur:

(I) Almost all of the growth over the next few years is EM-driven, and much of it in countries where scepticism and criticism are irrelevant factors, being largely ignored by the leadership.

(II) A new view is gaining ground: If the climate is changing as dramatically as suggested by various weather events year-to-date, maybe the ‘Chernobyl risk’ is a risk worth taking? If that view is gaining ground in a country as hostile to nuclear as Denmark, I would argue that it can happen anywhere.

The latest on SMR

In a research paper from September 2022 which you can find here, I introduced a new nuclear technology called SMR. SMR stands for Small Modular Reactor and is, as it says on the tin, a new, smaller reactor type that is based on the module principle. Take another look at the image on page 1 of this paper. Whereas a conventional nuclear reactor takes up the size of a football pitch, an SMR reactor only requires the space of a tennis court. Furthermore, SMR reactors are manufactured by robots in a factory, then shipped to the installation site and assembled there. This makes the installation process both faster and safer, as the risk of human error has been dramatically reduced.

A typical SMR reactor module is 20 metres high and 2.7 metres in diameter. Up to 12 of those modules can be paired together to increase the output. All reactors will, independent of humans, switch off under certain conditions, and they are submerged in water tanks, made of concrete. They are therefore resilient to earthquakes and impermeable to aircraft impacts. In other words, the SMR technology offers significant safety features that do not exist in conventional nuclear power plants.

For years, sceptics have argued that, whilst fine in principle, SMR reactors will never become costs-competitive vis-à-vis fossil fuel-based power stations. However, things are changing. Technological advances over the past 18 months, high fossil fuel prices and a long string of extreme weather events have changed the dynamics. The SMR technology is suddenly much more competitive and governments, eager to address the climate issue, have said that they are willing to compromise, even if SMR is not yet fully competitive – for the sake of future generations.

Only a few weeks ago, the Canadian government teamed up with the Province of Ontario and placed an order for three SMR reactors in addition to the one they already had on order (see the story here). The four SMR units are expected to generate 1,200 MW of electricity in total, similar to the output from a conventional nuclear power station, and 1,200 MW is enough to power 1.2 million homes.

Over the next few years, you should expect the SMR technology to become the prevailing nuclear technology. As mentioned earlier, an SMR power station doesn’t take up much space, and it is expected that many will be located in suburbs, much closer to where the energy is used. That will meaningfully reduce transmission costs and energy losses.

SMR is the latest, and will probably also be the last, nuclear fission technology before we begin to switch from fission to fusion – something that I expect to happen at some point in the 2030s. The fuel in an SMR reactor is uranium while, in a fusion reactor, it is lithium. Given the breakthrough of SMR over the past 18 months, demand for uranium could grow exponentially over the next 5-10 years.

Our current Uranium Basket

Our uranium basket accounts for about 13% of the Megatrend Portfolio at present. This makes uranium the largest basket in the portfolio. The IRR on that basket is +26.4% so far, which is a number that can be compared with the performance of the two leading uranium ETFs, VanEck Uranium + Nuclear Energy ETF (NLR) and Global X Uranium ETF (URA), both of which have delivered IRRs in the low to mid-teens over the last 15 months –.

I ought to point out that our performance – +26.4% – is gross of fees, while the two ETFs – +12.8% and +10.9% respectively – are both net of fees. It is also worth noting that our uranium basket was topped up in February (in hindsight, at the wrong time!), whereas the two ETFs are entirely passive.

Our Uranium Basket peaked in February, following which it sold off as investors temporarily turned cold on uranium. At the low point in April, the drawdown was almost 24% – significantly more than the decline in the uranium price. The drawdown could be the result of the high equity beta in the Uranium Basket or the consequence of poor liquidity in some of our holdings, or it could indeed be a combination of the two. Hard to say.

Adding Cameco to the Uranium Basket

We have decided to increase the blue chip-presence in our uranium basket. If our thesis is correct, institutional investors will increasingly invest in uranium, and many uranium stocks are not liquid enough for the needle to move in large, institutional portfolios. Having said that, we are not going to walk away from all of the less liquid names we hold in the Uranium Basket.

The Canadian uranium mining company, Cameco, is very liquid, whereas the liquidity of the ADRs of Kazatomprom, the Kazakhstani mining company which is the undisputed world leader in uranium mining, is reasonable but not great. Behind those two, liquidity in the uranium industry is poor. I am reluctant to recommend investing in Kazatomprom, though, as there is significant geopolitical risk associated with investments in Kazakhstan – particularly at present.

Cameco (CCJ on NYSE) is the largest uranium mining company in the western world with a market cap of about $15Bn.  Over the last 12 months, it has traded about 4.5 million shares daily, making it (by far) the most liquid uranium mining company worldwide.

The stock has performed very well in recent years.  From a low point of about $6 in March 2020, it now trades at about $36 – up over 40% over the last five months alone.  The Canadian government’s decision to build several new nuclear power plants in Ontario, including three SMR reactors, has helped to drive the stock price higher more recently. And in Georgia (USA), the first new reactor in ten years came onstream recently.  All of this has created plenty of noise in the investor community, and Cameco has been a prime beneficiary.

It is very tempting to wait for a pullback before investing, but the weather news from all over the world in recent weeks can only increase the pressure on governments to phase out fossil fuels ASAP.  Cameco, being as liquid as it is, will almost certainly benefit from that, and we have already begun to establish a position in it.

Final few words

It is not only in North America that nuclear is experiencing a bit of a comeback.  Only days ago, the Swedish Minister for Climate and Environmental Issues, Romina Pourmokhtari, said that the Swedish government is prepared to change the legislation in the country, so that it can expand its nuclear programme dramatically.  Announcements like that will almost certainly spark further interest.

Niels

23 August 2023

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