Uranium – It’s all about supply! (Part 2)

Ever since Fukushima in March, uranium equities have been clobbered by a flurry of negative news and political risk but as we showed in Part 1, the uranium industry does not face a lack of demand, it is more at risk of a supply shock once the Megaton to Megawatt (M2M) programme in the U.S ends in 2013.

After Fukushima, spot decreased violently (decrease of 30 percent) however, long-term contracted prices were not greatly affected (decrease of 10 percent). Despite this, uranium equities lost on average around 60 percent (chart 1). This massive drop can be partly explained by sentiment and a heightened risk in owning uranium producers. This risk is illustrated in chart 2 where the cost of equity of most uranium miners expectedly increased from Q1 onwards. Interestingly, Paladin Energy and Energy Fuels saw decreases in their cost of equity, but still suffered massive price decreases of 59 percent and 74 percent  respectively (chart 3).

The power of sentiment has also driven most uranium producers below or to a price to book of 1 (chart 4). This comes despite mean uranium price forecasts increasing (chart 5).To highlight this irrationality, Uranium Participation - a fund that invests in spot uranium prices - has been trading at a NAV of 0.92 relative to its book value, meaning that the fund could be liquidated and investors would get a return of 8 percent simply from the liquidation.

Although no short-term catalysts seem to exist for uranium producers, any shift in the current gloomy sentiment could potentially spur a rally in the sector. For more patient investors, anti-nuclear investment sentiment may subside if long-term prices begin increasing, which should remove much of the fear overhanging uranium producers. In addition, this may decrease their cost of equity resulting in quick appreciation in valuations.

The risk still remains that the giant Cigar Lake mine - which was flooded and subsequently closed and has seen its reopening postponed for three years now - will actually begin production in 2013. A natural hedge to this risk could be to simply invest in the mine owner, Cameco, and if the mine starts producing, long-term prices may decrease but the company should benefit from the mine's output and related earnings. Furthermore, if the mine doesn’t produce, or re-opening is further postponed, Cameco may still benefit as long-term prices will most likely increase.

To summarise Part 1 and Part 2 of this blog series, there is stable and growing demand in the uranium industry, but the question remains what kind of impact the end of the M2M program as well as the Cigar Lake mine will have on supply and consequently on the price of uranium.