Sprott Physical Uranium Trust: All Stars Are Aligned For Uranium Bull Market
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Most investors will be familiar with the uranium bull thesis. A majority would agree that the uranium price, sooner or later, has to move higher, in order to incentivize new primary supply. However, the real challenge is in getting the timing right. In this article, I will argue that new powerful catalysts are coming into play, which make an investment in physical uranium an attractive medium-term speculation.
There are two main investment vehicles to gain exposure to physical uranium. The first is the Sprott Physical Uranium Trust (OTCPK:SRUUF) (U.UN:CA) (U.U:CA) (SPUT), which is the main focus of this article, while the second is Yellow Cake (OTCQX:YLLXF).
The Sprott Physical Uranium Trust (SPUT) has main listings on the TSX (U.U and U.UN – the first is in US dollars, the second in Canadian ones), but is also available on the OTC market under SRUUF. Yellow Cake has listings on the LSE under ticker symbol YCA and on the OTC market under YLLXF.
They are very similar, in the sense that both securities are backed by physical uranium holdings. So they both exist entirely to provide investors with a way to speculate on the uranium price. However, the underlying mechanisms are quite different, as I will explain later.
In the end, it should not make any significant difference: both securities should track the physical uranium price. However, I prefer the Sprott vehicle, simply because with Yellow Cake one is betting on both the uranium price and the management’s market-timing abilities. Since the purpose is to speculate on the uranium price only, I would keep things as simple as possible and stick with SPUT.
The uranium thesis
In this section, I will review the uranium thesis. All numbers in this section are taken from two main sources: the 2020 uranium “Red Book” from the Nuclear Energy Agency (NEA) and world-nuclear.org.
The main reason for investing in physical uranium is the belief that it is in the early innings of a new bull market. The uranium price has to rise, in order to incentivize new production, and thus fix the deficits of the currently under-supplied market.
As can be seen from the above graph, the deficits in the uranium market have been steadily growing since 2015. However, apart from a brief span during which the uranium market was roughly balanced, the deficits actually go back to the 1990s. The issue is that, besides primary supply from mining, there are also secondary sources of uranium. Such sources include civil stockpiles (held by governments and utilities), military warheads, recycled and depleted uranium.
It is extremely difficult to predict exactly when the secondary sources will be exhausted, since the uranium market is very opaque. Most governments do not divulge the amount of uranium they hold. Besides, most contracting by utilities is done by means of individual arrangements.
The consequence is that there is uncertainty about the timeline over which the bull market will play out. In addition to secondary supply, other important factors include the speed with which the Japanese fleet is restarted and the re-negotiation of long-term contracts by utilities. The main point, however, is that sooner or later, the gap will have to be filled by new primary sources of production.
This, of course, is predicated on the assumption that demand for uranium is not going to decline significantly, which however seems like a safe bet. Over the next 20 years, nuclear energy is in fact forecasted to retain its current 10% market share of worldwide installed capacity, and actually to experience moderate growth of around 2.5% per year.
Things get really interesting when we compare the demand side with the supply side. On the supply side, the current spot price of around $50/lbs is below the cost of production for most new undeveloped primary sources. Here is the global production cost curve.
This graph is based on figures from 2021, when the average spot price was around $35 / lbs. Since then, the price has already moved higher and is currently standing just below $50/lbs. But, even at the current spot prices, the highest-cost producers are still unable to break even. The uranium price is therefore expected to move higher.
Not only does the uranium price have to move above the price necessary to incentivize new production, but it might overshoot and move significantly above it. This is because of the following peculiarities of the uranium market:
- Demand is inelastic. Fuel costs are a small percentage of the operating costs of nuclear power plants. This makes utilities almost price insensitive.
- Many utilities have not yet returned to the market and their contracts are all going to expire in a limited span of time over the next few years.
- Supply is also inelastic. Exploring, permitting, developing and putting into production a new uranium mine can take up to 10 years.
- The spot market is thinning because of demand from financial players.
The last point deserves further comment. The financial players just mentioned include precisely the Sprott Physical Uranium Trust and Yellow Cake. Both are scooping up pounds from the spot market and locking them away, thus further accelerating the process of burning through secondary supplies.
As a result of the points just mentioned, the uranium price could rise dramatically to the upside, even above its equilibrium price. A similar dynamic occurred during the last uranium bull market, when the spot price briefly spiked to around $140/lbs.
I consider a scenario where the uranium price moves decisively above $70/lbs as a high probability one. However, as always, there are no certainties. Possible reasons include: a catastrophic nuclear accident, an underestimation of secondary supplies, a breakthrough in nuclear technology making uranium reactors radically more efficient (and thus needing far less fuel). I would rate all of these scenarios as low-probability ones.
How SPUT works
The Sprott Physical Uranium Trust is based on an at-the-market (ATM) mechanism. Every time SPUT trades at a premium to NAV, it is forced to buy up more uranium (by issuing and selling new shares in the trust), which sucks up supply from the spot market, which further moves the price upwards, until the premium to NAV disappears. Since SPUT is just passively accumulating uranium pounds, i.e. it does not plan to sell them, these pounds are permanently removed from the available supply.
In this way, SPUT is helping price discovery, in an otherwise opaque market. It is doing so efficiently, thanks to the ATM mechanism which, in practice, provides an automated and cost-effective way to raise new capital driven by investors’ demand.
Since its inception in July 2021, SPUT has already locked away, as of this writing, more than 57 million pounds, or almost 26 thousand tonnes of uranium. Total primary uranium supply in 2021 was 57 thousand tonnes (about 77% of total demand). In other words, the fund has bought 45% of total uranium’s annual mining production and 35% of the world’s annual total demand!
As you can see, the uranium market is not very big and the trust can and does move the market significantly. There is no doubt that the launch of the fund was one of the catalysts that set the uranium price into motion last year, moving it off the $30/lbs floor into the $40/lbs region. Just compare the graph of the fund’s holdings with the spot uranium price.
In my opinion, the most interesting part about how SPUT works is that, while there is a very clear-cut mechanism for capital raising, there is no mechanism at all to ever sell the uranium. This creates an incredibly bullish scenario, with a positive feedback loop that can drive prices higher for a long time. The point is that SPUT is a totally price-insensitive buyer. Even as the price rises, SPUT will not sell. At the same time, interest from investors will increase, and new money will pour into SPUT. Which will force SPUT to buy up even more supply. Which will drive prices even higher. And so on.
New catalysts on the horizon
So why has the price appreciation stopped? As already mentioned, SPUT can trade either at a premium or a deficit to NAV. Its market capitalization is set by trading on the TSX, while its NAV is linked to the current uranium price. SPUT can issue new shares to fund its purchases only when it is trading at least at a 1% premium to NAV. Right now, however, it is trading at a more than 10% discount to NAV. So, as can be seen from the following plots, the purchases have slowed down.
The whole uranium sector has recently been trading in a correlated way with the overall market. Thus, with the sell-off of the market this year, money has also flowed out of SPUT. Besides, at the end of April, there was a significant piece of bad news, as the company’s application to be listed on the NYSE was rejected by the SEC. If SPUT had been listed, it would have been undoubtedly a game changer. It would have increased liquidity significantly and allowed more investors, especially institutional investors, to get long. I would expect SPUT to challenge the decision and try again in the future to get listed. However, for now, we have no further updates on this front.
The point is that this setback, together with some negative macro-economic sentiment, has created a very interesting discount. The discount was as big as 20% at some point in July. It has partially disappeared, but still, it is now possible to buy physical uranium at a 10% discount.
Not bad, especially because the macro scenario is still incredibly bullish for uranium, as many catalysts line up in the near and medium term. Let’s go through them.
On the supply side, the list of catalysts includes: inflation, stricter environmental regulations, producers’ market discipline, and uncertainty about supply.
First of all, persistent inflation is increasing the production costs for most miners, thus also increasing the uranium break-even price.
Environmental regulations have been getting stricter, thus making it more difficult to get new mines permitted.
Major uranium producers are still maintaining market discipline, keeping production below their full potential. Cameco (CCJ), for instance, has indeed announced intentions in February 2022 to restart production at McArthur River, but it is also planning to run it 40% below its annual licensed capacity in 2024. Kazatomprom, too, is planning to keep production around 10% below its capacity in 2024.
The war in Ukraine and geopolitical tensions are adding uncertainty about supply. Roughly 40% of uranium’s primary supply is located in Kazakhstan, which has ties to Russia. For instance, the main export route from Kazakhstan of yellowcake (U3O8) goes through the Russian port of St. Petersburg. Western sanctions could target Russian exports of uranium and its derived products. It appears unlikely because it would disproportionately harm the sanctioners rather than the sanctioned (but one should never underestimate political stupidity). Besides, before the Russian invasion of Ukraine, Kazakhstan was the victim of severe political unrest, in January 2022. This unrest was actually short-lived and had no effect on uranium production. However, if the Kazakh supply were to be seriously in doubt in the future, for any reason, then the uranium price would definitely spike significantly. One just has to remember what happened to nickel in the aftermath of the Russian invasion to understand what a powerful driver uncertainty about supply can be.
On the demand side, the following bullish drivers should be noted: overfeeding by nuclear operators, the green energy transition, the expiration of long-term contracts, and the impeding energy crisis. Let’s unpack them.
Uncertainty about supply is pushing nuclear plant operators to keep more stock than strictly necessary. This overfeeding is already evident in the downstream of the nuclear fuel cycle but is also moving to the upstream, which is pushing the price of yellowcake higher, catching up with the conversion and enrichment prices, which are already at record levels.
Most western countries have pledged to abide to their decarbonization goals, which is creating widespread awareness that nuclear has to be a part of the green energy transition. In other words, nuclear energy has established itself as an irreplaceable part of a well-diversified energy mix, especially because of its safety and reliability in any condition. This should be contrasted with renewable sources like wind, solar or hydro, which are unable to cover baseload demand on their own, because of volatility in weather conditions.
Many long-term contracts are due to expire in the next few years, which will force utilities to come again to the market to renegotiate at higher prices, which will help price discovery.
The impeding energy crisis, with uncertainty about gas and oil supplies from Russia and inability by OPEC to take up the slack, is forcing countries to keep their nuclear plants active, or even to expand their capacity. Western politicians, in particular, are expressing a desire to break free from their reliance on Russian energy without jeopardizing their net-zero commitments. This policy is exacerbating the energy crisis while also creating a powerful tailwind for all clean energy sources, including nuclear power. In fact, here is a collection of recent news about countries revising their energy strategy or looking to expand their nuclear capacity.
- France is delaying nuclear reduction plans while announcing the construction of six new reactors and considering the construction of an additional eight.
- Japan is pushing for an accelerated restart of its nuclear fleet.
- China is going to increase its nuclear capacity by 40% by 2025 (from 51 GW to 70 GW).
- The EU is going to label nuclear energy as a transitional green investment in its taxonomy, thus allowing access to billions of funding from environmental investors. This change is expected to take effect starting from January 2023.
- Even Germany has come to its senses and decided to keep its nuclear plants active for the coming winter.
Overall, the fundamentals for the uranium market could not be more bullish.
An investment in physical uranium has an attractive risk/reward profile. On the one hand, the downside is limited, since the uranium spot price is already below the level needed to incentivize new production in an undersupplied market. On the other hand, there is still significant upside, even after the run-up in prices over the last year. When secondary supplies are burnt through, the equilibrium price is probably going to be around $70-80 / lbs, implying a 40-60% upside.
SPUT is an excellent investment vehicle to speculate on the uranium price. As of August 18, it is trading at a 10% discount to NAV. Besides, because of its ATM mechanism, SPUT might be squeezing the price well above its equilibrium level.
Recession fears and the rejected application for listing on the NYSE have drawn money out of SPUT, but the fundamentals of the uranium market remain strong, with a lot of catalysts on the horizon. If the market sells off again, SPUT might also sell off, but I would view it as a buying opportunity for investors with a multi-year horizon.
The only real scenario where the thesis turns out to be wrong is if the world turns away from nuclear energy, as might happen following a catastrophic nuclear accident or the discovery of new more efficient ways of baseload energy production. These scenarios seem unlikely, especially in the short and medium terms, which is why I rate SPUT a BUY.