📜 The Global Opportunity in Uranium Investing (w/ Adam Rodman)
ADAM RODMAN: My name is Adam Rodman. I am the founder and CIO of Segra Capital Management, a Dallas based hedge fund. We've been particularly focused on the nuclear power and uranium space over the last several years. And Real Visions invited me back here today to talk about it for, I think, the third installment of Segra's views on the topic. For those of you who missed the first two installments, what we've been very focused on is the commodity, uranium, the mined substance commonly known as yellowcake or U308. It's a very niche and kind of small commodity in the scheme of things, but powers or is the critical fuel for what is arguably the most important power source globally, which is nuclear power. And so in the most simplest terms, uranium, U308, yellowcake is a mined powdery substance that global producers pull out of the ground in far flung places such as Kazakhstan, but also in the US, Canada, and Australia. It's then enriched and converted into fuel that can be used by the globe's reactors. And that would be nuclear power plants. So one of the big questions that were asked often is around our call from I think the episode we did for Real Vision in November, December 2017, that some of the world's biggest and best minds were going to have to come offline, essentially, as some of their contracted material was going to come up for recontracting, given how low prices were. So generally speaking, a miner, a producer of uranium will sell forward into long term contracts and lock in a price. And while we've now been in this multi-year bear market, many producers stayed solvent and profitable because of those past contracts. But as time moves on and the cycle progresses, and eventually, these producers have to restructure their contracts, market prices tend to prevail. And what we tried to hammer home back a little more than a year ago now in our first installment was that no miner was rationally going to sell their pounds at a loss in a new contract. And so we were good or we were lucky in predicting that Cameco in particular was going to be forced to permanently shut down MacArthur River. At the end of 2017 they announced a temporary shutdown, and then a permanent one just this past summer in 2018, which removed a significant portion, 15% to 18% of world supply from the market kind of in one fell swoop, which is a very, very big deal. But really, the economics behind that decision to a certain extent still apply today. So what I urge everybody to keep looking at is really, what the global marginal cost curve is in the world, which is where people can profitably mine the next marginal pound of uranium versus prices in the market today. And really, when I was last on, or in the first full installment a little more than a year ago-- I forget exactly-- but uranium prices were either in the high teens or low 20s. We've moved now closer to $30, which is a very good return on a percentage basis. And I believe it makes uranium the best performing hard commodity for 2018, which was a brutal year for resources. But reminding everybody that we have a long way to go. Because even if spot prices are $28 to $30, marginal costs are likely twice that going forward. And given that we see pretty significant deficits over the coming five or 10 years, marginal cost becomes all important, and it's much, much higher than it is here. The uranium market is unique not only kind of in how off the radar it is, but also, in the way that it's traded. So there are really two important prices. One you can pull up on your Bloomberg. And unfortunately, it's the less relevant one which leads to a lot of the opportunity in the market, the inefficiency in the market. And the second is the contract market, which is essentially a bespoke bilateral agreement between XYZ utility and a producer of uranium. And those numbers get aggregated by third party sources, but they are not public and transparent in the way that spot prices are. You can pull up spot prices on a Bloomberg terminal. It's technically quoted in spot and the futures market. But again, it's pretty thinly traded, and this is somewhat of an indicative price. It has been important for sentiment for reasons that I think we can maybe get into when we talk about supply and demand a little bit further. But it's not exactly relevant to the market, because when again, let's take a utility, let's just say, Duke Energy goes out to supply their long term fuel requirements. They don't source the bulk of that material in the spot market. They don't go in and buy every day. They will go to one of the producers of uranium and essentially strike a term contract whereby they receive a predetermined amount of material at a predetermined price delivered to them in all the years that the contract specifies. The market today has had very, very little-- in fact, 2018 had just about no contract volume going through-- despite a rising spot price. And to take it back to the two different prices, it's important because spot prices maybe are a little bit of a sentiment indicator. As people look to see whether or not things are going up or down, spot might be a daily price that you can look at. But the economics of any mine or miner is going to be driven by where they're ultimately able to contract their uranium long term. We believe those prices today are effectively at the marginal cost, at a minimum. Meaning that prices of uranium today are really $45 to $65 depending on jurisdiction, et cetera, even though the spot price only shows $30. But I think what the market is waiting for-- and again, why the opportunity continues to improve, get better and better even after the MacArthur mines shut down, spot prices rallied, is that the market is waiting to see for contracting start. And people, investors, especially after an eight year bear market, are skeptical that prices will actually be at an economic price. And I guess what we believe strongly and what I'd be urging viewers is to be looking for in whatever news source or other third party source you can work contracts eventually get struck, because we believe it has to be at an economic price. That economic price is almost 100% higher than the current spot price. And that that is the critical data point for the market to really take off. Because again, the spot prices, while they might be a feel good price, a sentiment indicator, a directional indicator, they're not driving the business model necessarily of any mining company out there that mines uranium. Production cuts and spot buying has led to a very strong move in the underlying commodity in 2018. But important catalysts to look for the space as a whole really revolves around contracting. Getting back to the basic dynamics of the uranium market, it's a pretty simple market. You have really, one buyer, and that's global utilities. And you have a relatively small group of mines that produce and then sell to those utilities. But unlike other commodities, and I think I mentioned this in some of the other interviews or segments that I did for Real Vision, demand is completely inelastic. It doesn't really come in when prices are low. It doesn't really stop when prices are high. It just really comes in around the cycle. But when utilities find that they have uncovered requirements going forward, usually, for the next five or 10 years, they re-enter the market. Again, buying not because prices are low or high, but buying purely on need. And that's because the actual uranium price, the U308 price, is a very, very small percentage of the cost of operating a reactor. Going forward, what are the all important catalysts for the uranium market as a whole really are uranium buying, the beginning of the contracting cycle, and then where they are going to be able to find those pounds of uranium that they need for their requirements into the future. They being the existing nuclear reactors, but also, the very large quantity of new reactors, which are being built and delivered over the next several years in the emerging markets. And given that we are forecasting a deficit, and a deficit that doesn't have a good chance of being met because of the lack of Capex invested in the space over the last eight years, we think that they might have a lot of trouble doing so. Meaning that prices can really accelerate to the upside, again, once the contracting cycle begins. The other element this thesis is that there are a lot of natural catalysts that have to occur in this market in the case that we're wrong in our views. And what do I mean by wrong in our views? Let's just say that contracting is delayed, utilities don't come in to buy, meaning that there is no contract price that goes through at $50 or $60, that then justifies further mine development, and new supply coming into the market. Well, the economics of the existing mine base isn't getting any better. In fact, costs are rising. So it's an environment where we have a rising cost curve. The price dynamics that forced Cameco to shut down MacArthur River, won't be changing in that circumstance. So again, in this low price environment, only more supply is going to be forced to come off as less legacy contracts exist. So producers are going to be forced to strike new contracts at prevailing market prices, which is below their cost of mining and as they face the natural depletion of their resources. However, as we saw in 2018, and as will continue in 2019 and 2020, if prices don't rise to restart mines, the likes of Cameco and other producers will follow, will buy in the spot market, which is cheaper than producing. Creating kind of a natural floor in the market. So while that's not a catalyst per se, we still look at it as a driver of prices short term. Because the spot market again, is thin. It's not exactly relevant to utilities, but it is important for setting a base in terms of the way that market dynamics are established. And that base should, in our opinion, continue to rise in a noncontracting environment, acting almost as its own catalyst, at the very least, as a margin of safety. Because you have a bid, a persistent bid in the market to be buying material, even if the contracting cycle doesn't start. And then that seems to be lost on all on a lot of market participants. What is lost on a lot of investors is that if prices stay, let's just say, where they are now, producers will continue to shut in supply. Take the pounds that would otherwise be coming out of mines, and replace that with spot market purchases. Which will at very least underpin that price at these levels, if not drive it higher, until that contracting cycle starts. So call that a catalyst, if you want, a natural catalyst. Or at the very least, you know, call it a margin of safety. But either way, it's a very strong dynamic which gives, I think, investors protection here, even in the downside. While we wait for the extreme portions of the thesis to come over the next one, two, three plus years. So one question that we get asked often, given that we've been kind of vocal proponents of this idea over the last year, year and a half, is why we haven't seen kind of a lockstep move in the equity space with the price of spot. Again, spot rising from the high teens towards $30, that's a significant return. No equity in the space has matched that I can think of, the return of the underlying commodity. And so why is that? Well, before we get into it, let's talk about the market structure. The uranium and nuclear power related sector has been decimated in the post-Fukushima world. Talking about uranium specifically, the market capitalization was around $130 billion pre-Fukushima. There were 450 plus companies in the space. And today, we have 40 companies, and a market cap even when including giants like Cameco Corp, and now, Kazatomprom that is under $10 billion. And before Kazatomprom's IPO in 2018, it was around $7 billion. It's been really decimated, and there aren't a lot of options. In terms of the companies that are left-- really, most of the companies are miners. But they get broken down into those that are currently in production. So they have an active mine. Those that are developing mines or restarting mines if the price gets to a level that's economically viable. And then there are really, exploration companies. So companies that are going out and trying to build a resource base to eventually build a mine. So when we take that, let's say, opportunity set in the context of the uranium price, maybe we can understand why the equity space hasn't really followed suit. Undoubtedly, the producers, those that are currently producing, have seen the best performance within the space. And that's probably obvious, because your average investor looks at what they're going to end up selling the price for. In the market or in a contract that's rising, it's better for their business model. But development companies and exploration companies have been laggards. And they've really traded more defensively than the resource sector, which had a very, very bad 2018. But they have not been moving in lockstep. And that's because the critical component to them having a viable business model is a contract price that enables them essentially, to fund their mine development or exploration, and then produce economically in the future. And we think there is a huge opportunity in this, generally speaking, because we forecast supplydemand, which we believe goes into a significant deficit. And then we layer over a price that we believe the world needs to see those various pounds at different time intervals and a different demand levels to essentially bring that production online. And what that makes us highly confident in is that the contract price, and the forward price, however you want to think about it, today is above $55 or so globally for the next marginal pound. And if and when that happens, you know, contract cycles are inevitable. Utilities exist in the world. It's actually a growth industry. Demand for nuclear is growing. And they will eventually contract. In fact, the upcoming years are heavy contracting years. Yes. So people who are skeptical of the market would maybe point to the lack of equity follow through for most of the sector as showing that it's wrong, or that prices aren't going to rise and. I just choose to take the other side of that. Again, contract prices are what's relevant. We didn't see contract pricing in 2018. Part of that is due to the section 232 petition filed by US miners, essentially asking the government to put a quota system in on US uranium, forcing US utilities to buy a certain quota of material from US producers. Until a judgment is finalized on that, US utilities have been absent from the contracting market, and global utilities have followed the US block in waiting to see the resolution before contracting. But that doesn't mean that the price isn't going to be higher. In fact it gives, I think, investors a very small window of opportunity in a highly inefficient market to front run the inevitable, which is contract prices that reflect the economic price of mining. Which again, is much higher than the market is being given credit for. In the last section, I mentioned section 232. Let me just quickly and simply kind of summarize what that is and why it matters. Many viewers might remember the petition to the Trump administration to kind of protect the US steel industry from foreign dumping of steel. And the avenue by which they asked the Trump administration to protect that domestic industry was called a section 232 petition. It goes to the Commerce Department. It essentially presents why action needs to be taken to protect a certain domestic industry. The uranium mining industry in the US took a lead from steel companies, and decided that because the likes of Kazakhstan, potentially Russia, had been selling cheap, cheap material into the market, pushing down prices, and thereby, endangering their business models, that they too, should get a form of protection from the Commerce Department so that they could be viable. The reason it becomes extremely relevant here again, probably more so than for other commodity markets, is that it put US utilities and global utilities in a holding pattern for striking new term contracts. And that is the only demand in this market. There is almost no financial speculation, at least not yet, in the uranium market where the likes of you or I would go in and take very, very large uranium positions expecting a resolution, and expecting utilities to come in. It happens a little bit here and there, and there were some financial volume speculator volume going through in 2018. But it's not like oil, or copper, or really, any other commodity in that sense. So it's all important that utilities enter. But while they wait to find out how the US government is going to rule on where they are allowed to source their uranium fuel, everything has been put on hold so. And I think the most important thing to understand about the way that utilities interact with producers, and therefore, why 232 ends up being important, is that the price of uranium. And by that, I mean the price at which a utility can source contracts for uranium has been, in our opinion, at $45 or $50 or $55 for the last several years. But no transactions have taken place. A year ago, spot prices were at $20. And a fuel buyer would go to their manager and say, listen, we don't have uranium for delivery in 2022, '23, '24, and '25. We're a little low. We should go buy some. And the fuel manager would say, great, go out there, and try and source material. Fuel buyer goes to XYZ uranium production company, says, hey, we're looking for a four year contract, where are you guys going to sell this material? And they say $50. Fuel buyer goes back to fuel manager and says, $50 is the price. And the fuel manager pulls up his Bloomberg terminal and sees spot prices at $20, and says, there's no way I'm paying more than 100% premium to what I see on the screen. The market's been oversupplied for many, many, many years. There's no reason for me to move. And the way that I would boil down everything that's happened over the last 18 months-- supply cuts, growing demand out of emerging markets, every catalyst that we've listed for you not only in this segment, but the ones before-- is shifting the power to that of the uranium mining industry globally. That's to say that they now wield more power enforcing that bid offer spread in the market to be crossed. Because they've now shown that they're willing to shut in production, by spot to converge to two prices, et cetera leaving utilities in a bad position to source their material when the contracting cycle starts without being at much, much higher prices. And 232, just to tie it all together, just forced the market to wait a little bit longer, because those contracts weren't going to happen or aren't going to happen until we get a resolution. We as a firm have obviously dedicated a lot of time to this topic. And the question I think for many, is maybe, why, or why is this cycle so different. In the context of a commodity cycle that has inelastic demand, deficits are all important. And not a lot of people that are around in the investment community today were here investing the last time the uranium market went into a deficit, which was many decades ago. Even when we've seen epic price runs to the tune of multiple hundreds of percent in a few quarters time, it was done in a balance to surplus market. Which leads us to wonder you know exactly what is going to happen in the uranium market if we do stay in sustained deficit. And to be clear, by our numbers, and I believe we've done as much work as anybody, if not more on the topic, we're in deficit now, and we will be in sustained deficit for the next several years going forward. And the longer it takes for the price to rise, the more severe the deficit is going to be in the future. Meaning that positioning today kind of becomes all important, because when these cycles move, they move quickly. And again, if a contract gets struck tomorrow, we believe wholeheartedly that it's going to happen at a price that is maybe 50%, 75%, 100% higher at a minimum, to spot prices, and the entire sector will likely rerate. The mega bull case comes if and when the market realizes that at any price, there is not enough material that can be produced from global mines and secondary supplies to fill the growing demand from the existing and growing nuclear fleet globally. And that's kind of the big picture.