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Tuesday, December 5

Portfolio Update: Uranium

Uranium 10.2% (as of 11/30/17, in the Commodity Book) 

OM outlined his initial thesis on Uranium stocks back in April.  Here’s the brief recap…
- After a multi-year price war as suppliers sought to build/maintain market share, 2 producers now control over 50% of supply.  It also takes years (literally, 5-7 years) to test drill, permit and build a mine. 
- The primary demand is nuclear power plants.  The 2011 Fukushima earthquake resulted in mass shut-downs (Japan and Germany) but we’re very slowly seeing Japanese plants come back online and new plants being approved and built (China and India).  Existing plants have long-term contracts (2-10years), with the majority coming due in 2018-2020.

The combination resulted in an industry operating with the price of the commodity beneath the cost of its production.  Yet, illogically, nobody wanted to cut production and so the suppliers kept producing at negative cashflows even as nuclear plants remained sidelined (or on the drawing board) post-Fukushima.  Lo and behold, uranium and the suppliers’ stocks got monkey-hammered (or insert your dramatic adjective of choice), with the URA ETF collapsing 80-90% from its 2011 peak. 

However, irrationality can only last so long, and (almost) nothing goes down forever.  After a brutal five years of cash flow negative production, and no investment, sanity finally returned.  The two biggest players (Cameco and Kazatomprom) both announced production cuts in 2016, and URA confirmed a yearly uptrend in 2017 (the price was higher than any level seen in 2016).  Despite volatility, URA never retreated to its 2016 low, and the combination of the fundamentals and technicals was enough for OM to take an initial position.

So what has changed?  Cameco just threw in the towel!!   It shut down two of its Canadian mines, one of which is the largest in the world (11% of supply) for at least 10 months.  The shut downs come replete with some dazzlingly blunt comments from the CEO, including that due to the oversupply in the market “it does not make economic sense for us to continue producing at McArthur River and Key Lake”  and “we can actually buy uranium cheaper than we can produce it.

Read that last one again, and let your mind boggle.  The CEO of the 2nd largest uranium producer in the world, closed down the world’s largest uranium mine (which is in the bottom half of the total cash cost curve globally) because it is cheaper to buy uranium in the open market. 

With evidence of supply-side discipline finally arriving did OM go out and buy some more uranium?  Hell yeah, he did – adding to URA and starting a small position in NexGen Energy (NXA, which owns attractive deposits in the Athabasca Basin, Canada) in the days following Cameco’s announcement.

STOP THE PRESSES 
OM intended to post the above over the weekend.  Thankfully, his failure to do so, means that this post isn’t already out-of-date.  Why?  Well, I’m glad you asked!  In the above post, OM had studiously avoided the rumors that the Cameco cut was choreographed with Kazatomprom, who would announce something similar when the dust had settled.

Want to guess the news that OM woke up to today?  Another England collapse in the Ashes, of course.  But other than that?  Oh, just Kazakhstan saying it will reduce its uranium output by 20% over the next three-years starting in January, thereby cutting global uranium supply by another ~10% over that period.  

Surely a coincidence that the two biggest players cut supply within weeks of each other to balance (if not more) and over-supplied market.  What fortunate timing too, given most long-term supply contracts are coming due over the next 3-years.  The intriguing thing about market-related psychology is that it can work in both directions.  Will the disciplined nuclear utilities, who saw an over-supplied market and were content to run down their inventories now see a market that’s moving towards being under-supplied and race each other to secure new long-term contracts?   After all, I’m sure Cameco and Kazatomprom are well aware that the last time there were large contract rolls, which coincided with supply disruption (due to the flooding of the Cigar Lake mine), it was 2006 and spot uranium went up 4x in less than 18months.

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