The Bubble & Uranium Stocks

The dramatic rise in the price of uranium brought a plethora of new mining and exploration companies to the market. Alongside these new firms, established companies were increasing their current uranium mining capacity and taking all possible measures to cash in on the 'hot' commodity. The almost exponential growth in the price of uranium coincided with rises in the price of stocks which were involved in uranium production. The graph below shows the price movements of Uranium U3O8 alongside three of the largest uranium mining companies, Cameco Corp, Rio Tinto and Areva (all prices are in USD). As can be seen clearly from the graph, all three mining companies experience significant price rises as the uranium bubble materialises.

In the summer of 2008, problems in the US sub-prime mortgage market came to light and the notorious financial crisis ensued. This caused the uranium bubble to burst and prices (of pretty much all assets) to tumble. Many of the new companies that had simply jumped on the uranium bandwagon were forced out of business while more established companies diverted capital away from uranium production or simply abandoned it altogether.

The Uranium Bubble: Demand Side

Worries over climate changes and the supply of fossil fuels means that a strong case can be made for the use of nuclear power. According to the World Nuclear Association, worldwide nuclear power capacity is increasing steadily, with over 60 nuclear power reactors under construction in 13 countries (figures accurate as of August 2012). Alongside this increase in reactors, further nuclear capacity is being created by plant upgrading and plant life extension programmes.

China has by far the most ambitious nuclear programme with almost 30 new reactors currently under construction and even more about to start construction. There are also plans in place to build some of the most advanced nuclear reactors in the world with an aim to achieve a five-or six-fold increase in the country's nuclear capacity by 2020!

Although not on the same level as China, both India and Russia have extensive plans for nuclear expansion. Of the 7 nuclear reactors currently under construction in India, 2 are expected to be completed in 2012, the country's aim is to supply 25% of its electricity from nuclear power by 2050. Russia is planning to increase its nuclear output by 50% by 2020 and should have 10 new reactors operating by 2017. It's a shame that all of this will be happening long after the completion of the Megatons to Megawatts Program which would have alleviated some of the demand pressures.

Even though they are not likely to contribute much to the expansion of nuclear capacity in the near future, over 45 emerging nuclear countries are actively considering developing nuclear power. For full details of worldwide plans for nuclear reactors click here.

The result of this dramatic worldwide increase in nuclear capacity is higher demand for uranium in the future, which, given the concerns surrounding future supply (and the already sizable demand-supply gap) led to speculation in the uranium market and the subsequent uranium price bubble.

The Uranium Bubble: Supply Side

The almost exponential growth in the price of uranium began in 2005, a year which saw world uranium production fall short of world demand by around 40% (approximately 108 million pounds were produced when 178 million pounds were required). Taking this into consideration, it would not be unreasonable to assume that the hike in uranium prices was triggered by the fear of a uranium shortage. But why would prices only begin to shoot upwards in 2005 when, as mentioned in one of my earlier posts, uranium production has not met requirements since around 1987? I have no doubt that the shortage in supply was a contributing factor to the bubble but there appears to be a lot more going on beneath the surface!

Cigar Lake Mine (pictured below and coincidentally beneath the surface), located in Saskatchewan, Canada, is the largest undeveloped high-grade uranium deposit in the world. Construction of the mine began in 2005 and production was originally planned for 2007. The unhindered completion of this mine would have boosted uranium production and prevented demand and supply pressures pushing up price but this was not to be the case. In October 2006, a retaining wall collapsed the mine experienced a devastating water inflow which caused the mine to flood, and if that was not enough, a second inflow occurred during the first attempt to remove the water from the first flood! These events created great uncertainty around the future supply of uranium which could have acted as the catalyst for the price bubble. Cameco Corporation (majority owners of the mine) now anticipate production to begin in the fourth quarter of 2013 but given how often their production timeline changes, I wouldn't hold my breath. For a full article on the revised production timeline click here.

The Russian Megatons to Megawatts Program (for more information click here) is another factor which contributed to the uncertainty surrounding the future supply of uranium. The program was implemented in 1993 and was an agreement between the United States and Russia to dismantle Russian nuclear weapons with a view to converting bomb-grade uranium in to low-enriched uranium (LEU) for fueling American nuclear power plants. The program, which has so far seen 472.5 metric tons of bomb-grade uranium recycled into LEU will be completed in 2013 when the target of 500 metric tons (the equivalent of 20,000 warheads) has been reached. The completion of this program means that a valuable asset in uranium production will be lost, causing the supply and demand gap in the uranium market to widen.

Uranium Market Fundamentals

There is no formal exchange for uranium. The commodity is not traded on an organized exchange such as the LME and only recently has NYMEX offered structured uranium futures contracts (full specifications for these contracts can be found here). While uranium futures are a useful hedging tool for producers and users uranium, the transparent pricing mechanism provided by the NYMEX contracts means that speculators are becoming an ever-growing market contingent. The pie charts below shows the changing composition of buyers in the Uranium U308 spot market between 2000 and 2012.

Uranium price indicators are developed by a small number of private business organizations such as TradeTech and UxC Consulting who assess price related data and analyze developments that affect the uranium market. The UxC Consulting Company is a leader in the nuclear industry and their Uranium U308 price indicator provides the final settlement price for the NYMEX contract mentioned above. Uranium U308 the chemist’s name for the compound however it is also known as ‘yellowcake’ uranium which is a lot less intimidating. The term ‘yellowcake’ comes from the metals early production methods which resulted in a bright yellow product resembling cake batter.

The graph below shows the full spot price history of the spot Ux U3O8 price index. Beginning in 1988 the price fluctuates at a level just shy of $20 until 2005 when the price begins to climb drastically to a peak of around $135 in 2007. I will discuss this price rise in my later posts. In the aftermath of the bubble the spot price has remained closer to the $50 mark and has been significantly more volatile. This increased volatility is a result of increased trading activity in the market as traders attempt to make a quick profit. Record spot market activity was observed in 2010 when the spot price broke through the $60 mark for the first time in two years.

Uranium: Who? When? What? Why? Where?

German chemist Martin Klaproth (below) discovered uranium in the mineral pitchblende in 1789. Uranium is a heavy metal which occurs in most rocks in concentrations of 2 to 4 parts per million. The element was named after the planet Uranus and its chemical symbol is U.

The picture of Springfield’s Nuclear Power Plant at the beginning of my blog is not just for fun! It is there because the main use of uranium is to fuel nuclear reactors in the production of electricity. Uranium is an abundant source of concentrated energy; this is illustrated by the example provided in Emsley (2001) which states that one kilogram of uranium-235 can produce as much energy as 3000 tonnes of coal (assuming complete fission).

Depleted uranium is around 60% more dense than lead and is used as stabilizers in the keels of yachts and boats and as counterweights in aircrafts. Depleted uranium is also used for radiation shielding in the transportation of radioactive materials.

The military makes takes advantage of depleted uranium’s weight and density properties by using it to make armour-penetrating ammunition. The metal also has a propensity to ignite on impact at temperatures over and above 600 degrees centigrade which make it a very worrying adversary!

Kazakhstan, Canada and Australia are the world’s biggest players when it comes to uranium mining, consistently accounting for around 65% of the world’s total uranium production. Kazakhstan has shown the greatest growth in uranium mining over the last seven years, contributing just 6.4% of total production in 2005 compared with 29.4% in 2011. The graph below clearly shows that worldwide uranium production has constantly fallen short of world uranium requirements in the last seven years although the situation seems to be steadily improving. We would have to go all the way back to 1987 to experience a situation where uranium production was on a par with the demand requirements!

Blog Introduction & Bubbles

My blog is going to centre upon the bizarre ‘Uranium bubble of 2007’, a period in time which saw  uranium prices rise from a level around the $20 mark to incredible highs in the region of $135.

Before I explore this particular bubble in more depth I would first of all like to get a more general flavour for what an economic (or speculative, or market, or price, or financial) bubble actually is, how common they are and what the supposed causes of these seemingly evident drifts away from market efficiency are said to be.

So, what exactly is a bubble? Before answering this question it is important to recognize that bubbles are not confined to the price of a particular commodity such as uranium but that they can form in economies, business sectors, stock markets or even individual securities. An interesting list of some of the more bizarre and exotic bubbles which have come to pass can be found here.

The earliest recorded bubble occurred during the 17^th century in the Dutch Tulip market and is affectionately referred to as ‘Tulip Mania’. Put simply, a bubble is a situation where the price for a particular asset (business sector, economy, etc.) is significantly higher than its fundamental or intrinsic value. This period of overly-inflated prices is usually (but not always) followed by a sharp decline in prices and when this happens the bubble is said to have ‘burst’. Given their definition, it is clear that bubbles fly in the face of standard financial market theory which postulates that asset prices should tend towards their intrinsic values. An article by Buchanan (2008) entitled ‘Why Economic Theory is Out of Whack’ highlights this contradiction and discusses the US mortgage market bubble which triggered the recent financial crisis. The full article can be accessed here.

Economic bubbles are probably more common than supporters of market efficiency would like to admit. Beginning in 1630’s with the aforementioned ‘Tulip Mania’, economies around the world have experienced bubbles in a variety of different sectors. The 1720’s saw bubbles form in the stocks of South Sea Company and Mississippi Company, the 1840’s endured ‘Railway Mania’, and then we had the Florida land boom of the 1920’s. More recent bubbles have included the Dot-com bubble of the 1990’s and the 2007 Romanian property bubble.

With regards to what causes economic bubbles, a consensus has not yet been reached but it is worth mentioning some of the popular (possible) explanations. The first contender is excessive monetary liquidity in the market which can be caused by a combination of easy money and an expansionary monetary policy. This provides the financial system with an excess supply of money until a situation is reached where too much money is chasing too few assets and bubbles inevitably form.

The moral hazard problem played a considerable role in the US sub-prime mortgage market and is another possible cause of bubbles. It is the idea that an investor shielded from risk may behave differently given this protection than if he/she were fully exposed to the risk borne by investment.

Other psychological factors which are said to support the formation of bubbles are herd behaviour and greater fool theory. Herding relates to the idea that investors will buy or sell an asset in accordance with the current market trend, for example a strong upward trend will induce frantic buying and cause a bubble to form.  Greater fool theory is an unsupported (yet quite amusing) explanation which suggests that bubbles are driven by the behaviour of overly optimistic investors known as ‘fools’ who buy overvalued assets with a view to selling them to others, the ‘greater fools’ at a higher price.