Abstract
The uranium market has had an unusual evolution, and its current state is very much a product of its historical development. Beginning in the 1940s, uranium production was driven by military necessity. From the 1940s until the 1960s, the U.S. government was the only uranium buyer (a monopsony), and hence a market didn't exist in the traditional sense. To stimulate the desired amount of domestic production, the United States set prices successively higher, leading to a uranium rush in the ore-rich Southwest. The buying program proved so successful that more uranium was mined than the government needed, so the government lowered the price and ultimately stopped buying. This effectively ended this price cycle, which can be thought of as the first uranium boom.
Uranium is one of the most abundant elements in Earth's crust; the challenge is to find it in concentrations that are economic to mine. This takes some time to do, but with enough lead-time and effort, a considerable number of sufficiently rich uranium deposits have been discovered and put into production.
The second market cycle began with the advent of the commercial uranium market in the late 1960s. At that time, the U.S. government held a monopoly on the provision of enrichment services for the commercial market. This was another vestige of the military era; enrichment is a key step in producing weapon-grade material, and all enrichment technology at that time was in the hands of governments. Because the vast majority of nuclear reactors require low-enriched uranium fuel, U.S. government control of the enrichment process allowed it to dictate uranium demand via its enrichment contracting practices. Since the government wanted to be able to plan its enrichment capacity, and was contemplating its eventual privatization, it forced utilities to commit to enrichment services before their reactor construction schedules were firmed up, and in some cases before they had even ordered a reactor.
This contracting approach ended up greatly inflating enrichment and uranium demand. When reactor schedules were delayed for various reasons, including the Three Mile Island accident in 1979, need for enrichment services declined notably, but utilities were still required to deliver uranium to fulfill their enrichment contracts with the U.S. government. This created a situation where for years much more uranium was mined and milled than was needed to fuel reactors, even discounting the great amount of uranium that went toward military applications. Eventually the excess uranium supplies were worked off, but in the process, price, as well as uranium production and exploration, was greatly depressed. Inventory liquidation occurred in two waves–the first was associated with the utilization of commercial inventories, followed by disposal of military inventories, the latter coming from highly enriched uranium (HEU) contained in dismantled nuclear warheads that was blended down to commercial-grade nuclear fuel in the post-Cold War era. The primary source of this fuel is from the 1993 deal between the United States and Russia involving 500 metric tons of HEU from dismantled Russian warheads, which will expire in 2014. The United States has also blended down some of its excess HEU for use in commercial reactors.
The inventory disposition phase set up the third, and current, price boom in uranium. The liquidation of massive amounts of uranium inventories depressed uranium prices for a considerable period of time, and the low prices that resulted gave the appearance that uranium supplies at such low prices were plentiful. In response, uranium producers severely cut back their production expansion plans, and utilities saw little need to contract forward since supplies seemed assured. The problem was that uranium consumption was increasing and inventory supplies were being drawn down, but replacement supplies were not forthcoming as production was not expanding. This situation eventually placed additional demand pressure on the supplies that were available, which was reflected by an increase in price. Since it takes considerable time to expand production either at existing mines or through development of new mines, price can increase for an extended period of time before production can grow to satisfy demand. For instance, world production outside the former Eastern bloc, including the world's two largest uranium-producing countries, Canada and Australia, was steady from 1997 to 2006 despite a 2,000 percent price increase during that period, when prices rose from a low of around $7 to a peak of $136 in 2007.
During this third price boom a number of countries around the world began the process of expanding their existing nuclear power programs or initiating programs. The rapid rise of uranium prices at the same time that nuclear power was taking off gave the impression that uranium supplies were inadequate to fuel nuclear industry growth, which is not the case. Uranium is one of the most abundant elements in Earth's crust; the challenge is to find it in concentrations that are economic to mine. This takes some time to do, but with enough lead time and effort, a considerable number of sufficiently rich uranium deposits have been discovered and put into production. The problem is that the uranium market has exhibited an element of market failure, where the excessive involvement of governments resulted in a long period of more uranium being mined than was needed for commercial purposes, followed by a long period of depressed production from which the market is currently trying to recover.
In the uranium market, there is no formal exchange, and contracts are negotiated bilaterally. The main buyers are nuclear utilities, and the main sellers are uranium producers, but there are a number of intermediaries including traders and hedge funds that participate primarily in the spot market. The vast majority of uranium is transacted under long-term contracts, which typically start two years or more in the future and run ten years or longer. Over the past four years (including 2008), long-term contract volume has averaged 200 million-250 million pounds per year, three to five times the levels of the 1990s, when prices were depressed.
In uranium, any contract that calls for delivery within the next 12 months is considered a spot contract. In recent years, annual spot volume of uranium oxide has been as high as 35 million pounds, but this total often includes the same pounds that have been sold two or three times during the course of the year. So far this year, spot volume has totaled almost 19 million pounds and is on track to reach 35 million for the year.
The primary price referenced for the uranium market is the spot price. Commercial spot prices for uranium were published on a monthly basis starting in 1968, and in 1987 the Uranium Exchange Company began publishing spot prices on a weekly basis, a standard that continues today. Since there is no exchange in uranium, prices are determined by tracking market activity and the offers, bids, and transaction prices that result from this activity.
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Despite there being no formal exchange and the lack of liquidity that this implies, the uranium market has attracted the interest of hedge and investment funds. The first hedge fund buying took place in 2004 when the spot price was around $20. Hedge funds, which had been involved with other commodities that experienced strong price gains, saw the potential for dramatic increases in uranium prices due to a perceived undersupply. While uranium can only be stored in a licensed facility, it's possible for individuals and companies to own uranium for speculative purposes, as is the case with other commodities.
Investment funds saw the same potential, and first entered the market during early 2005. Investment funds were created to allow individual investors that don't have the financial resources of hedge fund partners to gain an interest in the commodity. An investment fund will buy and hold uranium, and the value of the fund will fluctuate with the price of uranium. Individuals that want exposure to the uranium price can do so by purchasing shares in the fund. Currently, there are two uranium investment funds: Uranium Participation Corporation (UPC), listed on the Toronto Stock Exchange, and Nufcor Uranium Limited (NUL), listed on the London Stock Exchange.
The entry of hedge and investment funds added notable demand to the spot market and contributed to pushing spot prices to very high levels. The price increase that began in 2003 accelerated in the latter part of 2006 following the announcement of flooding at the Cigar Lake mine in Canada, the second time flooding was reported there, delaying the mine's projected 18-million-pound output for several years, which represents about 10 percent of global reactor demand. In early 2007, the Ranger mine in Australia experienced flooding stemming from a typhoon, further adding to supply worries and stoking increased speculation and price increases.
As demand outstripped supply, sellers auctioned their uranium, which resulted in a bidding war, and pushed the spot price to $136 a pound. Eventually, the higher prices reduced demand, and subsequent auctions did not generate much interest, leading to suppliers withdrawing from the market. When the Energy Department decided to go through with an auction of some of its uranium inventory, it drove prices lower.
Once prices started to fall, hedge funds and others looking to sell found that they could not easily liquidate their holdings. While some speculators were able to liquidate before prices fell, there wasn't a ready market to purchase all of the speculative uranium holdings, and attempts to sell, from hedge funds or others, were met with successively lower prices. The spot price fell even more rapidly than it ascended, eventually dropping all the way to $75 before rebounding to $93, before falling again. In 2008, it reached a low of $57 before recovering to $64.50 at the time of this writing. The long-term contract price is much higher at $80, although utilities are much less willing to pay this price given the dramatic decline in the spot price and the belief that price will stabilize at lower levels.
In the midst of this considerable price volatility, 2007 saw the introduction of derivatives–futures and options–into the uranium market. In May 2007, the New York Mercantile Exchange (NYMEX) and Ux Consulting partnered to introduce a financially settled uranium futures contract. This contract, which is listed on the Chicago Mercantile Exchange and NYMEX, settles at the end of each month based on the Uxpublished uranium oxide price. As a financially settled contract, there is no delivery of material, and the contract is settled with cash. Even in physically settled futures contracts, however, the vast majority are used to hedge price risk and do not go to delivery.
To date, uranium futures contracts have not been terribly active, although in their first year they were more active than some other NYMEX product launches, and so far 2008 has seen more activity than 2007. It should be noted that futures contracts were not immediately embraced in other energy markets, such as oil and natural gas, but today these markets are extremely active, and the NYMEX futures price for oil is one of the most closely followed statistics in the world.
The uranium market has continued to exhibit a considerable amount of price volatility, as future supply and demand are uncertain. Production is well below consumption, with the gap between the two filled by inventory supplies. A large portion of this inventory comes from uranium supplied under the HEU deal with Russia, which provides 24 million pounds of downblended uranium to the market and is set to expire by 2014. Since this represents about 14 percent of annual reactor requirements of about 175 million pounds, its loss will place additional pressure on producers to expand mining operations.
After years of little to no growth, production has started to increase. The bulk of growth has occurred in Kazakhstan, which early on saw the potential for a market rebound. To date the Central Asian country has been successful in meeting its production goals, yet a key question going forward is whether it can attain even more ambitious future targets. African countries such as Namibia, Niger, and South Africa can also ramp up uranium production quickly; however, their mines have been plagued with electricity shortages and other problems, making the ultimate rate of growth uncertain at best.
On top of this production uncertainty, there is the question of how quickly nuclear power will actually grow and increase global uranium demand as well. China, India, Russia, South Africa, South Korea, Ukraine, and other countries have ambitious plans. Although in the United States there has yet to be an actual new reactor order, in the rest of the world 22 reactors were ordered in 2007 and another 10 so far in 2008. In all, there could be 670 gigawatts electric of installed nuclear capacity from 58 countries by 2030, up from 375 gigawatts electric in 30 countries this year, according to estimates from Ux Consulting.
Of particular interest on the demand side is what happens with India. India is unique in that it was shut out of the world market after it used its foreign-supplied civilian nuclear capacity to produce plutonium for nuclear weapons. India currently is not able to operate its reactors at full capacity due to a lack of domestic uranium, but it is looking to rejoin the market pending approval from the International Atomic Energy Agency and the Nuclear Suppliers Group. Due to India's long-standing absence from the market, its potential participation has likely not been factored into price expectations, and thus India's entry could have a notable impact on future price.
India's situation shows that governments still have a strong influence on the uranium market through nonproliferation and trade policies. In the non-proliferation and trade arena, the United States is hoping to extend the current HEU agreement, but Russia is resisting. On the supply front, governments can affect uranium production by regulating production, exploration, and export. Governments clearly have a strong impact on uranium demand via their policies on nuclear power as well. One example is U.S. tax credits and loan guarantees for new nuclear reactor construction. Federal involvement is even stronger in countries such as China and Russia, where the central government has a much greater say over capital expenditures than in the United States. In a relatively new development, governments are instituting carbon-mitigating policies or taxing carbon emissions, which could create favorable conditions for increased nuclear power.
Given the unusual evolution and nature of the uranium market, supply and demand uncertainties may be considered endemic and will result in considerable price risk in the future. Market players are attempting to address this risk with specific terms and conditions in long-term contracts and through emerging derivatives. Derivatives will help market participants transfer price risk when making procurement and investment decisions. In addition to the introduction of derivatives, there is an effort in the industry to push for greater market liquidity and price transparency, which should generally strengthen the spot market. The ability to manage risk in the uranium market will ensure adequate supplies to support the future growth of nuclear power.