While many have recognized how increased electricity generation has been a driving force behind higher natural gas prices, hardly any attention has been given to the developing bull markets in both coal and uranium. In this month’s issue we will examine how the world’s insatiable appetite for electricity has led to growing demand for both coal and uranium and how to profit from this trend.

One of the most overlooked facts about modern economic growth is that it always results in electricity growth. Even in years when economic growth is flat or negative, electricity consumption nearly always increases. In the US, there have been only two years since 1949 (1982 and 2001) where electricity consumption declined from the previous year (Source: US DOE). The below table clearly displays the growth in US electricity consumption over the past five decades:

US Electricity Consumption

While I have used the US as an example, the same pattern of increasing electricity consumption can be seen in nearly every country around the world. Below is just a sampling of countries that have had explosive growth in electricity consumption over the past two decades:

International Electricity Consumption
(Billion Kilowatt Hours)

What do past patterns of electricity consumption tell us about future consumption patterns? Barring a worldwide and severe economic dislocation, consumption of electricity around the globe will continue to rise in the future.

How will worldwide demand for electricity be met? Due to the spiraling cost of both oil and natural gas, it is becoming increasingly clear that much of tomorrow’s electricity needs will be met by coal, nuclear power and to a smaller degree, renewable energy sources such as wind, solar and hydro-electric power.

Coal has been the mainstay of electricity production in much of the Western world for decades. Despite efforts to reduce its reliance on coal, the US currently produces approximately 52% of its electricity from coal fired plants. Below is a table of coal consumption for electricity generation in the US from 1992 to 2002:

US Electricity Produced From Coal

Due to a substantial public awareness campaign by several coal producers, there is a widespread belief in the US that coal will be cheap and plentiful for years to come. While coal supplies should remain adequate, I believe the era of cheap coal has ended. While the spot price for Powder River Basin coal has remained flat, coal prices in most parts of the US are up at least 50% in the last 12 months. It should be noted that most coal producers have multi-year contracts to sell coal at a fixed price and have been unable to fully exploit the recent rise in spot prices. While much of the incremental coal demand is for feedstock for electricity generation, a significant portion of new demand is for metallurgical coal used in steel making. Steel producers, who have witnessed rapidly rising demand for their products in the past year, have substituted lower priced and lower quality coal (typically used to create electricity) to manage costs in the very tight markets for high quality metallurgical coal.

A confluence of events has lifted coal prices to some of the highest levels in years. We are seeing demand from China add significant pressure to worldwide coal prices. China, the world’s number two exporter of coal behind the US, has limited exports due to increased demand domestically. Earlier this year, China capped all coal exports at 80 million tons, down from 93 million tons in 2003. The move was made to ensure supplies to Chinese power stations and avoid blackouts that affected two-thirds of the country last year. This has caused Asian importers of Chinese coal, such as Japan, Korea and Taiwan, to pay record prices for coal imports this year.

Rail transportation woes in the US, due in large part to increased rail traffic, have led to record low coal inventories at many coal powered electricity generating facilities. During  Arch Coal’s Q1 conference call (NYSE:ACI), Chief Executive Steve Leer estimated U.S. electric utilities are holding roughly 110 million tons of coal, down substantially from inventory levels of 2001 and early 2002 and about 17% below the five year average.

Also leading to upward pressure on coal prices is the decrease in reserve life at many coal mines across the US.  According to the US Department of Energy, in the decade from 1991 to 2002, reserves at producing mines have fallen 17% and the reserve life of productive mines has fallen from 22.1 years to 16.6 years. The decline in overall operating reserves means that an increasing number of individual mines are approaching the limits of useful mine life. Mine operators deferred new mines in recent years because future reserves tend to be in deeper, thinner seams. New mines will be costlier to operate and will require large capital investment and contracts at higher coal prices.

Before we examine the world uranium market, I believe some background might be beneficial. The majority of all uranium produced in the world is used by the nuclear power industry. Very little uranium is consumed for other purposes such as nuclear medicine or for military uses. Once uranium is extracted from the ground it must be milled into uranium oxide (called yellowcake) and converted into uranium hexafluoride.  Most commercial nuclear reactors cannot use uranium hexafluoride and require enrichment prior to use.

The enrichment process involves increasing the percentage of Uranium-235 (U-235) atoms found in natural uranium. More than 99% of natural uranium is composed of uranium-238 (U-238) atoms. The balance—less than 1%—consists of slightly lighter U-235 atoms. Most reactors need uranium fuel with a U-235 content of between 4% and 5%. Low enriched uranium (LEU) is the final product of the enrichment process.

After a worldwide boom in uranium prices in the 1970s that saw prices rise from approximately $6US a pound to over $40US a pound, much of the last twenty years has been very lean for the industry. However, times are changing for the world uranium market. Over the past year, we have seen a strong rebound in uranium prices and the fundamentals are in place for much higher uranium prices in the near future.

The energy crises of the 1970s focused a great deal of attention on the search for domestic sources of energy in the US. The nuclear power industry was seen as vital to America’s energy independence. For a variety of reasons, the nuclear power industry did not come to dominate electricity generation in the US. The US produces 20% of its electricity from its 103 nuclear generating facilities. No new facilities have come online in over a decade and none are currently on the drawing board. Clearly, this was not the scenario that the many proponents of nuclear power expected to unfold. High expectations for the future of nuclear power led to unsustainably high uranium prices. In the early 1980s, uranium prices were well above the cost of production. However, as evidenced in the below table, high prices would eventually set the stage for an extended period of depressed prices. (It should be noted that the current spot price of uranium is at $17.75US – a ten-year high.)

US Domestic Uranium Prices

There have been a number of distorting forces at work in the uranium market over the last 25 years. One of the most disruptive forces to the domestic uranium market has been the actions of the US Enrichment Corporation (USEC) (NYSE:USU). Prior to the USEC’s transformation from a governmental entity to a private one in 1998, the US government transferred a significant stockpile of 50 tons of highly enriched uranium (HEU) and 7,000 tons of LEU as well as the country’s only uranium enrichment facility to USEC at no cost. Since 1998, USEC has been dumping its stockpile of uranium onto an already glutted market at the rate of approximately 6 million pounds a year. (This can be confirmed by reviewing the notes attached to the company’s 10K. Long term uranium assets have declined substantially over the past six years.) I recently spoke with a USEC company representative and he informed me that USEC will be selling uranium out of inventory for three to four more years.

There have been a number of distorting forces at work in the uranium market over the last 25 years. One of the most disruptive forces to the domestic uranium market has been the actions of the US Enrichment Corporation (USEC) (NYSE:USU). Prior to the USEC’s transformation from a governmental entity to a private one in 1998, the US government transferred a significant stockpile of 50 tons of highly enriched uranium (HEU) and 7,000 tons of LEU as well as the country’s only uranium enrichment facility to USEC at no cost. Since 1998, USEC has been dumping its stockpile of uranium onto an already glutted market at the rate of approximately 6 million pounds a year. (This can be confirmed by reviewing the notes attached to the company’s 10K. Long term uranium assets have declined substantially over the past six years.) I recently spoke with a USEC company representative and he informed me that USEC will be selling uranium out of inventory for three to four more years

With the fall of the Soviet Union in the early 1990s, a new source of uranium suddenly flooded an already glutted world market. Through the Megaton to Megawatts project that began operations in 1994, USEC and its Russian partner TENEX have converted 200 metric tons of HEU into LEU that can be used in nuclear reactors to generate electricity. Reprocessed uranium, combined with increased natural uranium imports from former Soviet Republics simply killed domestic uranium producers.

The below tables clearly lay out the damage imported uranium unleashed on domestic production:

US Uranium Production

US Imports of Uranium

While some of the recent strength in uranium prices can be attributed to the washout of many supply sources in years of low prices, increasing demand is also driving up the price of uranium. Despite the fact that it has been over a decade since the last nuclear reactor came online in the US (the Comanche Peak-2 was the last one to come online in 1993), the country’s nuclear fleet is consuming increasing amounts of yellowcake. Through the process of “uprating” or squeezing more output from an existing nuclear facility, utilities have been able to increase plant productivity. Utilities have been using power uprates since the 1970’s as a way to increase the power output of their nuclear plants. To increase the power output of a reactor, typically a more highly enriched uranium fuel is added. According to the April 2003 Nuclear Regulatory Commission (NRC) Fact Sheet on Uprates, the NRC has completed 92 such reviews resulting in a gain of approximately 4,022 MWe (megawatts electric) at existing plants. Collectively, an equivalent of more than three nuclear power plant units has been gained through implementation of power uprates at existing plants. Many NRC licensees have indicated they plan to ask for power uprates over the next five years. If approved, uprates would add another 2,270 MWe to the nation's generating capacity.

While the US will experience increased uranium consumption mostly through uprates, the bulk of the world’s increased uranium demand will come from new plants. According to the Paris based International Atomic Energy Agency, as of January 31, 2004, there were 440 nuclear reactors in operation around the world (103 in the US) and 31 nuclear power plants under construction. I believe we are about to witness a tremendous change in the nuclear electricity generation industry as rapidly modernizing countries lead the revitalization of the nuclear energy industry, which in turn will lead to markedly higher uranium prices.

Percentage of Total Electricity from Nuclear Power

What I find most interesting about the above table is the fact that the world’s two most populous nations, China and India, produce a very small percentage of their electricity from nuclear facilities.  India is a great example of a country that has embraced nuclear energy as the future. The country currently has six operating nuclear reactors which have a total combined capacity of 2,270 MWe. According to India’s Nuclear Power Corporation Ltd (NPCIL), a government agency that controls the country’s nuclear power industry, India plans to increase its nuclear generating capacity by more than 700% to 20,000 MWe before the year 2020. NPCIL appears committed to making this lofty goal happen. There are currently eight nuclear reactors currently under construction in India, which will have a combined capacity of 3,980 MWe when fully operational.

China is another great growth story for the nuclear power industry due to its unquenchable thirst for new electricity sources. While China is a relative newcomer to the nuclear power industry (its first reactor was put into service in 1991) it plans on making up for lost time. Early this year, the country brought online its Qinshan No. 2 reactor, bringing China’s nuclear fleet to nine reactors with two more currently under construction. Total nuclear generating capacity in China currently stands at 6,587 MWe. It appears that China’s nuclear reactor building boom is just getting underway.  Construction of four new water-pressurized 1,000 MWe reactors is expected to begin in 2005.

With world uranium consumption of approximately 172 million pounds a year and worldwide production of only 92 million pounds a year (the difference is made up through existing above ground supply), the world uranium market is possibly the world’s most unbalanced commodity market (Source: Uranium Information Center). Canada, the world’s largest producer of uranium, supplies about 30% of the world’s current uranium production and is home to the most productive uranium region in the world, Saskatchewan’s Athabasca Basin.

In conclusion, the fundamentals of natural resources used to supply with world’s growing electricity demand continue to change and that offers investors opportunities. While there are well run firms leveraged to coal and renewable energy sources, I believe investment in uranium exploration and production companies, particularly those situated in the Saskatchewan Athabasca Basin, offer a higher upside. That said, investors should be mindful that uranium exploration firms fall into a speculative investment class and are appropriate only for aggressive investors.

© 2004 Bill Powers, Editor
Canadian Energy Viewpoint
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Bill Powers
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Information presented in this newsletter was obtained from sources believed to be reliable, but accuracy and completeness and opinions based on this information are not guaranteed. Under no circumstances is this an offer to sell or a solicitation to buy securities suggested herein. The editor may have an interest in the companies mentioned. All data and information and opinions expressed are subject to change without notice.