Thoughts on spot uranium – “spoughts”

A common source of anxiety for uranium retail investors, spot price down a nickel or dime, has been “where is this uranium coming from? The dudes on YouTube said spot was empty…” Inasmuch as an illiquid, opaque, complex market with relatively few buyers and sellers can have rules – we can at least attempt to define what spot is and isn’t.

Defining how uranium is purchased – and there’s really no guide for this – is an important conversation to have, especially with those new to the space. Welcome to the uranium market, here’s your complementary copy of Dark Shadows, a browser app which refreshes the URNM ticker every five seconds, and a blog post about uranium market mechanics.

So what is spot uranium?

The first problem is that “spot” doesn’t have an exact definition. In the strictest sense, spot uranium is what is immediately available on-hand, at conversion facilities. But a more popular definition extends the window to any transaction for delivery in the next three months, while another contemplates transactions with delivery over the subsequent 365 days. Factor in location premiums, different payment terms, uranium origin considerations, existing business relationships…and the picture gets fuzzier.

There’s a lot going on here. Or maybe more accurately, there’s not a lot going on here. Even in recent years where spot uranium plays a larger role than the term market, there simply aren’t that many transactions. Contrast the uranium spot market’s ambiguities with other commodities: 10,000 MMBTU of natural at the Henry Hub in June 2021 trades with a standard contract with significant interest. That specific contract has a concrete meaning, whereas “spot uranium” doesn’t.

[n.b.: beyond the spot window lies “mid-term,” generally used for quantities of fixed-price uranium for delivery two to five years out, and “long-term,” whose pricing indicators serve as a rough pricing guide for multi-delivery, large-quantity contracts covering a period which extended beyond five years. We’ll talk about these more at the end of this post.]

Consider also that the supermajority of uranium “deliveries” in the West are not physical deliveries, but rather book transfers of the ownership of fungible (i.e. interchangeable) uranium within big co-mingled accounting systems at conversion facilities. And the UF6 produced by these conversion facilities is also co-mingled across a similarly small number of enrichment locations and their material accounting systems. Let’s avoid going down the Ship of Theseus-esque “what is uranium, actually?” and get into the mechanics.

The nuclear fuel cycle is a well-oiled machine

The majority of the world’s nuclear fuel passes through through four conversion facilities (located in Canada, the USA, France, and Russia) and seven enrichment facilities (located in the USA, Western Europe, and Russia). The scale of these facilities requires them to operate on a different schedule than the reactors that they serve. Let me explain.

Loading fuel into nuclear reactors is a batch process, occurring on a 12-, 18-, or 24-month periodicity depending on reactor operations. Fuel cycle facilities (mines, converters, and enrichers) are flow processes – material is constantly being processed upwards through the nuclear fuel cycle. So while an end user might pay for a tranche of material at a specific time or represent a certain amount of inventory at a given location in a specific material form, it doesn’t always correspond to the physical material flowing through the pipeline. Often, the physical production, processing, or transport of material significantly predates the purchase of that material by the end user. As a result, there is over- and under-production throughout the fuel cycle on an incremental basis; it’s the natural inefficiency created by the disconnect between continuously-operated supply facilities and irregular purchases and variable requirements from the buy side.

[n.b.: when certain market players like banks, hedge funds, or physical vehicles need segregated supply (e.g. not co-mingled with all the other pounds), the purchase and storage of this material plays by a different set of rules and might carry a premium to the reported prices.]

Apologies if I lost you there – but I promise this is going somewhere.

Enter the nuclear fuel traders

I think there’s a real misunderstanding of the role of uranium traders and financiers among the uranium equities crowd. Traders are critical to the efficient operation of the global nuclear fuel cycle. The major producers handle the bulk of the load of sales and logistics, while traders provide liquidity and flexibility on a smaller scale. They play matchmaker for orphaned and excess material, odd lots, and location mismatches. Traders can bridge language and trade barriers, or transform a seller’s pricing or timing preference into something else that they can sell to an end-user. This “time-shifting” of supply is key.

Lest this sound like too much of a love letter, it’s also true that traders can act in ways that promote or suppress prices and/or volatility in ways that can defy macro trends.

Boiling this section down to one more takeaway: it’s a bit nails-on-chalkboard for me when market commentators talk about “trader churn” in the spot market as if it’s meaningless ephemera. Trader-to-trader transactions are how the inefficiencies in the market work themselves out and how different parties deploy their own unique character onto the market (their cost of capital, pricing predictions, relationships and sales strategy).

Where does spot uranium come from?

Broadly speaking, there are four types of spot seller:

  • Intentional spot sellers: suppliers who sell product into spot, enjoying full upside and full downside of market prices and lower administrative/marketing costs
  • Offtakes: many producers (including minority owners) lack the resources to fully market their uranium supply or desire long-term certainty and so their pounds enter the market via intermediaries (some who prefer to sell the pounds on the spot market)
  • Flex-Downs and Variability: many nuclear fuel contracts include a quantity flexibility. Generally, any price-protected quantity is flexed down in low prices and flexed up in high prices. In recent years, with prices down, flex-downs create excess supply for the taking. So too would a mine exceeding contracted production targets in a given year, with an owner looking to make a little extra cash.
  • Profit-takers: anyone who holds physical supply – at any price – can assess current price as an opportunity for profits. This includes, but is not limited to, arbitrage related to backwardation (sell today, resupply later).

I don’t want to make this sound monolithic, especially because events like reactor closures, M&A, and other strategy shifts (supplier inventory reduction) can generate sources of material as well. Additionally, fixed-price, long-term contracting is rather out of vogue right now – so while flex-downs were significant sources of supply on the way down from 2011’s prices, many of these contracts have run their course and there aren’t as many opportunities as there used to be.

So too do I want to point out that each of these supply sources is itself sensitive to price, price projections, and corporate strategy. Low prices might increase the number of pounds that enter the market because of flex-downs. High prices, or a negative price forecast, might loose pounds from inventories of profit-takers. Offtakes might reduce in magnitude if producers decide there is more money to be made in direct sales. And the number of and volume from intentional spot sellers might increase in a negative price environment with very bullish predictions (sound familiar?).

[n.b.: spot-selling is different than spot-indexing. Many sellers offer material at market prices but in sales agreements signed many years in advance. So the spot price matters not just to deals concluded in the short-term, but also to many more pounds being sold under long-term agreements with full or partial indexing to the spot price of the day.]

Roundup: how can we understand the forward market through the spot price?

We can think of the uranium market as occupying one of two dynamics:

  1. There is more spot supply than spot demand
  2. Spot supply is constrained

These two market dynamics could be simplified down to “contango” and “backwardation,” although I think that a constrained spot supply doesn’t necessarily lead to backwardation.

We’ve been in the first dynamic for quite a while. The primary impact of excess spot supply (and of low interest rates) is the formation of a forward curve – a pricing forecast which reflects today’s cost of spot plus a cost of capital to hold the material until a chosen forward delivery date. Even for sellers who plan on filling a forward order with future production, this forward curve sets a rough band of price competition. With a $30 spot price, we might expect a price like $34.73/lb, which is $30 inflated at a rate of 5% for three years. Imagine a utility seeking 100,000 pounds of U3O8 for delivery in three years’ time:

The pricing expectation for that mid-term delivery will be based on the available spot supply plus interest, but the means of supplying it could be filled with available spot material or future production by the winning supplier. That supplier could be:

  • Finding a home for spot supply they can’t discharge in the current market
  • Buying spot today and financing
  • Taking a market position – filling the delivery with a “back to back” sale at a different time or with a different pricing mechanism
  • Brokering – matching a different seller to the buyer’s request

But again, I think the key takeaway is that the pricing expectation, or at least an available sale at some quantity, is set by the spot price plus financing. And other sellers try to find ways to compete with that forward curve. Very large quantities might not be available for sale at a given time, so these mid-term style purchases occur in smaller tranches. At some point, several mid-term quantities begin to look like a long-term contract, so in this way, the spot price also sets pricing expectations in the long-term.

The second half of this coin is what begins to happen if spot price increases, and especially if they enter backwardation (when near-term supply is more expensive than forward supply). Imagine that a utility is seeking spot supply in a market that has seen a recent price increase:

One hypothetical way to provide spot material in a rising market is to break carry-trades. What was once a forward sale of financed spot material re-enters the market, and the seller finds an alternative source of supply to make that forward delivery. So too could a producer temporarily reduce their inventory position to sell into this near-term delivery if it had a greater net present value than some hypothetically-produced quantity in the future.

I admit that these dueling examples are a little esoteric, but not without purpose. The market, especially prior to the COVID-19-driven mine closures, was significantly oversupplied and many of these excess pounds found a home in these sort of structured transactions. And while breaking a carry is, to some degree, robbing tomorrow to pay for today, the inventory positions of many market participants (including end users) will provide resistance to temporary volatility. This is an important way that today’s market is different than the bull markets of yesteryear – forward coverage is lower, but some of that forward coverage comes in the form of inventory that can be accessible early with the right incentives.

I’ll finish this discussion with a look to the future: when prices are below the cost of production, spot price plus financing costs set the forward curve. However, once spot price begins to rise, production costs will begin to be more competitive in the later years of the “mid-term,” and producers may have a hand in setting forward price expectations rather than financiers. This isn’t an exact science, as market participants will continue to update their own opinions and projections as prices go up or down, and the market has a ways to go prior to entering a new dynamic.

Closing spoughts

This is admittedly a fairly simplified overview, but there are a few key takeaways from this discussion:

  1. There’s not an exact definition of “spot,” so reported spot prices reflect a blending of several different factors.
  2. Traders perform important market functions to bridge inefficiencies in price, timing, and location between other market participants.
  3. Uranium enters the spot market at every price, but quantities and origins are dependent on both price and price projections.
  4. Available spot supply, plus interest, creates a forward curve of pricing expectations.
  5. Inventory earmarked for future sales can re-enter the market to suppress volatility.
  6. The market will undergo a transition once the traditional forward curve begins to intersect with the marginal cost of production in the mid-term.

As always, thanks for reading!

3 thoughts on “Thoughts on spot uranium – “spoughts”

  1. Outstanding discussion, I would say these dynamics are un-appreciated and not well understood. In a different vein, similar to a consumer trying to understand what determines the cost of their doctor or hospital bill, one is dealing with 3-D Chess!

    Like

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