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Understanding the Uranium Market

The following commentary comes from an independent investor or market observer as part of TheStreet's guest contributor program, which is separate from the company's news coverage.

By Kevin McElroy

NEW YORK ( TheStreet) -- The disaster in Japan seems to worsen by the minute, and while I wouldn't be too quick to follow the sensationalism coming from the mainstream media, I don't doubt the seriousness of the tsunami's destruction, nor the effects of nuclear power plant failures in Northern Japan.

I also don't underestimate the political ramifications of the nuclear part of this disaster and how some governments may be inclined to halt or slow their nuclear programs.

And while uranium stocks are getting slaughtered along with almost every other asset today, I think that now, more than ever, it's important to look at the facts with a cool head.

Today I'm enlisting the help of my colleague and friend, Tom Cullis, to help fill in some of the gaps on the uranium story.

Tom adds a scientific outlook on the markets, as he's worked as a research scientist on DNA extraction projects among other highly specialized and technical endeavors.

He recently wrote to me to explain some of the key points of the uranium supply story, and I think you'll find his insight extremely helpful. If you read the information below, you'll be better informed than 99% of other investors on this topic, and that's information you can use to your advantage during these uncertain times in the market.

As of Jan. 1, 2010, there were 437 active nuclear power plants in the world producing over 370GW. There are also currently 56 new plants under construction capable of producing an additional 512GW. That means a capacity increase of 14% is well on the way in the pipeline for nuclear power, with plans for 29 more plants under review in the U.S. alone and over 100 worldwide.

Nuclear capability is projected to grow at a faster rate than world energy consumption over the next 10, 20 or 50 years.

I believe the recent uptrend in growth is only the beginning. Right now, we have the opportunity to get into a well established industry with a terrific safety record that could lead to the use of nuclear power to triple, or more, in the coming decades.

One of the hardest parts of forecasting growth rates in commodities is the changes in consumption that occur because of rising prices. Sometimes it's an inferior product that suddenly looks more attractive, or an uneconomical resource becomes cost effective, and sometimes people just plain old use less.

When oil prices got out of hand a few years ago, Americans cut their mileage by 10% and Canadian oil sands suddenly were profitable and started pumping out the barrels. Uranium is protected from these forces to a large extent for several critical reasons. First, almost 90% of the known reserves are economically feasible at today's prices as noted by the International Atomic Energy Agency (IAEA) in its 2010 report:

"Identified conventional uranium resources, recoverable at a cost of less than $130/kg U, are currently estimated at 5.7 million tonnes uranium (Mt U). There are an additional 0.7 Mt U of identified conventional resources recoverable at costs between $130/kg U and $260/kg U."

This means even a doubling of price will only increase cost effective reserves by about 12%. It would take a real price increase of 300-600% to make other known sources of uranium cost effective. While there are many high estimates of unknown reserves, it will take several years to find, study, extract and ultimately bring these deposits to market before their supply starts bringing down the price of uranium.

The second big defense uranium has against rising fuel prices is that the cost of uranium is a very small portion of the total cost of nuclear power. If the price of coal, natural gas and uranium were to double overnight, the cost to produce electricity from coal would increase by more than 50%, natural gas electricity would increase by more than 90% and nuclear power plants would see their costs rise by a paltry 10-15%.

Even if people use less electricity due to higher prices, it is likely that they will use more from nuclear power as coal and gas plants see their profits squeezed. The higher commodities go, the more attractive nuclear power will be and the higher the margins of nuclear plants will be.

In fact, rising commodity prices is a third part of the perfect scenario that is driving growth in nuclear power. The majority of the cost of nuclear power comes up front in the cost of construction and the cost to service the loans to get that construction going.

The ideal situation then involves low interest rates to go with high commodity prices and we have had historically low interest rates for years now. Not only have we had low interest rates for the past 10 years but we have commitments from the biggest central bank in the world to keep rates low for as long as it takes to get the economy back on track.

It is, of course, these ridiculously low rates and the massive printing of money that keeps them low that is fueling the current boom in all things commodity related. Ben Bernanke might as well sit in front of Congress and say "I will drive the world towards nuclear power" because that is exactly what he is doing.

Nuclear power even has a third protection built in for the current environment. As a commodity investor, you feel your heart beat with fear when the words "cap and trade" or "emissions tax" are uttered by a politician eager to win votes or increase government revenue. Conservative estimates of proposed plans put cost increases for fossil fuel generated electricity in the range of 20% with precious little of that going towards the profit margins of commodity companies. For a virtually carbon-free energy such as nuclear, a 20% increase in power rates means only one thing: a 20% increase in profits.

If nuclear power were just 10 or 20 years old, you would see it on the cover of every magazine and every nuclear stock would be going to the moon. Stock analysts would be comparing nuclear energy to the internet revolution and predicting every half baked mining company to quadruple in value over the next ten years.

In the same way that the growth of cities, the discovery and refining of oil and the integration of the assembly line merged into a force to propel the automobile industry from what was essentially a bunch of enthused hobbyists into the most valuable industry in the world in a few decades, the gathering storm (or really the gathered storm) of peak fossil fuel production, high commodity inflation, low interest rates and looming environmental laws will blow the expansion of nuclear power across the globe.

Tom's suggestion: look to buy shares of the world's largest uranium miner, Cameco Corp. (CCJ).

Right now the price of CCJ is in freefall, so I wouldn't suggest trying to catch a falling knife. But if you have capital ready, you'll soon be able to purchase these shares at a steep discount when uranium prices bottom.

Wyatt Investment Research, founded in 2001 as a publisher of newsletters, offers independent investment research of financial markets, stocks, bonds, ETFs and mutual funds to about 250,000 individual investors. The company is led by founder Ian Wyatt, who serves as publisher and chief investment strategist.

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