Uranium trading – will good sense ever prevail?

30 January 2009

The nuclear industry must undergo a huge number of changes for the nuclear renaissance to gain solid substance. Its development was cut off in its prime during the 1980s and many of the structural features we see today show clear signs of this. It many ways it resembles the commercial aircraft supply sector at the beginning of the jet age, for example, with lots of separate companies producing their own reactor designs. The key requirement at present is for a lot of new reactor orders – one paradox is that this won’t keep existing structures in place but serve to change things very rapidly. In the reactor supply business, the result will likely be consolidation around a smaller number of designs and suppliers, which can meet the requirements of scale economics. Generation IV reactors will also only likely become reality if there is a lot of construction activity on Generation III – without this, there will be little commercial interest in their development and they will remain 25 years away, within the arms research institutes and governmental advisory committees.

The way in which nuclear fuel is bought and sold is also in need of change as it’s caught in an obvious time warp that may conceivably eventually threaten the nuclear revival. Yet on the face of it, there isn’t a big problem. Reactors (with the exception of some in India, for nonproliferation control reasons) have been getting the fuel they require and are unlikely to go without in the future – at least for the next ten years or so. There are still substantial inventories of fuel held within the commercial fuel cycle throughout the world, if supply of uranium from mines becomes constrained for some reason or other. There are also notable secondary supplies of reprocessed uranium, civil plutonium and government inventories, which can be called upon if needed. The uranium price has risen sharply over the past few years to reflect the need for new primary production and this appears set to happen, eventually, following an upsurge in both exploration and mine development activity. So what is wrong? Surely the market mechanism has worked rather well and everyone should be happy?

The uranium market (and most of the attention is on this, but there are similar markets for conversion and enrichment services) is clearly somewhat imperfect and has been only just good enough to do its job, in other words encouraging the participants to behave in a way that brings forward adequate supplies. But it fails to reach what many participants desire in terms of liquidity and transparency and there is general dissatisfaction amongst market participants about the way it operates.

In reality, the market has now moved from a long period of oversupply in the 20 years up to 2003, where hopes for new demand from additional reactors were frustrated and abundant secondary supplies pushed the price down to around $10 per pound. The boot was very much on the buyers’ foot and they became lulled into a false sense of security, believing that they could buy as much uranium as they needed at these low prices. Although there was plenty of industry discussion about this period inevitably ending (secondary supplies can clearly not last forever), there were no price signals until the market suddenly tightened during 2003 and the sharp price spike began. Financial speculators became interested in uranium (indeed, the price became an easy one-way bet for a time) while hundreds of small mining exploration companies added uranium to their portfolio and raised substantial sums on the stock markets.

The uranium spot price peaked at $137 per pound in the middle of 2007 but has since slipped back sharply, in a series of stages, ending 2008 at $52. While volatility is a characteristic of most commodity prices, with tendencies to both over- and under-shoot deeper market fundamentals, this cannot be healthy for the nuclear business, which involves heavy investment in projects with life cycles of 30 to 60 years. The higher prices have naturally been much enjoyed by the uranium producers, who see them as justification for staying in the business over so many bad years and also a reward for the risks they will be running in developing new projects. Yet the extent of the price decline (as low as $45 per pound in November 2008) imposes a worry that projects will now not go ahead and potential supply shortages could appear in the future (together with another and possibly more dramatic price spike).

Fears of this happening may be a further and unwanted impediment to new reactor orders. Potential investors in new reactors have enough potential risks on their mind without uranium producers saying that there could be shortages unless prices rise back towards $100 per pound. Everyone knows there are plenty of proven uranium resources in the ground – the question is how to get these to market in a timely manner and at prices which balance out the interests of both producers and consumers in an equitable way.

“What is needed...is some form of more organised, longer-term contract market”

This should really not be too difficult, as both uranium producers and reactor investors/ operators have similar time horizons, with new projects going through lengthy approval stages then taking several years at the construction stage, before running for 40 years and beyond. The uranium market also has features which suggest that it should not be so volatile and be capable of offering parties proper clear price signals. Most importantly, reactors are generally fuelled only once per year (or less) so demand is very ‘lumpy’ and not continuous (contrast this with a coal-fired generating station). This leads itself to long-term contracts, negotiated between buyer and seller, which may last for up to 20 years. These are highly confidential but may reference quoted industry spot prices, announced each week by Ux Consulting and TradeTech, while also containing escalation clauses, caps and floors. This has been the traditional way in which nuclear fuel has been sold, with producers using the security of long-term contracts as collateral for raising project finance.

It is somewhat odd, therefore, that most attempts at reforming the uranium market have been concentrated in the spot market, involving relatively small quantities for near term delivery. This historically has accounted for only 10% of so of total deliveries, and suffers from major complaints about lack of transparency and liquidity. Of course everyone wants transparency, but doesn’t want their own deals made visible, while liquidity is largely unavoidable, given the lumpy nature of demand referred to above. Attempts have been made to ‘commoditize’ the uranium market into something akin to other metals markets, with quotations on NYMEX and other exchanges, attempts to introduce standardized contracts and Internet trading platforms. Yet, all seem to miss the most important point – that there is ample evidence to suggest that few people really want to trade small quantities of uranium (the standard NYMEX unit is only 250 pounds, whereas it takes 2000 times that to refuel the average reactor). For the financial players, it is far too complex a market to understand and their interest has now rapidly abated – it was the hedge funds and other financiers whose sell-off explains a lot of the uranium price decline throughout 2008. There are essentially far easier things to bet on than uranium.

For the industry itself, the spot market should only be a residual, essentially an outlet for when buyers and sellers have made mistakes with long-term contracts, leaving them with too much or too little uranium. Also acting as an outlet for additional secondary supplies, when the sellers seek cash quickly, not wanting longer-term contracts. The concern comes, however, when whatever drops out of the spot market is referenced in long-term contracts, as is currently often the case. If the spot market could be made more transparent and liquid (which seems impossible) this could be more appropriate. But can sensible decisions be taken about mine investments on the back of the kind of price volatility we have seen in recent times? The answer is obviously ‘no’ and the current risks to the next generation of mine projects are an obvious reflection of this.

What is needed, then, is some form of more organised, longer-term contract market. There are, however, plenty of objections to this concept, notably that many parties rather like the current opaque system (the smart ones may well benefit from it), that nothing like this exists for other metals and commodities, that (even if standard contracts can be devised) either party could rat on the deal if it looks like not favouring them and finally that many buyers and sellers will not want to tie up so much of their future purchase or output at fixed prices so far in advance, effectively missing out on any shorter term advantages available in the spot market nearer delivery time. This may seem a formidable list, but the concept of trading reasonably sized quantities (maybe 25 tonnes, or an eighth of a standard annual reactor reload) for delivery at maybe 6-month intervals in each year from 2010-2020 ought to be investigated. An active market in such contracts is not an impossible dream – those who originally buy and sell don’t have to hang onto the contracts over their operable life, and as the delivery date comes closer, this term market can effectively become the spot market. So smart buyers and sellers could still take advantage of good foresight about how supply and demand will turn out nearer delivery date.

The problem is really one of inertia – too many market participants are happy enough with the current imperfect arrangements (they will admit) and they do not to want to rock the boat too much. Buyers may end up paying too much or too little for the uranium they need, but they are confident they will get adequate supply and their reactors will still run (although they will still fight tooth and nail to minimise costs). The uranium producers are, however, fundamentally in a weaker position as the price outcome can kill them – this is the worry for the longer-term future of nuclear. The contractual arrangements are largely at the buyers’ insistence and one would hope that the sellers would use a time such as now, when they still have a degree of market power, to encourage their customers to look at new ways of trading. But certainly not towards the reform of the spot market, which seems to excite a lot of people without much good reason behind it.

Author Info:

Steve Kidd is Director of Strategy & Research at the World Nuclear Association, where he has worked since 1995 (when it was the Uranium Institute). Any views expressed are not necessarily those of the World Nuclear Association and/or its members

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