The Case for Energy Stocks & Especially Uranium
As subscribers to J Taylor’s Gold & Technology Stocks are aware, your editor was slow in aggressively investing in energy stocks because he took the view that we were on the verge of a deflationary collapse. Gold performs best in a deflationary environment but commodities, including energy generally are very poor performers in periods of an economic depression or recession.
I remain very concerned about prospects for a deflationary collapse of our monetary system thanks to all the debt money that has been created post 1971. Having said that, it would be foolish not to jump on the bandwagon to profit from various inflation plays, chief among them being in the energy space.
The focus of our new letter will be three pronged in terms of the kind of energy stocks we invest in. It will cover some traditional oil and gas stocks staring with those covered in this newsletter, some new uranium stocks and some energy technology stocks, starting with those covered in this letter. In addition, we expect to recommend a solar technology stock in our first issue.
We will also be providing a Model Portfolio strategy just as we do in J Taylor’s Gold & Technology Stocks except that this letter will focus on individual energy stocks while filling out the gold allocation in the Model Portfolio with a gold mutual fund. For those of you who are not familiar with our Model Portfolio performance, a $1,000 investment in this hypothetical investment would have grown to $2,666 through January 28, 2006. By contrast, a $1,000 investment in the S&P 500 would still have been down by 13% over that same time frame.
While J Taylor’s Gold & Technology Stocks is focused on gold, J Taylor’s Energy & Energy Tech Stocks is focused on all things energy. So this letter will be about recommending specific stocks in the energy areas mentioned above as well as some others into the future. Our gold exposure will be in the Model Portfolio in the form of a mutual fund and/or a gold/silver ETF.
On the other hand, we don’t want to burry our talents in the sand so that we don’t lose them because even if you do that you lose the time value of money. A current version of “burying your talents in the sand” would be to follow the advice of the likes of Abby Joseph Cohen over the past few years who continues to tout the S&P 500. Yes we know markets can, will and have humbeled us countless times in the past, we mention this performance because we think it suggests we are doing a credible job of building wealth over time in a responsible manner by identifying and then investing in new secular trends. But that’s enough bragging. We have lots of work to do.
The Case for Uranium is Uniquely strong
Following the Three Mile Island nuclear accident of the early 1970s, nuclear energy has been dismissed as a viable source of electric power generation in the United States. And after the horrible accident at Chernobyl in the former Soviet Union, much of the world chose not to build new nuclear power plants. The Three Mile Island event proved to be virtually harmless. On the other hand, the Chernobyl accident killed more than 30 people immediately, and as a result of the high radiation levels in the surrounding 20-mile radius, 135,000 people had to be evacuated. Much of the world wanted no part of this form of energy.
But times have changed. The world is seemingly reaching its limits in terms of producing greater amounts of energy, just at the time when demand for hydrocarbon-generated energy is skyrocketing, due to a transfer of wealth from the West to billions of human beings in places like China, India, and other highly populated, lesser developed countries. The dramatic rise in the price of oil and natural gas has put the western economies, which are in decline relative to the rest of the world, in a major bind. To try to outrun this basic economic decline, our foolish Fed policy makers are printing more and more money, which only causes fuel prices to rise even more dramatically, at least in nominal if not real terms.
So higher oil and gas prices are causing huge economic problems, but that’s not all. Were it not for an unusually warm winter so far in the highly populated northeastern U.S., millions of Americans faced the potential this winter of inadequate sources of natural gas to heat their homes. And electric power plants, which have come to rely on natural gas as their sole means of power generation, might also have been faced with shortages leading to “brown outs.”
While it is true that much of the immediate concern with respect to natural gas is more related to infrastructure inadequacies (especially following last summer’s devastating hurricanes in the Gulf of Mexico), natural gas supplies are certainly not unlimited. Moreover, to build infrastructure to either bring more natural gas to populated areas or to build liquid natural gas (LNG) facilities is enormously expensive and also creates big time environmental concerns.
There may also be the possibility of using coal to meet future electricity needs in the U.S. and around the world. This is one market we want to explore more fully in future issues of J Taylor’s Energy & Energy Tech Stocks. We understand there are some very clean coal burning technologies now that can greatly reduce emissions into the environment. And the U.S. has vast supplies of coal—so much coal in fact that the U.S. has been called “the Saudi Arabia of coal.” With severely higher costs for oil and gas, perhaps coal can offer a partial solution to meeting the global energy needs. Even with cleaner burning coal technologies, however, this form of hydrocarbon is certainly not deemed “politically correct” by the ruling elite. Economic pressures combined with better technologies may change that, but for now, coal is a no, no!
With such a pronounced rise in the price of oil and gas prices, electricity fees have been rising considerably as well. And so with rising oil and gas prices, it is paving the way for some marvelous forms of renewable alternative energy technologies to emerge as economically viable alternatives to hydrocarbons. In J Taylor’s Energy & Energy Tech Stocks, we will be covering at least one developing geothermal energy company as well as a unique wind to electric “utility” company. We expect to soon tell you about a solar company with some unique technologies that I believe can also be hugely successful. One of the new technologies I am most excited about turns animal waste into methane gas, which is then either refined and sold to gas companies or is used to generate electricity in smaller more rural markets. The scope of the potential markets for this “cow dung to electricity” is measured in the billions of dollars in North America. On top of that, this technology solves a horrendous water pollution problem.
Nothing Now Looks More Promising Than Nuclear
J Taylor’s Energy & Energy Tech Stocks will research companies producing energy from any and all economically viable sources of energy. We are very excited about the energy sector as a whole and believe very considerable profits can be earned in the months and years to come. But nothing appears to offer the significant road to wealth creation that uranium does at this point in time.
We started off this report noting the two accidents that caused nuclear generated electricity to be scorned in recent decades. Then we touched on a couple of positive aspects for nuclear power, those being: (1) it’s environmentally clean compared to hydrocarbons, and (2) uranium is abundant in parts of the world that are not so politically challenging to the U.S. and other western countries. While those factors are meaningful in favor of nuclear power, the choice of what to use to generate electricity comes down to which is the most economic source of electric power generation.
That choice appears to favor nuclear, hands down. From a macro-economic perspective, substantially rising oil and gas prices impose economic growth constraints on an economy simply because manufacturing input costs hurt profit margins, and more money spent to heat homes and travel on the nation’s highways takes spending power away from consumers. And if, God forbid, people froze to death because of inadequate heating in cold winters, that kind of event would be economically devastating.
While capital costs of building a nuclear power plant are considerably greater than for constructing a conventional hydrocarbon fueled electric plant, once built, operating costs are almost nonexistent. That’s because such a small amount of uranium is required to generate enormous amounts of electricity. The Federal Energy Regulatory Commission has reported that nuclear power costs 1.72 cents per kilowatt-hour, while oil and gas cost above 5.5 cents. But most of that 1.72-cost-per-kilowatt-hour for uranium is related to depreciation of fixed assets. The actual cost of uranium in generating electricity from nuclear power is far less than that. Consider this. The energy in one uranium fuel pellet—the size of the tip of your little finger—is the equivalent of 17,000 cubic feet of natural gas, 1,780 pounds of coal, or 149 gallons of oil! In other words, once a nuclear power plant is built, the risk of skyrocketing uranium prices leading to huge increases in the cost of electricity production is almost nonexistent.
In fact, Kevin Bambrough, a research analyst at Sprott Asset Management, has calculated a theoretical price of $500 per pound for uranium before it would reach a level that would begin to require any noticeable pass-along costs to consumers. To put this potential for a $500 uranium price into perspective, take a look at the following chart.
Note with the price of uranium (U3O8) at $36.25 at the end of 2005, we are a long way from the point of any kind of pain threshold for consumers or for power companies. And in “real” terms, the price of uranium is less than a third of the way to the peak of about $110 per pound hit in 1976 before the Three Mile Island incident. In fact, another analyst, David Mason of Augen Capital Corp., has speculated that we could see a uranium price of $100 per pound within the next year or two. And James Dines stated in his 2006 Annual Forecast letter, "The coming uranium buying panic has already begun!"
Supply & Demand
Uranium markets are certainly not the freest markets in the world. Governments are definitely involved in the uranium markets to an extent—they bid for uranium for nuclear weapons if nothing else. But ultimately, the price of uranium, like anything else, is determined by supply and demand. Let’s hope that uranium is not used to build more nuclear weapons. To the extent that happens, the price of uranium could rise even more dramatically. But even if no new nuclear weapons are built, there is a severe shortage at the present time. And the demand for uranium is expected to grow considerably in the future, as there are well over 50 nuclear power plants on the drawing board for construction over the next several years. China and India head the list, with construction of at least several per year a distinct possibility.
But with such a small amount of uranium required to generate such a large amount of electricity, isn’t it possible that uranium mining firms might be hit with major oversupplies of this other yellow metal, such that price plummets and the uranium mining industry faces another depression? In theory, I believe that will happen at some time in the future, but the prospects for oversupply are at least several years away and possibly much further away than that. At present, only about half of all the uranium required for existing power plants is being produced from uranium mines. And with new plants expected to come onstream year after year over the next 10 to 15 years, we should see a constant demand for this commodity.
As to supply, it is true that uranium is an abundant element in the surface of the earth. But permitting projects and then getting them into production usually takes many years, so oversupply any time soon is not likely, in my view. Having said that, J Taylor’s Energy & Energy Tech Stocks will focus on either producing companies or companies with proven reserves/resources already outlined. Before the collapse of uranium prices in the mid to late 1970s, a lot of exploration work was carried out in Canada and the U.S., so there are many projects that are at an advanced stage and have been picked up by alert junior mining firms. But at this point, we have just two uranium companies on our list. They are UrAsia Energy (OTC Pink Sheets – UAEYF/Toronto Venture – UUU) and Northwestern Energy (OTCBB – NWTMF/Toronto Venture NWT).
There are only four publicly traded uranium producers in the world right now, and UrAsia Energy is one of them. That company expects to increase production to 1.4 million pounds this year. With costs at less than $8 per pound, its profit margins should be very substantial. And its uranium resources located in Kazakhstan are enormous, such that production is expected to ramp up toward and beyond 10 million pounds per year over the next few years.
Northwestern Energy, which has a tiny market cap, could become the first publicly traded uranium company to produce uranium in the United States if it is able to get its Utah project into production later this year. With a grade of around 0.35% uranium and 2.04% vanadium, the per-ton value of this deposit may exceed $600. If those numbers hold up, this should be a very profitable company. With custom milling available, we think NWT could be producing uranium and vanadium and some hefty cash flows relatively soon. If so, we think this stock is going to fly.
We have a dozen or more uranium stocks on our radar screen. We expect to limit our recommendations to no more than six of those, and then we want to be sure we follow those eight or nine uranium stocks very carefully and thoroughly so we can keep you up to date on the fundamentals for those companies. And we expect to use the technical charting skills of our friend and partner, Roger Wiegand and another technical analyst and friend of mine who also lives in Queens New York, namely Steve Gofner, to help us look for good entry and exit points into and out of these stocks for shorter-term oriented traders.
What Could Go Wrong with Our Bullish Uranium Thesis?
Is there anything that could go wrong with my bullish uranium thesis? My short answer is an unequivocal “yes!” The one concern I have is the same concern that has kept me from being as bullish as other analysts on energy over the past several years, and that has to do with my concern that ultimately the global economy is headed into the tank—big time! Yes, I believe we will experience a major global depression akin to or worse than that of the 1930s. I had thought it was imminent, but clearly the policy makers are printing money almost literally from helicopters these days to try to keep the economy from succumbing to powerful deflationary forces. Because debt is the raw material from which fiat money is created and because debt is growing so much more rapidly than income, there will be a day of reckoning. And when that day comes, I do not want to have my portfolio heavily weighted in energy stocks, because demand for energy will most likely plummet very vividly. With the decline in demand will come a major decline in prices for those commodities—especially hydrocarbon fuels.
Why would we be more bearish on hydrocarbons than uranium? Because as pointed out above, nuclear electricity remains extremely cheap to produce compared to oil and gas. With the economies of the world in a depression, existing nuclear power plants are likely to remain, producing electricity, and thus demanding uranium, even as demand for oil and gas declines sharply. Of course, depending on how many new uranium plants come onstream, we could see a decline in uranium prices during a global depression, if that event occurs some years away. But the chances of falling uranium prices now are about as great as George Bush’s giving Saddam Hussein a pardon.
To help us prepare for a tipping point from inflation to deflation and thus a need to lighten up on inflation assets like energy stocks, I created my Inflation/Deflation Watch on January 31, 2005. But as discussed above, the present concern is certainly not one of deflation but dramatically higher rates of inflation. With this measure of inflation growing at almost 15%, the stage appears to be set for continued dramatic increases in oil and gas which paves the way for alternative sources of energy, the most promising of which appears to be uranium fueled nuclear power plants.