A distorted market

3 September 2002

The past year witnessed a sharp spike in enrichment prices in the USA, as USEC's actions began to bear fruit. Ironically, this price boost is just what Urenco and its partners need to win contracts that could finance a competing centrifuge plant in USEC's backyard. By Clark Beyer and Jeff Combs

The market for uranium enrichment services has been complicated by unique commercial and political factors throughout its history. Until the mid-1970s, the US government enrichment enterprise dominated supply to the western world. Later, exports from the USSR and the launch of European enrichers Eurodif and Urenco significantly reduced the US role in Europe and parts of Asia. The market became truly global by 1990, as most utilities worldwide could buy from all four primary producers. However, in the early 1990s, a dumping case was brought by the Uranium Producers of America against the former Soviet Union, which essentially closed the US market to imports of Russian commercial SWU.

Since the end of 2000, SWU prices in the USA have increased some 30% primarily as a function of the USEC trade action. This, combined with the ten-year embargo of Russian commercial SWU in the US market and the generally sold-out position of Urenco, gives USEC a near-monopoly position for new business in the USA.

Outside the USA, SWU prices have shown some upward pressure since the trade case began, but are likely to stay well below those in the USA as competitive pressures force European and Russian suppliers to concentrate on winning new business in Europe and Asia.

Supply and demand

Fundamentally, the enrichment market remains only slightly oversupplied, despite significant "nameplate" overcapacity. Of the four major primary enrichers, only Urenco, with its low-cost centrifuge capacity and modular production design, is producing at full capacity. Russia, which also possesses low-cost centrifuge capability, is prevented from producing at anywhere near capacity due to trade restrictions imposed by the European Union and the USA. Utilising gaseous diffusion technology, the economic capacity of Eurodif is somewhat below its nameplate capacity, but producing at even this lower level is now threatened by the trade duties in the USA.

In the short term, technology advantages have not always led to immediate commercial advantages, but the market is gradually coming to the realisation that technology must win out in the long run. The power-consumption properties of centrifuge enrichment, a mere fraction of that required for gas diffusion plants, mean that the winning technology of the present and future will be centrifuge. Hence, the last two years have witnessed Urenco's consistent, measured expansions of its centrifuge capacity, the shutdown of one of USEC's diffusion facilities, and Cogema's ongoing search for a replacement technology or partner.

Russia remains a wild card, the elephant in the room that few are willing to acknowledge. With up to 20 million SWU capacity at four low-cost centrifuge facilities, what happens to Russia's presence in the world market is a factor that all market participants must ponder, and will likely continue to be heavily influenced by political interference. Russia currently faces a total embargo (due to expire early in 2004) on commercial SWU in the USA, a 20% limitation in the European Union, and very limited access to the Japanese market due to historical preferences. How these restrictions and purchase policies change in coming years could have a significant impact on world supply and market-share dynamics.

Figures from Ux Consulting indicate that nameplate primary production capacity for enrichment services, at over 50 million SWU (including HEU SWU), greatly exceeds world demand as shown in Figure 1. Demand for enrichment services is expected to grow modestly over this decade, increasing slightly from 35 million SWU in 2002 to 39 million SWU by 2010. Taking into consideration the lost capacity in Russia from HEU blending and tails stripping reduces the overhang somewhat, but it still points to significant overcapacity, which would be more of a market factor absent the trade restrictions that characterise the market. In this regard, while Russia's Techsnabexport (Tenex) exported roughly 5 million or so commercial SWU in addition to the 5 million SWU from HEU last year, it could have exported more commercial SWU if it had greater access to the market.

Figure 2 shows how supply is brought much closer to demand levels when considering the economic capacities and marketing constraints of primary producers that reduce the operable capacity of the plants. Eurodif, for example, operates at close to 8 million SWU despite its nameplate capacity of 10.8 million SWU for reasons of optimising production costs. USEC, which must also market the Russian HEU SWU, is expected to produce only about 5 million SWU at its Paducah plant in its current fiscal year (which runs through the end of June 2003), below its economic capacity and well below its nameplate capacity. Trade restrictions limit Tenex's ability to export much more than 10 million SWU, half of which is comprised of blended-down HEU. Thus, most of the primaries, with the exception of Urenco, find themselves operating plants on a significantly underutilised basis, hence the interest by Tenex in continuing to strip (re-enrich) UF6 tails from Urenco and Cogema as a way of keeping centrifuge capacity operating, earning export revenue, and mitigating a tails disposal liability for the European enrichers.

Since the mid-1990s, the spot enrichment market has been close to nonexistent, as shown in Figure 3 which compares new spot and long-term contract volume over this period. The heyday of traders in the mid-1980s to the mid-1990s was in part driven by large inventories of enriched uranium product (EUP) liberated from utilities and governments. Soviet EUP began to enter the market via loan replenishments and direct sales, and spot prices sunk to roughly half the level of long-term contract prices from primary producers. With virtually all of those inventories now gone, primary enrichers capture at least 95% of new demand. Spot prices, as in many commodities, now tend to be even higher than long-term prices, as producers seek to charge a premium to buyers that are unwilling to sign up for long-term commitments.

Utility contracting review

Enrichment contracting slowed considerably over the past year as buyers around the world, and especially in the USA, absorbed the impact of the USEC antidumping case against Eurodif and Urenco. Figure 4 shows the small volume of long-term SWU contracting so far this year. In reality, this slowdown began in the middle of last year, after SWU prices broke the $100 barrier. To avoid paying these higher prices, utilities elected to exercise upward quantity flexibilities in existing contracts, when possible. As shown in Figure 5, spot volume, especially sales of EUP, have remained quite low so far this year.

According to US Energy Information Administration figures, US utilities took delivery of 10.4 million SWU in 2001, 94% of which was under long-term contracts, and only 12% of which came from actual USEC production.

Prices showed dramatic strengthening from the beginning of 2001 into mid-2002 (Figure 6), rising from $86 to $107 in that period (mainly reflecting activity in the USA in the wake of the trade case). On the other hand, the SWU price in real terms is now 2% lower compared to January 1996. Since early 2002 prices for spot purchases have leveled off and are holding steady around $107, with base prices for long-term contracts going at a several dollar discount. With the US trade restrictions, only USEC and Urenco can pursue new business, and Urenco's typically full order book in the near term means that USEC is the principal option for US buyers needing material in the next few years. This near-monopoly has kept many potential buyers on the sideline, waiting to see what happens with Cogema's appeals to its dumping order, while those who must buy have little choice but to pay the higher market prices.

Outside the US, there has been some price strengthening in Europe, as suppliers digest the impact of the US market dislocation. Russia also faces milder restrictions in Europe, where EU utilities are limited to purchasing roughly 20% of their needs from Tenex. As a result, prices in Europe appear to be rising toward the $90 level, but are unlikely to close the gap further with US prices. Asia is expected to be the most competitive market under the circumstances, as all four enrichers battle for market share in Japan, Korea and Taiwan. At present, there are no indications that prices for new contracts have risen above the levels that existed when the market reached its competitive zenith several years ago, but there has been no recent contracting in Japan.

The HEU agreement

In mid-2002, USEC announced that it had succeeded in negotiating a new long-term market-related SWU pricing structure with Tenex that is more favourable than the previous base-escalated contract price. USEC will now pay prices for the Russian SWU that are calculated by taking a discount off of a moving-average basket of spot and long-term published indicators for the duration of the agreement, which is scheduled to expire in 2013. Although the new pricing scheme was negotiated commercially between the parties in early 2002, and Russian governmental approval was received relatively quickly, the deal was held up by the US Department of Energy (DoE). The DoE wanted certain assurances from USEC regarding continued operations at the last operating diffusion plant in Paducah, Kentucky, as well as a commitment to new technology deployment, before ratifying a new pricing mechanism that would provide some financial relief for USEC. Ultimately, USEC and the DoE agreed on this as well as other critical issues related to remediation of contaminated feed transferred to USEC from DoE in a Memorandum of Agreement signed in June 2002.

Another major development regarding HEU occurred after the Bush-Putin summit of May 2002, when the availability of additional quantities of HEU in commercial markets became a possibility following the announcement a new nuclear arms treaty between the two countries. Presidents Bush and Putin appointed a joint US-Russia expert group to examine this issue. Soon after the announcement of this expert group, a DoE official sought to reassure suppliers of SWU and uranium that the USA would not take any action to harm the US nuclear supply industry. This means the most likely scenario for any additional HEU supplies would be to have them introduced at the end of the current HEU deal, or after 2013. This scenario is likely to be acceptable to most suppliers, now that they have adjusted to the presence of the original material in the market.

It is also likely the case that the Russians are in no hurry to make additional HEU supplies available, given that they will be receiving notably less revenue under the new HEU SWU pricing mechanism than they did under the initial contract terms. Nevertheless, the deal stipulated that payments to Russia will not be less than $7.5 billion over the 20-year agreement.

Along these lines, some US utilities have pressured US and Russian officials for direct access to the HEU supply, including any new supply that is made available. They have argued that Russia will receive more money by not having to fund USEC's considerable overhead, and utilities will benefit from lower prices. So far these efforts have failed, as USEC has lobbied successfully to maintain control over this source of supply. A joint US-Russia governmental report on additional fissile material disposition is expected in October of this year.

trade restrictions

In November 2001, the US Department of Commerce (DoC) issued its final determination, applying combined antidumping and countervailing duties of 32% against France (Eurodif), but only 2% against Urenco facilities in the UK, Germany and the Netherlands. In January 2002, the International Trade Commission (ITC) ruled 4-0 that the alleged dumping had indeed harmed the domestic market. Urenco's modest countervailing duty is likely to have little effect on its US activities. However, as noted earlier, Urenco has little unsold capacity over the next several years, so its ability to market to the USA is limited from this perspective.

As a result of these actions, Cogema is effectively barred from the US market pending a variety of appeal mechanisms, none of which are likely to have an impact before early next year. Due to the consequent rise in SWU prices and trend of the US dollar, among other factors, there is a good chance that the French duties may be reduced upon completion of the first Administrative Review in February 2003. Nevertheless, it is a severe blow not only to Cogema's future sales potential in the US market, but also to its efforts to merely service existing US customers.

The LES initiative

The long-term future of the uranium enrichment market will in many ways depend on investments made in the next five years in new enrichment technologies and facilities. Certainly sufficient capacity exists in Russia, along with existing European capacity (where Urenco continues to expand its output), to more than make up for a total cessation of USEC production at Paducah and Portsmouth. However, the current trade restrictions (and perhaps historical contracting practices and biases) would probably inhibit a smooth flow of this material to buyers worldwide. It is also clear that the US government and US utilities do not want to be completely dependent on imported SWU.

Companies planning to build new enrichment facilities in the US face the usual financing and rate-of-return obstacles in an industry lacking fundamental demand growth. However, what makes this investment even more problematic is the uncertainty on the supply side. The unpredictable and ever-changing nature of trade restrictions, which keeps much of Russia's vast centrifuge capacity at bay, coupled with the potential for additional HEU supplies, makes it nearly impossible to project exactly what the supply side will look like 10-15 years from now.

Perhaps the most hopeful long-term development for US buyers is the recent progress toward the goal of building and operating a US-based centrifuge enrichment facility using Urenco technology. In a much-anticipated press release in July 2002, Urenco announced that the partners in the new Louisiana Energy Services (LES) venture would be the utilities Exelon, Entergy and Duke Power, along with Canadian uranium producer/converter Cameco and fabricator/plant vendor Westinghouse. The addition of Cameco makes eminent sense, given Cameco's large presence in the market, and the fact that this venture would more or less complete Cameco's vertical integration efforts. Cameco and Westinghouse also bring to the team a degree of political influence and sophistication in dealing in US governmental circles that Urenco has heretofore lacked.

Aside from the political battle, Urenco enjoys a number of advantages over USEC in bringing a new US facility to fruition. First, it has developed its gas centrifuge technology over the past 25 years at three European locations, where total capacity now exceeds five million SWU annually. Its ability to expand output incrementally through modular units has given it an important cost and flexibility advantage over larger players. It is currently deploying its seventh generation centrifuge machine, allowing the company to develop machines with continually lower unit capital and operating costs, and useful lifetimes that may exceed 20 years without repair or maintenance. USEC, on the other hand, is trying to resurrect a nearly 20-year old effort that produced a centrifuge design that has virtually no operating history behind it.

LES has yet to announce its choice of site for the new plant, but such an announcement is imminent. Regular exchanges with the NRC have already begun, as the consortium seeks to improve on the process that plagued previous regulatory efforts surrounding the original, ill-fated Louisiana Energy Services venture.

USEC's plans

USEC is also pushing forward with plans to adopt a replacement technology. To date, however, the history in developing and commercializing new enrichment technologies in the US is far from distinguished. The DoE spent $5 billion in the 1980s developing centrifuge technology, only to cancel it in favour of laser separation. AVLIS research consumed another $2 billion, yet USEC, which inherited this technology from the DoE, gave up on AVLIS in 2000. USEC has committed much smaller investments in the Australian SILEX technology, with little progress to date, as did its efforts to obtain access to Urenco's technology. Current plans are focused on USEC's funding of a programme with the DoE to demonstrate and deploy centrifuges based on the original GCEP design dating from the mid-1980s. USEC claims that, with new materials and processes, its centrifuge production costs are expected to be lower than that of the competition, and will have high performance and reliability.

Another issue is USEC's well-publicised financial problems. In May, Standard and Poor's downgraded its debt rating to "junk" status (although its outlook is "neutral"), and operating income has declined since the company's privatization and subsequent stock floatation. On the other hand, USEC argues that its cash position - along with the HEU agreement now in place - puts it in a strong position to move forward with its plans.

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