Twice in the past week, I have been asked about investing in the nuclear power sector, so today I thought I would provide an update on the industry.

Last November the International Energy Agency (IEA) published its annual World Energy Outlook (WEO). The World Energy Outlook 2016 is a 667-page report that delves deeply into the energy sector and projects trends to 2040 under a variety of scenarios.

One of the key conclusions of the report is that a world seeking to combat climate change is going to require more nuclear power. A lot more nuclear power in fact.

The report considered three possible future scenarios.

The Current Policies Scenario (CPS) depicts a path for global energy systems based on policies or measures in place as of mid-2016. Future changes in policy were not considered except for those that have an expiration date.

The New Policies Scenario (NPS) takes guidance from the Paris Agreement on climate change, which was adopted in December 2015. Many governments have made climate pledges in response to the Paris Agreement that are not yet reflected in legislation, but these pledges are assumed to be realized in the NPS.

The WEO found that neither of these scenarios would accomplish the intended goals of the Paris Agreement to limit the concentration of greenhouse gases in the atmosphere to around 450 parts per million (ppm).

Thus, the report looked at a “450 Scenario.” Unlike the other scenarios, this one works backward from an intended result and identifies the cuts that would be required to achieve the goals. The following graphic highlights the future projected energy usage in various categories under the scenarios:

Source: The IEA’s World Energy Outlook 2016

There is a lot of data in this graphic, but I want to focus on nuclear power consumption under these scenarios. Even under the most conservative scenario, nuclear power expands by 30% by 2025 and by 56% by 2040. Under the 450 Scenario, nuclear power has to shoulder a much bigger burden, as it scales up primarily to replace coal-fired power. In this case, nuclear power demand increases 45% by 2025 and 140% by 2040.    

The report concludes that nuclear power is essential to meeting the climate goals outlined in Paris. Under the New Policies scenario, installed nuclear capacity growth is concentrated heavily in China (46% of new capacity), then India, South Korea, and Russia (30% of it cumulatively) and the U.S. (16%).

It seems like nuclear power is poised for growth, so what are the risks and opportunities?

The political climate for nuclear power has been chilly since the March 2011 nuclear power disaster at the Fukushima Daiichi plant in Japan. The downturn in the nuclear energy sector following this catastrophe caused an oversupply of uranium, and prices fell from $70 a pound just before the disaster to $30 a pound by year-end 2016: 

    Source: Cameco website

Wang Ying, chief executive of a division of China National Nuclear Corporation (CNNC), acknowledged at a conference last year that the oversupply is coming down, but warned “I think perhaps we have a bottom of around $20 per pound at present. But unfortunately today because of excess supply and storage, I don’t think it will be more than $40 by the end of this decade.”

Soaring demand doesn’t always lead to rising prices, as investors in the oil sector know all too well. The other side of the equation is supply, and uranium stockpiles are equivalent to around seven years of demand at current usage rates. Thus playing the nuclear boom by investing in uranium companies like Cameco Corp (NYSE: CCJ) may not be the best near-term option. (Although if you do want to invest in a uranium miner, Cameco notably has managed to generate positive free cash flow in each of the past three years). 

That doesn’t mean there are no promising investments in the sector. There are utilities like Exelon (NYSE: EXC), which owns a quarter of the nuclear power plants in the U.S. But a purer play in the sector is BWX Technologies Inc (NYSE: BWXT). This spin-off of Babcock & Wilcox is the only domestic producer of particular reactors and components for nuclear power plants. The company is cash flow positive, although it has taken on more debt in the past year. Shares are up 37% over the past year, it has a yield of 0.8%, and it has a consensus analyst rating of Outperform.

BWXT appears to be an attractive way to play the projected growth spurt in the nuclear power sector, but this isn’t a Buy recommendation. To be clear, the purpose of this column is to cover topical energy issues, and sometimes put companies of interest on your radar. Investors who are looking for particular Buy and Sell recommendations can find those in the subscriber-only Energy Strategist.

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