Complex industry offers a global play into rising fuel costs, shortages
MADRID (MarketWatch) -- For investors who can push aside a troubled history, and their own squeamishness, the complex nuclear industry can offer a global play on the rising costs of commodities and increasing energy demand.
Of course, pausing over the historical legacy is understandable. Outside of the obvious human and environmental cost of such disasters as Chernobyl in 1986 and Three Mile Island in 1979, the dollar cost is high if something goes wrong. The Three Mile Island disaster turned into a $2 billion liability within minutes, by some estimates.
Nuclear is also a tough sell because new reactors are extremely expensive and time-consuming to build, so returns are rarely realized quickly. It's been over 30 years since the last power station was built in the U.S., and only a handful have been built in Europe since the mid-1980s.
But there are plenty of reasons to think investing in nuclear power will pay off. Uranium, which forms the basis of nuclear energy, is in abundant supply, unlike many other commodities. Surging global demand for energy, concerns over global warming, erratic fossil-fuel prices and high-profile accidents related to oil and coal production have all pushed nuclear back to the top of political and environmental agendas worldwide. See full story: Nuclear option is back on the table.
"There is a tigerlike market out there right now of aggressive capitalist activity that is occurring in anticipation of a huge growth in the global nuclear industry," said London-based John Ritch, director general of the World Nuclear Association, or WNA, an association comprising 180 companies that represents the global nuclear-energy industry. He said major companies are competing to claim a role in the supply chain.
"In the 21st century, the nuclear industry will build hundreds, then thousands of power reactors worldwide." Ritch added. "You can see the activity most vividly in India and China, which have the world's two largest nuclear construction programs. But nuclear reactors will be built in at least 40 other countries." See story on Asia's nuclear ambition.
Since 2008 the WNA has had its own nuclear index acting as a benchmark of performance for the nuclear-energy industry and, through licensing, as a basis for exchange-traded funds such as the PowerShares Global Nuclear Energy Portfolio ETF /quotes/comstock/13*!pkn/quotes/nls/pkn (PKN 16.94, -0.73, -4.13%) and London-based WNA Global Nuclear Fund ETF.
Launched in 2008, the PowerShares ETF is down 3.3% in 2010, through mid-May, after having rallied 27% in 2009. In comparison, the MSCI EAFE (Europe Australasia Far East) index is down 10.3% in 2010 after a 2009 advance of 15%.
Two other trackers are the S&P Global Nuclear Energy Index, which is tracked by iShares S&P Global Nuclear Energy fund /quotes/comstock/15*!nucl/quotes/nls/nucl (NUCL 35.58, -0.54, -1.50%) , also launched in 2008, and the DAXglobal Nuclear Energy Index, the base for the Market Vectors Nuclear Energy ETF /quotes/comstock/13*!nlr/quotes/nls/nlr (NLR 18.56, -0.89, -4.55%) , launched in 2007. The iShares fund is down 11.9% on a year-to-date basis, while the Vectors fund is down 9.4%. The Vectors fund lost 45% in 2008, bouncing back 17% in 2009.
The nuclear plays
Ritch said ETFs are a good way to play the nuclear industry because an index like the WNA's is composed of global stocks from seven different subsectors: uranium mining, nuclear generation, plant infrastructure, uranium storage, nuclear conglomerate, uranium enrichment and nuclear-fuel transport.
"Nuclear is a complicated investment because there is no single stock that will give you a composite of the entire range of activities involved in producing nuclear energy," said the WNA's Ritch.
The DAX index comprises many of the same sectors, with nuclear cleanup and uranium processing separate sectors. Reactor maker Areva /quotes/comstock/24s!e:cei (FR:CEI 342.90, -1.90, -0.55%) of France and Japan's Toshiba Corp. (JP:6502 469.00, -24.00, -4.87%) /quotes/comstock/11i!tosy.y (TOSYY 30.89, -1.09, -3.41%) , are the first- and third-heaviest-weighted stocks in the WNA index.
Exelon Corp. /quotes/comstock/13*!exc/quotes/nls/exc (EXC 39.68, -0.91, -2.24%) , which operates the biggest fleet of nuclear-power plants in the U.S. and the third-largest fleet in the world, is the No. 2 stock for the WNA and owns the top weighting in the DAX index.
Roger Conrad, the Alexandria, Va.-based editor of Utility Forecaster, said investors who want nuclear exposure should stick to the biggest players in each sector, such as French power operator EDF SA /quotes/comstock/24s!e:edf (FR:EDF 34.74, -0.88, -2.47%) or Exelon in the U.S.
"Big companies can run a plant better," Conrad said. "That's because they have scale and financial power, and they can apply lessons learned at one plant to another, minimizing outage times and costs."
Bigger also equals better, in his view, on the engineering side and among uranium producers. He said Canadian-based uranium producer Cameco Corp. /quotes/comstock/13*!ccj/quotes/nls/ccj (CCJ 23.33, -1.17, -4.78%) , which ranks No. 2 globally in its category, is politically secure and also is a desired acquisition for a lot of Chinese uranium companies. See also Uranium's all aglow.
Commodity prices are a big factor for nuclear stocks, which is another reason big companies fare better.
"There have been times we've seen, in the last 10 to 15 years, natural-gas prices at $1. They don't last long, but, while they do, nuclear energy can't compete with that," Conrad said. "Companies of scale have the best chance of weathering these ups and downs in the marketplace."
And engineering, mining and power providers in the U.S. are dealing with totally different issues from those faced by companies in Europe and China, he said. Huaneng Power International /quotes/comstock/13*!hnp/quotes/nls/hnp (HNP 23.09, -0.41, -1.75%) has the power to build nuclear plants and intends to, but he said there is more risk with Asia owing to a lack of regulatory history.
The funds
The Market Vectors ETF considers itself a pure nuclear play because it targets companies that generate 50% or more of their revenue from the nuclear industry. Utilities -- EDF, Exelon Corp. and Constellation Energy /quotes/comstock/13*!ceg/quotes/nls/ceg (CEG 33.28, -1.40, -4.04%) -- are the top three holdings, but the bulk of the portfolio leans toward miners and suppliers.
The basic drivers for a fund weighted toward miners and builders, such as the Market Vectors ETF, are supply and demand for uranium and the construction of new plants, said Ed Lopez, marketing director at Van Eck. "Demand for parts, supplies for new construction around the world and political-will talk from governments seeking out clean energy may lead to demand for the shares of suppliers and miners," he said.
Shares may also get a bump when prices of fossil fuels go up, which make nuclear look cheaper.
"If crude oil continues to move up, or you get beyond $100 [a barrel], and if people start to feel that in their pocket there may be a greater urgency to seek out alternative sources of energy," said Lopez.
Lopez said Market Vectors is well-placed if the industry starts to see a build out again, but he said investors may find it takes time to see returns on utilities that are financing the plants.
"If there is a buildout, investors may want exposure to the suppliers, the people doing the work and building the plants and the miners, companies supplying the fuel. The potential to see returns from these types of players may come more readily than you might see from a utility, which can take five to 10 years to build," he said.
The third-biggest holding in the ETF is Constellation Energy. Cameco and uranium miner Energy Resources of Australia claim the next two spots.
John Kohli runs one of the oldest utilities funds around: the Franklin Utilities Fund /quotes/comstock/10r!fkutx (FKUTX 10.68, -0.08, -0.74%) , which got its start in 1948. The San Mateo, Calif.-based manager said that more than half of the utilities he owns -- all U.S.-focused -- have some nuclear exposure, but the exact level is hard to quantify, as nuclear only makes up 20% of the U.S. power supply, with coal the dominant supplier at 50%.
His fund has fallen 3% on a year-to-date basis and has lost 4.6% on a three-year basis, but it's up 5% and 8% by five- and 10-year measures.
He said he's got his eye on two drivers for his nuclear exposure: a U.S. energy bill and Southern Co.'s /quotes/comstock/13*!so/quotes/nls/so (SO 33.78, -0.15, -0.44%) plans to build the first new power plant in the U.S. since the industry stalled 30 years ago.
The top two holdings in his fund are Southern and Entergy /quotes/comstock/13*!etr/quotes/nls/etr (ETR 75.33, -1.47, -1.91%) , and he also owns Exelon. He called those the purest plays available for nuclear. "We like nuclear because it's clean, there are no carbon emissions from nuclear unlike coal and we like the fact it's cheap to produce," he said.
His fund has benefited from nuclear exposure for much of the past decade, he said, though he noted the economic decline has been a short-term negative for almost all of the industry over the past two years.
The reservations
There are plenty of socially responsible funds out there that won't touch nuclear, such as the New Alternatives Fund /quotes/comstock/10r!nalfx (NALFX 35.65, -0.56, -1.55%) , which makes heavy bets on alternative energy. Co-manager David Schoenwald subscribes to the view that the potential benefits of nuclear power are outweighed by safety risks and high costs.
Domini Social Equity /quotes/comstock/10r!dsefx (DSEFX 26.20, -0.18, -0.68%) is another fund that won't invest in nuclear, said David Kathman, a Morningstar analyst based in Chicago who covers utilities funds.
"There still is some squeamishness, mainly among socially responsible funds," he said in an email interview. "I don't think anybody needs nuclear power as an investment, but some of my utility-fund managers think that nuclear-heavy utilities are a good investment."
To be sure, the risk of accidents never really goes away for nuclear investors, said Utility forecaster's Conrad. "If there were to be an accident, it would be catastrophic. You've always got that working against it."
But the WNA's Ritch said safety measures are vastly improved these days. He pointed out that systems deemed unsafe after Chernobyl have been eliminated.
"Investors can be quite confident that there will not be another Chernobyl. Reactors like that simply don't exist anymore and will never be built again," Ritch said. "The global nuclear industry today boasts an extremely impressive safety record built on 14,000 reactor-years of operating history."
Barbara Kollmeyer is an editor for MarketWatch in Madrid.
