Thursday, May 10, 2007

Uranium futures – Has the time come for trading?


Uranium prices have exploded over the last two years with the renaissance of nuclear power as a clean alternative. This increase has created a surge in stock prices for uranium mining companies and a desire to trade the underlying commodity. This back drop has led the NYMEX to introduce a uranium futures contract.

A futures market will allow greater price standardization and transparency. These features should facilitate trading and liquidity in this market and provide a mechanism for hedging as well as speculation. Investors will have a mechanism for easily trading the commodity. Producers and users will have the ability to cheaply trade a standardized contract to offset risks.
Nevertheless, the old battlelines from the introduction of a futures market begin again. The development of future markets has not changed for decades in spite of the changes in trading technology. There will usually be two groups fighting over the development of a futures market. The forces for transparency who usually are the buyers of the product will like to see a successful contract. The forces for an opaque market, the sellers who often have market power given their size or have better information about the pricing of the market, may prefer the status quo. This simplistic dichotomy does not fully represent the story for a successful futures market but has played out in the past.

A successful futures market needs enough fragmentation so that some buyers and sellers see the value in marketing and pricing through centralized markets. For example, centralized pricing has been extremely valuable for the competitive crude oil and natural gas markets. Lack of local competition and problems of delivery and standardization have stalled the development of electricity future trading. Uranium which is more akin to other base metals may have a better chance of success.

Some argue that a futures market cannot really develop unless there is a viable spot and forward market. This argument places the development of a futures market as standardization of forward contracting that already exist. Certainly, the success of futures is furthered when there are already exists some hedging and forward contracting mechanism. NYMEX is using UX consulting which is the leading pricing service for uranium yellowcake to help provide a price benchmark. They provide weekly prices and information on forward arrangements.

Unfortunately, a normal scenario is that major players initially sit on the sidelines observing the market which leads to a lack of liquidity. The lack of liquidity does not allow for the development of a two-way market, so the contract dies a quick death. What may be different this time is the strong price move which has caused many traders outside of the nuclear industry to be interested in the market.

There has been growing interest in uranium mining companies, so interest in uranium ore is at a high. A recent survey by a hedge fund blog of a wide range of financial professionals suggests there is more than passing interest in a tradable market.

Let the market begin.

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