For the world's No.1 uranium producer, Cameco, trouble came in the form of an underground tsunami last week.

Work had to be halted at the company's 50%-owned Cigar Lake mine, which is currently under construction to tap into the world's largest undeveloped uranium deposit in northern Saskatchewan. Plagued by flooding since 2006, the water inflow rate suddenly jumped from about 30 cubic meters per hour to 600. While the company indicated it would need more time to study the problem further, an optimistic assessment would be that the projected production date of 2011 will have to be rolled back further, while a pessimistic read on the situation would envision complete abandonment of the project.

While this is clearly not good for Cameco shareholders, shares of other uranium producers, including Australian Energy Resources, controlled by Rio Tinto Group (NYSE:RTP) and Canadian Denison Mines (NYSE:DNN) rose sharply on the news as the prospect of lower future supplies of uranium raised hopes that spot prices would rise in the near-term. Since peaking at well over $130/lb in mid-2007, uranium prices have been in a steady downtrend, currently trading at about half the peak value at about $64/lb.

Global Mining Production Projected To Decline

While it's likely that much of last year's price spike was due to speculative activity, deteriorating supply fundamentals did provide a supportive backdrop to the price gains; and could help lift prices again.

Over the 10-year period from 1996 to 2006, global production of uranium from mining increased at only a 1.9% average annual rate, with production actually declining in five of those years. In 2006, world production declined by nearly 6%, and the world's biggest producers, Canada and Australia, saw production drop 15% and 20% respectively.

Looking ahead, by 2020, of the 10 largest uranium mines in the world, six will be depleted, two will be in their final stages, one will be upgrading and only one will be producing. With 58% of global demand for uranium now being met by primary mine production, a reduction in supply from this key source will have to made up from elsewhere. Historically this has come from stockpiles, which are now rapidly shrinking, and the downblending of highly enriched uranium sourced mainly from the former Soviet Union's nuclear arsenal. (For more on the supply and demand relationship, read our Economics Basics Tutorial.)

From Russia, With Love

Concerns about the prospect of dwindling mine supplies probably lay behind the U.S.'s decision last January to allow significantly greater volumes of re-processed uranium from decommissioned Soviet nukes to enter the market. For years the U.S. government has restricted Russian supplies fearing that Russian dumping would hurt the major American uranium supplier, USEC Inc (NYSE:USU).

Beginning in 2011, Russian uranium exports to the U.S. will increase from 16,559 tons a year to 514,754 by 2020. Right now about half of U.S. commercial reactor fuel is sourced from Russian nuclear warheads and that percentage will likely increase further as more Russian supply enters the market. Not surprisingly, uranium prices plunged when the deal was announced.

Bottom Line

With both candidates for the U.S. presidency now making increased reliance on nuclear power a key part of their energy independence platforms, the prospect of ever increasing reliance on Russian nuclear fuel to achieve this end seems somewhat contradictory. Moreover, as the continued presence of Russian tanks in Georgia raises the specter of a return to the Cold War, there's no certainty that the Russians won't renege on the deal. We all better hope that the folks at Cameco make the decision to invest in bigger pumps.

By Eugene Bukoveczky

Eugene Bukoveczky is a free-lance writer and investment researcher. He holds a CFA designation and has spent several decades working in the investment business in places like Toronto, New York, London and Dubai. He currently resides in Nova Scotia, where, when not writing, he devotes his time to chopping wood, growing his own vegetables, riding his bike to the store, and thinking about other ways to reduce his carbon footprint. At the time of writing Eugene Bukoveczky did not own shares in any of the companies mentioned in this article.