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Foundation Coal Holdings Inc Q3 2008 Earnings Call Transcript 1 comment

October 22, 2008 | about: FCL

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Foundation Coal Holdings Inc (FCL)

Q3 2008 Earnings Call

October 22, 2008 10:00 am ET

Executives

Todd Alan - VP of Investor and Media Relations

James Roberts - Chairman and CEO

Kurt Kost - President and COO

Frank Wood - CFO

Analysts

Michael Dudas - Jeffries & Company

Brett Levy - Jefferies & Company

Paul Forward - Stifel Nicolaus

Luther Lu - FBR Capital Markets

Pearce Hammond - Simmons & Company

David Lipschitz - Merrill Lynch

Michael Goldenberg - Luminous Management

Justine Fisher - Goldman Sachs

Lawrence Jones - Barclays Capital

David Gagliano - Credit Suisse

Jeremy Sussman - Natixis

Wayne Atwell - Pontis Capital Management

Joe Downey - Copia Capital

Ted Bernard

Presentation

Operator

Greeting and welcome to the Foundation Coal Holdings Inc., third quarter financial results conference call. At this time all participants are in a listen-only mode. A brief question-and-answer session will follow the formal presentation. (Operator Instructions).

As a reminder, this conference is being recorded. It is now my pleasure to introduce your host, Mr. Todd Alan, VP of Investor and Media Relations for Foundation Coal Inc. Thank you, Mr. Alan, you may begin.

Todd Alan

Thank you, operator. Good morning everyone and thank you for joining Foundation Coal third quarter 2008 Earnings Call. This call is being recorded and will be available for replay for a period of two weeks. The live call can also be heard on the Internet and will be archived on our Web site at www.foundationcoal.com for one year.

Joining me on today’s call are Jim Roberts, Chairman and CEO of Foundation Coal, who will summarize our third quarter results, discuss our 2008 and 2009 guidance and provide a brief market outlook, Kurt Kost, our President and COO, who will address our operating results and update you on our operating initiatives and Frank Wood our CFO, who will provide the details of our financial results.

Please let me remind you that various remarks that we make on this call concerning future expectations, plans, and prospects for the company constitute forward-looking statements for the purposes of the Safe Harbor provisions under the Private Securities Litigation Reform Act of 1995.

These statements are made on the basis of management's views and assumptions regarding future events and business performance as of the time the statements are made. Actual results may differ materially from those expressed or implied. Information concerning factors that could cause actual results to differ materially from those and forward-looking statements are contained in our filings with the Securities and Exchange Commission including our annual report on Form 10-K. Now I'd like to turn the call over to Jim Roberts. Jim?

James Roberts

Thank you, Todd. Good morning, everyone. As a company and as a management team, we are not satisfied with our operating results for the third quarter, and in particular, I am not satisfied with our results during the quarter. In my statements today, I will briefly discuss the issues that shaped our third quarter results, update our guidance for 2008 and '09, and provide you with a brief market overview.

As we announced on September 29^th, Eastern production in the third quarter fell approximately 800,000 tons short of the expectations. During the quarter, adverse geology reduced our Eastern production by about 650,000 tons. The most significant geological challenge we encountered was the presence of sandstone at our Emerald mine in the C district.

This is the section beam mine by the new long wall that was installed in the first quarter of this year. Kurt will discuss the operational details with you in a moment. In addition, regulatory inspections, changing interpretations of the regulations, and slow regulatory approval processes are limiting our Eastern production.

We estimate approximately 100,000 tons of production were lost due to these intensified regulatory impacts in the quarter. Finally, tight labor market conditions in Central Appalachia impacted us in at least two ways. First, the shortage of labor contributed directly to our production short-fall, and second, several rounds of wage increases have driven cash costs up substantially.

As a result of these headwinds, Foundation reported a third quarter net loss of $32.2 million or $0.71 cents per share. Third quarter earnings included an $11.2 million after-tax impact or $0.25 cents per share from net unrealized mark-to-market losses on diesel hedges and certain OTC contracts that will reverse in subsequent quarters and that we view as a special item.

I would now like to focus on each of the issues that impacted our results. First regarding adverse geology, the recondition backup long wall was installed in the B district of Emerald in late September, and two long walls are now in production at the mine.

As we had mentioned on previous calls, some adverse geology at Emerald was anticipated, and the decision to add a second long wall was made to mitigate the negative impacts. The planning, development, and installation of the second long wall has taken longer than originally planned. Now that both long walls are operating in October, we have seen a significant increase in production month to date.

Second, many operators in the Eastern USA are dealing not only with increased inspection activity, but a dynamic interpretation of existing regulations and operating practices that were previously accepted as industry standards. Basically, the goal line is constantly changing, creating an environment of uncertainty as it relates to the operation and planning of our facilities.

The result is more operational downtime at all mines. Foundation has, and will continue to maintain the highest level of compliant standards in response to this. And as a result, we have maintained a compliance rate better than the industry average.

Finally, labor shortages in Central Appalachia have intensified, and new measures to retain skilled employees have been implemented. Retention has been improved by reducing overtime demands on our existing workforce, improving our training programs and adjusting wages higher.

Recruiting and retaining skilled employees will require a long-term solution, and Foundation will dedicate the necessary resources to meet this challenge. While geological challenges vary from mine to mine, productivity impact stemming from regulatory action and a shortage of skilled labor are pervasive and ongoing issues in Eastern United States.

In light of this operating environment, as well as production constraints at our Emerald mine, we are adjusting our 2008 EBITDA guidance to a range of $300 to $320 million. Also, we are adjusting our full-year 2009 EBITDA guidance range to $500 to $625 million, a level which we believe is achievable based on our current hedge position and our outlook for pricing on our open tons.

Now I would like to provide you with a brief market overview. We believe that long-term fundamentals will continue to be highly favorable for the United States industry due in large part to increasing exports driven by strong European demand and a relatively weak dollar. Domestic exports are projected to be approximately 85 million tons this year, and should remain strong, if not increase in 2009.

This level of export has occurred at a time when imports are down, and Eastern production up only slightly at best. Since 2006, U.S. exports, which come almost entirely from these, are up some 35 million tons and given the decrease in imports, the net result is about 40 million tons less available for domestic consumption.

Consequently, the market for Eastern coals became extremely tight. Prices rose sharply compared to last year, as much as two to threefold at the summer peak, and inventory levels contracted significantly in the east. Based on data from Genscape, we believe that inventories in regions of the Eastern United States now stand at approximately 30 days of burn, which are below historical averages.

Despite these tight conditions and strong pricing, Eastern producers have been unable to increase supply in any meaningful way. Recent estimates put year-to-date production growth for the Eastern at 1 to 2% range. However, based on recent announcements of production shortfalls from several Eastern producers, these estimates likely will be revised downward, probably towards flat year-over-year production.

More importantly, given the inability to secure new 404 permits in Central Appalachia, the impact of regulatory activities and a persistent shortage of skilled labor, we do not believe production can expand meaningfully in the east. On the contrary, supply may contract further, especially in Central Appalachia. The long-term fundamentals for coal are very strong in the global stage, and the driver continues to be unprecedented growth in Asian demand, which is ultimately fueling demand for U.S. exports.

Coal has been the fastest growing fossil fuel for five years. The seaborne coal market including steam and met is approximately 1 billion tons annually and growing. China is poised to add 50 gigawatts of coal-fired generation annually and India is set to add 78 gigawatts through 2012. Overall, 300 gigawatts of new coal-fired generation are expected to be built in the next five years.

This works out to over 1.2 billion tons of new coal demand annually, and is greater than the total annual coal production in the United States. Given this outlook, the question should be where is the coal going to come from?

Already we have seen decreasing exports from Indonesia, the largest steam coal exporter with approximately 28% of the export steam coal market, as the company struggles to meet its own domestic electricity needs. Exports from Vietnam are down for the same reason.

Exports from Australia have room to grow long-term, but were temporarily interrupted by extreme weather events in the first half of 2008 and are constrained by infrastructure limitations for at least the next couple of years. Even when Australian exports do ramp up in the future, there is little doubt that Asian demand will fully absorb whatever Australia can produce.

Exports are also reportedly down from Poland and Russia, both suppliers to Europe. Of pivotal importance to Europe is South Africa, one of the largest exporters of steam coal and a long-term supplier to Europe. South African coal is increasingly finding its way to India, a trend that is expected to continue.

This leaves Europe more dependent on coal from the Americas. So long term, we believe there are strong fundamental drivers for the coal industry both at home and abroad. However, the threat of worldwide economic slowdown and tight credit markets could impact global demand in the near term. Already the threats of global economic slowdown and weakening steel demand have driven spot prices of coal lower in the financial markets.

Some steel manufacturers are shutting in capacity, and some steel companies have rescinded all guidance due to the lack of near-term visibility. These threats are real, and will almost certainly have some impact on pricing, though we do not believe they change the long-term view for coal.

Given the lack of near-term visibility in a rapidly changing worldwide economic landscape, I am not going to try to predict exactly where demand and pricing of US coal will go in 2009, but I will offer the following observations. The company's best positions in the current environment will have, one, a highly hedged position with less coal exposed to volatile and potentially decreasing prices, two, limited to unpriced metallurgical positions where prices could turn sharply and quickly, and three, limited exposure to 404 permitting issues.

I believe that anyone that knows this industry and our company would conclude, as I do, that Foundation Coal may be among the best positioned companies as we enter this uncertain environment. We are 94% committed on price in 2009. We have only 1.5 million tons of met production, of which greater than 60% is priced for 2009.

And we have only 1.5 million tons of surface production in Central Appalachia, compared to a total of some 123 million tons of surface production in that region, which greatly limits our near-term exposure to 404 permit issues. With that, I will now turn the call over to Kurt Kost for general operations and progress on our organic growth initiatives.

Kurt Kost

Thank you Jim, and good morning everyone. We've mentioned our safety track record many times before, but our performance year-to-date has been remarkable. Year-to-date, the incident rates for both surface and underground mines are well below the national averages and well below Foundation's 2007 incident rates.

Year-to-date, Eagle Butte and Paynter Branch, have all had zero reportable injuries, and we remain on pace to achieve a record year for safety in 2008.

Now, I would like to discuss the operating results for each of our regions during the quarter. As Jim mentioned, Northern Appalachia production was negatively impacted by our sandstone intrusion that reduced production at our Emerald Mine. After successfully managing through the roof fall in the C district during the second quarter, mining advanced steadily until late August, when an area of sandstone in the roof dipped down into the mining area near the head gate.

We are cutting our way through the sandstone, and recent drilling indicates that there is a potential for additional problematic areas of sandstone ahead of us in this panel.

Offsetting these challenges in the C district, we installed the reconditioned long wall in the B district in late September. That wall is producing well, and we anticipate favorable mining conditions for this panel throughout the rest of the year. Based on the expectation of strong production in the B district, along with two long walls in operation, we expect to achieve planned production and shipments from Emerald during the fourth quarter.

Similarly, we expect budgeted fourth quarter performance from our Cumberland mine, which recently emerged from a scheduled long wall move in late September. Based on our current information, we expect that mining in the C district and Emerald may be slower than originally anticipated, because we are likely to be in and out of adverse geological conditions from time to time, which has led us to adjust our production forecast for the future. We now expect Northern Appalachia production to be in the 13.5 million ton range in 2009, and around 13 million, plus or minus a half a million tons in subsequent years.

To mitigate the geological issues, we are implementing a significant improvement effort focused on three areas, people, process and technology. We are assigning our best employees to the critical areas at Emerald for reviewing our operational practices to maximize our productivity, and we're exploring new technologies to better forecast the sandstone intrusions and improve our operating performance when faced with these conditions.

So yes, we are taking a more conservative approach to our production guidance in Northern App, but we're also taking an aggressive approach to improve our operating performance.

In Central Appalachia, third quarter 2008 shipments of 1.6 million tons were down approximately 1.5 million tons compared to the third quarter of last year, primarily due to the absence of sand fuel related purchase coal shipments.

However, production in shipments fell short of expectations by roughly 150,000 tons, due to a combination of factors mentioned earlier, namely increased regulatory disruptions, a shortage of skilled labor, and adverse geology encountered at a few of our West Virginia mines.

Labor has become particularly challenging, as we have struggled to maintain production with available manpower. We have been demanding much of our workforce. In many cases, employees are working three Saturdays a month. If we’re to retain our most valuable resource, our people at the mines, we need to adjust the overtime schedules.

Therefore, as we look forward, we are revising our production guidance in Central Appalachia to account for the realities of the current labor market and ongoing regulatory impacts. We now expect total Eastern production in 2009 to range from 19.5 to 20.5 million tons. In subsequent years, Eastern production should be in the 18.5 to 20.5 million ton range.

Our PRB operations performed relatively well during the third quarter. Year-to-date, our shipments from the PRB are 1.6 million tons lower than the comparable period of 2007. In part, this reflects weather related interruptions in the second quarter, but it also reflects our commitment not to sell coal absent a reasonable return on investment. Higher federal coal leasing cost and more expensive commodities and equipment necessitate adequate pricing. If market conditions warrant, we are ready to produce at our full capacity of 55 million tons per year beginning in 2009, up from approximately 51 million tons this year.

Now I would like to address our market position and our recent sales activity. We are currently sold out for 2008; and as Jim mentioned, we are 94% committed and priced for 2009. Since it appears that metallurgical coal could be most vulnerable to an economic slowdown, it is important to note that we now have nearly two-thirds of our metallurgical coal committed and priced for 2009; and of that, nearly 90% is our high-quality Kingston mid-wall coal.

During the quarter, Foundation sold over 3.8 million tons of Eastern coal at average prices in the triple digits for delivery in years 2008 through 2011. Of this amount, 2.5 million tons are set for delivery in 2009. In the East, contracted average realizations per ton for 2009 delivery increased to $65.41, up substantially from $57.77 just last quarter.

This average realization includes the expected impact of our recent force majeure at Emerald, which drove result in some lower price tons originally scheduled for 2008 delivery being carried forward into 2009 and 2010. Our Eastern committed and priced tons do not include legacy contracts covering approximately 1 million tons in 2009 that are subject to index pricing.

These index contracts tend to lag changes in the market prices and thus are expected to ultimately price below the prevailing market price in 2009. In the PRB, we priced over 11 million tons of delivery in 2009, ‘10 and ‘11 at pricing reflective of the forward market in the low to mid teens. .

Turning now to our ongoing growth initiatives, our coal gas business continues to expand, selling approximately 3 million cubic feet of gas per day. We remain on track to maximize utilization of our gas processing plant, which can process 5 million cubic feet of raw gas per day. We plan to double the capacity of our gas processing plant to accommodate production growth beyond 5 million cubic feet per day level in 2009.

Permitting for the plan Foundation and Freeport Mines continues to progress. We expect to break ground on the Foundation mine in late 2010 timeframe. And if the market conditions are supportive, we can begin to work on the Freeport mine as early as late 2009.

The Freeport mine, as you may recall, is an expansion project designed to access metallurgical and thermal grade coal and produce 2 to 3 million tons per year. The Foundation mine is expected to come online in 2015, producing roughly 7 million tons per year of steam coal from the Pittsburgh seam, with further expansion possible if market conditions warrant.

We have the ability to increase our capacity in the PRB by 10 million tons per year to a total of 65 million tons with the addition of truck and shovel equipment and we continue to evaluate this opportunity with an eye toward market conditions and pricing for PRB coal.

In summary, Foundation coal had a very challenging third quarter. However, we clearly expect strong results in the fourth quarter, and we are implementing activities to generate more consistent operating results in the future. In addition, I believe that our conservative approach to hedging our production, combined with our limited exposure to open met coal and limited exposure to 404 permit issues in West Virginia, uniquely position us to deliver significant shareholder value in the current market environment.

Now I would like to turn the call over to Frank for a more detailed discussion of our financial performance. Frank?

Frank Wood

Thank you Kurt, and good morning everyone. In days of uncertain economic climate, Foundation maintains a strong liquidity position with $331 million available under our revolving credit agreement and the company continues to generate cash. Our capital expenditures have remained relatively flat compared to last year and our capital requirements are manageable based on our cash provided by operations.

Looking forward, based on our current guidance, we expect to continue to generate significant cash flow throughout 2009, and if anything, our liquidity position should improve further in the coming year.

During the third quarter, coal sales revenues rose 14% to $401 million. The total revenues also rose 14% to $409 million, as increased realization more than offset lower shipments from Northern Appalachia to Central Appalachia, to a lesser degree, the PRB. Cost of coal sales rose to $350 million in the third quarter of 2008 compared with $283 million last year.

The increase was driven by higher expenses in all major expense categories. Total cash costs excluding purchased coal in Northern Appalachia and Central Appalachia, each increased approximately 16% compared to the same quarter last year. However, on a per-ton basis, total cash cost, excluding purchase coal grew up approximately 28% and 38% respectively due to the lower number of tons shipped.

We now expect that full year 2008 cash production cost per ton, excluding purchased coal, will show a percentage increase in the mid teens. During the third quarter, Foundation recorded unrealized net mark-to-market losses of $11.2 million after tax, which reduced earnings per share by an estimated $0.25. The unrealized net mark-to-market losses, which review the special item during the quarter, included a $4.5 million after-tax loss on diesel fuel hedges and a $6.7 million after-tax loss on over the counter coal contracts.

All of these unrealized losses will reverse by the end of 2009. Foundation's Board of Directors voted during the quarter to increase the company's share repurchase authorization from 100 million to 200 million.

Through October we’ve continued to opportunistically repurchase shares. To date, we have repurchased 86 million worth of Foundation's common stock at an average price of $35.80, of which 39 million has been repurchased, since the end of the second quarter.

As we look forward to 2009, we believe that Foundation's regional diversification, highly committed and priced production, limited exposure to potential downside and open market prices, and little near-term exposure to permitting issues in central Appalachia, all combined to make Foundation one of the best positioned domestic producers in the industry.

With that, operator, we will now open the queue for questions.

Question-and-Answer Session

Operator

Thank you, gentlemen. We will now be conducting a question-and-answer session. (Operator Instructions).

Thank you. Our first question today is coming from the line of Michael Dudas of Jeffries & Company. Please go ahead with your question, sir.

Michael Dudas - Jeffries & Company

Good morning, gentlemen.

James Roberts

Good morning, Mike.

Kurt Kost

Good morning, Mike.

Michael Dudas - Jeffries & Company

Jim, I'd like you to maybe elaborate a little bit on your comment in your prepared remarks of dynamic interpretations relative to inspector issues in underground mines in the East. Have citations per shift for Foundation increased a lot over the past six to nine months? And do you think that it's pretty much overall throughout the industry? Or are there more selective aspects given certain mine's geology or companies?

James Roberts

No. I think the answer to the latter part of the question, we think it's across the board. We don't think of picking on any particular mines, although, they do move in waves at times. So they will focus on certain areas and certain mines for a period of time and you would see an uptick in that.

We have seen an increase in the number of citations, but it's not so much an increase in the number of inspections, but there are certainly more citations on each inspection, and they're more severe. In the past you may have gotten a violation, and today they're more inclined to shut the mine down.

So what we're seeing here is a real impact on cost, along with all of the other safety measures that we're implementing, that’s a real cost here is the last production. That's what we're seeing an increase in.

Michael Dudas - Jeffries & Company

Kurt, you mentioned about your issues in Central App. Did you say your impacted production was 150,000 this quarter off a 1.6 million base because of these issues?

Kurt Kost

Well, in Central App, the impact was probably more, yeah, it was around 150,000 tons, and it was a combination of geologic factors with some plain coals and some roof falls, along with the Hampshire impact. We're having a situation where, as Jim mentioned we're kind of chasing a moving target on the inspectors, and also, we had some labor issues, it minimized our ability. As we're having to rededicate employees to address the Hampshire issues, it does minimize our ability the be cutting coal. You add all that up, those were the impacts for the third quarter.

Michael Dudas - Jeffries & Company

Historically, your turnover rates havve been relatively low in single digits. Is that increased dramatically?

Kurt Kost

For the total company, we're probably in the low teens for a total turnover, but in Central App, this year has been particularly hard on us. We're probably this year, on an annualized basis, in the low 20% range.

Michael Dudas - Jeffries & Company

My final question, maybe for Jim, you did an excellent job going over your view of the supply and demand with dynamics worldwide. But coming back to the East, given the situation at your own company, would you agree that this would be replicated at many of the other smaller or less low capitalized operators in Central Appalachia and maybe even severely limit whatever production growth that might be anticipated by buyers or observers in the markets?

James Roberts

I think what has occurred with us is a reflection of what's going to happen throughout the market. I think that what may aggravate the situation in the near term and I want to make it clear that I'm very bullish on the market in the long-term, but we can't ignore the near term headwinds that the industry and all industries are going through.

But when you add the labor impact, the current market conditions and just a general or across the Board increase in cost, it's hard for us to see how production in the East can grow at any appreciable or measurable amounts. In fact, we think it's going to come down more quickly than we expected in the past.

Michael Dudas - Jeffries & Company

Even if prices were to fall to a level where some of these higher costs would be much more quicker to come off the market in your opinion higher cost the mines are?

James Roberts

I think that what is being masked here is that if we go back just a year, we had a lot of thin fuel coal that was being produced because the thin fuel was basically allowing high cost mines to operate. At the time that the thin fuel was expiring, which was at the end of last year, we had this pretty big spike at prices, which allowed these higher cost mines to continue.

If prices go down, and even for a shorter period of time, I think we have the aggravated effect that mines that have come on because of the higher prices will close, but also mines that probably would have gone down at the end of the synfuel tax rebate will also go away. So there could be a magnified result here if prices do dip in the first half of next year.

Michael Dudas - Jeffries & Company

Thank you, Jim. Thank you, Kurt.

James Roberts

Okay.

Kurt Kost

Okay

Operator

Thank you. Ladies and gentlemen, our next question will be coming from the line of Brett Levy of Jefferies & Company. Please go ahead with your question, sir.

Brett Levy - Jefferies & Company

Can you talk a little bit about what you are hearing in the met-coal market, high vol, low vol, pricing you're hearing. Just a little bit about maybe demand from China and that kind of thing?

James Roberts

Well, what we're hearing on the met side is more from our domestic customers and export. We really haven't seen any softness yet on the pricing. Our last contract was probably more than a month ago, was very strong. It's pretty quiet right now, and what we're seeing are the announcements from various fuel companies of shut-ins or cutbacks. On the international market, that market is really just getting started, as far as negotiations. That's on a fiscal year basis, and there's at least another four months in negotiating that can occur on the international market.

Brett Levy - Jefferies & Company

Have you heard of any shipments being turned away or anything like that?

James Roberts

No, we have not heard that, and we are still shipping pretty aggressively on our fuel shipments. So, no, we haven't heard any of that.

Brett Levy - Jefferies & Company

In terms of the labor shortage, what are the things you can do about that? Is it something that's addressable with cash? Is it something that's addressable with trying to bring people in from different areas? Obviously, there's a training issue there. Is there a long-term strategy to address the labor shortage?

Kurt Kost

Yes. This is Kurt. Some of the things that we're doing, specifically in Central Appalachia, is that we've ramped up our internal training program. We have an apprenticeship program where we're bringing in low-skilled or non-skilled underground miners, and basically exposing them to the coal mine and putting them with experienced people, so they can become productive and safe coal miners within a one to two year timeframe. So we're doing that.

We're also looking at not only recruiting in the local area, but we're also expanding out into regions outside Central Appalachia, trying to tap into maybe Illinois Basin or even at North Carolina where there had been underground operations in the past.

As I mentioned in my prepared remarks, we're also taking a hard look at our operating schedules. Our employees have been six days a week, three out of the four weeks in a month, and we just feel like for us to be able to retain our skilled people. We're going to have to give them a little more time off and improve their quality of life. So, I think that will help us.

Then the last piece is, yes, we've taken a very hard look at our compensation program, and we have made some significant adjustments to the hourly wages for our West Virginia operators from where we started at the beginning of the year to make sure that we're being in a competitive and fair market price for our employees.

Brett Levy - Jefferies & Company

Alright. Thanks very much.

Kurt Kost

Thank you.

Operator

Thank you. Our next question is coming from the line of Paul Forward of Stifel Nicolaus. Please go ahead with your question, sir.

Paul Forward - Stifel Nicolaus

Hi, good morning.

James Roberts

Good morning, Paul.

Kurt Kost

Good morning, Paul

Paul Forward - Stifel Nicolaus

Just wondering on this guidance of $525 million to $625 million of EBITDA for 2009, what sort of cash cost increases are you assuming in those numbers? I don't know if there's anything explicit you could give us, but what are you thinking about as far as just a basic overall company-wide number?

Frank Wood

Paul, this is Frank. We're still in a process of modeling that as we continue to work through our budget, but what we've modeled so far our cash cost increases that are not all that different from what we experienced this year. We've modeled into the low-teens in terms of overall percentage increase in total cost. It will probably benefit to some degree on a cash cost per ton basis because we should have more tons, particularly from the PRB to average down next year, but in terms of just the overall rate of increase of the cost elements themselves, we're generally modeling somewhat slightly in excess of 10%.

There's some reason perhaps to be optimistic that maybe that's been a little too influenced by our experience this year and not necessarily by some of the signals we see. I've noticed in the last two months, the quoted price for rebar steel has gone down 30%. We haven't seen any effect immediately on our cost yet, but that gives me some reason to be optimistic, that perhaps we're being on the conservative side, but that's the way we've viewed it so far.

Paul Forward - Stifel Nicolaus

Okay. Great. Also, looking at Emerald, I think you had mentioned some further sandstone intrusions that you'll be running into. Looking at the transit Emerald over the last few years, can you really think of Emerald as still being a 6 million ton per year mine? We haven't really hit 6 million since 2005, and what kind of production rates do you think going forward, if you're going to have 13 million out of Northern Appalachia? Was Emerald contributing to that?

James Roberts

Well, Paul, one of the things that we tend to cover Emerald with is that, at the end of the day, it's a poor operation. But in reality, there aren't a whole lot of longwalls in the country that actually produce 6 million tons or more. Even this year with the problems that we have, we’re still looking at a number between 6 and 6.3 million tons for Emerald, despite the setback we had in the third quarter.

2009, we have a range of 6.5 million tons for Emerald, and we believe that that's a conservative look at taking into consideration what we expect from both panels that we will be mining, one in the B district and one in the C district. But we anticipated a couple of years ago, that the C district would give us more challenges with sandstone, and that's why we made a decision to go ahead and put second longwall in.

The problems with Emerald, even though they are directly related to the sandstone, the real problem is that it has taken us much longer to get that second longwall in. Had we got it in when we originally had planned, we wouldn't be talking about the short falls that we've had had this year.

So a long answer to your question, yes, we think that Emerald is a 6 million ton plus per year mine. There could be in some years, and it goes way out, where you get into a situation of flow times that could actually interfere with that production, but that's beyond our realm right now in 2009. But, under normal conditions with both longwalls running, we believe that it's easily a 6 to 6.5 million ton mine.

Paul Forward - Stifel Nicolaus

And maybe just one last follow up on that point. 6 to 6.3 for the full year, just looking at the entry data, it looks like it was 4.2 in the first three quarters of the year. So does that difference explain the implied very strong fourth quarter guidance that you could potentially be doing 2 million tons at Emerald this quarter, and that that would make up for a lot of the misses over the last couple of quarters from just Emerald alone?

James Roberts

We look at it as a business unit up there, and yes, we are looking for a very strong performance from Emerald in the fourth quarter. That has built the basis of our strong expectations for the quarter. We also have in addition to that Paul, some strong pricing coming into the fourth quarter, not only in Northern App, but also in Central App, that we think will give us a boost. So, at the base of it all, it is expected there will be a very strong performance from Emerald.

Paul Forward - Stifel Nicolaus

Yes.

Kurt Kost

Paul, we've been working to this point all year long. I think we mentioned it in our last earnings call, were we anticipated strong performance once we had our both walls running in the B and the C districts, and here in late September, we were able to get our second wall operational, and as we mentioned in our previous prepared remarks, we've been seeing some very strong performance over the past two to three weeks.

So our confidence level is quite high that we will do very well in the fourth.

James Roberts

Paul, we also have Cumberland down for a long, long move in September, which aggravated the third quarter results and part of that is due to Cumberland has been mining so well, that longwall move was moved up a little bit because it mined out the panel a little bit earlier than we expected. So third quarter was impacted was impacted not only by Emerald's situation, but also that Cumberland was down for a couple of weeks. Fourth quarter, we don't have any longwall moves, so we expect strong performance from both Cumberland and Emerald.

Paul Forward - Stifel Nicolaus

Okay. That's good. Thanks.

Operator

Thank you. Our next question so is coming from the line of Luther Lu with FBR capital markets. Please go ahead with your question.

Luther Lu - FBR Capital Markets

Good morning.

James Roberts

Good morning, Luther.

Kurt Kost

Morning Luther.

Luther Lu - FBR Capital Markets

Kurt, could you explain a little bit about the contract position for 2009 particularly related to those colors? For instance, there are 1 million tons of steam coal in northern Ap. Is that Northern Ap or Central Ap?

Kurt Kost

That would be central Ap.

Luther Lu - FBR Capital Markets

Okay.

Kurt Kost

There are no collars in 2009, there are only index contracts.

Frank Wood

Okay. What about the 2010? I think there are three contracts, 0.8 million tons of met coal with average top of 194. Could you tell me where the bottom is for that end, for the contract?

James Roberts

This is Jim, Luther. The 194 relates to an average price for our metallurgical contracts that are committed. One of those contracts has a collar. We would call it at a price that is representative of 2008 pricing range, with a collar wrapped around it.

The other contract is a contract that was signed prior to the run-up in today's pricing, which is actually bringing the average down. In that case, 2010 is expired, the lower price contract expires in 2010, and the collar contract goes through 2010.

Luther Lu - FBR Capital Markets

Okay.

James Roberts

So it's a combination of what I recall, by today's standards, the lower price contract and one that is at the price north of in 2008, in the $275 range with a collar wrapped around that.

Luther Lu - FBR Capital Markets

Got you. I want to go back to the Emerald mines. So, you are operating at with two long walls. Can the long wall development keep up? Or have you add more labor to the mine? What is the cash cost at the Emerald mine these days?

Kurt Kost

Well, Luther in terms of the development, we've been working on our development sections, and that was one of the challenges that we had in getting our B district long wall setup up and that's why there was this delay. But right now, we're looking at continued performance off of both long walls through the end of the year. We do not anticipate any development issues through end of the year.

Then we also are forecasting our development to be adequate in order to maintain, a 6 million to 6.5 million ton level for 2009. We have been adding crews at both of our properties throughout the year to improve our development performance.

I mentioned in the prepared remarks, Luther that one of the things we're looking at from a technology standpoint to improve our performance also relates to CM development. There was a new machine that Joy has been manufacturing, and we're going to be installing that machine probably late fourth quarter, early first quarter of 2009. We have high expectations that we'll be able to drive up our CM performance and improve our flow time situation going forward.

Luther Lu - FBR Capital Markets

Okay. One more thing about this rollover tons. For the 650,000 tons missing shipment in the third quarter, how much of that is rolled into 2009?

James Roberts

Well, Luther, the exact amount on that is not determined. What we've done in our guidance is put the best estimate that we could on what will be rolled over in '09. It was actually going to be some tons rolled from '08 to '09, and a small amount of tons rolled from '09 to '010.

So when you do the calculation on what our new pricing is for '09 and '010, we didn't sell anything in the East that was under a $100 a ton in the past quarter, but you might come up with some lower numbers, particularly for I think 2010. That's because of this rolling over of some of the tons and Emerald that we missed in '08.

So again, several hundred thousand tons and the bulk of it will be rolled over into 2009. A smaller amount will be rolled into 2010. That brings down the average. Because there really isn't very much coal committed out in those years. But I want to make the point that we didn't sell anything in the East, but particularly in Northern App, it was under a $100 in the past quarter.

Luther Lu - FBR Capital Markets

Okay. Thank you.

Operator

Thank you. Our next question is coming from the line of Hammond Pearce with Simmons & Company. Please go ahead with your question.

Pearce Hammond - Simmons & Company

Yes. Good morning.

Kurt Kost

Good morning, Pearce

James Roberts

Good morning, Pearce

Pearce Hammond - Simmons & Company

Just a question on the growing gap between the price for labor, non-union versus union. How do you see that impacting the union contract and the union labor force specifically?

James Roberts

Well, Pearce, the union contract, I think, as you know, was signed a couple of years ago, and it goes through the end of 2011. We haven't seen any issues in relation to that. The wage increase and the benefit, particularly the benefit increase and our contributions to the pension fund went up significantly in that contract.

So when you look at the union contract, it's not something you just focus on the hourly increase. There was a significant increase in the hourly contribution amount over this five-year period into the pension plan. So, I really can't say much more about that. We expect the contract to run its course through 2011 and see what happens at that point.

Pearce Hammond - Simmons & Company

Great. Onthe pension, Frank, given the drop in the equity markets, do you foresee that you might have to make a greater contribution to fill in any sort of funding gap?

Aso, do you think there may be any regulations coming from a new administration in Washington that might want to tighten up the funding gap and pension plans? Thank you.

Frank Wood

Pearce, yes, we recognize as you do, that the equity value of our pension plan assets and our own plans, which doesn't include the multi-employer yield to be right plan that Jim just spoke of. Those values have been dropping particularly here in the last several weeks.

We don't have any quantification of it yet, but we do think there undoubtedly will be some impact in 2009 and subsequent years in terms of funding. It's not going to be an amount that's going to cause us any amount of financial distress, I don't believe, but it is something we'll have to deal with.

In terms of whether or not what will happen with legislation, I'm really not in a position at this point to predict that. I think it will obviously probably be a topic of conversation.

Pearce Hammond - Simmons & Company

Thank you.

Operator

Thank you. Our next question is coming from the line of David Lipschitz, a private investor. Please go ahead with your question.

David Lipschitz - Merrill Lynch

Hello. I am still at Merrill, I think.

James Roberts

You surprised us there, David.

David Lipschitz - Merrill Lynch

Yeah. I thought so. In case somebody hasn't told me anything….

James Roberts

Have you opened your mail this morning?

David Lipschitz - Merrill Lynch

Exactly. A question on the PRB. You talked about how inventories are still too high. We hear from others about stuff moving further and further east. Has there been any talk, whether it's about cutting production because there's too much inventory or are the returns still just good enough where prices are right now to keep producing where we are producing?

James Roberts

Well, I can't speak for others. I think you have to look at the actions and words and make the comparison for yourself. Our action has been that we have 55 million tons of capacity and we're shipping roughly 51 million tons this year, and implied in that, is okay. There were some weather incidents earlier in the year, but there is also a conscious decision on our part not to sell coal at a return that we don't believe is justifiable.

When we look into 2009, our production is going up because we believe we've sold coal with increased margins, and also at returns that justify that production. So, it's an individual company decision. We look at it from a margin basis and a return basis, and we, in fact, implemented our decision not to produce as much coal as our capacity in 2008.

David Lipschitz - Merrill Lynch

This is a follow-up, but you talked about you have the potential to bring on another 10 million tons. Would you want a certain percentage that sold before you say, okay, we're going to bring that on, or would it be just like, 'Oh, the market looks like it's turning around. We're going to start to bring that on'

James Roberts

When we brought on the last Phase I and II, we brought Phase I on only after we had a fair amount of the coal sold. When we brought on Phase I, it also gave us a little bit of Phase II production. So we benefited by bringing the equipment on. We got a little bit more than the capacity we needed in Phase I.

I would say we will not bring on another 10 million tons unless we had a very, very clear picture of the pricing and our ability to sell the coal before we would spend that money. And that also goes for the case in the east on our Freeport operation. We're not going to build mines or invest in equipment and then hope that business shows up after we do it.

David Lipschitz - Merrill Lynch

Okay. Thanks.

Operator

Thank you. Our next question is coming from the line of Michael Goldenberg of Luminous Management. Please go ahead with your question, sir.