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CONSOL Energy Inc. (NYSE:CNX)

Q3 FY08 Earnings Call

October 23, 2008, 10:00 AM ET

Executives

Thomas F. Hoffman - Sr. VP-External Affairs

William J. Lyons - EVP and CFO

J. Brett Harvey - President and CEO

Analysts

James M. Rollyson - Raymond James

Michael Dudas - Jefferies & Co.

Shneur Gershuni - UBS

Brett Levy - Jefferies & Company

Luther Lu - FBR Capital Markets

John Bridges - JPMorgan

Brian Gamble - Simmons & Company

David Lipschitz - Merrill Lynch

Jeremy Sussman - Natixis Bleichroeder Inc.

Sunil Jagwani - Catapult

Paul Forward - Stifel, Nicolaus & Co.

David Gagliano - Credit Suisse

Mark Caruso - Millennium Partners

Operator

Ladies and gentlemen thank you for standing by and welcome to CONSOL Energy's Third Quarter Earnings Conference Call As a reminder today's call is being recorded. I would now like to turn the conference call over to the Senior Vice President of External Affairs Mr. Tom Hoffman. Please go ahead.

Thomas F. Hoffman - Senior Vice President-External Affairs

Thank you, operator. Good morning everyone. Welcome to our third quarter earnings call. With me today are our Executive Vice President and Chief Financial Officer Bill Lyons and President and Chief Executive Officer Brett Harvey Brett Harvey. We will be talking about results for the quarter just ended as well as our outlook for the remainder of the year and for 2009.

Some of our discussions will be forward-looking in nature. Forward-looking statements are subject to business risks. We have enumerated those both in the earnings release that we distributed at 7:00 this morning as well as in our most recent 10-K and 10-Q and we would ask you to take a look at those at your convenience.

With that, we will begin this morning with Bill Lyons, Bill?

William J. Lyons - Executive Vice President and Chief Financial Officer

Thank you, Tom and thank you to everyone for joining us this morning. CONSOL Energy reported earnings of $90 million or $0.49 per diluted share compared with the net loss of $5 million or a negative $0.03 per diluted share in the third quarter of 2007. From an earnings standpoint, this is the best third quarter, we have had in 15 years.

CONSOL is financially strong and we believe that energy fundamentals will prove to be surprisingly resilient over the next several years. This view is further validated by the upgrade in our credit rating that we received on September 15th from Standard & Poor's. Our corporate credit rating was raised to 'BB+'.

Net cash from operating activities was $213 million compared with $142 million in the third quarter of last year. This improvement primarily reflects higher net income that is attributable to higher average realized pricing for coal and gas and higher gas sales volumes partially offset by $104 million decrease in the period-to-period comparison for the proceeds from our accounts receivable securitization facility.

For our Coal segment, total sales for produced coal were $751 million versus $615 million for the third quarter of last year. This represents an increase of approximately 22% and was driven by increased prices. Average prices were $51.07 per ton for the third quarter up $10.79 per ton or 27% quarter-to-quarter.

Average pricing piercing the $50 per ton level marks the beginning of a price mix momentum that Brett spoke about in the earnings release What we mean by this is that we will see average realized prices continue to rise as older contracts in the mix are replaced with new higher priced ones that were negotiated during this years significant run up in prices.

On the cost side of the ledger, operating costs for company-produced coal in the period-to-period comparison increased $7.42 per ton. Now there were a number of drivers impacting costs including production shortfalls that in the short run increased unit costs because a high percentage of our costs are fixed. The excess escalation of costs of labor and materials.

There are increased costs related to the execution of plans to address longwall development shortfalls and there was lower productivity and the need for greater use of materials such as roof control supplies to meet new safety regulations We will have a thorough discussion of these issues in our 10-Q.

So let me focus this morning specifically on supply and maintenance costs and labor since they represent about three-fifths of the increase. Supply and maintenance costs have increased about 40%. The increase in supply and maintenance costs is attributable to a number of items including the higher costs of items used in the mining process, higher gas well plugging costs, increased roof control costs, higher explosives and fuel costs and higher equipment maintenance costs.

For example, we are installing higher strength seals and a greater number of seals to isolate mined-out areas of our mines from the active areas thus adding to costs. This is basically a new federal requirement. The new seal requirements will result in the elimination of problems such as those we experienced at Buchanan last year but it will take time and resources to fully implement this procedure throughout our underground mines.

We are doing more development so that the longwalls will not be idled following the move. What that means more labor and more supplies just as roof falls, which add to the costs. We are eliminating the use of combustible cribbing in mines such as Buchanan but that means using more expensive non-combustible, temporary roof support. These supports can be installed quickly, but they add to costs.

We have grown the business through the acquisition of AMVEST, but that means high fuel and explosive costs because AMVEST does a significant amount of surface mining, which uses more of those materials than our underground mines. Our labor and related costs have increased approximately 20%. The labor issue is straightforward. We have hired more people to address the development issue and wages and benefits for existing employees have gone up.

Overtime a number of these costs should decline to what I call a steady state level as we complete some of the catch-up work in things like development and sealing and we have become more efficient in integrating the new safety protocols into our planning and mining process.

As we have noted several weeks ago production for the quarter just ended was lower than expected due to a number of situations and these included the roof falls along several main line belts. The delays in longwall production following equipment moves at several mines because preparation of the new areas to be mined were not complete and delays due to increased government safety inspections.

We continue to address the development issues and are made a number of important changes that should positively impact productivity, enhance production over the next six months. Thus far we have added crews and changed work schedules to increase longwall panel development, which we anticipate will yield benefits quickly.

We have also worked with the equipment manufacturers to development better haulage systems for continuous mining machines, the increased rates of advance in development sections of the mine. While we haven't yet found any game changing technology, we intend to continue to explore technological advances with our equipment manufacturing partners.

In addition we have modified mine plans at several of our longwall equipped mines to increase the ratio of coal produced by longwall equipment compared to that produced by continuous miners. Now despite the challenges in production and costs, operating margins were up $3.37 per ton or 28% quarter-to-quarter due to higher realized pricing per ton in the quarter just ended as well as some lost sales of high value metallurgical grade coal in last year's third quarter due to the Buchanan outage.

Let me turn now to the Gas segment, where we reported record results. Yesterday CNX Gas in which CONSOL has an 81.7% ownership position reported third quarter net income of $67.4 million or $0.45 per diluted share more than double the net income from last years third quarter This is the highest quarterly net income in the gas company's history This was driven primarily by a 38% increase in sales volumes and a 42% increase in average sales price period-to-period.

The gas company also reported record production of $19.7 billion cubic feet which is I said was at 38% higher than last years third quarter and 5% higher than the second quarter of this year. Average operating margins at CNX Gas were $5.89 per Mcf an increase of 58% versus last years third quarter.

We cannot be more pleased with our investment in CNX Gas. They have provided steady growth in production and profit margins, while prudently but successfully expanding their footprint beyond Southwest Virginia which I will talk about in a moment. Looking now at the business we concluded during the last three months the company scheduled an additional 3.1 million tons of coal for 2009 delivery including approximately 1.8 million tons of new sales at an average price of $116 per ton bringing the total tons committed in price to $58 million tons at an average price of $57.63.

In addition, there are $2.5 million tons capped at a maximum average price of $43.66. At quarter-end CONSOL had between 9.5 million and 13.5 million tons of anticipated coal production unpriced for 2009 of which approximately 4.3 million tons is metallurgical grade coal. This is based on our production guidance range of 68 million to 72 million tons next year. For 2010, the coal business has 29.2 million tons committed and priced at an average price of $48.27.

Now let's take a look at the gas company's position for 2009. Yesterday CNX Gas increased their production guidance for 2009 to $85 billion cubic feet. Approximately 42 billion cubic feet of next years expected production is hedged at an average price of $9.74. And for 2010, CNX Gas has reiterated their production goal of 100 billion cubic feet.

Now let me give you a quick overview of our coal and gas capital projects. To alleviate the development issues that we encountered this year we have plans for seven longwall face extensions that are scheduled to be completed between 2009 and January of 2011 During 2009, we expect to complete longwall face extensions at Bailey, Loveridge and Robinson Run and other three longwall face extensions will be completed throughout 2010 with the seventh expected to be completed in January of 2011.

Our upgrade of the underground haulage system at Shoemaker is on schedule and is expected to be completed during the first quarter of 2010 with an annual anticipated production of $6 million tons. And finally for coal, the new slope and overland belt at the Bailey Mine is expected to be completed in the fourth quarter of 2009. This will reduce the time and distance coal is transported underground thereby lessening mining delay and increasing productivity.

Now during the quarter CNX Gas added to its acreage position. Currently the gas company controls 3.6 million net acres. The bulk of these acres acquired were coalbed methane acres in Northern and Central Appalachia. CNX Gas continued to execute their drilling program, which resulted in Virginia, Mountaineer and Nittany coalbed methane operations achieving their record productions in the quarter.

Now during the quarter CONSOL Energy's Board of Directors authorized a share repurchase program of up to $500 million of the company's common stock over the next two years The share repurchase plan will be used from time to time depending on a number of factors including current market conditions, the company's financial outlook, business conditions including cash flows and internal capital requirements as well as alternative investment options.

Now during the quarter just ended the company repurchased approximately 1.2 million shares at an average price of $39.05 And also during the first three days of the fourth quarter we have purchased an additional 900,000 shares at an average price of $38.35 for a total of 2.1 million shares repurchased since we received the authorization. The share repurchase program maybe used periodically as the company monitor's general conditions in the equity and debt markets.

In addition CONSOL Energy's Board of Directors recently authorized a purchase of additional shares at CNX Gas Corporation up to an aggregate amount of $150 million. As everyone knows CONSOL Energy currently owns 81.7% of CNX Gas. As we said in the news release in March of this year and as we have mentioned many times on this call, we do not intend to sell or otherwise divest ourselves of our shares of CNX Gas that we currently own. We intend to continue buying shares of CNX Gas common stock from time to time in open markets based on a number of considerations including price.

From a financial management perspective, I believe that both share purchase program provide additional avenues for us to return value to our shareholders and should serve as a barometer of our confidence in our future business prospects. In summary, this was the good quarter. The best third quarter as I said in 15 years. Coal and gas prices were high and our Gas segment produced record volumes led to record earnings for them.

Although it was a challenging quarter production wise for our Coal segment, we believe that we are addressing these issues with near-term and long-term solutions. We believe that we are going to benefit from the long-term demand for energy and as lower priced legacy coal contracts open up to reflect that long-term global demand.

And with that, let me turn it over to you Brett for your remarks about our strategic direction and the state of energy markets today.

J. Brett Harvey - President and Chief Executive Officer

Thank you, Bill and I appreciate the detail that you have given here. It's good to be with all of you again. And today's financial markets, I feel like it's time for us to step back and take a deep breath about where we stand versus other companies and our ability to earn cash as well as earning for our shareholders and create value like we have with our strategy over the last five to six years. 2009 is solid. 2010 looks good to us but the outlook is less clear because of global issues, we will talk about those in a minute.

CONSOL will be strong through 2009 because we have a very strong hedge position in coal and gas is in a good position as well. Low-vol met coal and high Btu steam coal will command the premium prices in this energy market, whether it's a demand energy market or slower economy, these two are base valuable commodities.

Cash and liquidity allows us to be disciplined in both sales and production puts us in a great position for 2009. We will have the flexibility to defer our slow CapEx without undercutting fundamental growth strategies that we have in our strategic plan. Global supply constraint is likely to offset any softening in demand resulting from a slow economy. Those with cash and strong balance sheets will have the flexibility to manage in any environment and that is CONSOL.

We expect in the fourth quarter to expand our margins in coal based on price and return to productivity based on longwall development ratio between longwall coal and development. Having said that I think we are in a position right now to open this up for questions and I will be glad to take those right now

Thomas F. Hoffman - Senior Vice President-External Affairs

Operator, if you would instruct our listeners on the queuing process.

Question and Answer

Operator

[Operator Instructions] And our first question comes from the line of Jim. Rollyson of Raymond James. Please go ahead.

James M. Rollyson - Raymond James

Good morning gentlemen.

J. Brett Harvey - President and Chief Executive Officer

Hi, Jim.

James M. Rollyson - Raymond James

Brett could you maybe spend a minute just talking obviously there has been a lot of different numbers but as it relates to pricing and what you're seeing maybe spend a minute on what you're seeing in terms of Eastern steam coal prices and how recently you may have booked some coal just to kind of give us a sense for where the real market is right now?

J. Brett Harvey - President and Chief Executive Officer

Sure. I'll be glad to do that. In the last three weeks we've done deals on Eastern steam coal at everything plus $110 per ton. On the low-vol met side we've done deals at 1.2 million tons for 2009 between $285 and $310 a ton. On the Eastern steam side I might want to reiterate we've signed up almost 3 million tons of Eastern steam coal plus the 110.

So, we see the market stable and strong and '09 looks very good for pricing. We still see in any economy the base energy demand of which our coals are related to in steel as well as steam coal is in demand and very strong… very strong pricing.

James M. Rollyson - Raymond James

And on the met side presumably that's with domestic US steel makers?

J. Brett Harvey - President and Chief Executive Officer

Yes it is.

James M. Rollyson - Raymond James

Any thoughts as to how that pricing might holdup as you go further in time to the international negotiations? Do you expect that to generally holdup when you get to the international settlements?

J. Brett Harvey - President and Chief Executive Officer

Well we expect met pricing to roll into the international environment because we believe they're linked. The other piece that we really believe and I'm really satisfied with is that our high premium low-vol coal is going to demand higher prices and will move into that market as well just like it did here in the Eastern United States. What we're seeing is this premium high low-vol pricing creates value for the steel guys as their coke plants become more efficient in a different marketplace for themselves.

James M. Rollyson - Raymond James

Understood. And last question may be for Bill you spent some time talking about the different things you're doing to try and alleviate maybe some of the issues that cropped up this quarter trying to help offset some of the rising cost situations. Can you give us a sense as you get into these longwall face extensions and some of the other projects you're doing the magnitude of which you're hoping unit costs will kind of come back down?

William J. Lyons - Executive Vice President and Chief Financial Officer

Jim that is an excellent question. Our average costs are somewhere around $41. I think $41.64 for nine months. I would hope that it would stabilize there maybe even a little bit lower based on production increases in the fourth quarter. And then I think that would be a good base number and from there I would hope that it would only be inflation that would cause the cost increases for 2009

James M. Rollyson - Raymond James

Very good. Thanks guys

J. Brett Harvey - President and Chief Executive Officer

Thank you.

Operator

Okay. Thank you. And the next question comes from the line of Michael Dudas of Jefferies. Please go ahead

J. Brett Harvey - President and Chief Executive Officer

Hi Mike.

Michael Dudas - Jefferies & Co.

Good morning gentlemen

J. Brett Harvey - President and Chief Executive Officer

Hi, Michael.

Michael Dudas - Jefferies & Co.

I have two questions first Brett could you maybe share your views on how sustainable the tightness in the Atlantic basin may be for high quality high-Btu thermal coals and what you're seeing and what you've contracted over the past nine months and what you anticipate? Is the term business still being looked upon there and is that a sustainable type level especially given maybe the change that we've seen in the dollar and freight rates over the past two, three months?

J. Brett Harvey - President and Chief Executive Officer

Okay that's a good question. It's broad but we'll get right to the point. The term [ph] business that we're seeing right now we're negotiating is anywhere from one to seven years, we're negotiating right now. So we still see term deals in the Atlantic market is very strong and most of that domestic right now and a little bit of softness on the European side. The domestic is solid and is steady right now.

I think there is some real issues that is pushing the Atlantic market and I think shortage of labor especially in Central App geology issues probably across the board everybody is hitting tougher geology. The old saying about every generation gets the best of what's left; the mining business is really true.

And then we've got these new safety rules that are putting pressure on productivity and on top of that we've Fola Coal and surface mining in West Virginia that even in a declining heavy demand for energy based on the economy this is such a strong base commodity even in a declining situation. These things are probably going to decline supply faster than demand for energy. So we see some real strength there.

Michael Dudas - Jefferies & Co.

Which kind of leads to the second question, and it's along these lines Brett. Would you anticipate that even if demand were not to falloff or the market was continued to be quite strong, do you think over the last six months given what you've experienced at your company and what you're seeing with your competitors that growth in Appalachian Northern and Central Appalachian production into 2009 and possibly 2010 may not occur even at much higher coal prices than we are? And if coal prices were for some reason to fall dramatically would you see discretionary impact to mines coming off stream especially in Central Appalachian?

J. Brett Harvey - President and Chief Executive Officer

Well I don't think as we've seen in the past year, we've seen rapidly rising coal prices again flat to declining demand especially in Central App. And Northern App is more of a function of when we want to bring it on and when we want to bring the capital into the business. Clearly, we'll bring Shoemaker back at the right time to match our contracts.

But ironically the supply constraints in the US and other parts of the world may prove to keep supply and demand in balance at a time and a slowdown of global economic growth would suggest a decline in energy demand. So, I really think that even if we were to take mine 84 out overtime and bringing it just to a met product. So I don't see prices as demanding this. I think it's a function of bringing them on against the constraints, we see with labor issues, productivity issues and the things that are and 404 permitting in West Virginia that's what holding us back.

Michael Dudas - Jefferies & Co.

Thank you, Brett.

Operator

Okay. Thank you. And the next question comes from the line of Shneur Gershuni of UBS. Please go ahead

Shneur Gershuni - UBS

Good morning guys.

J. Brett Harvey - President and Chief Executive Officer

Hi, good morning.

Shneur Gershuni - UBS

Just a couple of questions. One is actually just a follow-up to the last question or line of questioning was, can you remind us how much you've actually committed to ship into the European markets for 2009 and for 2010 or sort of I guess, give us an idea of tons that will still be leaving the continent at the end of the day?

J. Brett Harvey - President and Chief Executive Officer

Okay. From CONSOL directly we plan to ship 2.7 million tons in '09 into those markets on the steam side. And for '010 it's probably about 1.5 million that's where we are today. Now that could go up depending on pricing, if we see rapidly rising prices in Europe again we'll probably increase that. But right now that's what we see for '09 and '010.

Shneur Gershuni - UBS

And two other questions. I guess, one relates to your share repurchase program. Can we assume that you may slowdown some of the longwall moves or some of the CapEx that you intend to do over the next year or so to execute on the share buy-back program? Obviously the prices in CNX right now is lot below where you were purchasing earlier and obviously would prove to be I guess, more favorable to where you were purchasing historically? Would you consider actually slowing down the capital projects to actually purchase more shares and so forth?

J. Brett Harvey - President and Chief Executive Officer

Bill.

William J. Lyons - Executive Vice President and Chief Financial Officer

Okay. We're not going to change longwall moves or anything like that. But in terms of slowing down capital it could very well be. I mean it's certainly a fluid, we'll say situation out there and CONSOL Energy we're very fortunate is that we've many opportunities and that includes internal investment. We payout very good dividend and we intend to be a leader in dividend. We can do acquisitions because of our financial situation and as well as share buybacks and that could be either in CONSOL Energy or CNX Gas.

Being in a fluid situation we're going to have to… we're going to judge this at any given time one opportunity maybe to look better than the other. But again the big thing for CONSOL Energy is our strong, strong financial position and it allows us to take advantage of different opportunities

Shneur Gershuni - UBS

Okay. And one last final question. Just with respect to the MHSA situation and so forth. I mean, we've kind of been hearing about MHSA ramping up for probably the last three quarters or so fines are definitely up and they're just writing everything up under the sun at this point. Where you do you get the sense it will peak. I mean, at some point they are going to run out of things to write up all the mines and I'm not just talking about CONSOL I'm talking about all of the underground miners in the East? There has to be a point where they basically run out of things that they can write up and you hit this peak and the negative hit on the productivity side or do you think that it's not going to get any better but it is not going to get any worse?

William J. Lyons - Executive Vice President and Chief Financial Officer

Well, what we see when we see changes in MHSA like this like we saw with the law originally. When you see a change in the way they do business we have to adjust to it and we have to adjust the way we do business. We think that it will level off at some point as we adjust and create a response to that environment. We'll do it with two things. We'll do it with technology and we'll also do it with trained manpower to adapt to what they're doing

Now when we'll level off I think we're probably moving into that mode right now. But it's not clear as they continue to change; we'll continue to change with them. But your reaction time at least for us tends to be 6 to 12 months from a real change in the way MHSA approaches a problem.

Shneur Gershuni - UBS

Okay. Well then I guess just as a follow-up to that you modestly took down your production guidance for the fourth quarter is that because you kind of expect the MHSA issue to sort of play through into the fourth quarter or?

J. Brett Harvey - President and Chief Executive Officer

I think we're getting a better handle on what it's costing us to do this in the short term as we adjust for change in technology in the long term. So if you go back to what I said last quarter as optimistic as I am I thought we would have this all solved in the third quarter.

We've adjusted the fourth quarter just a little bit because we see a jump in productivity but maybe not as high as I would expect it. So and we're looking at what they expect as well. I think, we're seeing a changed environment at the MHSA level as well. So it's hard to give you a clear answer other than we're getting our hands around it and we'll address it for the value of our shareholders.

Shneur Gershuni - UBS

That's great. Thank you very much.

Operator

Okay. Thank you. The next question comes from the line of Brett Levy of Jefferies & Company. Please go ahead.

Brett Levy - Jefferies & Company

Hey guys. Big Sandy Barge has got a seven handle on it I wanted to get a sense from you obviously that kind of flies in the face of everything we're kind of seeing out there. What kind of volume is moving there is that just tiny, tiny amounts? And if you had to cut a contract today could you cut it with a seven handle or would it be above 100 again?

J. Brett Harvey - President and Chief Executive Officer

Talking about the Big Sandy movement right?

Brett Levy - Jefferies & Company

Yes.

J. Brett Harvey - President and Chief Executive Officer

Not the Big Sandy River.

Brett Levy - Jefferies & Company

Yes.

J. Brett Harvey - President and Chief Executive Officer

I think you tend to see lower quality low volumes moving onto Big Sandy. Let me reiterate what we've done in terms of bigger volumes 2.9 million tons in the last three weeks at over $110 a ton and that kind of covers mostly Northern App stuff and very little Central App stuff that would be competitive with the Big Sandy. But Big Sandy those are very low volumes and I think it's plus… I believe its plus $100 from the mines that we would ship out of that area.

Brett Levy - Jefferies & Company

So, if you had to cut a contract today it would still be above $100 in your view?

J. Brett Harvey - President and Chief Executive Officer

Yes.

Brett Levy - Jefferies & Company

Okay. And then as some of the weakness kind of roll through is there a particular geography where you guys would be targeting to be opportunistic on the acquisition front?

J. Brett Harvey - President and Chief Executive Officer

Well there are assets that we would like to have all around the country. These are key low cost assets that match our low cost structure. There are pieces in the West and there are pieces some in the Northern App and Central App that we would like to see. But specifically I think it's more based on price and opportunity, and where we see strong synergies that's, where we'll move, where we can take our low cost techniques into the marketplace.

Brett Levy - Jefferies & Company

So, the stuff that's adjacent to you might be attractive as well?

J. Brett Harvey - President and Chief Executive Officer

Sure, certainly.

Brett Levy - Jefferies & Company

Thanks very much guys.

J. Brett Harvey - President and Chief Executive Officer

That's always attractive.

Operator

Okay. Thank you. The next question comes from the line of Luther Lu FBR Capital Markets. Please go ahead.

Luther Lu - FBR Capital Markets

Good morning guys.

J. Brett Harvey - President and Chief Executive Officer

Hi, Luther.

Luther Lu - FBR Capital Markets

Just a couple of things first, I noticed that in the press release you mentioned 550,000 tons of crossover tons will be switched back to the Northern App steam market? I was wondering if you can give me your best assessment of how much of this crossover ton was in place into the met market for the US overall this year.

J. Brett Harvey - President and Chief Executive Officer

I think it was about 25 million tons.

Luther Lu - FBR Capital Markets

25 million tons of crossover tons.

William J. Lyons - Executive Vice President and Chief Financial Officer

That's crossover tons in total in the east that we would see that has potential to crossover between met and steam.

Luther Lu - FBR Capital Markets

Okay. Great.

J. Brett Harvey - President and Chief Executive Officer

Does that answer your question?

Luther Lu - FBR Capital Markets

Yes. And then I also noticed that third quarter '08 and third quarter '07 had similar shipping volumes but the freight expense I know is a pass-through expense but still freight expense jumped 35%. So could you give us a little bit of sense of what is the shipment rate from mines to ports in Northern App and the Central App?

J. Brett Harvey - President and Chief Executive Officer

Well Luther in terms of that you're right that's a total pass-through to us and shipping rates are up and lot of that is based on the value of the coal. So again we don't look at that as to be a major issue for us. And for the most part as I said these, we sell our coal FOB mine and this is really an issue that customers have with the railroad or whoever is doing the shipping for them. But if you want to ask offline with Tom Hoffman or somebody they could probably give you more specifics.

Luther Lu - FBR Capital Markets

Okay.

J. Brett Harvey - President and Chief Executive Officer

After the call.

Luther Lu - FBR Capital Markets

Okay. Great. And can you give us a sense of this international met coal negotiation. When do you expect the settlement with the Europeans to take place?

William J. Lyons - Executive Vice President and Chief Financial Officer

We expect that it will happen in the first quarter for delivery in April probably around February.

Luther Lu - FBR Capital Markets

Okay. On the steam coal contracts that you mentioned that you signed with the European customers the 2.7 million tons when were those contracts signed?

J. Brett Harvey - President and Chief Executive Officer

Those contracts the 2.9 million tons were for Eastern steam coal and they were with domestic utilities that the 2.7 million tons for '09 those were signed probably six months ago.

Luther Lu - FBR Capital Markets

Okay, six months ago.

J. Brett Harvey - President and Chief Executive Officer

Yes.

Luther Lu - FBR Capital Markets

Okay that's all my questions. Thank you.

J. Brett Harvey - President and Chief Executive Officer

Thank you

Operator

Okay. Thank you. The next question comes from the line of John Bridges, JPMorgan. Please go ahead.

J. Brett Harvey - President and Chief Executive Officer

Hi, John.

William J. Lyons - Executive Vice President and Chief Financial Officer

HI, John.

John Bridges - JPMorgan

Hi Brett, Bill and everybody. Yeah, I was just wondering there is some commentary about layoffs at mine 84. I just went into sort of trajectory of the transition there to this better quality material?

J. Brett Harvey - President and Chief Executive Officer

That's the natural progression of from moving from a steam coal mine to a met coal mine. We'll go into this with continuous mining methods for the met coal. We're pulling away from longwall production so your development cycle changes and you're losing less people. The nice part about that is we're taking those people and repositioning all of the supervisors and anybody that wants a job into our other mines that are expanding. So we're taking advantage of that labor pool. But you have to announce it if you ship won't mind… definitely won't mind out. So that will happen in the fourth quarter.

Thomas F. Hoffman - Senior Vice President-External Affairs

John, this is Tom. It's only 40 to 50 people who are affected and those layoffs were they to occur will occur in the last couple of weeks of December

John Bridges - JPMorgan

Okay. Great. And then I wonder if you can give us a bit more guidance I know there has been questions already on what sort of cost escalation we should put in going forward. I know the current situation with the changes is not a great guide to the future. But what sort of cost escalation should we put in for say next year?

William J. Lyons - Executive Vice President and Chief Financial Officer

John that is an excellent question. Quite frankly it's a question we usually ask you. So I don't know I mean, when you take a look at all of the dynamics that are going on right now and the drastic drop in commodity prices we naturally expect that we won't see double-digit increases in commodity prices like we saw probably in the last 12 to 15 months.

But the fact we saw copper at an all time low and we had issues of copper. In fact that was the major problem we had people were stealing copper everywhere because it was worth so much. I don't know I would think that maybe 2, 3% might be a number to use. But again with the economy being in such shape and until we get some more clarity I don't know if I would answered [ph] or guess.

J. Brett Harvey - President and Chief Executive Officer

There is two components there one is the commodities themselves and I think Bill addressed that pretty well. The other one is we're going to see as the productivity rises on our ratio between longwall tons and development tons you are going to see the costs naturally go based on productivity to the favor of the cost structure

And I mentioned that earlier because I really see the fourth quarter we'll have expanding margins on every ton, which will give a good preview for next year on price as well as productivity and that's the good way to see it because in second and third quarter we really lost some productivity issues expanding margins based on the productivity problems we had with longwall development. So we're going to see that reimbursed along with commodities. So I don't see as much pressure in '09 and we'll give you those details when we come out in January.

John Bridges - JPMorgan

Okay. And then a follow-on some of these issues seem to have come from catch-up capital the slope Bailey and so on. What's a good ongoing capital number we should use going forward because it sounds as if the cost of seals, the cost of extending longwalls and the softening is going to raise the capital number we should be using just for maintain capital going forward

J. Brett Harvey - President and Chief Executive Officer

John, I would say the extension of the longwalls give us a productivity bump, which helps our cost structure and so that capital returns very quickly. I would say marked capital you could figure on an ongoing basis 3.25 to 3.50 a ton.

William J. Lyons - Executive Vice President and Chief Financial Officer

John we'll give you further clarity on our capital expenditures in January.

John Bridges - JPMorgan

Thanks a lot, Bill. Thanks, guys. Good luck

Operator

Our next question will come from the line of Brian Gamble with Simmons & Company. Please go ahead.

Brian Gamble - Simmons & Company

Yes. Good morning guys. Bill just wanted to touch real quickly on a follow-up. I understand '09 is tough to gauge to you guys what the costs are going to be. You did mention in your opening comments that you might be able to come in a little bit below the nine month average in 4Q?

William J. Lyons - Executive Vice President and Chief Financial Officer

Yeah that's correct.

Brian Gamble - Simmons & Company

What assumptions are you baking into that? Are you baking in increased productivity?

William J. Lyons - Executive Vice President and Chief Financial Officer

Yeah, that's right. Its increased tonnage.

Brian Gamble - Simmons & Company

An increased tonnage as well, okay. How much lower could those numbers possibly be? I mean, we are talking just modestly or we talking a decent chunk?

William J. Lyons - Executive Vice President and Chief Financial Officer

Well I don't know what a decent chunk is okay? I would expect it to be under $41.64.

Brian Gamble - Simmons & Company

Okay, that's fair enough. And then when Brett when you talk about the 25 million met tons that were crossed over this year obviously you guys had the minor position that's rolling back into the steam market.

Would you expect if we did continue to see weakness on the met side for all of those tons to potentially rollback? Are there certain metrics that you look at and say oh, well maybe half of them go back next year? What's kind of the feeling on that?

J. Brett Harvey - President and Chief Executive Officer

John, I wouldn't… if you look at the met business worldwide the 25 million tons is a response I think to a strong met market. I would say half of those tons are in a structure that could never come back to the steam market just based on cost to operate. But if you look at the costs of new coal covenants worldwide or the build-out of those we think it's going to be pretty strong all the way through so that coal that has good met characteristics is probably going to stay there.

I would be surprised if out of the 25 million 10 million would come back and out of that 10 million that would come back I would say half of that would just go out of business because it can't compete with the steam market.

Brian Gamble - Simmons & Company

Great. And then just wanted to follow-up on a previous question on M&A. Obviously you guys are looking for the best uses of your capital going forward. But specifically on the M&A side what kind of attitudes have you seen recently with the pullback and all the multiples, I mean, are people saying hey these things are too cheap?

I don't want to sell down here or they of the opinion hey the run up might have been too far but there are opportunities out there for buyers to come in and maybe we can get a deal done sooner rather than later, kind of walk us through peoples thought process and how that market is in today's environment?

William J. Lyons - Executive Vice President and Chief Financial Officer

I think a lot of this reflects the current credit situation. There is no doubt that credit is tighter and quite frankly it's just too early to tell the full impact of what all this might be. Obviously we're seeing some slowdown in global economic growth. When you start taking a look at that there is no doubt that smaller producers and those with substantial debt will be the most affected and they're going to have trouble coming up with the money for equipment purchases or new capital capacity additions.

I think tight credit will be a major impact on acquisition opportunities. Larger deals that were financed with debt will be very, very difficult to do, but smaller acquisition of assets that we can see I think are very doable. And I think this may the emphasis may shift from acquisition to merger in some cases.

So again when we look at it I think that it is going to be hard to do acquisitions based on the credit the smaller acquisitions I think can be done in companies like CONSOL that have liquidity and we are going to generate, what we feel a very robust cash flows. In the next quarters, we are going to be in excellent position to be able to take advantage of some great opportunities out there.

J. Brett Harvey - President and Chief Executive Officer

And you need to keep in mind that we're looking at coal and gas because we see opportunities on both sides of the fence Okay?

Brian Gamble - Simmons & Company

Thank you very much.

J. Brett Harvey - President and Chief Executive Officer

Yes.

Operator

Okay. Thank you. And the next question comes from the line of David Lipschitz of Merrill Lynch. Please go ahead.

David Lipschitz - Merrill Lynch

Thank you. Hi everybody. I just have sort of a quick question. Bill in your remarks you said something about 68 to 72 for 2009 estimates? But in the press release it says 70 to 74, I just wanted to confirm, which what…

William J. Lyons - Executive Vice President and Chief Financial Officer

Well 70 to 74 is the right number.

David Lipschitz - Merrill Lynch

So that is the right number, okay

Thomas F. Hoffman - Senior Vice President-External Affairs

Dave this is Tom. Let me remind everyone listening though that with regard to the out year production guidance that we only update that once. We update that in January. So while I'm not intending here to suggest that it will change everybody should be aware that it is subject to change and that the final guidance for '09 won't be given until we announce earnings in January.

William J. Lyons - Executive Vice President and Chief Financial Officer

But that's the last one we put out.

David Lipschitz - Merrill Lynch

No because Bill said in his opening remarks that next year would be 68 to 72. So I was just wondering whether is that a new--?

William J. Lyons - Executive Vice President and Chief Financial Officer

No, no.

David Lipschitz - Merrill Lynch

Because based on production guidance of 68 to 72, I just want to make sure.

William J. Lyons - Executive Vice President and Chief Financial Officer

Of course, it sounds like. So, it's 70 to 74.

David Lipschitz - Merrill Lynch

Okay. Thank you. That's all.

Operator

All right. Thank you. The next question comes from the line of Jeremy Sussman of Natixis. Please go ahead.

Jeremy Sussman - Natixis Bleichroeder Inc.

Hi. Good morning.

J. Brett Harvey - President and Chief Executive Officer

Hi, Jeremy.

William J. Lyons - Executive Vice President and Chief Financial Officer

Hi, Jeremy.

Jeremy Sussman - Natixis Bleichroeder Inc.

Just to clarify you said you signed 1.2 million tons of met coal at those prices, was that correct?

J. Brett Harvey - President and Chief Executive Officer

Yes. We did 1.2 million tons of met domestically between $285 and $310 per ton.

Jeremy Sussman - Natixis Bleichroeder Inc.

Great. [inaudible]. And then you also mentioned potential you're negotiating anywhere from a one to seven year deal. Can you give us a sense of how a seven year deal would be structured to whether there would be price caps any backwardation or fuel escalation clauses and that?

J. Brett Harvey - President and Chief Executive Officer

Well in today's market we would probably stay away from price cap because the price cap basis that we did got us to these higher markets. I would say they would have some reopeners in it and there would be some indices between the reopeners that was addressed to costs.

But the real deal would be the utilities trying to tie up capitalized volume to assure themselves supply of coal and it would be I think on the side of the supplier how these things opened up and what price they were opened up at. So we feel pretty comfortable with those kinds of contracts going forward.

Jeremy Sussman - Natixis Bleichroeder Inc.

Great. And then I guess, just my last question. Can you take us through maybe a two or three maybe of some of the mines that have been running kind of below the run rate that you would like to see this year kind of talk about some of the problems that you've seen?

And basically how things have either improved or based on where they're running now or how you plan to kind of get things backup and running little bit more smoothly?

J. Brett Harvey - President and Chief Executive Officer

I think Loveridge is one of the mines we struggled with and we were adding McElroy [ph] is there, Robinson Run. We've added crews there to solve the problems. The McElroy mine with two longwalls running there we were behind on development. So those were the three main ones that we had for the year and we solved that with technology manpower and scheduling of people.

And there is a piece of it though but we're still addressing as it related to the safety issues and the drop in productivity based on the new safety laws that we've just about got that solved. But that's still something that we're working with. But those three mines, I would say are back on track and the development is where it should be.

Jeremy Sussman - Natixis Bleichroeder Inc.

Great. Thank you very much

Operator

Thank you. The next question comes from the line of Sunil Jagwani [ph] of Catapult. Please go ahead.

Sunil Jagwani - Catapult

Hi.

J. Brett Harvey - President and Chief Executive Officer

Hi.

Sunil Jagwani - Catapult

First a quick housekeeping question. The 1.2 million met tons is that included in the updated contract addition that you mentioned in the press release for 2009?

William J. Lyons - Executive Vice President and Chief Financial Officer

No it's not.

J. Brett Harvey - President and Chief Executive Officer

No it's not.

Sunil Jagwani - Catapult

Okay

William J. Lyons - Executive Vice President and Chief Financial Officer

Excuse me. Those numbers that we were talking about were deals that we've done essentially in October.

J. Brett Harvey - President and Chief Executive Officer

In the last three weeks.

William J. Lyons - Executive Vice President and Chief Financial Officer

So they are not included in the third quarter reports

Sunil Jagwani - Catapult

Okay.

William J. Lyons - Executive Vice President and Chief Financial Officer

But we wanted to give the updated numbers because of this turmoil in the market; we wanted to make sure everybody understood that it was still very strong.

Sunil Jagwani - Catapult

Got you. The math wasn't working that's why I wanted to check. The other question is a little bit more theoretical if you look at heat rates and gas prices today it would be… for utility given if they had the choice to justify purchasing Central App coal given the risk surrounding deliveries and I guess just basically price.

So how much of the continued strength in price would you attribute to I guess the lack of switchability in the short term. And I guess also the view that maybe the fall in gas prices is also short-term because just on an economic standpoint it's hard to see why the thermal coal prices in the East would sustain themselves above $90. It's good that they are. But I'm just wondering why and how that makes sense, I guess, from just an economic calculation stand point?

J. Brett Harvey - President and Chief Executive Officer

Well if you look at the total load of energy between coal and natural gas especially on electricity the margin between the two isn't a big margin. So gas could never replace coal. So if you look at the BTU equation that's one thing.

And then when you look at the margin between the two you have to look at it region by region and some places can switch more and some can't. But we see it as about a 3% switch between the two in total and then you would have to figure out utility-by-utility.

What we're seeing though is $100 coal of our quality runs up against $7 gas on a regular basis and they'll switch where they can. What we like about that is when they start switching to gas it creates huge demand on the gas supply of the country because we're using electricity for gas and that busts the bubble within six months and then we see rising gas prices.

We've seen this cycle about four times since 2001. I think we're going to see it again. So I hope I answered your question. But what we're showing is that CNX Gas benefits from we win both ways it can solve with coal and gas depending on what the utilities are choosing.

Sunil Jagwani - Catapult

Sure. I understand. Okay. Thank you.

Operator

Okay. Thank you. The next question comes from the line of Paul Forward of Stifel Nicolaus. Please go ahead.

J. Brett Harvey - President and Chief Executive Officer

Hi, Paul.

William J. Lyons - Executive Vice President and Chief Financial Officer

Good morning Paul.

Paul Forward - Stifel, Nicolaus & Co.

Hello. Couple of questions here. One is you have got just looking at your production guidance you have got somewhere close to 4 million tons of coal that you'll be producing this quarter that you weren't producing in the third quarter thankfully with the effect of the better productivity and all the investments you've made.

But if you put this new production into the market this quarter recession with stronger dollar limiting export growth won't this undercut the kind of pricing that your utility customers will be expecting for '09 as their inventories… they are able to build inventories and particularly when you have got a lot of volumes on price for 2010?

William J. Lyons - Executive Vice President and Chief Financial Officer

Okay, that's a good question. All of this is already sold was baked into the equation. The prices are on it and it was already expected all year long. So if you look at the inventory level of these customers they need that coal to get through the winter. And if you look at our own inventory levels we're at an all-time low. So, it's already sold and it's not new coal into the marketplace, it is coal that they're expecting.

Paul Forward - Stifel, Nicolaus & Co.

And can you give us any sense of the breakdown right now if you're signing new deals? I know you talked about deals signed two and three weeks ago that seems like an eternity. But the difference between within North Appalachia your high sulfur versus lower sulfur-types of coal today?

J. Brett Harvey - President and Chief Executive Officer

Yes. I can give you that. The lower sulfur coal is going to get a better price especially if it's around 13,000 BTUs. So what you have to look at is sulfur and BTUs. The higher sulfur coal with lower BTU that we tend to see in Moundsville on the river it will probably have a $15 hook on it on a negative way just based on lower BTU and higher sulfur.

So the spread is going to be about $15 depending on those two issues. And the mix changes because the mines come in and out of sulfur and come in BTUs stays pretty constant mine-by-mine. But the Moundsville coal will drag probably about $10 to $15 off their price. But Moundsville coal is sold out for all of next year at very good prices.

Paul Forward - Stifel, Nicolaus & Co.

All right. And maybe lastly, I mean I know you can't turn on a dime here with new projects but your shares are down 75% from the top back a few months ago. The market is clearly fearful that in a recession we'll have excess coal production relative to demand maybe for a year maybe a couple of years. Why not reconsider some of the investment in extension projects that you had announced at a stronger coal price environment?

J. Brett Harvey - President and Chief Executive Officer

Well here is what we do and as we start to see that volume doesn't sustain the returns that we want to have. We'll actually start shutting the mines down or pulling projects back. What we'll do is pullback on the highest cost mines and we'll spend the capital where we get the highest rate of return. Some of these longwall extensions give us a very high rate of return. So we would probably finish those and shut down the mine to respond to that kind of the marketplace.

Paul Forward - Stifel, Nicolaus & Co.

Are these returns better than say buying back your own shares at $0.28?

J. Brett Harvey - President and Chief Executive Officer

I think we have the ability to do both.

Paul Forward - Stifel, Nicolaus & Co.

Okay. Thanks.

J. Brett Harvey - President and Chief Executive Officer

But what I've told management that we'll stay within our budget and the projects that we've got online; we're not going to be inefficient with those projects. We'll finish them.

Paul Forward - Stifel, Nicolaus & Co.

Thanks.

Operator

Okay. Thank you. The next question comes from the line of David Gagliano of Credit Suisse. Please go ahead

J. Brett Harvey - President and Chief Executive Officer

Hi, David.

William J. Lyons - Executive Vice President and Chief Financial Officer

Hi, David.

David Gagliano - Credit Suisse

Hi good morning. I just have a couple of questions. First of all on the longwall extensions for 2009 will they affect production while those are happening?

J. Brett Harvey - President and Chief Executive Officer

No, no. That's just part of the longwall moves. They'll just go into panels that are wider.

David Gagliano - Credit Suisse

Okay. And so those were part of the original plans for when you were putting together the guidance for 2009 in terms of production?

J. Brett Harvey - President and Chief Executive Officer

That's right. It's more towards the end of '09.

David Gagliano - Credit Suisse

Okay. In term of the commentary earlier regarding the export market I was wondering if you could round out that commentary a little bit. I think you mentioned 2.7 in terms of your expected exports in 2009 I think you mentioned 2.7 and actually I forget the other number in terms of the steam market. I was wondering if you could just tell us one what are your steam exports for 2008 and also if you can give us the same numbers for met i.e. 2008, 2009, 2010 for steam met?

William J. Lyons - Executive Vice President and Chief Financial Officer

Okay 2008 is 3.6 for steam 2007… excuse me 2009 is 2.7 for steam is what we're thinking right now. And on the met side it's going to be about half of our met production. So it should be… let me look domestic will be about 1.9 million tons and international will be about 1.6 million tons of low-vol coal that's our export side and that's what we see for '09.

David Gagliano - Credit Suisse

That is [ph] for '09 '08 is about 1.6 was that where it was?

William J. Lyons - Executive Vice President and Chief Financial Officer

Yes.

David Gagliano - Credit Suisse

Okay. Thanks. And then I just want to make sure the price caps there was a very slight downward adjustment that seems to be the only change in price caps. It's not material but I just want to make sure there is no material reset in those price caps tied to things like spot prices etc cetera, should that be the only change we should expect to see?

William J. Lyons - Executive Vice President and Chief Financial Officer

They only related to quality adjustments. And so that's part of the contract.

David Gagliano - Credit Suisse

Okay, perfect. Thanks very much.

William J. Lyons - Executive Vice President and Chief Financial Officer

Thank you.

Operator

Okay. Thank you. And our final question comes from the line of Mark Caruso [ph] of Millennium Partners. Please go ahead

J. Brett Harvey - President and Chief Executive Officer

Hello Mark

Mark Caruso - Millennium Partners

Good morning guys. Just a quick clarification, I guess, it's partially off of what Shneur was asking. The committed tons at a price does that include… that does not include the 1.2 million met tons or the 3 million steam that you talked about in the release or does it include it? I'm just confused because it seems like I heard it both ways today?

Thomas F. Hoffman - Senior Vice President-External Affairs

Mark, this is Tom again. The stuff that we were talking about earlier the 1.2 million met those are deals that we've done in the last couple of weeks. In other words subsequent to the end of the third quarter. So they are not included in the way we report [ph] it. But as Brett said we thought it was important to tell you that we had done these rather than wait until January because I know everybody is concerned about where pricing maybe going.

Mark Caruso - Millennium Partners

Okay. And then how about the steam tons, are the steam tons in the table or are those in addition?

Thomas F. Hoffman - Senior Vice President-External Affairs

No they're not.

J. Brett Harvey - President and Chief Executive Officer

They're just done within the last three weeks so they would be closed in the open tons you see in the third quarter report.

Mark Caruso - Millennium Partners

Okay. So instead of 64 we're talking about like 67 million tons then?

William J. Lyons - Executive Vice President and Chief Financial Officer

That's about right.

Mark Caruso - Millennium Partners

Okay. And the second question is I know we were talking earlier about costs and talking about hopefully the fourth quarter will be below the nine months average. But I know [inaudible] in the press release is also talking about some costs improvement as productivity improves and some other things you're doing.

So, as we look forward I know you are going to give us an update is being below the 41.64 sort of a good run rate and could see better improvement as other things you guys are doing start to really come to fruition in 2009?

J. Brett Harvey - President and Chief Executive Officer

Well higher volume clearly gives us better cost structure and because you've got a kind of… in the short time you have a fixed cost between materials and manpower. If you get more tons per hour it gives you much better deviser of your cost into more tons.

William J. Lyons - Executive Vice President and Chief Financial Officer

Let's be clear on this. What we look at is not necessarily costs and not necessarily realization. Our decision is based on expanding margins. But it could very well be that we mine some very high cost tons that we'll get extremely good margins on and again our goal is to increase margins and that's what we look at when we make our decisions.

J. Brett Harvey - President and Chief Executive Officer

Yes. But having said that I want to reiterate to everybody as these tons increase in terms of volume against this fixed manpower we should see productivity pushing costs down and we'll stop seeing the rising costs that we saw in 2000… excuse me in the second quarter and third quarter Okay?

Mark Caruso - Millennium Partners

Great. Thanks guys.

Thomas F. Hoffman - Senior Vice President-External Affairs

We would like to thank everybody for joining us this morning. Brett I think you had a couple of thoughts you just wanted to add again.

J. Brett Harvey - President and Chief Executive Officer

Yeah. I would just like to let everybody know that CONSOL is in a strong position for '09 '010 is good but it is not as clear as it was maybe a couple of months ago. We feel very strong about it.

In '09 we have a very good hedge position in coal and gas. Our low-vol met coal and our high--Btu steam coal will command premium prices in any marketplace. Financially we're able to be disciplined in both sales and production and our ability to even buy our own shares back.

We can slow our CapEx down if we need to. Supply constraints overall will likely offset potential slow demand for coal if we see a drop in energy demand. Those with strong balance sheet like ours will have the ability to be very flexible and command real value going forward.

I feel like a CEO stranded on a strong financial rock in the middle of a swirling stream of financial uncertainty and you just need to know from a CEO's perspective our plans and our strategies have been solid and we feel like we're in a good spot in any market going forward. Thank you

William J. Lyons - Executive Vice President and Chief Financial Officer

Again, thanks everyone for joining us. Chuck Mazur and I'll be available for the rest of the day offline. Operator if you would instruct our listeners on the playback information.

Operator

Certainly and ladies and gentlemen this conference will be made available for replay after 12:00 pm today until Thursday, October 30th at midnight. You may access AT&T Executive Playback service at anytime by dialing 1-800-475-6701 entering the access code 963475. International participants dial 1-320-365-3844. And again that access code is 963475.

And that does conclude our conference for today. Thank you for your participation and for using AT&T Executive Teleconference Service. You may now disconnect. .

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Source: CONSOL Energy Inc. Q3 2008 Earnings Conference Call Transcript
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