Patriot Coal Corporation Q3 2008 Earnings Call Transcript

Oct.29.08 | About: Patriot Coal (PCXCQ)

Patriot Coal Corporation (PCX) Q3 2008 Earnings Call Transcript October 28, 2008 11:00 AM ET

Executives

Janine Orf - IR

Rick Whiting - CEO

Mark Schroeder - SVP and CFO

Analysts

Jeremy Sussman - Natixis Bleichroeder

Paul Forward - Stifel Nicolaus

Brian Gamble - Simmons & Company

Luther Lu - FBR Capital Markets

Leigh Goehring - Chilton Investment Company

J.D. Kritser - Steelhead Partners

Franklin Ross - Lynch Foundation

Mark Liinamaa - Morgan Stanley

Michael Dallas - Jefferies

Wayne Atwell - Pontis Capital Management

David Epstein - Advent

Jacob Muller - AM Capital

Michael Lukacs - Appaloosa

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Patriot Coal Third Quarter 2008 Earnings Call. For the conference, all the participant’ lines are in a listen only mode. However, there will be an opportunity for your questions and instructions will be given at that time. (Operator Instructions). As a reminder, today's call is being recorded.

With that being said, I will turn the conference now to Ms. Janine Orf. Please go ahead.

Janine Orf

Thank you, John. Good morning and thank you for joining Patriot's third quarter 2008 conference call. I am Janine Orf, Director of Investor Relations for Patriot Coal and with me are Rick Whiting, CEO of Patriot and Mark Schroeder, our Senior Vice President and CFO.

On this call, we will be discussing our results for the 2008 third quarter and our outlook for coal markets. As a reminder, forward-looking statements should be considered along with the risk factors that we note at the end of our press release, as well as in our Form 10-K, 10-Q, S-4 and 8-K reports.

Finally, we will be referring to non-GAAP financial measures, which are reconciled in our earnings release available at our website, patriotcoal.com.

Now I would like to turn the call over to Rick Whiting, Patriot's Chief Executive Officer. Rick?

Rick Whiting

Thanks, Janine and good morning, everyone. Thank you for joining us this morning. My remarks will provide a perspective on the quarter ended September 30, explain how we are dealing with the operating issues that Patriot and other Appalachian miners are experiencing and also cover the steps the management is taking to deal with the uncertain economic conditions.

The accomplishments during the third quarter were mixed. On the positive side, we completed the Magnum acquisition on July 23 by exchanging Patriot shares for those of Magnum. The acquisition diversifies our production profile by bringing more surface operations to our portfolio. Magnum also enhances our ability to serve the electric utility industry, an important position to the economic conditions impact metallurgical coal markets. Of greatest importance, the Magnum acquisition provides critical mass and growth opportunities that can be capitalized upon when market conditions warrant an investment.

The integration of Patriot and Magnum is progressing well and we continue to see synergies, especially from optimization of commercial transactions. The strong coal markets continued during the quarter and I am pleased to report that 36.5 million tons of our 2009 business is now committed at prices that will improve our earnings profile. The strong markets also benefited the third quarter with average selling prices up over 20%.

And our commitment to running safe operations was recognized during the quarter as the Apogee complex received the Mine Safety and Health Administration, Sentinels of Safety Award. And our mines posted excellent safety results during the quarter.

The production from the combined Patriot/Magnum operations was a major disappointment as the common issues of Appalachian mining combine to reduce our output by 1.4 million tons below our expectations. The issues included a shortage of skilled workers, geologic problems at the Federal and the Panther mines, downtime resulting from increased MSHA inspections and a delay in obtaining a major surface mining permit at Hobet. Very high diesel fuel, steel and explosives costs during the quarter presented additional challenges to us.

Management is responsible for anticipating and dealing with all of these issues and we are taking steps to correct these challenges. The Federal mine should work its way through the difficult geology in late November and the Panther mine should accomplish the same task in December. We are alerting – we’re altering the 2009 mine plans for both mines and plan to minimize our exposure to the areas with the difficult geology in future panels.

To more effectively deal with MSHA, Patriot is beefing up teams to identify and mitigate potential problems before the inspections occur and to quickly mitigate any issues that MSHA identifies.

The delayed Hobet permit has been received now. As the new owners of the surface mines and their related permitting challenges, we are committed to find a creative, positive solution to these permitting issues.

And to help address the shortage of skilled workers, we idle the high cost Jupiter operation. We have offered employment opportunities at nearby Patriot-affiliated companies to employees of the idle Jupiter operation and are pleased that of those skilled workers and operators offered employment, the vast majority have accepted. An improved compensation program, coupled with more aggressive recruiting and training programs, should improve our ability to attract new hires and deal with the issue of worker shortages.

As you may be aware, during the quarter, Patriot issued force majeure letters to customers of a number of our mines due to production difficulties. Each customer contract is unique, under contract terms, in some cases, we will need to make up the volumes for missed deliveries, but in others, we will not.

Our service and reliability are critical to maintaining strong customer relationships. We are working very closely with our customers to minimize the disruption and deliveries. Although some of these issues will linger into 2009, we are confident that real progress will be made to overcome them.

The turmoil in the financial markets has obviously created a challenging environment in which to predict the future of the global economy, the needs of our customers and the cost of our inputs. Although no one crystal ball is perfect, we would like to describe our view of the future and how management is running Patriot to deal with these uncertainties.

At the highest level, we believe the coordinated and individual economic and financial stimula will avoid a prolonged recession. Although some turmoil is to be expected over the next six months or so. We then expect a steady economic recovery, led by the availability of credit in the developed countries.

Although we expect overall US electricity generating growth to be relatively flat for 2008, we expect 2009 to show growth of 2%. Our smaller yet important customer base in the steel industry is expected to show some retrenchment in output over the next 6 to 9 months with a noticeable recovery likely in the second half of 2009.

Patriot's priced coal sales position of 36.5 million tons for 2009 and 23.4 million tons for 2010 puts us in an excellent position to work our way through the recovery.

As you can see in our earnings release, our committed selling price shows marked improvement from 2008. Importantly, during the quarter, we settled meaningful quantities of domestic metallurgical coal business in excess of $225 per ton on average at the mine.

This included some multiyear business with future years' prices colored around 2009 pricing. Although customers, like ourselves, will be careful as they enter into new commitments in the coming weeks, we expect to be able to place our remaining unsold products in the market at excellent margins.

So, how we manage Patriot differently during this challenging environment? First, we will be very conservative as we deploy capital. We will strive to live within our means and will only deploy capital if market conditions merit. Second, we will attack our cost structure with focus and ferocity.

Improving our productivity is a critical aspect of this step. Third, we will extract every remaining synergy from the Magnum acquisition, billing loss costs under contracts, optimizing our sourcing under our contracts, sharing best practices between our properties. Those are a few examples of our area for focus. And we will treat employees, customers, lenders and suppliers and all others in a fair and professional manner.

Patriot is in a very strong position to prosper going forward. We have excellent employees and assets, as well as a diverse customer base. Patriot has numerous organic growth opportunities and the skills to complete accretive acquisitions. Out of adversity comes strength and we expect to emerge from the current market conditions a much stronger company.

At this point, let me turn the call over to our Chief Financial Officer, Mark Schroeder to further discuss the third quarter results. Mark?

Mark Schroeder

Thanks, Rick, and good morning, everyone. Let me begin with a discussion of the supplemental data portion of our earnings release. Please note that the 2008 figures include Magnum's results following the acquisition on July 23.

In the third quarter of 2008, Patriot sold 8.2 million tons and posted revenues of $490 million compared to sales of 6 million tons and revenues of $293 million for the third quarter of 2007.

Sales volume increased 2.2 million tons compared to the year ago quarter, primarily as a result of the acquisition of Magnum Coal. We sold 1.2 million tons of metallurgical coal in the 2008 third quarter. This amount was down several hundred thousand tons due to the lower production at the Kanawha Eagle and Wells complexes from the labor and MSHA factors mentioned by Rick, as well as normal minor vacations during the month of July.

Segment EBITDA per ton was $4.09 in the 2008 third quarter compared to $5.61 in the prior year period. As Rick noted, our volumes were approximately 1.4 million tons lower than what we had expected during the quarter.

As you know, since operating costs include a high fixed cost component, the lower production had a direct impact on our EBITDA. At average revenue of almost $60 per ton, a 1.4 million ton shortfall has a very large impact on EBITDA.

In Appalachia Patriot's average selling price increased almost $10 to $65.84 in the third quarter compared to the 2007 average selling price. Appalachia operating costs increased to $60.75 per ton in the third quarter due to three main factors. First, lower production levels during the third quarter as we discussed earlier. Second, higher material and supply costs and contract minor costs. And lastly, increased royalties due to higher average selling prices.

Segment EBITDA for Appalachia was $5.09 per ton for the 2008 third quarter. While we are seeing the benefits from higher prices, this was more than offset by the impact of the lower production during the quarter.

The average selling price in the Illinois basin was 37.17 in the third quarter, a $4.16 improvement compared to the price reported for the prior year. As with the Appalachia segment, the Illinois basin pricing also continue to benefit during the quarter from strong coal markets.

Operating costs in the Illinois basin were 36.58 per ton in the third quarter, up $5.24 from the prior year. Primarily because of higher material and supply and labor costs on a slightly lower production base. We also experienced a roof ball on a main belt at the Highland mine during the quarter, which slowed production for several days.

Turning to the income statement portion of the release, EBITDA for the quarter was negative $2.2 million. EBITDA was impacted by the production issues I just discussed, which more than offset the higher average selling prices.

I would like to point out that, in accordance with US GAAP, this quarter included approximately $122 million of sales contract accretion related to the purchase of Magnum. Sales contract accretion results from the allocation of purchase price in the opening balance sheet. Essentially, in the July 23 post acquisition balance sheet, we have recognized a liability to the extent that coal pricing on July 23 was higher than Magnum's contracted coal prices.

As you will recall, pricing in July was at all time highs. So we ended up with a net liability at the purchase accounting date of approximately $930 million as a result of this process. This liability will flow into income as we shipped tons under Magnum's contracts. The last of these contracts will ship in the year 2017, but the bulk of this amount will flow into income by 2010.

Sales contract accretion is included as an income item within operating costs and expenses and is included in net income, but not in EBITDA or segment EBITDA for purposes of financial reporting. Also, as a reminder, sales contract accretion is non-taxable.

Looking forward to the fourth quarter, we anticipate the accretion to increase net income by approximately $160 million. Please note that these amounts are subject to further refinement as we finalize the purchase price allocation over the next several months.

As we look forward, we expect to experience continued inflationary pressure in certain elements of our cost structure. But in other elements, if current trends continue, we could experience some deflationary benefits. You may recall that with the addition of Magnum, we expect to use approximately 30 million to 35 million gallons of diesel fuel annually.

At the time of the acquisition, there were no hedges in place against the significant cost component. In recent days and weeks, we have locked in diesel fuel hedges for 2009 when market prices per barrel of oil averaged just under $70. Fuel hedges entered into total approximately 50% of our 2009 expected fuel usage and a smaller portion of 2010 needs.

Additionally, recent steel prices have declined and if the current trends continue, this should result in lower costs for roof balls and other steel related materials and supplies. So for certain of our costs such as labor, we expect inflationary pressures, but for others, such as fuel and steel related costs, we could see some deflation benefits as we look towards 2009.

Our capital expenditures totaled $40.7 million in the 2008 third quarter and $74.1 million for the first nine months of 2008. Note also that these amounts include capital expenditures on the Magnum assets since July 23. In light of the current economic climates, we are taking a hard look at our capital expenditures. And we are continuing to look at our mining complexes to ensure that we make the best use of our investments.

As Rick mentioned earlier, during the quarter, we announced the idling of our Jupiter mine as one step in the process of identifying synergies and optimizing our combined operations. Our depreciation, depletion and amortization of $42.2 million in the 2008 third quarter includes the estimated purchase accounting impact of the Magnum transaction.

Interest expense increased $3.9 million this quarter compared to the prior year amount, primarily related to interest on our convertible debt. We recognized an income tax benefit in the 2008 third quarter of $2.6 million as a result of our net taxable position. As I just noted, sales contract accretion has no tax impact.

Turning to the balance sheet, we have slightly more than $200 million of total debt as of September 30. You will recall that, in May, we completed a $200 million, 3.25% coupon rate convertible debt, an offering that matures in 2013. We have three years remaining on our revolving credit facility and have more than $150 million credit available as of September 30. We had no borrowings against this facility and at $8.1 million of cash at September 30.

Looking forward, Patriot is largely contracted for 2009 at favorable prices. We’ve added new disclosures in today's release detailing the average price per ton for contracted business in 2009 and 2010, both by segment and by thermal versus metallurgical coal.

As of September 30, of our expected 2009 volumes, up to 3 million tons of met and up to 2 million tons of thermal were unpriced. Of expected 2010 volumes, up to 7 million tons of met and up to 13 million tons of thermal remain unpriced and of expected 2011 volumes, up to 9 million tons of met and 22 million tons of thermal remain unpriced at September 30. We will update these tonnage amounts as we finalize our production and capital expenditure plans as part of our ongoing budget and strategic planning exercise.

Looking forward to the fourth quarter, the immediate costs required to address labor shortages and transition in production plans to optimize our combined operations will make it difficult to show significant sequential improvement in EBITDA. The extent of the improvement in the fourth quarter will be influenced by the success of our ongoing recruitment efforts and the return to more normal conditions at our Federal and Panther operations.

In closing, recent pricing negotiations have been very favorable and we believe the continued industry wide supply constraints, especially in Central Appalachia, will help keep coal markets tight. We have initiatives in place to address the production problems we encountered during the quarter and we look forward to reporting on our progress in future quarters.

Looking towards long-term valuation, Patriot has a well diversified portfolio with 1.9 billion tons of proven and probable reserves. We have a balanced operating platform with about a third of our production from surface and two thirds from underground mines. We have customer relationships spanning more than 25 years and we have experienced employees at all levels -- in the mines, at supervisory levels and in our top management ready to fully participate in positive, long term trends in the coal industry.

This concludes our prepared remarks and at this time, Rick and I will be happy to take your questions and with that, I will turn the call over to our operator. John?

Question-and-Answer Session

Operator

Thank you. (Operator Instructions). And first, from the line of Jeremy Sussman with Natixis. Please go ahead.

Jeremy Sussman - Natixis Bleichroeder

Hi, good morning.

Rick Whiting

Good morning.

Jeremy Sussman - Natixis Bleichroeder

I guess my first question is, you talked about living within your means and taking a look at CapEx. Can you just discuss a bit how that jives with you guys being an acquirer? I mean, are you still looking at certain acquisitions or is the focus more on kind of improving existing operations first and then we will see where that takes us?

Rick Whiting

I think your last remark is probably right on. I think our highest priority, given the performance we have had over the last few months, is to get our own shop in order and make our operations on. That’s not to say we won't have our antenna up as the markets warrant us looking around for other acquisitions -- small, medium and large, but right now, I have one priority to get the mines operating like they are capable of.

Jeremy Sussman - Natixis Bleichroeder

Okay. That's fair. And then in terms of, it looks like you priced about 3 million or 4 million tons if my math is right of '09 met coal this quarter. If that’s the case, how much was done sort of close to that $225 level? And then just kind of backing into that 6 million plus tons that you have hedged at $134 I believe, I guess are there some legacy contracts in there, that are in there?

Rick Whiting

Absolutely, in the $134, certainly, there are prior contracts. So some of it was collared business perhaps and some of it was business that went into the period of '09. As far as the price of $225, that is basically an average of multiple qualities. There is a range around that on the high end it was well above 250 and on the low end, probably a little under 200.

So when you put it all in the bucket of what we committed during the period, it was average north of 225. But certainly, we have some products, everything we have is hard coking coal, it is all high volatile coal as you know, but some of our products warrant a much higher price. The Harris type product is well north of 250 in the market.

Jeremy Sussman - Natixis Bleichroeder

Great. And then lastly -- I appreciate that. You mentioned that kind of it is going to be tough to improve things in the fourth quarter. So I guess what sense do you have that maybe that's sort of a transition quarter where you are working through some things in Federal and in Panther to help get you to a stronger '09? I guess what sort of things do we need to see there for that to be the case?

Rick Whiting

Well, as I have said, we are going to kick in stronger as the quarter moves along later in November in the case of or just as we move into November with Federal and then we are going to make a sheer change out at Panther later in November, which will benefit us starting in early December. So what the message there is that we haven't done very well in the month of October and we have some more work to do in the coming two or three weeks to get postured to not only get set up for December, but as we move into the new year. So you are correct, it’s going to end up being continue to transition and improve and get set for a strong production and sale year next year.

Jeremy Sussman - Natixis Bleichroeder

Okay, great. Thanks, Rick.

Rick Whiting

You’re welcome.

Operator

Our next question is line of Paul Forward with Stifel Nicolaus. Please go ahead.

Paul Forward - Stifel Nicolaus

Hi, good morning. Just a couple of questions, on the third quarter, you had 1.2 million tons of met coal production. When you look at your guidance for '09, you have got 6.1 million so 9.1 is potentially what you could do if you sell all that remaining 3 million as met coal. Just wondering how you get from that 1.2 million, which was obviously a tough quarter in the third quarter to what specific things have to happen for you to be able to do 9 million tons of met coal production in '09 versus a very tough third and fourth quarters of this year?

Mark Schroeder

Paul, this is Mark, in the first quarter, we did a little over 1.4 million tons. In the second quarter, close to 1.3 million tons those are both Patriot only before the addition of Magnum. So as you looked at the third quarter number of 1.2 million, it is certainly disappointment in being lower than a Patriot only number when it includes some of Magnum is even more of a disappointment. So a normal quarter would be based off more like a 1.4 million number for Patriot only and then add several hundred thousand for the Magnum side. So, I guess the bulk of getting back to a more of a run rate in the high single digits to a 10 million number is operating both for a full quarter at where they should be producing.

Rick Whiting

I would add, Paul, that we had Harris phasing down and ultimately out next year, but Harris phasing down at the end of that mine and based on decisions that were made two or three years ago, the new Black Oak mine not coming up in production until we get into '09. So we’ve had kind of a dip year by design or by long term planning that was done earlier where the production dropped. So with Black Oak coming in in '09, gradually building up and getting up to full levels by 2010, that adds another complete increment that helps move the quarterly volume up more in the 2 million to 2.25 million range -- million tons.

Paul Forward - Stifel Nicolaus

And sorry, Black Oak is how many tons per year?

Rick Whiting

I would say it’s going to ultimately be about 2 million tons per year. Probably next year it will be something less than that.

Paul Forward - Stifel Nicolaus

Okay. And what’s the risk of some of this coal slipping back into the steam markets if some of the crossover tons can't find a home in this very difficult environment for the steelmakers?

Rick Whiting

I think there is some possibility that and therein lies where we came up with our 3 million tons of met unpriced. We have kind of drawn the line and made certain assumptions on that. The coals that would be most likely to move back to steam would be the coals up on the river, the Panther and/or the Kanawha Eagle. But the primary production at Kanawha Eagle is Eagle seem, which is a metallurgical coal and in Panther is all Eagle seem. Those would be -- they were the last to come into the met market, they would be the first to move back out. We have no concern, and in all markets thick and thin for the last 20 or more years, the Wells and the Rock-Lick, Harris type product and the Black Oak, they always have a prime spot in the blends, both here in the US and overseas and including Brazil.

So the ones that we are looking at and are making judgments on as to which market they will move into and how much volume are the coals up on the river, Kanawha Eagle and Panther. But it is not beyond our imagination that some of that may have to move back to the steam market. The good news is they are very strong, can be very high heat and travel well, steam coals, low sulfur steam coal that will also command a strong price relative to the other markets, relative to other coals in the area.

Paul Forward - Stifel Nicolaus

Alright, and maybe just one last question. You have 29 million tons committed from the Appalachians next year. We haven't yet seen a full quarter of volumes from Magnum. What would you say is your target run rate from the Appalachians maybe for the fourth quarter of this year and 2009 versus the 6.4 million Appalachian tons that you saw this quarter? What should we expect there in the fourth and in a better set of operating circumstances hopefully in '09, what do you think a quarterly run rate is from the Appalachians?

Rick Whiting

I think, 8 plus, 8 and 8.5 million ton range.

Paul Forward - Stifel Nicolaus

8 million to 8.5 million tons, okay?

Rick Whiting

I will say 8 million is probably a pretty good number.

Paul Forward - Stifel Nicolaus

Alright. And costs were almost $61 this quarter, is there an expectation next year that moves significantly one direction or the other?

Mark Schroeder

Paul, we are still working through the budget exercise, we’ll continue that over the next couple of months. Some of those factors that impact the costing, I mentioned fuel earlier and steel costs. Both of those are working in our direction as we look forward to next year. That the third quarter amount was very high or is very high and it’s high because of the production shortfall that we have. If you have a normal production level, we would be back to where we were closer in Q1 or Q2. So I think the 61 is high already I think we will be benefiting some on the fuel and the steel related costs for [heard] some on labor costs as I go forward.

I guess that’s a long winded way of not giving a specific answer other than to say I think there is a number of factors they continue to move as we get through the next couple of months here and work towards finalizing our budget. We’ll have a better handle and at the same time, we’ll have a better handle as to how we are going to come out of the production side on the changes we are making at Federal and at Panther.

Paul Forward - Stifel Nicolaus

Okay, great. Thank you.

Rick Whiting

Thanks Paul.

Operator

Next with line of Brian Gamble with Simmons & Company, please go ahead.

Brian Gamble - Simmons & Company

Yes, good morning, guys.

Rick Whiting

Good morning Brian.

Brian Gamble - Simmons & Company

You both mentioned kind of a little bit of frustration with the continued integration and how all of the mines are operating Magnum or Patriot alike. Could you maybe go over a little bit of the synergies that you have been able to realize so far and then additional synergies that you hope to be able to realize on the cost side of things to help us out when we try to model out '09?

Mark Schroeder

I guess I will, Brian. Initially, I think the number I had thrown out previously was $35 million to $75 million and as we have spent some time over the last couple of months going through that, that still feels like a number that is in the range. We continue to work on it but it’s a number that’s in the range. Somewhere around $10 million to $15 million or so of that is going to be related to insurance type items, workers' comp, consolidating some of our property and casualty programs. There is several million that relates to just some of the management, staffing, office type work that we’ve done or combination that we have done.

And then there is a bigger chunk that relates to optimizing both the sales side and the operating side of things. So Jupiter being one of those as an example also things like moving coal from the CSX to the NS, moving coal from barge to rail, optimizing which customers are shipped out of our mines, whether it is a Magnum or a Patriot mine.

Having the transportation alternatives, having the ability to arbitrage some of the differences in NS versus CSX or barge versus rail, as we look at those and look at specific opportunities, we do see a number that still falls in that $35 million to $75 million range. So a portion of it’s going to be the sort of administrative, insurance, office type. But a bigger chunk is going to come from optimizing our sales portfolio, customer sourcing piece of the equation.

Rick Whiting

Brian, we had one example in the last few days where we have been able to arbitrage a coal supply agreement that was an Appalachian agreement to actually given the change of situation where they could use high sulfur coal, I will sent to a scrub unit., we are bringing coal out of the Midwest and when you do arbitrages like that, there can be meaningful amounts of money in a simple resourcing and that was clearly one that with Magnum not having the Midwestern sourcing and we having that was a some low hanging fruit. We continue to run into opportunities like that in our joint contract portfolio. It’s one of the benefits we have talked about going all the way back to the spin off having the multiple basins.

Brian Gamble - Simmons & Company

Sounds great, and then on your committed tonnage, the chart and all the numbers that you gave are as of quarter end, is that correct?

Mark Schroeder

That is correct. Yes.

Brian Gamble - Simmons & Company

And have you continued to sign in the last three or four weeks or has that been something that, because the market has been such that those contracts have been few and far between?

Rick Whiting

Most of what we have done in the last few weeks has been rounding out volumes for '08. There has been some very minimal amounts, primarily in Illinois basin for '09, so it has been pretty quiet on the Appalachians sales front for '09 since the turn of the quarter, Brian.

Brian Gamble - Simmons & Company

And then when you talked about earlier some of the tons that you had to force majeure for '08 can be rolled over into '09 while others may just kind of go by the wayside. Can you put any volumes around that for what might have to be rolled over into '09? And I am assuming that if you did roll it over and then that would obviously decrease your uncommitted position for next year.

Mark Schroeder

Brian, we were about 1.4 million short from what we had anticipated in the third quarter and we expect to be short again in the fourth quarter from what we had anticipated. If I had to combine those two numbers, think about what may rollover, I am probably at a number somewhere around 2 million tons, maybe a little bit north of 2 million, but somewhere in that range.

Brian Gamble - Simmons & Company

Great. And then final question for me, on the CapEx side of things, obviously you mentioned restraint as you go into '09. Do you have a number on the maintenance side of things that is going to have to be spent when you talk about what’s going to be developed in the fourth quarter and looking at reshifting those longwall developments and then as you look in full year '09. So essentially a CapEx number of growth versus maintenance for next year?

Mark Schroeder

The way I have talked about CapEx in the past and maintenance, as I said, maintenance has been about 75% of what we spend on an average basis and as I look at going forward, I would say somewhere around $5 to $6 a ton. That being said, it’s more like a comment back in July. Now that I sit here in October and we have had a tough economic climate and a tough financial market, really all bets are off on capital. We are spending a lot of time looking through the detailed spend that we have. I think the maintenance number will still be at least 75% it probably will ratchet up a little bit from that. But I think the $5 to $6 spend is probably a number that is going to be more likely south of that than north.

Brian Gamble - Simmons & Company

Thank you, guys.

Rick Whiting

Okay. Take care.

Operator

And next will line of [Meenakshi Zadar] with FBR Capital Markets. Please go ahead.

Luther Lu - FBR Capital Markets

No, this is Luther Lu. Hi guys, how are you?

Mark Schroeder

Hi, Luther.

Rick Whiting

Good morning.

Luther Lu - FBR Capital Markets

Good morning. Just want to follow up on the rollover tons. Mark, you mentioned roughly 2 million tons. And how much of that 2 million is already included in the reported number?

Mark Schroeder

All of it is in the price number if that is what you are referring to. It is in the priced column for 2009.

Luther Lu - FBR Capital Markets

Okay. So even including the fourth quarter missing production.

Mark Schroeder

We’ve made an estimate as to about how much of -- what we are short in '08 is going to roll into 2009.

Luther Lu - FBR Capital Markets

Okay, got you. On your reported income statement, there is -- operating cost is roughly $55.42.

Mark Schroeder

Yes.

Luther Lu - FBR Capital Markets

And in terms of volume, I got about 452 million, but reported operating cost is only 362. What is -- could you explain the delta there?

Mark Schroeder

Sure. Two things. One, past mining obligations. We do not include that amount in the operating cost per ton on that supplemental page. So over the quarter, that was roughly $31 million, $31.5 million and the other big piece is this $121.9 million sales contract accretion. That shows as a credit or a reducing amount in the line item called operating costs and expenses. But I did not include that when I showed you an operating cost per ton number.

Luther Lu - FBR Capital Markets

Okay. Okay.

Mark Schroeder

So if you back those two items out from your number, you will get back to the operating cost per ton, $55.42 number.

Luther Lu - FBR Capital Markets

Okay. Alright.

Mark Schroeder

Just call me separately if that doesn't work, Luther and I will walk you through it.

Luther Lu - FBR Capital Markets

Okay, that would be great. And then can you walk us through how we go about modeling this amortization of this legacy contract?

Mark Schroeder

Yes. I guess I will start by saying that the number is preliminary and by that I mean it is not final. We spent a fair amount of time coming up with the dollar amounts in the opening balance sheet. We have had some outside valuation people look at it as well, so it is still subject to change, but it has gone through a lot of work to get to the point where we are. I mentioned the total net liability on the acquisition date of a little over $900 million. I mention that there is about $121 million, $122 million that rolls out in the third quarter. That is a third quarter that has two full months and a few days -- July 23 on.

So if I look at the three full months in the fourth quarter, the number is going to grow from $122 million probably to something more like $150 million to $160 million.

Luther Lu - FBR Capital Markets

Okay.

Mark Schroeder

And then it will -- the bulk of it will come down in 2009 and 2010. And if I look at the 2009 number, it's probably going to be a little bit south of the fourth quarter, but in that range on a quarterly basis and then each year from that, it will drop lower and lower.

Luther Lu - FBR Capital Markets

Okay.

Mark Schroeder

It is amortized or it rolls into income as the tons are actually shipped, so the bulk of what Magnum had on July 23 was '08, '09 a little bit of '10, a little less of '11 and all the way out. There is one contract that goes all the way to 2017. So we will actually show a little bit all the way through that year, but again the bulk of it runs out through 2010.

Luther Lu - FBR Capital Markets

Okay. And do you have like a rough estimate of your tax rate for fourth quarter and 2009?

Mark Schroeder

2009, let me answer that one first. I would guess we will be at most an AMT taxpayer, so more like a 20% at most. It is probably down a little bit from that, but again, we are still working through the budgeting exercise. In the fourth quarter of this year, I don't envision much of a tax rate at all. I think it will be the zero rate similar to where we are through nine months. The sales contract accretion is a non-tax item, so I don't expect to have much, if any, tax liability in the fourth quarter.

Luther Lu - FBR Capital Markets

Okay. And as far as the past mining obligations, can we expect a similar run-rate for the same quarter going forward?

Mark Schroeder

The only piece I would do is, again, keep in mind that Magnum has about 2 1/3 months rather than three months, so it will track up a little bit from where the third quarter was to get the full three months of Magnum.

Luther Lu - FBR Capital Markets

Okay, got you. And if I may, just finally, one question on the permitting issue, any of the Magnum legacy contracts can be force majeure if these guys run into permitting issues going forward?

Rick Whiting

We are still evaluating that. There may be some circumstances where we can do so. I would rather not get into that discussion in a public forum, but we certainly are taking a very careful look at our contracts to see if that is a possibility for us.

Luther Lu - FBR Capital Markets

Okay, great. Thank you, guys.

Mark Schroeder

Thanks, Luther.

Operator

In the line of Leigh Goehring with Chilton Investment Company. Please go ahead.

Leigh Goehring - Chilton Investment Company

Hello, everyone. Just a question on that 3 million tons of unpriced met that you still have for 2009. Am I right to assume that most of that is basically marginal potential crossover back into the thermal type met?

Rick Whiting

No, there is still some meaningful quantities, Leigh, of our normal, high-grade products going back to the original Patriot properties. It is probably -- at least a third or more is the normal high-grade products.

Leigh Goehring - Chilton Investment Company

Okay, one-third. But the other two-thirds could wind up back in the thermal market?

Rick Whiting

We have already made assumptions that some pretty meaningful quantities from Panther and Kanawha Eagle are already going to the thermal markets. So I think we are probably in pretty good shape. It is subject to that possibility, but we have made some pretty conservative assumptions on the amount that can continue to go into the coking market from those two properties.

Leigh Goehring - Chilton Investment Company

And just a question on the 2 million tons that you have unpriced in the thermal market. Is your strategy basically to sell that spot or are you going to try to get that out in some sort of contract basis?

Rick Whiting

I think we will look at both. We probably do -- we have enough tons left that we would be interested in some annual business at the appropriate prices. And if we don't achieve those, it is not unusual for us to have the kind of quantities we have and sell them on a quarterly or spot basis.

Leigh Goehring - Chilton Investment Company

Okay. And finally is the bid/ask spread between what the utilities want to buy the coal at and the industry, Appalachian industry want to sell it at, is it still that $20 to $25 bid/ask spread?

Rick Whiting

As far as on a physical basis, I think that is true. I am sure it is tighter on the traded markets and they have continued to move down as you have observed. But I don't think we are very close at all in terms of the physical market, at least in the case of our company. There are just too many unanswered questions out there, not the least of which is what is going to happen with the Valley Fill litigation that is still pending.

Leigh Goehring - Chilton Investment Company

So you still have great confidence that the offered side of the market by the coal industry is still the right price?

Rick Whiting

I am still confident that the numbers for physical sales will be substantially above the current traded market.

Leigh Goehring - Chilton Investment Company

Okay. Thank you very much.

Rick Whiting

Okay, Leigh.

Operator

In the line of J.D. Kritser with Steelhead Partners. Please go ahead.

J.D. Kritser - Steelhead Partners

I just had a question for you guys on the met coal that was contracted in Q3, just doing the math on the on the $225 million, on the $3 million and kind of the average of the, unless I am missing something, on the, what you had on before seems to be implied around $43 a ton. If you average that with the $225 contract in Q3 you get to $134. Am I missing something there?

Mark Schroeder

JD, I can look at the number. I guess the $134 has -- yes, it is not all $3 million --

Rick Whiting

Well first of all, the total booked -- let's see -- the net booked was not as high as $3 million. It was more in the 2 million ton range.

Mark Schroeder

I know your number is not right. I'm just trying to think through the math here. We didn't book a full $3 million in the period, so that $3 million is at $225, it is a number less than that.

J.D. Kritser - Steelhead Partners

Okay, that would bring it up to probably maybe $60 a ton.

Mark Schroeder

Some of the met business, part of that $6.1 million for 2009 is business that was booked earlier in, even some of it in 2007. But business that both Brasilia July 1 to June 30 period and some of the Japanese fiscal year periods ending in April. So there is some of that carryover into 2009 that was business booked well before the run-up. It is not $43 business. It is certainly higher than that, and I think the $43 math probably comes from using.

J.D. Kritser - Steelhead Partners

It comes from using $3 million booked in the Q3. So if that number goes down, the number goes up for price.

Mark Schroeder

That's correct.

J.D. Kritser - Steelhead Partners

In light of what you guys contracted in Q3, is that going to have any impact on your guidance for Q9? I know you guys have put a number out there of around $750 million to $950 million.

Mark Schroeder

I guess on the '09 guidance I would say we are still in the process of working through the budget exercise. And I guess I am not trying to cop out here, but I am just trying to let you know there are a lot of the factors that are just moving all around different than where they were at July, not the least of which is fuel and steel and what is going on in the met market. So we are continuing to work through math. I am putting the budget together. We will update our volumes. We will update with this carryover tonnage from 2008 into 2009 and really it's an exercise that is not done yet. We need to keep working over the next several weeks and really two months to finalize where we are in 2009.

Rick Whiting

I will say the price achieved on those tons of coal booked during Q3 were very much in line with our assumptions at the time we did the earlier guidance that you mentioned. So we weren't dramatically off base, high or low. It was pretty well in line on average with what we had assumed. So there certainly wasn't any erosion as a result of those sales transactions.

J.D. Kritser - Steelhead Partners

And obviously I think that is helpful to know, and obviously with the prices weakening in the market I am not sure kind of how you went about that process, how much of a discount to the current market did you take at the time when you did it? Given for the full amount of tons you had open?

Mark Schroeder

We did some -- back when we were doing the 750 to 950 we didn't take the high end of the traded market at the time, so we did have some discounting built into that. And although the traded markets have come off quite drastically from where we were back in July and really did come down from where we were in our assumptions, we don't feel the traded market is indicative of the fiscal market these days.

J.D. Kritser - Steelhead Partners

Okay. Thank you.

Rick Whiting

You welcome.

Mark Schroeder

Thank you.

Operator

And next in the line [Franklin Ross with The Lynch Foundation]. Please go ahead.

Franklin Ross - Lynch Foundation

How are you guys? How are you doing?

Rick Whiting

Hi, Good morning.

Franklin Ross - Lynch Foundation

Just a couple of quick questions. On the revenue accretion that goes through on your income station statement to the revenue line so the 486 in sales does that go through?

Mark Schroeder

No, it's actually going through the operating costs and expenses line.

Franklin Ross - Lynch Foundation

Okay.

Mark Schroeder

What I try to do is keep the revenue as a pure number and therefore it did not go through there. It went through operating costs and expenses.

Franklin Ross - Lynch Foundation

Okay. I just wanted to make sure. And how many tons are you guys going to be exporting in '08 and then in '09 if you have a number for that?

Mark Schroeder

I do. It is about -- if I recall, 15% or so, 13% is what we did through -- is this the third quarter only? Sorry, I have a piece of paper I am looking here. It is about 13% in the third quarter, and I think that number is about where we anticipate it to be for the full year. Somewhere in the 85/15 split.

Franklin Ross - Lynch Foundation

And that is out of total production?

Mark Schroeder

Yes, it is.

Franklin Ross - Lynch Foundation

And when you look at '09, have you seen it softening at all on met demand from people across the drink?

Rick Whiting

I'll say this. We haven't seen any change of attitude about wanting the quality and quantities that we have, but the price decision and the shaking hands for next year, the April 1 year, that process has slowed down. I think everyone is just taking a kind of taking a pause here to see how their markets shake out, what their true needs are going to be. So the discussion slowed down. We thought earlier, and I even stated I thought we would do the international right on the heels of the domestic settlements. But it is going to drag out for a while.

Franklin Ross - Lynch Foundation

And I guess my last question is when you look at asset value I mean, kindly Patriot is trading at a market cap of around $900 million and it has $200 million in debt. And you guys have, what is your current reserves?

Mark Schroeder

1.9 billion tons.

Franklin Ross - Lynch Foundation

I mean, just out of curiosity, how much do you think it would cost to go out and acquire 1.9 billion tons of coal in your resource areas?

Mark Schroeder

Certainly more than our market cap.

Rick Whiting

A large multiple.

Mark Schroeder

The coal in the ground is worth a lot of money. It is hard to put a value on that but certainly it is more than $0.50 a ton.

Rick Whiting

It's a wide range. There are some of these tons that probably won't be mined for a couple of decades, but there are other volumes that carry these high-priced chemical feedstock type numbers for the metallurgical industry. So it is a big range. All tons are not created equal in terms of their inherent quality and the ability to get them out of the ground. But certainly out of that number there are some very mineable and very market worthy tons at major margins. So it should be a very large number, and it takes a long time to amass that type of reserves in contiguous locations.

Franklin Ross - Lynch Foundation

Thank you very much.

Mark Schroeder

Thanks, Franklin.

Rick Whiting

Thanks, Franklin.

Operator

We’re in the line of Mark Liinamaa with Morgan Stanley. Please go ahead.

Mark Liinamaa - Morgan Stanley

Following up on valuation questions, clearly the market is discounting a pretty significant deterioration in pricing power relative to the contract data we are getting from the companies. Everybody is talking about supply discipline, but they are also talking about a pretty rosy outlook again to 2010 for exports and competition with gas. Do you see any risks that the industry over produces, or is there some reason to believe -- because we have in the past -- or is there a good reason to believe that we will effectively be able to match supply and demand? And the prices now suggest these shares should be significantly higher, but that will continue?

Rick Whiting

If there was an urgency or a tendency to overproduce in the regions where we operate, I don't know that there is, but if there were I believe the external factors, some of which are beyond our control, will dampen and limit that ability to grow dramatically. I think we are going to have to work very hard in Appalachia, particularly central Appalachia to hold our own. And holding our own would fly in the face of a lot of projections made over the last four or five years about the demise of that industry. So to hold in the 220, 225 million tons per year range for Central App I think would be a huge victory. I think the ability to grow that number is very remote given all the factors we've talked about in our litany of things that have happened to us as an industry in the last year.

Mark Liinamaa - Morgan Stanley

In a worst-case scenario how much could demand come in, and could you comment at all about marginal pricing type, where you really start to see pressure on high-cost producers?

Rick Whiting

Well on the thermal side some of the variables are coals coming in from other regions and imports, while they are off a bit, are still pretty meaningful part. I suppose there could be some more imports if the world markets dropped off coming in to affect the use of Central App coals. There is a lot of talk about how much natural gas could come into those markets. I think you put them all together and you probably wouldn't come up with more than 10 million tons of downside there assuming that the utility plants where we operate, where we sell are all at low cost base load in their markets and generally run at all times when they are not on a service maintenance and certainly in peak periods. So as far as the use of our product, I think there is very limited exposure. You know the growth is not big. It is 1% or 2% a year nationwide. It is going to be probably under 1% this year, probably 1.5% to 2% as I said next year. So the use part we are not concerned about. I am not particularly concerned about the other coals to come in when we have high [eContent] and more favorable freight rates from a location standpoint, erosion from the other basins in particular. I think there will be some shifting around with scrubbers and people will gravitate to nearby coals from Northern App and the Midwest to come to some of the plants that in the East have traditionally taken the very low sulfur coals. So there will be some shifting that way, but I don't see major erosion. I would think that even if it was 10 million tons there is as much likelihood that supply side could fall off an equivalent amount and keep things in a very nice balance.

Mark Liinamaa - Morgan Stanley

And then any other commentary from the trade rags that suggest utility buyers are waiting for the coal industry to capitulate and sell at any price, no risk there?

Rick Whiting

I would say that is always a potential practice. It is a process that has gone on for decades, and depending on the sense of urgency and the actual situation. I will say that while we have had a pretty mild August and September with lower electric demand and we are kind of in more of a normal cooling degree days in the recent months, that in spite of that and in spite of increased production in Central App year-to-date, of I think 6 or 7 million tons, 5 to 7 million tons the days of inventory at the Central App using power plants is only up a couple days. It is still under 40 days. It is still down probably 7, 8, 9 days from a year ago. So higher production, pretty mild second half of the summer and inventories have not grown very much. So I think that helps me answer that question to some degree.

Mark Liinamaa - Morgan Stanley

Thank you, and good luck.

Rick Whiting

Okay, take care. Thanks.

Operator

We’re going to line of Michael Dallas with Jefferies. Please go ahead.

Michael Dallas - Jefferies

Good morning everybody.

Rick Whiting

Good morning, Michael.

Mark Schroeder

Michael.

Michael Dallas - Jefferies

Rick, could you talk a little bit about the retention of labor since the acquisition? You think you are pretty much done with where the minors would need to be, and what are your targets for turnover or reduction thereof going into 2009? Do you think your company is better positioned than many of your competitors in the space?

Rick Whiting

I think our turnover, we've been working hard to get our arms around that as we've integrated the companies. Overall it has probably been 10% or 12% turnover so far. I think with some of the things we've done in terms of work schedules and benefits packages and basic wage rates, that we have halted the exits and are starting to turn the tide as we move into 2009.

Rick Whiting

Good morning, Michael.

Mark Schroeder

Michael.

Michael Dallas - Jefferies

Mark, what is your sense in the marketplace for credit availability for competing producers, shippers, brokers, contract miners? Do you think there is going to be a significant impact towards that going forward, and I guess could that allow some opportunities for Patriot to help out some of their competitors, so to speak?

Mark Schroeder

Very timely question, Michael. I guess first off, I would say from Patriot's standpoint I'm sure you know, we have a $500 million facility, it still has three years to run. We have LCs against that could eat up some capacity but we still have $165 million or so of capacity. So from our standpoint, good capacity out there to fund what we need as we go forward. As I look to the outside and other producers and suppliers and buyers of sorts, I think it is a concern. We mentioned that the CapEx for our own company -- I think you are going to see other companies, other producers doing the same thing. I think you are going to see suppliers doing the same thing. I think right now there is just a very general concern over the availability of liquidity and those that have the facilities available and still have some legs before those facilities mature, are going to be in better shape than the ones that don't. So I think there are some opportunities out there for those companies that have more liquidity than others. Hopefully that addressed what you were looking for.

Michael Dallas - Jefferies

That does, and my final question is regarding just general maybe Rick, you could talk a little bit about what you are seeing out of Highland and the Illinois basin and relative to threat from PRB, and how well Illinois coal has been coming into the scrubber and possibly even keeping its export market share down through the South.

Rick Whiting

Well, most of those coals, as you know, that we have mined in western Kentucky pretty well stays in the region. Some of it moves down the river a little bit for export, some of it goes into the state of Florida, has historically. But an awful lot of it stays with four or five utilities right there in that same region, everything from TVA to E.ON. So we aren't seeing with our product line -- I'll just speak to that first -- a lot of coal moving into down into the Southeast yet. Of course, we have the lion's share of our production tied up with long-term contract with Peabody. That ultimately goes on to one of their customers, so that goes for another four years. So we don't have big volumes at this point to pursue those new scrubber markets in the Southeast. Anything we would do would probably be more brown field additions, we would have to bring on over the next two or three years as those markets materialize. So as Patriot we are not feeling any pain or seeing any negative impact from a market share being lost in any of the other regions including Powder River.

Michael Dallas - Jefferies

Thank you, gentlemen.

Rick Whiting

Thank you.

Operator

We have question from Wayne Atwell with Pontis Capital Management. Please go ahead.

Wayne Atwell - Pontis Capital Management

Thank you and good afternoon. I guess it's now turn to afternoon.

Rick Whiting

Good afternoon, Wayne.

Wayne Atwell - Pontis Capital Management

Sorry to beat this to death, but if we could talk about the purchase price adjustments, if you talked about some minor changes if prices change what you would characterize as materially either up or down, would you change those or are they pretty much set in stone with some modest tweaking?

Mark Schroeder

Good question, Wayne. They are set in stone, so those will not change. They are reflecting the market that existed on July 23, the date of closing. The changes and the tweaks in the purchase accounting would be to the extent we go through the valuation of the other items, the valuation of fixed assets for purchase property and equipment to the extent we go through that valuation of land, to the extent we fair value all the liabilities that are out there. Again, we've done that on a preliminary basis, but those are subject to some fine tuning. But as far as the sales contract accretion piece itself, it would only change to the extent that the overall purchase price to allocate would change.

Wayne Atwell - Pontis Capital Management

Okay.

Mark Schroeder

The values that we assigned -- the values that existed on July 23 do not change.

Wayne Atwell - Pontis Capital Management

Okay, and basically once again we talked about this a lot, but this was an effort when you closed on the transaction to bring the prices that were already booked and committed into line with the market as it existed. So if prices were, let's say you sold -- they had sold prices at $30 and the price was $50 so then you market it in at $50 and then you wrote up the difference over time.

Mark Schroeder

That is correct, it is measuring the -- I'll restate your example but if the market was at $50 on July 23, and the contract was at $30 effectively you would take that $20, set it up as a liability on the purchase accounting date and then accrete or flow that into the income statement as those tons ship. To the extent of $20 per ton. All of it is discounted, all of is tax effected so I don't want to go through all the math, but your overall example is a good example.

Wayne Atwell - Pontis Capital Management

Okay, thank you.

Operator

We have a question from the line of David Epstein with Advent. Please go ahead.

David Epstein - Advent

Hi. I might have missed it, but can you go through what you signed in thermal in Q3? You said nothing in October, but how much did you sign in Q3 and was it in September timeframe or July timeframe?

Rick Whiting

I'm going to use round numbers, but for '09 thermal -- total thermal booked in Q3 was around 600,000 tons.

David Epstein - Advent

Did you book a lot for 2010, 2011? What kind of prices did you book it at?

Rick Whiting

I probably won't get into the prices, I will just say this, we didn't have any backward dated pricing as I see here looking at the information I have. We booked for 10 and 11, we booked in the neighborhood of 0.5 million tons in each year for thermal coal.

David Epstein - Advent

Okay, thanks.

Operator

In the line of [Jacob Muller with AM Capital]. Please go ahead.

Jacob Muller - AM Capital

Hello.

Rick Whiting

Good morning.

Jacob Muller - AM Capital

Good morning.

Rick Whiting

Good afternoon, I guess Jacob.

Jacob Muller - AM Capital

Good afternoon. When you look at the, the Guyan has up to 3 million of met and 2 million of thermal, what is the low end of that?

Rick Whiting

Well in previous guidance and discussions of tons we have put like 1 million ton ranges, so in keeping with that I guess that would be a reasonable number to assume on the low end, one million off of any of the projections we've made. That should be a little tighter than that in the first year, but as you get further out 10, 11 maybe widen back out but that is what we -- instead of doing 1 million ton range and repeatedly doing that and having a lot of numbers on the page we decided just go it up to and certainly there is some potential it could go over that. But again, we are taking in the context of our capital considerations and everything we are looking at right now we continue to be reasonably conservative. But I would say 1 million tons lower would be a reasonable range to assume in that category, which is a pretty big percentage on 3 million. I realize that.

Jacob Muller - AM Capital

When you think about the unpriced met tonnage, keeping in mind that next year obviously is very hard to look at, what is the worst-case scenario on pricing when you think about your met tonnage for next year?

Rick Whiting

I don't know if I have a number on that. Fair off -- that up as far as any, I've got a little bit of an issue relative to pointing to prices. I would rather stay away from that question actually. Obviously I have a number in my mind but I don't think I should comment on that. But certainly I don't think there is anything from the supply side on hard coking coal that shows major erosion of pricing from the standpoint of supply. It is still very tight for all the hard coking coals in Australia and the U.S., and lowball out of the U.S. and highball, are getting increasingly difficult to get out of the ground for all producers. So I don't have any doomsday scenario, and I don't assume any huge erosion, if any. I guess that the absolute worst case is we couldn't move the tons at all, but that thought doesn't even enter our minds. I'm sorry to be a little bit elusive on that one, but all things considered I would rather not talk prices in public forum of uncommitted tons.

Jacob Muller - AM Capital

I am just asking when you think about the long-term outlook of the met coal market, they tripled this year in the international seaborne market. So is there any scenario where you envision that kind of reversing itself is really the question that I have.

Rick Whiting

I see a scenario that if tons can be brought online and moved through the transportation and port systems, then prices could come back to a level that would justify capital investment in long-term, long life projects, 5, 10 year type projects and some risk-adjusted capital return. To me that is where the numbers over time should make sense. Until there are enough tons to satisfy the appetite from a supply side I think it will be well north of that. But ultimately it should come back with many of the companies being investor held companies needing to achieve attractive returns, once again risk-adjusted coal mining is less predictable than manufacturing. So thus you are probably looking at returns well north of 15% would be kind of a guideline.

Jacob Muller - AM Capital

What prices would be needed to get that kind of number?

Rick Whiting

I think with the cost regime in Appalachia today it is probably well north of $100, I would say somewhere in the $125 plus range. Which is, I guess, half or less of where markets are today. But nevertheless, costs for high grade coking coal is rapidly moving up through the 70s and 80s, probably before long we will be nudging up against $90 and $100 per ton, short ton at the mine loaded in the railcar. That's an industry number I am talking about.

Jacob Muller - AM Capital

And how does that compare globally though? Freight rates obviously way down, so you are getting into lock with other markets as well here, right?

Rick Whiting

You got a lot of factors, certainly, with freight rates plummeting. That does open up the opportunity for the longer haul suppliers, such as Australia if they can get the coal out of the ground, to move back into some of the Atlantic markets if the demand were not there in Asia. So that is a huge variable that can impact the future flows, which have moved a lot directionally and going more to two separate basins in the last two or three years. That could have South African and Australian coal seeking markets if the appetite is not in Asia. I am convinced the appetite will continue to be there and be the most attractive market because it is the lowest freight for their products. But you are hitting on a very good point. Freight is another factor.

Jacob Muller - AM Capital

I don't think freight is sustainable at these levels either.

Rick Whiting

I can't see how people will be in business. I think there will be bankruptcies on the freight -- on the ocean vessel side, already are.

Jacob Muller - AM Capital

There was one just today, actually.

Rick Whiting

$9 and $10 rates. So that is not sustainable either. You are back to the same premise I am making; over time you have to make returns on your investment.

Jacob Muller - AM Capital

And one final question, when you look at your -- obviously your costs are very high in Appalachia right now, and maybe you've heard sort of -- obviously productivity were to move back up you would be looking at a $5 decrease at least in your cost of production or so? Where do you see your costs competitively compared to your peers? Where in the overall cash cost to production, which quartile do you see your company in? How much -- in other words, how much high priced, high cost production is you [allow] to that is kind of protecting you at this level?

Mark Schroeder

I guess it is a little hard to compare ourselves with others out there. We do have met and steam. We have different percentage of met and steam than others. We have different percentage of underground versus surface. That being said as a precursor I guess I would still say we are probably in the mid range or so. I don't think we are at the high end of the cost. I'm sure we are not at the low end of the cost. I would put us somewhere in the mid range of the overall cost structures that are out there. I know there are some with thinner seams, more difficult mining challenges that have a higher cost structure than ours. There are other operators out there that today enjoy a better cost structure because they are more of a surface operator. And I think when you combine all of it and combine the mix of our business with others I'd probably rank us somewhere in the mid point. We were certainly high this quarter. The production level just has a huge impact when you talk about the divisor here but it has a huge impact on the divisor when you're not getting the tons out of the ground, your costs just, they are not friendly numbers.

Jacob Muller - AM Capital

What was the dollars per ton, what was the exact amount in dollars per ton you would say the low productivity hit you this quarter?

Mark Schroeder

I guess I would answer by saying the second quarter in total we were at a -- I ought to talk Appalachia. Appalachia we were at $53 a ton roughly in the second quarter, and we are at $60, almost $61 a ton in the third quarter. The second quarter wasn't the greatest quarter in the world, but I will tell you the third quarter was a hell of a lot worse, and I don't know if $8 is the difference, but it is certainly something that second quarter is not an unreasonable number.

Jacob Muller - AM Capital

Thank you very much.

Mark Schroeder

Thank you.

Operator

And our final question comes from the line of Michael Lukacs with Appaloosa. Please go ahead.

Michael Lukacs - Appaloosa

Hi, how are you doing? What is the -- all the postings in letter of credit for?

Mark Schroeder

A number of different things, reclamation, self-insure on the workers comp side, those are probably the two largest. There is some OPEB post retirement benefit related obligations out there that we post letters of credit for that, as well.

Michael Lukacs - Appaloosa

And you funded through the P&L expense?

Mark Schroeder

Yes, we do. It runs through the interest. We are funding it at the LIBOR spread, and that runs through as an interest cost component.

Michael Lukacs - Appaloosa

And they also make you fund the LC? Where does that cash go? It comes as an expense, but you didn't include a cash flow statement on these numbers. Where does the cash go from that expense in the line? Does it go into a fund?

Mark Schroeder

No, it is not a funded liability. It is a cost that we pay a letter of credit fronting fee and a cost that we pay that is equal to the spread, but it is not funded, so it is not debt. It is not money that is paid out by us other than for interest.

Michael Lukacs - Appaloosa

But is that $30 million a cash expense? On the income statement?

Mark Schroeder

No, it is not near that much. It is 2.5% of $300 million on an annual basis.

Michael Lukacs - Appaloosa

What is the one for past obligations?

Mark Schroeder

That is roughly $31 million in the quarter, and that does roll through the operating costs and expenses line item on the P&L.

Michael Lukacs - Appaloosa

That is a cash item?

Mark Schroeder

Yes, it is.

Michael Lukacs - Appaloosa

Okay. And then can you speak a little bit about the pension? The pension, you are funding the pension for the parent or for your Peabody employees? Is the pension obligation Peabody's?

Mark Schroeder

The pension obligation is Peabody's, and Peabody retained those obligations, so that is not an obligation of Patriot. For UNWA individuals we are part of a pay as you go multi-employer, and we do pay those amounts. But for prior -- for Patriot employees today that were prior Peabody employees, Peabody held onto that pension obligation, so that is not an obligation of our company.

Michael Lukacs - Appaloosa

But you still pay payments to it?

Mark Schroeder

No, we do not. No, we have no pension obligation. We have no pension payments related to those employees. The only pension amounts that we pay are related to the UMWA retirees, and we pay that through the multi-employer fund.

Janine Orf

Michael, you might be talking about the post retirement benefits, which people often confuse with retirement.

Mark Schroeder

Okay, when you say -- I'm sorry, if you were talking about pension, pension we don't have any. If you are talking about post retirement benefits, that was a liability this company had of about $1 billion, $1.0 billion at our spin-off in October of ‘07. Peabody retained about $500 million of that obligation, and we retained the other $500 million. The expense related to that shows up in the line item called past mining obligations, and that is a cash amount. The expense related to the $500 million that Peabody retained is totally through Peabody's statement. It does not run through our statements at all. It is not a cash expense that we have.

Michael Lukacs - Appaloosa

Okay, and just to reiterate one more time because I -- it did seems a little confusing, as of the last call, I guess, as I was speaking to Mark Schroeder who was making these comments, you talked about that there was 6 million to 7 million tons open. And again, I just -- I don't know how we are getting to 134 for these numbers. If there was 6 million to 7 million tons open, that is purportedly means 3 to 4 orders was contracted this quarter. And at 134, like a caller had said previously, you would have to have like $50 contracts in there.

Mark Schroeder

Sure, Michael. The other piece of that was some of the tons that were the shortfall in the third quarter and the shortfall in the fourth quarter that eat into what we had available for those tons in 2009. So we are going to have some tons that roll over from 2008 into 2009, so that does eat into what we have available. If you are talking about --

Michael Lukacs - Appaloosa

What do you mean by that? You said you priced six and you had another three available at met. You priced six at 134 and you had three available, so what do you mean?

Mark Schroeder

That’s what’s remaining now, so we are suggesting that there is 9 million total tons that will be shipped in 2009, 6 of them which are priced now, three of which are not priced yet. And when we talked about in the last quarter what was available for pricing, it was a higher number. And what I am indicating is that higher number came down as you look at 2009 for those tons that would have been shipped in ‘08 and now we are going to be shipped in ‘09.

Michael Lukacs - Appaloosa

The pricing discrepancy still stands, though.

Mark Schroeder

They carry the pricing of 2008 into 2009.

Michael Lukacs - Appaloosa

Okay, so there is $50 coal now, $55 coal?

Mark Schroeder

There is coal that was priced in 2007 as an example that are part of those tons that we had planned to ship during 2008, that’ll actually ship in 2009, so they are going to carry over that pricing. I think the previous caller said something like a $43 number. There is nothing on met that low, but there is a combination of some lower-priced contracts plus contracts that we did most recently impacting 2009.

Michael Lukacs - Appaloosa

Okay. What is Magnum's under-funded pension, or what’s Magnum total pension gross number?

Mark Schroeder

Same thing on the Magnum site. If you are talking pension, Magnum does not have a pension. Magnum does have a post retirement benefit obligation, and that’s included in our overall number that is shown on the balance sheet. I think in total our number is somewhere around $900 million, and that’s $500 million, roughly, of Patriot and about $400 million or a little less than $400 million of Magnum. So again, it’s not pension. It’s post-retirement benefit, but it totals about $900 million.

Michael Lukacs - Appaloosa

Okay, and what is the best way to look at those -- the working -- in terms of your liabilities and your balance sheet, your asset retirement obligations, and you know the workers comp line, that plus the LCs is a total obligation? Or is that double counting?

Mark Schroeder

Well, the LCs, again, are not -- they are not an obligation. They are not funded. It is a credit enhancement that is applied to a whole, to, I guess, give some backstop so that if we do not pay the liabilities as a credit enhancement availability that would cover it. So I think you need to look at just the total liability amount that’s showing on the balance sheet and not include the LC amount.

Michael Lukacs - Appaloosa

No. I reckon that -- that’s -- but it obviously drains, pulls away from your liquidity and in the event of a bankruptcy, it is a funded obligation.

Mark Schroeder

The $500 million facility that we have has roughly $330 million of LCs, so it does pull down the $500 million by that amount. That leaves us with a number I mentioned earlier, somewhere around $165 million of availability under the revolving credit facility. So you are right, it does pull down the $500 million. It’s not funded, but it does eat into the capacity available on the $500 million such that we are to a point of around $165 million of availability today.

Michael Lukacs - Appaloosa

Okay. Thanks. And can you guys include a cash flow statement going forward?

Mark Schroeder

Yes, we will continue to look at that, sure.

Michael Lukacs - Appaloosa

Alright, thank you.

Mark Schroeder

Thanks for your questions.

Operator

And no further questions in queue. Please go ahead with any closing comments.

Janine Orf

Yes. We appreciate you all taking time today to listen in on our call and look forward to speaking with you again next quarter. Thank you.

Rick Whiting

Thank you every one.

Operator

Ladies and gentlemen, that does conclude your conference for today. Thank you for your participation. You may now disconnect.

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