James River Coal Company Q3 2008 Earnings Call Transcript

Nov.24.08 | About: JAMES RIVER (JRCCQ)

James River Coal Company (JRCC) Q3 2008 Earnings Call Transcript November 6, 2008 11:00 AM ET

Executives

Beth Cook – Director, IR

Peter Socha – Chairman, President and CEO

C.K. Lane – SVP and COO

Analysts

Jim Rollyson – Raymond James

Michael Dudas – Jefferies & Co.

Jeremy Sussman – Natixis Bleichroeder

Luther Lu – FBR Capital Markets

Justine Fisher – Goldman Sachs

Mark Caruso – Millennium Partners

Operator

Good day, everyone and welcome to the James River Coal Company Third Quarter 2008 Earnings Conference Call. Today's call is being recorded. At this time for opening remarks and introductions, I would like to turn the call over to the Director of Investor Relations, Ms. Beth Cook. Please go ahead.

Beth Cook

Thanks, Kim, and good morning. Welcome to James River Coal Company's Third Quarter Earnings Call. We released our earnings today and our current release is posted on our Web site and was furnished to the SEC on the Form 8-K. As we noted in our press release, we will be using an updated slide presentation during our prepared remarks. The slides have been posted to the Company Web site and furnished to the SEC on an 8-K.

With me today on the call, our Peter Socha, Chairman and Chief Executive Officer; C.K. Lane, Senior Vice President and Chief Operating Officer; Sam Hopkins, Vice President and Chief Accounting Officer; and Jim Ketron, Vice President and General Counsel.

Before we begin this morning, I need to remind you that this call will contain forward-looking statements. These 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 Annual Report on Form 10-K and other SEC filings.

Now, I will turn the call over to Peter.

Peter Socha

Thank you, Beth. Good morning, everyone. I hope everyone survived the election and the wall-to-wall coverage of the election. Before we begin I have gotten several questions this morning and I am certain that Justine will pin me to the wall on this so I'm going to say a couple of opening comments on the waiver and amendments that we did. They were still being done. One reason why there was not quite as much specificity in the press release is that they were still being done. The last e-mail that I saw were at quarter one this morning. But they are in essence is a -- particularly on the letter of credit facility, it is a double waiver, it's a waiver of September, it is a waiver of December.

On the revolver, it's a waiver and then it's an amendment but as a practical matter, they are very, very similar. So we are pleased to get those done. They were finally done just a couple of hours ago and we are very happy for our ability to work with the lenders -- to continue to work with the lenders and to get us well into next year where obviously we are looking at a much brighter picture.

Today I'm going to cover the market overview and contracting, C.K. will cover the operations and then we will both do Q&A.

On the market overview, there are a lot of mixed messages coming from the market and they are hard for all of you to read. They are hard for us to read, but I thought I would talk about a couple of the ones that I have noticed anyway. We'll talk about a little bit about supply, demand and exports, inventories in our neighborhoods of the Southeast and then a few conclusions that we have.

On the mixed messages, this is just really interesting. We looked at China and China has obviously slowed and we certainly saw the Arcelor announcement on steel production yesterday. China has certainly slowed. Their last reported numbers were down from 11% to 9%. But as we have talked about on calls in the past I think, but certainly in conferences that we have webcast one data point that I look at very closely in China is the fixed asset investment number. To me that is steel, that's highways, that's power plants, that's trains, that's airports, it's the big stuff that uses a lot of energy, the metallurgical coal or thermal coal and that is where they are using their foreign currency reserves.

And I looked at that and what caused this was I looked at the June number and I looked at the September number and the year-to-date between June and September had actually gone up indicating that between in that period that their fixed asset investment had actually grown up by a fair amount. So that's a mixed message.

We look at the coal stockpiles at ARA in Europe. They are obviously high, but then we read about India, India has 77 power plants and they are down to last number I saw was just over 4 million tons of coal. So probably less than Southern Company carries just by themselves.

Some regions of China we've got some reports that their electric generation is down year-over-year primarily the regions that are export-driven, that are manufacturing and export-driven. But the Vice Chairman of I think Shanghai Electric did a presentation last week indicating that they are still on track to grow their grid by 300 GW within the next couple of years which is a tremendous amount of growth in thermal demand within China. So again, a mixed message.

This next one on U.S. generation, intuitively, you would think the generation would be impacted by a recession. I think most of us would agree that the economy has slowed and we are probably in a recession. So intuitively you would say, okay, well, generation is going to slow down. But we follow AEP and we follow Southern Company for obvious reasons.

AEP, because it covers that whole Midwestern -- a broad swap across the Midwest that we look at. And if you look at their generation this year and you look at their generation in the third quarter of 2006, it's flat. It's down less than one half of 1%. So their generation has not really come off.

Year-to-year comparison I think is interesting, mainly because it's weather-related. In the case of Southern Company, their degree days were down by I think 12% and AEP was 20% or 21%. But just comparing 2008 to 2006, they are basically flat on generation. So again, just something that is a difficult thing to read.

We were doing if you remember our slides from the second quarter call, we had a year-to-date EIA production for Central App. Beth and I were looking at the data on that the other day and it just shows an absolute spike in the third quarter. It just goes vertical on the year-to-date and we both were a little bit perplexed by that. And so what we did was we went and looked at -- we knew that there had been 10 force majeure notices issued, 10 from the major producing companies in Central App had issued 10 force majeure notices.

So we knew that production was down and then the public company reports started coming out. So Beth and I just looked at, okay, of the public companies, what has happened with their production for Q3? And it's actually down 1.2 million tons year-over-year, Q3 to Q3. And yet EIA is showing a positive 5.7. So we are trying to sort out where the differences are there.

And then this last message is on exports. We get asked this question probably more so than any other and that is what will exports be in '09? If exports stay strong next year the U.S. market probably stays tight. If exports ease off, then the U.S. market probably softens up a little bit, from a supply and demand, not a pricing but from a supply and demand. Pricing is a whole other issue. We will talk about that in a minute.

But what I thought was interesting on the Norfolk Southern call, Don Seale, from Norfolk Southern was very specific that their exports actually accelerated in September and October. That they were up year-over-year and the quarter -- third quarter to third quarter by quite a bit. But in September and October, they accelerated even more.

So we thought that was a very interesting comment. But that they may only shift met coal, but it is coal leaving the U.S. that retains tightness in the U.S. So those are the things that we look at as we try to do our sales and marketing and we try to do our contracting and try to sort out what are we going to do both for '09, '10 and '11.

Turning to the slide six I guess it is. Supply to us appears to be flat even though all year we've had prices that have been way, way, way above historical levels. And ordinarily, you would see a supply response. We haven't seen that response this year. And we think that there is certainly a message there to the market that we have an inelastic market.

Domestic demand does appear to be down a little bit. We'll talk about that in just a minute and then exports appear to be stable, but they are stable at a very, very high level.

Turning to South Atlantic inventories, you can see -- the green line there is it doesn't have any seasonality to it at all, but that represents roughly 35 days to 40 days in the South Atlantic. So you can see which would be target for most of our utility customers that would be target. So you can see that we are quite a bit below what they would consider to be target just channel checking we would agree, we think that maybe it even be a little bit lower than this.

But you can see there has been a little pick up here in the last couple of weeks. We think partially that may be some of the EIA data issues that I mentioned earlier. And then also we've had a very cool August and September. So there was probably a little bit of a downturn in demand during that period.

On contracting, challenges, challenges we have. We certainly caught the top. If you look at what we did and July, the swaps, the financial swaps have just plummeted since July, but the physical market that we live in every day has not changed that much. Inventories continue to be tight, supply continues to be flat to down and demand continues to be okay. But the financial trades have really come off by quite a bit.

So the way we look at it, the way we distinguish what is happening is we believe and we've spoken to a number of people about this, the four largest players who trade coal contracts because of credit restrictions have all been reducing their books and so, you have this excess of sellers, you have very few buyers, and we think that has pushed down the actual contract prices, the financial contract prices.

What's interesting is -- I was looking at some of the European prices yesterday and just it looks like Europe put in a bottom or at least the European prices put in a bottom last Monday, we're up about 23% or 24% since that time. So it appears as though the real physical borrowers are coming back into the market. We have gone from -- on the API4 which is South Africa, we have gone from $90 to $110 just since last Monday. So that's something that we are watching very closely. It certainly will have an impact on U.S. pricing.

As I mentioned, our physical market remains very tight. The biggest problem we have right now with our customers is price discovery, because you have financial prices that are reported that are very low and you have a tight market and so the utility for obvious reasons, the utility will want to buy at the lower financial price and yet we look at it as a very tight market.

So those discussions are always very interesting and it creates problems for both sides. It creates problems for the utility, because they are regulated entities and they have to answer to state regulatory bodies and so they would have to answer for why they were buying coal for greater than reported market prices.

One interesting note on that did come out last night. A Japanese utility was reported last night; a Japanese utility just did two-year contracts at $24 above the reported prices, above the financially reported prices. Arch apparently came out -- I haven't seen them yet -- but Arch came out with some slides yesterday I think showing very similar type results.

Our view of 2009 is actually very simple and that is we think that demand may fall, you will get some fuel switching from coal to gas. We've seen a little bit of it, not much, but we've seen a little bit of it. And then we do have the weak economy. So we think we may see some back-off of demand. I am 100% convinced that we will see supply come off by more than demand comes off.

If you look at regulatory, we've seen it from all of the other companies; C.K. will talk about it in just a moment. It appears as though the regulatory environment that we work in today has reduced productivity somewhere into 10%. I've heard 10% and 12% mentioned. We probably would not disagree with that.

On the permits, nothing has been resolved on Chambers. The hearing was at the end of September. I was not able to attend the hearing, I wanted to. I have listened to the audio of the hearing a couple of times and we can talk about that during the Q&A if you like.

Labor, C.K. will talk about. Credit constraints for most of you who live in the financial world, you understand what this is doing. It is certainly impacting the mining industry. Had a long conversation with someone yesterday connected to the bonding part of our industry and they are absolutely seeing an impact. So we think that, that could impact production in 2009. It will; there is no question in my mind it will. The only question is the magnitude of the impact.

On our results on the contracting, we -- last year, if you recall at this time we did not have a lot of Central App coal contracted. By the time we came out with an update in the first week of December, we had written a fair amount of contracts. We are very similar to that this year. We are in conversations with the utilities. We have a meeting this afternoon with one of the utilities and we will see where they lead. We have not reached any conclusion on them yet, but we are in conversation. But it is very similar to what happened in 2007.

In the Illinois Basin, we did lock up. We were very successful. This was throughout the period. This was not necessarily early in Q3. There was one contract within this group that was reached recently and you can see that we locked up 725,000 tons at an average of $64 and this compares to just a little bit less than $31 last year. The prices in the Illinois Basin as we have said before publicly, they have firmed up and now we are certainly able to demonstrate that through the contract book.

With that, I will turn it over to C.K.

C.K. Lane

Thanks Peter. I will talk about a few things in the operations that we are focusing on. First, I want to talk about is safety. We continued to have a good year this year, improved over last year. We use an industry standard NFDL rate and through this year, we are at a 2.64 NFDL rate, last year, we were at a full-year of 4.42 so our safety continues to improve. That number is below the national average.

We were also pleased that we had two of our mines win the Sentinels of Safety Award. It's one of the most distinguished safety awards that's given out. Our Blue Diamond Coal Company Mine #77 received the award for large underground category and our Triad Mining Freedlandville East received the award for the Small Surface Mine category. And this is the second time that Freedlandville East has won the award. They also won in 2005.

In District 7, industry gives out awards along with the Kentucky Cabinet for safety and our Beechfork Mine at Bledsoe Coal Corporation won that this year at the Kentucky Coal Association Meeting back in October. So safety continues to be one of our main focuses and results this year, we have been very pleased.

On the labor side, as Peter mentioned, labor continues to be tight and impact production. In the quarter, we were able to hire a new Senior Resources Manager in September, he will be reporting directly to me to help on the labor side. We are getting more aggressive on our recruiting using billboards, our Web site and various employee bonuses. And we are also focusing a lot on our retention of our employees and training and we have training classes set up for electricians, foreman, welders, medical technicians.

And the thing that we are doing a little different there in that is instead of trying to send these folks to class at night after work, we are taking them out of the workforce for a week and sometimes two weeks at a time and sending them to a class to stress the importance of going to the class and making sure they get through it. So a little bit different there.

We are continuing to have anywhere from one miners to four new miners at each mine. These are folks that are extra on the payroll that we are training to run equipment, shuttle cars, roof volters and continuous miners. And we are also working a lot with our employees on trying to communicate with both the employee and their spouses in communication meetings to keep them aware of the things going on in the company and things they can do to help. So a lot of focus on safety and a lot of focus on labor at this point.

As far as last time we talked about some of our projects, to give you a quick update of those, at Log Creek, we have begun the engineering and site preparation work and we have also started some surface mine development for Log Creek and we will start surface mine production early next year at Log Creek.

On the metallurgical mines at McCoy Elkhorn, we are continuing to work there. We would expect the first company mine and the first contractor mine to open up in December this year with production ramping up early in the first quarter of next year.

At Montgomery Creek, that's the Cheyenne resources property that we purchased. We did start production there, we were delayed on approval of the ground control plans that has to be submitted to MSHA, but production continues to ramp up and we should see full production at that operation in the first quarter of 2009.

We changed our product mix a little bit at our Shamrock operation. We were able to add a Stoker Plant Modification to that plant in September. It was about $150,000 capital investment and we expect about 10,000 tons of Stoker production per month. That basically is about a $50 premium to our normal steam coal that would have come out of that plant.

Just in summary, again, we talked about labor and the regulatory issues. As Peter mentioned, they continue to have a huge impact on production much like the other operations in the Central App region that we have talked about it. I agree with Peter, we are seeing that 10% to 12% impact to productivity there.

On the underground operations in the quarter, we did have lot of issues on a couple of our mine on roof control and still the issue with building seals, we had one operation that had to construct seals again this quarter.

Labor market remains tight especially for skilled positions and the electricians and continuous miner operators. On the surface mines, we had two mines that were impacted by the ground control plans and a change in the policy on that. And we still see pretty high raw materials costs, but we do see that dropping some. Diesel now is down to below $2.50 a gallon and that continues to drop with the change in the oil so that will be a positive impact on our costs.

And with that, I will turn it back over to Peter.

Peter Socha

Okay, Kim, we'll take -- if you have any questions, we will take them.

Question-and-Answer Session

Operator

Thank you. (Operator instructions). Our first question is from Jim Rollyson from Raymond James.

Jim Rollyson - Raymond James

Good morning, Peter.

Peter Socha

Good morning, Jim.

Jim Rollyson - Raymond James

Peter, you didn't give us a cost bridge this quarter. So, first question, probably one of the most important I guess is, is cost in Central App you kind of noted in the press release, you had some particular unusual issues, but the things seem to be maybe normalizing back down to what they should be plus or minus what's going on with raw materials. You were thinking -- you have been running in the upper 40s; you have been guiding in the upper 40s. Kind of thoughts on where this normalized cost number goes out to? I guess as it looks forward to fourth quarter particularly next year, and I recognize that --

Peter Socha

I think -- yes, we will come out with guidance. We are in the budget process now. We have gone through two iterations. We have shared it with the Board so we will come out with cost guidance here probably before the end of the year. We are certainly -- right now we are down below -- first of all, you got to back out the $1.50 or $1.80 or something like that of incremental royalties on the 58. So back that down, so you are at say, 56. We are down below that now, we are quite a bit below that. But the productivity is definitely an issue right now. So we will have updated guidance. It's somewhere between -- right now what we are seeing is somewhere between our previous guidance at this quarter. As C.K. said, we had the seals issue. At Montgomery Creek or at the Cheyenne, we had an awful lot of moving around of dirt.

You would think that when you buy a property and it has a permit that you would go onto it and mine under the existing ground control plan that would not be an issue. What happened was because it is a change of operator, they then start you back, it's like going back to zero. So you start with as though there was not an operation there and then you have to build your way back up to a ground control plan that is from our standpoint would be a little bit easier to work with. And so there was an awful lot of moving around of dirt there. You're right, we did not do the bridge and maybe should have, but between that and the seals, you probably got another several dollars. And then as you well know, oil and diesel and everything else was actually pretty high for most of the quarter.

Jim Rollyson - Raymond James

Sure. How much of those things do you think are recurring problems versus some one-off issues?

Peter Socha

Well, the ground control plan we pretty well got that -- we have one approved. We are working under it now. We have moved all the dirt so that's nonrecurring. One thing we did try to emphasize both on the slides and in the press release is right now we are kind of in a steady as she goes mode. The acquiring of Cheyenne and getting the new ground control plan, well, it was approved. It's not entirely to our liking, but we will get there. We will demonstrate to the regulators that this ground control plan that we want to do is the right one.

The seals, those were built. We lost some shifts. Those were built and they are done. The roof control, we are using a bit more on the longer bolts, the cable bolts now, but steel is coming off. So as you and I usually talk about on these calls, you get one thing pushing another way, pushing one way and you get another thing pushing another way. The cost of the steel is coming down, but we are using a few more of the longer bolts than we have in the past. So recurring, there is not a whole lot that was recurring within the third quarter numbers, Jim.

Jim Rollyson - Raymond James

So I guess if you had to peg fourth quarter and then we will look at '09 when you get the guidance, but fourth quarter numbers (inaudible) handle for costs and so forth?

Peter Socha

I don't want to go there, Jim. I don't want to get into – it's hard enough and some companies don't do it at all. It's hard enough giving annual guidance on things like costs given the high fixed cost ratios of the business. But when you get into doing quarterly cost estimates, it gets even that much more difficult, if the facts are greater.

Jim Rollyson - Raymond James

Okay. On the --

Peter Socha

We are operating. I think it's fair to say right now we are operating on pretty much a steady as she goes basis.

Jim Rollyson - Raymond James

Okay. On the contract side, you kind of laid out this picture of demand may be slowing down a little bit because of the economic picture and the credit crisis and what not. But at the same time obviously you are pretty bullish on some support on pricing from the supply side falling. I guess my question would be, you didn't add any volumes in Central App during the quarter and it seems like your scenario would suggest maybe better support to pricing than what the market certainly implying in stock prices, but not necessarily -- think it's probably not that likely you're going to see a big upward movement in price in this environment either. So with that being my thought process, why wouldn't you lock up more of your coal? Or I guess you're starting to -- ?

Peter Socha

Stock prices are just disconnected, not just our industry, but across the whole economy, stock prices are just disconnected. You're right. I do think that demand will fall and I -- and you've done a study on this so you are aware of it. There is not a lot of correlation between the economy and coal fired generation. There just isn't if you look at it statistically. But I will concede the point. I will say, okay, the economy is soft in '09. Coal generation is soft in '09 and then you have some met gas switching. So let's say that from Central App, if it's a 200 million ton basin, maybe we lose 10 million tons, maybe 5% off of generation, off of demand. I have no problem at all getting to a number that's greater than that off a supply base. You look at a 10% to 12% drop in productivity off a 200 million ton base, there is 20 right there.

You've got some companies that are in these major growth modes, okay, so you're going to have some add back on that. You've got labor that is still tight, but that's going to have an impact and then you've got the credit crunch. The issue of the credit crunch I think could be easily be as great as on the permitting or on the -- on productivity. And on the permitting side, you've got half of Central App production that comes from surface mining or 46% whatever the number is. And no permits, virtually no permits have been issued in the last 18 months. So as people run out of opportunity to haul things a longer distance, you start to see mines that are just no longer economical particularly as the swaps prices have fallen off, have gotten soft. That actually takes a number of these mines and makes them uneconomical.

C.K. made a comment to the Board the other day it would not be a bad thing at all for us to see prices soften further given our contract book for next year. I mean you've heard me say this before. I love our book for next year. I just absolutely love our position for next year, but I am not going to go out and try to sell out everything I have for next year at these prices that I think have been pushed down. You've got the four big players that are over half of the swaps business and they are all either reducing or eliminating their book. They are pushing them down materially.

And so you just have a lot of trading but you have a lot of trading to the downside and the physical world hasn't changed that much. So I don't feel like I need to chase the prices down or the prices -- the question the real challenge is were the higher prices of the summer an anomaly, because you had a lot of these financial players bidding against each other into a thin market. Or are the prices now the anomaly because they are all trying to get out of a crowded trade? But the real world that we see everyday, there is less coal being mined, the coal that's being burned is kind of okay, it's flat to down a little and the stockpiles are very low. So how do you rebuild the stockpiles?

Jim Rollyson - Raymond James

Right. I guess on the met side, since you actually are now -- will be involved in that market. I presume you are a little bit of -- your 500,000 tons of met is going to go domestic. And obviously, other guys are signing up that coal today and over the last few weeks. Would you suspect you guys will get involved in negotiating those contracts fairly soon or (inaudible) -- ?

Peter Socha

Yes, we are involved in those right now. Because of the production schedule, we are involved in those right now.

Jim Rollyson - Raymond James

And based on the range of --

Peter Socha

And you are right about domestic, you are correct about domestic.

Jim Rollyson - Raymond James

And I guess if you look at the range of what people have been signing up domestic met, it is obviously quality dependent, but we have kind of seen maybe a lower 200s on the lower-end and as high as north of 300. Assuming this is pretty much the lower-end of the curve it's high vol --?

Peter Socha

I don't even want to comment on it yet. Until we have something booked that I can -- it's kind of like with the Illinois Basin, we could say that prices were up, we could say that prices were tighter, but until we could come out and demonstrate to you and demonstrate to our shareholders, this is what we've actually done, I'd rather wait on it.

Jim Rollyson - Raymond James

Okay. And last just little easy question and I'll let somebody else ask questions. Diesel has come down. Where are you guys on the potential for hedging?

Peter Socha

Well, I would love to -- right now -- and I think we will -- I would love -- we don't have the balance sheet. To do hedging now you got to have the balance sheet and you got to have the capital access and things like that. That's Q1 thing for us. And I would give anything to have diesel prices stay where they are through Q1 so that we could hedge. But right now we do -- we hedge through, as you know, we hedge through the sales contracts in Indiana, but I would -- we burn 700,000 gallons or 800,000 gallons a month. I would love to take another -- and third of that is hedged or 25% of that is hedged, I would love to double what we have hedged, but that's a balance sheet issue.

Jim Rollyson - Raymond James

Yes. Very good. Thanks, Peter.

Peter Socha

Thanks, Jim.

Operator

And moving on our next question is from Michael Dudas from Jefferies & Co.

Peter Socha

Mr. Dudas!

Michael Dudas - Jefferies & Co.

Peter, C.K., good morning.

Peter Socha

I will try to be shorter with you, Mike. As you and I have talked about before, sometimes I can't find a period.

Michael Dudas - Jefferies & Co.

You Pete? Come on, seriously. Two things, first, you did a very good job laying out some of the issues in Central Appalachia going into 2009. Just maybe on a general basis, will the market be surprised by a much tighter U.S. market in 2009 or will they be surprised by the fact that the global export market has declined dramatically and coal will be coming back into our shores?

Peter Socha

Oh gosh, what a great -- I can't do that on a short answer, Mike. I just can't do it. Genetically impossible. I think the world market -- let me talk international first. I think that India is going to be the keystone. This is my own view. India will be the keystone to what happens on the world market. You've got -- as I said you've got 77 power plants, 55 of them have less than seven days of coal, 30 or somewhere in the 30 range have less than three days of coal. They really let it run down by quite a bit. And so if they start taking much more of the coal from South Africa which it appears that they are doing -- if you just look at the last week, India was authorized to import 20 million tons for the year; the first six months they only imported five. Primarily, price related because the prices have gotten so high. Now it appears as though they are reversing course and they are trying to build up their stockpile. If that happens and you've got ARA starting to draw down as they head into the winter season into the heating season, then you've got competition for coal.

You've got India and Europe both competing for coal from South Africa. And then it gets interesting on what happens on that dynamic. As I think you know, I'm going to India to talk to some people just to learn more about it, because I think it will have such an impact on the U.S. market and on pricing and this kind of gets to Jim's question and that is do you lock everything up? Do you hold something back? What do you do? And this is similar to the trip to Europe that we did last year where we got there and we found out there was no coal at all, no where. And that's when we held out and held out and everyone called us and called us cowboys and fools and idiots and everything and ultimately it turned out to be the right decision. So I really want to get a sense of what's happening in India.

On the U.S., I think people will be surprised. I think we are in a new period of volatility, Mike. And I think people will be surprised at how quickly production comes off line next year, particularly for the 1 million ton, the 2 million ton guy. With the credit markets the way it is right now, that guy doesn't buy equipment. He typically leases equipment. Well, we've talked to leasing companies. They are not writing a new lease this year, the remainder of 2008. And who knows what they will do in 2009 so they can't lease equipment. To do surface mining, they've got to have bonding. Well, they can't get a bond with any type of credit anything other than cash. If they use contract labor, the contract labor company they are using needs a bond for workers comp usually. So it just -- it permeates everything that they are trying to do. And then you've got soft prices. So you have this scenario where the guys are selling into a falling market and these are the folks who don't have the contracts the way we do or the way that Alpha does or Massey or whatever. They sell to us.

If you noticed in the press release, purchase coal for us last quarter went to nothing because the prices were so high we couldn't pay it and then turn around and flip that coal at $62 or $54. That's reversing. C.K. and I were talking about it this morning, that's now reversing where we are getting offered the purchase coal. But I think the U.S. market I think we could be surprised by how quickly supply comes off line in '09 if the permitting situation stays the way it is and if the capital markets stay the way they are. I think that may be the surprise.

Michael Dudas - Jefferies & Co.

I appreciate that, Pete. Thank you.

Peter Socha

Sorry to go long-winded on you, Mike.

Michael Dudas - Jefferies & Co.

Great, thanks.

Peter Socha

Thank you.

Operator

Moving on, our next question is from Jeremy Sussman from Natixis.

Peter Socha

Good morning, Jeremy.

Jeremy Sussman - Natixis Bleichroeder

Hi. API4 pricing going from 90 to 110. Is physical coal starting to go back into the market? Have you seen anything specifically yet either for you guys or in the U.S. with the Europeans coming here?

Peter Socha

Not yet, not yet, there was a flurry -- last year if you recall last year, it just popped out of nowhere and it popped out of nowhere really after our conference call last year. So that was kind of interesting. Their stockpiles are higher this year. And so we haven't seen it yet but we are more of a -- we are kind of third level here as opposed to an Alpha or Consol [ph] really which sells directly into Europe or the European sales office.

Jeremy Sussman - Natixis Bleichroeder

But you think it will come at some point?

Peter Socha

I don't know, Jeremy. I think that if you listen to the railroads, a lot of what was done last year were multiyear contracts and so I think that if we keep the exports at those same levels, that's a good thing. Whether or not we sell any more next year I don't know, I tend to think not. For one thing, they are shorter term contracts for us and I am not really interested that much in doing a one-year contract or a six-month contract. Everything we do now I'm trying to stretch out into '10 and '11.

Jeremy Sussman - Natixis Bleichroeder

Sure. That definitely makes sense. In terms of a marginal cost in Central Appalachia, I'm trying to get a sense of maybe where floor pricing could go before a lot of tonnage comes off line. I guess where -- how should we be thinking about that here?

Peter Socha

I don't think pricing will be the driver of supply. I really think it will be the labor permitting, regulatory and credit markets. I don't think pricing itself will be it. I don't know if we are at the pricing level right now or not. We're certainly a lot closer to it.

Jeremy Sussman - Natixis Bleichroeder

Right. Makes sense. And then obviously you guys didn't really sign any CAPP coal this quarter, but in terms of just what you are seeing out there in general, what are the latest physical prices out there for term business?

Peter Socha

We are -- I am not kidding, we are having conversations today with some of those customers. So -- and they listen to these calls just like you do. I hate to put us in an awkward position.

Jeremy Sussman - Natixis Bleichroeder

Fair enough, fair enough.

Peter Socha

Anymore than we usually are.

Jeremy Sussman - Natixis Bleichroeder

And then you mentioned natural gas switching next year. What's the potential size of that market that you see?

Peter Socha

The highest number I've heard is 2b a day which would be 30 million tons across the U.S. so it'd be 2.5% to 3%. I am probably not in that category. I am probably a little bit in 1 to 1.5b a day. But what surprised me -- I had dinner two weeks ago with several gas companies and drilling companies. I mean these rigs are laying down, as soon as they are finishing these holes, they are laying the rigs down. On the shale plays, they will have good production next year but the following year on their curve, based on their curve, you could see firming prices late '09, early '10 on the gas. But I was very surprised. It kind of reminded me of the -- not at the time, but certainly today of what happened with Middle yesterday where they just came out and said we are slashing steel production. And that's what these drilling -- these E&P companies are doing. They are just slashing -- they are saying finish the hole and then take the rig somewhere else. We don't need it.

Jeremy Sussman - Natixis Bleichroeder

Right, right, no, makes sense. So you are probably more in the 15 million ton to 20 million ton?

Peter Socha

Yes, across the U.S.

Jeremy Sussman - Natixis Bleichroeder

Right, right.

Peter Socha

Across the whole U.S. That's less of an impact in the Southeast but across the U.S.

Jeremy Sussman - Natixis Bleichroeder

Sure. And then lastly, you said you listened to Chambers. I guess how is that going to play out?

Peter Socha

I did. The first time I listened to it and the first -- it's an hour and a half. The first 45 minutes it was pretty depressing. And then the second time I listened to it in the second 45 minutes -- I think the bar is certainly higher that's not going to change. You just have to do more to get a permit. It costs more. We are certainly seeing that in engineering costs and things like that. But it seemed like what they were saying was what to the -- or what they will say to the core is you have to delineate things like structure and function of a stream. It was -- the way that the core was doing it on those permits was it was almost merged together into one section and they were saying -- the judges were asking a lot of questions about we really want you to look at things separately, we want you to look at them and clearly identify them. How you analyze it, why you decided to go the way you did. So I came away a little bit more optimistic. I don't want to handicap which way I think the judges will go, but it was very interesting. It's very, very interesting. But the bar is raised. The bar is raised today. What we have to do today and what everyone else has to do today to get a permit is a quantum leap above what it was in the past. And I think it will remain so no matter which way the appellate court rules.

Jeremy Sussman - Natixis Bleichroeder

Great. Thanks, Peter.

Peter Socha

Okay. Thanks, Jeremy.

Operator

(Operator instructions) Our next question is from Luther Lu from FBR Capital Markets.

Luther Lu - FBR Capital Markets

Hi, Peter. How are you?

Peter Socha

Hi, Luther. How are you today?

Luther Lu - FBR Capital Markets

Good. Good. I want to ask you a few questions on the supply issues you mentioned. If you think that the production will fall off due to credit constraints and regulatory issues, why not wait hiring the new labors? Can't you just pick up the guys get laid off?

Peter Socha

Well, C.K. and I -- I will tell you the whole credit issue and everything has really come up at least in my mind within the -- I know it's been out there for a while, but the impact on the mining industry it's really gelled in my mind within the last couple of weeks. And C.K. and I have not had a chance to sit down and just over a pitcher of beers and talk through it. I think that if production comes off, I think you will see greater availability of labor. The issue for us would be with some of these smaller companies -- and I will let C.K. give his view of it -- with some of the smaller companies they are not -- they may be working there because they used to work here or they used to work at one of the other companies. So I think -- I don't know that it will loosen up the labor situation as much as -- it wouldn't be a direct correlation where, okay, there is 500 people that are no longer working at smaller companies or capital constraint companies, therefore, there is 500 more for us to go out and hire. C.K., what do you think?

C.K. Lane

I think it's really two issues. One, I think if some mines do close or if the economy does go down, there may be physically more people that you can hire from, but it's still a question of skilled laborers and getting skilled laborers on a second shift is still our biggest challenge.

Luther Lu - FBR Capital Markets

Okay.

Peter Socha

Luther, I could see some of the pressure coming off of the labor, but the skilled positions there is still a shortage. As C.K. said, there is still a shortage of skilled positions.

Luther Lu - FBR Capital Markets

I see. Okay. And then on the --

Peter Socha

Don -- if you remember, Luther, Don alluded to it a little bit on their call about labor loosening up when someone asked him a question about his cost guidance for next year.

Luther Lu - FBR Capital Markets

Okay. Okay. Well, and then on the surface mining issue, how much production do you think will come off because of this lack of permits? And also if you look at the Chambers recent moves, it seems like every time the coal companies said, well, if you do this, then all these people would be out of jobs and then he partially stays the permits -- ?

Peter Socha

Yes, I thought it was interesting how he worded that order and also apparently how he said in court which is in essence -- I'm going to paraphrase it here. Coal is very important to West Virginia. And nobody is going to get a clear win here. Can't you all just work this out? And I will give you the time and the space to work it out, but coal is very important to the state of West Virginia. So I think in that particular case, it was so important to that county that, that was almost like a microcosm. But I think that there is some recognition of the importance to the economy of West Virginia and Kentucky, for that matter. I agree with you completely. How much comes off? I don't know. Right now I don't know. I do know that there have been virtually no permits issued a year and a half and even if the appeals court were to rule completely in favor of the Corps of Engineers, you are still looking at probably a one to two to two and a half year period just to work through the backlog.

Luther Lu - FBR Capital Markets

Okay. So in other words if in January the decision comes out of (inaudible) circuit court is in favor of the producers, then you are talking about maybe a short-term hiccup in production -- ?

Peter Socha

Yes. I don't -- right now I do not expect this -- your partner was at the hearing so he probably has a better feel for it than I do. But I think it's longer than short-term. I think because of the bars that have been raised, if there is a backlog of permits now, we don't know how many of those permits in the backlog will meet the new requirements -- or do meet the new requirements.

Luther Lu - FBR Capital Markets

Okay, I see.

Peter Socha

So it's not just a matter of okay, we are going to start with the stack and work our way down. I think it's probably a little more involved in that.

Luther Lu - FBR Capital Markets

I see, okay. And then finally switch gear a little bit on the export stuff. How is the trains coming along nearby your office?

Peter Socha

Trains have been fine for us. Trains have been absolutely fine. Every time I hear comments about the trains, I always have to call the people who are in charge of the transportation for us and I also call the railroad just to make sure. But I don't know if it's the customers that we are shipping to and the rail route, it's just a highly trafficked route and it's very easy for the railroads. It's an easy run for the railroads. If part of it has to do with private sets versus system sets, the utilities that we ship to by and large have their own train cars and going to export they have to use cars that are owned by the railroad or leased by the railroad. There some -- trains have been fine. For us, trains have been fine.

Luther Lu - FBR Capital Markets

Okay. Great. Thank you.

Peter Socha

Thanks, Luther.

Operator

We will hear next from Justine Fisher from Goldman Sachs.

Peter Socha

Hi, I knew you were out.

Justine Fisher - Goldman Sachs

Eventually, I will get on, right?

Peter Socha

I knew you were out there.

Justine Fisher - Goldman Sachs

So I still have a question about the waivers.

Peter Socha

Well, I was trying to do was to get you from 30 questions down to 10. That's what I was trying to do.

Justine Fisher - Goldman Sachs

The first question on the debt side is understood there a lot that, that $24.2 million of the short-term debt is represented by the term loan that will be paid down with the proceeds --

Peter Socha

That's correct.

Justine Fisher - Goldman Sachs

-- of the equity issue. What's the -- there is like $5.5 million --

Peter Socha

That's correct also.

Justine Fisher - Goldman Sachs

-- what is that debt?

Peter Socha

That's $4.5 million or $5 million. We now own a piece of the letter of credit facility is the way I look at it.

Justine Fisher - Goldman Sachs

Okay. So there is $4.5 million to $5 million debt that is left on the balance sheet. I just want to know -- so that's letter of credit?

Peter Socha

Well, the letter of credit facility is I don't think it's really on the balance sheet, but we now own a piece of it.

Justine Fisher - Goldman Sachs

Okay. So that's what debt represented by. And then if the revolver -- I guess -- it was a timing issue as to why you had to obtain a waiver because if you weren't planning on drawing down the revolver anyway, you wouldn't necessarily have needed the waiver. Was the waiver so that you would still have access to the revolver?

Peter Socha

Yes, and also it was the way the covenants were set up particularly the fourth quarter covenant. There was an assumption there of fair amount of spot coal that just given the way production has been going in the last several weeks or the last couple of months. Anyway, we just felt like let's go ahead. If we are going to set ourselves up for '09, let's go ahead and do a waiver of intent amendment of both September and December.

Justine Fisher - Goldman Sachs

But technically, if you weren't -- if you would have been in violation of the covenants and you didn't get a waiver, you wouldn't have had to pay anything back anyway because -- ?

Peter Socha

Well, yes, technically. I guess you're right there.

Justine Fisher - Goldman Sachs

Okay. And then my other question is about the pricing for next year because I think we are looking at potentially spot prices coming down and costs clearly escalating. And I just wanted to make sure how firm is the 9619 for next year? I mean that's in the bag, right?

Peter Socha

Purchase order firm.

Justine Fisher - Goldman Sachs

Okay. So because even if we assume that you sell the remaining coal at even $50 a ton or something like that, you are still looking at an average price that's 80 and it seems -- I just wanted to --

Peter Socha

But then we've got Stoker in there as well.

Justine Fisher - Goldman Sachs

Pardon?

Peter Socha

Stoker, don't forget --

Justine Fisher - Goldman Sachs

Right, but even if we are low balling it, you still get to an average of $80 and so that $96 is pretty firm, right?

Peter Socha

That $96 is contract firm.

Justine Fisher - Goldman Sachs

Okay. And then --

Peter Socha

Justine, we've gotten that question several times on do the utilities -- can the utilities get out of the contract and all that and the answer is no. It's a contract.

Justine Fisher - Goldman Sachs

Okay just double checking.

Peter Socha

It's a purchase order -- basically a purchase order.

Justine Fisher - Goldman Sachs

Okay. And then on the cost side, is 2% cost escalation to aggressive to assume for next year?

Peter Socha

No, I would say that's too low.

Justine Fisher - Goldman Sachs

Just too low?

Peter Socha

Yes I would say that's too low.

Justine Fisher - Goldman Sachs

So I mean –

Peter Socha

How can I say that? I feel very confident that C.K. would agree with me on that.

Justine Fisher - Goldman Sachs

So from this quarter, that's too low?

Peter Socha

No, from this quarter. I thought you were just talking in terms of general from the year -- year-over-year.

Justine Fisher - Goldman Sachs

Okay, from the year--

Peter Socha

I'm sorry, I misunderstood you. As we always do, we will come out with guidance between now and the end of the year. The way we do it is after the Board has approved the budget we usually come out with guidance.

Justine Fisher - Goldman Sachs

Okay. And how much -- maybe this question is not easily answerable, but how much of current costs -- third quarter costs to be specific, do you think might be affected by companies not being as careful on the mining side because prices are high? We had talked about that at the beginning of the year that when prices go up, maybe companies will mine harder to reach coal, maybe you are not as -- ?

Peter Socha

I see what you are saying.

Justine Fisher - Goldman Sachs

-- as careful on the cost side?

Peter Socha

Well, given the prices that we are shipping at, that has not been issue with us. I understand what you are saying though. I don't know. How much will come off of Central App because prices have come down and have fallen below marginal costs just in general and the basin. Something will come off. I don't know how much, Justine.

Justine Fisher - Goldman Sachs

Okay. And then just two other quick questions. What was CapEx for the quarter?

Peter Socha

I don't have that number in front of me, but the Q will be filed within a couple of days.

Justine Fisher - Goldman Sachs

Okay. And then -- that was it.

Peter Socha

One more?

Justine Fisher - Goldman Sachs

No. You didn't get one more. Thank you very much.

Peter Socha

Thanks, Justine. Take care.

Operator

We will take our next question from Mark Caruso from Millennium Partners.

Mark Caruso - Millennium Partners

Good morning, Peter.

Peter Socha

Good morning, Mark.

Mark Caruso - Millennium Partners

How are you?

Peter Socha

I am well. How are you?

Mark Caruso - Millennium Partners

I just had two or three quick ones. Just as a clarification because I got on little late. Were there any changes to the '09 covenants?

Peter Socha

No. We just -- we did the double waiver of September, December. '09, we decided to leave where they are.

Mark Caruso - Millennium Partners

Okay. Great. And then you had signed some great tons here in the Illinois Basin, it looks like production is coming up nicely. Do you feel like the issues that were there the second quarter will kind of overcome them?

Peter Socha

It was all weather. I don't want to say it was all weather, but it was -- as we talked about, they really got hit with a lot of wet weather. And we're driving around in a lot of mud for the first half of the year. In the first quarter, it was a lot of rain over a long period of time. In the second quarter, it was probably just as much rain but it was bigger storms spaced out. I think in the third quarter, you've seen what they are really capable of doing.

Mark Caruso - Millennium Partners

Okay, so this is sort of a good base to build on you think?

Peter Socha

Yes, I think so.

Mark Caruso - Millennium Partners

Okay. Good. And then you mentioned to Justine just now Stoker. I know we hadn't done much as far as the CAPP but I want to see where things stand as far as how you are thinking about Stoker here either for the balance of the year or just going forward because I know the idea is to hold out on that because that is the premium product -- ?

Peter Socha

No, it's more of a -- yes, it's not necessarily hold out on that or make a market call this way or the other. It's more that those just have annual periods to them. They just have periods where the industrial accounts seem to be buying a lot and we are in that period right now. We are in conversations -- I don't know. C.K. we are in five or six conversations, four or five?

C.K. Lane

Yes, I think with Stoker and with metallurgical coal which should be two of our best prices to sell still left to sell in '09.

Peter Socha

Yes, we are in those conversations today, Mark. And that's pretty much true every year where around this time we are in those conversations.

Mark Caruso - Millennium Partners

So we are done with 2008 as far as this year goes?

Peter Socha

Yes, yes, we are done. Right now, we are counting -- we are not quite counting the hours to '09, Mark, but we are pretty close.

Mark Caruso - Millennium Partners

Got you.

Peter Socha

We are definitely counting days and we will be counting hours soon.

Mark Caruso - Millennium Partners

And I remember the last call there was some possibilities of some test burns from guys in the Southeast maybe for some Illinois Basin and I know there is potential for some international interest. Is that still out there?

Peter Socha

Right now, it's on hold. We need to get fulfilled all of our contracts we have out there before we start taking it anywhere else. There is interest. There is clearly interest, but I want to make sure that everything we have under contract that we told people we would ship them that we are going to do that.

Mark Caruso - Millennium Partners

Great. Perfect. Thanks, Peter.

Peter Socha

Thank you, Mark.

Operator

And that does conclude our Q&A session today. Mr. Socha, I will turn the conference back to you.

Peter Socha

Thank you, Kim. And thank you everyone for joining us today. We look forward to speaking to you. I think it will be the end of February. And if you have any questions, feel free to call -- call. Thank you.

Operator

And that does conclude our conference call today. Thank you all for your participation.

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