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Executives

Brett Harvey - President and CEO of CONSOL Energy, Chairman and CEO of CNX Gas

Bill Lyons - Executive Vice President and Chief Financial Officer

Dan Zajdel - Vice President of Investor Relations

Analysts

Luther Lu - FBR Capital Markets

Scott Hanold - RBC Capital Markets

Mark Caruso - Millennium

David Heikkinen - Tudor, Pickering, Holt

Shneur Gershuni - UBS

Michael Dudas - Jefferies

Brian Gamble - Simmons and Company

John Bridges - JPMorgan

David Gagliano - Credit Suisse

CONSOL Energy Inc. (CNX) Q1 2009 Earnings Call April 23, 2009 10:00 AM ET

Operator

Ladies and gentlemen, thank you for standing by and welcome to the CONSOL Energy and CNX Gas first quarter 2009 results conference call. As a reminder, today's call is being recorded. I would like to turn the conference call over to the Vice President of Investor Relations Dan Zajdel. Please go ahead.

Dan Zajdel

Good morning everyone and welcome to our joint earnings call with CONSOL Energy and CNX Gas. With me this morning is Brett Harvey, Chief Executive officer of CONSOL Energy, and Chairman and CEO of CNX Gas. Also with us today are Bill Lyons, Executive Vice President and Chief Financial Officer for both companies. This morning, we will be discussing first quarter results for both companies.

This morning, we will be discussing first quarter results for both companies. In addition, we will be discussing our views on the outlook for the remainder of 2009. Any forward-looking statements we may express or our expectations for business results, actual results as you know are subject to business risk, and we have enumerated those risks in both earnings releases issued this morning, and in our SEC 10-K filings.

In addition, the U.S. Securities and Exchange Commission permits oil and gas companies in their filings with the SEC to disclose only proved preserves that a company has demonstrated by actual production or conclusive formation test to be economically and legally producible under existing economic and operating conditions.

We may use certain terms in this conference call such as unproven resources or reserves which SEC guidelines strictly prohibit us from filing with our filings with the SEC. We also caution you that the SEC views such unproved resource or reserve estimates as inherently unreliable and that these estimates may be misleading to investors, unless the investor is an expert in the gas industry.

With that, let me begin our remarks and then take questions. We will start with Bill Lyons. Bill?

Bill Lyons

Thank you, Dan and thank you everyone for joining us this morning for the joint CONSOL Energy and CNX Earnings Call. CONSOL Energy is reporting net income of $196 million or $1.08 per diluted share for the first quarter of 2009, and this is compared with the net income of $75 million or $0.41 per diluted share in the first quarter of 2008.

Net cash from operating activities was $250 million, compared with $146 million in the first quarter of last year. We are very pleased with these results particularly in relation to the backdrop of the current economic environment.

The $196 million of net income represents 160% increase over the first quarter of 2008, and it is another record quarter for us. The $250 million of cash flow from operations represents 70% increase over the first quarter of 2008. Both the earnings and cash flow increases were primarily driven by higher average coal prices, and higher gas sales volumes.

This past quarter again illustrated the financial power of being a diversified energy company. Let me highlight some of our first quarter results. For our coal segment, our total margins for the first quarter were $17.38 per ton, an increase of $11.20 per ton over the first quarter of 2008. This margin expansion is the key driver in our step-change in profitability.

Our 16 million tons of production this quarter is down 173,000 tons from the first quarter of 2008. This decrease in production is not operations related, but market related. We have throttled back production to match the shipments to our customers.

As Brett has said on many occasions, we will exhibit the production discipline to prevent excessive growth in our inventories. From an operational standpoint, the mines are doing well. In particular, we have made great strides in improving our longwall development, an issue that challenged us last year.

CNX Gas also had an outstanding quarter, posting net income of $55 million or $0.36 per share. This was 10% higher than the March 2008 quarter. Production increased 38% quarter-over-quarter. The production we achieved in the first quarter along with the better than expected results in the Marcellus Shale has given us confidence to raise our full year production guidance from 85 Bcf to 87 Bcf. The 87 Bcf if achieved will represent a 13.5% increase over the 76.6 Bcf we produced in 2008.

I do not need to tell this group that the financial markets have been in disarray. If there is one lesson to be learned from the events of the past nine months, is that capital structure matters. CONSOL's solid's balance sheet and excellent liquidity has enabled us to continue to prudently invest in our businesses without diminishing our earnings power.

In March 31, 2009, CONSOL Energy, excluding CNX Gas had $365 million in total liquidity, which was comprised of $72 million of cash, and $293 million available for immediate use at below market interest rates. This credit facility does not expire until 2012.

Separately, as of March 31, 2009, CNX Gas Corporation had one $105 million in total liquidity available for immediate use at below market rates. This credit facility does not expire until 2010.

During the first quarter, we have expended $300 million in CapEx, split about evenly between our coal operations and our gas operations. This is consistent with the comments we made during last quarter's conference call, when we stated that we will continue to identify and allocate resources to strategic areas that are critical to our long-term success, but to proceed carefully to ensure that we protect our financial position.

The capital spending we made in the first quarter was directed at making our fleet of longwall mines even more competitive. We are replacing our track haulage at Shoemaker with more efficient belt system.

At Bailey, we are extending the longwall face and replacing longwall shields, in addition to putting in an overland belt system. At Buchanan, we are upgrading our water disposition facilities.

On the gas side, we are executing our drilling program and continuing to acquire acreage. At CNX Gas, we have grown from a company that was producing 48 Bcf in 2005 to one that this year will produce 87 Bcf. This is an 80% increase in four years, and we have done it by drawing only $80 million against our credit facility.

All of these projects represent solid investments that will increase the competitive position of CONSOL from both a cost and an environment perspective. When markets rebound, CONSOL Energy will emerge even stronger.

When markets rebound, CONSOL Energy will emerge even stronger. We remain steadfast in our confidence in our business model. We believe our diversification into two premium fuels, that is high-BTU bituminous coal, and natural gas will give us a diversified portfolio that will prosper in the next decade by providing energy to our country.

Our businesses have many common traits. Both the coal and gas business are safe, low cost operations. These attributes are especially important in these uncertain economic times. Both the coal and gas businesses are the highest margin operations in their respective sectors.

Now, this is partly due to the low cost but also due to location. Our coal and gas assets are able to capture value that other producers give to a railroad or a pipeline. We have much of our coal reserves in gas acreage outright.

This means we are able to capture more value for our shareholders. We don't have to pay a royalty to the Federal government or to others. Finally, there is a dependable long-term demand for the products we produce.

Brett, with that, could we have your comments on the quarter as well as the market.

Brett Harvey

Okay. Thank you, Bill. It is good to be with all of you. It is always a good opportunity to give you a glimpse of how we see CONSOL Energy going forward as well as talk about what we have done.

You can see our strategy is sound. We have great assets and a great position. We are well capitalized underneath the most densely concentrated energy part of the world. This energy that we have in the ground whether it is gas or coal is located in exactly the right position.

The demand for energy has dropped. We are a low cost producer in both products, and we continue to be a leader in safety. We have skilled people, which I think is the greatest assets in the energy business in the United States, and the greatest concentration as well. Thanks to our employees for a good safety record for the first quarter, and a good production record in both companies.

I think the watchwords we need right here are, just to plan on coal production is where we are at. Just look on the coal side, this is a very technical year in terms of how we deal with customers that are concerned about their position, and concerned about their sales of energy, and where they are headed versus our contract with them, of which, we believe are valuable, and being a long-term producer and a suppliable source of energy. They see that too. So, we are working the issue out so both of us win going forward.

The other side I would say is prudent gas growth. If you look at what we have done, we have stayed within our cash flows. We have taken our gas position to the sweet spots. We are getting very valuable gas production out of Virginia, and our Marcellus Shale activities are very profitable with internal rates of return that are very impressive.

We are the low cost producer in both gas and coal in this region. Our margins reflect that in any market and any situation as long as this society is going to use energy, we are going to be there to supply it at margins that exceed or beat anybody else around us. Location is important. Transportation is important. We are in the right place with our assets.

Now let's talk about gas for a minute. Demand for energy is certainly down as we've talked. Rigs are dropping everywhere. The most productive rigs are still operating. We only have one rig operating in the Marcellus shale at this point in time, but it is very successful. We have eight rigs running right now on the gas side, compared to 22 rigs running a year ago. We are only drilling in the most valuable places that we see. We are not drilling to hold on to land positions, we already own these positions, and we will continue to be prudent in how we spend that capital. The demand for energy is down, the price is down. But we are developing our gas business for the term and when prices go up we will be at higher volumes.

Let's talk about coal. We have cut back production on the coal side. From where we originally planned, we are down 6 million tons a year. We have idled the Buchanan mine, probably the most valuable mine in the United States, until the customers are ready to take the coal. We cut back on over time in our major mines, (inaudible) overhead on the corporate side to the tune of about 85 to 90 people.

We are matching the orders that come in. When the trains come in, we mine the coal. We are not building inventory of any great measure. We are concerned about that, because we know there are customers that built some inventory. We are concerned about some of our weak players around us in the coal business of building inventory and creating a problem.

Now, what happens in these situations, is we have been through this before, maybe not as dramatic as it is today. But what happens is, we see a drop in demand and that eventually brings a corresponding destruction of supply response when the economy changes. As it turns, we are spending capital in our mines for the turn, and also in our gas company for the turn to be in a better position going forward. When it does turn, you will see that happen.

Now, on the coal side, supply response is going to be very weak coming out of this. We see a lot of our competitors going out of business, a lot of the contract miners are leaving. We see some of the bigger companies holding on to pricing from last year, but running out of those contracts. We see problems with financing, and we do see that it's going to be shortcoming on the turn on the coal side.

We have well capitalized mines, that are prepared at low costs to come into this new marketplace as it turns. The response right now is very slow. The orders are slower than we thought for the year, but we are working those out. While mountaintop mining in West Virginia is a huge issue for Central App, and we think it will shorten the market, and maybe even start to make things turn quicker.

With that, I would like to turn it open to questions, so we can get what's on your mind. Thank you.

Dan Zajdel

Operator, if you could instruct our listeners on how to get into the question queue, I'd appreciate it.

Question-and-Answer Session

Operator

Certainly. (Operator Instructions). And first, we've the line of Luther Lu with FBR Capital Markets. Please go ahead.

Luther Lu - FBR Capital Markets

First question is on CapEx. Can you elaborate a little bit on the $1 billion CapEx spending and will they be spent on gas and coal?

Brett Harvey

Sure, I will be glad to do that. I can tell you that when you split it, it is about 60-40. Coal is 60, 40 would be gas, in terms of percentages. And now gas is probably more flexible. If the gas price stays down, we can adjust that. But we are building to 87 billion cubic feet, and we have committed to that, and we think that's the prudent thing to do, because it's very low cost gas, even on the turn, our margins will grow there.

On the coal side, we are finishing, like we said last quarter, we are finishing the projects that emphasize our low cost position in Northern App. These are projects that we started before the change in the economy. Certainly, we are going to finish them, and you will see us drop off capital wise quarter-by-quarter to the end of the year, and if the market doesn't change, we will probably be in both companies, the maintenance cap level going forward until we see a change.

So, we are extending [phases] on the coal side, in our most valuable mines like Bailey and Enlow. We are doing over time as well, projects that give us more capacity in these world class mines, as well as lower costs. And those things are all going into place. And we are doing it all within our cash flow, which we think is very prudent, and we will be well prepared for the turn in the energy markets and the economy.

Luther Lu - FBR Capital Markets

Okay. Great. And it seems like the cost is holding up very well, given the current environment. But you are reducing the volume again. So, can you give me a little bit of guidance on the cost side?

Brett Harvey

Well, the cost side, certainly it's a little bit harder to hold costs, as your volumes drop. But we are doing that pretty well. I think the way we are organized, we are very focused on that. We are working on all of our things that we consume. We are trying to get those prices down as well. And we are very focused on the volume. I would rather have a little higher cost in the short-term per ton, than I would have volume on the ground, in terms of inventory. And so we are trading those off. We would rather not build any inventory, because that sends a wrong signal to our customers. So, the cost structure is going to be more related to where we are at. We are closing unprofitable mines as we go. So that's helping our cost structure as well.

Luther Lu - FBR Capital Markets

And final question if I may, any deferred shipment that took place in the quarter, and how are you managing that situation with the customers?

Brett Harvey

Well, on the methane side, we have, what we would call, a pushback in the fourth quarter, as the steel business went into kind of a shutdown mode. So we are working out that with our major customers, what we call pushback from the fourth quarter. We have had some pushback from the first quarter, with the same steel companies. And on the steam side, I would say in the first quarter, we had 300,000 or 400,000 tons of not, I wouldn't call it a pushback, because I think, that is a wrong term. I would call it the rescheduling of shipments to match their burn in our contract, so we both get maximum value out of our relationship.

Luther Lu - FBR Capital Markets

Okay. And you mentioned in the press release, that you are may be spreading the value over time, or are you receiving cash payment? How are you dealing with the payment issues?

Brett Harvey

Okay. As you know, every contract is different. Here is what we are doing. We are accepting cash payments in lieu of shipping. We have done some of that. We are recovering 2009 contractual value over years, we are extending contract over years against the same kind of economics, that we would be satisfied with. We are renegotiating contracts to close unprofitable mines. We are engaging in arbitration to protect contracts in some cases, and there are arbitration clauses in many of our contracts, and we will protect our rights there.

Also, we are challenging, what we think are (inaudible) thoughts coming from some customers, just based on their position economically. So, we are looking at all those things. We are dealing with them. I won't be specific on this call, in terms of who we are dealing with. But those are the ways we are getting things done.

Operator

Our next question is from the line of Jim Rollyson with Raymond James. Please go ahead.

Jim Rollyson - Raymond James

Brett, could you maybe share your philosophy on how you are looking at booking 2010 coal at this point? I mean, are you still kind of working out deals, or thinking of working out deals with customers that are at prices, that seem reasonable, compared to where the spot market is? Or do you hold out ways until you hold off longer than maybe you normally would to try and get to where pricing starts to improve a bit, or do you fill that in with some of these deferrals or just kind of, what are you thinking right now?

Brett Harvey

Well, I think what we are going to do. We have 54 million tons sold for next year, and we also have, I think we are going to have some of the tons in 2009, if the economics we are at today, slide into 2010. So the combination there, we are not going to meet the price -- the spot market price that we see today, really isn't a reflection of what we believe the market is. We think the market for next year is going to be a reasonable market. We are going to take some of the economics of this year, go into next year, and maybe sign longer contracts with them.

We've already done that with one big customer in the south. So, it is really a tactical this year based on their burn, and their inventory where we are headed for next year. But, we'd rather wait right now. When it comes to pricing, I think we would wait, but we do have 54 million tons sold.

I guess the $64,000 question is how much are we going to mine, and I think that's directly related to what they are going to take, and what they are willing to sign up for, because we are not going to build inventory.

Jim Rollyson - Raymond James

Understood. Obviously, you've got production guidance coming down for the second quarter and for the year. This is kind of two-part question, do you think you will ship some of the inventory you built in the first quarter throughout the second, third and fourth quarter or is the market too weak? Secondly, do you think there is any more downside risk to your 62 million tons?

Brett Harvey

We expect our inventory level to be about 1.7 million tons by the end of 2009, which will probably be up about 300,000 tons from where we ended last year. I think that is a very prudent place to be. In the meantime I think we are about 2.4 million right now. So, we will see that wind down the rest of the year. And where we really want to make sure the inventories are right by the end of the year is on the met side. So, we should be in a pretty good shape there too.

Jim Rollyson - Raymond James

Any thoughts on whether you guys might end up shipping or producing less than 62?

Brett Harvey

I tell you what we see right now is 62. I would say it is a tactical year. It could go up a million or down a million. We don't know right now. This is about where we see it.

Jim Rollyson - Raymond James

Great quarter.

Operator

Next question is from the line of Scott Hanold with RBC Capital Markets. Please go ahead.

Scott Hanold - RBC Capital Markets

Specific to the CNX GAS, when you look at the Marcellus, it looks like operations are going very well there. Can you talk in terms of the increase in your natural gas production expectations for this year of 2 Bcf. How much of that has the shale in there? I know in the past you tended not to put the shale opportunity there. But, how much of that is shale right now?

Brett Harvey

I would say 2 Bcf. Let's talk about the Marcellus Shale a little bit. Every well we drill seems to get a little bit better. In fact, were dramatically better than the first well. Our cost is running in the line of about $3.6 million to $3.7 million for every new hole, where our first well was about $5.2 million to $5.5 million.

In terms of production, our fourth and fifth wells are running at about 4.8, and I think our fifth well is now running about over 5 million a day. Our IP rate seems to be holding at about 4 million cubic feet a day.

So, I'm really upbeat on our position on the Marcellus Shale. A part of the reason I'm so upbeat is we own this acreage and we don't have obligation to drill. We have obligation I think just to be prudent about how we step out from what we have. I think it is a very valuable position for us.

Scott Hanold - RBC Capital Markets

You are running one rig right now on the Marcellus. Is that the plan for the rest of the year? If so, I guess that sounds like you'll a total of 10 to 12 wells down by the end of the year? I guess it seems that your aggregate shale production could actually exceed [2 Bcf]? So I am kind of curious on that 87 Bcf target. If I guess there is some slowdown in activity in some of those CBM and more of an increase there on the shale side?

Brett Harvey

I think you might see that over time. But right now, we are saying, that’s going to affect it by two. If we continue to be this successful, it is going to have more influence on what we are doing, and it will probably grow that number. However, it is hard to predict right now, because we've only got have five holes.

We plan to be at 11 holes total for the year. So, as we get more results and we have a longer history in the first wells that we did, we will be a lot more accurate about what we are going to do.

Scott Hanold - RBC Capital Markets

Okay. Could you talk in terms of a couple questions of regarding Marcellus activity? First, you make a point that you have not had the butane's and propane's in that. Can you talk a little bit about the geology in that area, why do you all think you don't have the processing issue others do in the southwest part of the basin.

Secondly, infrastructure is always a concern regarding Marcellus activity, and what is your capacity there, and how much investment may need to be done?

Brett Harvey

On the infrastructure side, we don't have any capacity problems, and we don't foresee any within in the budget that we have given you, and the volumes we have given you. We have the capacity of about 290 million cubic feet per day capacity. In terms of our issues around the quality of the gas, I guess, I would say I would rather be lucky than good, and I think we are lucky in a lot of cases.

It is a location issue. We are doing very well in those locations, but I don't want you to under estimate our ability to blend gas between the coals seam gas and the hot gas coming out of the Marcellus Shale, which gives us the ability to blend gas without treating the gas and avoiding those costs.

So, when you look at CONSOL, look at us as dimensional, not just one play in the Marcellus Shale, but multiple plays and abilities to blend this gas to pipeline gas without a lot of treatment and costs.

Scott Hanold - RBC Capital Markets

Okay. Do you have a sense of like, when you look at the five Marcellus wells that you have down in Greene County, how expansive this area can be where you don't have the processing issues others could have. Are these wells fairly spread apart throughout some of that acreage?

Brett Harvey

You need to look at the way we drill in a very tight compact situation. In fact, some of these holes are right next to each other, and because we don't have the obligation to jump around and keep our land that way because of the commitments we've made, we are a little more successful in deploying our capital in the sweet spots and developing those first.

Scott Hanold - RBC Capital Markets

So at this point your sense of how expansive a sweet spot, you still need to do more developments. Is that fair?

Brett Harvey

Yes. I would say, yes, but we do believe that position is a sweet position, and will continue to look like that going forward, but that will be proven out as we expand on them.

Scott Hanold - RBC Capital Markets

Last question is on the Chattanooga Shale, regarding what is your thoughts there as to today's pricing. Where could your activity be there going through 2009?

Brett Harvey

Clearly, it is a higher cost than what we are doing. Like I said earlier, we are in the sweet spot between Virginia and our Marcellus Shale. I think if you see rising gas prices, you will see us put some more there. We have a great acreage position there. We are having success on what we have done there, and we are having the same issue there.

We have gone to the horizontal drilling. We are seeing success, and we have the multi-level fracing capabilities between coal and shale, which I think will be our next Virginia in terms of value, because we see natural gas as being a very valuable commodity going forward, and we think we have a great position there.

It will probably unfold at a higher pricing, however, when the pricing as low as it is today, we will stay in the sweet spots. So, we will develop that as the price rises.

Operator

Our next question is from the line of Mark Caruso with Millennium. Please go ahead.

Mark Caruso - Millennium

Could you elaborate on the 1 million tons that came down in the guidance and where that is coming from? Northern Appalachian or Central Appalachian?

Brett Harvey

About 800,000 of it is Buchanan, and about 200,000 is Northern Appalachian. These are customers that have actually bought out their contracts. So, we are either going to resell that coal or not mine it until somebody buys it. So, I would say 800,000 Buchanan and 200,000 Northern Appalachian.

Mark Caruso - Millennium

You mentioned earlier with Buchanan that the mine is down until basically customers want the coal. Can you give us a better sense of timing and how you are thinking about that, and also if there is any inventory?

Brett Harvey

Right now I would say that Buchanan will run, and this is just what my gut is telling me, I think it will run in June, and I think it will run the rest of the year at a lower rate of production than typical but it will continue to run. That's the way we are looking at it right now.

We think the shipment will be right around 2.6 million. We hope it is more than that. However, right now we are seeing 2.6 million, and our ability is to go up to 5.5 on that kind of run rate. But, like I say, we are not going to build a lot of inventory. Inventory write there is dropping somewhat, but its right around 500,000 tons. And so that's the reason we are keeping it down, because we are moving the inventory first, and we will bring it back when we see it balance. Okay.

Mark Caruso - Millennium

And just one last question, it looks like despite the moves, the realizations didn't change much. Is that just a matter of stronger steam realizations, because I think, actually most of us thought it was going to Buchanan being the driver to the realizations. But it seems like, well you were able to do it this quarter and got this holding up, it seems like steam realizations are much better.

Brett Harvey

If you go back into the last couple of years, the meth business drove our realization harder than it seemed, because of legacy contracts on the steam side. What we saw in the fourth quarter and this year, is a step change on the steam side that was dramatic, and that dramatic step change really put us in a better position at higher volumes. And so you are seeing that.

If you looked at our earnings last year, we did really well on the gas side, and the coal side lagged a little bit. Now, I think it's flipped. The gas side is going to be down a little bit because of gas pricing against our hedge, and the coal steam side is driving our bottom line more than any of it. And just think if we were to move that meth coal in the first quarter, we would have had a much better quarter with the meth coal removed. So, the power here is dramatic and the margins are impressive.

Operator

The next question is from the line of David Heikkinen with Tudor, Pickering, Holt. Please go ahead.

David Heikkinen - Tudor, Pickering, Holt

Just a question, kind of following into the coal and methane operations on the CNX, CXG side. As you think about Virginia, core operating area makes sense and continues to move forward. Where is your breakeven gas price now for that operation, or where do you slow down?

Brett Harvey

I would say, that's a sweet spot. I would say it's $2.50.

David Heikkinen - Tudor, Pickering, Holt

And as you think about your other areas, you have hit that threshold where you'd slowdown. Where would you speed back up, on the coalbed methane side?

Brett Harvey

I would probably do a little more in Virginia. Step out there and then probably go with our mountain area.

David Heikkinen - Tudor, Pickering, Holt

Next? And as we look at kind of the inventory on the Marcellus, the real question is, you've got a lot of captured inventory on the gas side, and a whole lot of future value, dependent upon how fast you could develop it. Do you think about the people constraint, or what is the constraint, assuming that we get back to normalized prices that are in that $6 range at some point. Is it a people constraint? How do you think about what keeps you from accelerating that pace of development?

Brett Harvey

I don't think it is people. Right now it is market. I think we are prudently staying with our cash flow, so we don't get into debt so to speak. But I would say, we would just put on a second rig in and push Marcellus really hard and prove that out faster. So, it's a matter of picking up another rig and getting it on the ground. I don't see any constraints other than economic constraints in the short-term, in terms of pricing.

David Heikkinen - Tudor, Pickering, Holt

And then on total ownership of CXG. Can you talk to us, kind of big picture as far as how you think about continuing to buy shares and what the overall outlook is from a CNX standpoint?

Brett Harvey

As you know CONSOL Energy is very excited about the future of CNX Gas, and that's the reason, we bought some shares in the fourth quarter. We didn't buy any in the third quarter. I think we are watching the market and the cash flow real well, in both companies. But we continue to be interested in those shares in terms of value and we think it is a valuable company, and we will continue to look for opportunities, if the opportunity is right there. But right now we see it as though we have the ownership, we have partners and will do good for both of us.

Operator

Our next question is from the line of Shneur Gershuni with UBS. Please go ahead.

Shneur Gershuni - UBS

One question I wanted is, kind of follow-up to both Luther and to Jim's question before. When you talked about renegotiations of contracts, have you received any pushback at all from the overseas customers that you were shipping to? And Bill maybe, I was wondering if you can address one of the points where you had said about potentially taking cash up front, would that create a mark-to-market situation on the contracts, on a go forward basis?

Bill Lyons

No. I don't see it will create a mark-to-market situation on a go forward on that. Basically, we get paid, we reflect the income there. And I don't think it will trigger any of the FAS-133 issues on derivatives.

Shneur Gershuni - UBS

But you would record the revenue, when you deliver the tons in 2010 or...

Bill Lyons

What, in terms of going forward or the money that we got in now?

Shneur Gershuni - UBS

The money that you got in now.

Bill Lyons

Reported now. When we get the money in, it's a contract settlement we look that way. And again, this is not a lot, and as a result it doesn't paint how we -- our normal delivery, more normal sale criteria.

Shneur Gershuni - UBS

Okay. And just wondering if you guys can comment on export customers, if there has been any negotiation or pushback?

Brett Harvey

Sure. I'd be glad to see that. The term pushback, I think is a term that the customers use. It has the wrong connotation I think.

Shneur Gershuni - UBS

Sure.

Brett Harvey

We are not seeing any real change in schedule for them. We see CONSOL moving about 2.4 million tons out of Baltimore. We think third parties are going to move around 2.5, which is a total of five, which is down from 9.1, about fourth -- from nine to five for the year, and the vessels are coming. We are a very reliable [swing] supply to that. Remember, coal is still a low cost fuel for Europe, and these contracts are important to them. I think we will move it, and I think we will move it on schedule, when we plan.

Shneur Gershuni - UBS

Just a couple of other quick questions may be if I can just ask on the CXG side. Should storage hit 3.5 trillion cubic feet, let's say in July or August, and it just sort of slows down the entire system and so forth. Do you have wells that you have outlined as having the potential to be shut in, in case, the entire storage network eventually approaches full and so forth? And also, if you can comment on day rates and drilling costs, if they have come down materially for the rates that you are running at this point?

Brett Harvey

Well, let's talk about day rates and drilling costs. Those are all coming down and we are negotiating, almost well by well now, in terms of what people can do. We are taking advantage of the soft market competition in that world. That's part of the reasons we are now down on the Marcellus well to 3.8 million, where we were in the five before. Part of it is efficiency and part of it is just, we are getting better deals with our people.

In terms of how we cut back if storage is full, you look at economics of everything, and of course you don't want your coalbed methane wells full of water, so you don't shut them in as fast. But we also have the ability to pullback on the sealed gob areas behind the mines, and use that as somewhat of a storage itself. So, we are very flexible that way, but we will do it on a hole by hole, and region by region economic basis.

Shneur Gershuni - UBS

Okay. And just last two questions on the coal side. I guess, one is crossing (inaudible) item. Given the fact that you are slowing down the operations and so forth. Are you picking up any reclamation work at all? Can we see that legacy liabilities come down next year as a result of the legacy work that's being done this year? And also you'd mentioned in the press release about the PRB and so forth, I was wondering if you've seen any evidence that there is less PRB that's being blended in the east now just due to the fact that the eastern prices have completely collapsed?

Brett Harvey

Well, I think the PRB is not moving in at any more rate or any less rate than it was before. I would say that PRB coal coming into this area is more a function of rail rates, than it is of deliberate total costs. And I think the rail rate takes that more than anything else, and that's pretty steady. In terms of reclamation, I would say we are probably steady. We see that as compliant with the law, doing what we need to do to be prudent, till we don't have big surges year-to-year and I think that's steady. So we are going to see that to be about the same going forward.

Operator

Our next question is from Michael Dudas with Jefferies. Please go ahead.

Michael Dudas - Jefferies

Brett, two questions. First, I would like you to elaborate on your comments in your prepared remarks relative to the financial situation of competitors. Are you seeing that up and down Appalachia or is it really just concentrated among smaller, less well capitalized underground miners in Central Appalachia? And on top of that expectation, how quickly do you think the EPA permitting backlog issues will factor into at least taking 2010 lower cost tons off the market quicker than people would had thought?

Brett Harvey

I would Central Appalachian surface and underground are being hurt very rapidly. The small guys are struggling. The people who need financing are having a hard time getting it. I have talked to some of the major operators down there, and they are saying that, people are shutting down all around them, especially the smaller guys.

In terms of the larger operations, I would say, all of the eastern coals are being affected. What bothers me more than anything else when I see some of the larger guy's inventory is they are not showing the discipline they need to do that, and I think that plays into the hand of the customers for a while but not very long. I think they get themselves into financial trouble by doing that.

I don't want to be specific about that for obvious reasons. I think that the issues down in Central Appalachian with the 404 permits, I think it is a huge issue. I think it could take Central Appalachian well below 180 million tons a year capacity, and that will make well capitalized mines like we have in the east very valuable. That's an offshoot from that. I think it is bad government policy to change the rules in the middle of all this capital, but that's what we are dealing with. If I were a buyer on the utility side, I would be very nervous about that.

Michael Dudas - Jefferies

My second question leads onto the last part of your answer, maybe you can comment a little bit about some of the policy and some of the directive that have been coming from either the administration, the expectations in Congress relative to energy or carbon policies, the issues that the EPA are putting forth that have been well documented. Is this something that CONSOL is reacting toward in a more aggressive way? Are you surprised by it? Will that allow you to be more disciplined in how you allocate your capital in the next X amount of years relative to investing in coal?

Brett Harvey

We think the gas company will benefit tremendously by the aggression that we see from the Federal government on the coal side. We also see that the Federal government will eventually realize that chipping away at its own economic foundation is a mistake, and they will continue to push on CO2 issues. I don't think there will be a law passed this year, but I think it will continue to be an issue against new capital coming into coal, which I think will debt that is capitalized more valuable, and gas valuable.

I think if you look at our portfolio of gas and coal, and the way we are set up on capitalization on both sides, I think we are in a good position to weather this storm. I think as government policy pushing back on coal as the most abundant domestic resource has some issues with it, but in the short-term I think CONSOL is well prepared to handle that.

On a national basis, we are putting ourselves in with ACE, National Mining Association, other groups to make our case with the federal government so we don't make mistakes for the society. So, that's where we are at.

Operator

Our next question is from the line Rehan Rashid with FBR. Please go ahead. If you can take yourself off mute. We will move onto Brian Gamble with Simmons and Company. Please go ahead.

Brian Gamble - Simmons and Company

A lot of the big picture stuff has been talked about. Maybe, I can hit on a couple of specifics. You mentioned last quarter that you hadn't put too many diesel hedges in place for '09, but were starting that process. Maybe an update on what you have done so far and what you are forecasting for the rest of the year?

Brett Harvey

I think, we've hedged some of it, and it's mostly affecting on our surface mines. But not knowing whether we are going to get permits or not makes it hard to hedge. So, I would say we are about 40% hedged.

Brian Gamble - Simmons and Company

And then, when you mentioned Buchanan obviously being down, maybe coming back down in June, and then you through that volume out for, hopeful, you know, 2.5, 2.6 million tons for the year. Does that mean that Q2 run rates shipping out of inventory will likely look like Q1 on a volume level, and then maybe a ramp up in Q3 and continued ramp in Q4. Is that what it looks like?

Brett Harvey

You hit it right on.

Brian Gamble - Simmons and Company

You mentioned last quarter that NYMEX obviously trading below what you see out there on the contract side of things. Giving that NYMEX continues to trade off low 40s on the spot, mid-40s for the turn for '09, what do you see is the actual current level for steam volumes in order to be contracted in today's market?

Brett Harvey

Let's talk about the forward looking prices. I think like last year, when it was $130, there wasn't much coal movement at $130, because it was all contracted for. And now when you see it at $40, that just tells you there is nothing moving. There is absolutely no market, and they are running out of contracts. So that's just floating around in an area where nobody is buying or selling. So, I would say, I wouldn't be surprised to see Bailey type steam coal next year. We think it would have between 65 and 75, somewhere.

Brian Gamble - Simmons and Company

And then finally, there have been some specific M&A rumors out there recently. Wanted to get your take on a more general basis, do you think today's market has opportunities for M&A activity, given not only supply/demand balance, but also financing that is involved? Do you think some deals are possible, or do you think that that's more of a 2010 type of event?

Brett Harvey

Well, one thing I can tell you and this is just natural. Last year, when we talked about M&A, everybody, we weren't so much in a humble position, because the prices were up. As we get in more of a humble position as operators, you are going to see people tend to nudge up to each other just trying to survive, and you will see some of that happen. I don't think it's going to happen in these first couple of quarters this year. I think after you get to see the pricing fall off of last year's pricing, and people try to do new contracts, and their margins squeeze, you are going to see people start to go get together. There are going to be small guys and big guys, I would guess. I think it's going to happen in both coal and gas. And so, we are looking at opportunities in both sides of our company.

Brian Gamble - Simmons and Company

I am ready to sneak one last one in. When you look at the Baltimore run rate for exports, down roughly 45% year-on-year, do you think that can be generalized for the entire export market, is 40% run rate lower in 2009 than we saw in 2008. Is that a fair assumption?

Brett Harvey

I would say it's a great indicator of what is going on, yeah.

Operator

Our next question is from John Bridges with JPMorgan. Please go ahead.

John Bridges - JPMorgan

Congratulations on the results. These contract settlements, do you have a dollar number for that? I'm just trying to figure out, if those settlements are skewed in the first quarter, or if we are going to spread out over the rest of the year?

Brett Harvey

I think, I would say they are going to be spread out and specific, John, we are not in a position where we can put that out to the public. But we gave you how we are doing it with different customers, but I think some of these cash payments will be spread out over time.

Bill Lyons

John, let's be clear on that. Is that, these are unusual items. The goal isn't to sell coal and then make a contract settlement. As things become normalized, you probably won't see any contract settlements. We will just continue to ship like we normally do.

John Bridges - JPMorgan

Okay. You used to give a breakdown of northern and central App. Are you going to do that going forward?

Brett Harvey

You mean in terms of pricing?

John Bridges - JPMorgan

No. In terms of tonnage.

Brett Harvey

Tonnage. Let's see. We don't have that broken down. But we can get that for you offline.

John Bridges - JPMorgan

Okay. I will get that on coal. And you mentioned mountaintop, any sort of overview, any overall comments on that?

Brett Harvey

Well, I can comment on this. We have seen a real change in the EPA and we have seen a change in -- we went to the law side of it last year, now we are going through the federal government side of it this year. There is a lot of resistance to mountaintop mining, and the permits are being called into question at a much higher level of scrutiny. Things that we thought were settled 10 years ago on those issues, are now back on the table. And we have real concern about how quickly those permits are going to be done down there, and how it's going to affect surface mining in central App. So, all I can say, is a lot of concern and it's an ongoing process. I think even the state of West Virginia and Virginia and others are concerned at how aggressive the federal government is right now.

Operator

And next, we'll go to the line of David Gagliano with Credit Suisse. Please go ahead.

David Gagliano - Credit Suisse

Thanks. Obviously most of the questions have been covered. But I do have a couple of follow-ups. First, regarding your comments on the renegotiation of contracts, you mentioned a lot of different things in terms of what's going on right now between you and your customers. I was wondering if you could quantify the total 2009 volumes that could be potentially be pushed out or renegotiated?

Brett Harvey

I don't think we are prepared to do that. I would say that, a lot of this is a function of how much load they have on their side and how they adjust to their own inventories. We will work that over time. But it's hard to see into the fog in terms of what their loads are and what the economy is, because if you look at the utilities, especially, their loads are down dramatically, especially in the south, and they are adjusting for that. We will adjust with them and maintain our value. And so, I would say much of what you saw in the first quarter, is already in the numbers. So it's not like it is devastating to us, it's just something we have to do to keep that relationship in place and keep the values there.

So David, it is kind of hard to quantify at this point.

David Gagliano - Credit Suisse

Okay. Are any of the negotiations tied to the 2.6 million tons of meth that's targeted out of Buchanan? And if so, how much?

Brett Harvey

We are negotiating with our two largest customers. We are not at final agreements with them right now, but it is about 1.3 million tons.

David Gagliano - Credit Suisse

Of the 2.6 million target?

Brett Harvey

Yes.

David Gagliano - Credit Suisse

And then just on the cash payments, just where did they actually flow through the income statement in Q1? And can you give us? I don't know if you can do this, can you quantify the amount that was within the Q1 results that associated with the cash payments? Or at least give us a feel for magnitude.

Brett Harvey

We don't give other income.

David Gagliano - Credit Suisse

Other income?

Brett Harvey

Other income and I'm -- we generally give some of the settlements in our 10Q and I can tell you, we will have that out shortly.

David Gagliano - Credit Suisse

Okay. In terms of order of magnitude, can you give us a feel for the size of how much was in other income, associated with these payments?

Brett Harvey

It's not that significant, David.

David Gagliano - Credit Suisse

Not that significant.

Brett Harvey

And again, as we go back there, we are not in the business, and our customers are not in the business to speculate on coal contracts. They want to have the coal, we want to deliver the coal. And it's just that we hit an anomaly in the market, which crosses out through some settlements. This is what I consider to be pretty unusual and it's something that won't take place, we don't anticipate taking place a whole lot in the future.

David Gagliano - Credit Suisse

Yeah exactly. And that's what I was trying to get to much of the result was priced as unusual...

Brett Harvey

No. What we are starting to do is, mainly give you some flavor as to what we are doing to work through the market. And basically, what it is, is that, we are working with our customers, like we always do, and in some cases, we push out the tons or change the tons, change the delivery, and in some cases, which I would say is by far the exception, is that there is some type of settlement. Settlements are not usual and not significant.

David Gagliano - Credit Suisse

Okay. And then just the last question I have, switching over to Buchanan, I was wondering if you could just talk a bit about the water issues at Buchanan. You alluded to it in your prepared remarks. And I think they were highlighted in previous press releases. And lastly, are there any permitting issues at Buchanan? And that's it.

Brett Harvey

The water issues are issues that are an issue between two property owners in the area, and one of them us, and one of them owners of where we have extracted the coal. And it has to do with the volume where you put the water in terms of ownership of land. That's being worked out right now, between the legal system. Some we had to announce. We have plenty of pump capacity in our own minds to store water and we also have capacity to discharge water into the streams themselves at certain times. So, it is something that we have worked out, and we are working it out.

We are actually putting a system in to clarify the water in our old facility, and we are building that right now and it will be done in the fall of 2010. So that will really put that problem to bed. In terms of other permitting issues, I think we are in good shape. We don't see any permitting issues otherwise, and we just talked about that because it was a legal issue and we had to make sure everybody was aware of it.

David Gagliano - Credit Suisse

All right. Perfect. Thanks for clarifying. Appreciate it.

Dan Zajdel

Operator, I think we are out of time. If you would like to wrap it up here. But before you do John, let me just say, I will be available for investors throughout the rest of the day. Tom Hoffman will be available for reporters later today. And with that, operator, could you instruct our listeners on the replay information?

Operator

Certainly. Ladies and gentlemen, this conference is available for replay. It starts today at 12:00PM Eastern and will last until April 30th at midnight. You may access the replay at any time by dialing 800-475-6701 or 320-365-3844, the access code is 995167. Those numbers again, 800-475-6701 or 320-365-3844 and the access code 995167.

That does conclude your conference for today. Thank you for your participation. You may now disconnect.

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Source: CONSOL Energy Inc. Q1 2009 Earnings Call Transcript
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