CONSOL Energy Q2 Earnings Transcript

| About: CONSOL Energy (CNX)

CONSOL Energy Inc. (NYSE:CNX)

Q2 Earnings Call

July 30, 2009 10.00 AM ET

Executives

Dan Zajdel - Vice President of Investor Relations

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

J. Brett Harvey - President and Chief Executive Officer

Analysts

Michael Dudas - Jefferies & Co.

Brian Yu - Citi

William Eagan - Raymond James

Shneur Gershuni - UBS

Scott Hanold - RBC Capital Markets

Amir Arif - Stifel Nicolaus & Co.

Pearce Hammond - Simmons & Company

Brian Singer - Goldman Sachs

David Lipschitz - CLSA

Lasan Johong - RBC Capital Markets

Justine Fisher - Goldman Sachs

Paul Forward - Stifel Nicolaus

Garrett Nelson - Davenport & Co.

Mark Caruso - Millennium Partners

Operator

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

Dan Zajdel

Thank you, John. 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 second 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 US 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 reserves 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 today with Bill Lyons. Bill.

William J. Lyons

Thank you, Dan. And thank you everyone for joining us this morning for the joint CONSOL Energy and CNX Gas Earnings Conference Call. CONSOL Energy is reporting net income of a $113 million or $0.62 per diluted share for the second quarter of 2009, compared with the net income of $101 million or $0.54 per diluted share for the second quarter of 2008.

Net cash from provided from operating activities is $316 million just about equal to the 324 million in the second quarter of last year. We're very pleased with these results, particularly in relation to the flat backdrop of the current economic environment. To put these quarterly results in another perspective, CONSOL Energy earned $1.25 million per day, and these are quality earnings, supported by cash generation of $3.5 million per day.

This past quarter again illustrated the financial power of being a no cost, diversified energy company. Let me highlight some of the second quarter results. For our Coal segment, our total margins for the second quarter were $10.94 per ton. Now even though this was down from the record setting $17.38 per ton coal margins, we achieved in the first quarter of 2009. It is a meaningful increase of $4.04 per ton, 59% from our core margins in the second quarter of 2008. Margin expansion is the key driver in our step change in profitability.

Our 14.4 million tons of production this quarter is down 2.2 million tons from the second quarter of 2008 and down 1.6 million tons from the first quarter of 2009. This decrease in production is not operations related, but market related. CONSOL Energy made production cut to help in the core market into equilibrium. Demand is down for our sting coal customers. We have work with them to address their coal stock poll issues are preserving the value of these contracts for CONSOL Energy.

We are beginning to see steel producers slowly bring back coking capacity. Net coal deliveries are resuming from the cannon mine in the second half of this year at production levels that will again contribute to earnings and cash flows. It reduced our overall production guidance for the year to 58 million tons. We expect to ship based on these revised production schedule which should reduce CONSOL Energy's coal inventories to beginning of the year level of 1.6 million tons.

From an operational standpoint the mines are doing well. We believe, we have addressed and corrected the systematic issues we had through capital investment and management changes. When the economy recovers CONSOL Energy's coal segment is ready to move. As the low cost producer in Northern Appalachian we're positioned for additional profitable growth.

As for our gas segment CNX Gas, had an outstanding quarter. Production increased 20% quarter-over-quarter to 22.5 Bcf a record. This record production was driven by better than anticipated results in the Marcellus Shale and coalbed methane. This quarterly production record is even more impressive considering the facts that the Buchanan mine long was idle for almost the entire quarter which differed 1BcF of gas production.

We are very excited about our Marcellus Shale opportunity. I am sure you have read our Marcellus Shale press release earlier this week where we announced that we have extended our footprint in that play by 40,000 acres bringing us to over 230,000 acres in the Marcellus Shale.

We are both expanding and consolidating our position in the Marcellus Shale. Our Marcellus the delineation continued this quarter as we completed three more wells. We now have eight and seven vertical wells in production. The refinement of Marcellus Shale drilling techniques continues with cost now trending to below $3.5 million per well. Multiple wells are being incorporated into a single pad with plans to drill up to six wells per pad, thus reducing costs.

In the second quarter of 2009, overall cost of CNX gas operations were $3.57 per Mcf slightly better than they were in the second quarter of 2008. However, the production volumes and controlled costs were not enough to overcome the depressed spot price for natural gas; even though we had over a half of our gas production hedged at $8.96 per Mcf, our pro-Mcf realizations dropped by $2.92. Net income in CNX Gas was $33 million or $0.22 per diluted share. This is about one half of the net income earned in the second quarter of 2008. The decrease in net income as a result of the lower spot prices.

We thought it prudent to lock up lock-in pricing on more of our GAAP reduction for the next three years especially with future prices being much higher than the forward month. For 2010, we have 46 Bcf locked in at just under $8 per Mcf. The earnings release has the complete detail.

We think this is a good hedge position at this point. We still have upside when prices rebound but we locked-in a significant portion of our 2010 gas revenue. This will provide financial support for next year's drilling and leasing programs. The production we achieved in the second quarter has given us the confidence to raise our full year gas production guidance from 87 to 89 Bcf. The 89 Bcf will represent a 16% increase over the 76.6 Bcf we produced in 2008.

As our financial results continue to show, CONSOL Energy's solid balance sheet and excellent liquidity has enabled us to continue to prudently invest in our businesses without diminishing our earnings power. At June 30, 2009 CONSOL Energy -- that's excluding CNX Gas had $62 million in total liquidity, which was comprised of $101 million of cash and 361 million available for immediate use at below market interest rate.

This credit facility does not expire until June 2012. Separately as of June 30, 2009 CNX Gas Corporation had a 112 million in total liquidity, which was comprised of 8 million of cash and 104 million available for immediate use, again at below market rates. This credit does not expire until October 2010.

Our short-term borrowings under these facilities were 452 million at June 30. This is down 106 million since the beginning of the year. The weighted average interest rate on these borrowings was under 1.5% of the first six months of 2009.

During the second quarter of 2009, we have expanded 200 million in CapEx, and for the six months our CapEx is 500 million. This is split about 55% in coal and 45% in gas. This is consistent with our comments that 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.

Determining the proper level capital spending is always the challenge and the challenge is magnified in this difficult economic environment. Our goal is to provide and allocate capital and a manner that maximizes long-term shareholder value. In the energy business, this requires a high degree of understanding of pricing, demand cost, competition and project investment requirement. It also requires flexibility to change directions when our CapEx models indicate the change is needed.

We expect our CapEx spending to be around $1 billion since 2009, which is at about the same as it was in 2008. You will complete the cost improvement projects at our low-wall mines like the Bailey overland belt system, and the shoe maker hollage (ph) system to enhance our position at the low cost producer.

We will probably ratchet back our spending in other areas for the coal segment until there is more clarity in the market. On the gas side we'll limit our spending on drilling until gas prices rebounds. However, with the success we're having in the Marcellus Shale we expect to allocate more capital to acquire Marcellus Shale acreage.

We remain stead fast in our confidence in our business model. Our powerful balance sheet and our status is a safe low cost producer enables us to effectively compete and produce strong earnings and cash flows even during times of economic turmoil. Between our coal and gas reserves in Appalachian CONSOLe Energy controls the greatest concentration of BTUs in the eastern United States. We believe our diversification into two premium fuels high-Btu bituminous coal and natural gas give us a diversified portfolio that will prosper in the decade that come by providing safely and economically a fundamental human need which is energy. Brett your comments

J. Brett Harvey

Okay. Thank you Bill, and welcome to everybody. It's good to spend time with you again to discuss the quarter and where we see the future.

I'm going to talk about the energy markets first because I think that sort of framework of our strategy and give you good look the way I see it's going forward. Coal markets are down because its natural electricity is tremendously down especially in Appalachian, Northern Ap, Central Ap; the entire region sees a drop of anywhere from 10 to 18% drop in our utility demand for energy at that's there level and then of course that backs up into the stock piles. So we see the stock piles at the plants rising, probably more dramatic in Central Ap, but Northern Ap also. We are concerned and I'm concerned that the supply is still too much for the present demand on the electricity side and that's why the stock piles are rising.

I'm concerned about the restraint, that has been announced in the coal markets, is not showing up at the mining operations of some of our competitors. They're building stock piles against, growing stock piles as utilities which I think in the long ones can create a problem for them and for the industry over the next 12 months.

The demand for steam coals is very weak and we continue to use our contracts to deliver and we make those deliveries based on the need of the utilities and then the economics between us is pressed out and captured overtime. It is not an easy energy world. Even on the gas side we see the demand for gas is down just like all demands for energy, the storage is going up, gas prices are down. Now the advantages that we have, is we are the low cost producer in both of these energies, and in any given market we're going to have the highest margins but we have to control our financial capabilities in cash and balance sheet, as we work away through this.

What we've decided to do and I reiterate this again, we're pulling back on the coal side to match our shipments, we'll continue to do that and we'll still be the highest margin producer as well as the highest performers on the coal side. If you look at what we did for the entire year, we're the highest performance coal company on our coal segment of any public coal company in the marketplace.

The flipside of that is we are the lowest cost gas producer but very high rate of growth. We will continue to grow the gas company because of its low cost structure and compare ourselves for higher margins in the returning gas market as we see a turn.

Let's talk about gas in general first. We are a low cost growth gas company, that's a good thing to say. We increased our guidance by $2 billion cubic feet this year to 89. We are margin driven, we are focused on getting the highest margins for the gas that we return. Is not about having more gas, but being in the highest margin gas in any given market. We are having great success in my opinion in the Marcellus Shale, as Bill talked about our average drill hole production holds about 3.5 million and we expect those costs to maintain or even drop from there.

We're in the position where we drill these holes together. We don't have big obligations to hold land by minimum drilling techniques. A lot of our fee position gives us the opportunity to mix our Marcellus Shale Gas with our coalbed methane gas and create optimum value.

When Bill talked about in Appalachian having the highest concentration of energy, we really do have between our Coal estate, our Gas estate, from Marcellus Shale estate all within the same acreage. It's that very powerful position, and we trying to take advantage of that. Our success in the Marcellus Shale, we will continue to keep one rig running in the Marcellus Shale and drill hole as fast as we can to develop that. But rather than spend a lot of our capital on drilling at this point in time we are looking to spend more of our capital on acquisition or consolidation of Marcellus Shale place and the sweet spot that we see especially within the coal estate where we have maximum control of how we optimize the use of coal and the use of gas in our region.

So the other day I went down to visit our Marcellus Shale operation and I want to tell the shareholders, that we have a long history of being world class coal operators and longwall operators and doing the right thing and extracting a Btu's of very low cost.

My impression of our operations of Marcellus Shale as well as our CBM operations, we are now world class across the boards and all of these gas extraction as well, very impressed with our techniques, our technology and ability and the age, the average age of this young work force coming into the gas business is very impressive.

So, I personally observed the world class operation that five years ago was in the industry. So that's good for our shareholders to be well. We're well hedged in gas for '09 and '10 as Bill talked about and I think that's important that we see these financial margins and our shareholders can count on us making good money on high margins through this very difficult energy world.

Okay, let's talk about Coal. A watch where it can tell to manage inventory, that's our number one objective. That creates a lot of innovation in my opinion on how we get things done. As we saw coal deliveries slow down in the second quarter, we had to be very nimble of how we handle our production versus our stock products. We intended to have our stock pile at the end of the year for CONSOL Energy at where we starting the fourth quarter 1.6 million tons. And these we have to manage this because stock piles of our customers are rising and moving around and we need to react to that.

We've slowed our longwall production down in the second quarter to match the shipments. That means we've to accelerate our longwall development ratios against longwall whole production and that is raised our cost for the couple of months and the short-term. Now think about it, we outperformed everybody else, in the coal industry as we raised our cost purposely to accelerate our longwall position for the future. So we are setting ourselves up, even in a marketplace where we're performing very well, to have a higher margins going forward. We have some one time adjustments for the quarter we will look at those and decide what to do with those.

But I can tell you we have a good quarter it's well managed and we are on the right track. The marketplace is something that we can't dictate, that's the function of the national economy. What we can dictate is how we handle our cash, when we deploy our cash and what we do in the short-term. Both things are very focused within CONSOL Energy. We are building that for a long-term. We are building I think a bridge for 2010 to a better energy market in 2011.

You'll watch has hedge our position on coal and gas as we strengthen the balance sheet and weather the storm. We are concerned about inventories at the coal supplier side; we are concerned about production coming from the west. It's on the second quarter where production are Powder River Basin actually went up which I think is a mistake, for not showing enough restraint in the marketplace just coal producers against demand for energy. So with that I'd like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) And first we have line of Kuni Chen with Merrill Lynch. Please go ahead.

J. Brett Harvey

Hello?

Unidentified Analyst

This is actually Chris Brown, filling in for Kuni Chen, good morning.

J. Brett Harvey

Hi Chris.

Unidentified Analyst

On the gas side, will you continue to layer in hedges at about 22 Bcf per quarter, did you slow back your hedging activity at these low gas prices?

J. Brett Harvey

I think it right now we have hedging strategy that's layers in. And as we see it move up about $0.50 from, we'll lay in. But it if starts to drop of course we won't hedge on the drop. So we're -- we tend to hedge on the spike so we'll take advantage of that as we see that happen.

William Lyons

And also Chris, we'd have the advantage of having both coal and gas. So we look at the total risk portfolio and if one side is doing better than other that influences how we do our hedging with the--again we think we're in a excellent position on our hedging were very pleased to have a well EPS hedged it almost $8 an Mcf for next year.

Unidentified Analyst

Then in your guidance you did about 10 million tons to committed price tonnage for 2010. Incremental tons they carry pretty high pricing the 60 plus range, can you give us some color there or is that more of a mix issue with perhaps more met coal being booked for the year?

J. Brett Harvey

Well, I think not as mostly steel coal I think we did a better--we got about 1.3 million tons of mix that is priced as well as we, I think we are opened about 3.3 million tons of met for next years as well. So the met isn't a big influence. But I think the steam price is going to hold. If you look at our average price, I would predict that our average price for next year is going to be very similar to the average price for 2010. And having said that, that's why I call it a bridge. I would expect 2011 to rise off of that number.

Unidentified Analyst

And then, just finally a question on the cost side. Obviously, there's the cost absorption issue at these lower lines, do you expect that to get worse in the second half or do costs basically stay at some more levels that we've seen this quarter?

J. Brett Harvey

I wouldn't say you'll see the cost drop over the second half. Now, I want you all to keep in mind that 15.1 million tons in the third quarter, you probably see the cost to stay up a little bit and then you see them drop in the fourth quarter. Third quarter is always tough for a big underground operation to deliver maintenance in third quarter we have lot of vacations in third quarter. So you will see the cost move around. But if you look our history third quarter is always tough. But all longwalls will be operated in the second half which should drop our cost structure versus our development structure that we talked about, I talked about earlier.

Unidentified Analyst

Okay great. Thanks.

J. Brett Harvey

Okay, thanks.

Operator

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

J. Brett Harvey

Hey Michael.

Michael Dudas - Jefferies & Co.

Good morning gentlemen. Brett could you characterize how the industry comes out of this downturn in the sunset; are we going to see further Appalachian production cutback which is pretty much most people anticipate in the marketplace. And how quickly could we see that and as your scenario when is the western global markets recover which seems to be occurring at a previous reasonable pace that we could come back to some tighter coal conditions in to later 2010-2011?

J. Brett Harvey

Yeah, I think in the short-term we have to for lack of words we have to burn our way through this large volume, is around ground today. And that's going to create, for marginal players of financial problem. So I think you'll see some forced financial situation where people close down, not by option but by force and that's in short-term, I'm say six, 12 months.

After that, that means supply destruction is happen so at the end to 2010 to 2011 the utilities we are going to read that and see that the supply is down they are going to probably keeps there stock piles up a little bit higher out of fear, in my opinion and you will see -- that was the global market will move coal prices, I think pretty rapidly for towards the end of '010 into '011. And also met demand as we've already seen the met demand will continue increase and we'll see very strong met prices. That's why we're open at 3.3 million in 2010 we see some opportunity there to go back to some pretty high margins based on our low cost position.

Michael Dudas - Jefferies & Co.

Have you see those negotiations maybe accelerating a little quick quicker than you would have thought few months ago on the Buchanan product?

J. Brett Harvey

I don't think so, I don't think so, I think that market even though its moving the steel market itself even though its moving it's very tenuous and are they taking that day-by-day. The steel companies are -- were in a shock as we all know and they're walking out very slow so I don't think there is going to negotiate very fast. Hoping on their side I think that is the supply goes to their side but I don't think it will.

Michael Dudas - Jefferies & Co.

And my final question Brett, is how important do you think coming out of this downturn in the coal market will the international market be for U.S. producers and especially somebody like yourself who's very well positioned in the export market?

J. Brett Harvey

Well, in our position to move to our own port facilities, we expect that capacity on our own port facility to be an outlet for harder markets so to speak and we'll move there -- we'll move to the highest margin marketplace, and we're capable of doing that as you know.

Michael Dudas - Jefferies & Co.

Thank you Brett.

Operator

Our next question is from the line of Rehan Rashid with FBR Capital Markets. Please go ahead.

J. Brett Harvey

How you doing?

Operator

Rehan..

William Lyons

Are you there?

J. Brett Harvey

Rihan? Apparently he's not there.

Operator

And we will move on. Will go to Brian Yu with Citi. Please go ahead.

Brian Yu - Citi

Great. Thank you.

J. Brett Harvey

Hi.

Brian Yu - Citi

Hi. With the metallurgical coal shipments, it looks like, the those shipments incited your pricing in the second quarter a bit. As we look on the back half where would you expect on that coal shipment to rebound to, a negative half a million ton mark on a quarterly basis?

J. Brett Harvey

I think we expect by the end of year be at 2.3 million tons of shipments; and July through December that's another 1.7 -- almost 1.8 million tons of shipment, leaving Buchanan. We are running that the Buchanan mine on two shifts and we have potentially another 500,000 tons that we can sell it. Now, I hope we can sell all the other 500,000 tons because that will lower out cost structure and raise our margin over the rest of it. Right now we are predicting that the average sales price for the year, the tons that I just mentioned are about a 100,000 of tons.

Brian Yu - Citi

All right. And then just to follow up on that, we are hearing just a lot about the demand out there from China for metallurgical coal. Is there a particular market that's better positioned to serve them, because other coal producers have reported, they're saying yes, the demand is strong but doesn't seem like anybody is getting the volume benefit this year?

J. Brett Harvey

Well I find it interesting for Eastern Coal producers to talk about the Chinese market because nobody have really moves coal to that marketplace. It's just when that marketplace is strong it tends to have an influence on world pricing. The natural markets for eastern coals are Brazil, Europe and the general domestic steel industry. And when they strengthen, we will strengthen and those are the markets that we look at, those are markets that we have contracted for and those are our long term customers. So if we get the right price we will move coal to China but, China is a long way from Eastern United States and I would take you granted as how the people talking about China and their shipments.

Brian Yu - Citi

Thanks for that. And just switching topics with the choice and we are seeing very high stock piles as you mention now with the lack of global warming, helping that the coal burn this year Would you expect additional on cutbacks and production of later during the summer if burn rates don't improve?

J. Brett Harvey

Based on our for consoled self based on second half we believe we are going to be able run along walls and sell the coal that we have. There is more clarity in market in the last two quarters, now during the first two quarters. So we believe we'll be there, now in terms of the overall market place I would say as I said in my remarks there can be some forced production to go offline the marginal high cost players are going to be pushed up just based on financial problems. This is a -- when there is the big pile of coal like that out there the utility level cross the board could create real strain on those with good balance sheets and the margin marginal producers.

Brian Yu - Citi

Thank you.

J. Brett Harvey

They'll forced out.

Operator

Our next questions from Bill Eagan with Raymond James. Please go ahead.

J. Brett Harvey

Hi Bill.

William Eagan - Raymond James

Good morning guys. With what you guys see today, do you expect any volume growth next year or are you think it's more flattish with this year?

J. Brett Harvey

Well, I think the volume will grow because we have, when you itself we have the Shoemaker mine coming online is contracted for; you have the net business coming back online which is the above the 5 million tons a year. And so those two pieces you are going to see the growth and I think where we seeing the cut back in the, even in the period of about 4 million tons, you'll see it come back. So I wouldn't be surprised to see this and about 65 to 68 million tons to next year. But I can tell you this right now, the market is not there, we're not going to mine it, and we will do what we did this year and manage our costs and our developments and our prices without building inventory.

Brian Yu - Citi

And looks like the tax rate are going to step this quarter. What are your thoughts for the second half of the year?

William Lyons

The tax rate is probably going to be around 29-30%. Sure, where tax rate is very dependent based on a mix of income and also percentage depletion is very mine dependent. But I would say good numbers is about what we have it for the six months.

Brian Yu - Citi

Okay. Thank you very much.

Operator

And next in line Shneur Gershuni with UBS

Shneur Gershuni - UBS

Hi, good morning guys.

J. Brett Harvey

Hi Shneur.

Shneur Gershuni - UBS

Don't want to deliver the whole 2010 thing too much. But I was just wondering if you can walk me through the thought process, you kind of have despite higher costs this quarter, you still have kind of lowest cost relative to your peers in the market place, and I was just wondering if you can walk me through your contracting thought process for 2010. Do you undercut competitors and take share, but are you -- or are you more focused on returns and kind of if you can talk that your appetite to keep production at current levels or given your inventory balance that has changed to actually reduce production further.

J. Brett Harvey

We believe for '10 we have about 21 million tons that are on priced. Those on priced tons, we will negotiate to price but we will only, we are not driven towards more volume or capturing market-share. We are driven more towards the highest margins and controlling the inventory of our own operations and I think that's where we make the most money that's the sweet spot. I think by trying it, grab market-share it affects the price of the entire market place and I don't think that's a right path to go on. So you will see us be very aggressive on our pricing, we've already locked in about 40 million tons and good prices and I think puts us in a very good position.

Shneur Gershuni - UBS

Happy to hear that actually. I was wondering if you can just another question or two here. If you can talk about acquisition opportunities for both CNX and CXG, do you expect to just to do tuck-ins like what you just did with NiSource or do you see something bigger on horizon?

J. Brett Harvey

Well I can tell you on both coal and gas we are looking at small deals and big deals and when the time is right we will move, our balance sheet is prepared and sitting in there to make these kind of moves and that's our intention is to consolidate as we see the bottom of the market our opportunity where somebody willing to jump in with us and then create a bigger company.

Shneur Gershuni - UBS

And one last final question. Do you foresee any reclamation or development type work over the next two quarters that will continue to pressure cost?

J. Brett Harvey

Well we are getting some pressure on our longwall compliance and that showed up as our cost, a one time cost on the second quarter. There is always pressure on environmental issues but that's a matter of compliance and we're seeing from the present administration from the EPA and things a tighter control and I think overtime that that will limit the volume response on the coal side as well as it will slow down some of the gas permits overtime as well through. But that's what we do once everyday, so I don't see there is been a big problem. So there is nothing really to know out there.

Shneur Gershuni - UBS

Great, thank you very much.

Operator

Our next question from Scott Hanold with RBC Capital Markets. Please go ahead.

J. Brett Harvey

Hi Scott

Scott Hanold - RBC Capital Markets

Hey, good morning. The horizontal CBM well in the Pocahontas theme (ph), is that some New York trying and what is the so you kind of talk about past business rates and relative to I guess the is forced you might thought there was pretty thin and just kind of wondering the logistics of being in zone there.

J. Brett Harvey

We have a few wells in that scene and there is lot of gas in that scene. We are trying to build extraction techniques to fit similar to what we do in the thicker seams. I think that you have to be determined in terms what is cost structure is if technical continues to do it.

But we look it what we do we tend of move to the sweet spots and as a price drops and the sweets parts right now were the thicker seams and also to Marcellus Shale plays which we will continue to add land position for more opportunities and we'll continue to optimize our tremendous field position on the coal bed methane side.

Scott Hanold - RBC Capital Markets

Okay. And Brett can you talk about your current thought you have given the continue improvement in Marcellus well results, how you think about your drilling coal bed methane wells versus Marcellus Shale wells when you're kind a doing a capital budget and that actually if you could provide that too into the bigger picture of CONSOLE as a whole, where does kind a coal fit into that picture when you're deciding where your best are spend?

J. Brett Harvey

Well, I could tell you this, we look at our capital across both companies and where we see at the highest rate or return opportunity, we certainly do that. And we're committing some contracts on coal sources; of course we have to do that. But nice part is we have about to grow both of them and we've been doing that. We put a lot of money into the coal side to re-establish the high margins there and we could probably, we'll probably be in a position for the next couple of years of harvesting the coal side and growing the gas side rapidly on the Marcellus Shale side. So I think you can look at CONSOLE Energy from that perspective. The coal bed methane piece, that is very low cost under Virginia and will weigh that against Marcellus on the dollar-for-dollar basis but is nice to have those kind of options and that is the optional in this company.

Scott Hanold - RBC Capital Markets

Okay. And one last question on sort of the ownership as there is now, what are your current thoughts I mean you are asking relative market, picking up safety shares late last year, early this year, what are the current process as far as you know what, do you thinking longer term for the here ownership in TXG?

J. Brett Harvey

But we picked up the shares because we though they were exchanging into values and that was our strategy of the time, that was more in investment I mean the investment similar we really know and as we've -- as the board is announced we made an offer for the other shares, it didn't work out, so we have partners out there and will continue to grow partners until the Board that makes different decision.

Scott Hanold - RBC Capital Markets

All right. Appreciated it, thanks.

Operator

And next in the line of Amir Arif with Stifel. Please go ahead.

Amir Arif - Stifel Nicolaus & Co.

Thanks good morning guys. Couple of quick questions on the gas side, you mentioned that you want to live within cash flow but you want to keep that one horizontal rig active out there but that rig to handle those price as many wells so can you just let us know we should be thinking up in terms of new well completions in the Marcellus for the second half?

J. Brett Harvey

Well we drilled eight wells and I would say we are going to keep that rig going on here so our intention is too keep it running and I think we still stay within our cash flow.

Amir Arif - Stifel Nicolaus & Co.

Okay, that are you looking for 12 wells instead of six in the second half?

J. Brett Harvey

We could end up -- yeah I would say.

Amir Arif - Stifel Nicolaus & Co.

Okay. And the increase in the production guidance I am guessing a lot of that they can have grown is really just going to show up in the 2010, number not really turned up in that '09 increase that the first statement?

J. Brett Harvey

I would say yeah.

Amir Arif - Stifel Nicolaus & Co.

Okay. And it's also in the Marcellus in terms of you mentioned that you look in increase rate which position out there? Would you looking to stay focused and the Southwest Pennsylvania, West Virginia region or you are looking to move to other areas of -- say like the Northeast and...?

J. Brett Harvey

Yeah, we're going to stay focused on where we have massive land controls based on a coal state and because we have a lot to do and lot of say about the permitting process and where we drill, on our key positions. So we'll continue to consolidate around Southwest and Northern West Virginia, that's a sweet spot for us.

Amir Arif - Stifel Nicolaus & Co.

Okay. And one final question on the Huron shale, you've got lot of acreage and lot of potential out there but you did take consistently charge for that test well, does that reflect or reduce the outlook on that play or is it simply just a accounting rules and low gas price at the end of the quarter?

J. Brett Harvey

I think in this marketplace, we have less appetite to develop that we will in the future, but it play some hard gas for us and that was on the edge of the Huron. So I would say -- I wouldn't take anything serious about that I think that was just well and then the market changed and we will go back to that in a big way when we see the opportunity.

Amir Arif - Stifel Nicolaus & Co.

That was great. Thanks.

J. Brett Harvey

Okay. Thanks.

Operator

Our next is question from Pearce Hammond with Simmons. Please go ahead.

Pearce Hammond - Simmons & Company

Good morning.

J. Brett Harvey

Hi Pearce.

Pearce Hammond - Simmons & Company

Brett, can you provide an overview of the current permitting environment from your prospective and then what the potential impact might be to CNS operations over the next year or so?

J. Brett Harvey

Well. I would say that if you look at the EPA has been very aggressive with the change in administration especially on mountain top mining's. And so those areas were we have mountain top mining associated with Ambest (ph) acquisition or Nordcreek (ph) acquisition. Those things are I would say very great we get the quarter against just a one point and then you got the EPA reinvestigating there is another point and so it's a very unsure situation of mountain top mining in the Central Appalachian, which I think, are threaten to statement driven as the region based on the governments approach to it.

Now, where it fits CONSOL Energy clearly we won't -- to mines that we have, but its not our major contributor to CONSOL Energy, Central App in total to us to seven to 8 million tons and weak going away with that and that probably could enhance the value of Northern Ap coal if we saw huge constraint there.

So I think that plays out based on -- it's a political debate, more than I think an engineering debate. Will clinical debate to side of mountain top mining is something that could be done in a big way going forward. Its grey and I would say that we've got 12 months of discussion before it becomes clear

Pearce Hammond - Simmons & Company

And how would you see potentially impact in underground operations in Central Appalachian there be any impact and specifically to Buchanan?

J. Brett Harvey

I don't think it would affect Buchanan, because the underground operations tend to be isolated from mountain top issues. But all issues related to mining opinion reviewed and I think underground mines have less impact but all mining has been reviewed for its impact and it's like over time regulation you get tired and tired, you just have to learn it to deal of it and it becomes for you cost structure.

Pearce Hammond - Simmons & Company

Great and then one other question, if an ANR and FCL if they do merge do you expect any sort of change in the competitive dynamic in Northern Appalachian?

J. Brett Harvey

I actually I don't. I would say that they have two well capitalized mines in Northern Appalachian, we've competed with them for 30 years and I don't see a big change there in the marketplace. So they are already there, they're not new mines and they are already part of it. They're well run and we don't mind competing with them. I think that, they just made a bigger company to compete with and may be their balance sheet structure will give them an opportunity to show more strengthen marketplace.

Pearce Hammond - Simmons & Company

Great, thank you, Brett.

Operator

And next to Brian Singer with Goldman Sachs. Please go ahead.

Brian Singer - Goldman Sachs

Thank you. Good morning.

J. Brett Harvey

Good morning Brian.

Brian Singer - Goldman Sachs

Just holding up on that earlier question, I forgot to the second half production outlook, I mean specifically your expectations for higher fourth quarter volumes, you mentioned greater clarity their and I was wondering if you could add a little bit more color on its inventories, do you say high what is driving the clarity that at our market conditions from improve or the volumes will shift?

J. Brett Harvey

Well, I think its matter of the contractual relationships. The prospect from the utilities has been pretty well deal with. The tons are sold or scheduled. We know what the inventories are, the major customers. And it's like any other year the closer you get to the end of the year, the more clarity you have. And I would say that really where it's at. We've had major discussions was most of these utilities. And you also the met coal, the met coal coming back as of almost 2 millions tons.

Brian Singer - Goldman Sachs

Great, thanks. And then can you differentiate a littler more on the conversations you are having with customers the thermal customers taking your Northern versus Central Ap and how that translated into thermal tons price during the quarter in the current environment.

J. Brett Harvey

Yeah, we were already priced it was just a matter of them having to build this technical physically because of stock piles were rising rapidly across the board. When we talked about pricing, we weren't talking about pricing in '10 and in some case '011.

Brian Singer - Goldman Sachs

I'm sorry, that is what I was referring to. Thank you.

J. Brett Harvey

Well we see the price in this firm and we have taken some of the economics that has been differed for '09 first into '10 which I think Bill help us to build bridge into '11; and other couple of as you saw people have actually paid us not to take the tons which will see the value of that unleashed in 2010 as well.

Brian Singer - Goldman Sachs

Great. And then lastly, geographically when think about acquisitions, do you think, you thinking more about the consolidating the Marcellus and Appalachian coal assets or are you focusing more on diversification into non eastern coal and gas prices?

J. Brett Harvey

Well, I guess from my perspective, I'm going to go for the highest margin of acquisitions. And if there are outlast or they're in the Marcellus shale that's where I'm going to go. So, I think right now from our perspective, and the assets that we do around, the highest margins are coming from our assets within the region we're at. When we talk about the concentration of Btu's in the Eastern United States, and the position we're in, it's hard to step out of that without revaluating what's around it first.

Brian Singer - Goldman Sachs

Thank you very much.

Operator

Our next question from David Lipschitz with CLSA, please go ahead.

J. Brett Harvey

Hi Dave.

David Lipschitz - CLSA

Hey, good morning. Question for you on your inventory, you said you wanted to get back out of the 1.6, where do you stand now?

J. Brett Harvey

We're about 2.8. And we ended the second quarter at 3.5, we think by the end of third quarter will be 2.2 and then in the first quarter 1.6.

David Lipschitz - CLSA

Okay.

J. Brett Harvey

And keep in mind Dave, that's very critical though because if you put that on the ground as cash lying on the ground is safe in the bank we take that serious.

David Lipschitz - CLSA

So in the third quarter then your production will be 13.1 but your shipments obviously would be significantly higher than that?

J. Brett Harvey

Yeah, in fact we're already -- if you look by the end of the second quarter in the first month we've dropped 700,000 tons.

David Lipschitz - CLSA

My next question is you say you potentially can do 65 million tons next year after-market's there. But do you think then we pretty much be in a balanced situation by the end of 2009 with inventories sort of that you some other potential could increase production from this year's to next year's level and it could be a lot of smaller -- -- that our business take just take their market share?

J. Brett Harvey

I don't think -- I don't think the stock piles will be in balance until probably the end of the second quarter next year. And I think the utilities are going to see a supply risk as people drop out based on economics on supply side and so they'll pick a higher level, I think for a couple of years just for insurance. And that'll create some ships, it won't drop to where it was when everything fell off. So we're looking at the end of the second quarter of next year.

David Lipschitz - CLSA

Okay. Thank you.

J. Brett Harvey

You bet.

Operator

And next in line we have Lasan Johong with RBC Capital Markets. Please go ahead.

Lasan Johong - RBC Capital Markets

Thank you. How -- in terms of number of days, how much storage do you think is left out there from you customers put perspective?

J. Brett Harvey

I think they are up from last year's average of about 25 up to about 45, 45 days overall.

Lasan Johong - RBC Capital Markets

45 days overall current storage?

J. Brett Harvey

Yes, and that storage at the utilities, some of them as high as 80 days. It depends on what utility or what, or whether they're merchant generator or regular utility. But it varies quite a bit, but I would say their storage is what it was at this time last year.

Lasan Johong - RBC Capital Markets

Okay and how much coal to gas switching will see this year?

J. Brett Harvey

I think about 25 million tones and will see in the lot more in the Central Ap area.

Lasan Johong - RBC Capital Markets

But do you think there is higher probably of that increasing or decreasing overtime?

J. Brett Harvey

I don't think you can increase very much because you have a fixed amount of gas even it’s converted against coal. So if you ran them all probably a yearly move would be about 35 million tons. Should you run them all year long.

Lasan Johong - RBC Capital Markets

But not exceed 35 million.

J. Brett Harvey

And it will take time to built new plants. So yeah about 35 million tons on the margin between the two.

Lasan Johong - RBC Capital Markets

One last question the acreage that apparently sold to CXG 20,000 acres, how much more of that potential is there?

J. Brett Harvey

That was just a clean up of what we had within the coal estate, and we sold it back to CXG along with our consolidation with the deal with NiSource, that's all we had.

Lasan Johong - RBC Capital Markets

That was it.

J. Brett Harvey

It was a nice piece to find.

Lasan Johong - RBC Capital Markets

That was it there's no more of that kind of synergy stick that you can do?

J. Brett Harvey

I wish it was.

Lasan Johong - RBC Capital Markets

So do I. Great. Thank you very much.

J. Brett Harvey

Yeah.

Operator

And next go to Justine Fisher with Goldman Sachs. Please go ahead.

Justine Fisher - Goldman Sachs

Good morning.

J. Brett Harvey

Good morning Justine.

Justine Fisher - Goldman Sachs

I have a question about the inventory building at the mine because I think most of what we read about the papers is about inventory that utilities and I know you guys are commented on your inventories. But are the build you are seeing at our, your competitors are those based on, you think production that they have already kind of planned it down and turned upstairs not a buyers that they are building like is that or is that utility well based on their current production or is that just a hang over from probably pretty last few months before they may have announced recent cut.

J. Brett Harvey

I don't really know all I can tell you is when I drive (ph) by it makes me nervous and the issue is if you see inventory build at the utilities and inventory build at the coal mine that just extends the live the coal has to be burn through and I think I really put pressure on marginal producers because that coal is going to move to the utilities before you see any price movement and the marginal guide is going to have more quarters of pain before it turns.

Justine Fisher - Goldman Sachs

I mean this may be an unanswerable question but if we know how many days are in hand of the utilities -- I mean how many days might have add to the total inventory in US that needs to be kind of before we get to normalize level is that a number that you guys can even hazard a guess in?

J. Brett Harvey

That's in my opinion that's a number you got to be asking coal companies. We don't know how much is out there, we can tell you what we're doing and that's why we're announcing that.

Justine Fisher - Goldman Sachs

Okay. And then, one last question. I know the consistent question for you guys about consolidation typically tends to the within were between Appalachian to PRB but would you guys consider acquiring international assets, I'm thinking more Latin America, than anywhere in Asia?

J. Brett Harvey

Yes, if we could add value and take up expertise there, certainly we would.

Justine Fisher - Goldman Sachs

Great, thanks.

Operator

We will go to Paul Forward with Stifel Nicolaus. Please go ahead

Paul Forward - Stifel Nicolaus

Good morning. Part of the all-in production cost in second quarter, we're all the way to $45.42 a ton, when you consider that moving parts going into 2010 you will have recovering longwall production, you should add, I believe to step up in labor cost as well, but if you can get up to the 65 million ton run rate, where would you anticipate cost go from 2009, are they flattish, is there chance to possibly pull them down?

J. Brett Harvey

I think it would look more like the first quarter.

Paul Forward - Stifel Nicolaus

All right.

J. Brett Harvey

Yeah I think it would look more like the first quarter because we have pressure on our purchasing, we have pressure on all of our commodities and if this market tends to stay like that, it should be right around that level. Now, mostly because, when you look at the first and second quarter, the biggest movement in cost was a change in ratio between longwall coal and longwall development. We're developing, if you look at the development ton against the longwall tons probably four to one in terms of costs, and so when you change that ratio, your cost rise, but you also increase the value of the company based on its almost like I have it inventory in a strip mine fit because your last step is to run longwall through and its very power position in the changing market.

Paul Forward - Stifel Nicolaus

Okay. And on the 2011 commitments, just from the pervious quarter to this quarter it looks like they went down and aggregate by about million tons. So I just wondering why were they down and as far as not much in a way, but new commitments happening for 2011. And there's always a difference between yourselves customers on what an appropriate prices but would describe it that between go between yourselves and customers on unacceptable price for 2011 and beyond, as being unusually wide?

J. Brett Harvey

I don't think, still typically that's not the issue, I think the issue is we have the customers are readjusting and we are to and so there is some open issues between us, I think if you called Vance (ph) or Bill offline they could probably walk you through the whole thing.

Paul Forward - Stifel Nicolaus

Okay, thank you.

J. Brett Harvey

Thank you.

Operator

And we'll go to Garrett Nelson with Davenport and Company. Please go ahead.

Garrett Nelson - Davenport & Co.

Good morning everyone.

J. Brett Harvey

Hi Garrett.

William Lyons

Good morning.

Garrett Nelson - Davenport & Co.

Most of my questions have been answered. But what kind of export volumes are you anticipating for the CNX or in terminal for the year, and are you expecting a meaningful balance in export demand in 2010?

J. Brett Harvey

Well, we expect about 4.7 million tons and most of it the terminal this year and about 3 million that's, and next year I would say -- it all depends on European pricing. But, it could go up as high as 8 to 9 million in some of that stuff that we're looking at for next year.

Garrett Nelson - Davenport & Co.

Okay, and through the first half, where do exports stand?

J. Brett Harvey

About 2 million tons.

Garrett Nelson - Davenport & Co.

Okay. And how much of that is your coal?

J. Brett Harvey

1.53 million.

Garrett Nelson - Davenport & Co.

Okay, great. Thank you.

J. Brett Harvey

All right.

Operator

And go to Mark Caruso with Millennium Partners. Please go ahead

Mark Caruso - Millennium Partners

Hi. Good morning guys. I just had a few clarification questions. The first was Brett, you mentioned earlier the came back to run in the longwalls rather continues mines which have cost is been, did I hear you right to that start to happen in the second half of the year given more visibility?

J. Brett Harvey

We believe by September 1st all longwalls would be running as these are normal capacity.

Mark Caruso - Millennium Partners

Okay. And then, you guys plan on shipping more from inventory, so that impact cost negatively since its higher cost or just trying to think, how to think that from a high level?

J. Brett Harvey

Yeah, that won't affect cost.

William Lyons

Inventory is always sold its price so it won't affect our cost structure at all.

Mark Caruso - Millennium Partners

Okay perfect and than lastly on the Marcellus, you guys just increased the acreage position here to 235,000 as you look at the landscape you mentioned earlier you know we get some gases small and large are you seeing opportunities to pick up some of those assets from some of your coal competitors or do they sort of realize what they have now and I guess second to that would you consider doing a JV or considering a lot of the international majors out to get into the play.

J. Brett Harvey

So, we are okay with JVs we've offered some of that in some case we've done that as you saw we did it deal last year. We are looking in all these opportunities the gas piece in the Marcellus Shale I can't emphasize enough to our shareholders. That's a valuable position that we are already to in we don't have obligations to drill to hold the land we have already and we announced a major deal and if we were on 80 acre spacing, looking at the same kind of success we are seeing among ourselves feel right now with the wells that we have its anywhere from five to 80 within that 40,000 acres was just announce. Now that's got to be proven out, but I'm telling you is this is a powerful position and we are going to continue to enhance it moving forward. Out of capital any discretionary capital that we have moving forward with the rest of the years is going to be in an acquisition of opportunities.

Mark Caruso - Millennium Partners

Great, thanks guys.

William Lyons

Yeah, thanks. I think, we are going to wrap it up here and I will be available in my office for the rest of the day, if anybody else has any questions, but operator could you please instruct the callers on the replay information process.

Operator

Certainly, and ladies and gentlemen, the replay starts at 1:00 PM Eastern and will last until August 6 at midnight. You may access the replay at anytime by dialing 800-475-6701 or 320-365-3844 the access code is 106655 those numbers again 800-475-6701 or 320-365-3844 and the access code 106655. Mr. Zajdel any closing comments.

Dan Zajdel

I would just like to thank everybody for participating and again I will be in the rest of the afternoon. Thank you.

Operator

And ladies and gentlemen that does conclude your call. You may now disconnect.

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