CNX Gas Corp. Q3 2009 Earnings Call Transcript

CNX Gas Corp. (CXG)

Q3 2009 Earnings Call

October 22, 2009 10:00 am ET

Executives

Daniel Zajdel – Vice President, Investor Relations

Bill Lyons – Executive Vice President and Chief Financial Officer

Brett Harvey – Chairman and Chief Executive Officer

Analysts

David Khani – FBR Capital Markets

Shneur Gershuni – UBS

Jim Rollyson – Raymond James

Michael Dudas – Jefferies & Co.

Tony Chan – Bank of America

John Bridges – JPMorgan

Scott Hanold – RBC Capital Markets

Brian Yu – Citi

Paul Forward – Stifel Nicolaus & Co.

Presentation

Operator

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

Daniel Zajdel

Welcome to our joint earnings calls 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 discussion third quarter results for both companies. In addition, we will be discussing our views on the outlook for the remainder of 2009 and for 2010. Any forward-looking statements we may express or our expectations for 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 any proved reserves that the company has demonstrated by actual production or conclusive formation tests 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 resources 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 and 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?

Bill 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's reporting net income of $87 million or $0.48 per diluted share for the third quarter of 2009, just about equal to the net income of $90 million or $0.49 per diluted share in the third quarter of 2008. Net cash provided from operating activities is $162 million compared to $213 million in the third quarter of last year.

The third quarter is usually the most challenging financial quarter for us because of normal vacation shutdowns. In addition, these vacation periods provide us with the opportunity to do wide ranging maintenance while the mines are not in operation. This results in higher operating costs.

We are pleased with the third quarter results, particularly in light of the current economic environment. This past quarter again illustrated the financial power of being a low cost diversified energy company.

Before I go into the details of our third quarter results, I want to call your attention to some changes we are making in the format of our press release that we hope you will find useful. We've taken what we used to call our coal business and split it into our metallurgical coal business and our thermal or steam coal business. The activities of our metallurgical coal business and our steam coal business are key performance indicators that disclose important aspects of our company.

In our view this additional information can be used to give evidence as to how these businesses are being managed in the differing environments in which they operate. We hope that this will provide more transparency and understanding of the company and as a result provide significant insight into the sources of CONSOL's value.

In our met coal business we sold 700,000 tons in the third quarter at an average price of $97 per ton, with costs of just over $60 per ton we had an all-in margin of $37. We believe our met coal costs may be the lowest in the United States. Low cost coupled with premium low volatile coal make us believe that our met coal business is without equal.

On the thermal or steam coal side we sold 13 million tons in the quarter at an average price of $58 per ton. This was up 24% from last year's average realized price per ton. We believe this to be the highest price per ton that we have ever realized for our thermal coal in a single quarter.

Cost per ton of thermal coal was $47.83, up 5% from last year. Almost all the increase can be attributed to our decision to reduce production to help the market stay at an equilibrium. Thermal coal financial margins for the third quarter were $10.24 per ton or seven times the financial margin of the year ago.

While many of our thermal coal contracts were priced last year when the thermal coal market was tight, we do believe that a substantial portion of this pricing reflects the continued scrubber build out, increasingly our thermal coal is being priced for its high head content not its sulfur content.

Margin expansion is a key driver in our step change in profitability in both our metallurgical and thermal coal businesses. We are maintaining our 2009 production guidance of 58 million tons. Of this, 1.9 million tons will be Buchanan coal destined for met coal customers. This means that in the fourth quarter we expect to produce 700,000 tons of met coal and 13.4 million tons of thermal coal.

Our current inventories are at 500,000 tons of met coal and 2.8 million tons of thermal coal. By year end we expect no change in our met coal inventories and we expect to reduce our thermal coal inventories by 700,000 tons.

Our mines continue to do well. We are out in front with our development work so that when the demand for thermal coal rebounds we'll be ready and able to meet the increased need. As the low cost producer for both met coal and thermal coal, we are well positioned for additional profitable growth.

Our gas segment, CNX gas, of which we own an 83.33% interest had another outstanding quarter. Production increased 26% quarter-over-quarter to a record 24.8 Bcf. This record production was driven by better than anticipated results in our Virginia coal bed methane and our Marcellus Shale operations. In the third quarter of 2009 overall costs at CNX Gas operations were $3.44 per Mcf or $0.41 better than they were in 2008.

However, the record production volumes and lower costs were not enough to overcome the press spot price for natural gas. Even though we had 13.2 Bcf of our gas production hedged at $8.69 per Mcf in the quarter, our average realized price per Mcf was $6.25, a reduction of 36% from last year's third quarter.

Net income at CNX Gas was $35.5 million or 23% per diluted share. This is about one half of the net income earned in the third quarter of 2008. The decrease in net income is solely the result of lower spot prices.

CNX Gas has an envious position in what some are now calling the world's second largest gas field, the Marcellus Shale formation. We are very excited about our Marcellus Shale opportunity. Our current footprint is 230,000 acres of which 2/3 are considered by most to be category Tier 1 acres. We are actively seeking additional acreage. Our goal is to increase our position to 250,000 total acres by the end of the year.

Our acquisition efforts remain focused on southwest Pennsylvania and northern West Virginia where we have many inherent advantages. If you've seen the latest slide on this CNX Gas Website you know that we've been driving down drilling costs while increasing our per well estimates of reserves.

Right now we believe that we can earn a 26% after-tax return on our horizontal Marcellus Shale wells with $5 gas. Keep in mind that all this drilling has occurred on acreage that CNX Gas owns in fee. This means that we have 100% net revenue interest. No other producer that I'm aware of can say this.

You might have seen that we reiterated our 2010 gas production guidance of 100 Bcf. We feel that 100 Bcf is a reasonable starting point and assumes one horizontal Marcellus Shale rig for the next year and the drilling of 175 Virginia CBM wells, plus some ancillary drilling. We are currently formulating our 2010 plans, but this much is clear. When gas prices rebound we will have the ability to quickly add rigs.

There were some other items in the quarter that may be helpful to mention. We incurred additional idling costs primarily at Mine 84 Shoemaker in Jones Fork; impacted net income by about $13 million. Additional reclamation requirements at our Central Appalachia surface operations impacted net income by $4.2 million. And dry hole costs and lease drops impacted net income by $3.5 million.

Also notice that the decrease in coal demand caused a reduction of $6.3 million in net income from our transportation activities this quarter compared to the 2008 third quarter.

Well, let me return to CONSOL Energy's overall financial position. Our balance sheet remains strong and we continue to have excellent liquidity. This combination has enabled us to continue to prudently invest in our businesses without diminishing our earnings power. At September 30, 2009, CONSOL Energy, and that's including CNX Gas, had over $500 million in total liquidity available for immediate use at interest rates that are well below market.

So in the third quarter of 2009, we have expected the $193 million in CapEx and for the nine months, our CapEx is $689 million. This is split about 60% in coal and 40% 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 while protecting our financial position.

Determining the proper level of capital spending is always the challenge and the challenge is magnified in this uncertain political and economic environment. Our goal is to provide and allocate capital in 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 requirements.

It also requires flexibility to change direction when our CapEx models indicate a change is needed. We continue to expect our CapEx spending to be around a billion dollars for 2009, which is about the same as what it was in 2008. While we are still formulating our 2010 spending plans, we believe that we'll be in a position to ramp up drilling in the Marcellus Shale when gas prices rebound.

On the thermal coal side, we will not be starting any new production projects until we begin to receive additional customer commitments. The increasingly stringent regulatory environment for coal also concerns us.

We remain steadfast in our confidence in our business model. Our powerful balance sheet and our status as a safe, low-cost producer enables us to effectively compete and produce excellent earnings and cash flows even during times of economic turmoil. Among our met coal reserves, our thermal coal reserves, and our gas reserves in Appalachia, CONSOL Energy controls the greatest concentration of BTUs in the Eastern United States.

We believe our diversification into three premium products gives us a diversified portfolio that will prosper in the decade to come by providing safely and economically a fundamental human need, which is energy. With that, Brett, your comments on the quarter.

Brett Harvey

Okay, thank you Bill. Bill has done a good job of covering the numbers and part of the strategy. I'd like to give you a color from my perspective on where we're at and where we see the marketplaces. Welcome to the gas shareholders as well as the shareholders of CONSOL Energy, which includes coal and gas. It's good to talk with you and answer questions today.

Let's talk about gas first because I think it continues to be a very bright spot in the marketplace, and as we know, overall the chosen field, so to speak, in terms of the way the government looks at it and regulation. We see continued growth there. We raised to 92 Bcf. We did this through the price trough. We believe, we think, prices are going to go up.

Our ability to add more revenue at higher volumes is certainly in place. That's why we continue to grow. And one thing I want to stress very, very adamantly is we're doing it with very little debt. We're using our own cash to grow. We're the second highest growth gas company in the United States and by far the highest growth within our region. That needs to be noted by those who evaluate gas companies on growth.

We have the lowest unit cost in the industry. We lowered them again based on volume and our ability to control and maximize our capital spending in the footprint that we have.

Our CPM side is growing and it's stable. I look at that as a very long-term valuable play and from our shareholders' perspective, I see it as a long-term annuity that's going to keep giving and giving and giving.

Now, let's talk about the Marcellus Shale. There's a lot of press about the Marcellus Shale, and a lot of excitement about it, and let me tell you that we're very excited about it. It is the real deal. We're doing very well in the Marcellus Shale as you can see by the charts that we put out today.

These are very valuable wells. We have control in the technology. We have control in the costs. We're adding acres to the Marcellus Shale and we expect to be at 250,000 acres by year-end. And don't forget, most of that is fee. We already have it in fee. We haven't paid hundreds of millions of dollars for that position, which is a real advantage to our shareholders.

The rate in gas next year at 100 Bcf, we think, is a very doable and that's a good base to start off of. If we see gas prices rise we will add another rig. But right now, we think it's very valuable to our shareholders to add more opportunities to drill as we see the Marcellus Shale continue to add value to society as quote, "The chosen fuel" natural gas going forward.

Our hedge position is very strong for 2010. We have 48 days that are about $8. That's a good position. That will give us cash flows. In fact I think it's one of the best positions in the gas business.

Our focus, as always, is on being a low-cost producer at a very high growth rate using very little debt, growing on our own cash and developing the highest margins in the industry. Those are our goals and objectives, and clearly we want to do it in a safe way, and we've been able to do that.

So with that, I'll move on to the coal side. When we look at CONSOL energy in total it's clear there's two pieces. We talked about the gas. Now we're looking at the coal side.

This is a market-driven business right now and we cut 7 million tons in 2009. We have strong real margins on that 58 million tons that we cut to. We showed you the steam in the met side, how we break it out. We think the delivery side on the steam side is going to be soft.

We think that the stockpiles and we know the stockpiles are high and it's about a 60-day supply for the utilities in the Northern App, what I would call our strategic market area. And when you look to the southeast it's as high as 80 to 85 days. So that is a real effect on the Central App production.

On the met side, we see movement there. In Asia, the steel plants are running at about 75% capacity. Domestically, we're running about 60%. We see some upside there. We see demand coming on the met side, and we believe that our locked-in number price at about $114 or $115 per ton of what we've priced for 2010 is solid and that's a good base to come off of. We don't expect a price anything less than that next year.

We have cost pressures at this lower volume, and I want to say that we've controlled our cost very well. With any volume-type business you have to adjust yourself. I think our operations people have done a good job of doing that.

We've accelerated our development within this cost structure, and when things turn and there's a bigger demand for steam coal, we can add extra days to big eight long walls and we think we have the ability to create quick value for our shareholders in 2010 when it rebounds.

Now, we still see 2010 as a bridge year. Our capital is going to be very focused on efficiency projects that were already authorized in 2008 and we will finish those. We will only do [mop] capital. We will add no new projects in coal. We're concerned about the inventories at the customer's level and we think that 2010 is a bridge year to us.

I think a tighter market and a volume constraint market based on financial capabilities of our competitors as well as the pressure from federal government and the state governments for a new environmental push at a much higher threshold in terms of what has to be done to extract coal from the ground, especially in Central App as it relates to mountain top mining.

We see the steam business as very stable, flat. We think the Buchanan Mine met coal is in great shape. We believe it's ready to operate at full production all the way through 2010, 2011, and 2012 and it is well capitalized. And in terms of regulation, the seals are done very well and we believe it's set up to do very well for our shareholders.

There is an upside in volume for steam if we see a change when it changes, but our shareholders need to be aware that we're not going to mine this coal unless we have a place to put it. We've got to manage our inventory. We're not going to put ourselves in a distress position. We think some of our competitors have done that and that's why we believe 2010 is a bridge and we will work our way through that as a reliable large supplier in the east.

On the met side, we have the highest margins in the industry, I believe, in terms of big volumes. On the steam side, I think we have the highest margins as well and I think we're well-hedged. We're in a great position. When you look at the coal business, you see it as, I think, it's a big cash machine. It gives us a lot of flexibility to do things in gas, to make more moves in coal, to make acquisitions when the time is right.

But an asset base like CONSOL Energy has, if you think of CONSOL Energy in terms of energy in the ground per acre, between gas and coal, there's no more concentrated value on a heat basis anywhere else in the world.

We have a key position there and I'd like our shareholders to continue to be aware that that is an advantage by location and one of the greatest markets in the world in terms of use of energy, so with that, I would like to open it up for questions.

Question-and-Answer Session

Operator

(Operator Instructions) Your first question comes from David Khani – FBR Capital Markets.

David Khani – FBR Capital Markets

Can you talk a little bit about your expectations for natural gas price because obviously it has a big swing factor both on the coal side and obviously on your current natural gas production?

Brett Harvey

Right. We expect 2010 to average $6 to $7.

David Khani – FBR Capital Markets

$6 to $7 okay, and second is, can you talk a little bit about your customer base and sort of the industrial nature, I guess, of the Northern App region? Are you starting to see signs that the industrial side is picking up and so therefore the demand for power would pick up?

Brett Harvey

Actually, David, we just see some movement, which would be considered bright spots, but all of our big utility customers on the industrial base side show very weak sales and that's why we think that 2010 is going to be a bridge year in terms of energy growth. We just don't see it at the utility side. They built inventories and they're not burning down the inventories, so we see it as flat for probably the next four quarters.

David Khani – FBR Capital Markets

And then going back a little bit to the $6 to $7 per Mcf or Btu, how much of an impact do you think that will be on the steam coal demand inside your region? Have you guys done that math there?

Brett Harvey

We think it shifts. It's about 25 million tons, but we think it shifts at about $5.50 per million. If you look at the cost structures of our big competitors in the Marcellus Shale, $5.50 where it breaks down. And they're not making money unless they're above $5.50 and we see that as a natural economic break and they'll shift back to coal at that point and time, so about $5.50 is where we see it right now.

David Khani – FBR Capital Markets

And then how much met, I think, do you guys expect to export for 2010 and then, are you seeing any signs also for the steam coal side for 2010?

Brett Harvey

We see the steam coal side as being a pretty bright spot. We expect to, on the met side, export about 3.5 million tons and on the steam side, we expect that to increase year to year. The price is rising right now. If you look at the Bailey-type coal, at the mine, it's up to about $53 into Europe if you look at all the components going all the way to Europe and that's rising.

We think that our port capacity that we have at Baltimore is going to give us an advantage there to raise volumes and move that coal into the Atlantic market.

David Khani – FBR Capital Markets

Could you just remind everybody how much you've exported for this year so we know what the measurement is for next year?

Brett Harvey

I think this year it's going to be about 3 million tons.

David Khani – FBR Capital Market

On the same site?

Brett Harvey

Yes.

David Khani – FBR Capital Market

One last question. If you add back the shifts and then obviously run Shoemaker, what would be your productive capacity you think, assuming the demand was there?

Brett Harvey

If it was a demand-driven market, I think we could probably add 6 million to 7 million tons.

David Khani – FBR Capital Market

Six to 7 million tons, great. Okay thank you.

Operator

Your next question comes from Shneur Gershuni – UBS.

Shneur Gershuni – UBS

I was wondering if I can just start on the gas side for a second. I'm trying to reconcile, I guess, your production guidance and so forth. Just given the strong performance of the three quarters thus far, are you kind of expecting the fourth quarter to tail off relative to the third quarter production levels, or would you expect the trend to continue to be up quarter-over-quarter?

Brett Harvey

The storage is full. We're not sure exactly what's going to happen to storage, but the trends in terms of productive capacity is probably right there. We don't know how the storage is going to do if we have to curtail or do anything like that, so we're pretty conservative on how we're looking at the fourth quarter. But if we have an open market, we're going to see growing trends because we're capitalized to do that right now.

Shneur Gershuni – UBS

Are you saying, your guidance said that there's no actual curtailments modeled into your numbers?

Brett Harvey

No, there isn't.

Shneur Gershuni – UBS

Okay, my next question is just with respect to your thought process with respect to your 2011 hedging strategy and so forth. Should we continue to expect you to layer in hedges in 2011? Is that sort of how we should be thinking that you'll do one to two years at a time and so forth?

Brett Harvey

Yes, we'll continue to do that. I think that's been successful for us. But one of the real strategies is as we grow we want to come back at higher prices and higher volumes, so we will weigh in similar to what we've been doing at $0.50 increments. If we see a big jump, we'll probably take more at higher prices.

Shneur Gershuni – UBS

And can you also talk a little bit about the impact of lower completion costs and what it's doing to your ability to stretch your CapEx further to drill more wells and so forth?

Brett Harvey

Well, I think that's an interesting subject because if you look at our completion costs over, we've gotten better and better at that for two reasons. One is we've got the technology and the expertise and the experience now.

The other one is we can be more efficient because of our footprint. We're looking to drill six wells per pad now and that makes us a lot more efficient than some of our competitors who have to jump from pad to pad to hold their lease position based on their requirements.

So those two advantages I think put us in a good place and I think in some cases we can be below 3 million per hole on Marcellus Shale, which is right in the leading part of the industry right now.

Shneur Gershuni – UBS

Given you were just talking about drilling off the pad and so forth, does that mean you're doing less exploratory work and we should see a slowdown in sort of [proved] reserve growth as you just sort of move off to a pad drilling type of performance, or, should we continue to see reserves continuing to grow at a healthy rate?

Brett Harvey

I think you'll see our reserves grow very rapidly based on our success and what we're doing. We're not focused on growing the reserves. We're focused on growing money and wherever the optimization there is, we'll cut it off. Now the reserve is interesting but we own it in fee. We know the gas is there and we're going to optimize the capital to get the highest rate of return in the short-term for our shareholders.

Shneur Gershuni – UBS

If I can just switch to coal for a second, first and foremost, thank you for the improved disclosure with respect to the met coal. You said in your prepared remarks that you don't expect any change in inventory. One of your competitors yesterday said that they were turning away business and so forth.

Is this more expectation that stock prices have weakened that you don't want to sell those tons into this market? Is it market conditions or so forth? If you could sort of give us a little bit of color with respect to that.

Brett Harvey

There's probably two things there, and I think one thing is that a lot of this is under contract and we'll move it when the time is right. There's no real spot market that we're seeing that is heavy right now. I'd be surprised if people are turning business away at this point in time but so that's $500,000 really is the mix of the contracts, our ability to produce and we actually produced a little bit more than we thought we would in the third quarter.

Like I said Buchanan is doing very well, so we built a little inventory, which is good news because that drops the cost and gives us more room when the market does change., so it's more preparation for what we think is a pretty strong market for next year on met.

Shneur Gershuni – UBS

And one last question if you don't' mind, you've done a lot of work on face extensions and so forth. Assuming input costs kind have remained constant and demand returns, what kind of productivity improvement do you expect and how would that impacts cost and so forth.

Brett Harvey

Well what happens is when you widen face you drop your ratio between your development ton and your long wall tons, so we should see a downward pressure on long wall production cost and that's part of the mix., and so overall it should rise in productivity. We expect to see I would say on tons per hour, we expect to see about a 2% to 5% increase in productivity.

Operator

Your next question comes from the line of Jim Rollyson – Raymond James.

Jim Rollyson – Raymond James

Brett, looks like just on the booking side, it looks like you added about 11.7 million tons this quarter versus last and the kind of imputed prices is in the low 50's. I was kind of wondering if some of that was the collared coal that you guys note from quarter-to-quarter because it looks like that number went down and just maybe try to back into what kind of prices you're seeing for what your booking outside of those collars.

Brett Harvey

Yes. The collared coal is in there and I think that you've done a good job of picking that up. There is no met coal in that either, so you're seeing steam coal prices. Our expectation for '10, if you look at the Shoemaker River, type of coal, you're going to be $50 to $55 and if you're looking at the Bailey end low type coal we expect to be about $60 to $65.

Jim Rollyson – Raymond James

Perfect. That's very helpful and your preference right now seems to be from the capital side focusing on the gas side of the business with acreage and development. Are you seeing opportunities on the coal side for deals or is it still a little early for some of the guys to see some pain as contracts role out. I mean kind of what's your thought process on the coal side.

Brett Harvey

We're watching it very close and we think it's a little bit early on the coal side, but we are opportunistic when it hits right. We have models that show what we'd like to do at certain times, at certain prices, so I think it is still a little bit early. There is still some pain in the coal business to come for the people that were in poor financial positions.

Jim Rollyson – Raymond James

Excellent, and the last question from me is your kind of view on the number one the EPA shenanigans as it relates to permits and how you feel you guys are positioned, and secondly any thoughts on this recent regulation potential of the coal waste as hazardous material instead of non-hazardous.

Brett Harvey

Right, as always when you see a change in administration you see a change one way or the other in how they look at all these mining issues. It never gets better it always gets tighter and that tightness reflects on two things.

One is larger companies have the ability to adjust to that and smaller companies have a much tougher time adjusting to those kind of issues. We think in Central App. the mountain top mining issue is, I think, a very pointed issue there and critical to get permits there.

We think it will affect, we have low exposure to Central App. but we think it will affect Central App. in a big way and that could translate back into advantage into Northern App. because we have very big mines that are low capitalized and have 20 to 25 year lives, and that's just a function of the government pushing it around.

We'd rather see everybody get permits and be competitive but if there is a positive for us it does push value back to Central App. excuse me Northern App to Central App continues to struggle based on permitting.

Jim Rollyson – Raymond James

Any thoughts on the coal waste stuff that's coming out of the EPA?

Brett Harvey

Well they're trying to make natural materials into toxic materials. I don't know, there'll be some legal action over that and I think they will write some new regulation, I think in an effort to throttle the industry somewhat, but over time that just makes coal more valuable and the world capitalized coal.

All of this gets passed through into the price of electricity over time and they think they're hurting the coal business, but all they're doing is driving the price of electricity up. And if you look at over the last 20 years the regulations I think for good reasons have got tighter and tighter and we've got cleaner and cleaner and I think that's continue to go like that but it will be reflected in the power prices going forward.

Operator

Next question in queue will come from the line of Michael Dudas – Jefferies.

Michael Dudas – Jefferies & Co.

Brett two questions, first the ability for Buchanan to ramp up given your current mine plan and what you're budgeting for 2010. If demand is there when can we see full run rate potential of that mine?

Brett Harvey

Well if have the sales I think you could run through 2010 as about 5 million tons. And if beyond that I would say we would have to add some capital to the prep plant as well as put that vertical build in, which could give us another million tons and I believe it would take 18 months to get all that installed, so it's a bit of the chicken and the egg.

When the market strengthens we'll probably do that because I see Buchanan as having the ability – at that quality the market is going to be very strong going forward I believe.

Michael Dudas – Jefferies & Co.

Do you anticipate a major change in the customer mix of your Buchanan coal in 2010, '11, '12 than what you've been witnessing in the past?

Brett Harvey

We think that the domestic market will stabilize to soften. We believe there is a very large growing market in Brazil and the Atlantic market will probably be a little more diverse than we have been. And as you saw we actually move some coal to china about 400,000 tons this year and they're very interested in the quality of the coal.

Now that's a long haul but we're willing to work with all of them if we can get the right price at the mine.

Michael Dudas – Jefferies & Co.

And Brett turning to the export thermal market given where the dollar is and freight rates are could you see a scenario where we start to see a recovery in some more demand for Northern App. or Central App steam coal maybe sooner than people anticipate if Pacific face continues to be strong and New York may need our coal?

Brett Harvey

I agree the weak dollar is probably the biggest driver and there is also the piece of some of our coal is the PCI type coal, so you can see some real strength in us taking the PCI coal with our Buchanan coal into the market place in the Atlantic and creating more volume that way.

So that would be like leverage up Buchanan with PCI coal and that would take away from the steam market in the U.S. and that would really drive us to have more capacity [inaudible] at our port facilities in Baltimore.

With the weak dollar those combinations, I think even steam could get in there, so I think that is going to be the story of 2010 more than anything. If the dollar stays weak we'll see more coal move out of the United States.

Michael Dudas – Jefferies & Co.

My final question is, a year from now do you anticipate further significant involuntary production cut backs in the market and do you think that the market will see some continued discipline as they move to the first part of 2010.

Brett Harvey

I think there is going to be financial discipline. I think there is going to be environmental discipline and I think there'd be some just straight discipline where people don't want to build inventory. Public companies don't like to build inventory and put their dollars on the ground. They'd rather pull back, so those three factors I think is going to drive it into another 50 million tons of cut.

Operator

Our next question comes from the line of Tony Chan with Bank of America

Tony Chan – Bank of America

I guess just first off on the EPA, some new roles coming down the pipeline as far as sulfur emissions. I just want to get your take on how you see that playing out as emission caps come down and how that could be certainly a positive for Northern App.

Brett Harvey

Well it's a positive because the tighter – at this point in time the tighter the mission the more of the scrubbers the more the scrubber the bigger the market is for sulfur and coal because at the end of the day the utilities are buying heat. If they put the mufflers on to get rid of the sulfur, it's just an advantage for Northern App because they want the high Btu coal once they build the scrubbers.

So I would say Northern App's value would increase and the advantage that Central App had on sulfur decreases so the tighter the better from a Northern App perspective.

Tony Chan – Bank of America

I mean do you see a potential material shift in those emissions caps?

Brett Harvey

No, I don't see much. I think that the second part of the Clean Air Act is very tight. I think EPA is going to be more focused on CO2 and their wish is to monitor CO2. I think they believe they've got sulfur under control. They might adjust some things, but I don't think it's going to be a real – much tighter than that last part of the Clean Air Act.

Tony Chan – Bank of America

And just on Buchanan and going back to met coal, any operational issues that we should be thinking about going forward, anything that kind of keeps you up at night, from an operational perspective, as we ramp up to higher rates next year?

Brett Harvey

From an operational perspective and the way Buchanan's capitalized, I'd say no. From a safety side, always, that keeps me up at night. That is a very gassy mine and we watch it very close. We monitor it close. And that's always a concern.

But the way we've changed the mine plan, the way we've done the seals, the way we've done the ventilation, the way we've done the width of our longwall panels there and put the best science to it, even our roof control in the intersections, we've taken all the wood out of the mine, put all steel in the mine for roof support. I would say, technology-wise and production risk, we've lowered the bar a long ways.

Operator

Your next question comes from John Bridges – JP Morgan.

John Bridges – JP Morgan

One interesting question that keeps on coming up is this disconnect between the firm coking coal prices and the sloppy or flat steel prices in China. I just wondered if you had a view on that?

Brett Harvey

Well, I think it all lies in the coke pile. You know the price of coking coal varies based on how much coke they have on the ground and how much their ability is to move the price from quarter to quarter. But I don't have a lot of say about that, other than I do believe that they're going to line up again.

We're hearing there's a shortage of coke in Europe right now and the – I think the Chinese have the ability to manipulate because they're such a large volume consumer. They push the market around a little bit. And so the values haven't lined up yet, but I think they will over time. I hope I've answered your question.

John Bridges – JP Morgan

Well, we'll keep on pushing on that one. And then you had some permits, the AMVEST related permits that the EPA's looking at, any word with that list?

Brett Harvey

That permit right now, we are running the bigger mines that we have in AMVEST and they're running on year-to-year permits. We had five other permits in the queue and those permits were more expansion-type. And we'll continue to push for those permits, but it's not in our 2010 plan at this point in time.

John Bridges – JP Morgan

And then a final one for Bill maybe, in your cash flow, there's a big swing on other operating liabilities. Is that anything in particular? It went from 18 positive last year to 30 million to 40 million negative this year.

Bill Lyons

The only thing on that, John, is that we are making some payments into our pension fund. And as a result, that takes up some cash flow, but other than that, it's just timing. It's nothing significant there.

Operator

Your next question comes from Scott Hanold – RBC Capital Markets.

Scott Hanold – RBC Capital Markets

Can you talk about any kind of thought change or process going on regarding how you best allocate capital between the coal and the gas business? It sounds like you did say the $6 to $7 gas price outlook for 2010 which is actually pretty good relative to the rates of return you guys can get. So could you just talk in general about your appetite to ramp up in that type of environment?

Brett Harvey

Well there's two choices we have on the gas side. The first choice is to add more acreage, which we think is very valuable in the Marcellus Shale. That's been our priority and continues to be our priority on the gas side in the short term.

We also have the ability to ramp up with a second rig, maybe a third rig depending on where we see gas prices and so that's a very quick rate of return for our capital. And if you look at CONSOL in total, we've actually used our free cash flow to grow our gas business out of nothing over the last five years.

Now, going forward, if gas prices strengthen, we will add the second rig and we'll add more volume as quickly as we can as we continue to add more acreage into the Marcellus Shale. From the coal – each rig is about $100 million a year and that gives you look at what it would take to get that done.

From the coal side is they're very long-term projects but they create huge cash flows to build the gas business over time. So think of the coal business, at anywhere from 60 million to 70 million tons and feeding the 100 billion ton market consumption for electricity, at a very optimal rate with high margins creating enough cash to keep itself alive so it keeps the cash machine alive and grow the gas business.

So in short I would say the next three or four years you can see the coal business in what I would call a harvest mode creating a lot of cash and the gas business in a strong, very strong growth mode. And that's where our cash will go.

Now, if we see an opportunity to grow in coal at the right price we'll do that as well with an acquisition. But in terms of new projects, gas is where it's at right now.

Scott Hanold – RBC Capital Markets

And so, if I can read between the lines, if gas is above $6 next year you're looking at anywhere from two to three rigs?

Brett Harvey

We could get there, yes.

Scott Hanold – RBC Capital Markets

And with respect to the acreage pickup you guys are planning on doing, how big do you want to make the Marcellus for you all and what opportunities to pick up more acreage do you see? Are there some synergies with the coal company that allow you to get stuff like you've done in the past or is it basically just getting a lot of the land men out there and picking up what's left?

Brett Harvey

Well two things are happening. One is people aren't living up to their drilling commitments and so we'll go back and pick some of that up. But we're going to pick it up within our footprint of where we see the most value.

There's two kinds of value. There's the value of what's right next to you. There's the value of where we think the most gas is and there's also the political value of where you have the most influence with coal and gas and so forth.

And we also see some places where we can even pick some more up with coal relationships, so I hope I've answered your question. It's kind of a shotgun approach but we're looking at all those things at the same time.

Scott Hanold – RBC Capital Markets

It sounds like all of the above. And then how big do you want to try to get the Marcellus? I mean is there a number that's comfortable or is it just add it as you can?

Brett Harvey

I think if we were at 400,000 acres I think that would be a good place for us to be in. I think we can accomplish that.

Scott Hanold – RBC Capital Markets

And one last question, if I could. On your recent Marcellus results it looks to me they're pretty decent and I sort of respect the fact that a lot of this is a statistical play and there will be some variability, but the last couple of wells that came in did have smaller peak production rates. Is there anything you can lend as far as color on that or what you expect from some of your step out activity?

Brett Harvey

I think the last one we did was up at 2.8 million per day. So we are seeing some variability, but they're all high rate of return projects.

Daniel Zajdel

And I would just add, too, keep in mind, Scott – this is Dan – that we're moving to the Nineveh area in northern Greene County which we've started drilling already. We refer to the one well in the release. The wells in that area are going to have much longer laterals.

Everything we've drilled to date has been a lateral of somewhere around 2,100 feet. As we go to 3,000-plus foot laterals, we'd obviously expect higher IP rates and higher EURs.

Brett Harvey

Yes.

Scott Hanold – RBC Capital Markets

Do you expect to put more frac stages on those longer lateral wells, too?

Daniel Zajdel

Yes. Right now, we're doing frac stages for about every 300, 350 feet of lateral.

Brett Harvey

So you'd see that. If you're out 1,000 feet, you've got three more frac stages.

Operator

Your next question comes from Brian Yu – Citi.

Brian Yu – Citi

My question relates to your coal production costs and we've seen that kind of fluctuate quite a bit and I think some of that has to do with just greater development tons, given the lower volumes. But if you sell down at a, call it 60 million ton per year run rate, where should we look at your unit cost tracking?

Brett Harvey

Well, I would say if we settled in about that rate you would probably see about flat year-to-year because we're going to get some productivity jumps. I'd say around $43 to $44. You can see it pretty flat. And you mentioned 60 million tons. Now with 70 million tons you've got a different cost structure. So it all depends on where you are on volume.

The reason you jump around at these levels is because remember you're in a market constrained position. So you're not opening the mines up at its full efficient capacity. You're trying to match the market.

So the fluctuation really is a reaction to that, to control inventory which is – the advantage you'll see in this is we've been able to develop our longwalls at a much faster rate, the longwall blocks.

Bill Lyons

Also, Brian, keep in mind that even thought cost control is very important and we're not downplaying that, we're really focused on margin expansion. So if we can expand our margins and have to bring on some higher cost production, we will do that.

And again, it goes down to coal mining is non-manufacturing and all mines are equal. And you have different cost structures because different geologies. And as a result, we believe we focus on margins then that will increase our profitability.

Brian Yu – Citi

And when should we next expect some – and you made your longwall moves because it looks like all of them are running now.

Bill Lyons

Okay, our longwall moves, when you have the number of longwalls that we have and you move them twice a year, at any given time you're moving a longwall. So basically, things are just moving according to plan. We probably have what, 12, 13 longwall moves a year. And so you could see we're always generally moving a longwall, so --

Brett Harvey

I would say I'm looking at it this way. That's baked into CONSOL numbers because we have so many longwalls and we tend not to emphasize those because they're already baked into our numbers.

Brian Yu – Citi

And then just on the metallurgical coal with your commitments, could you provide us a breakout of how much of it might be related to domestic versus international business? And is there any kind of pricing differential between those two markets relative to your 115 per ton position?

Brett Harvey

I would say on the domestic market it's about 1.8 million and the rest of it would be the international market. And I would say at the mine it's going to be a very similar price.

Brian Yu – Citi

And what about as it pertains to the 1.4 million tons you have committed right now?

Brett Harvey

Let's see. I'm not sure. It's right around $114 a ton. And domestic, I think it's about half and half.

Daniel Zajdel

We probably we have time for one more question.

Operator

Your next question comes from Paul Forward – Stifel Nicolaus & Co.

Paul Forward – Stifel Nicolaus & Co.

On the, on your – total CONSOL's inventories went from 3.5 million tons to 3.3 during the third quarter. I guess I was just wondering at the production rate that you're operating at, which was obviously a low level, why didn't you see more of an inventory decline? And where would you expect that to be by year-end if all goes well?

Brett Harvey

Right and that's a good question. Two things happened. We brought the mines back that were idled in the first part of the quarter. They were more productive, which is a good thing, but that also creates a problem in a market constrained world.

Central App is – we're running Central App a little bit harder. We've gained some inventory in Central App. And we think the price is going to change there probably in the first or second quarter. And so we're building a little inventory there.

We also have at the port offsite – okay, let's go to the end of the third quarter. There's 2.6 – 2.5 million tons at the mines at the end of the third quarter. There's 800,000 tons offsite of which 400,000 is ready to be shipped within the next two or three weeks.

So we expect to be back down around 2.6 million tons at the end of the fourth quarter. And I would say about a million of that is going to be Central App. And we will sell that coal and move it. We think we even might be able to move it into the near met coal category. Okay?

Paul Forward – Stifel Nicolaus & Co.

And well, does the presence of somewhat higher inventories, that doesn't – does that change any of your expectation for the Shoemaker startup and whether you might – and we know that that's a low cost mine that you want to have operating in 2010. I guess the question is does it – do you have to make room for that by possibly taking some production out of high cost mining elsewhere?

Brett Harvey

No, no. Actually Shoemaker, we bought it back. It's sold. Everything that comes out of there is already sold. So and it's on schedules and it's with big utilities that burn lots of that type of coal. So we're not concerned about that at all.

Paul Forward – Stifel Nicolaus & Co.

And then maybe lastly, your guidance on met coal for 2009 production was 1.9 million tons. That implies a 700,000 ton production rate at Buchanan in the fourth quarter. Just I know it was a really good quarter a year ago, but last year it was 1.4 million tons produced at Buchanan.

Just wondering again, what's the – you're just waiting for the market for this coal to come back to the point that you can produce at that full rate? And I guess I'm just curious why –

Brett Harvey

Somehow we got a bust here because I got almost 1.2 million tons in the fourth quarter from Buchanan.

Paul Forward – Stifel Nicolaus & Co.

I guess the thing is that in your press release you say 1.9 million tons of met coal production for the full year. And I believe the year-to-date production number was 1.2, which would get to a 0.7 number.

Brett Harvey

It's actually for 2009 at 3.1. So, we need to look and see if we've got a problem there. But –

Paul Forward – Stifel Nicolaus & Co.

But you're anticipating production at Buchanan at 1.2 in the fourth quarter.

Brett Harvey

1.2, that's right.

Daniel Zajdel

All right, thanks everyone for participating on the call. Tony, could you instruct us on the replay information?

Operator

Thank you, sir. Ladies and gentlemen, this conference will be available for replay after 1:00 p.m. Eastern time today through October 29th, 2009 at midnight. You may access the AT&T teleconference replay system at any time by dialing 1-800-475-6701 and entering the access code of 106655. International participants may dial 320-365-3844. Those phone numbers again, 800-475-6701 and 320-365-3844 using the access code of 106655.

And that does conclude your conference call for today and we do thank you for your participation and for using AT&T Executive Teleconference. You may now disconnect.

Copyright policy: All transcripts on this site are the copyright of Seeking Alpha. However, we view them as an important resource for bloggers and journalists, and are excited to contribute to the democratization of financial information on the Internet. (Until now investors have had to pay thousands of US dollars in subscription fees for transcripts.) So our reproduction policy is as follows: You may quote up to 400 words of any transcript on the condition that you attribute the transcript to Seeking Alpha and either link to the original transcript or to www.SeekingAlpha.com. All other use is prohibited.

THE INFORMATION CONTAINED HERE IS A TEXTUAL REPRESENTATION OF THE APPLICABLE COMPANY'S CONFERENCE CALL, CONFERENCE PRESENTATION OR OTHER AUDIO PRESENTATION, AND WHILE EFFORTS ARE MADE TO PROVIDE AN ACCURATE TRANSCRIPTION, THERE MAY BE MATERIAL ERRORS, OMISSIONS, OR INACCURACIES IN THE REPORTING OF THE SUBSTANCE OF THE AUDIO PRESENTATIONS. IN NO WAY DOES SEEKING ALPHA ASSUME ANY RESPONSIBILITY FOR ANY INVESTMENT OR OTHER DECISIONS MADE BASED UPON THE INFORMATION PROVIDED ON THIS WEB SITE OR IN ANY TRANSCRIPT. USERS ARE ADVISED TO REVIEW THE APPLICABLE COMPANY'S AUDIO PRESENTATION ITSELF AND THE APPLICABLE COMPANY'S SEC FILINGS BEFORE MAKING ANY INVESTMENT OR OTHER DECISIONS.

If you have any additional questions about our online transcripts, please contact us at: [e-mail]. Thank you!