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CONSOL Energy Inc. (NYSE:CNX)

Q1 2010 Earnings Call Transcript

April 29, 2010 10:00 am ET

Executives

Dan Zajdel – VP, IR

Bill Lyons – CFO

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

Nick DeIuliis – EVP & COO, CONSOL Energy and President and COO, CNX Gas

Bob Pusateri – EVP, Energy Sales and Transportation of CONSOL Energy and CNX Gas, and President, CONSOL Energy Sales Company

Analysts

Chris Brown – Merrill Lynch\Bank of America

Michael Dudas – Jefferies

Shneur Gershuni – UBS

Brian Singer – Goldman Sachs

John Bridges – JPMorgan

David Khani – FBR Capital Markets

Jeremy Sussman – Brean Murray Carret

David Gagliano – Credit Suisse

Pearce Hammond – Simmons & Co.

Paul Forward – Stifel Nicolaus

Operator

Ladies and gentlemen, thank you for standing by and welcome to CONSOL Energy and CNX Gas first quarter earnings conference call. As a reminder, today's call is being recorded.

I would now like to turn the conference call over to Vice President of Investor Relations, Mr. Dan Zajdel. Please go ahead, sir.

Dan Zajdel

Thank you John, and welcome to our joint earnings call today 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, Chief Financial Officer, Nick DeIuliis, Chief Operator Officer and Bob Pusateri, President of Sales.

This morning, we will be discussing the first quarter results for both companies. In addition, we will be discussing our outlook for remainder of 2010. Any forward-looking statements we may express or our expectations for results as you know are subject to business risks and we have enumerated those risks in both earnings releases issued this morning and our SEC 10-K filings.

Let me start the call with you today, Bill?

Bill Lyons

Thank you very much, Dan, and thank you everyone for joining the joint CONSOL Energy and CNX Gas earnings conference call.

A new year is traditionally time for enthusiasm, excitement and often a start of change. These certainly apply to CONSOL Energy. The first quarter of 2010 continued our string of strong financial results, and with the acquisition of Dominion Resources' Appalachian E&P business, 2010 will be a year that will change the landscape of CONSOL energy.

The key event in the first quarter of course is the acquisition of the Dominion Appalachian E&P business for $3.475 billion. This is a transforming event for the company. During our deal road show and in today's release we have spoken at length on the merits of this transaction. So I won't repeat them there. However I would like to briefly comment on the financial side of the deal.

On March 26th, CONSOL energy offered $44.3 million common shares, concurrently with $2.75 billion high yield notes split between two tranches and that's of 7 and 10 year senior notes. The simultaneous offerings were marketed over four day road show that covered over 250 accounts in New York, Boston, New Orleans, Los Angeles and San Francisco, achieving a 76% hit rate on one-on-one equity meetings.

The debt security is priced at 8% and 8.25% on the 7 and 10 year offerings and the order book was multiple times oversubscribed and when you add to the $2 billion credit facility that we are in a process of completing, that's over $6.5 billion that various investors have entrusted to us.

We are both humbled and inspired by the response of the tappable markets to investment leases. The Dominion E&P acquisition complements our existing assets and will be highly correlated to value creation for our shareholders. The Dominion transaction will close tomorrow.

The second major event of the year is our launching of the tender offer for the shares of CNX gas that we don't currently own. With the Dominion acquisition almost at hand, it makes sense for us to have all our gas assets managed as one business. With a tender price of $38.25 per share and with $25 million shares outstanding, we anticipate paying $965 million for those shares. We expect the tender offer to be completed by May 26.

Now let's review our results for the quarter. We had another excellent quarter. CONSOL energy is reporting net income of $100 million or $0.54 per diluted share for the first quarter of 2010, the GAAP net income that was impaired by several items. We incurred fees of $47 million associated with the Dominion acquisition.

We also incurred noncash charges totaling another $47 million. These charges include $25 million associated with reclamation accruals at the Fola mine and $22 million associated with certain legal accruals. If you choose to adjust for these items, our adjusted net income was $156 million or $0.85 per diluted share. Our adjusted EBITDA was $349 million. These numbers show the underlying strength of our assets.

Back in October we characterized 2010 as a bridge year. Then in January we acknowledged that the bridge appears to be a lot shorter than it was in October. Our first quarter results support our optimism for 2010. What has happened, in the low-vol coating coal last October, we expected to sell un-priced 2010 coal for around $135 or $145 per ton at the mine. Our latest sales are in the $170 per ton range.

Also last October, we had an entirely new – we've added an entirely new category of sales. This is our high-vol coking coal. This coal from our Pittsburgh 8 steam mines and Northern Appalachia is selling in Asia and Brazil for prices much higher the loans you get by selling it into the domestic thermal market. So, coal for 2010, we have sold or committed 2.1 million tons at an average price of $73.

The thermal business has improved since last October also. The colder than normal winter enabled generators to reduce stockpiles from the record levels of early December. Our thermal business has also benefited from our selling of the high-vol coal to Brazil, and Asia. Since it's the same coal that we sell to domestic thermal customers moving tons overseas has the added benefit of tightening up the domestic market.

Now that we are into the shoulder season, thermal demand has weakened a bit Inventories are still higher than we care to see somewhere around 55 to 60 days. On the gas side, spot prices have weakened considerably. At year-end, they were around $6 per Mcf. Today they are at $4.25. In our first quarter results for GAAP however, we had a very good average sales price of $7.24 per Mcf because of our strong hedge position.

With our strong hedge position for 2010, and our low cost structure, we expect to outperform our gas peers this year. In summary, both our low-vol business and our high-vol business are doing very well. The thermal coal business has improved considerably, and the gas business is outperforming its peers.

This quarter results show once again the value to shareholders and earnings shares in a diversified energy company that has best in class assets in four separate categories, world class low-vol assets at Buchanan, high-vol assets in the Pittsburgh seam that didn't exist six months and that we ship out of our 100% owned Baltimore terminal, the highest Btu thermal assets in the country and our gas company's leading position in possibly the world's largest gas formation, the Marcellus Shale. This collection of assets can't be duplicated by a portfolio manager cobbling together pure plays. You can only invest in these best of class assets by buying CONSOL Energy shares.

The numbers speak for themselves. CONSOL Energy has established himself as a company that generates strong earnings in cash flows by utilizing a sustainable model that provides financial flexibility. This flexibility enables us to react and to adapt the changing economic environments in markets while continuing to prudently invest in our businesses.

This quarter again demonstrated the financial power of being a low cost diversified energy company. We remain steadfast in our confidence in our business model. Our balance sheet and our status is a safe low cost producer enables us to effectively compete and produce exceptional earnings and cash flows even in uncertain economic times.

CONSOL Energy controls the greatest concentrations of Btu in the Eastern United States. For almost 15 decades now, and through many business cycles, CONSOL Energy has remained committed to optimizing shareholder value by putting safety first, by being respectful to the environment and the communities in which we operate, and by providing meaningful employment opportunities. We remain committed to these values.

With that Brett, could we have your comments for the quarter?

Brett Harvey

Thanks Bill. Thank you all for spending time with us to listen to us, and also give us the opportunity to answer your questions.

Our format changed a little bit on our press release, so there's a lot of information there. I think it's very straightforward information, and some of my comments are there, so I'll make mine brief and we'll get to the questions as soon as possible. But first I'd like to talk about some strategic things as well as forward-looking things.

First, let me say as a fourth generation coal miner myself, we grief for the 29 lost lives in West Virginia. And those are tough things for the entire industry. I can tell you, though, that CONSOL Energy has an unwavering commitment to zero accidents, and we believe that we are the generation that can bring these mines to zero accidents, and our intention is to steadfastly do that until we're at zero everywhere in our corporation.

Progress is been made inside CONSOL, and anytime we have an accident of any kind, it is an exception to our beliefs and our values, and we operate that way, and our shareholders need to be aware of that.

Let me move into the coal business. The met coal market plays itself we see as it's been very robust. Our expectations for the year have been exceeded on pricing. We've done some good deals on the pricing side, but let me talk about our China sales.

Our relationship with EXCO has been a good one. I can tell you as in 2010, that 90% of all met coal coming out of North America into China's steel mills will come directly from CONSOL and EXCO. That should give you focus on who is moving the coal into that country, into that great expanding market, and who has the legs up to do that.

With our relationship with EXCO, we've been able to do that, and I'm very proud of our marketing people and our abilities to get that done. We see that as a growing market. We believe we'll hit 3 million tons of that high-vol coal into China this year, and we believe it's going to grow into next year.

Now, we don't have firm numbers on what next year looks like, but we're optimistic, it will grow from 3 million, and that gives us the concept of continuing to push the BMX mine because of its high quality value, and it's a low cost structure that it will have on the high-vol met coal side as well as expansion of the Baltimore port when we see that that expansion is necessary for the use of our relationship and our shareholders.

I expect the market to be good enough to where we could approve the expansion of the Baltimore facilities in 2011. With this change in high-vol met and low-vol met, for 2010 we believe we will be the number one or number two met producer in all of North America. That is a strong function of our asset-based, and it's a test to the value of this Company across the Board.

Now let's talk about the steam coal side. The steam coal side is not getting the legs as quickly as we thought it might. I think the demand for power is down a little bit, but you can see their margins are robust and powerful, and as we see the demand for power in the U.S. come back, we believe that the supply will be short on the rebound, which will force upward pricing movement on all steam coal in the United States, especially for domestic power.

We think things will tighten dramatically on the environmental side as well as safety constraints related to the accident in West Virginia. And I can tell you, that on the steam side we are sold out at very high margins for 2010. We have no coal available in the Pittsburgh 8 seam for the steam market in 2010 beyond what's always been signed up.

Okay. Let's talk about gas. Great acquisition that we made, we're very excited about that. But I'm going to talk about what we're doing within CNX Gas first. The CBM side continues to be the low cost producer with expansion very rapidly on our Virginia properties, and at real value to our shareholders across the Board. That is been a great success. That's where we started into the gas business, and we see great success going forward there, as a low cost producer in any gas marketplace.

Now let's move to our Marcellus Shale piece. Now we already had that within our estate as we moved from CBM into Marcellus Shale. We saw the value there. We continue to siege huge value there. We're having great success on those wells, as you can see in the documentation that we put out.

It puts us in a position of the low cost producer in both CBM and Marcellus Shale in any marketplace we are going to be the highest margins just like we are at coal, and that brought us to the acquisition. When we saw the acquisition of Marcellus shale to be available, we move forward with a strong balance sheet, tied up very valuable resources in our backyard.

There's been some chatter about CONSOL's in going more into the gas business and walking away from coal. I can tell you from the earnings that we just announced, why would we walk away from the best assets in the country. What we've done is enhanced our position in our backyard for our shareholders, and that will create huge value over time.

Let's talk about the acquisition a little bit more directly. That's a big acquisition, and it has a lot of value. We are putting together plans to optimize what we see for the next 10 years for expansion in that Marcellus Shale, and what we intend to do is take the net present value of the value of that deal, and move it forward for our shareholders with innovations, and development of the resources, however that looks.

We are very flexible. We intend to do that and monetize the value of that as quickly as we can into the pockets of our shareholders. We are in a low cost high margin position across gas, Marcellus as well as CBM. On the met business, we are in a low cost high margin position in the steam business. We are in the low cost high margin position, and we have flexibility on every one of these assets with great transportation assets as well as skills and management to get this job done.

Let's talk about earnings a little bit. We did not have to rebound from the recession because we had a record year last year driven by the coal business. If you go back to 2008, our strong year was driven by gas. If you go to 2009, our strong year was driven by coal. If you look at 2010, our strong year is been driven by coal and coal margins.

We believe from 2011 and on, that our strong low cost position in coal and gas will drive on these two different cycles, real value to our shareholders and an expediential way from where we've been in the past. We are very excited about our ability to operate these two very valuable resources in our backyard, and when we call our backyard, we are talking about Pennsylvania, West Virginia, Ohio, and this region right here where this is the energy of the Eastern United States, and we own the biggest low cost percentage of that.

With that, I'd like to answer questions. John, could you please instruct the listeners on the procedures for asking questions.

Question-and-Answer Session

Operator

(Operator Instructions). And first to the line of Kuni Chen with Merrill Lynch\Bank of America. Please go ahead.

Chris Brown – Merrill Lynch\Bank of America

Hi. It's actually Chris Brown filling in for Kuni Chen. Good morning.

Brett Harvey

Hi Chris.

Chris Brown – Merrill Lynch\Bank of America

What level of production cuts in the App region are you forecasting this year in light of about upper permitting process and higher safety inspections, and then any thoughts on what the per ton cost increase could be for underground miners going forward?

Brett Harvey

Every time we see an adjustment like that in terms of the constraints, in terms of safety, there is a cost, but that usually winds out as the debate goes on with restrictions and so forth. We think it will tighten up. We don't know how much. I think last time we saw it was almost $0.60 a ton with the last act that was put together. So, I think on the permitting side we are a little more concerned about because the EPA has been very tight with their permitting in Central Approximately, and I think they are looking at state-by-state with new interpretations and the laws that we have to adjust to.

So, that's unfolding right now. We can't give you specifics, but what I can tell you is, when the economy rebounds dramatically and we think it will. The supply was short-going into the recession, and the supply will be tighter coming out, and that gives pressure on pricing. We don't have specifics. We just feel the pressure, and typically when we see this kind of pressure, we see it on the cost structure as well as the ability to get permits, probably six months out.

Chris Brown – Merrill Lynch\Bank of America

Okay and then how much coal do you expect to ship from Shoemaker next year, and is this coal suitable for the high-vol market?

Brett Harvey

The Shoemaker coal, what we call the river coal is the highest sulfur that we have. We plan to ship 4.8 million tons of it into the steam market, but it is not a met coal. The met coals are more the Bailey/Enlow, and also by the way the 4.8 million tons is already sold. The met coal tends to be Bailey/Enlow, Blacksville leverage type coals more on the inner part of lower sulfur of the Pittsburgh 8 seam.

Chris Brown – Merrill Lynch\Bank of America

And then lastly what type of CapEx would be needed to expand the core capacity?

Brett Harvey

About 50 million tons, or $50 million and we think it would take about 18 months, and that would not disrupt our flow right now. Now, we believe with operations and the coals that we have going through the port right now that we can push the port up to about 13.5 million tons a year, with what we are doing now, if we add that $50 million of capacity, we could probably bring it up to about 18 million tons a year.

Chris Brown – Merrill Lynch\Bank of America

Okay, great. Good luck guys.

Brett Harvey

Thank you.

Operator

And next we go to Michael Dudas with Jefferies. Please go ahead.

Michael Dudas – Jefferies

Good morning, gentlemen.

Brett Harvey

Hi Mike.

Michael Dudas – Jefferies

You mentioned about the Virgin opportunity relative to high-vol coal to China. How do you foresee that playing through your discussions with traditional thermal coal customers for that type of coal product? Has there been a bit more of a concern, and if this market is sustainable in China, how significant could Pittsburgh 8 supply the Chinese coal market with that product?

Brett Harvey

Well, we have about 25 million tons open for pricing next year, and we have sometimes opened that we could actually move into that marketplace over time. The steam side, you can see this is – it started out as met coal if you go way back. It went to the steam business as we built the plants in the region. Now it's going back to the met market to Pittsburgh 8 team. I think we'll see a split there. I think we'll see the expansion of the BMX, and I think the region will demand these Btu on the steam side.

But I think we'll see a convergence of price between the met side of the mine, and the steam side of the mine because it's the same coal, and the same capitalized region. So I think you'll see a convergence of price towards the met price at the mine.

Michael Dudas – Jefferies

When do you think the Board would be ready to receive a proposal for BMX expansion to improve, and possibly what you could be doing on the water side to expand Buchanan's opportunities?

Brett Harvey

I expect we'll be building – in the budget for next year we'll authorize the expansion of the port. That will be in the '011 budget. On BMX, we're already developing the mains of BMX, and I would expect full capitalization. We'll have a lot to do with the way we see the market unfold and the next 6 months to 12 months will probably dictate that.

Michael Dudas Jefferies

And Buchanan?

Brett Harvey

Buchanan itself, we don't have a plan to expand Buchanan where it's at in the vertical belt and some of the issues around Buchanan it's running very well at 4.8 million to 5 million tons a year and we don't plan to expand it that would be after BMX if we did anymore expansion there.

Michael Dudas Jefferies

And finally, Brett, you mentioned or Bill mentioned in prepared remarks about looking at the new Marcellus assets and looking at a 10 year plan to optimize and bring forward to NPVs to shareholders. How quickly can you get to those types of numbers? How are you going to share that with the investment community, and in early indications, do you think it's significantly different or changing from what you've put forth to the shareholders in the deal show last month?

Brett Harvey

I'll let Nick talk to that because he's done a lot of work on that the last few weeks.

Nick DeIuliis

Our plans to drill and monetize the 750,000 acre Marcellus footprint, they continue to evolve and right now the general rig schedule that we see is having three rigs running by late summer this year having five rigs up and running start of 2011, and then going to ten rigs by the start of 2012.

So that's the general sort of rig schedule, which correlates to drilling schedule. The specific drilling plans are laid out in detail and when you look at the major areas of where we have the 750,000 acres, right now obviously we've drilled 17 and put into sales 17 horizontal wells in the Greene County area, that's going to continue to be an area of focus for drilling.

We will be drilling wells, horizontal wells in the (inaudible) Barber County areas in Northern West Virginia late this year, and we will be drilling wells in sort of the Westmoreland County, Indiana County corridor as well by the end of 2010 and to 2011. What we see with regard to those two areas, that's the Northern West Virginia, and Indiana, Westmoreland County areas is exiting. These were the acres we picked up from the Dominion acquisition, and we started looking at well logs, vertical wells that were drilled by Dominion prior to the acquisition and horizontal wells drilled by third parties in both of those areas. You'd be excited as well.

Brett Harvey

One point I want to make Mike, that we if don't see core in that long-term plan, we're likely to do some partnership to add value to our shareholders to bring value forward if it's of interest to other people.

Michael Dudas Jefferies

Yes. So that is still open?

Brett Harvey

Yes.

Michael Dudas Jefferies

Thanks. Brett, Nick, I appreciate it.

Brett Harvey

Thanks.

Operator

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

Shneur Gershuni – UBS

Hi, good morning guys. I guess just as a kind of a follow-up to the last questions on gas, if I understand it correctly, would you be interested in sharing some of the shallow reserves or entering into JVs in that or were you just talking specifically with the Marcellus?

Brett Harvey

I can tell you, we are open to all the possibilities. Whatever is good for our shareholders and we see value, we will go ahead and do that. We will keep the core where we see expansion value to our balance sheet, but if there's pieces that we don't see in the 10 year to 15 year plan, we will obviously create value very quickly in any core horizon meaning when we did deal with Dominion, we didn't just buy Marcellus Shale, which is the buzz right now as you know.

We've got every level of value associated with that company, and if it's here on or whatever it is, we will be looking to monetize or do some partnerships with people, and that's only good for our shareholders and the proper way of moving that present value forward.

Shneur Gershuni – UBS

Great, and just continuing on the gas front and Nick maybe you can help me with this here. But you drilled the GH 2B CV well this quarter and you had an IP rate of 5.7 million cubic feet per day and you averaged 5 million cubic feet to date for the first 47 days, how does that make you think about your ultimate recoveries from those wells? Does that make you think about changing and revising them upwards or would when well doesn't make one test and say forth? I was wondering if you can comment on that.

Nick DeIuliis

But it's a great question. We've drilled 17 horizontals to date and put them into the sales meter as we speak and we've just completed two additional ones that will be cracking shortly, but when you look at those wells collectively and cumulatively, when you look at sort of the IP and the EUR per footage drill drilled to horizontal way, we are basically at or doing better than what our original EUR projections indicated, and we are also actually doing better than the peer group on average.

So what happens with regard to those specific wells, and once the implications moving forward, I think there's an upside potential with regard to what we've been assuming for recoverable reserve for the 17 that we've drilled to date and put into line? I also think that when you look at future wells that we're going to be drilling, 3500 foot plus laterals along with 10 plus frac stages for horizontal well are going to be the norm, and that will have a more than proportional increase in EUR and production curve NPV as opposed to capital cost.

So, from our perspective we are starting from a pretty conservative base on reserve, and the trick there obviously is improve upon that in incrementally increase the recoverable reserve with longer footage.

Shneur Gershuni – UBS

I was wondering if I can follow-up with two questions on the close base. I was wondering if you can kind of talk about, you put out some great new information, really appreciate the new tables, but you sort of highlight your high-vol costs and so forth, and they're interestingly low and I was wondering one if the royalty costs associated with the higher priced tons are included in that, and then secondly when we think about relative to the tables that you put out in the past was – were these basically your absolute lowest cost mines in the thermal assets prior to moving them into the high-vol category.

Brett Harvey

So obviously, when you take a look at where the coal is coming on the high-vol side, its coming from Bailey/Enlow and Bailey/Enlow is the lowest cost producer in the Pittsburgh scene. So that's what reflecting the lower cost on the high-vol side.

Nick DeIuliis

And the royalties are in that.

Shneur Gershuni – UBS

Royalties are in. And one last question. With respect to the Baltimore port, you indicated that you're sold out this year. My understanding that EXCO is obviously using some of the capacity over and above what you're shipping of your own tons. When you look out to next year, is there a potential for conflict of interest or does EXCO have to shift your tons first before it uses any capacity for any other deals that it would like to use.

Nick DeIuliis

There's no conflict. Because we own the port we have the right to the capacity. We'll work that out with EXCO but that's not a problem. That's why we considered expanding rather than having any conflicts. We'll expand for value between us.

Shneur Gershuni – UBS

Right. Thank you very much.

Operator

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

Brian Singer – Goldman Sachs

Thank you good morning.

Brett Harvey

Good morning.

Brian Singer – Goldman Sachs

On the thermal side, what's the reaction among your utility customers when they see thermal tons getting sold into the met market? Is the magnitude too small to raise any eyebrows in the face of high inventory levels or are you seeing any more specific willingness among utility customers that contract here?

Bob Pusateri

Brian, this is Bob Pusateri. Brian, we're currently engaged in several discussions with utilities for coal for the calendar year 2011 and those discussions are going such that they're more concerned about a reliable source of supply and I think overall, they understand that prices in northern App are going up, given what's happened in central App and so far we're very pleased about the business that we've taken so far for 2011, and you can probably get to that calculation with the table that we provided. So right now, I think we're sitting in a really good spot, and we have nearly 30 million tons of coal that will be priced for 2011 and we're expecting a great margin increase.

Brian Singer – Goldman Sachs

And do you expect the 30 million tons will be contracted gradually over the course of the year or are you looking to do more sooner, rather than later.

Brett Harvey

We'll do it on the normal schedules and within the contracts and the confines of our relationships with the utility. One thing I can say about this is there is a concern about capitalized capacity that's built for power plants that were built in the region and when some of that coal leaves the area, we tend to see a gravity, there's a rise in price to match whatever the sales price is. Is it the mine, weather its steam or met.

Brian Singer – Goldman Sachs

Great. Thanks, and, shifting to the Marcellus, can you talk a little bit more about the West Virginia portions of your acreage and what you're acquiring. Obviously the state line was not drawn on geologic boundaries but can you just talk about the timing of how you plan to choose your drilling locations between Southwest PA and West Virginia.

Brett Harvey

Well first of all, a lot of that West Virginia acreage was locked up by Dominion and that's why you didn't get a lot of buzz out of like the money that was spent to the north in Greene County and Washington County. We plan to go in and make sure that that value is there. We see success there. We see a very rapid rising amount of permits being done there from our competitors.

We also, when we look at the geologic structure, the Marcellus is actually thicker in that area and all of the indications on the wells that Dominion had drilled vertically there, the logs [ph] show that it's very prosperous in terms of gas and so we're excited about putting laterals into that, with the technology that has been developed in the north and we think it could possibly be better than Greene County and Washington County. Wouldn't that be great for our shareholders?

Brian Singer – Goldman Sachs

What's the timing of testing that?

Brett Harvey

We'll be drilling horizontal wells in Northern West Virginia by the end of this year, early next year. So late 2010, early 2011.

Brian Singer – Goldman Sachs

Thank you very much.

Operator

And next we go to John Bridges with JPMorgan. Please go ahead.

John Bridges – JPMorgan

Good morning everybody.

Brett Harvey

Hi John.

John Bridges – JPMorgan

Congratulations on the results.

Brett Harvey

Thank you.

John Bridges – JPMorgan

It looks like your starting a new fashion from the relative [ph] result that everybody wants to buy gas.

Brett Harvey

Well, if it makes sense and if it's in their backyard like ours, it does make sense. Because if you add gas and coal together on a steam side with 75% of electricity, that's the business we're in.

John Bridges – JPMorgan

Great. With respect to the Pittsburgh 8 coal coking, the last time we spoke, you were saying that it was sort of being used in blending and in sort of semi coke and what I'm trying to get a handle on is the extent to which the new technology is enabling the steel makers to use more of this stuff. Have you been able to pin down what they're up to?

Nick DeIuliis

John, I can tell you, in a recent visit to China, what we saw was that the Chinese are using this product as they blend with their own coals within the country of China. And this makes us very, very excited because we thought at first that we were going to have to blend here in the United States our high-vol coke and coals with something else in order to make them acceptable.

But to date, all of the vessels that we've shipped, they've been 100% high-vol coal and the tests that have occurred so far have been – we've gotten excellent results on them and we look forward to increasing our tons to China and we believe that we're going to get several opportunities in both Japan and Korea in the second half of the year.

Brett Harvey

John, one comment there on that, John. This is Brett. Our brand at CONSOL is going directly into the steel mills, not as a blend with other coals, but it's being branded by EXCO directly into those steel mills, which I think really gives us a good reputation, a leg up on a very rapidly growing market.

John Bridges – JPMorgan

And then you say that it's going as PCI coal into Brazil.

Nick DeIuliis

Yes.

John Bridges – JPMorgan

Amazing. Great, great. And then just a bit of bookkeeping. The Fola reclamation, what was that?

Nick DeIuliis

Basically it's a reclamation accrual. Anytime that you have somewhat of a change in mine planned, you always have an adjustment to reclamation accruals and this has to do with everything from having to reduce some of our capacity there due to market. Also has to do with things like changes in how regulators view certain things.

We do our annual study on mine closing reclamation every year. This is part of our normal review of Fola. It's just that Fola; because of particular circumstances we decided that we needed to accelerate the recognition of some of those accruals. So it's not a cash item. It's, accrual item related to just changes in circumstances at Fola.

John Bridges – JPMorgan

Many, many thanks and we appreciate your comments on (inaudible) safety, Brett and Nick.

Brett Harvey

Thank you

Operator

And next go to David Khani with FBR Capital Markets. Please go ahead.

Brett Harvey

Hi David.

Operator

David Connie, your line is open. Possibly take yourself off mute.

David Khani – FBR Capital Markets

Sorry about that. Can you hear me now?

Brett Harvey

Yes.

David Khani – FBR Capital Markets

Sorry about that. I should know by now. Can you talk a little bit about the size of exports to China? Is there any ability to also ship some of your coal as a met coal to Japan?

Brett Harvey

That's – Bob just mentioned that that market is being developed. We focused like a laser on China because we see that as the most rapidly growing market first. At the more established marketplaces, the coal that they're used to using like in Japan and Korea, are a little bit different. But as we show success in China, we'll see that coal move into those areas as well. We're just focused on China first. We think it can move to those too and I think we'll see some success of that in the second half of the year.

David Khani – FBR Capital Markets

Okay, great. Thanks, guys.

Brett Harvey

Thanks.

Operator

And we go to Jeremy Sussman with Brean Murray Carret. Please go ahead.

Jeremy Sussman – Brean Murray Carret

Hi, good morning everyone.

Brett Harvey

Hi Jeremy.

Jeremy Sussman – Brean Murray Carret

Hi, really two things. First is from the Bailey type high-vol, can you give us a little more of a sense of maybe what we can see next year, maybe if you can – kind of what's the limiting factor there and then secondly, also on the high-vol side you've idled a couple of mines in the past there. Any thoughts about bringing anything back on-line on that front?

Brett Harvey

Well on the idle mines, we won't bring anything back until we've optimized what's already running because its cost structure expands margins and we wouldn't bring on high cost mine until we've optimized what we already have and that just makes sense.

So if you go beyond that and you look at the high-vol mines themselves, six months ago we weren't even talking about China. In fact, I've chastised some of our competitors for even talking about it and then we got right into it. That's evolving and I would say if we look at next year – the 3 million tons this year we know are for real and the freight is showing up.

We're loading them up and we're getting the job done. They're being introduced as the steel mills. Like Bob, Bruce [ph] and Terry was there about a month ago and he saw this happening. We expect it to continue to expand as our reputation increases in China and opportunities unfold and so we have essentially 30 million tons of capacity that's already built into our mine of this kind of coal that can go that direction.

Of course, right now it's in the steam market and so I think we'll see a gradual movement and I don't know where it ends. Right now we see it at three. Next year, we probably can see it at double that. But we don't have that in hand. I'm just estimating. And it could move up to ten over time. We don't know. It's a new market, we're expanding and we'll give you blow by blow as we know. But we do know this is a real market and they're excited about it. Bob?

Bob Pusateri

Jeremy, what will really drive the number of tons that we decide to put into that market will be the response that we get from the utilities here in the United States and as we move on throughout the calendar year, we will look at all of our opportunities and we will weigh those opportunities here versus what we did in 2010 over in China and if we can match the price for a term business here in the United States then that's the way we'll go.

Jeremy Sussman – Brean Murray Carret

Great, thanks Bob and I, just as a follow-up assume it's safe to say that the utilities are well aware of the premium that you guys are getting in China for these prices?

Bob Pusateri

It's my hope that they're listening to this phone call.

Jeremy Sussman – Brean Murray Carret

That's great. Thanks.

Operator

Our next question is from David Gagliano, Credit Suisse. Please go ahead.

David Gagliano – Credit Suisse

Hi. First of all, actually I have a related question to the previous one. Just overall, regarding your volume growth next year with the restarts you make and switching from thermal to PCI et cetera. What should be assuming for 2011 total coal sale volumes and if you could take a stab at breaking that down between thermal, high-vol, which I think we may have gotten a bit of a number, thermal high-vol, low-vol and PCI. Thanks.

Brett Harvey

I would say it will be – we haven't really given guidance for '11 but I can say that $55 million of steam. The rest will be met. And I think we could be between anywhere from $63 million to $68 million on the total for next year. That hasn't been totally brought out yet but I'm giving you broad numbers. So we aren't really ready to talk about the total for 2011 yet.

David Gagliano – Credit Suisse

Okay. Well that's a helpful framework. Just my follow-up. Stepping back for a minute, obviously you're business has encompassed thermal met in that gas market. So my question is on you a industry wide basis, how much coal do you think could be displaced by natural gas incrementally from here assuming the net gas price stays around $4, and at the same time how much coal do you think will move out of thermal market on an industry wide basis and into the PCI high-vol markets?

Brett Harvey

I would say in our market area, about 10 million to 15 million tons will be displaced by gas. In total country wide I would say 25 million to 30 million and most of that will be in the – what I call the southern company area, would be to the south. We see a lot of gas generation there. If it stays around $4 we're going to see that happen. I also believe that we're going to see about 20 million to 25 million tons of capacity pulled out of the central App, just based on restrictions of mountain top mining and the permitting issues we see down there.

So there's a lot of combinations moving here but the growth on gas versus coal will not happen beyond that number I don't believe until we see more gas plants built and the utilities or somebody making the commitment to build these gas plants. I do believe that will happen in the next couple of years but right now with the demand for energy down overall, compared to where the market was a couple years ago, there is capacity in coal and gas to the point where all markets are being fed on existing plants. So the max we're going to see I think is about 25 million to 30 million tons a year until we see new gas plants build. But I think new gas plants will be built before new coal plants.

David Gagliano – Credit Suisse

Okay. And just to confirm, 25 million to 30 million tons displaced incrementally from here, not counting what was displaced last year, correct?

Brett Harvey

No. No. I would say that's the total on a yearly basis that you would see.

David Gagliano – Credit Suisse

Okay.

Brett Harvey

I wouldn't say that it was 20 last year and another 20 now because the capacity on the gas side is not there.

David Gagliano – Credit Suisse

Okay. And then the one component that I don't think you addressed was the switch. How much thermal do you think leaves or how much coal do you think leaves the thermal market and moves into the high-vol PCI market.

Brett Harvey

I'll let Bob talk about that.

Bob Pusateri

David, what we're seeing is, estimates of about 15 million tons of central App coal that will crossover into the met market and as you can recall, that 15 million tons is pretty much what we saw in 2008 and we believe the conditions in the second half of the year will be similar to what we saw back then and it will be somewhere in that range.

David Gagliano – Credit Suisse

Okay, perfect. Thanks very much.

Operator

And we go to Pearce Hammond with Simmons & Co. Please go ahead.

Pearce Hammond – Simmons & Co

Good morning.

Brett Harvey

Hi Pearce.

Pearce Hammond – Simmons & Co

Many coal producers have discussed increasing their high-vol or crossover met coal production during these quarterly earnings updates. Because of this, have you started to see any change in customer behavior or any weakness in the high-vol met market?

Bob Pusateri

No. You heard Brett say earlier that at least we believe that CONSOL will put upwards of 93% of all of the northern App coal into Asia in 2010. So far we haven't seen any other northern App producers do that. As we go forward for 2011, we believe that that will continue. A number of utilities are out, Pearce looking for solicitations. I think a lot of them are testing the market because they're starting to see a possible shortage of high Btu thermal coal starting as early as maybe the fourth quarter of this year.

Pearce Hammond – Simmons & Co

Great. And then, Bill, on this certain legal accruals, the $22 million, what specifically was that?

Bill Lyons

Usually I don't go into specifics on the legal accruals. They're just part of overall contingencies that we list in our foot notes. I can tell you that there's nothing unusual there. However we will disclose it in 10-Q that about $12 million of that is related to a settlement we had at our Jones Fork [ph] mine where basically we gave an option as part of that settlement.

It's sort of technical in terms of the accounting ways you do it is basically you have to – we did it on a royalty basis as part of that settlement. We get a royalty. We have a present value, the stream of royalties and we compare that to the net book value of those assets. As a result that indicated, there was a loss of $12 million. Obviously if there's more coal mine or prices go up, that accrual will be less.

Pearce Hammond – Simmons & Co

Great and one last housekeeping question. So for 2010, it's fair to say you are sold out on your low-vol Buchanan product?

Bob Pusateri

Yes Pearce, that is correct.

Pearce Hammond – Simmons & Co

And then for the high-vol, you could have more to go.

Bob Pusateri

That's correct. We have about another million tons we're holding back.

Pearce Hammond – Simmons & Co

Perfect. Thank you, gentlemen.

Bob Pusateri

Thank you.

Operator

And next go to Paul Forward with Stifel Nicolaus. Please go ahead.

Paul Forward – Stifel Nicolaus

Good morning. Very good performance on the cost side in northern Appalachia for the quarter. I was just wondering, when you look at the low-vol total cost per ton in the quarter, it was at about $69 and in the previous, when you had to split that out, it was mostly in the Buchanan mine in the fourth quarter but it was a very strong quarter. I know it was in the 40 territory. What was the difference between the fourth and the first quarter on the cost side of things in low-vol and where would you expect that to trend going forward?

Brett Harvey

Well Paul, there were a lot of things that went into the calculation of the cost per ton there. Part of it is the volumes we had. Part was as we tried to develop the mine, redevelop that mine and make sure that it runs efficiently and effectively. I think overall what you have to look at, not so much the costs but the margins, – we have outstanding margins there and we're going to operate that mine in a way to protect those margins. I would expect that the cost for the quarter, in the first quarter we're probably a little bit on the high side and there could be some reduction in there. But again, I want you to take a look at the margins. It's very important that we operate that mine effectively and efficiently and also protect both the gas operations there.

Paul Forward – Stifel Nicolaus

Okay, great. And then when you look at the guidance of – when you add the Dominion properties you're suggesting 127 Bcf of production of gas for the full year. What would you say – that seems like you're essentially taking the 40 or the current production rate at Dominion and then adding it to the 100 Bcf at CNX Gas. I was just wondering if what you see has any upside potential to that 127 number.

Bill Lyons

Let me speak to that. We're adding what we said CNX Gas was going to do and then what Dominion was going to do on a pro-rated basis. Those two add up to that number. Remember, the expansion that we're going to do was already calculated into the 100 Bcf on the CNX Gas side and there's really a lot of drivers here we're permitting and rigs coming on and everything else. I would say 2010 is a real gear up for a rapid expansion in 2011 when you put all these pieces together. So I think 127, that's a good number. There might be a little bit upside but we're not ready to say that at this point in time.

Paul Forward – Stifel Nicolaus

All right. Appreciate it.

Bill Lyons

Yeah.

Brett Harvey

John, before you give the replay information, just let me remind everybody that any forward-looking statements that we may express here today or expectations or results are subject to certain business risks and we've enumerated those risks in both the earnings release issued this morning and in our SEC 10-K filings. So with that, just as a reminder, John, could you please give us the replay information?

Operator

Certainly. Ladies and gentlemen, it starts today at 1:00 pm eastern time. It will last until May 6 at midnight. You may access the replay at any time by dialing 800-475-6701 or 320-365-3844. The access code 153450. Again those numbers, 800-475-6701 or 320-365-3844 and the access code 153450. Mr. Zajdel, any closing comments?

Dan Zajdel

Thank you everybody and I'll be in my office for the rest of the day if anybody has any follow-up questions. Thanks for listening.

Operator

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

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Source: CONSOL Energy Inc. Q1 2010 Earnings Call Transcript
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