Peabody Energy's (BTU) CEO Greg Boyce on Q2 2014 Results - Earnings Call Transcript

Jul.22.14 | About: Peabody Energy (BTUUQ)

Peabody Energy Corporation (BTU) Q2 2014 Earnings Conference Call July 22, 2014 11:00 AM ET

Executives

Vic Svec - Senior Vice President, Global and Corporate Relations

Greg Boyce - Chairman and Chief Executive Officer

Glenn Kellow - President, Chief Operating Officer

Mike Crews - Executive Vice President and Chief Financial Officer

Analysts

Michael Dudas - Sterne Agee

John Bridges - JP Morgan

Caleb Dorfman - Simmons & Company

Brandon Blossman - Tudor Pickering Holt & Company

Evan Kurtz - Morgan Stanley

Justine Fischer - Goldman Sachs

Paul Forward - Stifel, Nicolaus

Neil Mehta - Goldman Sachs

Lucas Pipes - Brean Capital

Mitesh Thakkar - FBR Capital Markets

Timna Tanners - Bank of America Merrill Lynch

Jeremy Sussman - Clarkson

Operator

Ladies and gentlemen, thank you for standing by and welcome to the Peabody Energy Second Quarter Earnings Call. For the conference, all the participant lines are in a listen-only mode. Later, there will be an opportunity for questions. Instructions will be given at that time. (Operator Instructions). And the conference is being recorded.

I’ll turn the conference over to Mr. Vic Svec, Senior Vice President, Global and Corporate Relations. Please go ahead.

Vic Svec

Okay, thank you John, and good morning everyone. Thanks for taking part in the conference call for BTU. And with us today are Chairman and Chief Executive Officer, Greg Boyce; President and Chief Operating Officer, Glenn Kellow; and Executive Vice President and Chief Financial Officer, Mike Crews.

We do have some forward-looking statements. They should be considered along with the risk factors that we note at the end of our release, as well as the MD&A section of our filed documents. And we also refer you to peabodyenergy.com for additional information.

And with that, I’ll now turn the call over to Greg.

Greg Boyce

Thanks, Vic, and good morning, everyone. In the second quarter Peabody delivered solid U.S. performance and we advanced a number of key operational improvements in Australia. I am very pleased with the team’s continued actions to increase safety and productivity, manage costs and drive capital efficiency.

I’d like to begin with Peabody’s view of the current market fundamentals, and then we’ll discuss our strategic positioning. The seaborne coal markets remain over supplied, but we are seeing some signs of rebalancing. Coal demand is expected to rise in the second half of the year on improvements in global economic growth as a result of additional Chinese stimulus, Asia expansion, and improving Atlantic’s steel requirements. We project further improvement within the metallurgical coal market in 2015 as production growth flows and demand continues to increase.

There have been approximately 20 million tons of announced metallurgical cutbacks in the first half of 2014, much of which are likely to occur over the coming months. We also expect Australian export growth to slow in the back half of this year and into 2015. We believe that the long-term metallurgical coal demand piece remain solid and is supported by growing steel intensity from ongoing urbanization trends in Asia. It’s estimated that some 70 million people per year will migrate to cities by 2020, requiring more coal to meet rising steel demands.

Within the seaborne thermal coal market, demand continues to increase as well. India’s coal generation is up 12% through June with imports expected to reach record levels this year. And India’s new Prime Minister recently stated that the government will work toward providing power, water and sanitation for every household by 2020, further driving coal imports. In China, coal generation is up 5% through June while domestic coal production is down, leading to rising thermal imports. In addition, more than 2,000 smaller mines are expected to close by 2015 as the growing amount of Chinese coal production is on economic.

Developing nations continue to turn to coal for affordable power with Indonesia expected to double its coal consumption over the next 10 years by adding 60 gigawatts of coal generation capacity. You see this decade along 29 countries have added 335 gigawatts of coal generation, and this trend is expected to continue at the same pace.

Now in the U.S. market fundamentals remain strong with 2014 coal demand expected to rise 30 million to 40 million tonnes reflecting a continuation of utility switching from gas to coal over the last two years. U.S. coal generation increased 20 million tonnes year-to-date through June while gas generation is down 2%. PRB inventories are at 49 days used, down nearly 30% from a year ago levels. This reflects a dramatic improvement over the last few years as the inventory overhang has been removed. We expect continued inventory reductions over the next six to eight weeks.

But still rail performance has been disappointing and continues to impact the PRB. Western Rails are hiring additional crews and adding locomotive power to improve the heavily congested system. And this investment may take some time to be fully realized, but will provide continued incremental improvement. We estimate that 15 million tonnes of PRB shipments have been missed in the first half of the year due to the low power rail performance and utility coal conservation measures due to inadequate deliveries. In the second quarter we estimate that Peabody’s Western volumes were impacted by 1 million to 2 million tonnes related to this rail performance. And as a result we’ve lowered the top end of our 2014 U.S. sales guidance by 5 million tonnes.

Now on the public policy front, we’ve seen changes in carbon dioxide initiatives in both Australia and the United States. Australia just recently repealed its unpopular carbon tax and a major policy reversal, as it resulted in higher electricity rates and negatively impacted businesses and jobs. The repeal is projected to lower power bills and lead to an increase in Australia’s global competitiveness.

And the U.S. Environmental Protection Agency has proposed carbon dioxide regulations that would require states to reduce emissions from existing electric generating plants. Should the rules be finalized in their current form, third parties have projected significant potential impacts to generation, electricity rates, jobs and economic development. Already approximately 20 states have passed legislation or resolutions calling for alternative approaches and the rules are also being contested by congressional delegations, state officials, labor unions and others.

Peabody believes that the proposed regulations represent poor policy with significant economic harm. These proposals are a long way from being finalized and when they are, they’re very likely to be aggressively litigated.

To summarize our market view, coal is enjoying its largest share of global energy mix since 1970, now representing more than 30% of global energy use. Coal is the fastest growing major fuel and is expected to become the world’s largest energy source in coming years. As energy needs rise around the globe, Peabody is well positioned with an exceptional production base aimed at the best growth market served from US and Australia, and we continue to take appropriate actions to manage current market challenges. These include our owner operator implementation in Australia where we’ve had great success in reducing costs and better aligning our workforce. And we continue our focus on portfolio optimizations including the pursuit of non-core asset sales. Since last June we’ve sold $160 million worth of non-core assets and are looking at additional opportunities going forward.

I’d now like to take a moment to introduce Glenn Kellow, Peabody’s President and Chief Operating Officer. At Peabody, Glenn is responsible for all aspects of our global operations along with safety, sales and marketing and business development. Glenn joined us last fall from BHP Billiton, where he served as President of its global aluminum and nickel business, and he’s a former Director of the World Coal Association and the National Mining Association. Glenn has a strong track record of performance and brings valuable multinational leadership experience across a number of commodities, including coal. In his short time with Peabody I’ve already been impressed by his breadth of knowledge and solid contributions to our operational advancements.

So with that I’ll now turn the call over the Glenn for an update on our operations.

Glenn Kellow

Thanks, Greg and good morning everyone. I look forward to working with all of you and becoming more engaged with Peabody’s investor and analyst activities. In my first nine months at Peabody I have been impressed with the quality of the workforce, the world-class assets and the real improvements being made in safety, cost management and capital efficiency. These are challenging times for coal producers, but Peabody benefits from a solid operating platform and we are redoubling our efforts to make sustainable improvements to our operations, move down the cost curve and become even stronger as the market improves.

I’d like to begin by reviewing Peabody’s operating priorities and my specific focus areas along with the progress that we’ve made so far this year. First, we seek to drive strong performance at our operations and build on safety and productivity gains. At Peabody we believe that strong operations must also be safe operations. Peabody’s 2013 global incidence rate was nearly 50% better than the U.S. average, and in Australia our incidence rate has improved 45% so far this year.

Within our operations we commissioned the longwall top coal caving system at the North Goonyella mine, which reached stabilized production levels by the end of the second quarter. Output increased over 130% compared to the first quarter and we are now focused on optimizing the benefits with the new equipment and enhancing yields over the next several months. We also completed the installation of a replacement longwall at the Metropolitan mine late this past quarter. The ramp up has been very successful and we expect to realize additional productivity and cost improvements as the year progresses. And we have seen significant first half productivity improvements across our entire platform with our Australian productivity increasing 35% and U.S. productivity increasing 11% compared to the prior year period.

Peabody’s solid second quarter operating performance is due in part to these productivity improvements. Our U.S. platform continues to perform well in the face of railroad bottlenecks and our Australian thermal mines achieved higher than expected production and cost savings that helped offset lower seaborne pricing. These actions relate to our second focus area, targeting additional cost improvements. This includes the owner operated strategy Greg mentioned, which eliminates contract overhead, brings in right sized equipment to increase productivity, better aligns our workforce and greatly improves our mine planning.

We are advancing the conversion at our Moorvale Mine in the third quarter, which will increase our owner operated production to over 90% of our Australian output. And while we’ve implemented significant cost improvements across our platform we’re not done. We look to further reduce that by spending both in SG&A and procurement activities, and the team continues to deliver additional reductions.

Our first focus area is continued capital efficiency activities. Capital spending in the first six months totaled $65 million as Peabody benefits from a well capitalized platform to the investments that have been made over the last several years. Our team is working to increase availability across our global fleet of equipment and these efforts have resulted in real reductions to both operating and capital expenditures. We envisage being able to maintain these lower sustaining capital levels for several years.

Our U.S. capital spending includes the Gateway North extension, which will provide replacement capacity as the low-cost gateway mine transitions to a new long life reserve area. The slope construction is ahead of schedule and production ramp up is targeted in the first half of 2015. All of these improvements also put us in a good position for long-term growth using our leading reserve position, our business development activities and our global network.

That’s a review of our top operational priorities for 2014 and our recent performance. I look forward to continuing to update you on Peabody’s progress on operating initiatives. For a discussion on our financial results I’ll turn the call over to Mike Crews.

Mike Crews

Thanks Glenn and good morning everyone. With higher U.S. adjusted EBITDA, lower Australian costs and consolidated adjusted EBITDA above the high-end of our guidance range, Peabody’s second quarter results reflect the continued steps we are taking to offset challenging market conditions. I’ll begin by discussing our quarterly results starting with the income statement and then provide an outlook for the third quarter.

Second quarter revenues increased to $1.8 billion on higher overall volumes and revenues per tonne in the West, which more than offset lower realizations in the Midwest and Australia. Adjusted EBITDA of 213 million reflects our cost containment actions and operational improvements that help to offset the decline in seaborne market pricing.

Taking a look at the major components, U.S. operations generated adjusted EBITDA of $292 million, up 12% from the prior year. Volumes rose 5% on growing utility demand particularly from the Powder River basin. As we discussed in our outlook last quarter, Western revenues per tonne increased 6% with the finalization of a long-term coal supply agreement that will result in higher realizations going forward.

Midwest realizations declined 4% on a roll-off of legacy contracts. Midwest cost per tonne were temporarily impacted by higher overburden ratios at multiple surface mines related to sequencing as well as the timing of maintenance cost in the quarter. We expect cost to improve in the third quarter as stripping ratios normalize. Western U.S. costs declined 3% on cost containment and a greater mix of PRB volumes.

In Australia adjusted EBITDA of $12 million reflects 155 million of lower seaborne pricing compared with the prior year. Nearly a third of this pricing impact was offset through sustainable cost reductions and improved longwall performance that Glenn discussed. These cost in operational improvements also more than offset a significant decline in seaborne pricing from the first quarter leading to slightly higher sequential quarterly results.

Australian volumes increased to 9.7 million tonnes in the quarter, while revenues per tonne declined 15% on lower seaborne pricing. During the quarter we shipped 4.8 million tonnes of metallurgical coal at an average price of $96 per short tonne, and we sold 3.1 million tonnes of seaborne thermal coal at an average price of $69 per short tonne, with the remainder delivered under a domestic thermal contract.

Cost per tonne declined to $72 due to better longwall production and sustainable cost savings. Strong production from our low cost thermal mines also contributed to the cost improvement.

Turning to taxes; we realized income tax expense of 5 million compared to a targeted tax benefit due primarily to higher than expected earnings from our U.S. operations. Both diluted loss per share from continuing operations and adjusted diluted loss per share totaled $0.28.

That’s a review of our income statement and key earnings drivers. Peabody generated positive operating cash flow in the second quarter, while capital expenditures totaled 40 million. With our lower first half capital expenditures we are again reducing our whole year capital spending range to $210 million to $250 million. We continue to have substantial liquidity of 2.1 billion with nearly $500 million of cash and no significant debt maturity until 2016.

I’ll close with a review of our outlook. For the third quarter we’re targeting adjusted EBITDA of $140 million to $190 million, and adjusted diluted loss per share of $0.53 to a loss of $0.40. These ranges reflect longwall moves at three of our four longwall mines, including the move at Metropolitan that was accelerated into the third quarter as a result of stronger than expected production, lower realizations in Australia and the Western U.S., higher production rates at North Goonyella and the elimination of the carbon tax in Australia along with the implementation of further cost reductions.

I also refer you to our Reg G schedule in the release for additional quarterly targets regarding DD&A, taxes and other line items.

So that’s a brief review of our second quarter performance. Operator, we will be happy to take questions at this time.

Question-and-Answer Session

Operator

(Operator Instructions). First we have Michael Dudas with Sterne Agee. Please go ahead.

Michael Dudas - Sterne Agee

For Greg or Glenn, so it appears of course the cost reduction strategies and the improvements that you’ve had have been quite positive. And it sounds like you mentioned 90% of your fleet will be owner operated I guess by early next year. How do you think Peabody compares with the rest of the Australian mining operations and are there others that have kind of maxed out at the cost reduction volume opportunities and given where both met and thermal prices are, we should may be start to see some more meaningful reductions at the margin from exports out of Australia in each market?

Greg Boyce

May be I’ll start and then let Glenn fill in some more detail. But if you recall we have had a number of conversations around the competitive advantage that Peabody had with the opportunity to go to these owner operated conversions. I mean we have been able to move on the cost curve to a much greater degree I believe than any of our competitors in Australia, because of that unique opportunity it’s kind of bitter-sweet. It was bitter when we had all of these contractors, but it’s been great that we have the opportunity to replace them because the cost savings and the productivity improvements as you heard in numbers have been significant. So, I think that has enabled us to bring our cost positions down to a much greater degree.

I think when you look at year-over-year, the numbers that I looked at, would say that the last half of ‘13 net exports are pretty much similar to the first half of ‘14 net exports, which shows you that the growth in export volumes and production out of the Australia is starting to significantly slow as those projects came on in the later part of ‘13 and are moving in. So, as we look forward and we indicated we think the supply growth continues to slow year-over-year while demand continues to grow. So, Glenn, Mike I mean the other part of your questions was, now that we’ve converted our operator, what more do we think we can accomplish within the context of the operations?

Michael Dudas - Sterne Agee

Yes.

Glenn Kellow

Thanks, Greg. Well, certainly having an owner-operated fleet greatly assists in our overall productivity. We’re able to eliminate the contracted margin; greater workforce alignment, having the right size to match equipment is critical going forward. And in instances where we didn’t do the mine planning, it enables better mine planning. But can’t speak for the rest of the industry, but we are continuing to aggressively look beyond that in terms of other cost reductions both through our procurement activities and our SG&A activities. And we believe that there is more opportunities ahead in that space of which we built some of those factors in the cost guidance we have given for this year.

Michael Dudas - Sterne Agee

Excellent. My follow-up is relative to asset monetization, maybe an update on where you stand? Are there any targets that shifted? Could we see something that gets done over the next three to six months on the budget similar to what you have mentioned in your prepared remarks of 160 million that you have monetized over the last 12 months? Thank you.

Greg Boyce

Well, I would just say Michael that continued asset monetization particularly non-core asset monetization or specifically non-core asset monetization is a high priority for us. And Glenn and the business development team are spending a significant amount of time looking at what we can continue to put into that portfolio of assets available for sale, and then where we can market those. So, I think if you look out over the next six months to a year, certainly we would expect to be in a position to accomplish more of those. They are always going to be lumpy in their nature in terms of when they occur, but I can tell you it’s a major focus for us right now as we continue to look at increasing our cash intake from the sale of non-core assets.

Operator

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

John Bridges - JP Morgan

Just wanted to dig a little bit deeper into the improved prices that you mentioned in footnote two you have got references to how they impact with Q2. But I thought you said that they were going to impact going forward as well?

Mike Crews

Hi, John, this is Mike. So what happened is with the contract negotiation of this nature, you continue to ship tonnes on a provisional basis and then once we agree upon price, there is a cumulative benefit to that. And that when you see in the footnote disclosure you can see the impact of that adjustment on the second quarter which equates to about $35 million. So, not only do you have a catch up for prior periods in the first quarter of this year, then we benefit from that higher pricing going forward in the back half of the year albeit not at that cumulative catch up level.

John Bridges - JP Morgan

And does that run over into 2015?

Mike Crews

It does.

John Bridges - JP Morgan

What’s the length of the contract?

Greg Boyce

It’s multiple years, I don’t know exactly what year, I’d have to go back and check whether it’s ‘16 or ‘17 contract year.

John Bridges - JP Morgan

And then as a follow-up. Goonyella, the improvement there. What sort of quantum of improvement do you see from the top coal caving that was going to be pretty significant?

Glenn Kellow

Well from a design perspective at the time of the implementation of the project we talked about at least 0.5 million tonnes on an annualized basis. As we’ve sort of highlighted through the commissioning, we've been able to substantially improve output up 130% this quarter versus the previous quarter. We still think that some further optimization to go, and that’s through essentially automation across all shifts as well as the improvement in yields, but those additional tonnes are included in the guidance that we’ve given.

Operator

Our next question is from Caleb Dorfman with Simmons & Company. Please go ahead.

Caleb Dorfman - Simmons & Company

The last quarter we talked about possibility of trimming some net production with Australia. Greg or Glenn, can you give us some update on where you are in thinking through that process?

Greg Boyce

Sure, couple of things. We talked about how we continually review those operations within our portfolio that are higher cost, and make sure that we can ensure their competitiveness. To the great, great activities and performance of the team down in Australia, we fundamentally are reshaping our cost profile at our operations. So where we sit right now is really looking at those operations that are remaining higher in our portfolio, but within albeit a lower cost profile than they had even a quarter ago, and then looking at how much of those cost reductions are long-term, structural, sustainable and how do they impact the go-forward profitability based on their current market.

So we’re still actively looking at all of those operations. I would remind everybody, we take action and we have operations that are non-economic. We shutdown a couple here in the U.S. over the last two years, we shutdown Wilkie Creek in Australia, we curtailed some of our volumes out of Caballo in the Powder River Basin. So it's something we actively do, but where we find ourselves in a situation is we want to make sure we understand where that competitive end point is and how these operations will meet, and particularly where the team is doing such a fabulous job lowering the cost profile, we want to make sure we get it right. So still under the valuation stages and probably why it’s taken a bit longer than it would have otherwise, because frankly the team is doing much better on the cost performance.

Caleb Dorfman - Simmons & Company

And then I guess is a follow-up. If you are having so much success cutting the cost structure of these operations. What would it take to lower your annual cost tariff, or is that just not possible yet because we are halfway through the year already, moving three longwall moves in Q3?

Glenn Kellow

Yes, I think you’ve touched on one of the key issues around. The third quarter, it’s a combination of multiple factors, it is. When you undertake a cost reduction program of this magnitude, there’s a huge number of ideas generated that have to be filtered through, evaluated and put into place. So you look for full-year benefits and some of that we had from last year that carried into this year. So there is more to do there, and it’s ultimately around how much we can realize from those cost reductions. But at the same time, what you’ll see in the second half versus the first half is an increasing mix of metallurgical coal in our overall sales mix, and that raises our overall cost profile.

So the combinations of both of those are reflected in our guidance for the year. The other thing I'll go ahead and point out we've had the carbon tax repeal and what we’ve said previously, is that could be a little more than a dollar per tonne benefit on an annual basis, and it will benefit the third quarter. But we did incur that cost in the first two quarters, and we had already assumed in our cost guidance that that will not be there in the fourth quarter, so there is a limiting factor there.

So I think it’s a function of where our overall volume comes out for the year, our cost reduction initiatives, how quickly we can bring those together, and that will ultimately drive along with our mix where our cost profile will be for the full year.

Operator

We’ll next go to Brandon Blossman with Tudor Pickering Holt & Company. Please go ahead.

Brandon Blossman - Tudor Pickering Holt & Company

Let’s start with the big one. Greg, obviously or arguably we’re at the bottom the very bottom of this cycle. Is there in the back of your mind, any opportunities for consolidation, maybe some domestic peers as you guys go forward. Obviously you’re in a much better position than some of the peer group from a balance sheet perspective?

Greg Boyce

It’s an interesting question, and I think I’m sure it’s probably one that I’ll have to ask all of those other peers as to their views. We have said before that our strategy is to make any changes to our portfolio; it should be to as portfolio managers upgrade our portfolio of operations. So we will be looking for what we would call Tier 1 assets. And frankly right now we’re not sure we see any of those quickly making it to market. We would be looking asset additions of the highest quality, and how they might fit. But in terms of just general industry consolidation particularly when you are talking about say the Eastern U.S. that’s really something for others.

Brandon Blossman - Tudor Pickering Holt & Company

Got it, I think I understand the read through there, just near term. So question on Australian net production. Was that volume, the sales volume a surprise relative to where you had expected it to be coming into the quarter and what were the drivers if that was a surprise, what were the drivers in that surprise?

Glenn Kellow

I think if you look ratably it was pretty well in line with what our expectations were to perhaps slightly higher, which is given the fact that we were trying to ramp North Goonyella up on finalization of the commissioning for longwall top coal caving, and we did have the move at Metropolitan. I would say we were at the upper end of what our expectations are.

Greg Boyce

Yes, I think if there was any positive, pleasant outcome for the quarter, it was a fabulous performance at Metropolitan in terms of making that longwall move and getting that new longwall up and running and exceeding the ramp up and then continuing to perform extremely well through the quarter and that was a big component of the second quarter.

Operator

And next go to Evan Kurtz with Morgan Stanley. Please go ahead.

Evan Kurtz - Morgan Stanley

For my first question just a quick one on Australia. Can you give us a sense on how much carryover tonnage on the met side came in from the first quarter into the second quarter numbers?

Greg Boyce

Yes, it was about 1.3 million tonnes of carryover from the first quarter into the second quarter, which is not an uncommon number. But I would just remind everybody, because the rollover pricing and the carryover tonnes for the third quarter is going to be essentially flat pricing.

Evan Kurtz - Morgan Stanley

And second follow-up is just, hearing some mumblings that after very long period of time there’s actually maybe some progress being made on renegotiating some of the Australian take or pays. And I just wanted to confirm if you are hearing anything along those lines.

Greg Boyce

We’re not hearing anything in particular. I mean as Glenn has talked about, we’ve got a fairly extensive global outreach program to all of our suppliers as part of our procurement efforts, that includes transportation providers as well as equipment and fuel and consumable suppliers. But in terms of anything specific, I don’t have any specific details or really have heard of anything major being announced.

Operator

And we’ll go to Justine Fischer with Goldman Sachs. Please go ahead.

Justine Fischer - Goldman Sachs

I too got a follow-up question first of all on the Western pricing. So I understood your answer that for the next quarter Western pricing will be down quarter-over-quarter just because the impact to our customer contracts won’t be as big as it was cumulatively for the second quarter?

But then another question, so my question is how is PRB pricing going for you guys aside from the customer contract. I know a lot gets lost in the noise with the customer contract and given the fact that it’s all of the Western not just PRB. But I think a lot of people have been focusing on the potential improvement in PRB pricing over the summer because of low inventories, because of where gas was. And we don’t seem to have seen that. So are you guys just seeing utilities out of the market just because, just on an overall demand cycle of weather and to a hot August to get the PRB spike that some people had expected.

Greg Boyce

Justine a couple of things to kind of respond. I think in terms of customer activity, clearly we are seeing customers sit on the sidelines because you don’t really need to buy something that you can’t get delivered. And so while there is tremendous interest, there really isn’t anything getting concluded because everybody is focused on getting their original 2014 contract deliveries. So that clearly is impacting the OTC market and what’s happening there. I will tell you that our conversations with utilities in a general perspective is extreme interest in looking at ‘15, ‘16, ‘17 looking at now rethinking their inventory level of targets for ‘15 and ‘16.

And so I think the real step change is will be as we continue to finalize ‘15 and then multi-year contracts for ‘15, ‘16, ‘17 and beyond out of the Power River Basin. You will note that during the quarter, we priced 35 million tonnes, about 27 million tonnes of that was under the openers, under existing contracts.

Just for a flavor of that, almost all of that was priced in the early part of the quarter and ran when obviously things were a bit stronger. So I think for this year, we’re going to have to really look at, to the extent that the railroads continued to improve. They’re adding power, they’re adding crews, they’re getting through their maintenance period. And as that volume continues to flow, I think we will see utilities begin to step in and buy incrementally more tonnes and then contract heavily or more heavily for 2015.

Justine Fischer - Goldman Sachs

And then the second question that I have is on China. I think that was probably where a lot of us got the met market forecast wrong, everyone knew that Australian supply was coming on line. And to your point made earlier the export growth out of Australia has slowed. But I think the one thing that has kept met coal prices lower than what some may have expected is just the lack of aggressive Chinese buying in the market driven by Chinese internal supply and demand. So my question to you is what are you guys hearing from Chinese buyers of met coal? Are they sitting on the sidelines now, how are the inventories and are they much more comfortable sitting on their inventories because they view domestic supplies available or for some other reason? What you guys are hearing out of China and when do you think we could see that buying come back?

Greg Boyce

Yes, I think our sense out of China as it probably has a little bit more to do with the ratio of pig iron production to steel production. Steel production China is up around 3% year-to-date, which is pretty much in line with what the World Steel Institute forecast for the year. But pig iron production is only up about 1%, so clearly there has been destocking of steel inventory within China. We’re now seeing increase in iron ore imports and starting to see signs that going into the back half of the year, now that has been a better balance between pig iron and steel production with a stimulus to China that is starting to take hold.

We think the met coal demand imports through the back half of the year are going to pick up from the first half of the year. So I don’t think the answer is that China believes that they’ve got the ability to satisfy their own met coal production. I think the real question was the type of steel production or the pig iron production was not growing at the same rate so it was softer than overall steel demand. And we see that reversing as we go through the back half of the year.

Operator

Our next question is from Paul Forward with Stifel. Please go ahead.

Paul Forward - Stifel, Nicolaus

And just a follow up on that last question on the outlook for met coal. When you evaluate kind of the customers’ needs and inventory levels in this depressed market over the next few quarters. Can you contrast the outlook that Peabody has for PCI compared to coking coal and what’s going to lead the way out of this downturn?

Greg Boyce

Well, certainly in terms of growth rates demand we see PCI within the context of the overall coking coal market. PCI growing faster than the other types and that’s just merely a reflection of the new steel capacity that’s been built which can all accept PCI type coal. So we see that growth rate faster. I think when you look overall at where we’re at in the met coal markets; there is no question that we’ve talked about having significant export seaborne exports growth as a result of projects that were commissioned back in the 2011 and ‘12 timeframe coming into the market. We’ve also seen all other major producers respond the way you would expect them to respond in terms of driving cost down. One of the components and ways to drive cost down is to obviously increase productivity and reduce your output.

But we think when you look at both of those, we’re through if you will the low hanging fruit or the large volumes that come into the supply side from either new projects or major productivity pushes. And it’s probably one of the reasons why the six month to six month the last half of last year first half of this year exports out of Australia relatively flat in terms of the change. And so as demand continues to grow and we’re no longer seeing that volume growth, obviously these markets can turn very quickly.

Operator

Our next question is from Neil Mehta with Goldman Sachs. Please go ahead.

Neil Mehta - Goldman Sachs

You’ve done a great job here on CapEx, you continue to find a way to cut here quarter-after-quarter. You think this new guidance is a reasonable run-rate to assume post 2014? How should we think about pluses and minuses relative to this baseline on a go forward?

Glenn Kellow

As you said that what we said in the past that we are benefiting from a well capitalized platform from investments that have been made over the recent past. We’re still ensuring that we are making investments with a focus on safety and productivity. And in this year we also have particularly in the back half, we also have Gateway North and some ongoing modernization work at Metropolitan to take advantage of what has been a great startup of that activity. We think we can maintain these levels while sustaining capital for several years to come.

Neil Mehta - Goldman Sachs

All right, and then the currency here is ticked up a little bit. How sensitive is BTU to a $0.05 change in the AUD USD exchange rate or whatever of sensitivity metric that you can provide.

Mike Crews

This is Mike and that’s typically the sensitivity that we look at. So for the rest of this year a $0.05 change in the exchange rate has the sensitivity of about 25 million. They were relatively well hedged for the rest of the year at an average rate that’s a bit below where the spot is today.

Neil Mehta - Goldman Sachs

And for 2015 more of an unhedged year?

Mike Crews

Yes 2015 is a bit lower it’s mid 50% range. Ultimately that going to depend on where our cost profile is, actually our hedge rates have been ticking up a bit as we are taking cost out of platform, but it’s in the mid 50. So the sensitivity would be a bit higher, a $0.05 change would be about 60 million holding everything else constant.

Neil Mehta - Goldman Sachs

And then one thing that’s been striking is the lack of volatility in a global net markets. We’ve been stuck here at $113 or wherever the spot is for several months. Why do you think volatility is this low in met right now? And how much liquidity is there in the stock markets that we see on daily basis?

Greg Boyce

Well couple of things, first of all you really do have to start with what the market fundamentals are. And we’re going through and we have gone through a period of oversupply, ample supply at a time when even though demand was growing, it was growing at a slower rate than it was before. So, if you look at where we have been in terms of pricing for the last two quarters and obviously we look towards the market turn. But you’re really seeing a floor, and as the price has stayed longer at this level we are seeing more and more of this high cost production exit the market. And of course when it exits the market it’s probably exiting the market for a fairly long period of time if not permanent exits out of the market.

So, I think in terms of the turnaround it doesn’t take much to get this market in balance and then it doesn’t take much because there is no new capital going into this sector, to where demand is going to out run supply. And we all can see in the past what happens when that occurs. Sometimes it’s a nice orderly ramp up and sometimes the discontinuity in the ramp up can be pretty quick and pretty dramatic. We’ll just have to see what factors relative to production volumes and demand going forward look like.

So, overall I think you really always have to come back to what are the market fundamentals underlying the price and the volatility at any point in time.

Operator

And we’ll go to Lucas Pipes with Brean Capital. Please go ahead.

Lucas Pipes - Brean Capital

Glenn my first question is on the owner conversions in Australia, I think you mentioned you are targeting over 90% by year-end. Are you planning to take that to a 100%? And if not could you maybe elaborate on the reasons why some operations would be left out?

Glenn Kellow

I think that’s why we think about 90% is about the levels we’ve got. And when we look forward we have got some lines under a long-term, operating under a long term contract. We have got others that perhaps shorter life of those mines don’t lend itself to going through the owner-operated conversion. So, as we’ve indicated Moorvale, which we expect to get through at the end of this quarter. We’re probably comfortable with that level of the overall portfolio.

Lucas Pipes - Brean Capital

And then Mike to kind of go back to the third quarter guidance versus second quarter performance. Would you kind of directionally agree with the approach of taking out the 35 million from the Western segment? And then my numbers that would be roughly 30 million gap between second quarter performance and the midpoint of third quarter guidance, but that 30 million then essentially be a combination of slightly higher Australian cost to the longwall move. And then also some of these carryover tonnes that wouldn’t be available into third quarter?

Mike Crews

I mean I don’t know I can comment on specific dollar amount as I mentioned previously there is a cumulative effect on that contract that will tick down in the third quarter. And with the longwall moves, there is two longwall moves in Australia typically of higher cost and lower volume. The third one is one that we began in Colorado that’s largely going to be driven by cost. But those are -- and then we’ll have lower realizations on Australia pricing as Greg noted with carryover pricing on met. As we said we’re 20% -- excuse me with rollover pricing on met since we typically would have a carryover benefit in the following markets since flat quarter-to-quarter then there is no doubt that there is well. So, it’s a combination of all of those slightly offset by the benefit from the carbon tax repeal.

Operator

Our next question is from Mitesh Thakkar with FBR Capital Markets. Please go ahead.

Mitesh Thakkar - FBR Capital Markets

My first question is on the Gateway Mine. The transition to the new reserve development; how would it impact OpEx if at all? And any additional CapEx you need to spend if you can split it out of the total guidance that will be great?

Greg Boyce

Sure, in terms of the capital for Gateway development my recollection is that somewhere in that $60 million to $65 million range, this year, and then there will be some additional capital next year. Glenn maybe you want to come in.

Glenn Kellow

And in terms of cost, it’s a low-cost mine operating in that region has being highly successful for us. And we expect a very similar sort of cost fall going forward by taking the same team and same equipment overall. So it’s a pretty low-cost solution to continue to sustain the production that we’ve seen, success that we’ve seen from Gateway across to that Northern area.

Mitesh Thakkar - FBR Capital Markets

And just a follow-up to that, when you think about your total CapEx spending for this year obviously you have been bringing it down over the last several quarters. And then you think about the $60 million to $65 million still kind of from the Gateway contribution. Shouldn’t your more normalized maintenance CapEx be lower by almost that amount, if not what am I missing here?

Mike Crews

Well I think the difference would be, you’ve got sustaining capital in the past we’ve said that’s $1.25 per produced tonne or just something a little bit or something in that range. And then that gets supplemented by some of these projects as we have replaced the mines organic growth or things of that nature. So, our sustaining capital has come down overtime as we benefit as Glenn noted from the prior investments that we’ve made. So as that starts to filter its way through, as we said we can keep capital at these levels through the period of the LBA payments, eventually get to the point where some of those replacements have to take place.

So while the Gateway North spending may come off for that replacement activity, it’s going to get replaced somewhat by some more sustaining capital as you move back into that phase.

Mitesh Thakkar - FBR Capital Markets

And can you remind us when does the PRB LBA go off?

Mike Crews

Through 2016.

Mitesh Thakkar - FBR Capital Markets

2016.

Operator

And next go to Timna Tanners with Bank of America Merrill Lynch. Please go ahead.

Timna Tanners - Bank of America Merrill Lynch

I have maybe a really basic question, but I was just hoping you could provide some color with regard to the third quarter guidance. As usual it’s pretty wide amount of EBITDA forecasting which I appreciate, but in light of the known price for a lot of your PRB and your met tonnes. I was just wondering if you could help us understand what kind of factors could drive the lower end or the higher end range that we can try to keep an eye on them and maybe the sensitivities to the extent possible. Thanks.

Mike Crews

Timna this is Mike. So, one of the things we talked about our three longwall moves, which is quite a few in any given quarter. When I had mentioned previously around our expectations on met production, Metropolitan in the second quarter was part of that. So it’s one of these as to longwall moves. We do a lot of these. We are very good at it. But sometimes things happen, so we’ve built some variability into our guidance for things like that. We continue to look at our shipments, shipment deferrals can impact us. We had some weather at the end of the first quarter, so that will drive some variability as well. And I think those are probably the two of the largest. I guess the third one would be given the rail issues that we’ve had in the Powder River Basin that could potentially impact what our volume is for the third quarter.

Timna Tanners - Bank of America Merrill Lynch

That’s more volume and cost driven than anything on the price side?

Mike Crews

That would volume and cost drive, yes.

Operator

And ladies and gentlemen, we have time for one more question and that will be from Jeremy Sussman with Clarkson. Please go ahead.

Jeremy Sussman - Clarkson

Greg, you mentioned rail issues in the Powder River Basin. Any sense of they are actually getting better and maybe what if you can elaborate on what exactly do you think has been sort of the issue on that front?

Greg Boyce

Well, couple of things Jeremy. I think I mean if you just look at July performance over June, I think June was one of the lowest performing months that we’ve seen in number of quarters. July is falling in right behind that, even though we’ve started to see some incremental improvement. But if you go back year-over-year, year to date in ‘14 versus the same period in 2013, the railroads are up about 4% in volume. The issue is the demand was significantly higher than 4% up. So the railroads in the past when they find themselves in these situations, it’s all about adding power and it’s about adding crews. And then it’s all about rebalancing their network to try and get higher fluidity and higher speeds on the track.

Now the weather has not helped them, we’ve had a number of weather situations that have caused derailment just about the time that they were getting up to speed. So while it’s frustrating for us, it’s frustrating for everybody else and the coal sector I’m sure is extremely frustrating for the railroads as well. But this is a situation we work through before. It is about crews and it’s about power, and getting out of and then completing some critical maintenance and then not having that as an impediment to free flowing rail system.

So traditionally the third quarter of the year is one of the highest shipping quarters of the year. So as we continue to work through the rest of this month, August and September we would expect to see the rail system begin to increase and perform much better, and then hopefully that continues through the end of the year. And then with the changes that they’re making we would expect their ability to deliver in ‘15 to be much higher.

Jeremy Sussman - Clarkson

So not a whole lot of improvement at least yet, but they’re making the changes that you kind of expect. That should be the case more on the back half for this year into next year?

Greg Boyce

Correct.

Operator

And with that I’ll turn it back to you Mr. Boyce for any closing comments.

Greg Boyce

Well, thanks operator. And I want to thank everybody on the call today. Also would really want to thank the entire Peabody team for their hard work and efforts to improve productivity, reduce cost and ensure safety. We’re all seeing the results of that for the second quarter. We continue to have a leading presence in the high growth regions and we will continue to take those steps necessary to deliver increasing shareholder value.

So with that I appreciate your interest in BTU and we look forward to keeping you apprised of our progress during the quarter. Thank you.

Operator

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

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