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Alpha Natural Resources, Inc. (NYSE:ANR)

Q2 2014 Earnings Conference Call

August 6, 2014 10:00 AM ET

Executives

Alex Rotonen - VP, IR

Kevin Crutchfield - Chairman and CEO

Frank Wood - EVP and CFO

Paul Vining - President

Brian Sullivan - EVP and CCO

Analysts

Michael Dudas - Sterne Agee

Brandon Blossman - Tudor Pickering Holt

Caleb Dorfman - Simmons & Company

Lucas Pipes - Brean Capital

John Bridges - JPMorgan

Brian Yu - Citigroup

Neil Mehta - Goldman Sachs

Mitesh Thakkar - FBR Capital Markets

Evan Kurtz - Morgan Stanley

Kuni Chen - UBS

Operator

Greetings and welcome to the Alpha Natural Resources’ Second Quarter 2014 Conference Call. At this time, all participants are in a listen-only mode. A question-and-answer session will follow the formal presentation. (Operator Instructions) As a reminder, this conference is being recorded.

I would now like to turn the conference over to Mr. Alex Rotonen, Vice President of Investor Relations. Thank you, Mr. Rotonen. You may now begin.

Alex Rotonen

Thank you for participating in today’s Alpha Natural Resources second quarter 2014 earnings conference call. Joining me on the call today are Kevin Crutchfield, Alpha Natural Resources’ Chairman and CEO, who will provide a brief market outlook and summarize our second quarter results. Frank Wood, our CFO, who will comment on Alpha’s financial results and updated guidance. And Paul Vining, Alpha’s President and Brian Sullivan Alpha’s Chief Commercial Officer who will be available to address operational and marketing questions following our prepared remarks.

Note that various remarks we make on this call concerning future expectations for the Company constitute forward-looking statements. These statements are made on the basis of management views and assumptions regarding future events and business performance as of the time the statements are made. Various factors including those identified in this morning’s press release and our filings with the SEC may cause actual results to differ materially from those expressed or implied.

Also, see our press release for reconciliation of certain non-GAAP measures to GAAP measures. This call will be recorded and will be available for replay for a period of two weeks. And a replay of the event will be archived on our Web site at alphanr for a period of three months.

With that, I’ll turn it over to Kevin.

Kevin Crutchfield

Thanks, Alex and good morning everyone. As you’re well aware this was a tough quarter for Alpha. Significant challenges in the coal markets continue to hamper our results and some early signs of price recovery that we had anticipated in recent quarters simply have yet to materialized. At the same time we focus more than ever controlling those factors that we can control as we said since we began aligning our cost base and balance sheet with deteriorating market conditions in 2012.

While we don’t see any near-term catalyst that will create a more favorable pricing environment in either the thermal or the met market it is crucial that we continue to prudently manage our business so that we are well positioned when markets do improve. Unfortunately doing so sometimes means very difficult decisions with regard to our team. Last week our Company sent WARN notices to approximately 1,100 employees in our Central Appalachia operations.

Over the next two months our operations managers will conduct in depth assessments of the viability of the effective mines in relation to expected market conditions and potential to further reduce operating costs, but unless conditions change significantly, these mines will be ideal my mid October. While these notices are understandably unsettling for these employees I do want to stress that this decision was taken lightly and we remain hopeful that it will be possible for our companies to once again ramp-up hiring when workforce requirements are reinvigorated by more robust coal markets.

Turning now to our financial results. Total revenues in the second quarter of 2014 were $1.1 billion and adjusted EBITDA was $50 million compared with total revenues of 1.3 billion and adjusted EBITDA of 76 million in the second quarter of 2013. Coal revenues were 0.9 billion down from 1.1 billion in the year ago period. The decreases in revenues and coal revenues were primarily attributable to lower average realizations in each of our revenue reporting areas and lower shipments of metallurgical and PRB steam coal.

Although in the first quarter we expressed some optimism with respect to a potential bottom in met coal prices and anticipated the potential for improvements in the second half of 2014 and into 2015 prices remain sluggish and we do not anticipate any imminent catalyst to support more favorable near-term pricing conditions.

Coal markets broadly remain challenging with the metallurgical coal benchmark at $120 per metric ton, API2 pricing below the breakeven point for U.S. producers and domestic thermal pricing stalling amid softer natural gas prices, increased imports in the coastal regions primarily from Colombia and a shift of cross over met coals into the thermal market. In addition sluggish electricity demand which has not even returned to 2008 levels continues to confine coal demand.

That said Alpha is a resilient organization that is committed to ensuring that we’re taking all of the necessary measures to retain a strong and stable core despite tough market realities. Our performance on the cost side this quarter was outstanding and as a true testament to our team we achieved multiyear lows in Eastern adjusted cost of coal sales of $62.01 per ton. Although Powder River Basin cost came in above our expectations, this was primarily due to rail underperformance which continues to significantly hinder shipment volumes across all regions but especially in the Powder River Basin.

As I mentioned earlier, we also made the difficult decision to take additional proactive steps to further optimize production in the face of weak demand for thermal and met coals in the continued regulatory challenges. On July 31st we announced that we sent WARN notices to approximately 1,100 employees in Central Appalachia. We will continue to evaluate our company-wide cost structure as we assess the condition of the end-markets around the globe.

Based on the analysis that occurred over the last several quarters it has also been decided to operate the Emerald longwall mine only through the end of the second panel in district D indicating that it will likely cease production in the second half of 2015. While this decision is expected to reduce our Pittsburgh seam longwall volumes post 2015. We are pursuing initiatives at our Cumberland mine to increase volumes and broaden market exposure which should make up some of the margin loss from the higher cost Emerald longwall mine.

We also continue to prudently manage our liquidity and our balance sheet during this difficult market period. In the second quarter, we increased our total gross liquidity to 2.4 billion as a result of our $500 million Senior Secured Second Lien Notes offering in May. Frank will talk a little bit more about our balance sheet and recent capital structure changes in a few minutes.

While we had to make difficult decisions to adjust to ongoing market headwinds, we have continued our focus on Running Right this quarter. We will absolutely not back away from our commitment to safety in the environment excellence across Alpha. Key highlights include; four of Alpha’s affiliates earned Holmes Safety Awards from the state of West Virginia. Our Belle Ayr mine in the PRB won the State Mine Inspector and Wyoming Mining Association surface safety award; and Alpha received the Virginia Department of Mines, Minerals and Energy Award for Corporate Excellence in Mined Land Restoration. We continue to be very proud and appreciative of the Alpha team’s commitment to Running Right.

With that overview let me provide a little more context on the markets and what we are seeing. Starting first with met. The global seaborne metallurgical coal market has shown little improvement over the last several months as the market continues to exhibit pricing that we don’t believe is sustainable in the medium to long-term. As I mentioned although the third quarter metallurgical hard coking coal benchmark remained at 120 suggesting a bottom we do not currently see an imminent catalyst to spur a favorable pricing uptick in the near-term.

Increases in metallurgical coal production primarily from Australia continue to cause an oversupplied seaborne metallurgical coal market, with Australian year-to-date exports up 13%, or 10 million tons, to 90 million tons through June. After reduction of more than 20% in the first quarter of the same period last year Chinese import declines moderated during the last quarter, down 7% in April, 9% in May and up 22% in June resulting in a flat second quarter 2014 imports compared to the second quarter of 2013 and up 39% compared to the weak first quarter of 2014.

So far announcements to cut global metallurgical coal production are in the 20 million ton range and further production cuts are likely to be announced as the economics do not represent fair value for many of the global coal producers. We also believe that many of these announced reductions are not benefiting to current market dynamics as certain mines have yet to ideal or are selling their remaining inventory.

We expect this situation to persist for the majority of 2014 with market conditions gradually stabilizing and beginning to improve as we head into 2015. In our view and on a more positive note, the European metallurgical coal market remains stronger relative to the Pacific Basin with steal production having improved 3.8% in the first half of 2014 compared with the same period a year ago. As such we believe that we are well positioned for the long-term in our national and our largest markets in the Atlantic Basin.

Moving on to thermal, while last quarter we noted that we saw potential indications at the firming market for thermal coal, recent price trends have unfortunately not supported this expectation. Utility inventory levels at the end of June were at approximately 56 days of coal burn compared to a 5 year average of approximately 72 days and 75 days of burn as of a year ago. However, we simply haven’t seen the below average domestic utility inventory levels and the increased RFPs and buying discussions that we saw in the first quarter translates into firmer trends.

And rail underperformance continues to hinder shipping volumes across all regions particularly in the PRB. Unfortunately we don’t expect the PRB rail issues to materially improve during the second half of this year. Competition from the Illinois Basin intensified further during the quarter, contributing to lower pricing in Northern Appalachia. Continued soft conditions in Northern Appalachia were exacerbated by the threat of increased production from competing mines, and natural gas prices retreating below $4 per million Btu with basis differentials widening considerably in the Northern App region.

Utility inventories in Northern App stood at roughly 57 days of coal burn at the end of June, compared to approximately 46 days in March and roughly 72 at the end of 2013. Similarly, utility stockpiles in Central Appalachia are well below five-year normal average burn levels, at approximately 67 days burn level, down significantly from roughly 124 days a year ago. Again despite this, we see no demonstrated sense of urgency from the utilities, due in part to mild weather so far this summer and natural gas injections running above expectations for the past several weeks.

These factors, coupled with poor rail performance in the East, have significantly muted the Central App thermal optimism as we exhibited last quarter. Lastly, the seaborne market is equally uninspiring with API2 spot pricing remaining weak at roughly $76 per ton, and anticipated 2015 calendar year pricing declining over the past few months to under $80 per ton, both below breakeven for the majority of U.S. producers. Unless the API2 benchmark improves meaningfully to the mid 80s, we expect U.S. thermal export tons to decline materially in 2015 and continue to put pressure on domestic pricing.

So as I turn it over to Frank, let me just stress that while we expect sustained weakness in thermal and met markets through the end of 2014 and perhaps early into 2015. We are taking actions now to position Alpha for long-term success once the headwinds upside. As we have said previously we’ll continue to control the things that are within our control and be prepared to respond to the market demands when it improves.

With that I’ll turn it over to Frank for a more detailed discussion of our financial results and 2014 guidance and then we look forward to your questions. Turning over to you Frank.

Frank Wood

Thank you, Kevin and good morning everyone. I will walk through the second quarter results and provide additional color on key issues. I’ll also touch on cash flow items, and comment on our updated guidance. Coal revenues were 919 million in the second quarter down from our first quarter coal revenues of 953 million and down from 1.1 billion in the year ago period.

Compared to the year ago period, met coal revenues declined 180 million due to a 20% decline in shipments and a 15% decline in average sales realization per ton. Steam coal revenues declined 24 million mainly due to lower per ton realizations in both the PRB and the East and lower shipments from the PRB. Compared to the first quarter, second quarter met revenues were down 7 million due to a 4% lower average sales realization per ton primarily driven by lower prices for metallurgical coal exports.

Coal rail service resulted in a PRB revenue decline of approximately 19% compared with the prior quarter. Adjusted EBITDA for the second quarter was $50 million excluding an approximately 309 million non-cash goodwill impairment charge and the other items listed in the reconciliation of EBITDA and adjusted EBITDA to net loss a section of this morning’s press release.

Excluding the gain from the Rice Energy exchange recorded in the first quarter. Adjusted EBITDA was approximately 39 million and 76 million in the first quarter of 2014 and second quarter of 2013 respectively. The primarily drivers of lower EBITDA versus the same period last year were declines in met and eastern thermal sales realizations which declined by $14.64 and $4.01 per ton respectively, as well as lower metallurgical and PRB shipments. Compared with the first quarter very strong cost performance in the Eastern adjusted cost of coal sales was the primary contributor to adjust -- to increases EBITDA.

Speaking of cost we continue to be pleased with the success of our various cost reduction initiatives which resulted in very strong Eastern cost performance for the second quarter. Adjusted cost of coal sales in the East declined $3.72 to $62.01 per ton from the first quarter and $12.41 per ton from the year ago period. Compared to the prior quarter reduced second quarter Eastern adjusted cost of coal sales per ton were driven by reductions across most expense components including labor related expenses, sales related charges, the effective inventory changes and mine supplies.

PRB cost per ton was $12.06 up $1.83 from the prior quarter. As we mentioned in our earnings release this morning, rail performance in the West was very poor and elevated cost during the quarter has a largely fixer cost moving over were spread over fewer tons shipped. Unfortunately we’re continuing to experience substandard rail service thus far in the current quarter.

SG&A expense was elevated at 44 million in the second quarter due to merger related expenses of approximately 10 million, consisting largely of defense cost for legacy Massy litigation revenue. Excluding the merger related expense second quarter SG&A would have been approximately 34 million. We are maintaining our SG&A expense guidance for 2014 as we still have incremental SG&A expense savings to realize and employee compensation charges in future quarters are expected to be reduced.

Next I want to discuss Alpha’s liquidity and cash flow related items. During the second quarter cash flow used in operating activity was a use of cash of 217 million compared to the source of cash of approximately 3 million in the year ago period. Notably the second quarter 2014 cash flow used in operating activities included a net cash outflow of approximately 165 million to complete Alpha’s funding of the previously shareholder class action litigation settlement and 91 million for cash interest. We also, we purchased approximately 6 million of the 2015 convertibles which is shown as the net cash outflow from financing activities.

During the second quarter Alpha’s total liquidity increased by more than 250 million primarily due to proceeds from a $500 million senior secured second lien notes offering to approximately 2.4 billion consisting of cash, and cash equivalents and marketable securities of more than 1.4 billion including approximately 9.5 million shares of Rice Energy valued at 290 million as of June 30. Plus more than 900 million available under the company’s secured credit facility.

As a result of our year-to-date performance and expected results for the back half of the year we are adjusting certain elements of our 2014 guidance. Alpha now expects to ship between 75 million and 85 million tons of coal including 15 million to 18 million tons of metallurgical coal and between 26 million and 30 million tons of Eastern steam coal, both unchanged from earlier guidance. PRB guidance is being reduced to 34 million to 37 million tons to account for poor rail service in the second quarter with no meaningful improvement expected for the balance of the year.

As of July 17th based on the midpoint of these expected shipment ranges Alpha has 96% of its met coal committed price and expected average per ton realizations of $87.66 and 4% committed and un-priced we have 97% of our Eastern steam coal committed price and expected average per ton realization of $58.53 and 3% committed and un-priced. And in the West we have a 100% of our PRB coal committed price and expected average realizations of $12.12 per ton.

Alpha’s guidance for Eastern cost of coal sales in now in the range of $63 to $67 per ton reflecting $1.50 per ton reduction at the midpoint. Western adjusted cost of coal sales is expected to be affected by the reduced shipments primarily resulting from poor rail service. It is now expected to be in the range of $10.50 to $11.50 per ton approximately comparable at the midpoint to our results for the first six months.

Our selling, general, and administrative expenses excluding merger related expenses are expected to remain in the range of $110 million to $140 million. DD&A guidance is maintained in the range of 700 million to 800 million, while interest expense is projected to increase to a range of 270 million to 285 million as a result of a $500 million Senior Secured Second Lien Notes offering in May. The cash paid for interest is not expected to change from the previous range of 200 million to 210 million because the first interest payment pertaining to our new notes is not due until February 2015.

Capital expenditure guidance remains in the range of 225 million to 275 million for the year. Our capital expenditure guidance includes a $42 million lease by application installment payment due in the fourth quarter of 2014 with the final Belle Ayr Lease By Application installment payment of 42 million due in the fourth quarter of 2015.

For modeling purposes I’ll provide additional color on some key cash flows, we’ve realized or expect in 2014. As mentioned earlier, during the second quarter we paid 165 million for the shareholder class action law suit which completes our funding related to this legal case. For the EPA Consent Decree which we announced earlier this year, we expect to pay the civil penalty of 27.5 million in the current quarter. The current year related CapEx is reflected in our CapEx guidance for 2014. There is also potential for settlement of other legal matters before the end of the year in the low $20 million range in cash.

Operator, we will now open the call for questions.

Question-and-Answer Session

Operator

Thank you. We will now be conducting a question-and-answer session. (Operator Instructions) Our first question is from Michael Dudas of Sterne Agee. Please go ahead.

Michael Dudas - Sterne Agee

Good morning, gentlemen.

Kevin Crutchfield

Hey Michael.

Michael Dudas - Sterne Agee

Kevin, I appreciate the difficult decisions made on the cut backs that you announced last week. When you look at what markets as you maybe lookout towards 2015, which are the three buckets you guys spoke about met, domestic thermal, international might show the best signs of improvement going towards 2015 assuming we get a little bit help from the economy, a little bit help from maybe a more normalized weather?

Kevin Crutchfield

That’s a hard call, I’ll look to providing all that, at context I mean and the first thing around the announced cut backs that we made about three quarters of that is thermal and about a quarter of it is metallurgical. The price recovery that we have kind of anticipated in the last quarter on the thermal side never really materialized I think for a wide variety of reasons but I think that probably could in our stock on the met side and just in terms of the most potential for the nearest term signs of stabilization and actual price recovery, because as we have seen these 20 million tons of cuts the announced they’ll actually start to layer in inventories will deplete. I think we’ll see more cuts before it is all said and done we think there probably needs to be at least five if not another 10 million. So I think that will begin in the back half of the year at least stabilize the market if not hopefully start to improve a little bit as we head into 2015. So, that’s kind of a long way around of answering your question I think that point to at least the highest prospects in the near-term on the met side any additional color there guys?

Michael Dudas - Sterne Agee

My follow-up Kevin, would be as you look towards the production the rebasing of production for Alpha say for 2015, would that justify lower maintenance CapEx or CapEx level relative to your prior production level and there is going to be idling cost that might offset that to a certain degree or offset more than it would, so, just a little insight on that please?

Kevin Crutchfield

Yes so I think that would balance, I mean we wouldn’t take these steps, if we didn’t think it was going to help the cash flow position. So, yes there will be cost associated with idling whatever we choose idol in the third quarter but it will be smaller than the negative consequences of continuing to operate so on balance it will be a net positive from a financial point of view and yes these operations have sustaining maintenance capital requirements on the order of low tens of millions I am looking at Paul here for a little guidance but I think it’s somewhere in the $10 million to $15 million annual range. So, yes you would expect to see a reduction in our sustaining capital going forward as a result of whatever again whatever choice we have frankly when the time comes.

Michael Dudas - Sterne Agee

Thanks for your candor Kevin, I appreciate it.

Operator

Thank you. The next question is from Brandon Blossman of Tudor Pickering Holt. Please go ahead.

Brandon Blossman - Tudor Pickering Holt

Good morning guys.

Kevin Crutchfield

Good morning.

Brandon Blossman - Tudor Pickering Holt

Just follow-on Michael’s question, and obviously you don’t or I assumed that you don’t know actually what’s going to transpire here at the end of October or the beginning of October but directionally and kind of order of magnitude, what would you expect ’15 in terms of cost structure versus the $62 you are at today?

Paul Vining

Yes I’ll answer, this was Paul Vining. This may help, to give you some visibility around the cost structure of the mines that we warned at, year-to-date their cost are within a $1 or $2 our average Eastern cost for the year and with a fairly wide span ranging from one or two miles actually below $50 which obviously result from the coal and mostly lower quality export to some facilities that are at $70 and above and those obviously have some metallurgical products in them.

So if you roll it all together and all of these mines would be ideal on an average basis, it’s in the same zip code as our current operations. For those operations for negative margins negative cash flow and the expectation is that we’ll take offline those mines that aren’t going to be positive cash and they’re going to be negative margin next year. So cost expectations are certainly at the same zip code if not marginally lower dependent on the mix as we lower production percentage of longwall coal as the total Eastern mix goes up however compared to a year or a two ago the percentage of metallurgical production is actually a higher percentage of the Eastern mix so with several offsetting factors.

Brandon Blossman - Tudor Pickering Holt

Okay. Helpful things to consider, more specific question also probably on the CapEx side the Emerald longwall what will happen with that later in 2015?

Paul Vining

Yes, we expect go through recovery stage after we finish the second longwall panel, there is a significant amount of infrastructure in capital in the Emerald mine that will be removed over a period of months that will, all of which will have some affrication or most of which will have an affrication of the Cumberland longwall facility and will help to offset capital requirements there a couple of years in order of magnitude it’s probably $100 million more equipment that we will be able to turnover and put to good use at Cumberland.

Brandon Blossman - Tudor Pickering Holt

Okay, great. Thank you very much.

Operator

Thank you. The next question is from Caleb Dorfman of Simmons & Company. Please go ahead.

Caleb Dorfman - Simmons & Company

Good morning.

Kevin Crutchfield

Good morning.

Caleb Dorfman - Simmons & Company

As I know Alpha has been really proactive as a company in cutting production so with the cuts that you’ve identified in West Virginia and some of that beyond the met side, are there any other operations that you can point to that are marginal or cash negative in the current environment that maybe you would consider cutting or reducing production at in the future?

Kevin Crutchfield

Yes, without speculating Caleb I mean what I’d say is, we’ve spent a lot of time thinking about this and these are obviously very difficult decisions because there are good people, very good people on the end in these kinds of transactions and that’s very unfortunate, very unsettling to them. But we spend lot of time thinking through it and planning and that we believe the efforts that we’ve announced are going to be sufficient but what I’d also do is back that up and say that I think we probably more than anyone else should demonstrate it a willingness and the desire to do what we think is a responsible thing in the face of a very dynamic and ever changing marketplace and staying prepared to do more necessary but we don’t see that at this point in time.

Caleb Dorfman - Simmons & Company

Okay. That’s helpful. And then I guess I have a question for Frank, can you help me walk through the cost guidance, the midpoint is $65 a ton, you just put up $62 a ton in a quarter with essentially two longwall moves and first half with some 64, I guess why couldn’t cost be at the Q2 level again in the second half of the year is it just idling, potentially idling cost of these West Virginia operations?

Frank Wood

Yes it’s a couple of different things I mean obviously we gave you a range, so if you look at the range we could continue to perform close to where we have. One of the things that typically happens to it in the third quarter I think it will probably happen again this year is the time off that we have in the third quarter split across operations has a tendency to elevate cost it is kind of subtle but it’s almost inevitable every year.

So that one factor which hits the second half harder than it hits the first half and then in addition as you pointed out we’re going to have some potential for it. We’ve done a very good job in the first half of bringing the idling cost down it’s actually one of the components that helped in the second quarter versus the first but we do think there is potential without being specific to that point know exactly how much that that will potentially increase as we go through the next two quarters. So yes, I think those are really the couple of factors now of course we have really had in the second quarter very-very strong cost performance across virtually all of our Central App mines which in the mining business with condition variability and stuff probably doesn’t happen every quarter.

Caleb Dorfman - Simmons & Company

That’s helpful. You brought up the idling cost, do you have maybe a total dollar amount or maybe a $1 per ton that headwind cost are currently running and how that difference between the surface and underground ops?

Frank Wood

I don’t have, certainly I do not have any breakdown between surface and underground. We’re not tracking that currently in that form, but on an average basis for the first half of this year it has between $3 and $3.25 per ton.

Caleb Dorfman - Simmons & Company

Great, thank you.

Frank Wood

On Eastern tons not on all tons.

Caleb Dorfman - Simmons & Company

Okay, thank you very much.

Frank Wood

Thank you.

Operator

Thank you. The next question is from Lucas Pipes of Brean Capital. Please go ahead.

Lucas Pipes - Brean Capital

Hey, good morning everybody, and congrats on a great cost performance.

Kevin Crutchfield

Good morning.

Lucas Pipes - Brean Capital

I wanted also to touch a base lower on the cost side and kind of rough numbers would indicate to me that you took out about 40 million in cost in the second quarter versus the first quarter specifically in the East and I just wondered given that volumes were roughly flat kind of where you found those savings?

Kevin Crutchfield

Yes I think they were Lucas, I mean I think we mentioned most of the categories in the commentary I can just kind of repeat that I am not going to give you a breakdown of how much was each category while they all contributed significantly. Probably the single largest category which tends to swing quarter-to-quarter was the effective inventories on cost, which was beneficial to second quarter not as beneficial in the first so in that comparison but we saved cost in the labor and labor related areas, we save cost in terms of supply I think both from a usage and probably in the way that we purchase supply and unfortunately because realization particularly on the met side continue to decline we also saw lower cost on the royalties and sales related type cost. So, all of those were fairly significant contributors with the little bit of an offset from the effective delay the longwalls average in. Because the longwalls although it was good volumes the longwalls were higher cost per ton in the second quarter that they had been in the first. So, that tended to be somewhat of an offset.

Lucas Pipes - Brean Capital

That’s very helpful, thank you. And then switching to the longwalls, you mentioned that you could maybe offset some of the Emerald volume loss in the second half of ’15 that extension at Cumberland, can you maybe walk us through what exactly would be required to be done at Cumberland, how many additional volumes you might be able to get out of that mine and also what sort of capital must be required to do that?

Paul Vining

Yes, this is Paul Vining. I think you’re referencing the release for the script really is over terms not necessarily in the second half of ’15, we’ve got a couple of projects at Cumberland, the productivity projects that basically mitigate risk that we have encountered over the years relative to keeping the longwall fully engaged and that has to do with ground storage also it has to do with rail access and we’re in the process of building a rail access facility for the Cumberland mine that will be a bit de-risk it in the marketplace and also give us a significant amount of ground storage for clean coal storage.

Cumberland as a longwall mine will kick out 25,000 to 30,000 clean tons of day and until recently we have very little if any active store which meant if there were no barges the longwall backed up and didn’t run. So, we have the opportunity to pick up as much as 300,000, 400,000, 500,000 tons a year just out of that single move of providing some raw coal storage and also some clean coal storage for a mine that should operate well in the 7 million to 8 million ton per year range and be highly productive for a many-many years to come.

Lucas Pipes - Brean Capital

Great, well good luck with everything and I appreciate all the color.

Operator

Thank you. The next question is from John Bridges of JPMorgan. Please go ahead.

John Bridges - JPMorgan

Good morning Kevin and everybody. Well done on the cost and handling the last and all those other terrible things, just wondered we are relatively new to the coal space we have really experienced wool market and not much else, you have seen the ups and downs in the past, how would you compare this current situation with earlier downturns and to the extent which the coal companies now in particular Alpha are stronger to get through these tough markets?

Kevin Crutchfield

Well, what a great question. Again I guess I would say historically I mean it’s been obviously a pretty cyclical business and I think what we’re going through right now in part is another cycle but I think in part what we are going through this time also is secular in that we’ve seen -- what are likely to be permanent changes in the Energy mix of the United States due to the great things that have happened in natural gas and the ability to extract locked up gas molecules that we knew were there before but we couldn’t get out cost effectively now we know how to do that and it’s been exacerbated or accelerated through very aggressive, very overt regulatory environment that frankly in our view has had coal right in this cross there. So, in that regard I think what we’re experiencing is secular to a large extent and where it has been checked out I think there is still a bit of an unknown given where I mean I think we’ve begun to see now what the effects of the mercury neurotoxic standard are going to result in 20 gig or so, where in SPS on new coal fire construction, existing coal fleet is still a matter of some debate, but to give you some context, I think is 97 to 98 that large produced nearly 300 million tons of coal. It’s on-track to produce this year something what just...

Frank Wood

125ish?

Kevin Crutchfield

125 with the expectation that, that’s going to continue to shrink for a while, there’s always going to be fair amount of metallurgical coal dispatched out of the basin into a 20 million ton U.S. market with 35 million to 50 million tons of exports depending on, what’s going on internationally, so the question mark as always is what happens to the rest of the thermal footprint in Central Appalachia. And based on what we’re seeing right now, if things, great relations go through but today it doesn’t look good but obviously things change overtime. We have a big effort underway to try to push back on regulations that we frankly don’t think make a lot of sense for the United States so it’s a bit of question mark as to how that will end up I mean I think that’s one of the benefits of Alpha is having some regional diversity and product diversity because we play in domestic and international markets those thermal and met and it gives us some ability to flex based on what’s happening and we’re just at a point right now where unfortunately it’s now the perfect storm in terms of where things sit but if you wait long enough things will change and I think they will in time so our goal has been to control what we can control maintain a strong balance sheet and be ready to respond and flex into an improving marketplace when it does improve and I think in time it will. So, if you want to learn more about it, it’s probably best that we go offline because it’s a long story but I guess that’s 90 second that’s probably my best ability to sum it up for you.

John Bridges - JPMorgan

Yes, and as you say you got the bigger balance sheet so it is almost a too big to fail component to this situation maybe?

Kevin Crutchfield

Well, I wouldn’t really comment on that I mean I think our goal has been to be prudent with the balance sheet to try to be thoughtful, be responsive to what we are seeing in the market place and extend our runway but it looks things will change and our goal has been to be strong and resilient and be able to respond when market conditions do change and so I won’t take debate on too big to fair comment, nice try though.

John Bridges - JPMorgan

Just interested and then just looking forward to 2015, how much coal have you managed to sell for 2015 so far?

Kevin Crutchfield

Yes. Just given the state of flex that we’re in we’ve chosen to just avoid discussion around what we’ve done in 2015 and what the plans are for 2015 we’re going to use back half for the year to do more planning and thinking in that regard and I will expect that our next quarterly call will be in a position to provide a more valuable update in terms of kind of what we see, the last step looking a lot for 2015.

John Bridges - JPMorgan

Okay, fine. Thanks so much, guys.

Operator

Thank you. The next question is from Brian Yu of Citi. Please go ahead.

Brian Yu - Citigroup

Great, thanks. Kevin, I know you guys have done great job on costs as others have noted, I was just wondering if you look at your cost savings roadmap how far along are you on that. And can you give us a sense of what other aspects of the operations you’re looking and I guess excluding kind of curtailments, I am just thinking the sustainable cost improvements that you can implement?

Kevin Crutchfield

Yes. We’ve talked a little bit about that in prior quarters and I think in all the categories that we mentioned previously we expect to at least hit our targets if not exceed them with the exception of one category which is the idle yr mine expense. Now, the team has done a very good job in curbing those expenses down on the collection of idle mines we had at the time we started the problem we’re contributing assets to that asset class, giving them more and more to do, so we won’t hit our target in that area but I will say on balance we will still get everything that we’ve said publicly in terms of our cost reduction targets.

And the other thing I would say just as a little additional context and color to what Frank and Paul said about cost going forward, coal miners are very creative and a very resilient bunch and they see what’s happening out here. And it’s too early to count them out in terms of the things that they can create ways to create additional cost savings, so we have a lot of good initiatives going on inside the company, the maintenance initiative the methods and standards group that we have put in place to continue to drive efficiencies. So, I am not sure we found the bottom yet, I know what our guidance says and we’re pretty stuck on doing what we say we’re going to do but I believe there is more there to be had. But we want to be conservative and thoughtful and we say publicly. But again I would say that don’t count us out just yet so I think there is more positive things there to be seen.

In terms of additional big cost leverage, we don’t have anything of the scale that we’ve announced previously, that’s not to say that there aren’t ways that we can save additional cost o we are going to spend the balance of the year looking at that and would expect to update you probably the next quarter on kind of what we’re thinking in that regard.

Brian Yu - Citigroup

Got it. And second one is, I know you guys issued a WARN notice it’s unfortunate, but just in time for destruction guidance for this year was maintained does that reflect the timing of executing on those notices and then perhaps some inventory on hand that you could sale through at the mine now towards that’s why volume guidance has not changed in the east?

Kevin Crutchfield

Yes, if you look at the run rate where we are of the mines that were announced and when we would likely take action. So it would be a quarter of the annualized run rate it would be impacted in 2014 and even after the dust settles on that we were still generally within the guidance that we previously submitted so that’s why we stuck with it now -- yes, and we have tons in other mines that we can stoke as well. So for the year expect that just to see that change as we head into 2015.

Brian Yu - Citigroup

Alright, that is great. Thanks and good luck.

Kevin Crutchfield

Thank you.

Operator

Thank you. The next question is from Neil Mehta of Goldman Sachs. Please go ahead.

Neil Mehta - Goldman Sachs

Good morning guys.

Kevin Crutchfield

Good morning.

Neil Mehta - Goldman Sachs

Can you talk about in the rail performance in the PRB, what’s the path ultimately getting the bottlenecks resolved result and how do you think about that timeline?

Kevin Crutchfield

The path to getting it resolved is obviously completely within the control of the two western railroads in the PRB. We’ve had the average performance has been in the low 80% all year. We’ve been advised by both western railroads that that situation not improve the balance of this year, they are short people, they’re short power they have competing moves and other commodities that are taking an already short staffed and short powered fleet to other business line. So they are reacting as quickly as they can, but the locomotive market got very tight. So that was coupled with a demand signal from a lot of utilities out west given the winter that came on to them very quickly. So they respond slowly they’ve had weather issues, they have their own operational issues in the demand signal went strongly in the first and beginning of the second quarter. So all those things inspired to really hamper the western railroads and we’re not likely to see marked improvement for the remainder of the year or kind of hearing first quarter of 2015 from the western railroads.

The eastern railroads are largely a combination of the same factors. We’ve had very poor eastern rail service out of both eastern railroads as well one has been improving more than the other recently but we’ve had significant issues in the met franchise moving domestic met to the Chicago, Cleveland markets. So a lot of the higher price domestic business that we anticipated shipping in the first half of the year wasn’t delivered and instead the rail movements to the export were relatively better. So we had a disproportion at amount of tons go to the export market in an unplanned way over the first half of the year in rail service.

Neil Mehta - Goldman Sachs

So what gives you confidence that this is kind of logistical issue and therefore this temporary and ultimately look at results versus more of the structural issue where rails are going to be bias to serve the higher margin customer.

Kevin Crutchfield

A bit of history, this is not the first time that we’ve had I think somebody referred there is a meltdown in the class one railroad system recently. So if you’ve been watching this space for more than a couple of years this is not the first meltdown. So typically you go through cycles of capital investment and hiring. So the good news is the infrastructure is there, the ability of the railroad to respond to demand signals that came on very quickly combined with whether and other issues mean that it takes time to resolve these issues, they can’t turn on a quarter. So historical performance gives us confidence that it will improve and the fact that the infrastructure is there and we see steps being taken gives us confidence that it can and will improve.

Neil Mehta - Goldman Sachs

All right, very helpful answer. And last question, in terms of the E&P assets, can you talk about the path to potentially monetize those that are -- weren't sold to Rice and how you think about when the appropriate time to announce the joint venture partner would be?

Kevin Crutchfield

We have just a little bit of incremental information around the joint venture sale around the acres I mean I think lot add there and then whole lot of change since the last time we talk. We’re pleased with the progress solidifying the acres around the initial pads the JV has indentified what it believes on the first several pads where drill holes will decide. We’ve got a couple of permits submitted actually expect those back in the third quarter and we would expect to be drilling by the end of the year and flow in gas sometime in 2015. So we’re pleased with the progress that the joint venture is making. I think it’s still early stages in terms of try and distract delay about, what the optimum timing for an access it would look like if there is an exist and when that might be. We’re focused on getting the JV what it needs to -- continue to mass -- the critical masses of concentrated acres in this prolific area of the Marcellus. And concentrated on -- very focused on getting gas following up there so we are just taking one step at a time in place to keep everybody updated, as time passes and as we made progress.

Operator

Thank you. The next question is from Mitesh Thakkar of FBR Capital Markets. Please go ahead.

Mitesh Thakkar - FBR Capital Markets

Good morning and good job on the Eastern costs. My first question is on the PRB. And, Paul, looking at the PRB market it looks like particularly the 8400 call hasn't done much, not just recently but over last year or so. It is below that $11.00 level on the OTC market. And correct me if I am wrong, but when you look at your cost structure in the PRB, can you walk me through how to think about it going forward? I know you don't have a 2015 guide out, but maybe is there some opportunity of rationalization there where you think that it might not be necessary to operate both the mines and just maybe run one mine?

Paul Vining

Well, I’ll start with the last question. And probably two years ago we look at the possibility of ironing one of the mine because of the market capital and the outlook, but we came to the conclusion particularly was some of the opportunities to gain along to keep mine -- both mines operating than we fully intend to do so going forward. We took the mines down as you well know down into the sub 40 million on a combined basis and maintain pretty healthy cost structure, to learning experience for our workforce. We’ve actually instituted couple of new mining methods out there are not unique in terms of the application, but due to our particular bid operators, that’s been a big help.

We moved equipment from back east out into the PRB. And we have the intention as the market comes back to actually ramp the mines back up over period of time to back for their historical operating levels of 45 to 50 million tons. It’s really two very distinctive mine Eagle Butte is very, very low ratio, low BTU monitor. And by saying that I’ll say it’s a very low cost mine. So from the perspective of operating Eagle Butte, albeit low BTU, lower prices in the market which is still a very good margin and a profitable and positive cash flow operation and should be so for the duration of it’s like.

Belle Ayr has been an operation, I think it’s one of the oldest one in the Basin. It has liked many mines in its category and its neighbors have ratios they have plant over the years. And its cost structure compare to Eagle Butte is very different. It is on both railroads, it is on sounds the joint launch so it has some competitive advantage like a lot of the PRB mines sort of customers that really like the coal and that will pay a small premium for it from time to time. So there is going to be a balance, but both mines will operate to be very profitable and post 2015 absence some collapse in the pricing when the LBAs go away the PRB is going to be a very, very strong part of the footprint.

Mitesh Thakkar - FBR Capital Markets

Great. A follow-up on the Eastern side. On the Emerald mine, I understand there are four panels within that district, and I think you are more comfortable with the first two panels with respect to the geological issues and stuff. And today you announced your decision that you are not going to pursue the other two panels. Can you walk me through like is it just a pure -- not that the market is not there and I don't want to take geological risks, or is that something associated with incremental CapEx spending and reserve replacement? That will be great. Thank you.

Paul Vining

Yes. It’s a good question. I mean basically the two panels we’re going to mine our not unlike other panels, we have mined at Emerald. The third and the fourth panel in that particular district is bisected by some surface, instruction where we have to have in panel moves which are very inefficient, very expensive. On top of, as you go north in that reserve, the geology and the uncertainty and the conditions deteriorate and you combine that with a fairly -- it’s a steady issue it goes market but it’s obviously boxed in the PJM gas prices and power prices and overall price you’re seeing that’s healthy but stagnate the better business decision for us given the fact that this was the last long haul district in Emerald was to cut those two panels out and blow them all.

Kevin Crutchfield

Thank you.

Operator

Thank you. The next question is from Evan Kurtz with Morgan Stanley. Please go ahead.

Evan Kurtz - Morgan Stanley

Hi, good morning guys. Thanks for taking me in.

Kevin Crutchfield

Yes.

Evan Kurtz - Morgan Stanley

Good morning. Wanted to ask a couple of questions on met coal volumes and try to get a sense for what this recent announcement on islands means for supply. And if you could give us a production and run rate number if you were to shut down these mines on the met coal side, that would be really helpful. I understand that there's some crossover tons, just makes it a little bit more nebulous, but just maybe a baseline that we can think about.

Kevin Crutchfield

Yes, I mean it’s kind of hard to say because it’s very poor, we’ve got operations that we can ramp up another 1 million or 2 million tons of production without whole lot of effort and the 2 million tons we make takeout with the surface mines and be replaced relatively easily. I mean if you look at midpoint of guidance for this year I wouldn’t be shy about saying that’s achievable even with these mines falling out. Again this is going to be price dependent and it’s going to depend on the domestic metallurgical discussions which really have not even kicked off yet and certainly the movements in the benchmark over the next couple of quarters. So from the sustainability level even if we take these mines down which is very likely at least in some formal fashion they’ll be mostly in an ideal state we’ll be working with the local authorities to put them in a market to permit. We’ll have equipment outside and -- improves for some maintenance and environment obligations that will have remaining. But typically these mines will not going to go into final recommendation list unless near the end of their reserve line. So sustainability in production is very much a function more so of the market and our physical capacity reserves or capability that maybe physical on the ground that in the field.

Evan Kurtz - Morgan Stanley

It actually brings me to my follow-up question. I was going to ask what are -- on a per site basis the type of quarterly idling cost we should think about excluding the initial hit from severance, I would imagine. And then, furthermore, what would be the restart cost from one of these operations if you were to decide that the market is back?

Kevin Crutchfield

Well, restart process is going to minimal because we’ll maintain the equipment no doubt we’re going to move much of the equipment offside surely not in the sally. We’ve got plenty of equipment that we gathered over the next two or three years. The actual ideal cost is going to depend on discussions what we have with the local authorities and the degree of recommendation work that we have at the individual side and also -- ultimately go down if any survive. So I’m not going to throw a number out there for these particular operations what may or may not cost us holding for a year or two.

Evan Kurtz - Morgan Stanley

Okay. Thanks guys.

Kevin Crutchfield

Thank you.

Operator

Thank you. And our final question comes from Kuni Chen of UBS. Please go ahead.

Kuni Chen - UBS

Hi, good morning folks.

Kevin Crutchfield

Hi Kuni.

Kuni Chen - UBS

Good morning, folks. Quickly on CapEx. The run rate seems pretty low relative to guidance. What is in the second half CapEx mix that we didn't see in the first half?

Kevin Crutchfield

Well, obviously the first thing which I know you’ve taken into account is 42 million for the Belle Ayr because that is in the CapEx guidance even though we spiked it out talk about it separately. In addition to that we think the quarterly run rate which has been in the low 40s for the first half will pop up some part of it is some of the stock filing and market diversification investment we’re making for -- and some of that will come more into play later in the year, that one factor plus some of the regulatory types of expenditures while they kicked off they tend to be a little bit more heavily put later in the year, they don’t necessarily hit the ground running four more. So of that will also come in and I think accelerated late later in the year.

Kuni Chen - UBS

Got you. Then one last one. I think in the past you have talked about your met coal cost range at the different mines going from the mid-50s up to the high 90s. Can you update us on what that range would look like assuming these mines that you shipped a notice on are idle later this year?

Kevin Crutchfield

I don’t think I’m going to comment on what the cost I mean there is $30 plus spread depending on whether surface was deep and conditions and not. We continue to write it down and in some cases -- close smaller mines that are high cost and don’t fit the market and don’t positive cash flow and the other thing is quite frankly our employees continue to really stretch and reaching the stars and come up with productivity moves and cost moves that even surprise me. So I’m not really going to change anything we may have said before.

Kuni Chen - UBS

Alright, very good. Good luck, thanks.

Kevin Crutchfield

Thank you.

Operator

Thank you. Ladies and gentlemen, I’d now like to turn the floor back over to Mr. Crutchfield for any closing remarks.

Kevin Crutchfield

Thanks to everybody for taking the time to dial into our second quarter call this morning. I surmised by now everybody is well-versed this earnings season on the adversities that Alpha and other producers are dealing with, but also hope to compare to you that we’re fully committed to taking all necessary measures within our control to retain strong and stable core business which we believe will prudently resilient overtime. So, again many thanks and this concludes our call. Have a good day.

Operator

Thank you, ladies and gentlemen. This does conclude today’s teleconference. You may disconnect your lines at this time and thank you for your participation.

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Source: Alpha Natural Resources' (ANR) CEO Kevin Crutchfield on Q2 2014 Results - Earnings Call Transcript
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