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TECO Energy (NYSE:TE)

Q3 2011 Earnings Call

November 01, 2011 5:00 pm ET

Executives

Mark Kane - Director, IR

Unknown Executive -

John Ramil - Chief Executive Officer, President, Director and Member of Finance Committee

Sandra W. Callahan - Chief Financial Officer, Chief Accounting Officer and Senior Vice President of Finance & Accounting

Analysts

Dan Eggers - Crédit Suisse AG, Research Division

Jonathan P. Arnold - Deutsche Bank AG, Research Division

Ali Agha - SunTrust Robinson Humphrey, Inc., Research Division

Greg Gordon - ISI Group Inc., Research Division

Paul T. Ridzon - KeyBanc Capital Markets Inc., Research Division

Unknown Analyst -

Operator

Good afternoon. My name is Keisha, and I will be your conference operator today. At this time, I would like to welcome everyone to the TECO Energy's Third Quarter Results and 2011 Outlook Conference Call. [Operator Instructions] Thank you. Mr. Mark Kane, Director of Investor Relations, you may begin your conference.

Mark Kane

Thank you, Keisha. Good afternoon, everyone, and thank you for joining us for TECO Energy's Third Quarter Results Conference Call and Webcast. Our earnings along with unaudited financial statements were released and filed with the SEC almost an hour ago. This presentation is being webcast in our earnings release financial statements and the slides for this presentation are available on our website at tecoenergy.com. Presentation will be available for replay through the website approximately 2 hours after the end of the presentation and will be available for 30 days.

In the course of our remarks today, we'll be making forward-looking statements regarding our financial outlook and plans for 2011 and preliminary outlook for 2012. There are number of factors that could cause our actual results to differ materially from those that we'll discuss as our outlook and expectations today. For a more complete discussion of these factors, we refer you to the discussion of risk factors in our annual report on Form 10-K for the period ended December 31, 2010. Also today, we'll be using non-GAAP measures in the course of the presentation. There are reconciliations to the nearest GAAP measures, along with other helpful information contained in the appendix to today's presentation. On the call today, Sandy Callahan, our Chief Financial Officer, will cover the third quarter results and 2012 -- '11, '12 outlooks. Also with us today to participate in answering your questions is John Ramil, our Chief Executive Officer. Now I'll turn it over to Sandy.

Sandra W. Callahan

Thank you, Mark. Good afternoon, everyone, and thank you for joining us in the middle of a very earnings season ahead of the EEI meeting next week. In consideration of the time of day, I'll keep my remarks brief in order to allow plenty of time for questions. Today, I'll cover our third quarter and year-to-date results, discuss our new reserve discovery at TECO Coal, provide an update on the Florida economy and comment on our outlook for the remainder of this year and a preliminary outlook for 2012.

In the third quarter, GAAP net income was $90.2 million, or $0.42 a share, compared to $74.1 million, or $0.24 a share in 2010. The results in 2010 included the $24 million pretax, onetime refund at Tampa Electric. The non-GAAP comparison for 2010 is $74.1 million, or $0.35 per share, which excludes net charges of $23.1 million, primarily for taxes on the undistributed earnings at DECA II, which we sold last year.

On a year-to-date basis, GAAP net income in 2011 was $219.4 million, or $1.02 per share, compared to $182.4 million, or $0.85 in 2010. And again, the 2010 non-GAAP results were $226.6 million, or $1.06 per share, excluding charges of $44 million, primarily for the DECA II taxes affecting the quarter and for debt-retirement premiums.

The results drivers for the quarter and year-to-date periods were covered extensively in our earnings release, so I'll just hit a few highlights. We were pleased to see our eighth consecutive quarter of customer growth at the Florida utilities and also to see at both companies an uptick in growth in the third quarter from what we were experiencing earlier in the year. Tampa Electric was up to 8/10 of 1% in the quarter, which is the highest level we've seen since the fourth quarter of 2007.

A couple of comments on Tampa Electric's energy sales, particularly why they were lower than the third quarter of last year even though the degree days were comparable. Rainfall was 14% above normal, which can reduce demand significantly, especially if it occurs at the peak time of the day. The other factor that entered into the calculation of degree days was unusually high overnight temperatures, and customers typically don't adjust their thermostat for night time temperatures they'll adjust it on a hot day.

Like Tampa Electric, Peoples Gas experienced an uptick in growth in the third quarter at 9/10 of 1%, which is the strongest growth we've seen at Peoples' since the third quarter of 2007. TECO Coal third quarter sales volumes were slightly below last year at 2.1 million tons. The average selling price for the quarter rose to almost $90 per ton, as we expected. And the all-in cost of production continued to rise this quarter to more than $81 per ton. Like the rest of the Central Appalachian producers, our production costs were affected by the same factors we've been discussing all year and were exacerbated this quarter by some difficult geology in some of our underground mines.

And to complete the summary of the third quarter drivers, the impact of the sale of DECA II last year on TECO Guatemala results was largely offset by the lower interest expense at TECO Energy parent because of the debt we retired in December with those sales proceeds.

We are very pleased to report that TECO Coal's exploration activities have resulted in the discovery of additional metallurgical coal reserves. This will add 65 million tons of proven and probable met coal to our reserve base. There's another 9 million tons classified as resource, which means they can't be classified as proven and probable today, but could be reclassified in the future.

These new met reserves are located below existing reserves on properties already controlled by TECO Coal, and that's very beneficial for a number of reasons. For one, it means minimal royalty payments. It also means that permitting is limited to requesting amendments to existing State of Kentucky permits. In other words, no Section 404 permits are required.

The location of the reserves is such that production can be moved by conveyor belt to TECO Coal’s existing prep plant and no trucking would be required. And the existing prep plant already has the capacity to handle production from these additional reserves. The team at TECO Coal is evaluating mining plans and market opportunities for this coal, and we expect that it would be at least 2 to 3 years before initial production could commence.

Now turning to what we're seeing in the Tampa and State of Florida economies. The unemployment rates in both the state and local areas are improving, albeit slowly. In September, Florida's unemployment rate declined to 10.6%, and the local rate declined even more to 10.5%, compared to 12% and 11.6%, respectively, back in December. Year-to-date, the private sector has added more than 110,000 jobs in Florida, which has resulted in a net 92,000 new jobs, and that's the best 12-month job growth rate in the country. The unemployment -- the employment growth has been in the sectors that are shown on the slide.

In the same period, the Tampa Metropolitan area as it's defined by the U.S. Bureau of Labor Statistics added 18,000 new jobs in the sectors shown. And the expectation is for modest improvement for the remainder of the year. The housing market also continues to improve, compared to 2010. Existing home resales for the 12 months ended September were 7% higher than the same period last year, and that's particularly notable when you consider that last year included the Homebuyer Tax Credit program. On a sequential-month basis, after bottoming out in January of this year, existing home resale prices, as measured by the Greater Tampa Association of Realtors, have climbed pretty consistently this year, rising in 8 out of 9 months. The inventory of existing homes on the market has consistently been around the 6-month level of this year, and that compares to 8 months at the end of 2010, and 25 months at the deepest point of the downturn. And as I've mentioned before, 6 months of inventory is a level generally considered by economists to represent a reasonably healthy real estate market.

That being said, inventory only includes homes actively on the market, and we know that foreclosed properties yet to come to the market are likely to influence the real estate market and home prices for an extended period. RealtyTrac data shows that there are 10,000 homes in various stages of foreclosure in the local area, and that's down from 16,000 in March.

In the interest of brevity, I didn't include the usual graphs showing the various economic trends. These are in the appendix to today's presentation, however, and what you'll see in all of the metrics that we track is a continuation of the positive trends that we've been reporting in previous quarters.

Based on strong year-to-date results, but milder weather so far in the fourth quarter and the cost pressure we've experienced at TECO Coal, it is unlikely that we will be able to achieve the upsides included in our original guidance with only 2 months left in the year. Therefore, we are tightening our earnings per share guidance for the year to a range between $1.25 and $1.35, which would exclude any non-GAAP charges or gain. This range allows of our variations in weather at the utilities and for volumes and cost at TECO Coal. To put the milder October weather we just experienced in perspective, NOAA reported October-degree days that were 24% below normal and at a level that we have seen since 2004. So except for a long-range weather forecast for milder-than-normal weather, factors for the Florida utilities remain unchanged. We expect to earn our allowed returns on equity at both companies despite the milder weather.

TECO Coal expects sales to be between 8.2 million and 8.5 million tons at an average price of more than $88 per ton with about 45% of our sales going to the met and PCI markets this year. On the cost side, due to the cost issues in the third quarter, the full-year expectation of average production cost is $79 per ton.

The outlook for TECO Guatemala remains essentially unchanged with normal operations expected at both power plants. And of course, the substantially lower interest expense at TECO Energy parent will continue to benefit results in 2011.

Now turning to the business drivers that we see for 2012. The operating companies are currently in the process of developing their detailed business plans, and we plan to provide our formal 2012 guidance at the time of our fourth quarter earnings call in early February. For the Florida utilities, we expect them to earn within our allowed ROE band shown here. At Tampa Electric, that reflects a midpoint of 11.25%, and at Peoples Gas, the midpoint is 10.75%. The ability to earn those returns is sensitive to a continued economic recovery. So far this year, the utilities have experienced better-than-expected customer growth, and we expect growth to continue in 2012 at about the 2011 trends, or maybe a little stronger. Continued effective cost management will be a factor as well.

In 2012, we don't expect any major regulatory activities beyond the routine items, such as fuel filing. Capital spending will be moderately impacted in 2012 when Tampa Electric expects to make the initial investments in engineering and start working on the necessary transmission system upgrades to support its next round of generating-capacity addition.

Although the company is still reviewing its plans and options, the most compelling option is converting the 4 GE 7F peaking units at the Polk power station to combined cycle with an early 2017 in-service date. This option is compelling for a number of reasons. It allows us to take full advantage of attractive pricing in the state's capacity market through 2016, and the design being contemplated would provide excellent operating flexibility with both peaking and combined-cycle operation.

Another interesting aspect of this project is the potential to incorporate renewables technology into the design by sizing the steam turbine to accommodate concentrating solar at the Polk Power Station site in the future. Spending on this project, which would be a significant addition to utility rate base would ramp-up over the next 3 years with peak spending occurring in 2015 and 2016. And the size of the project would qualify for AFUDC. Next year at TECO Coal, we expect sales to be at levels similar to this year in a range of 8.2 million to 8.5 million tons. We will continue our efforts to move the sales mix closer to 50% specialty coals.

As I reported on the second quarter call, we have already replaced the below-market steam coal contract that expires at the end of this year with a contract that was priced at the market in the second quarter. The repricing of those 600,000 tons will add about $24 million to revenue, or about $3 per ton to the average selling price expressed across all tons next year. Because of when we signed our 2011 met coal contract, and I'll show you this in the next slide, we think there's the potential to price our 2012 met coal at average prices similar to those realized this year, or in some cases, may be at a premium to 2011 prices.

On the cost side, TECO Coal is working hard to manage cost, but we expect many of the factors that drove costs in 2011 to continue in 2012. At TECO Guatemala, the flagship San José Power Station is expected to operate normally next year. The plant is scheduled for a major outage, about double the normal number of outage days compared to 2011, which will reduce results in the quarter when the outage occurs.

Now here's the graph that I've mentioned a moment ago. You can see that at the time that we priced most of our 2011 met coal sales, the benchmark price for hard coking coal out of Australia was about $209 per metric ton, compared to the current $285 per metric ton benchmark. Now we don't sell this grade of coal, but this is the price that producers and buyers look to as the market price indicator with appropriate adjustments off that for quality.

This slide showing how much of TECO Coal's expected volumes are contracted really hasn't changed substantially since the last one we showed you. We are effectively sold on our steam coal for 2012, but the met coal contracting is happening later than it did last year. The timing of met coal contracting this year really isn't a surprise as buyers are working to assess just what their needs are in the current economic environment. And I'll close with our investor communications plan over the next several months.

We expect to file our 10-Q this Friday, and we'll probably see a lot of you next week in Orlando, at the EEI conference. And please, feel free to stimulate the local economies while you're down here in Florida. And then in late November, we will be up in New York helping your economy at the BMO Conference. And now, I'll turn it over to the operator to open the lines for your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Daniel Eggers.

Dan Eggers - Crédit Suisse AG, Research Division

Obviously, the coal announcement was the nice news today. I was wondering if you could try and maybe help us understand a little bit more about how that project was going to play through as far as what kind of CapEx will be involved in getting the reserves on mining kind of which you anticipate as ramping from a volume perspective relative to the low 8 million ton a year range,, it goes half right now.

John Ramil

Okay. Hey, Dan, this John Ramil. As Sandy noted, we have been working for probably a year and a half looking at these reserves and, we know that they're there. In addition to being high-quality met reserves, we do own or control the property on and they are right by. We can access them underground right by our current processing plants. So it's got the benefit of being high-quality coal, low-cost to get to the prep plant. And we do not need any federal permits. We can do it by modifying our existing state permits, and those are all pluses. What we would do we be spend the next year working on detailed engineering, permitting and mining plans to develop those reserves. Initially, it would not take a lot of capital for us to do that, probably somewhere between $10 million and $15 million of capital to do that. And then we'll have a better sense of what's going to take to fully develop. We think is going to be 2 or 3 years before production could start from those operations, and probably 5 to 6 years to get the full-production capability. Without having to detail engineering and mining plans, it looks to us like somewhere between 1.5 million to 2 million tons a year production could ultimately come from those facilities. And the prep plant there can handle that much additional coal going through it. And we'll also as I mentioned earlier, in addition, we'll be working on permit modifications we need to make to make that happen. We don't have a good solid number on what it would take to fully develop the reserves at Terry County at 10 years ago. It was not a significant development and was little bit shallower and that total project cost was about $60 million. Just looking at that number and looking at what we have here, it could be 3x of that amount to develop these reserves, and that's what we know right now.

Dan Eggers - Crédit Suisse AG, Research Division

Okay. When you think about the coal that you have they said was high quality, where does that fit in the met band?

John Ramil

It will be similar to our high vol B met coal, which we're -- right now we would at a market for that coal in the $130 to $140 a ton. We also -- since it would be new investment but underground mining, minimal transportation cost and minimal royalties, our estimate now would be about $90 a ton, all-in cost to produce.

Dan Eggers - Crédit Suisse AG, Research Division

$90 in today's dollars, so ramping inflation in cola could be higher but that's what it would be today.

John Ramil

Right, both the price and cost in today's dollars.

Dan Eggers - Crédit Suisse AG, Research Division

So you think you're going to have a 40-ish, $40 to $50 ton margin is kind of what you'd see on these reserves?

John Ramil

That's what we would look at right now.

Dan Eggers - Crédit Suisse AG, Research Division

Okay, got it. And then, Sandy, just to make sure I understood comments on the pricing of the met coal, the $285 versus the $209, when you say open to contract, kind of this year's benchmark, what you're saying is even if there is a drop-off in prices, you guys still see room to price at the similar levels. Is that a fair interpretation of what you're saying?

Sandra W. Callahan

Dan, I think point that I was making is when you're comparing year-over-year and looking at 2012, I think the focus tends to be on the fact that recently prices have come down. But you have to take into account when we price our 2011 sale, that have resulted in the average selling price that we have. And we priced those back at a time when that benchmark price was $209. It's now $285. So even though that $285 is down from where it has been, it's still above where we priced -- where the market was when priced for 2011. And so that's kind of the point that you can see very easily visually on that chart.

John Ramil

Dan, if you recall, at the time of this market, the time of our third quarter call last year, we reported that we were over 90% contracted, including most of our met. And that was well before the met coal pricing took off.

Dan Eggers - Crédit Suisse AG, Research Division

Okay, got it. I guess, one that's question on coal, the production cost at $81 a ton, should we assume that you're going to continue and inflate off this $81 level and oil prices have come back in, you guys haven't seen a lot of relief on some of the consumables?

John Ramil

Dan, our estimates for the year is right now at $79. So our expectation is we will do better in the fourth quarter on cost than we did in the third quarter. And it's just all for us. Looking at -- and more volume in the quarter, which will help quite a bit. A little bit of a comment on oil prices, there's interesting thing going on. While West Texas and Ermea [ph] has come down, Brent crude has stayed up above $100 a barrel. And diesel prices has stayed or closely tied to that Brent crude. And so from our perspective, the oil products that we used that drives our cost, we really haven't seen that let-up in their prices.

Unknown Executive

Dan, the last slide in the appendix shows the relationship between Brent, West Texas and Todd diesel fuel prices to reinforce John's point.

Operator

Your next question comes from the line of Paul Ridzon.

Paul T. Ridzon - KeyBanc Capital Markets Inc., Research Division

Sandy, I have a follow-up on the last question. If the benchmark is $209 last year and it's now $285, why are you seeing similar and not up pricing?

Sandra W. Callahan

Well, we did say that we would expect to potentially to see it price at above where we priced it in 2011. So I think the point is I don't think you should expect just because we feel like prices have come down recently that our met coal for next year would priced below where we priced it for 2011. I think there's some upside there.

Paul T. Ridzon - KeyBanc Capital Markets Inc., Research Division

And is this discovery of these new reserves kind of think about -- change your way of thinking about potential monetization of this asset?

John Ramil

Paul, this is John. It doesn't. I mean, we view the utilities as our core business. The coal in Guatemala are valued, and it doesn't change our view. We believe that's significant value to our coal business.

Paul T. Ridzon - KeyBanc Capital Markets Inc., Research Division

And then can you talk about price escalation on conveyor and rubbers and oil products? Can you just not kind of put bigger oil hedge on when you hedge your DECO and to try to cover that?

John Ramil

It's not as direct. We end up hedging or we can hedge direct cost price.

Paul T. Ridzon - KeyBanc Capital Markets Inc., Research Division

Okay. The correlation is just not there to support the investment.

Sandra W. Callahan

It's not, and then that we have to explain our mark-to-market adjustment every quarter.

Operator

The next question comes from the line of Greg Gordon.

Greg Gordon - ISI Group Inc., Research Division

So I guess, not to beat a dead coal mine with more coal questions, just thinking about your tonnage and your margins going into 2012, you're obviously -- you're saying that you can hold the line on costs -- I'm sorry, on the pricing that you're going to get on your kind of specialty coals. You're hoping that the mix improves marginally. And if I look at the $24 million of improvement, one underwater contract, that spread across all 8.4 million tons you're expecting to produce next year is an improvement of roughly $2.90 per ton, just amortize it. So I guess, I'm wondering you guys have kind of bounced up against this sort of $9 per ton margin across the entire business for a long time now. And those of us that have that have hoped that you'd should see sort of demonstrable structural improvement in the profitability of -- been stymied by market cycles and inflation and all sorts of other things, clearly not an easy business. Can we infer that you expect to break that sort of $9 to $10 per ton margin barrier next year? Or if not, what are the impediments?

John Ramil

Greg, this is John. Let me just tell you there's nothing we would love to do more than that. We're still putting our business plans together. But the best we can tell you right now is, given where the benchmarks are, we think we have equal to better pricing on our metallurgical coals. You're exactly right. The phase-out of the other market contract, we're going to pick up about $24 million on revenue, and that equates to about $3 a ton. And we're going to do everything in our power to keep costs down, and then hope that we get some help from other things that affect us, like oil prices as well. Hopefully, we can improve the margins. And if you look at our track record, our net income in this business in 2008 was about $18 million with actually a little bit more production than we’ve had this year, and we're telling you that we're going to have next year. And we've grown that to where we are now and the margins we have now. So, yes, we like for them to get bigger. But I don't think we can grow from a $2 margin to a $9 margin like we did in the last 4 years. I don't know that we can do that next year, but we're going to keep pushing it.

Operator

Your next question comes from the line of Ali Agha.

Ali Agha - SunTrust Robinson Humphrey, Inc., Research Division

Shifting for a sec, going back to the drilling business, or Sandy as well, when you talk about staying in the range for '11 and '12, could we, for planning purposes, assume you're targeting the midpoint? Is that the way to be thinking about it?

Sandra W. Callahan

We do target the midpoint, Ali. And based on specific factors, we may be -- either of the businesses on one side or the other of that. But we plan to the try to plan around achieving returns that are of that fashion, that we were authorized.

Ali Agha - SunTrust Robinson Humphrey, Inc., Research Division

And just to put that in context through the 9 months of this year or through the last 12 months, however you want to look at it, actual numbers, where are the currently earning ROEs?

Sandra W. Callahan

We're actually very close to those midpoints.

Ali Agha - SunTrust Robinson Humphrey, Inc., Research Division

Okay. And in the past, you talked about staying out from the rate case cycle for a number of years. And if memory serves me right I think you had said you couldn't stay out even through 2014. Could you just remind us what the current thinking is looking forward of when you believe you may need to go back in for the rate case?

John Ramil

We did not have any specific plans. As we told you, our strategy is to stay out as long as we can. And we like to keep doing that with a little bit of growth and continued aggressive cost management. As we do start implementing the expansion plan that Sandy talked about, we would need some help from rates for that peak spending and then the in-service of new generating capacity. So at the latest, that would indicate to somewhere around 2016, 2017 we'd be needing help.

Ali Agha - SunTrust Robinson Humphrey, Inc., Research Division

Okay. And then John, coming back to coal for a second, I want to flesh out your thinking on that segment a little more. You obviously gotten more reserves there as you point out. But when you look at where you are in the cycle, both pricing-wise and the valuation that you're pure credit public companies are getting, is your sense that, that peak valuations, at least in this cycle, are behind us now? Perhaps are there times when we're thinking about monetization or could you just flesh out your thinking more on where you see coal fit in to TECO's business overall?

John Ramil

Well again, the utilities are our core business. Coal in Guatemala we look at as value business. We're perfectly happy operating them, and they generate good cash flow, which we use for balance sheet improvement and investment in the core business. We have consistently done everything we can to add value to the coal business. And I think we have. If you look at, again, my reference to 2008 and what we earned there, that was probably about $70 million EBITDA business. And you look at that this year, it's going to be somewhere around $130 million. And you look at just everything else being held equal and the pickup on the new contract of the $24 million that Greg mentioned earlier, you start to get a number of $150 million of EBITDA value net business. So we've done a nice job of growing it, and now we have additional reserves to add value to that. Maybe we are past the peak a little bit, but maybe there's another one coming in the very near future on the value of coal. And when you look at 4 years, we doubled the EBITDA value. I don't think the -- and knowing we're on that trend, quite frankly, it would've been hard for us to sell that business unless when we knew we're getting a very, very good price for it. And we have not seen that. But when we see that price, we will know it, but we just not have seen it yet.

Operator

Your next question comes from the line of Jack D'Angelo [ph].

Unknown Analyst -

Can you guys just comment maybe just compare the level of demand are seeing today for your products versus 6, 9, 12 months ago, and how that sort of plays into what sort of spreads you're seeing versus the benchmark price?

Sandra W. Callahan

I think we're really not seeing a significant difference in demand. The timing is different, in terms of when buyers of the metallurgical coal are kind of going out of the market and looking for their supplies for next year. And it really has to do with them getting a good handle on what their requirements are.

John Ramil

I guess, I would add, Jack, that last year, we looked at when our met customers we're willing to sign up. It really was early in the year. And we're in a pattern that's kind of over time, more normal. It is usually fourth quarter and late fourth quarter when our domestic customers sign up, and that's where we are right now. And the best thing we can tell you about that, we're making the sales we expected to make this year under our contracts. And as we look at where the benchmarks were, as Sandy pointed out earlier, last year, they were in 200 to 210 range. And right now, they're about 280, and we see equal to or upside potential and where we could price it given that benchmark.

Mark Kane

Jack, this is Mark. There's a lot of stories in the trade publications about big discounts depending on the quality. What we're seeing and our expectation is, with our qualities, we're not seeing much discount from earlier in the year. It's holding in there, we're really strong.

Unknown Analyst -

Okay. And just so I understand, so you guys signed up your '11 contracts earlier. So this contract throughout the course of this year was below market. But now markets have come up a little bit, and so the contract is roughly at market, or your '11 contracts are roughly at market relative to where you see '12 now. So you think you'll be able to sign up roughly in line with where you were able to contract for 2011?

John Ramil

That's not what we said. What we said was when we contracted for our met coals for 2011, the Australian hard coking benchmark was in the 200 to 210 range. And right now, it's in the 285 range. So that's the only comparison we're making to the market.

Operator

Your next question comes from the line of Andrew Levy [ph].

Unknown Analyst -

You've given for vol B, I guess, $130 to $140 per ton. Is there any type of similar number you can give Valet [ph] or PCI or steam coal?

John Ramil

We would look at high Valet [ph] in the $170 a ton range and PCI, $90 to $100. Do you agree with that, Mark?

Mark Kane

Yes, those are probably pretty indicative prices.

Unknown Analyst -

Great. Anything on steam coal or that's kind of...

Mark Kane

We're sold-out for steam coal for next year.

Operator

Your next question comes from the line of Jonathan Arnold.

Jonathan P. Arnold - Deutsche Bank AG, Research Division

We have on coal again, on a slightly different tag. We had number of utilities talking about restructuring coal contracts, I guess, in the steam market, are you seeing any of that? And just some general comments on conditions in the contracting market. I know you're sold this year, but as you look beyond?

John Ramil

No, we took advantage of some utility RFPs during the second quarter. And we went ahead and locked up our steam production for 2012. And the only other thing that's happened is we had some production issues early in the year. We work one steam customer to defer some tons to next year but other than that, we haven't seen anything.

Unknown Analyst -

Okay. And as you -- you've obviously made this announcement today about incremental tons, do you have other sites where you might have similar or an additional prospecting that we could know about?

John Ramil

Well, we learned in addition to looking around us, we can look to deeper. So there's always that possibility in other places where we either own or have rights to the coal reserves. But that will take a while to do the drilling and develop it and make sure that it's real, just like we did here before we announced it. But the other thing that we mentioned that we are doing is we're looking at that 260 million tons of reserves that we already had, and looking at the quality of that and seeing if we need to reclassify that. If you may recall that we've never been real specific about the quality of those reserves. We kind of described it as they being in the same proportion as our sales mix. And as our folks have pushed our sales mix to include more specialty coals, we think that, that 260 base reserves may reflect that more. And we're doing some work to see if that's the case or not, and probably we'll have that ready, that work ready for next year's K.

Jonathan P. Arnold - Deutsche Bank AG, Research Division

And then just finally, as you think about the incremental tonnage opportunity here, should we think about it as a fully incremental to where current production run rates are? Or to some extent, is this kind of offset declines in production in some of the core?

John Ramil

I think that EPA permitting question is a factor in answering that question. If that logjam was to clear in the next several years, I think it's very likely that you can look at a good bit of this production as incremental. But if it doesn't, then some production will fall off. But the good news, as we have moved more towards PCI and steam coal, the productions that will probably fall-off would steam production.

Jonathan P. Arnold - Deutsche Bank AG, Research Division

PCI and met?

John Ramil

And the incremental picking up will be met, so it's dynamic.

Operator

And at this time, there are no further questions.

Mark Kane

Okay. So if there are no other questions, we'd like to thank everybody who joined us late in the day today. And I think there's 37 companies releasing between Wednesday, Thursday and Friday. We wish you good luck with that many earnings releases, and we'll see you next week at EEI. Thank you for joining us, everyone.

Operator

Thank you. This does conclude today's conference call. You may now disconnect.

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