CNX Coal Resources' (CNXC) CEO Jimmy Brock on Q2 2016 Results - Earnings Call Transcript

| About: CNX Coal (CNXC)

CNX Coal Resources (NYSE:CNXC)

Q2 2016 Earnings Conference Call

July 25, 2016 5:00 p.m. ET

Executives

Mitesh Thakkar - Director of Finance & IR

Jimmy Brock - CEO

Lori Ritter - CFO & CAO

Jim McCaffrey - SVP, Coal Sales

Analysts

Paul Forward - Stifel

Mark Levin - BB&T

Jeremy Sussman - Clarksons Platou

Lucas Pipes - FBR & Co.

Operator

Welcome to the CNX Coal Resources' Second Quarter 2016 Earnings Conference.

[Operator Instructions] Please note this conference is being recorded.

I would now like to turn the conference over to Mitesh Thakkar. Please go ahead.

Mitesh Thakkar

Thank you, Amy [ph]. Good evening everyone. Welcome to CNX Coal Resources' earnings conference call.

Today we will be discussing our second quarter 2016 operational and financial results. In the room today are Jimmy Brock, our Chief Executive Officer; Lori Ritter, our Chief Financial and Accounting Officer; and Jim McCaffrey, Senior Vice President, Coal Sales.

We will begin our coal today with prepared remarks by Jimmy and Lori, and then open up the coal for the Q&A session. Jim will join Jimmy and Lori in the Q&A portion of the call.

As a reminder, any forward-looking statements or comments we make about future expectations are subject to business risks, which we have laid out for you in our press release or in previous SEC filings. We do not undertake any obligations of updating any forward-looking statements for future events or otherwise. We will also be discussing certain non-GAAP financial measures. Definitions and reconciliation of such measures to comparable GAAP financial measures are contained in the press release and furnished to the SEC on Form 8-K. You can also find additional information on our website www.cnxlp.com.

With that, let me turn it over to our CEO Jimmy Brock.

Jimmy Brock

Thank you, Mitesh. Good evening everyone and thank you for joining us on today's call.

Before I go through my prepared remarks for the quarter, I want to take this opportunity to congratulate the CNXC team for successfully completing one year as a public company. While it was a challenging year for coal producers and MLPs, our employees stepped up their game and softened the impact of the challenging market conditions. On behalf of the CNXC team, I would also like to thank our sponsor CONSOL Energy for its continued guidance and support. Finally, thank you to all of you on the call, our unit holders, and the analyst community for your continued interest and support of CNXC.

Turning to reviewing the second quarter of 2016, CNX Coal Resources turned in another solid operating performance, which drove a modest improvement in our earnings over the first quarter of 2016 despite the continued slide in average realized prices. While coal consumption remained challenging early in the quarter, we are starting to see signs of improvement, specifically export prices. Although still low compared to the previous years, they improved substantially during the second quarter.

Domestically, somewhat as a bonus, and early indications are that coal burn is improving. As you may have noted in our press release, CNX Coal Resources reported adjusted EBITDA of $13.3 million and distributable cash flow of $4.8 million for the second quarter of 2016. While we're seeing positive developments in the coal markets for the current quarter, the board of our general partner has elected not to pay a distribution on subordinated units, which are all owned by CONSOL Energy. Lori will provide more details and the thought process around this decision in her prepared remarks.

First, let me provide you an update on our operations starting with our core values of safety and compliance. I am very pleased to announce that our Bailey Mine was awarded the 2015 Safety Award in the Underground Bituminous Coal Mine category by the Joseph A. Holmes Safety Association at the Pennsylvania State Council. Specifically during the quarter we were able to reduce the severity of the incidents compared to the same period last year.

On the operational front, second quarter was expected to be challenging with planned longwall moves at both Bailey and Enlow Fork Mine, while the Harvey Mine was [inaudible]. As anticipated, we moved four longwalls during the quarter. During the month of May at Enlow Fort Mine, we encountered some tough geological conditions that resulted in reduced advanced rates and production shortfalls.

Our operating teams did a good job navigating those challenges and production was normalized in the month of June. Similarly, during one of the longwall moves in the month of June at Bailey Mine, our team encountered different longwall recovery conditions, which increased the duration of the longwall move. To meet the production shortfall at Bailey and Enlow Fort, we decided to bring Harvey Mine back in production earlier, initially just on a temporary basis. However, as more trains started to show up and our marketing team was able to put more export business, we decided to run Harvey on a more steady state basis even after the Bailey and Enlow Fort production issues were resolved. While the four longwall moves during the quarter created upward pressure on costs, we were able to offset this pressure by improving productivity and deferring some discretionary spending.

I will also note that on MMBTU basis, our year-to-date production costs, including DD&A, was approximately $1.30, which compares favorably to some of the lowest-cost gas basins. One of the key differentiators we have is our motivated workforce. With all the changes we've gone through over the last 12 months, our employees have shown flexibility to adjust to changing market conditions and have delivered solid results for us. While much of the industry is going through financial distress, they are also losing some of their best employees. We have not lost key employees and I thank our employees for their dedication, hard work and flexibility.

With that, let me provide an overview of coal markets and an update on our marketing efforts.

I am very pleased to announce that we are now completely sold out for the second half of the year while running at a full production schedule. We also have a strong contracted position of 79% for 2017. The demand pool from our domestic customers is considerably stronger than it has been at any time in the last 14 months. This gives us confidence that our second half's domestic volume as a percentage of total sales will increase to 90% from approximately 69% in the first half. We have full expectations that our domestic customers will be taking their contracted tons and this will result in an improved pricing across the portfolio of 8% to 10% compared to Q2.

Our key customer inventories have reduced to levels that are now manageable, and we have two key customers operating with [ph] cash flow inventory levels below 15 gates [ph]. The combination of rising gas prices, hot summer weather, and reduced production has resulted in a changing marketplace. While we do not like to call the bottoms and tops in the coal markets, the month of May certainly felt like it could be a bottom. It feels like the markets have now turned and we expect pricing to follow.

Now let's discuss the second quarter. The second quarter is typically a weak quarter for coal burn as mild springtime temperatures softened the overall demand for electric power. Typically a number of facilities take advantage of the opportunity to perform scheduled maintenance during the springtime shoulder seasons. Unfortunately, due to the unprecedented warm winter, this past shoulder season began in October 2015 and lasted until the arrival of summer heat in May or June 2016.

April's coal burn came in below 40 million tons for the first time since 1979. Coal accounted for only 24.6% of the generation mix that month compared with 34.1% for gas and domestic demand for coal shipments fell sharply. Customer deferrals became problematic in the first quarter and continued to occur into the second quarter, peaking in May. CNXC was impacted by this lull in domestic demand and we reacted aggressively by taking advantage of export opportunities to actually sales volume quarter on quarter, while maintaining a positive margin.

During the second quarter of 2016 we sold 1.2 million tons to 51 different end-users domestically and internationally. As noted, the sales mix remains challenged by deferrals and resulted in approximately 35% of sales to the export markets and spot domestic and export shipment prices remained tepid [ph].

On the contracting front, we continue to book additional business for 2016 through '18, which allowed us to improve our contract book, specifically for 2016 we are now sold out for all of our production. For 2017 and 2018, the total sold position is now 79% and 55%, respectively, assuming a 5.2 million ton run rate for sales volume. This compares with about 50% and 35% contracting levels for upcoming years at this point last year.

I do also want to highlight that we still have upside exposure to benefit from rising power and coal prices through our netback contract and open positions in 2017 and 2018. Coal pricing has been historically cyclical and we are seeing a number of indicators pointing towards rebalancing and strengthening the coal markets as we enter the back half of 2016 and move towards 2017.

Domestically, hot summer temperatures bring the first real opportunity for the industry to work through the coal inventory overhang. Gas prices, which are a major driver of coal's competitiveness in the generation mix have persistently trend upward. Forward gas prices around $3 fundamentally support stronger coal burn and higher coal prices than what we've seen throughout the first part of the year. As a result, we expect that shipments of our already contracted domestic tons will pick up substantially in July through December with [inaudible] implications for realized pricing.

Also, export markets have strengthened recently. The API2 index, which is representative of steam coal pricing into Europe, increased by 28% between the end of Q1 and the end of Q2. It has also continued to gain ground in July.

In our more recently booked export business, our average netback price per ton has improved at least $10 compared to the business we booked in the first quarter of 2016. Stronger export markets provide an alternate outlet for domestic supply, happen to accelerate market recovery and improve our ability to optimize our sales portfolio to maximize cash flows.

With that, I will now turn the call over to Lori to provide the financial update.

Lori Ritter

Thank you, Jimmy.

Overall CNXC reported total coal revenues of $50.1 million for the second quarter from a sales volume of $1.2 million tons, compared to $63.8 million from a sales volume of 1.1 million tons for the same quarter last year. The $13.7 million reduction in overall revenue was driven by a $15.60 per ton lower average sales price, partially offset by 99,000-ton increase in sales volumes.

As disclosed previously, the lower average coal sales price per ton sold in the 2016 period was a result of the overall decline in the domestic and global thermal coal markets. Unprecedented warm winter weather resulted in reduced coal burns and increased coal inventories at many of our customer sites, which caused some of them to adjust shipment schedules under terms allowed in their contract. We replaced the reduced contracted tons with export tons, which significantly impacted our average realizations.

During the quarter, we sold 431,000 tons of our coal in the export market or approximately 35% of total tons sold during the quarter. This compared with 26% in the first quarter of 2016.

The average sales price per ton was also negatively impacted by a partial contract buyout executed by one of our customers. We received approximately $1.3 million for this partial contract buyout, which is reported in other income and not included in our average sales price per ton. Separately, we believe one of our customers has defaulted on their contract and we are currently pursuing legal action against them. We expect this to continue to weigh on our realization until the issue is resolved.

The total cost of coal sold was $42.5 million for 2Q16 or $7.6 million lower than the $50.1 million for Q2 2015. The decrease in the total cost of coal sold was driven by the significant cost reduction efforts we have undertaken since the initial public offering. Average total cost per ton sold were $34.46 per ton for the current quarter, compared to $44.15 per ton for the prior-year quarter. Unit costs benefited from lower labor costs, productivity improvements, vendor concessions, and reduced discretionary spending on maintenance projects and mine supply. As noted in our last conference call, the sequential increase in cost per ton was driven by four longwall moves during the second quarter.

Adjusted EBITDA was $13.3 million for 2Q16, compared to $20.1 million for Q2 2015. The $6.8 million decrease is mainly due to lower realization, partially offset by reduced spending and higher sales volumes as we've already discussed.

During the second quarter we generated $4.8 million of distributable cash flow after accounting for $1.8 million in cash interest and $6.7 million in estimated maintenance capital. Note that the actual cash capital expenditures for 2Q 2016 was $2.6 million, compared to $7.1 million in 2Q 2015.

During the second quarter, CNXC generated $16.7 million in cash flow from operating activities, including approximately $5.2 million in working capital changes. This allowed us to cover the full distribution declared for first quarter 2016 and pay down approximately $2 million on our revolving credit facility.

From a liquidity perspective, as of June 30, our $400 million revolving credit facility had $198 million of borrowings outstanding, which is $2 million below the borrowing at the time of the IPO. However, given the declining EBITDA over the last few quarters, our debt-to-EBITDA ratio was 2.7 times.

Let's turn now to an update on our expectations for the remainder of the year. Based on the results to date and our expectations for the remainder of 2016, we are reaffirming our previously announced guidance ranges. We expect coal sales of 4.5 million to 5.1 million tons, adjusted EBITDA of $59 million to $69 million, and maintenance capital expenditures of $18 million to $20 million.

The high and low end of the sales guidance ranges is one of the major drivers of our adjusted EBITDA outcomes. Furthermore, the customer mix could also impact our average realized price per unit and thus the EBITDA outcomes. We currently expect export shipments to be approximately 10% of our total coal sales for the second half of 2016, compared to 31% in the first half of 2016.

Finally, if the power prices in PJM West [ph] increase, we could see a benefit on our netback price contracts, which could improve our revenues.

As disclosed in our press release, our board announced that the partnership will pay full distributions of approximately $0.51 per unit to all the common unitholders for the quarter ending June. At this time our board elected not to pay a distribution to holders of subordinated units which are held in their entirety by CONSOL Energy.

Let me walk you through the thought process behind this decision. We generated approximately $4.8 million in distributable cash flow during the second quarter using our estimated management capital calculation as you see in the press release. However, using cash capital of $2.6 million, we generated $8.9 million in cash flow available for distribution. This helps us cover the 2% GP interest and a full distribution to our common unitholders with a coverage ratio of approximately 1.4 times.

Ideally we also like to cover the distribution to our subordinated unitholder. However, the past two quarters have produced weaker EBITDA resulting in our trailing 12 months leverage ratio increasing despite absolute reduction in borrowings on our revolver. We believe that, although not necessary at this time, it is prudent to minimize borrowings further on our revolving credit facility, which will preserve liquidity and minimize leverage ratios. This should help eliminate risks to our common unit distribution.

This decision not only underscores the support we have from our sponsor CONSOL Energy, but also highlights the flexibility our structure provides to preserve the distributions to our common unitholders. By not paying subordinated distribution, CNXC has lowered its cash outflow for distribution payouts by approximately 49% with absolutely no impact on our common unitholders. We believe this is a differentiator for CNXC. There is a slide post on our website under the Investors section which provides general information around the common and subordinated distribution.

For the partnership, this decision strengthens the balance sheet, boosts [ph] term liquidity, and improves resources to bridge better market conditions. We believe this improved liquidity should reduce risks to the common unit distribution and going forward should advance our strategy of pursuing additional dropdowns or other growth opportunities.

With that, let me turn it back to Jimmy to make some final comments.

Jimmy Brock

Thank you, Lori. As I noted earlier, this month we completed our first year as a public company, and what a year it was. Let's take it from the beginning.

Commodity prices for gas, oil and coal all slid dramatically to prices not seen in many years. Regulatory challenges continued to weigh on the coal industry. Capital markets were essentially shut down after our initial public offering and remained challenging for the coal industry as we speak.

For the first time since our coal mines were built, we did not have enough coal shipments to keep our employees working for a full five-day workweek. We've un-idled one of our longwalls as we work the remaining longwalls three to four days per week. We built and rebuilt our sales portfolio not once, not twice, but several times as we worked with customers on delivery schedules. And we endured all of this while sticking to our core values of safety and compliance.

The bottom line is we managed what we controlled and made the best out of a very challenging situation. We have repositioned the Pennsylvania mining complex as America's finest coal-mining complex destined to operate in a very competitive market. So let's look at where we are today.

On the operational front, we improved our productivity by 17% and reduced our cost by 22% in the second quarter of 2016 compared to the same period last year. On the marketing front we are 100% sold the remainder of 2016 and 79% sold for 2017, with the ability to benefit from price recovery through our netback contracts and open positions. We have penetrated several new customers and gained market share.

Commodity to markets seemed to be improving as well, with gas prices now close to $3 per MCF and U.S. coal production tracking 28% lower on a year-on-year basis. With the summer burn now upon us, the inventories at power plants have started to decline and we have seen increased domestic shifts.

Finally, on the financial front, our coverage and leverage ratios were negatively impacted by challenging market conditions. Although not necessary, we addressed this by our decision not to pay subordinated distributions. While it is our goal to pay all unitholders, this distribution decision reflects our commitment to our common unitholders. Looking forward, we expect the trend of deteriorating financial metrics to reverse as our employees continue to find efficiencies and innovations while we began to see improvements in the marketplace.

With that, I'll turn the call back over to Mitesh for some instructions on Q&A.

Mitesh Thakkar

We'll now move to the Q&A section of the call. Amy [ph], can you please provide instruction to our callers?

Question-and-Answer Session

Operator

[Operator Instructions]

First question is from Paul Forward at Stifel.

Paul Forward - Stifel

Good afternoon.

Jimmy Brock

Hi, Paul.

Paul Forward - Stifel

Just want to ask about the cash capital spending in the quarter. It was another approximately $2.6 million quarter after the first quarter of pretty similar cash capital spending. Just wanted to ask, I know that you're estimating maintenance CapEx levels of much higher than that, in the kind of $6.8 million per quarter territory. How long can you maintain capital spending at this low level, at this really reduced level? And how does this all relate to the guidance on maintenance CapEx for the full year of 18 to 20?

Jimmy Brock

I'll take the first part of it and take it over to Lori at the end. But I think the biggest reason some of the capital spend was down this quarter is purely due to timing of some of the things that we have in. But going forward, we expect to be somewhere near the guidance that we gave CapEx spend.

Lori Ritter

So the way that the capital timing is scheduled is it's heavier in the back half of the year. In the third quarter we hit summer shutdown, which we do a lot of projects in that period and such. That's why you see that tail up in the third quarter. And then again in fourth quarter, with like Christmas vacation, things like that, we do a lot of capital projects over those periods of time.

Paul Forward - Stifel

Great. And, Lori, I think you discussed an approximate coverage of about 1.4 times just on the common units plus the general partner distribution in the second quarter and that that reduced level caused the board to decide to suspend on the subordinated for the quarter. I was just wondering, in those discussions, if, are you looking to get back before reconsidering kind of a restart of the subordinated distributions, would you plan to be back up over two times on the common distributions before you would really plan to restart those subordinated distributions, or what was the discussion about kind of what you would need to see in order to get a restart of those subordinated distributions.

Lori Ritter

Sure. Our goal is pay all of our unitholders, including subordinate holders. Payment of distributions are quarter-to-quarter board decision, based on many financial metrics, both actual and forecasted. So as we continue to see improvements in the coal markets, and that in turn improves our metrics, this will support payments to all unitholders.

Paul Forward - Stifel

Okay. I guess I wanted to ask also about the, I know you have some market comments about some customer to down at pretty low inventory levels, but there's not a whole lot of market exposure or open tonnage in 2017, with only 21%. I guess I wanted to ask, as you see the market now, looking at 2017, as you plan to put that remaining 21% of the uncommitted tons to bed, are there better opportunities domestically or any export markets for the open tonnage, as you see the market kind of shaping up?

Jim McCaffrey

This is Jim, Paul. As we look forward, right now we're kind of keeping our powder dry as far as booking tons for the balance of the 21% for 2017. We think there's a lot of potential in the marketplace for improvement. I personally think the market has turned. And we're seeing a lot of demand pull today. And when we look at some of the stuff going on in the gas industry, we think that we'll see a movement in gas prices as well that will help propel power prices and give us some more revenue in the domestic market.

The international market primarily, you know, we played quite a bit in India and Asia and Europe this year. I could tell you that the tons that we had in Asia were primarily met tons. So we still have some crossover bed [ph] going to Japan and Korea. And those are typically priced a little bit more favorably than the thermal export tons, which we shipped quite a few tons to India, like in the neighborhood of 1.8 million. We have no Indian tons in our portfolio for the second half of the year and the prices that we've seen for this year and next year to date are not attractive to us for India.

As far as Europe goes, Europe's kind of interesting, there are some things going on there with the gas storage in the U.K., and of course the whole geo -- all the geopolitical events, you know, could create some gas shortage in Europe next year. And in Europe we just constantly daily look for the arb [ph]. And if we get the arb [ph], then we'll pull the trigger on doing the deal. We have no specific plan for any of those deals yet.

Back to the 19% -- or pardon me, the 21%, you know, of that 79%, 60% of that is priced and then the balance of it is -- I'm sorry -- 40% of it's priced, and the balance of it is either on a netback ton or colored ton, and so that split that portfolio it looks like.

Paul Forward - Stifel

Okay. Thanks very much.

Jim McCaffrey

You're welcome.

Operator

Your next question is from Mark Levin at BB&T.

Mark Levin - BB&T

Yes. Thanks guys. Two quick questions.

One, you said it quickly so I apologize, I'm not sure I got it, but there was some reference to an 8% to 10% price increase. Over what timeframe were you referring to?

Jimmy Brock

That was over second quarter.

Mark Levin - BB&T

Okay. So Q3 over Q2?

Jimmy Brock

Right.

Mark Levin - BB&T

Okay, great. And then on, secondly, as it relates to your netback contracts, PJM West, can you then talk about PJM West power prices, how that's impacting your netback contracts, and what's the sensitivity like? Where are the prices -- I mean if prices go to x, upper 40s, low 50s, what does that mean for EBITDA?

Jim McCaffrey

That's kind of a proprietary formula so we don't discuss this. But I could tell you this. The netback prices were very disappointing in the first quarter because of the extremely warm winter. We have seen some very slight improvement in them in the second quarter. But so far in the third quarter we're getting indications that the pricing will be considerably better.

PJM pricing overall, I would say, Mark, has been somewhat disappointing, and that's one of the reasons that we've kind of farmed out our marketing effort into other areas of the country just to diversify ourselves a little bit from PJM.

Mark Levin - BB&T

And when you think about your customer inventories, when you think about maybe customer inventories in the PJM region versus maybe further south in the southeastern United States, is there a big difference? Is there one market you expect to recover maybe more quickly than the other, from an inventory perspective at least?

Jim McCaffrey

From an inventory perspective, right now everybody has really taken coal. The demand pull that we're seeing on a day-to-day basis is really strong. For example, last week we loaded 605,000 tons into trains to leave the Bailey complex.

The southeast I would say right now is burning very, very hard, and we're seeing a lot of demand pull from them, but we're seeing it from the Midwest as well. Again, our PJM customers do not have a huge inventory pulse because of lack of space, our specific customers that are our primary PJM customers, so they are not heavily impacted by having a high inventory either, with the exception of perhaps one. So I think recovery in general is occurring throughout the portfolio.

Mark Levin - BB&T

Okay. Then one last question just for Jimmy and then I'll cede the floor to someone else. When the Board made the decision I guess to suspend the subordinated, is your view that, based on where coal prices are today, I mean, that you could maintain the comment that, I'll put it another way, that the comment is absolutely safe through at least 2017 and into 2018 under a scenario in which kind of the coal markets under a stress test scenario?

Jimmy Brock

I think you summed it up pretty well. Yeah, that's the case. The common unitholders are protected. Our forecast has been protected out through 2017 as well. And as we said, those decisions are based on X1 [ph] forecasted metrics when we make them. And with the improvement in the marketplace, we feel really strong about the subordinated units as well.

Mark Levin - BB&T

And Jimmy, even if things don't get any better, you feel like, even if we stayed at the same levels or that prices didn't recover much, if at all, you still think the comment is safe? You've stress-tested it so it's safe through 2017?

Jimmy Brock

That absolutely correct, yes. The common unitholders are --

Mark Levin - BB&T

That's perfect. Thanks very much.

Operator

The next question is from Jeremy Sussman at Clarksons.

Jeremy Sussman - Clarksons Platou

Hey. Thanks very much for taking my question. Just, could you maybe provide a little bit of a cost -- sorry, a bridge between where you shook out in Q1 of this? I think $42.99 per ton in terms of your average realized price and then this quarter down to about $40.61? Obviously a decent amount of variability in there, so that'd be helpful.

Jim McCaffrey

I can do it, Jeremy, I'm not sure I'll enjoy it, but I'll do it.

You know, we gave you some background last quarter, in the first quarter, saying that, because of, in general, the customer deferrals and some other customer issues, that we had a seven-day dollar impact on our realized price. And the second quarter we had the buyout that Lori talked about, which was really caused, you know, reflected by the dollar in the pricing. Even though we got it, it wasn't -- it didn't show up in the realization. And then we had some additional customer deferrals that were basically another dollar to a dollar in the quarter.

So, overall that's about an $8 to $9 -- $8 to $10 differential, and that's where it came from.

Jeremy Sussman - Clarksons Platou

That's super helpful. Maybe just to follow up on your comments earlier, the improvements that we're seeing in the international thermal markets. I guess looking ahead, or maybe first looking back, is it safe to say that there is somewhat of a lag effect for you guys in terms of the movement of API to the netback realizations and either way I guess, you know, should we start seeing the real uptick that we've seen over the last two, three months, and as early as Q3?

Jim McCaffrey

Actually, Jeremy, we will see some activity -- there'll be both. We'll have -- we have a few vessels. Like Lori said, we're only at 10%, so we had a couple of vessels that we took in Q3 prior to the run-up. But the run-up from the last earnings call to this earnings call is about 28%, just in the API2 pricing. And we were able to book some [inaudible] fourth quarter business and actually some first quarter business as well based upon hitting an arb that we thought was favorable to us.

Now what we'll do moving forward is actually, you know, we're sold out for 2016 and we're in, like I said, pretty decent shape for 2017, so we're keeping our powder dry. But we're looking every day for the right arb. And if we get that, you know, we'll take advantage of that instantaneously.

Jeremy Sussman - Clarksons Platou

Understood. Well, thanks for the color, and I'll turn it back in queue.

Operator

[Operator Instructions]

The next question is from Lucas Pipes at FBR & Company.

Lucas Pipes - FBR & Co.

Hey, good afternoon everybody.

Jimmy Brock

Hi, Lucas.

Lucas Pipes - FBR & Co.

So I wanted to follow up a little bit on the cost side. Jim, you mentioned you had a lot of longwall moves during the second quarter, yet your costs were very strong, in my opinion, again, yeah, moving up a little bit versus the first quarter, but overall kind of historically still exceptionally strong performance. How do you think that's going to chuck over the remainder of the year? Should we expect to go back to -- or should you expect to go back to Q1 levels given higher longwall output or not having those moves? How should we be thinking about your cost performance into 2017?

Jimmy Brock

Well, I think when you look at our costs, we guided 10% to 15% earlier. I think now we're somewhere around 13% to 18% over the previous year and cost improvements. I think we're going to sustain a lot of the cost mechanisms that we've had in place. Our operational team has done a phenomenal job of looking at efficiencies they can gain and new innovations that's going to help us on the cost front. So we continue to expect those to improve slightly. But I think when you're looking at the costs for the year, it's going to be somewhere between 13% and 18% improved over the previous year.

Lucas Pipes - FBR & Co.

That's very helpful. Thank you. And then maybe just to follow up on the marketing side, on the domestic markets specifically. It sounds like your customers are a little bit better-positioned on the inventory front. You want to keep some powder dry. So, first, maybe high level, when do you expect kind of the northern up-markets [ph], when I look at some, EIA or private surveys, it shows that inventories are generally still elevated. When do you expect that to be fully back to normal?

And then secondly, how much do you expect to contract between now and the end of the year? Another 10% or so of your 2017 volumes or how active are you going to be into 2017? Thank you.

Jim McCaffrey

Well, first of all, we think there's some lag on the EIA data. But when we look at our specific PJM customers, their inventories are all in better shape than they'd been in in quite some time. So, just sticking through my head on the real customers we have in PJM, you know, we have two with less than 15 days, we have another with 25 to 30 days, and we have one that's 45 to 50 days. That's the highest. So that's a little -- that 45 to 50 days is a little higher than normal but it's not unusual for that particular customer.

So I think that the inventory will start to come down relatively quickly and that we're seeing, like I said, this tremendous customer take to full call-away [ph] from the coal mines to keep inventories replenished throughout other areas of the country.

Just looking at the gas markets, our view is that the gas markets have a lot of possibility to trend upward as we go forward. We think storage is going to be down at the end of this year. We think it's going to be down again at the end of 2017. And we think that there'll be an imbalance between the supply and demand issues in the marketplace. And with the pipeline of projects that are being built out of the PJM area, we think that that'll give us some of the basis differential and we'll see improved pricing, which will enable our customers to get better power pricing, and better power pricing will lead to better coal pricing.

I'm not sure I answered the second part of your question, Lucas, I'm rambling a little bit. Maybe I forgot, what was the second part?

Lucas Pipes - FBR & Co.

Yeah. So the second part was just, put more succinctly, how much do you expect to contract between now and the end of the year for 2017?

Jim McCaffrey

I mean we're doggone under 80%, and I would expect that we'll push up close to 100% as we can assuming that we can contract favorable arbs and favorable pricing. I seriously doubt that we'll have another winter this year like we did last year. But we got caught last year not being prepared for that, and we'll make sure that we have the mines in good shape and we'll do it at a price that'll allow us to get back to paying our dividends again.

Lucas Pipes - FBR & Co.

Great. Well, I appreciate all the color. Thank you.

Operator

This concludes the question-and-answer session. I would like to turn the conference back to Mr. Thakkar for closing remarks.

Mitesh Thakkar

Thank you, Amy [ph]. We appreciate everyone's time this evening, and thank you for your interest and support of CNXC. Hopefully we were able to answer most of your questions today. We look forward to our next quarterly earnings call. Thank you everybody.

Operator

The conference has now concluded. Thank you for attending today's presentation. You may now disconnect.

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