Arch Coal Q2 2007 Earnings Call Transcript

Jul.23.07 | About: Arch Coal (ACIIQ)
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Arch Coal, Inc. (ACI)

Q2 2007 Earnings Call

July 23, 2007 11:00 am ET

Executives

Deck Slone - VP, IR & Public Affairs

Steve Leer - Chairman & CEO

John Eaves - President & COO

Robert Messey - SVP & CFO

Analysts

Luther Liu - Friedman, Billings, Ramsey Group

Jim Rollyson - Raymond James & Associates

Aaron Marsh - Duquesne Capital

John Hill - Citigroup

Mark Crusoe - Millennium Partners

John Malloy - Sound Energy

Jeremy Sussman - Natexis Bleichroeder

Michael Molnar - Goldman Sachs

David Gagliano - Credit Suisse

Brett Levy - Jefferies & Company

Michael Dudas - Bear Stearns & Co.

Sam Martini - Cobalt Capital Management

John Bridges - J.P. Morgan

David Lipschitz - Merrill Lynch

Michael Goldenberg - Luminous Management

Dhaval Patel - Columbus Hill

Presentation

Operator

Good day, everyone, and welcome to this Arch Coal Incorporated Second Quarter 2007 Earnings Release Conference Call. Today's call is being recorded.

At this time I would like to turn the call over to Mr. Deck Slone, Vice President of Investor Relations and Public Affairs. Please go ahead, sir.

Deck Slone

Good morning from St. Louis. Thanks for joining us. As usual and before we begin, I want to remind you that certain statements made during this call, including statements relating to our expected future business and financial performance, maybe considered forward-looking statements pursuant to the Private Securities Litigation Reform Act. Forward-looking statements by their nature address matters that are, to different degrees, uncertain.

These uncertainties, which are described in more detail in the annual and quarterly reports that we file with the Securities and Exchange Commission, may cause our actual future results to be materially different than those expressed in our forward-looking statements. We do not undertake to update our forward-looking statements, whether as a result of new information, future events or otherwise, except as maybe required by law.

I'd also like to remind you that you can find a reconciliation of the non-GAAP financial measures that we plan to discuss this morning at the end of our press release, a copy of which we have posted in the investor section of our website at archcoal.com.

On the call this morning, we have Steve Leer, Arch's Chairman and Chief Executive Officer; John Eaves, Arch's President and Chief Operating Officer; and Bob Messey, our Senior Vice President and CFO. Steve, John, and Bob will begin the call with some brief formal remarks and thereafter we'll be happy to take your questions. Steve?

Steve Leer

Good morning, and welcome to Arch Coal's second quarter 2007 earnings conference call. Arch reported fully diluted earnings of $0.26 per share in the second quarter compared to $0.48 a year ago. While U.S. coal market conditions in the first half of 2007 can generally be characterized as weak compared to the first half of last year, we are encouraged by several key trends that continued to evolve this past quarter and we're optimistic that the markets will continue to strengthen in the second half of this year and beyond.

I'd like to spend a few moments discussing these positive trends. First, year-to-date electric generation demand was up 2.7% through mid-July while coal production was down 2.6%. What's interesting to note is that coal production declined in both the eastern and western U.S. In fact, production out of the Powder River Basin during the first quarter of 2007 was up less than 1 million tons.

Preliminary estimates for the second quarter, which would include some shipping and weather challenges, suggest that production in the Basin is likely to be down this quarter. Furthermore, continued challenges in Central Appalachia, namely Judge Chambers' two decisions affecting valley fills and sediment ponds, as well as the MINER Act compliance issues including the Emergency Steel Regulations, are likely to further reduce production in this region.

In fact, since Chambers' ruling in March of 2007, there have been no 404 mining permits issued in his jurisdiction. Last year, a total of 15 permits were issued in the geographic area under Judge Chambers' jurisdiction.

These trends are moving supply and demand into balance. If these trends continue, and we believe they will, the supply/demand line will inevitably cross. The market is beginning to recognize this point as spot prices for prompt quarter delivery in key U.S. basins have been appreciating. The PRB is up 34% while central Appalachia is up 11% year-to-date respectively, and SO2 credits are up 25% over the same period.

Of course, coal prices started the year at very low levels, so we still view the current pricing environment as depressed. In fact, we do not believe that the pricing at current low levels is sustainable over the long-term, given expected cost increases and the returns required to reinvest in our business.

Given these trends, Arch continues to be comfortable with its strategic decision to remain substantially uncommitted in terms of coal sales for 2008 and beyond. Furthermore, Arch has made a decision to reduce our production volumes for 2007 below previously announced levels. We believe this is the right decision for Arch and reflects our market-driven operating strategy.

While no one can predict the precise timing of the market, when the market will reach a supply/demand balance, we are very bullish on coal markets for the coming year. Seaborne markets are strong and show no signs of slowing, driven by China's likely swing to a net importer of coal this year, as well as supply pressures in other exporting countries. We are starting to see some reaction in the U.S. coal markets to this tightness in the international marketplace.

The U.S. export market is gaining strength, with net and steam exports up 10% through May while imports into the U.S. are down by approximately 4% over the same time period. Arch continues to receive inquiries by Asian customers interested in taking shipments of our coal off the West Coast as well as European and Asian inquiries into our met coal availability. As supply in the international markets become even scarcer in the second half of 2007, it's likely that more domestic coal could move overseas.

Additionally, new coal fuel generation capacity is coming online. One plant in Council Bluffs, Iowa, has already started up this year, and more are on the way. In fact, we expect at least 9 gigawatts of new capacity equating to roughly 35 million tons of annual coal demand to come online over the next four years.

Although 9 gigawatts is just a fraction of the total new coal fuel capacity that generators hope to bring on in the coming years ahead, even that total represents a sea change for the industry. Another 10 gigawatts or so is in what we call advanced stages of development. We think that at least two-thirds of these plants will get built.

Additional plants are in earlier stages of development and as appears to be the case with several proposed plants in Florida may get stalled due to the uncertainty over climate concerns. Over time, however, we believe the serious need for new base load power capacity in many regions of the country, as well as increasing clarity in terms of potential climate regulation, will spur these projects forward once again.

We remain convinced that technology is the answer to growing climate concerns and we are confident that coal will play a growing role in meeting the nation's future energy requirements. I firmly believe that if we are serious about addressing climate concerns over the long-term, we need to invest more heavily in coal in this country, not less.

As mentioned earlier, given our view of the favorable outlook for coal over the next several years, Arch has taken steps to further reduce our volume targets for 2007, leaving low-cost tons in the ground that we believe will draw a better price in the future. By following this focused strategy, we believe that we will optimize value for our shareholders.

During the second quarter, Arch signed coal sales commitments of approximately 9 million tons annually for 2008 and 2009 for delivery from our western bituminous coal at prices ranging from $30 to $35 per ton. While spot pricing in this region has softened late in the quarter, we were pleased with our successful efforts to achieve a significant price premium to our second quarter average realized price per ton as these contracts are reset.

Additionally, Arch committed approximately 5 million tons of PRB coal for 2008 delivery at prices that are significantly higher than prevailing spot market pricing during the second quarter. Going forward, we have an unpriced volumes of approximately 5 million tons in 2007, 50 to 60 million tons in 2008, and 105 to 110 million tons in 2009. We continue to take a patient approach, preferring to maintain exposure to the upside potential of the coal markets.

We believe that this strategy will create the greatest long-term value for our shareholders and will enable Arch to obtain an appropriate return on its valuable reserves. Let me reemphasize that we believe the company is well positioned to capitalize on the strengthening U.S. coal markets during the second half of 2007 and beyond.

With that, I'll now turn the call over to our President, COO John Eaves, for further discussion of our operational performance. John?

John Eaves

Thanks, Steve. From an operations perspective, our mines performed very well during the second quarter 2007 despite the continued softness in U.S. coal markets. Overall, average price realization per ton expanded in the PRB, which was offset by lower price realizations in both our Western Bit and Central App regions. During the second quarter, we had less favorable customer mix on shipments out of our Western Bit operations as well as lower met coal sales in our Central App operations.

For the remainder of the year, we anticipate our per-ton pricing realization in Central App to be impacted by the smaller number of met coal sales. However, it's important to note that we could see more significant increases in Arch's met coal sales during 2008 following the start of the Mountain Laurel longwall during the fourth quarter of this year.

In fact, we are in the process of conducting test sales for the mines coal into the met market, with the expectation that we could book some tonnage in the seaborne market starting next year.

On the cost side, our strategy is focused on positioning our mines to run flexible production levels while managing our controllable cost. Although coal mining is a high fixed cost business, we have worked very hard to run our mines efficiently and profitably at lower levels. In the PRB, our costs were impacted by higher diesel and tire related costs, as well as a planned maintenance and repair activity on one of Black Thunder's draglines.

We were able to offset some of these per-unit cost increases at our PRB operations with increased shipments due to rail availability during the quarter. In the Western Bit, costs were affected primarily by three longwall moves during the quarter. In fact, we estimate we lost approximately 10% of our production in the quarter due to these moves.

However, we were able to pull from our coal inventory at our Western Bit operations during the quarter to meet our increased shipping commitments. Going forward, we will continue to target costs in the high teens in Western Bit as we mine deeper panels, which is consistent with the overall trend in this producing region.

In Central App., operating costs per ton declined, benefiting from stronger performances at several of our operations along with increased brokerage activity during the quarter. This strong cost performance was largely offset by significantly higher operating costs associated with the wind-down of Mingo Logan's longwall at the end of the second quarter.

We experienced extremely challenging conditions in the final longwall panel that caused both delays and a shortfall in production. Due to the depletion of Mingo Logan's longwall reserves, we made a strategic decision to divest this asset during the quarter. Our longwall reserves were depleted during the fourth week in June, which marks the completion of nearly 15 years of longwall production at this mine.

Mingo Logan longwall operation was regarded as one of the most successful in mining history, setting world records in production and move time during its operating life. We’d like to commend the workforce at that operation on their accomplishments and significant contributions to Arch Coal. Looking ahead, we expect the longwall at Mountain Laurel to start in the fourth quarter of 2007 and we believe this mine will have a beneficial impact on our overall cost structure in Central App during 2008.

Additionally, I would like to take a moment to recognize some of the outstanding achievements of our company and our mining operations during the first half of the year. At Arch, we make employee safety a core value. We're happy to report that our total incident rate improved by more than 20% in the first six months of this year compared with our 2006 performance.

This achievement is particularly impressive considering that last year was one of Arch's best years on record for safety. Additionally, we continue to develop and deploy innovative programs designed to further enhance our safety culture here at Arch with continued success. During the quarter, we also won several awards for excellence in safety practices and environmental protection. We were honored with the Earth Day Award at Sufco and Skyline for improving wildlife habitat in the Utah region.

Our Mountain Laurel mine in Central App. earned two mine safety awards for the West Virginia State Council, as well as a National Excellence Award for Corporate Citizenship from the American Coal Council for its community outreach program. We commend these operations for their demonstrated excellence in safety and their contribution to our communities and the environment.

Also, we would like to take note that Arch celebrated its ten-year anniversary as a public company on July 1. Since 1997, the company has grown both organically and the acquisitions into the leader of the U.S. coal industry and today contributes roughly 11% of the annual U.S. coal supply. We would like to thank all of our employees for their hard work, dedication and years of service. With that, I'll now turn the call over to our CFO, Bob Messey. Bob?

Robert Messey

Thank you, John, and good morning, everyone. I would like to take a few minutes to expand on some of Arch's major financial developments in the second quarter. First, Arch monetized its investment in our Mingo Logan Ben Creek complex at the end of the second quarter as our longwall operation closed. The purchase price was approximately $43 million, inclusive of working capital.

As part of the transaction, we have agreed to purchase approximately 1 million tons of coal from Alpha over the next two years to service sales commitments that cannot be sourced from any of our existing mines. As a result of this divestiture, we have recorded a net gain of $8.1 million, which includes the recognition of losses on several below market sales contracts, retained in the transaction that we will continue to service. This gain also effectively offsets higher operating costs associated with the wind-down of the longwall operation during the quarter.

Second, capital expenditures for the quarter totaled $75 million, primarily related to the ongoing development at our Mountain Laurel complex in West Virginia. We continue to project total capital spending of approximately $110 million this year for the development of the Mountain Laurel longwall, which is expected to begin production during the fourth quarter.

Total capital spending in 2007, exclusive of reserve additions, is projected to be in the $250 million to $270 million range. Our capital-spending program is typically weighted towards the first quarter of the year, due to the March timing of the third of five little funder lease reserve payments in the Powder River Basin. Going forward, we expect our capital spending needs for the second half of the year to be significantly less than the first half.

Additionally, we were able to make a meaningful reduction in our outstanding debt during the quarter, bringing the company's total debt balance at the end of June to $1.3 billion. Our debt to total capital ratio now stands at 47% versus 50% at the end of the first quarter. At June 30, our borrowing capacity under the revolver totaled approximately $550 million. We expect to continue reducing our outstanding debt for the remainder of the year.

In April, our Board of Directors announced the approval of an increase in the quarterly cash dividend from $0.06 to $0.07 per common share. This event marks this third dividend increase over the past four years. During the quarter, we elected to forego any share repurchases as we focused on debt reduction. Going forward, we will continue to evaluate the returns offered from organic growth projects, acquisitions, dividends and share repurchases as we make capital allocation decisions.

Additionally, Arch recorded an income tax benefit during the quarter, resulting from a $4 million reduction in its state valuation allowance. This reduction stems directly from a change in tax law in West Virginia and will now allow Arch to utilize its previously reserved significant West Virginia net operating losses carry forwards. Excluding this tax law change, Arch's year-to-date effective tax rate was reduced, reflecting higher percentage depletion deductions in relations to book pre-tax tax income.

As a result of higher excess depletion deductions and a federal valuation allowance reduction, we now expect an income tax benefit of $12 million to $16 million for the year 2007. I also would like to reiterate our revised 2007 guidance we now expect. Sales volume of 125 to 130 million tons, excluding approximately 3 million tons associated with the legacy Magnum contracts and retained Mingo contracts that we are currently servicing.

Earnings per share between $1 and $1.30 per share. Adjusted EBITDA in the range of $450 million to $500 million. DD&A of between $247 million and $253 million. As previously mentioned, capital spending of between $250 million and $270 million, and an income tax benefit of between $12 million and $16 million. Arch has made significant strides in adjusting to the current market while positioning the company to benefit from the expected positive outlook on coal markets in the coming years. With that, we are ready to take questions. Operator, I will turn the call back over to you.

Question-and-Answer Session

Operator

(Operator Instructions) We'll take our first question from Luther Liu (ph) with Friedman, Billings, Ramsey. Please go ahead.

Luther Liu - Friedman, Billings, Ramsey Group

Good morning.

Steve Leer

Good morning, Luther.

Luther Liu - Friedman, Billings, Ramsey Group

Hi. I have a question on the -- just, Steve, can you just describe the macro picture a little bit? Why are we seeing Central App. production didn't go down nearly as much as people expected, and why do you think you didn't -- Basin, year-over-year production is actually up?

Steve Leer

Well, I think there's a couple things. Illinois is first easier. There's certainly one, perhaps two mine developments that were started a few years ago that basically have come online this last six months or so and are starting to come on full line, so you're seeing that addition. That wasn't unplanned or a surprise to anybody. I think the Illinois Basin again has struggled. They need to get the scrubbers in place before that market really develops and I think you're seeing that.

You haven't really seen major developments beyond those that were committed to two, or years ago get announced here recently and we think that condition will continue until the scrubbing in the east gets a more stable operating base.

In Central App, Central App production is down by more than 5%. That includes the actual MSHA reporting data for the first quarter, which I think is more accurate than the estimates provided by EIA, but it includes EIA's estimates for the second quarter.

There is a lot of reasons, I think some people still have some contracts from the 2004, 2005, 2006 price run up that they are helping some of their operations. Our sense is many of those expire by the end of this year. The implementation of the miner Act is just now getting into full swing.

People are still wrestling through what the costs of that are. You have some support admittedly, it's a bit hard to get your arms around with the synfuel situation and we all know that expires at the end of this year as well.

And then if you just look back at the stubborn high inventories, that certainly have been an overhang on the marketplace, last year you could certainly make the argument the market was oversupplied by roughly 30 million tons. We have moved away from, but I think people announced or were looking at as planned production and there have been greater cuts off planned production than same actual year-to-year comparisons and that realization is just hitting home.

And we're just now starting to see the impacts and they will continue to evolve of the Emergency Steel Regulations, the Training Regulations. Our sense is every single sign from a production standpoint in Central App is for lower productivity and overall lower production.

There will be fits and starts. Someone could have a year-end situation where maybe they run the mine as hard as they can up till the end of the year, they have a high-priced contract, they're looking at rebuilding seals and they make a decision of whether to operate the mine in 2008 or not, driven on the economics.

But, we don't see a single sign that's positive for production in Central App. We see lots of signs that are negative. So it's kind of the lines inevitably crossed, the timing of that, a little hard to get your arms around. We've also seen the Judge Chambers' decisions and those decisions along with another judge's decisions are having an impact.

They will continue to have an impact. We would anticipate that the core will try to respond to some of Judge's concerns and there will be another test case out there at some point in time. But again when you look at the pond's decision, when you look at the valley fill decisions, when you look at the overall question that's really facing another judge of whether the 404 Nationwide 21 permitting is allowed under the Clean Water Act, we think there's three big hurdles for the eastern industry to climb.

They may get over one of them, but getting over all three of them in a timely manner is going to be a challenge and this thing is likely to drag on for some time. So it's a matter of time. The signs are there. I think it's fairly easy to read those signs that we can have differences of opinion.

Luther Liu - Friedman, Billings, Ramsey & Co

Right. So in the meantime for the remainder of 2007, for that 5 million tons on priced coal, could those coal be at risk of not getting sold?

Steve Leer

I would never say we wouldn't make a decision to adjust to the marketplace, because that's what our decision is. We see the marketplace looking for that kind of that coal, and a meaningful piece of that actually is committed, it's just un-priced.

Luther Liu - Friedman, Billings, Ramsey & Co

Okay.

Steve Leer

Approximately half is tied industry related. We would argue that given our overall production of that 125 to 130 you're looking at a very low exposure for this year.

Luther Liu - Friedman, Billings, Ramsey & Co

Okay, great. Thank you.

Operator

And, we'll take our next question from Jim Rollyson with Raymond James. Please go ahead.

Jim Rollyson - Raymond James & Associates

Good morning, gentleman.

Steve Leer

Good morning, Jim.

Jim Rollyson - Raymond James & Associates

Steve, you mentioned just kind of going back over what you said earlier and what's in the prepared remarks, just talking about absolute inventory levels you noted in the press release, obviously kind of high you think through June.

But you also talked, we've heard this before, that maybe some of that just a side from carryover from last year is the fact that utilities, maybe want a little bit higher level of inventory today than they did two or three years ago so everybody with the same problems.

Have you talked to many of your utility customers and kind of what's the sense you get for where they'd like that? I'm sure the answer differs depending on who you ask, but just kind of curious what your visibility is on that subject?

Steve Leer

Sure. I won't name specifics, but I can -- within the last month, I've had a conversation with three utility CEOs, and each one of them told me that they had raised their internal targets.

Furthermore, I asked the question, I said, well, let's just pick a number. If it was 50 days and you were at 55, what would your actions be? And they said, well, we'd pull back from buying.

I said if it was at 45 days and your target was 50, what would your actions be? He said, we'd be buying. He said we're not trying to use these were regulated utilities or not trying to take a view of the market.

We're trying to have an established stockpile levels that we'd run through our PSC approval process and it is what it is. So anecdotally, those three would certainly support a higher level. I don’t know John, if you have further discussions?

John Eaves

No its, I would agree, Steve. A number of utilities that we've talked to, have indicated they have raised their targets. They're all a little bit different, but you have to think there's a number of those evaluating that right now.

Jim Rollyson - Raymond James & Associates

Got you. Then just for the follow-up you talked about cutting obviously, gave us volume adjustments for your volumes for this year going down a little bit. Can you talk about where specifically you expect you'll reduce those volumes or anywhere in particular target?

Steve Leer

Jim, really, it's just cannot cross the board. We really don't want to get into those particulars. So, it would be 5 million across all our producing regions.

Jim Rollyson - Raymond James & Associates

Got you. All right. Thanks, guys.

Steve Leer

Thanks.

Operator

We'll now go to Aaron Marsh with Duquesne. Please go ahead.

Aaron Marsh - Duquesne

I was wondering if you could maybe talk a little more about the cost increases in the PRB and maybe give us a little bit of trying to quantify the contribution of the higher diesel cost versus some of the other inflationary aspects for some of the native operating leverage on lower production?

John Eaves

Aaron, this is John. A couple things were driving the cost increases in the PRB. Certainly, we had some diesel cost increases. We've got about 65% of our diesel hedge for the balance of the year.

So, and that's at about $2.46, I think. So the balance of that, we're driving our costs up. We also were out purchasing some additional tires. As you know, tire shortages are a common problem throughout the industry.

When you buy over and above your allocation, you're going to pay a premium in the marketplace for those tires. So, I think those two items were the big drivers during the quarter.

Also, we had a dragline outage that was about 10 to 11 days during the quarter as well. It was a planned outage, but that machine was down, one of our bigger machines that were down for 10 or 11 days. And also, we're a high fixed cost business, as we drop our volumes, our costs are going to suffer a little bit.

Aaron Marsh - Duquesne

Could you give us a sense of how much of it was from the inflation of the diesel and the dragline versus the lower production volumes?

John Eaves

We don't have that breakdown right now, Aaron.

Aaron Marsh - Duquesne

And just I have one more quick question. Can you talk maybe quickly about what the costs are to deliver, the rail costs for your customers are to deliver the coal maybe to Southeast?

John Eaves

Well, we sell all our coal FOB railcar at the mine and the utilities hold the rail transportation agreement. So we have no idea what those transportation rates are at this point.

Aaron Marsh - Duquesne

Okay. Thank you.

Operator

And we'll now go to John Hill with Citigroup.

John Hill - Citigroup

Yes. Thank you very much. Just wondering if we could get a little bit more clarity on the other income line on the income statement, the $17.5 million. Sounds like there's a number of different things in there between asset sales, insurance, settlements, etc.

Steve Leer

First, there's no insurance settlement. That was misreported by someone. We did have an insurance settlement in the first quarter, not second quarter. Just to clarify that point.

John Eaves

In the second quarter, with the approximately $17 million, $8.1 million is the Mingo Logan gain and then another $8 million is related to the non-core reserves, which we sold a state lease in the West and a small reserve in Central App.

John Hill - Citigroup

I see. Very good. And then could you give us a little bit more color on the tax side? I know that's always difficult to do in a conference call setting, but it does sound to be a significant change of events. And I was talking tax credit for the year, would you expect yourself to go back to being a taxpayer next year and could you give us a few more details?

John Eaves

Well, we hope that, when we look into '08 that our profitability will be higher and it's all based on the mine profitability, whether we're a taxpayer or not. We do anticipate a valuation allowance adjustment the latter part of this year, and that's basically our credit right now.

John Hill - Citigroup

Very good. Thank you.

Operator

And next is Mark Crusoe (ph) with Millennium Partners.

Mark Crusoe - Millennium Partners

Hi, guys. I was wondering if you could help quantify some more on the guidance, what specifically changed from the first quarter this quarter? Because it looks like the 5 million ton cutback doesn't account for the full change in guidance. I was wondering if you could walk us through that a little bit more.

Steve Leer

I'll let John get into it, but it's really driven on the volumes. When you do look at it, the overall incremental value of those tons given the high fixed costs are significant and I'll let him touch on that.

John Eaves

Yeah, Mark. I mean, certainly, as we've indicated, we're very high fixed-costs business. And when you take those tons out, they're very profitable tons. Those decisions are tough, but we feel like the long-term fundamentals are such in the pricing area that we're going to do better about leaving those tons in the ground right now and waiting for the market to improve.

Steve Leer

In a six-month period, if you treat the overall costs as fix, which is not an unfair assumption after removing sales sensitive costs, you'll get the projected numbers.

Mark Crusoe - Millennium Partners

Okay, thanks.

Steve Leer

Thanks.

Operator

(Operator Instructions) We'll now go to John Malloy with Sound Energy.

John Malloy - Sound Energy

Hey, guys.

Steve Leer

Good morning, John.

John Malloy - Sound Energy

Hey. You touched on it earlier, Steve, but could you just elaborate on a fundamental picture, how the inventories have seemed to build over the last couple of months while we've gotten pretty good data as far as production trends and demand trends? Like where the coal is coming from, I guess?

Steve Leer

The inventory data is coming in from the spring build, which traditionally you always get a spring build. It was a reasonably strong build, but it doesn't surprise us that we saw a build in spring. You burn it off in summer, you build in fall, you burn it off in winter. So that didn't surprise us.

We internally see, it seems like the inventory levels are somewhere 52, 53 days on our own modeling, but that's just what we're projecting internally. So, it wasn't a real surprise, it's been a little sticky.

I think again some of the announcements of people reacting to the concerns of the marketplace have been off a plan versus a year ago; but again, we're just seeing the inevitability of these declines as long as we have increasing electric generation and declining production, the lines do cross. We can debate the time frame.

John Malloy - Sound Energy

Is there any potential that inventories are being pulled from maybe a tertiary stock or from your inventories or your competitors' inventories?

Steve Leer

Inventories at the mines, everybody has their own situation and our view would be that some of the weather-related problems that occurred both in the east and the west probably added to some of the mine inventories and subtracted from others. But again there is one issue that we're trying to keep an eye on.

We don't have an answer, is it seems like just given diesel prices and trucking inventories on the river declined in the second quarter in the east and our presumption is they were diverted to the rail shipments.

Given the modeling that EIA does, that would have a tendency to overstate production because they take actual rail shipments and then basically a percentage in their model to represent the river, but we don't know that and we'll see that when MSHA data comes out here either late this month or early next month.

John Malloy - Sound Energy

Are you seeing any increase in RFPs recently?

Steve Leer

We're not seeing an increase. We usually have a steady flow. And customers are interested in seeing what the market is and whether they can lock down some coal for the next three to five years. But we're missing a pretty large percentage of those bids that we're putting out right now.

So, the 5 million tons that we secured for '08, we're pleased with that pricing, but we're missing quite frequently on these bids.

John Malloy - Sound Energy

Okay. And if there's not a move in the pricing environment, will you guys leave that 5 million tons in the ground, and would you potentially source some of your own contract volumes from the market versus your equity coal?

Steve Leer

Well, we're always looking on ways to maximize value, but at least 50% of that 5 million is already committed, it's just going to be priced in the market. So for the remaining volume, we'll see where we can maximize value for the company and her shareholders.

Operator

We'll now go to Jeremy Sussman with Natexis Bleichroeder.

Jeremy Sussman - Natexis Bleichroeder

Good morning, guys.

Steve Leer

Good morning.

Jeremy Sussman - Natexis Bleichroeder

Steve, I thought your color on cap production and pricing was very helpful. I was wondering if you could walk us through the same exercise with the PRB. Specifically, what type of catalyst do you see that gets us improved prices for 2008 out there?

Steve Leer

I think its supply/demand. Really, there's two views here that we have internally, both of which are very valid. First would be Central App. It is our view that given just the reserve degradation, let alone all of the other problems, the Central App decline will continue. And we think it's being accelerated by all of the other pressures in Central App, from the MINER Act to the various judges' decisions.

And coal demand hasn't gone away in the east, so as we go back to Judge Hayden I or Judge Hayden II decision, what we saw was eastern buyers first went to Colorado and then to Utah and then to Powder River Basin and bought available supplies because they needed the coal. That occurred overtime.

If you go back and try to track it over the previous two occurrences there, basically it was a one-year process or so and we saw declining production in the east and then it started declining rapidly after we were six months into the judge's decision.

We see that developing again for the third time and as we've said we've been down this road, so we think we understand Central App pretty well. We've been operating there now for 30 years and it just looks inevitable that that's going to occur.

The other issue that's a bit more interesting is that PRB for a variety of reasons this year, it looks like it's basically going to be somewhat flat six months to six months, 2006 to 2007. Expectations for PRB were for its normal growth trends to be out there.

It's being challenged, mining equipment, expansion of the mine, investments in the mines, the railroads have made investments in rail capacity, but we've certainly seen a lot of weather-related problems and equipment problems, both at the rails and in the mines.

So that is a new wrinkle that hasn't been there in the foreseeable past and we see that, we certainly have had a few customers in the Midwest, let's call it, that have said, we have higher stockpile targets, but we're not at them yet.

We have other customers that have said they are at it. We see some interesting developments going on there as well. It's a bit of a harder one, but these conversations for shipping PRB out of the West Coast become interesting in today's world coal markets, and obviously the dynamics there could change if that really comes to move some meaningful tons and the conversations are serious. Not much has happened, but the conversations are very serious. That's all I can say to that.

Jeremy Sussman - Natexis Bleichroeder

No, that's helpful, thanks. And just say it’s following up on the last part, given the strong met markets and export steam markets as well. How are you positioning yourself really to benefit from that? I assume Mountain Laurel should give you some flexibility there. May be you could touch on that a little bit?

John Eaves

Well, in terms of met coal, most of that coal would be going off the East Coast. We had the ability with our Mountain Laurel operation, which the dragging line will be starting fourth quarter to put most of that production in the met market or the steam market, depending on where prices are the most favorable. We also have the ability with some of our other mines to move in and out of the met market depending on the pricing.

So, I think we're well positioned for the met market. In terms of West Coast movements, I think the railroads are interested in that move. There are some conversations going on right now. There hasn't been a lot happening. There's been a couple of trains out of Montana that's been shipped out of the West Coast. So, it has happened. So, we're cautiously optimistic that eventually that will occur.

Jeremy Sussman - Natexis Bleichroeder

Great. That's helpful. And lastly, given for '08 your 50 million to 60 million tons of unpriced coal. Do you have a level of hedging that you'd feel comfortable with at the end of the year, are going into '08. Or is it more market conditions will dictate that?

John Eaves

It will pretty much be market conditions. We're always evaluating that against and our production levels and that's something, as we go through our planning cycle this fall for our '08 budget, that we'll be looking at real hard.

Steve Leer

We're comfortable where we are today. Coal markets are increasing generations up, so we're sitting there saying there's a bit of a supply overhang in terms of stockpiles. But other than that, on a worldwide basis, there appears to be a shortage, and domestically we like the direction of both the supply line and the demand line. So, we're feeling pretty good.

And a last comment on met. We have several customers now looking at, and starting to test Mountain Laurel coal. So, I think it's very timely with that longwall coming online in the fourth quarter, we could be very lucky and end up hitting the sweet spot here.

Operator

And we'll now go to Michael Molnar with Goldman Sachs.

Michael Molnar - Goldman Sachs

Hey guys, how are you. Just wanted to get some additional clarity on your thoughts on the new coal-fired generation of plants. But first one, did I hear correctly that you estimate two-thirds of them will be built, or was that relating to something else?

Steve Leer

We classify the really plants, the announced plants and I’ll call a three buckets, arguably even four, although we tend not to talk about the fourth one. The first one would be the 9 gigawatts or so that's currently coming out of the ground, the steel is being erected, they're being built, they have all their permits. We think those will get built over the next four years. And, as I mentioned in my talk, one of them already has come online this year.

There's another roughly 10 gigawatts very advanced stages, where they've gotten most or all of their permitting, they're near the groundbreaking stages. I think it’d be optimistic to assume that some of those don't get delayed. But at the same time, we estimate that approximately two-thirds or so of those get built. And again, the challenges that are out there are real in terms of climate change considerations, but most of the other permit issues have been answered.

Then, the third bucket would be announced, but not much has been done; and the fourth bucket has been announced with nothing really being done. And when we had given some presentations over the last year, the plant down in Everglades, for instance, in Florida, was always in our fourth bucket because really they hadn't done a lot other than they need the power.

We would also assume that most of that third bucket, will it be challenged get delayed. But the difference will be as we move forward, and if you have your utility analysts do a forecast of reserve margins across the FERC regions or different generating areas of the United States.

You'll see that as we move to 2012 or 2013, significant portions of the U.S. drop below the 15% reserve margin. We're going to be challenged for power, and we would expect by that period of time that we'll have more clarity on climate and carbon regulations. And once that's done, we would anticipate some of these plants moving from the advanced stages to construction stages.

Michael Molnar - Goldman Sachs

Great. That's great color. If you had to estimate and may be you don't want to this way, but I'll throw it out anyway. Let's say if you use the government number, 68 to 70 gigs of potential planned, and you break it up into these buckets. Have you put out an estimate of what you think, or do you have thoughts on what you think will get built by say 2015. Do you think that would be 30%, 40%, 50%?

Steve Leer

We haven't done that. We have made the statement that of the 9 to 10 gigs currently under construction. We think all of those will get built over the next four years, and come online, which adds about 35 million tons of annual demand, over and above where we are today. And the slow capacity creep that we continue to see in demand from existing coal-fired power plants, we expect to continue.

So, climate change is a challenge. We think technology is the answer. I think more and more people are coming to that realization, and we just can't forget the fundamental fact that we are consuming more electricity. We will continue to consume more electricity as a nation, and our existing generating stock is starting to reach its full capacity, and those are reserve margins, unfortunately here in St. Louis, we've seen the problems when something breaks or a bad storm comes rolling through, and you go without electricity for five days, it becomes more than an inconvenience.

Operator

We'll now take a question from David Gagliano with Credit Suisse.

David Gagliano - Credit Suisse

Hi, I was wondering if you could just fill me in on the 50 million to 60 million unpriced for 2008. How much of that is actually committed?

Steve Leer

I don't know it off the top of my head, David, but it’ be a pretty small percentage, probably 10%.

John Eaves

Less than 10%.

Steve Leer

Less than 10%, John says.

David Gagliano - Credit Suisse

Okay. And then, if market conditions don't improve, how much of that '08 volume would you be willing to leave in the ground?

Steve Leer

Yeah, we’d have to look at the market conditions, and there's not a hard and fast number that we'd do X or Y. But we sit look there at look market conditions, we'll look at profitability, we take a view on the future market. And what's the best long-term value creation for our shareholder, and we can always make a choice to park a dragline. They come off at increments. It's not like a smooth line, but we'll cross those lines when we get there, if we need to.

Yet again, I see nothing particularly in Central App that allows Central App to avoid significant declines over the next 12 to 18 months. And under that scenario, I don't think we'll be asking our self that question. But if we do, we will adjust accordingly.

David Gagliano - Credit Suisse

Okay. Just the last question, how much of that 50 million to 60 million is in the Powder River Basin?

Steve Leer

Again, we're not going to get into specifics, so you have to look at how it would be evenly across the entire company as a practical point.

John Eaves

Pretty much pro-rata, Dave.

David Gagliano - Credit Suisse

Pro-rata on the volume. Okay. Thanks a lot.

Operator

And we'll now go to Brett Levy with Jefferies & Company.

Brett Levy - Jefferies & Company

Hey guys, couple of things. If you guys sort of take the Mingo Logan slowdown to sales. Has that been quantified in terms of its impact on operating income?

Steve Leer

Well, it's quantified in our guidance, and then the start-up of Mountain Laurel would be quantified in the guidance, as well. And then, we really expect full production from Mountain Laurel to begin in 2008. Now, the practical side of it in Mingo Logan, it was in the last panel and if you look at the history of Mingo Logan, is that actually the life has been extended from early 2000 to today. It was down, what, 45 days during the quarter, with operational difficulties. The costs that we were incurring at Mingo this last quarter basically almost offset any gain that we realized from the sale, and it was the longwall driven.

Additionally, as the mine would have depleted its longwall, we would have incurred additional costs as we resized this from a 3 million to 4 million ton a year operation down to about 1 billion ton a year operation. So, those kind of projections were in our original guidance, they're in our guidance today what we didn't have was the significant operating difficulty the wall experienced in this last panel that basically chewed up any gain we had from the sale.

Brett Levy - Jefferies & Company

Got it. So essentially, you lost about $43 million in EBITDA during the quarter based on the Mingo Logan transition. It sounds as if by the fourth quarter, we should take normalized and add back almost a similar amount for the full ramp-up of Mountain Laurel?

Steve Leer

I think, on the assumption it ramped up smoothly, we always assume that it takes about a quarter for a new longwall or a big dragline to get its full production, sometimes we do it much faster than that, sometimes it lags.

I think it's also important to think that we had the western longwall moves impacting the quarter. We had the significant operating problems at Mingo Logan impacting the quarter, and the dragline outage in the PRB, which was planned, but it affects you two ways. It hits you in both production and then you have significant expense when you're doing a big turnaround on a dragline like that. So, you kind of get hit on both sides.

Brett Levy - Jefferies & Company

All right. I guess what I would say is, in future quarters, will you guys consider actually doing a breakout for some of this one-time stuff, or is it such a recurring thing?

Steve Leer

It's such a recurring, my view of longwall moves a great example. We had four this last quarter. We have one in the second half. I mean, that's coal mining and the average would probably be 2 to 3 a half, or 1 to 2 a quarter. But in any one quarter, you could have three or four, which skews it on the negative side. And the next quarter, you might not have any, which skews it on the positive side. Yet it's part of coal mining, and you can never get away from it.

From buying and selling both assets and reserves, I mean, we bought small reserves, we sold small reserves, that's an ongoing activity too, it's a bit lumpy. We over the years have always taken a portfolio approach on our small properties to our big properties, but it's really part of the business.

So, some folks call it an asset management group. We tend to just treat it as it is when it comes up, but it is part of the business.

Operator

(Operator Instructions) We'll now go to Michael Dudas with Bear Stearns. Please go ahead.

Michael Dudas - Bear Stearns & Co

Good morning, gentleman. First question, maybe to wrap up on the Central App theme. John, once we get into a full ramp of Mountain Laurel, let's say second quarter of '08 to be conservative, what's the Central App business going to look like? Could you remind us on steam met, industrial, surface underground, and what type of capacity output are we looking at for an '08, maybe even '09 run rate for Central Appalachia?

John Eaves

Mountain Laurel, as Steve said, it takes usually about a quarter to get ramped up. Our current projections are that we'll start the long wall mid-fourth quarter this year, so we should be at a pretty steady run rate for 2008, between 4 to 5 million tons out of Mountain Laurel.

We typically are going to run about 3.5 to 4 million tons out of Coal-Mac and then we'll run approximately 5 million tons out of our Lone Mountain and Pardee operations. So, in terms of the steam versus met, I think it depends on the market.

We have the ability to take most of that Mountain Laurel volume in the met market, if the market is there. We have the ability to take a reasonable percentage of our Cumberland River production in and out of the met market and we have the ability at Lone Mountain to take that in and out of the PCI market as well.

I think it's market driven and we'll just evaluate it at the time, but we are having meaningful discussions with international customers on our Mountain Laurel operation. We've had a number of them visit the mine, so there's a lot of interest there as well as domestically. As Steve indicated, we think our timing should be pretty good with the ramp-up of that operation.

Michael Dudas - Bear Stearns & Co

Thank you. My second question is regarding your 2009 contract position. I'm trying to remember back in the fourth quarter of last year, you took your expectations down to shipments in '06 -- '07 to be $130 to $135 million and now we're at $125 to $130, is that correct?

John Eaves

That's correct.

Michael Dudas - Bear Stearns & Co

Looking at the '09 position, is that '09 position of 105 to 115 based off a 125 to 130 run rate, or are we looking at maybe a year ago what you thought '09 shipments might be? And given you've had some asset sales and mix changes, is having that 80% to 80% plus exposure something that might change significantly over the next three to six months?

John Eaves

Again, Michael, it gets back to market conditions, but our normalized run rate is between 140 and 150 million tons.

Michael Dudas - Bear Stearns & Co

So that'd be better to look at that number relative to….

John Eaves

Again, depending on the market, but I think that's probably a good way to look at it.

Michael Dudas - Bear Stearns & Co

Terrific. Thank you, John.

Operator

And we'll now take a question from Sam Martini with Cobalt Capital.

Sam Martini - Cobalt Capital

Hi, guys. Just a question on some recent M&A. Are you hearing anything and how would you think about a change in ownership of Kennecott? I'll start with that.

Steve Leer

Well, you know we, it depends who the change of ownership was, I guess. I don't know.

Sam Martini - Cobalt Capital

Do you believe that they've been leading, there's been a lot of talk about them being a part of the drivers of some very competitive pricing out of the west. Can you give your views on that?

Steve Leer

I think at different times over the years, different companies have done what they needed to do for their company and it's really hard to, with confidential or private bits, and you hear rumors.

But we hear rumors about ourselves that we know aren't true, so we don't give a lot of stock to that. So what Rio might do with their assets around the world is, heck, you have to ask Rio.

But we do believe that overall in both the east and west, we're heading into a period of consolidation, principally probably in the east. We may see a transaction or two in the west.

You always have the question of -- you do some of the big, international mining houses, do something different in their view of U.S. coal. We certainly think that's a possibility at some point in time.

Sam Martini - Cobalt Capital

Do you, Steve, given your experience with Triton, do you believe that a western, do you believe anything's changed and that an existing western producer who's already in the Basin would be permitted to look at Kennecott?

Or it would have to be someone, an incremental producer? Could we consolidate PRB production if Kennecott were to come for sale, or would it have to trade with someone who's not already an existing producer?

Steve Leer

Again given -- I don't know about Kennecott at all or Rio Tinto Energy, but I think the Federal Trade Commission certainly asked a lot of serious questions during our purchase of Triton and I would anticipate that any existing producer in the Basin would face similar questioning.

There's no doubt in my mind it would be easier, much, much easier for another party who's not already producing in the Basin to enter it.

Operator

And we'll now go to John Bridges with J.P. Morgan.

John Bridges - J.P. Morgan

Hi, Steve, everybody. Just a question on the inventories, another question on the inventories. Last year, you told us there's been a lot of gas over the summer. To what extent do you think they may disappoint you in terms of your rundown in coal inventories by burning gas this year?

Steve Leer

Our sense is that you don't see the coal conservation, I would call it, that we saw last year when the utility customers came off a period of troubled deliveries, troubled supplies and they were, certainly in the first half of 2006, they were still conserving coal.

You saw some of them publicly talk about that. As far as the summer burn of gas, I think that was driven just on pure demand. The cost of doing that was high, but at the same time when you have a good, hot day or a series of hot days in Texas, you spend everything you can to generate electricity and gas was a part of that.

If we get a hot week between now and early September across much of the east or the western half of the United States, I think we'll see them burning some gas then, but I don't anticipate or see any of our customers making that statement that we're trying to conserve coal and we're using other fuels to do that. I think they really have gotten away from that position.

John Bridges - J.P. Morgan

Wouldn't they be motivated to burn gas given how high the gas inventories are and the risk that the gas inventories get full again this fall?

Steve Leer

That's a good question for the utilities. I've asked myself that a few times. I think it's a variety of issues. Again, you get to a really good hot day and the need for generation and the fact that we are on the border in many parts of the country in reserve margins, you'll spend single cycle units, if you have to, to generate electricity because it is the duty to serve and gas benefits in that scenario.

I think gas right now in the west in California is probably benefiting from the severe drought that the western half of the United States has seen, so logically you would anticipate gas may get a little pickup there.

And then people do it for other purposes as load balancing, sometimes as an environmental compliance, but in terms of sheer economics, coal is so much cheaper to generate than gas.

You choose coal. In fact, a month ago, I was with a CEO an unnamed CEO and we were in a small group. There were two or three utility CEOs and I was the only coal guy and a couple gas guys.

But anyway, in his talk, he said, I really don't care what the price of coal is because it's so much cheaper than generating with gas that I always choose coal when I can. Of course, I raised my hand and told him we needed to talk after his presentation, but it's true.

The economics drive coal anywhere in the nation right now with $6 gas or $5 gas, let alone if you look the forward curve, but there are other reasons that gas gets chosen as well.

Operator

And we'll now go to David Lipschitz with Merrill Lynch. Please go ahead.

David Lipschitz - Merrill Lynch

Yes, hi.

Steve Leer

Hey, David.

David Lipschitz - Merrill Lynch

My question is on the RFPs you said you were not getting hit on. Are they getting hit? Is nobody taking those RFPs? What's going on that other people are taking them, especially if it's an eastern type of order with prices where they are?

John Eaves

I think it depends, David. Unlike sometimes they're buying off of those, sometimes they're out checking the market. So I think it depends on the customer.

David Lipschitz - Merrill Lynch

Okay, thank you.

Operator

And next is Michael Goldenberg with Luminous.

Michael Goldenberg - Luminous

Good morning, guys.

Steve Leer

Good morning, Michael.

Michael Goldenberg - Luminous

I had a question on the production cut. Maybe I missed it, but where exactly are you cutting production?

Steve Leer

Again, we're not getting as specific there. Pro rata would be the best modeling, but it's in all of our basins. What we do is take a broad look at everything in the company when we're making that sort of decision.

We look at the market, the local market, the logical market and say, all right, where do we need to address the supply demand balance here, but it basically occurs across the company.

Michael Goldenberg - Luminous

My question is from the standpoint of, are some regions easier to bring back production once it's cut versus others? I'm trying to think if some of this production, if you cut it won't be more permanent?

Steve Leer

John, I'll let you answer that.

John Eaves

The one thing we've tried to do is create flexibility when we've ramped these mines down and we've looked at things such as overtime, contractors, work schedules and really trying to protect our well-skilled workforce. I think we've been able to do that so far, so if the market turns, I think we're going to have the ability to respond fairly quickly.

Michael Goldenberg - Luminous

And finally, if you are, let's say you are the only company to further cut production. Do you believe that your cut is sufficient to strength and prices, especially given that you said marginally, those tons are profitable.

These are not unprofitable tons you're cutting, these are profitable tons you're cutting. So I'm trying to -- do you think if you're the only one to cut 5 million tons, if that's going to be enough to change the market?

John Eaves

I think we can't respond for anybody else and we only look at it from Arch's perspective. And again if you do incremental margin analysis on those tons, given the high fixed costs, you can certainly make an argument from an accounting perspective they're profitable.

We tend to take a different view that number one, we'll continue to work on the fixed cost and over time we can eliminate additional fixed costs, you just can't do it over a one-month or a quarter period very easily.

On top of that, we look at the value of the reserves and the cost of replacing those reserves. By definition, every natural resource company is liquidating itself every day. And for long-term profitability, you have to replace those reserves.

Typically, those reserves will be higher cost because it's just the nature of mining. You mine your very best reserves first. So we're sitting there looking and I'll just pick an eastern reserve as an example right now.

If you look at Mountain Laurel, Mountain Laurel is a very unique reserve because we couldn't get it permitted. The Spruce mine, which is a surface mine that’s near Mountain Laurel, is the same way, but we couldn't get it permitted.

Their cost advantages over the current market is dramatic, we think, once they're in full production. And to commit them at today's lower prices just doesn't make sense, because the opportunity costs of replacing that reserve. Well, frankly you couldn't in those two reserves in the east. But the next increment just so much higher priced that we sit there and say, you've got to do a NIFO type of accounting, not a LIFO or a BIFO

accounting.

Operator

We'll now take a question from Dhaval Patel with Columbus Hill.

Dhaval Patel - Columbus Hill

Good afternoon, guys. Could you comment a little bit more about the overseas demand? It sounds like you've had an interest. I think you also commented in the first quarter you had some interest, but it doesn't seem like you've committed to any transactions. What has been the issue or when do you think you would start committing some coal to exports?

John Eaves

Really, with the new operation such as Mountain Laurel, there's a lot of testing that's involved, and we're in a process right now. The next contract year actually starts April 1 of 2008.

So we would suspect that we would continue testing between now and first quarter of '08 and have pretty firm discussions with those customers in this timeframe and probably lock something down around Christmas time end of January. Just depends on how the negotiations are going.

We feel pretty good about where we are right now and the level of interest we've had in that product. I would suspect shortly after Christmas we would book some permit tons for the 2008 contract year.

Dhaval Patel - Columbus Hill

And so it would mainly be committed to the met coal market?

John Eaves

On the export side, that's probably where most of that would go, yes. In Europe, the Far East, South America.

Dhaval Patel - Columbus Hill

Okay, great. Thank you.

John Eaves

Sure.

Operator

And due to time restraints, that does conclude our question-and-answer session. We do apologize if you were unable to ask your question, but you may contact Arch Coal with any additional questions you may have. And for closing remarks, I would like to turn the call back to Steve Leer. Please go ahead.

Steve Leer

I would like to thank everyone for joining us on the call today. We're very pleased with your interest in Arch Coal. And again, as we sit there and look at the supply/demand balance, we're feeling very good about where we are sitting.

There's a huge amount of positive milestones, as we call them that we see in the marketplace out there. Clearly, the business cycle hasn't completely gone away and we are seeing a bit larger stockpiles at the utilities that we're used to on a historical basis, but at the same time we're pretty confident that many of our customers, if not all, have raised their targets.

We see this thing coming into balance. Frankly, the marketplace has reacted some. We've seen price increases from the first of the year based on the indices published numbers. We think those trends will continue.

We would just like to see them continue at a faster pace. The market will be what it is, but again the trend lines are the right way. So again thank you for your interest and your time and we'll look forward to reporting third quarter in a few months. Thank you. Bye now.

Operator

Thank you very much. That does conclude our conference for today.

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