Massey Energy Co. Q4 2007 Earnings Call Transcript

| About: Alpha Appalachia (MEE)

Massey Energy Co. (NYSE:MEE)

Q4 FY07 Earnings Call

February 1, 2008, 10:00 AM ET

Executives

Roger Hendriksen - Director of IR

Baxter F. Phillips Jr. - EVP and Chief Administrative Officer

Eric B. Tolbert - VP and CFO

Don L. Blankenship - Chairman, CEO and President

M. Shane Harvey - VP and Assistant General Counsel

Analysts

Michael Dudas - Bear Stearns

Pearce Hammond - Simmons Company International

Paul Forward - Stifel Nicolaus

Luther Lu - Friedman, Billings, Ramsey

Shneur Gershuni - UBS

Justine Fisher - Goldman Sachs

Michael Molnar - Goldman Sachs

John Bridges - J.P. Morgan

John Hill - Citigroup

Laurence Jollon - Lehman Brothers

Jim Rollyson - Raymond James

Operator

Good morning and welcome to Massey Energy Company Fourth Quarter 2007 Earnings Conference Call. Today's call contains copyrighted material. It may not be recorded or rebroadcast without Massey Energy Company's expressed permission. Your participation in our call implies consent, please disconnect if you do not agree with this term.

Roger Hendriksen, Massey Energy's Director of Investor Relations will now provide opening remark. Please go ahead Mr. Hendriksen.

Roger Hendriksen - Director of Investor Relations

Good morning everyone and thank you for taking the time to participate in our conference call this morning. We appreciate your continuing interest in Massey Energy.

As you know, we distributed our fourth quarter press release after market closed last night and it is posted on our website and it's been furnished with the SEC on Form 8-K.

The members of our management team who will be speaking with you today are; Mr. Don Blankenship, Chairman President and Chief Executive Officer; Mr. Baxter Phillips, Executive Vice President and Mr. Eric Tolbert, Vice President and Chief Financial Officer. Shane Harvey, who is our new General Counsel, is with us in the room as well.

Before we begin, I need to remind you that the statements made in this presentation which are not historical in nature are forward-looking statements made pursuant to the Safe Harbor provisions of the Private Securities Litigation Reform Act of 1995 and are based on current factual information and certain assumptions which management currently believes to be reasonable. Financial and operational results for future periods may differ materially from current management projections as a result of factors outside the company's control. Information concerning those factors is available in the company's 2006 annual report on Form 10-K and other periodic filings with the SEC. In providing projections and other forward-looking statements, the company does not make and specifically disclaims any undertaking or obligation to update them.

With those formalities out of the way, I'll turn the call over to Baxter Phillips.

Baxter F. Phillips Jr. - Executive Vice President and Chief Administrative Officer

Good morning and thank you for joining us. We are pleased to be reporting on one of the most successful years in our history, in fact, by some measures you could say we had the most successful year ever, specifically in terms of EBITDA, increased cash balance and improving the safety of our markets.

From an operation standpoint, we were incredibly busy in the fourth quarter. We had more projects and initiatives underway than in any other time in my 27 years at Massey, as we work to implement and even accelerate our expansion plans. You could say it has been something of a transition period as we gear up to make the most of our opportunities in 2008.

Let me give you just a few examples of our many projects and some updates on our progress. We worked very hard to establish long-term and formal agreements with many of our members involved in critical mining operations. The three-year agreements with individual members included incentives and bonuses to encourage safety, longevity and productivity on the job.

We were very successful in getting the participation we have hoped for. We believe this will ensure the availability of labor to meet the demands of our expanded production plans over the next three years. We completed the transition of our Aracoma mine from longwall to room and pillar mining. The longwall has been shut down and three continuous miner sections are operating more efficiently in its place.

Rehabilitation work on the Pocahontas 3 scene and on Guyandotte Resource Group was completed in the fourth quarter and we have started production in this longwall metallurgical coal mine. We laid much new track, continue to build belt lines and obtain permits for three new surface mines. In addition to all of this, we were very busy with negotiations on the EPA settlement and the development of our relationship and agreement with Essar of India. During the fourth quarter, we began evaluating joint venture opportunities with Essar.

In spite of the potential for distraction, our teams throughout the organization did a great job of multitasking and did not lose sight of the need to produce coal and drive results to the bottom line. Our outstanding efforts resulted in the record results for the year and solid results overall for the fourth quarter. Our operating cash margin was $7.70 per ton, up 26% compared to the fourth quarter of last year. The margin increase was driven mostly by higher prices realized on steam coal shipped during the quarter.

EBITDA in the quarter increased 16% compared to the fourth quarter of last year and reached an all-time company record of $426 million for the year.

Our cash balance was $365 million at year-end, $29 million higher than at the end of the third quarter and $126 million higher than at December 31, 2006. And this was after we returned $43 million to shareholders in the form of dividends and repurchases of our common stock. We mined nearly 40 million tons of coal this past year. Through various transactions, we acquired approximately 50 million tons of new reserve... new coal reserves for a net increase of 10 million tons at year-end. This is the third consecutive year and the 15th year in the past 20 that we have increased our total coal reserves. I would be remised if didn't acknowledge the positive results of our safety improvement initiatives. As you know safety is job one everyday at Massey.

For 2007, we are very pleased to have reduced our NFDL incident rate to 2.05, which was a company record and significantly below the industry average of 3.31. We have several mines which incurred zero loss time injuries for 2007. And we are pleased to have been recognized with several safety awards during the year, including West Virginia Mountaineer Guardian Safety Awards.

We have a lot to be proud of from our 2007 operations and results, but it is also important to remember that all the efforts to implement our expansion plans have yielded many successes that will benefit 2008 and future results.

Now I'll turn the call over to Eric for a discussion of our financial details of the fourth quarter.

Eric B. Tolbert - Vice President and Chief Financial Officer

Thank you, Baxter. For the fourth quarter of 2007, we reported net income of $5.1 million or $0.06 per diluted share, compared to net income of $8 million or $0.10 per diluted share reported in the fourth quarter of 2006.

Net income for the full year of $94.1 million or $1.17 per diluted share compared favorably to net income of $41 million or $0.50 per diluted share generated in 2006. Produced tons sold totaled 9.6 million in the fourth quarter of 2007 compared to 9.3 million in the fourth quarter of 2006 and 10.3 million in the third quarter of 2007. Our average produced coal sales realization of $51.84 per ton in the fourth quarter was $1.33 per ton higher than in the fourth quarter of 2006, on the strength of utility coal pricing. The average per ton... price per ton of utility coal sold during the quarter was up more than $3 compared to the same period a year ago.

Cash cost for the fourth quarter of 2007 were $44.14 per ton, compared to $44.39 per ton reported in the fourth quarter of 2006. The quarter's cash costs per ton were impacted by the EPA settlement approval, higher diesel fuel pricing and the indirect costs related to compliance with the new safety regulations. Also included in the cash costs was the reversal of the Harman litigation accrual.

The fourth quarter tax expense and resulting rate were impacted by the non-deductible charge related to the EPA settlement and an adjustment to the company's deferred tax asset valuation allowance that was primarily related to the previously disclosed IRS audit of the 2003 and 2004 calendar years and a tax accounting method change.

We project 2008 produced coal shipment of 41.5 million to 43 million tons with an average realization approximating $55 per ton. We estimate our average cash cost for the full year 2008 will be in the range of $43 to $45 per ton. We also expect other income of $30 million to $100 million for the full year 2008. The result of this should enable us to fund nearly all of our 2008 maintenance and expansion capital expenditures estimated at $460 million out of our operating cash flow.

In the first quarter of 2008, we anticipate that our results will suffer somewhat versus last year due to the cost of completing the Aracoma transition removing in the Nicholas shovel to Republic, the rehabilitation of the Revolution wall, the continuing struggle to comply with new safety and environmental standards and the start-up of several new mines. Adding to this, our average realized price per ton will be about $1 lower in the first quarter than it will be in the full year overall.

Available liquidity improved to $479.3 million at year-end compared to $450.7 million in September 30, 2007 and $350 million at the end of 2006. Available liquidity at December 31, 2007 includes $365 million in cash and $114 million available under our asset-based revolving credit facility.

Our total debt at December 31 was essentially unchanged from the year-end 2006. Our total debt-to-book capitalization ratio was 58.5% at December 31, compared to 61.3 at December 31, 2006. And net debt-to-book capitalization was 45.1% at December 31st, 2007 compared to 52.2% a year earlier. At year-end, the restricted payments basket calculation of 6.625% senior notes would allow for up to approximately $27 million of share repurchases.

Cash capital spending was $73.8 million for the fourth quarter of 2007, compared to $59.6 million in fourth quarter of 2006 and the increases related primarily to the implementation of our expansion plan. Capital spending in the full year 2008 is expected to total approximately $450 million. And depreciation, depletion and amortization was $62.8 million for the fourth quarter of 2007, compared to $59 million in the fourth quarter of 2006. DD&A is expected to total between $250 million and $260 million for 2008.

Now let me turn the call over to Don.

Don L. Blankenship - Chairman, Chief Executive Officer and President

Thank you, Eric. Before we take your questions, let me take a few minutes to share my thoughts on the global domestic Central Appalachian coal markets and the outlook for 2008. The talk of economic slowdown or recession in U.S. has been steady for several months now. However, the shortage of energy in all forms continues. Most of the major coal producers including ourselves have already sold or committed a significant majority of the 2008 plant productions.

China has suggested they will reduce their coal exports. We have also seen several coal power generation plants in China close temporarily due to low stock cost. India is importing more and more coal to meet their growing baseload needs. We believe the energy required to fuel the economic expansion in these two huge markets will absorb much of the coal produced in the Pacific Rim and more. Several of the former Soviet Union countries are struggling to replace their demands in Russian coal supply. Australia has had port and rail problems and the recent flooding has only made matters worse. Columbia and South Africa are also straggling to meet demand for their coals. These facts combined with the weak U.S. dollar indicate the demand for export steam coal from the Eastern U.S. is probably sustainable for sometime.

In our home markets, utility stockpiles remain high at the end of the year, both in terms of tons and days of burn. According to some sources, year-end's coal stockpiles among utilities served by Central Appalachian producers were nearly 27 million tons or about 55 days of burn, and that's about 25% higher than the normal December.

However, demand created by the strength of the export market is offsetting any concerns about this high utility inventories. Demand for metallurgical coal has been strong domestically and in foreign markets for sometime, and we only see it getting stronger. The flooding in Australia has significantly reduced global supply and prices have moved significantly higher. While the disruptions from the flooding in Australia are likely to be short termed, we expect the continued economic growth in Asia will continue the increase coal demand in the long term.

Longer term, the weak dollar and high ocean freight rates create a disadvantage for U.S. imported steel. We believe this may drive investment and increase steel production in U.S. and increase the domestic demand for met coal. We believe new U.S. coal companies are now on the drawing broad.

The bottom line is that while we may go through a recession that slows economic growth in the U.S., we don't expect the demand for coal to suffer in 2008. Longer term, the underlying factors and market fundamentals that are driving increased demand for metallurgical coal appear to be sustainable.

The expansion plans we announced last quarter are in full swing. These expansions were developed with the expectation that the current steam coal market will be weak in 2008 and 2009. The current situation only enhances the opportunities that our expansion will provide us and encourages us to implement the current projects as quickly as we can. We are now starting the potential for even greater expansion in 2009 than previously considered.

Baxter gave you a few examples of our progress in his opening marks. Now, I will mention a few more. The 53 yard shovel is in the process of being moved from Nicholas to Republic. We are in the reconstructing stage now and it should be at full production this summer. This move will hurt first time production by about 600,000 tons with the lower ratio and higher quality coal that Republic will provide much lower cost and much higher margins going forward.

Our new Empire surface mine at, Kanawha County is ahead of schedule. The mine will produce nearly 1 million tons of coal production and will begin to ship coal in March. Baxter mentioned the new longwall mine at Guyandotte Energy Resource Group. The startup of this mine was made more difficult by the new Mine Safety Regulations, but it is now in production. The major belt line and low down expansion project at our Mammoth Resource Group is on schedule, and a new low down will be operational in the second quarter.

As we said in our press release, we expect to produce and ship between 2 million and 3 million additional tons each year for the next three years. However, if the coal market remain strong, we will search through ways to increase this number even further.

There is some risk as we have seen in the past. Sharply higher coal prices will result in a shortage of qualified experienced miners in Central Appalachian, but as Baxter mentioned we try to anticipate and mitigate this risk by offering incentive based on formal agreements to our key personnel. We expect voluntary channel would be down considerably 2008 compared to prior years, as a result of these incentives and this will be a key driver of our productivity improvement. We should also note that we have chosen to undertake an extra month of repairs, due to longwall equipment being moved from Aracoma to Revolution and therefore, the first quarter longwall production will suffer in order to benefit for the rest of the year.

In summary, we expect our 2008 cash cost per ton to be same as in 2007. And our operating cash margins before other income should be in the range of $10 to $11 per ton. We have a lot of work to do to deliver these results and it will be... not be easy, but with the prospects of higher volume, higher prices and higher margins, we are gearing up for an outstanding year. As Eric noted, much of our expansion, operating conversions, man rehabilitation and hiring will occur substantially during the first quarter.

This concludes our prepared comments. We would be happy now to answer any questions you may have.

Question And Answer

Operator

Thank you. We will now conduct the question-and-answer session. [Operator Instructions]. Your first question comes from the line of Michael Dudas of Bear Stearns.

Michael Dudas - Bear Stearns

Good morning everyone.

Eric B. Tolbert - Vice President and Chief Financial Officer

Hi, Mike.

Michael Dudas - Bear Stearns

Don, you mentioned in your prepared remarks about the abilities to build coke oven batteries in the U.S., could you expand a little bit about what you are hearing from your current customers? And when you combine that with some of the numbers we are hearing out of Brazil that could lead to anywhere between 25 million and 45 million tons of additional coke and coal demand. How well suited is the U.S. able to serve internal and external customers, given the reserve base and the capitalization of the industry?

Don L. Blankenship - Chairman, Chief Executive Officer and President

It's an interesting thing because we went through so many years, or you could say decades without building any coke ovens in U.S. and the demand in that area continue to decline. I believe we've reached a point now where there is about 40 million to 42 million tons of Australian coal, coking coal grow in the Atlantic basin. And when it gets pushed back, that alone creates huge imbalance between the Central App production and the demand. And of course we are seeing $450 and $480 coke prices, so there is obviously a shortage of coke and it's going to be a difficult thing to respond to. Massey is one of the few companies that has the ability to bring on an expanded metallurgical coal production.

We do believe that in addition to the couple of coke ovens that are been built in the States in the last five years there will be a couple of more plus, we think there will be three or so built in Brazil, which will be natural markets for our coke. So we see perhaps 15 million tons additional demand on top of the fact that the Australian coal may surrender this market and shift into the Pacific Rim. So we see a demand that's going to be very hard to meet and certainly I think that it will mean very strong for us.

Michael Dudas - Bear Stearns

So does that imply what you might be looking at expanding further in 09 and 10 from what you already put out into the market would most likely be targeted to the coking markets?

Don L. Blankenship - Chairman, Chief Executive Officer and President

Yes I looked briefly now let's say because it takes a lot of engineers and so forth instead of just executives, but I've been looking briefly at 1.5 million to 2 million tons of met production that could be brought online during 09 and being mature in 10. We believe that it's probably going to be wise beyond what we've done, but again there is a lot involved, it has not yet been studied from an engineering view.

Michael Dudas - Bear Stearns

And just quickly to finish up, could you tell us what 2007 turnover rates were versus 2006, where your expectation might be for 2008 on a voluntary front.

Don L. Blankenship - Chairman, Chief Executive Officer and President

I think that, Eric may have some numbers that he is looking for it, but generally, our turnover rate was not horrible in 07. The biggest issue is that it was focused underground which was where the met coal and the biggest need is and I think it was probably in the 20s underground and we are hoping to cut that number in half in 08 with these packages and I think Eric has such specific number.

Eric B. Tolbert - Vice President and Chief Financial Officer

Yes, Mike I have got the voluntary turnover for 2007 in the range of about 14% and that's down from about 22% in 2006.

Don L. Blankenship - Chairman, Chief Executive Officer and President

Do you show the underground and surface?

Eric B. Tolbert - Vice President and Chief Financial Officer

Surface, I don't have that, that's --

Don L. Blankenship - Chairman, Chief Executive Officer and President

They are 14% I think it was probably, Mike, in the 22%, 23% range, 24% range for underground and probably down almost to single-digits for other categories. So the big improvement we are trying to make and the focus of our incentives was underground.

Michael Dudas - Bear Stearns

Thank you, Don.

Don L. Blankenship - Chairman, Chief Executive Officer and President

Thank you.

Operator

Your next question comes from the line of Pearce Hammond of Simmons and Company International.

Pearce Hammond - Simmons Company International

Congratulations on a great 2007.

Baxter F. Phillips Jr. - Executive Vice President and Chief Administrative Officer

Thank you.

Eric B. Tolbert - Vice President and Chief Financial Officer

Hi Pearce.

Pearce Hammond - Simmons Company International

Don, can you refresh us on the Fourth U.S. Circuit Court of Appeals, where there are with the chambers ruling, when do you expect to hear something and what could be the impact if they do decide not to overturn that ruling?

Don L. Blankenship - Chairman, Chief Executive Officer and President

All right. We have Shane Harvey with us here. This'll be the first question he's fielded as the General Counsel. So we will let him answer that question.

M. Shane Harvey - Vice President and Assistant General Counsel

Briefs has been filed by both sides in the Fourth Circuit. One more brief is due on the industry side by us and by the different industry partners who have partnered with us and filed amicus briefs. I think that the case will probably be argued in the April to May timeframe and decision before this summer.

As to the impacts, we have as you know if you have followed it, had good luck in the Fourth Circuit before. If we do not receive a favorable ruling and it could slow permitting times in the future. But again, we think we have pretty strong arguments that the decision by the chambers court if you will was wrong and hope to get that overturned in early summer.

Pearce Hammond - Simmons Company International

Great, thank you. And then Don, from utilities right now for contracting for 2009 coal, are they calling you wanting to take a look at some coal or where are the utilities right now with prices as strong as they are and what's going on in the export market.

Don L. Blankenship - Chairman, Chief Executive Officer and President

I think that the utilities, of course, are well-stocked domestically with Central App coal and they tried as the price has ridden up to wait it out. I do think that some of them will have to come to the marketplace shortly and it will be interesting to see what kind of impact it has, although, we've not seen a great deal of that yet, we expect it will pick up probably in the second, third quarter.

Pearce Hammond - Simmons Company International

What prices are you seeing for '09 deliveries through utilities on Central App lower sulfur coal?

Don L. Blankenship - Chairman, Chief Executive Officer and President

$70.

Pearce Hammond - Simmons Company International

Thank you.

Don L. Blankenship - Chairman, Chief Executive Officer and President

Thank you.

Operator

Your next question comes from the line of Paul Forward of Stifel Nicolaus.

Paul Forward - Stifel Nicolaus

Questions here. Maybe to follow-up on that last one, highwall met, is there a... are you seeing any prices in the market that you might be able to discuss for '08 and I guess you are probably not signing a whole out for 09, but can you give us a sense of where the things are right now?

Don L. Blankenship - Chairman, Chief Executive Officer and President

Rather unbelievable, we have sold highwall met in the $114 range, it depends a lot on quality though, it's the high quality highwall met, we were probably few months ago we were selling $65 to $70 low quality and $85 to $90 high quality and now we are selling $85 to $90 and higher, but $114 of demand. We have actually sold some low while north of the $145 as the new startup and we don't know where the prices are going right now because they are going up so fast, we don't know where they'll settle down, but it reflect this three digits on about any reasonable quality of coal for metallurgical purpose.

Paul Forward - Stifel Nicolaus

All right. Well, that's good. Can I maybe just ask you on this, I think you had said in there in your prepared remarks, cash margins in 2008 of $10 to $11. Just looking at the midpoint of what you had put in the press release today, I come up with $11.50. Is that I guess mid point would be 55.50 on pricing and 44 on the cost side of things for cash cost, that's just a little bit up but it does have an impact on the model. Is that... should I be thinking about that differently or is that's what's in the press release the right way to think about cash cost versus expected pricing for 2008?

Don L. Blankenship - Chairman, Chief Executive Officer and President

I think there may be a little disconnect there, which is probably our fault of not getting right down of the detail, but we still have this unsold met coal floating around between $90 and $130 or so and then we have, of course, that drags the costs along with it because of the severance tax and royalty rates to be in a percentage of that numbers, so it gets a little complicated, but I think if you use 11.50 we should be there.

Paul Forward - Stifel Nicolaus

And how much of that unsold met's floating around just --?

Don L. Blankenship - Chairman, Chief Executive Officer and President

Do you have that number Eric? I think the big thing about our numbers, while he is digging that out, is the 32 million or 34 million unsold or 10 times in today's market with a big part of that beyond that. So Eric handed me a sheet that says, this is 08 here we only have like a million unsold met accounts and '09 which we are beginning to have discussion about already, we have 6 million unsold unprocessed met tons.

Paul Forward - Stifel Nicolaus

Okay that's excellent. And then maybe lastly, you lowered the low end of the range on other income for this year or for 08 from $50 million to $30 million and do you have reason for that?

Don L. Blankenship - Chairman, Chief Executive Officer and President

Yes, well one thing we are looking at, of course, we have seen this explosion in process in different markets and we have left ourselves some room there to buyback some trader coal at a loss in order to place it in the met market and so forth. So we thought we needed to allow for some losses on doing some switching that's what that represent.

Paul Forward - Stifel Nicolaus

Okay, excellent. Thanks you.

Don L. Blankenship - Chairman, Chief Executive Officer and President

Thank you.

Operator

Your next question comes from the line of Luther Lu of Friedman Billings Ramsey.

Don L. Blankenship - Chairman, Chief Executive Officer and President

Hello Lu.

Luther Lu - Friedman, Billings, Ramsey

Hello. You mentioned that $114 FOB mine, is that this quarter or last quarter?

Don L. Blankenship - Chairman, Chief Executive Officer and President

During this quarter for delivery over the next year and half.

Luther Lu - Friedman, Billings, Ramsey

Okay, great. And you guys changed the way you disclosed information a little bit, and if we were to use the 2008 contracted numbers and price range guidance, I come up with like a high 80s to a high 90s for the coal that recently signed, is that the correct range?

Don L. Blankenship - Chairman, Chief Executive Officer and President

Yes, most of the met coal we've been selling has been well north of $80, I'd say we have one $150 sale. So, the numbers have been moving around, some plus for these of giving numbers, we give the best number we have, but some of these contracts have indexes in them and they relate to diesel, fuel, and steel and all that. So there are indexing impacts to some extent.

Luther Lu - Friedman, Billings, Ramsey

I see, okay. And I noticed there is a slight jump in the SG&A in the fourth quarter, is that... can you give us some guidance on the SG&A for the year?

Don L. Blankenship - Chairman, Chief Executive Officer and President

I'll turn that over to Eric, you are looking for '08 guidance?

Luther Lu - Friedman, Billings, Ramsey

Yes. SG&A and interest expense and tax rate and things like that.

Eric B. Tolbert - Vice President and Chief Financial Officer

Okay Luther. On the SG&A, as you know that the bump up in the fourth quarter was primarily... we had an increase in our share prices of about 64% in the fourth quarter and that impacted our compensation... our stock-based compensation accruals. Into '08 I would expect that SG&A as a component of cash cost for SG&A to be about in a same range as it was for '07.

Luther Lu - Friedman, Billings, Ramsey

Okay.

Eric B. Tolbert - Vice President and Chief Financial Officer

And that's already build into our cash cost range of 43 to 45. And you said on interest, I think we are modeling somewhere in the $64 million range or so on interest expense and that's going to be more determined based upon the rates we will be earning on our outstanding cash.

Luther Lu - Friedman, Billings, Ramsey

Okay.

Eric B. Tolbert - Vice President and Chief Financial Officer

And then finally on tax rate, we expect tax rate for the full year to be in the 18% to 22% booked tax rate. The tax could be... that could change if there are some unusual items as well, but we are not projecting any.

Luther Lu - Friedman, Billings, Ramsey

Okay, great. Thank you.

Eric B. Tolbert - Vice President and Chief Financial Officer

All right.

Operator

Your next question comes from the line of Shneur Gershuni of UBS.

Shneur Gershuni - UBS

Hi, good morning guys.

Eric B. Tolbert - Vice President and Chief Financial Officer

Good morning.

Shneur Gershuni - UBS

Just want to give it a one quick question here. If you want to talk about the permitting situation, where are you right now with your permits, how far can you go excluding the new capital program that end if the Chambers decision stand? How much long can you run on your existing permit and take that separate from the fact that you've got this large capital program, so obviously that would move into maintenance I guess, category.

Don L. Blankenship - Chairman, Chief Executive Officer and President

It's always difficult to summarize such a complex thing, but let me say first of all that Chambers thing is a little bit different than Hayden and what the Chambers ruling was at least in laymen terms and counsel here can correct me if I am wrong, but was is it core of engineers didn't put us through and the hurdles and hoops and I need to put us through more hurdles and hoops. So we've begun the process of doing that in the event that Chambers rulings is not overturned that we may have a longer permitting process, more samples to take, more things to check for and so for so. We are working on that as a mitigation.

We have looked at numbers that said we would lose 7 million or 8 million tons of our surface mine production, if chambers were not overturned and that's one advantage of additional expansion underground, just trying to make sure we mitigate that. And we have protection in a number of our contracts in the event that chambers won't overturn, so it would be a complicated situation, but we have try to mitigate in contract terms, we are trying mitigate it by being prepared to go underground and we are trying to mitigate for going through the lengthier process and the more difficult process, at the same time that we are trying to overturn it. So... but I think the key thing to remember is that if it were to stand, our process would go, but Massey would be in as good or better position to deal with it than anyone else.

Shneur Gershuni - UBS

If I can have just one follow-up, production seems a bit like the fourth quarter, just wanted to sort of get a little bit more color on where you thought production came in relative to the plan and how you see whether it was lighter or not and sort of what was the reason behind that?

Don L. Blankenship - Chairman, Chief Executive Officer and President

We thought we were little bit weak in production. The Revolution longwall has been difficult for second half of '07 and Logansport longwall ran well, we had and it's not so much regulatory and statute changes, but we have had a difficult time with inspectors having a much stricter attitude about our mines being idled temporarily for small roof falls or having to do extra work on ventilation stopping and then having to build these 120 PSI seals. So we had even though we were prepared and did it well with a lot of step up in the safety rigs, we had a number of times that we were idled at this various operations.

One of the big ones being at Sydney and Guyandotte over having explosive atmosphere behind the seals, which up until just a few months ago was not an issue and that now is an issue. So that was probably the biggest disruption and we're putting things in place to try to mitigate the reoccurrences of those things.

Shneur Gershuni - UBS

So basically on a going forward basis, things would be more in line with your estimates?

Don L. Blankenship - Chairman, Chief Executive Officer and President

Yes, I think so. I mean, we have completed few strong sales at Guyandotte. We have built a number of them at Sydney, we are still building some there, which are the mines that sometimes get into the explosive atmosphere range and we are, of course, getting ahead of the curve and as many mines as we can, and we think that we're beginning to understand how the inspectors are going to interpret the rigs and how they are going to deal with it and we feel pretty good about our ability to get back to normal production once we sort of adjust to the new standard.

Shneur Gershuni - UBS

Great. Thank you very much, Don.

Don L. Blankenship - Chairman, Chief Executive Officer and President

Thank you.

Operator

Your next question comes from the line of Justine Fisher of Goldman Sachs.

Justine Fisher - Goldman Sachs

The first question that I have is just about 1Q production and I was wondering when you say lower production because you are continuing these mine changes, is that in steam or met coal and do you expect production to be on par with the fourth quarter, is that kind of a magnitude that you are talking about?

Don L. Blankenship - Chairman, Chief Executive Officer and President

I think that the shovel relocation, those tons, which if you extrapolate 600,000 lower half of the year to 300,000 in the quarter is steam coal. The Revolution longwall will lose 150 or so tons of met coal and we also have Logansport move which is probably going to cost us 80,000 tons in the first quarter of met coal. We also of course have a lot of start-ups, so it gets really confusing, start ups are always hard to predict how successful they'll be. So we don't know what they'll do in the first quarter, since we got about 8 mines online that haven't previously been online. So it's hard to predict, but we expect first quarter '07, '08 not to be measured but different and then we expect after that to be extremely strong.

Justine Fisher - Goldman Sachs

Okay. And then also on the cost side, I am assuming that the components of the $43 to $45 cost guidance is including safety and labor and raw materials and usual suspects. But can you talk about how many of those you think or how much of the cost is related to your mine change plan that maybe company specific and how much maybe the cost that will affect other Central App producers too?

Don L. Blankenship - Chairman, Chief Executive Officer and President

Well, our mine plan changes meaning where we are going to be mining like the shovel movement, longwall changes, the change in longwall to miner sections at Aracoma, those are all going to be, in our opinion, cost reduction exercise and so we expect meaningful cost reduction out of those changes. We did give considerable wage increases in order to make sure our work force was stable and incentivised to do these packages.

So my guess is that number is up as much as $8 million or $10 million on the labor side. And in addition to that, we have hedged quite a bit of diesel fuel, but we are still going to come in most likely about $20 million higher on diesel fuel in '08 than we did in '07 despite both years having successful hedges, so that's across the board about $0.50.

Once you get outside diesel fuel and labor and the normal switching of the transition, I should say and normal thing we don't see too much else that should bump the costs. In fact we've also spend a lot of capital on cost reduction, without lands and so far so -- other than a direct hit from diesel fuel and labor and swap you don't feel the commodities, we think everything else is mitigating efforts on costs cutting capital and a change in a mix of production.

Justine Fisher - Goldman Sachs

Okay. And then I just had one last question on '09 coal sales. I know that you guys appeared to have about 4 million tons of steam coal left and it doesn't seem like the utilities are approaching you to sell it, but at $70 first of all, would you sell Central App '09 coal at $70? And second of all, how if at all do you think you are mostly price position is affected your contract negotiating position in Central App for '09, vis-à-vis, the other producers that may have more coal open for pricing?

Don L. Blankenship - Chairman, Chief Executive Officer and President

I don't think there is much of any impact on what our so position is. I mean if we bid or offer coal to a utility I think the prospect is one of the better suppliers, so I think that we can do what we will there. I don't know the market right now on Central App steam coal is probably north of $70. So what we would do would depend on quality, depend on shift point and so forth, but it's in the range of what we would expect.

Justine Fisher - Goldman Sachs

But it doesn't seem like you are holding out the way for Central App steam goes to 80 you probably sell it if you're approached now?

Don L. Blankenship - Chairman, Chief Executive Officer and President

We might, I mean we don't have... how much steam coal did you show in there, Eric? We are showing a couple of million tons that's '09. But in essence, what we will do with what coal we have left is sell it as we're approach as opposed to be pushing it in the market and we are confident that we will sell in the $70 plus range.

Justine Fisher - Goldman Sachs

Okay, thanks so much.

Don L. Blankenship - Chairman, Chief Executive Officer and President

Thank you.

Operator

Your next question comes from the line of Mike Molnar of Goldman Sachs.

Michael Molnar - Goldman Sachs

Hi, good morning everyone.

Don L. Blankenship - Chairman, Chief Executive Officer and President

Good morning.

Michael Molnar - Goldman Sachs

If we look at the export market and if we take say, 50 million tons as sort of a baseline for exports from 2004 to 2006, how many tons in your judgment could we export may be in 2008-09 and how do you think about those ton if that could come out?

Don L. Blankenship - Chairman, Chief Executive Officer and President

Well, I think there is reason to believe if you get to 90 million tons in '09 what's happened, of course, to export terminals haven't been under pressure. So we really don't know what they can do about squeezing out efficiency and it's easier to export steam coal vessel than it is the met coal vessel and so for so, it's hard to predict those numbers plus you got New Orleans, which has not been moving hardly any coal. But I think you could do 90 million tons if everything else were aligned.

Michael Molnar - Goldman Sachs

Okay. And just a quick question, you mentioned in the press release for 2010 it's possible that you might get to mid to upper 60s in terms of your average realized price. Can you just walk us through some of the back-of-the-envelope math or estimates by segment for utility, met, industrial as you get to those numbers.

Don L. Blankenship - Chairman, Chief Executive Officer and President

Well, you can sell our 2010 steam coal right now for $67. So get into mid upper 60s range is not hard, when you get 25% or more met coal. But I would think we would sell our stream coal on the 21 million unsold tons that we would sell it in 60s and as we said earlier, we don't know where the met coal is going to be, but we got 9 million unsold 2010 tons of met coal and we have now got it in the number around 87 but it can go to 100. So I don't know where that number will be. We've only sold like 103 million tons out of our 12 in 2010, so it could be $20 higher than that if it's like it is today.

Michael Molnar - Goldman Sachs

And just related to the met coal, can you just remind me the quality you got to breakout your met coal what the percentage of high versus low grade met coal will be.

Don L. Blankenship - Chairman, Chief Executive Officer and President

It's always tough because it's sort of like a lot of other things, in the eyes of the beholder, what their situation is and what kind of coal business they have. But the thing to remember about us is we have extremely high quality met coal on the average. And I have said before on these calls that our metallurgical, high-vol coal allows the coke ovens to run faster and does less damage them to them and therefore it gets a really premium price when there is a coke shortage. So we would easily see some of our Marfork coals in the $170 plus range in '09, 010. So the other... the percentage wise, we've probably got, I don't know 70% of our coal that we would classify extremely high quality that goes on the met side and 30% perhaps that's mid to high. But we don't have any if you will, low-quality coal.

Michael Molnar - Goldman Sachs

Okay, great. Thanks Don.

Don L. Blankenship - Chairman, Chief Executive Officer and President

Thank you.

Operator

Your next question comes from the line of John Bridges of J.P. Morgan.

John Bridges - J.P. Morgan

Hey Don, everybody. I'm just trying to reconcile like some other guys on the call, this permitting issue and its impact. I think there is a sense at the end of last year that by now we'd begin to see some pressure coming through on tonnage, but Central App tons seem to have been holding up reasonably well. What's your sense as to what's happening to other guys realizing that you've got some of the better reserves down there, so you're less affected?

Don L. Blankenship - Chairman, Chief Executive Officer and President

I've only known of one specific mine that went out and I think it was probably a 500,000 ton mine as a result of Chambers or at least was said to be substantially part of Chambers. I think everybody is sort of on a fuse and everybody is looking for mitigation opportunities, if the Chambers were not overturned, we would be hauling the rock further to get it off of us and we would be back stacking more of it, which is more expensive, and doing a lot of things to try to mitigate it. And I'm sure they're competition would too, so I don't know that we fully understand our mitigation opportunities, let alone our competitors.

But we didn't anticipate... going to part of your question, much impact by now. Most of the impact will occur in '09 and '2010, but again, we think that there is a process to get permits that comply even within the Chambers ruling, if this takes a lot longer. So by the time we go out to say 2010 or 2011 it may have less impact than it would have in 2009.

John Bridges - J.P. Morgan

Okay. But even if you get a favorable ruling by mid-year, surely that's going to create a backlog and a hole in the production profile?

Don L. Blankenship - Chairman, Chief Executive Officer and President

Little bit, but in some cases, these permits are approved by the Corps of Engineers and I don't know if Shane wants to add to it, but if you overturn the opinion, the permits are already there, they are not like they are held in abeyance and we got to go through a process just like their issue, but they are held up and when the court ruling were to be overturned, we would hope that they would be immediately released.

M. Shane Harvey - Vice President and Assistant General Counsel

That's the case as to the forward issue, yes.

John Bridges - J.P. Morgan

Okay, and that's helpful. Thanks, Don and everybody.

Don L. Blankenship - Chairman, Chief Executive Officer and President

Thank you.

Operator

Your next question comes from the line of John Hill of Citi.

John Hill - Citigroup

Great. Thanks for the endurance on the call everyone.

Don L. Blankenship - Chairman, Chief Executive Officer and President

No problem. We appreciate you all for taking the time to ask us some questions.

John Hill - Citigroup

Sure. Well, the most of the headline ones I think have been asked, but just curious, with regard to the $22 million impact to EBITDA from the Harman case, what line in the income statement would that be included in?

Don L. Blankenship - Chairman, Chief Executive Officer and President

In the operating cash cost line and the $22 million interest is probably on the interest line, is that Eric?

Eric B. Tolbert - Vice President and Chief Financial Officer

Yes, specifically it's on the produced coal cash or cost of sales line, you'll find the $22 million in that line and then as Don mentioned, the impact of $11 million reversal on interest is in the interest expense.

John Hill - Citigroup

Right. So it's just the $22 million that is included in the per ton calculations and not the 11?

Eric B. Tolbert - Vice President and Chief Financial Officer

That's correct.

Don L. Blankenship - Chairman, Chief Executive Officer and President

That's correct and the 15 EPA is in that line as well.

Eric B. Tolbert - Vice President and Chief Financial Officer

That's correct.

John Hill - Citigroup

Very good. Thanks for the call, and we'll catch you later.

Don L. Blankenship - Chairman, Chief Executive Officer and President

Thank you.

Operator

Your next question comes from the line of Laurence Jollon of Lehman Brothers.

Laurence Jollon - Lehman Brothers

What was the operating cash flow in the quarter?

Don L. Blankenship - Chairman, Chief Executive Officer and President

$20 million or so, you got the exact number?

Eric B. Tolbert - Vice President and Chief Financial Officer

Yes, the change in cash was approximately I think $26 million. But I don't think we have disclosed the actual... the operating cash for the 10-K type cash flow statement yet.

Laurence Jollon - Lehman Brothers

Okay, thanks a lot.

Don L. Blankenship - Chairman, Chief Executive Officer and President

$26 million.

Laurence Jollon - Lehman Brothers

Thank you.

Operator

Your next question comes from the line of Jim Rollyson of Raymond James.

Jim Rollyson - Raymond James

Don, just one kind of 30,000 foot question here. You guys are undertaking obviously a pretty aggressive expansion plan over the next two or three years. You've been trying to get to some higher levels over the last four-five years and you have struggled for various reasons. Labor, productivity probably been one of them, what do you think your biggest challenges are in getting to 46 million tons, 48 million tons over the next two-three years. Is it labor, is it the permit issues that could cut some existing stuff, I mean what do you see today as the biggest risk for challenges to that?

Don L. Blankenship - Chairman, Chief Executive Officer and President

I think labor is by far the most uncontrollable, I mean, and that's the reason that we did that... went out and did what we did in advance of this. And it will be interesting to see what happens with this approach, but we intend to be very aggressive in maintaining and keeping our labor and we have demonstrated that to them with benefits and bonuses and deferred income and things at the hourly levels that you typically would see at the executive level.

So, we've demonstrated how much we value and need their service and going through a great deal of trouble, if a huge percentage of them under that top-up arrangement and at the same time we are incentivising new hires and so far so we have learned a lot of things from the last time for sustaining. You get up into $100 process, its... we get pretty wild, but certainly I think that we are better prepared this time than we were last time and certainly better prepared than anyone else is at this point.

Jim Rollyson - Raymond James

Yes. And it definitely sound like it. Do you think last time around it seem like one of the issues was a pretty good coal market environment and everyone was trying to get more coal out of the ground in Central App and that was people were taking labor off. Do you think this environment we are in today you'll see similar responses by Central App community in trying to get more coal out of the ground and it will become aggressive again?

Don L. Blankenship - Chairman, Chief Executive Officer and President

Well, I think that a lot of guys that jump shift last time ended up wanting to come back because they found that conditions weren't as good or that maybe the place they had gone didn't have the quality of equipment or the quality of programs that we have. So I think that there has been a learning process about some of the workforce in that regard. But the biggest difference doing this time and last time, we were trapped with hardly any net income model out of free cash flow and so forth, and this time we are not going to leave $10 million or $20 million of labor costs keeping us from keeping our labor.

So it's... if we get into a war, if you will, with our competitors about the labor then we've got of $400 million of liquidity and we are willing to fight for the labor this time even if it's few million dollars. Whereas the last time, we were number one, haven't seen that confident before, and number two, we weren't really prepared to respond as much as we are at this time.

Jim Rollyson - Raymond James

Very good. Thank you.

Don L. Blankenship - Chairman, Chief Executive Officer and President

Thank you.

Operator

[Operator Instructions]. Your next question comes from the line of Pearce Hammond of Simmons Company International.

Pearce Hammond - Simmons Company International

Don, just a follow-up question, can you provide an update on the Essar deal and has anything changed there, given the changes we've seen in the global marketplace here specifically with met coal?

Don L. Blankenship - Chairman, Chief Executive Officer and President

I went to India there in November and actually did almost a rollout tour and got to see what was going on up there first hand as opposed to read and write and I thought it was very educational. And when I got to know the Essar people, I was pretty impressed with them and nothing has changed there. We were very excited about the Essar JV because it's giving us some exposure to rollout markets and educating us and also giving us a chance to work with them, both abroad and in the North America. So we are excited about it, I would say that we're more excited about it now than we were at the time we signed the deal, even though we are still trying to figure out exactly what projects or what course to take.

Pearce Hammond - Simmons Company International

Thank you very much

Don L. Blankenship - Chairman, Chief Executive Officer and President

Thank you

Operator

There are no further questions at this time. Gentlemen, do you have any closing remarks?

Roger Hendriksen - Director of Investor Relations

Okay everybody. Thanks very much for joining our call. I appreciate your questions and look forward to speaking with you again soon. Thanks for your continuing interest in Massey Energy.

Operator

Thank you again for participating in today Massey Energy Company conference call, you may now disconnect.

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