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Arch Coal Inc. (NYSE:ACI)

Q4 FY07 Earnings Call

February 01, 2008, 11:00 AM ET

Executives

Deck S. Slone - VP IR and Public Affairs

Steven F. Leer - Chairman and CEO

John W. Eaves - President and COO

Robert J. Messey - Sr. VP and CFO

Analysts

James Rollyson - Raymond James and Associates

John Bridges - JP Morgan

Pearce Hammond - Simmons & Co.

Michael Molnar - Goldman Sachs

Michael Goldenberg - Luminous Management

Jeremy Sussman - Natixis Bleichroeder

Laurence Jollon - Lehman Brothers

John Hill - Citigroup

Michael Dudas - Bear Stearns

Luther Lu - Friedman, Billings, Ramsey

Paul Forward - Stifel Nicolaus

Gordon Howald - Calyon Securities

Mark Liinamaa - Morgan Stanley

David Gagliano - CSFB

Unidentified Analyst - Millennium Partners

Justine Fisher - Goldman Sachs

Operator

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

And 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 S. Slone - Vice President Investor Relations and Public Affairs

Good morning from a snowy St. Louis. Thanks for joining us this morning.

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 filed 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 would 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 second of our website at archcoal.com.

On the call this morning, as typical, 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 brief formal remarks, and thereafter will be happy to take your questions. Steve?

Steven F. Leer - Chairman and Chief Executive Officer

Thank you, Deck. And Good morning everyone and welcome to Arch Coal's fourth quarter and full year 2007 earnings conference call.

Today, Arch reported earnings per share of $0.56 and adjusted EBITDA of $143 million in the fourth quarter of 2007. The strong operational performance during the last three months suggest that the momentum is building as we enter 2008. For full year 2007, Arch reported EPS of a $1.21, making 2007 our second best year from an earnings performance in the Company’s 10 year history as a public company. Our best earnings performance record was in 2006 when market conditions were appreciably stocked stronger than in 2007. Given our current outlook, we expect to set a new earnings record in 2008 with meaningful expansion in the EPS and adjusted EBITDA.

I would like to take a few moments discussing highlights from 2007, as well as our view of our some of the trends in 2008 and beyond. In 2007, we estimate that U.S. coal consumptions rose by 2%, while domestic coal production declined by 1.5%. These trends helped to reduce building generator stockpile level. We estimate the generators entered the year holding 51 days of supply inline with last year’s level and probably indicative of the new target range going forward.

In 2008, we expect continued growth in power demand, although, at lower levels, given the forecast for a slower U.S. and economic growth. We further reduce and we believe this will further reduce generators stockpile levels. We also expect supply to… supply increases to lag, despite higher pricing. Due to the significant geologic quality and regulatory challenges facing several key U.S. supply days, in addition to the considerable amount of time it takes to add new capacity.

However, the biggest trend influencing U.S. coal markets in 2007 was robust export methane steam markets. Full imports into the United States were basically flat, while coal exports increased almost 10 million tons last year. More than 70% of this growth occurred during the second half of the year as markets began to heat up.

Today, in 2008, we have seen global coal markets strengthen even further in the wake of severe supply constraints and traditional coal export nations, particularly Australia, South Africa, and China. These are global supply constraints along with a weak U.S. Dollar have aided the movement of American coal to new places. The timing of our Mountain Laurel longwall startup has been ideal, allowing Arch to participate in a more significant way in strong export trends. We’ve exported Central App coal from our partially owned DTA term loan in Virginia, as well as Western Bit coal through the Gulf of Mexico to countries in Western and Eastern Europe, South America, Africa, the Middle East and recently, Asia. And we are in serious discussions to export our PRB coal to the Gulf of Mexico, a move that was last executed by Arch in 2005 as well as off the West Coast.

Given tight international supply conditions, we believe that these movements are all good and inevitable. We estimate that U.S. exports could reach nearly 80 million tons in 2008, representing a 30 million ton increase over 2006. Concerns have arisen over the potential U.S. port constraints as the industry is challenged with coordinating the logistics for rail, barge, and port movement. However, we do believe that it will be manageable, especially considering that the U.S. consistently exported more than 70 million tons annually in the 1990s and suppressed a 100 million tons to annually earlier in that decade.

Turning to the domestic market. No one seems to confidently know whether we are headed for or perhaps already in a recession. But it’s probably safe to assume that slower economic growth is likely for the first half of 2008. We have taken this into an account in our forecast and currently expect power generation in 2008 to grow roughly at one-fourth of its growth rate in 2007. But normal weather trends and continued strength in the global market should mute the negative impact of a weak U.S. economy in the short run.

Additionally, the U.S. is moving forward with the build out of new coal base generation. We estimate that 14 gigawatts of new coal-fueled capacity will startup over the next four years, representing approximately 50 million tons of incremental annual coal demand. At least seven gigawatts will be starting up and running by the end of 2009. Another eight gigawatts, representing an another additional 30 million tons of annual coal demand, are in advanced permitting stages. While this build out is the largest in the U.S. in over 30 years and is encouraging, it represents only a fraction of what is truly needed to expand and upgrade the country’s energy infrastructure.

Just look at the electric generation shortfalls in South Africa, that South Africa is experiencing today resulting from poor public policy decisions. We need to build more base load generating capacity in the U.S. to meet rising demand to replace antiquated plant and to prevent rolling brownouts and blackouts, and we believe coal is the best choice of fuel for that capacity. To combat coal’s poor perception by some, our industry armed with the support from coal base generators, railroads, and others have launched the campaign to educate the public about coal and to empower them to embrace America’s greatest domestic energy resource. Our vast domestic coal reserve… resources can help us to meet our growing energy demand needs with continued investments in coal and with continued investment in clean coal technologies can provide for a secure and clean energy future.

It is also important to note that the rest of the world understands and appreciates the invaluable coal role that coal plays in meeting rapidly growing energy requirement. Global coal demand is growing at a staggering pace, up 30% in just the past five years. In fact, China’s coal consumption could approach 3 billion short tons in 2008, which is nearly three times the size the U.S. market. India is targeting a sevenfold increase in its generating capacity by the end of the decade, much of it coal base and the rest of Asia is following the same business model.

Even European nations are in the process of doing an about face on coal due to the concerns excessive dependence on Russian gas, the inherent limitations of renewables for base load power and the still strong opposition to nuclear power in some countries. In addition, there is growing… a growing view in Europe that the developed world must drive advances in clean coal technologies thus providing emerging Asia with the tools they will need to address greenhouse gas emissions. According to Plat [ph] Europe has announced plans to construct more than 60 gigawatts of coal base power plants with roughly 10 gigawatts of these plants now under construction.

Lastly, oil continued to trade at elevated levels despite suggestions that crude has cratered when it falls below $90 per barrel. Research shows they are paying $3 a gallon for gasoline over an extended period time does impact the U.S. economy. That’s why we think it is good public policy to advance alternative sources of domestic fuel. Current coal to liquid projects such as our investment in the proposed DKRW Medicine Bow plant in Wyoming to greatly enhance America’s energy security and provide real economic benefits to our Company by bringing to market additional supplies of diesel and gasoline. We can also greatly reduce the carbon footprints of these clean fuels derived from coal by using the CO2 for enhanced oil recovery in our domestic oilfield such as our DKRW project envision.

Looking ahead, we believe 2008 will be a record earning year for Arch, given the favorable market trends we are currently experiencing, the strategic positioning of our operations to supply full market and the long-term energy needs of the global economy.

I will now turn the call over to our President and COO, John Eaves for further discussion of Arch’s coal sales and operating performance. John?

John W. Eaves - President and Chief Operating Officer

Thanks Steve. We had a strong operational performances as it reminds during the fourth quarter. All operating regions contributed almost equally to enhance the Company’s operating income in the quarter. Testament to Arch’s multi-regional strategy and to operating a diverse, but selective mine portfolio.

We are also pleased with the excellent startup of our Mountain Laurel Longwall in Central App. It’s an extremely competitive cost structure and substantial opportunity to sell in the robust, meth and polarized coal injection market This mine’s performance has exceeded our expectations today. In 2008, we believe the expected contribution from Mountain Laurel should help us significantly spend the regional as well as the overall Company’s operating margins.

Today, I would I’d like to recognize some of the most important accomplishments in 2007, and then provide some color on Arch’s sale and cost performance. In 2007, Arch ranked the first among major coal industry peers for safety performance as measured by total incident rate. Last year’s performance also represents our second best year on record for safety thanks to the success of new initiatives and our deep safety culture here at Arch. We’d like to thank each and every employee for their efforts and for keeping safety core value. Going forward, we will continue to remain focused on achieving our ultimate goal of zero incidents.

2007 also marks Arch’s best year on record for environmental stewardship and the best among our major coal industry peers as measured by the rate of Surface Mining Control and Reclamation Act Violations. We take our commitment to being a responsible stewards of the land seriously and go above and beyond in reclaiming former mine sites to natural and productive states.

Turning now to Arch’s sales strategy, we are pleased with the pricing levels achieved on our sales commitments signed during the quarter. With average spot pricing in the PRB and Central App up 50% and 34% respectively. During 2007, we believe that adherence to our market driven strategy has paid dividend. Today, we’ve committed a substantial volume of coal, principally for 2008 delivery into a strengthening market. We also retain significant upside as we head into 2009.

In Central App, the positive export story continues. We’ve committed significant volumes of meth coal from Mountain Laurel at prices up to 70% above the current domestic steam coal index price level. We’ve also been successful in blending some of our Lone Mountain Pardee for sale in the domestic and export meth markets, and we are committing steam coal for export for 2008 delivery at premium index prices.

In Western Bit, we’ve committed tons for export via rail and via Gulf of Mexico., at a substantial premium to prevailing fourth quarter index pricing for the region. We’ve also sold coal to Eastern generators at attractive pricing to fill the gap in supply as Eastern coal increasingly moves offshore. In the PRB, we’ve committed coal for delivery in 2008, and to a lesser extent, 2009, at pricing that exceeded the prevailing fourth quarter indexed pricing for the region. We’ve also priced a meaningful amount of PRB coal that was previously committed but not yet priced for 2008 delivery at an attractive level.

Our objective today has been to focus on near term agreements while preserving our upside potential in future periods. Looking ahead, we will continue to be market driven, and will enter into commitments that offer an attractive return, while leaving upside potential to benefit from our positive long-term view of coal market fundamentals.

In 2008, we have un-priced volumes of between 15 million and 25 million tons, a meaningful portion of which is already committed but not yet priced. Additionally Arch’s un-priced volumes are between 85 million and 95 million tons for 2009, and between 95 million and 105 million tons for 2010. On the cost side, we were mainly focused on maintaining nimble operations that are flexible to respond to the market demand. We will also remain focused on managing our controllable costs while eliminating non-essential capital spending, streamlining our operations and implementing programs that aid in containing rising commodity and input costs.

On a regional basis, our operating costs in the PRB were essentially flat in the fourth quarter, as we were able to offset commodity cost pressure with cost reduction and control in other areas. Operating costs in Western Bit region declined over $3 a ton in the fourth quarter due to absence of any longwall moves.

Going forward, we will continue to target average operating costs per ton in the $19 to $21 range which incorporates expected impact of future longwall moves. In central App cash costs declined under $39 per ton benefiting from the start of our low cost Mount Laurel operation in October. This strong cost performance was able to essentially offset higher sales sensitive costs and higher DD&A expenses, well significant commodity cost pressures in the quarter.

Looking ahead, we’re off to a good start and believe we have positioned the Company well to capitalize on a stronger market in 2008.

With that, I will now turn the call over to our CFO, Bob Messey.

Robert J. Messey - Senior Vice President and Chief Financial Officer

Thank you, John and good morning everyone. I’d like to briefly highlight some key items from 2007 and then focus on our outlook for 2008. The end of the year, the total debt was $1.3 billion and a debt to total capital ratio of 46% which is essentially the same level at which we began 2007. In a year that included significant investments to the start up of our Mount Laurel operation, the third of five reserve payments in the PRB and a opportunistic reserve addition in the Illinois basis we consider it a notable achievement to have held this ratio constant. We are comfortable with a debt level in this range going forward and coupled with our very low level of legacy liabilities we believe that Arch has one of the strongest balance sheets in the coal industry.

During the quarter, we announced that we will further streamline our capital structure by redeeming any remaining preferred shares as of today. This process will simplify our capital structure without having any material impact on our operations. We also expanded our commercial paper program by $25 million. As we continue to improve our balance sheet with attractive sources of low cost liquidity. On the tax front, we recognized that income tax benefit of $35 million from a reduction in our valuation allowance in the quarter. Previously we had established a valuation allowance to reserve for NOL carry forwards and end the tax credits that were not expected to be utilized. Based on our current projections of future profitability, we expect to utilize more base assets and have reduced the valuation allowance accordingly.

Now let me turn to the outlook for 2008. We currently expect earnings per share of between $2 and $2.50 and adjusted EBITDA in the range of $680 million to $790 million. This will be records for Arch. Sales volume on Company controlled operations will range between a $135 million and a $140 million tons. This range excludes all brokered activity that Arch employs in its trading activities with the global maximizing margins as well as the past returns that Arch currently services. We expect capital spending, excluding reserve additions to range from $310 million and $340 million with approximately $250 million allocated for maintenance capital to sustain Arch’s current level of production. At least a $100 million of this $250 million maintenance capital bucket will be earmarked for the transition to a new coal seam, the E seam at our West Elk mine, Colorado, and includes the cost first seen in new longwall. We will also spend $65 million to complete the construction of Black Thunder’s west loadout.

We currently anticipate spending between a $135 million and a $165 million on reserve additions. This estimate includes the fourth of five payments on our Low Thunder reserve in the PRB and anticipates additional reserve plays as opportunities arise throughout the year. As is typical in our operations we expect to spend a significant portion of our capital first quarter of the year. ED&A expense for 2008 is expected to range between $280 million and $290 million. Further we expect our annual tax rate to be between 8% and 14%. This guidance includes the realization of excess tax accretion, NOL tax benefit AMT tax credits and contemplates the potential for additional valuation allowance adjustments.

Looking ahead, we expect the first quarter to be a solid quarter. Or at least you should note that because of the expected timing of international shipments as well as contract re-pricing that will likely be the… weak, weaker than subsequent quarters. As you can see from our projections, we expect to generate free cash flow in 2008 and we will deploy that cash for we believe it will provide the greatest incremental returns to our shareholders. The four pronged approach will consider these opportunities as we evaluate returns offered. Organic opportunities that will further expand and upgrade our reserve base, acquisitions or divestitures that are accretive to earnings and enhance value, other strategic investments including BT new conversion technologies and not only expand the market for coal but also change coal’s value proposition in the market. And consider shareholder returns in the form of repurchases and dividends.

With that we are ready to take questions. Operator, I will turn the call back over to you.

Question and Answer

Operator

Thank you. [Operator Instructions].

We will take our first question from Jim Rollyson with Raymond James and Associates. Please go ahead.

James Rollyson - Raymond James and Associates

Steve, Peabody gave us their view yesterday on kind of sustainability of a recent top end PRB prices. I want to kind of get your thoughts on where you see that sustainability, are you guys starting to actually book all in the mid teens for PRB or are you still, at least, this in your contract position, you are still holding out a lot of production for maybe even higher prices. What’s the thought there?

Steven F. Leer - Chairman and Chief Executive Officer

Well, I think we probably start unfold or un-priced positions for 2008/9 and 10. Our view of the marketplace has now changed. We see continuous strength building in ’08 and in ‘09 certainly and we continue to have a significant un-priced position for all three of those years. And the pricing is building, I think one of the things… the demand is building. One of the things that which we spend a lot of time in doing is trying to think through where PRB might go and you’ve certainly seen kind of a normal base load growth assuming we grow at about a quarter of the rate we did last year in electric generation, but that’s 3 million to 5 million tons of PRB, additional demand, year over year, and we’ve seen new demand in the Eastern market has been the story, and we’ve been contacted by customers, as the Eastern coal gets exported, or gets consumed, or the supply constraint gets realized. You certainly see additional coal moving East, and that could be anywhere from 13 million to 15 million or more million tons per year. And then drill into the export market which is developing for PRB, which I think is open yet to see where that number finally comes out, other than that we were pretty confident there was going to be some.

And then a lot of folks haven’t thought through the new plant coming online in the second half of 2008 and on in the 2009 , that is you have two developments. You start testing the coal, you start building your base for the stockpile and then obviously you start building the stockpile for running the plant. And we see another 4 million or 5 million tons being absorbed out of the market place, so we’re feeling pretty confident and we continue to believe that there’s more upsides than downsides. Having said that, we’ve always said, we are not smart enough to pick the top from bottom of the market and in a rising, strengthening market, we will layer in sales as we move forward, and that view hasn’t changed.

James Rollyson - Raymond James and Associates

Obviously based on your portfolio, you are not ready to concede the top yet so, it’s good. This is a follow-up, could you guys possibly provide any guidance… detailed guidance, on your shipment volumes that you’ve given us, maybe between regions kind of roughly what you expect out of the three regions.

Robert J. Messey - Senior Vice President and Chief Financial Officer

We really haven’t got into that in the past and we prefer not to again. But we’ve always suggested as you look at our past production numbers, that our pro rata modeling is always a pretty sound assessment.

James Rollyson - Raymond James and Associates

Fair enough. Thank You.

Operator

And we’ll now take our next question from John Bridges with JP Morgan.

John Bridges - JP Morgan

Hi Steve. John Bridges.

Steven F. Leer - Chairman and Chief Executive Officer

Hey John. How are you?

John Bridges - JP Morgan

I am fine. Congratulations on the results.

Steven F. Leer - Chairman and Chief Executive Officer

Well thank you. The guys, throughout the company did a very nice job this last quarter.

John Bridges - JP Morgan

Well done. On a few of the export thing, that… there had been talk about shipping that out of Vancouver. Now we are talking New Orleans. Could you give us a little more, sort of color on that and how much you think will go through New Orleans?

Steven F. Leer - Chairman and Chief Executive Officer

Well it remains to be seen. We are in some serious discussions. In the past we have seen exports through New Orleans both Eastern and PRB coals and we have done that at the company. It really comes down to the market place and the shortage in the international market places. Within a reasonable number I don’t see there is a limit on the upside, it’s just what the market place will demand. So, if it is a 500,000 tons, a million tons, a couple million tons, it’s all doable, depends on the market.

John Bridges - JP Morgan

Interesting. And then there is a follow up. I was intrigued by your comments about Energy securities, I was talking to one of our utility people the other day and they were pointing out that the… there were areas where the reserve coverage on the Eastern seaboard was getting down towards that magical 15%. I just wondered what are your thoughts on that?

Steven F. Leer - Chairman and Chief Executive Officer

Well I do, and it deserves a lot more discussion than we have time for, but we have spent time with various utility customers and consultants and pictorially if you project out 10 or 15 years and have good government forecast of 1.8% annual growth on average in electric needs, the entire nation for the most part starts facing those energy reserve questions. And given the fact that we are not building probably enough power plants as quickly as we need, I think it is an almost inevitable outcome that those two lines end up crossing and we save some issues down the road and the exact timing will obviously depend on economic growth and demand. But, we are going to need all of our energy sources and we are seeing that in the world. South Africa is a great example where energy choices were suggested in the late 90’s that they needed to build the plants. They didn’t do it for budgetary and other concerns and we see the condition that they are in today. And of course China is growing so dramatically, they just can’t build them fast enough. At the end of the day more people use more electricity and we are going to need every energy source that the world can provide to meet those demands.

John Bridges - JP Morgan

Okay. Great. Thanks to you and good luck.

Steven F. Leer - Chairman and Chief Executive Officer

Thank you.

Operator

Our next question comes from Pearce Hammond with Simmons & Co.

Pearce Hammond - Simmons & Co.

Yes. Good morning and congratulations on great results.

Steven F. Leer - Chairman and Chief Executive Officer

Thank you Pearce.

Pearce Hammond - Simmons & Co.

Bob, your comments on Q1 I actually couldn’t catch it, were you saying Q1 was going to be a solid quarter and what were you seeing in longwall moves just trying to get a sense of Q1?

Robert J. Messey - Senior Vice President and Chief Financial Officer

I didn’t touch the longwall moves but basically we see Q1 being a little weaker than the rest of the quarters because of the timing of our international shipments and the way we pricing of contracts was end of the year.

Pearce Hammond - Simmons & Co.

And then for cost guidance for next year by basin, if you were to give a rough percentage increase ’08 over ’07, that would be helpful?

John W. Eaves - President and Chief Operating Officer

No Pearce. This is John, as we said last call we are going to probably hit 3% to 5% range on our costs. I mean as you can see about our fourth quarter, we have done a pretty good job in managing our costs and we will continue to do that, but there are certainly a lot of cost pressures on the diesel side, on the tire side, so let’s… let’s think we continue to monitor certainly in Western Bit, we didn’t have any longwall moves during the fourth quarter. So, as we go into the first quarter we are actually in a longwall move right now at one of our Western Bit mines, so we will have some cost pressures; but we feel pretty good about where our costs are moving forward right now.

Pearce Hammond - Simmons & Co.

So, again that 3% to 5% is a good percentage?

John W. Eaves - President and Chief Operating Officer

It’s a good range to look at.

Pierce Simmons – Simmons & Company

Okay, thank you.

Operator

Your next question comes from Michael Molnar with Goldman Sachs. Please go ahead.

Michael Molnar - Goldman Sachs

Very good morning everyone.

Steven F. Leer - Chairman and Chief Executive Officer

Hi Mike.

Michael Molnar - Goldman Sachs

Can you just remind us? How much do you export now and where could you see that going in 2009. I’m just trying to get an order of magnitude of the tons that you could export in a couple of years than what you do now?

Steven F. Leer - Chairman and Chief Executive Officer

Well Mike, it’s really hard to say right now, because we are in so many discussions with a lot of our international customers, but I would suspect that we will have exports in excess of five million tons for the Corporation during 2008. Like I said we still have discussions going on right now, we have a lot of domestic, metallurgical agreements that go within the states, but I would say five plus million between Steam and that will be exported this year.

Michael Molnar - Goldman Sachs

Okay. And the… I missed… I apologize. I missed the number of the… the reserve editions. I know you have the CapEx of $310 million to $340 million. What was the reserve edition number again?

Steven F. Leer - Chairman and Chief Executive Officer

$135 million to a $165 million and the majority of that again is our little blunder. Payment.

Michael Molnar - Goldman Sachs

Okay. Great. Thank you very much.

Steven F. Leer - Chairman and Chief Executive Officer

Thank you.

Operator

And we will now go to Michael Goldenberg with Luminous Management.

Michael Goldenberg - Luminous Management

Good morning guys.

Steven F. Leer - Chairman and Chief Executive Officer

Good morning Michael.

Michael Goldenberg - Luminous Management

Sorry, I might have missed part of the call but can you go over… about Western by Bituminous' lower costs per tonnage, and if that’s expected to continue because I do remember you guiding to somewhat higher costs a while back and now I am seeing it perceptively lower, if you can talk a little bit about that?

Robert J. Messey - Senior Vice President and Chief Financial Officer

Yes, we didn’t have a longwall move during the fourth quarter so, we didn’t have that cost impairment but I will say the mines ran very well during the quarter and we expect them to continue to run well. As we move into 2008 we do have one longwall move during the first quarter that will impact our costs, but the range we have given you of $19 to $21 per ton is a good range for 2008.

Michael Goldenberg - Luminous Management

So even though your… your actual cash costs were like $13 you are still saying that would be $9 to $21 or you mean all in?

Robert J. Messey - Senior Vice President and Chief Financial Officer

I’m saying all in will be $19 to $21.

Michael Goldenberg - Luminous Management

Understood, and secondly, I just wanted to understand when you say you sold up to 70% higher of current spot prices. Spot prices are of which date because obviously those are moving around very quickly. So, is it average spot prices for Q4 or is it today’s spot prices, which ones are you referring to?

Robert J. Messey - Senior Vice President and Chief Financial Officer

That would be from recent spot prices, so…

Michael Goldenberg - Luminous Management

That will be from last shipment?

Robert J. Messey - Senior Vice President and Chief Financial Officer

Yes, that matches and that compares I think to the steam index.

Steven F. Leer - Chairman and Chief Executive Officer

70% versus today. Somewhere in the $70 range for that steel price?

Robert J. Messey - Senior Vice President and Chief Financial Officer

Yes.

Michael Goldenberg - Luminous Management

So 70% higher than 70?

Robert J. Messey - Senior Vice President and Chief Financial Officer

Yes.

Michael Goldenberg - Luminous Management

Got it. Okay. Thank you very much.

Steven F. Leer - Chairman and Chief Executive Officer

Thank you.

Operator

Our next question comes from Jeremy Sussman with Natixis Bleichroeder. Please go ahead.

Jeremy Sussman - Natixis Bleichroeder

Steven, congratulations on Mountain Laurel.

Steven F. Leer - Chairman and Chief Executive Officer

Well, thank you.

Jeremy Sussman - Natixis Bleichroeder

First question is in terms of exports. What are you seeing on the steam side, are you seeing a lot of essential steam coal making its way, out of the… out of the marketplace. I guess what is the opportunity for that as we look forward?

Steven F. Leer - Chairman and Chief Executive Officer

We see a lot of interest on the utility side, we are exporting a number of vessels right now on the steam side, we see that interest continuing, and we’ve had a number of discussions for multi-year agreements. So, we would expect that to continue as we move into 2008.

John W. Eaves - President and Chief Operating Officer

And it’s not just in Central App, you are also seeing Western Bituminous coal move into the steam market, in that port and then, those… last corollary question there would be we are seeing steam coal indirectly leave because it’s being… the really high quality steam coal has been drawn into the metallurgical market, and in turn being exported as metal.

Jeremy Sussman - Natixis Bleichroeder

So, and I guess piggy backing on that last point for… for 2008, as it relates to Mount Laurel. Can you give us a rough idea of how much of that will be making it’s way into the meth market versus the steam market?

Steven F. Leer - Chairman and Chief Executive Officer

Well, our goal is to push as much into the meth market as we can, given the current market conditions. I mean we have given guidance in the past between four million and five million tons and we still stick with that… that guidance. And that will be between domestic meth and international meth and maybe a little steam in here depending on what happens in the market.

Jeremy Sussman - Natixis Bleichroeder

Okay. But the majority, it looks like will go into the meth market?

Steven F. Leer - Chairman and Chief Executive Officer

That’s correct.

Jeremy Sussman - Natixis Bleichroeder

Okay. Well, great. Thanks very much.

Operator

Next up is Laurence Jollon with Lehman Brothers.

Laurence Jollon - Lehman Brothers

Good morning. I… your comments around free cash flow used in ’08. I can appreciate that. I just curious to know about your revolver borrowings, because there is roughly, I guess, $250 million right now. I know you are prohibited from paying down obviously your notes and most of the other debt's permanent, but I want to get sense for how willing you are to pay down some of your revolver borrowings in '08?

Robert J. Messey - Senior Vice President and Chief Financial Officer

Well, actually the revolver borrowing at the end of the year is only $160 million. We also have a $75 million CP program that’s in the short-term debt. So, that leaves us approximately $640 million of liquidity. As case would come in, we definitely pay down that revolver, that would be the first thing we do as we look at the other opportunities.

Laurence Jollon - Lehman Brothers

Okay. And then secondly, your free cash flow in the fourth quarter seemed a little light or seems to be a significant use of cash more than capital. Do you have any color there? What’s the seasonality?

Robert J. Messey - Senior Vice President and Chief Financial Officer

I am not sure that we thought about that. I mean, there might have been just between vacations and payments. There might have been some movements back and forth, but there wasn’t anything particular

Laurence Jollon - Lehman Brothers

Okay. Thanks very much.

Operator

We will now go to John Hill with Citi.

John Hill - Citigroup

Great and thanks for the detailed presentation.

Steven F. Leer - Chairman and Chief Executive Officer

Okay, John. Thank you.

John Hill - Citigroup

Just on the subject that was discussed a few moments ago, on the kind of migration from thermal… steam markets to meth. In the past, we’ve talked about opportunities at Cumberland and Lone Mountain to switch back and forth between steam and meth. Are we doing this now? And if so, are we buying coal elsewhere to offset prior commitments into the steam market.

John W. Eaves - President and Chief Operating Officer

John, we are doing that. We are actually out… our trading group has been buying coal pretty regularly to free up tons to go to the meth market .So, they will buy against our steam for steam shipments and free up the meth. We’ve also been very successful in blending our Cumberland River and Lone Mountain products on the meth as well as the polarized coal market. So, we continue to be optimistic that those two operations will play a bigger role in the meth market with Mountain Laurel.

John Hill - Citigroup

How much does that add you think to the total meth volumes as we go from ‘07 to ‘08, not from Mountain Laurel that’s pretty well understood, but from this migration effect.

John W. Eaves - President and Chief Operating Officer

I mean, it could add plus 25% and we are trying to maximize as much as we can, but it would be at least 25% of the total.

John Hill - Citigroup

Great. And next question. Any update on diesel fuel hedging and what is essentially the planning basis for fuel costs that is embedded in the cost guidance.

Robert J. Messey - Senior Vice President and Chief Financial Officer

We currently have 40% of our volume which is around 40 million gallons hedged to date.

John W. Eaves - President and Chief Operating Officer

Total volume… requirement is 40 million gallons.

Robert J. Messey - Senior Vice President and Chief Financial Officer

And we have 40% of that and we expect to be closer to 70% to 80% hedged in the latter part of the year as we move into the market. Our hedge is about 280 and that’s kind of where we see the market right now. So, we’re layering that in as we see opportunities, but the 40% range is a pretty good number right now and 280.

John Hill - Citigroup

Very good. Thank you.

Operator

We will now to go to Michael Dudas with Bear Stearns.

Michael Dudas - Bear Stearns

Good morning, gentlemen.

Steven F. Leer - Chairman and Chief Executive Officer

Good morning, Michael.

Michael Dudas - Bear Stearns

Pretty cold in St. Louis today, isn't it?

Steven F. Leer - Chairman and Chief Executive Officer

It is. It’s gorgeous outside.

Michael Dudas - Bear Stearns

Of course.

Steven F. Leer - Chairman and Chief Executive Officer

10 inches of snow.

Michael Dudas - Bear Stearns

I figured that. First question, less… obviously, on the meth side, maybe for John. Your Mountain Laurel product, so you probably priced that last week or so two weeks to maybe 120 per ton at the mine, is that a reasonable price?

John W. Eaves - President and Chief Operating Officer

Michael, I won’t give you prices. But I will tell you we’re very pleased with some of the pricing we’re seeing. You’ve been reading the trade rags about recent pricing. And I can tell you most of that’s true plus some. So, we’ve been very pleased with the pricing we’re getting on our Mountain Laurel.

Michael Dudas - Bear Stearns

Okay. So, the answer is yes to that. Now secondly, are… this is to follow-up that part. How you are thinking about… are you thinking get it contracted quickly or because obviously have you waited a week you might have got a better price, how you thinking about layering that in? And can you use this is advantage to maybe block-in two or three year term business with maybe potentially some customers and lock-in such a pretty good margin.

John W. Eaves - President and Chief Operating Officer

Michael, we still have a meaningful volume to place in the meth market. We’ve been patient. We’ve got some pretty good opportunities as well. We have placed multiyear agreements for meth coal at very attractive pricing, and we continue to focus on that. So, we have serious negotiations going on right now about further contracts on the meth side, but we have completed some multiyear agreements.

Michael Dudas - Bear Stearns

My second question is for Steve. Looking at the Company this year, certainly, you are going to be generating some strong free cash. You’ve finished up your Eastern expansion. How is Arch going to look differently over the next 12 to 24 months? Are there enough organic projects to grow the Company? Is there something bigger and better out there? Where do you see the Company position after you’ve gone through this pretty strong capital spending program to grow the Company to get bigger or position it differently either in domestically or internationally?

Steven F. Leer - Chairman and Chief Executive Officer

Well, I think you hit on it, where you are wrapping up a fairly significant capital program. The timing looks awfully good on that. And we think between the combination of where the balance sheet is, where are really non-debt liabilities lie, we are in great shape. There are certainly opportunities we believe over the next year to two years for potential acquisition. We will look at them, if they make economic sense. And strategic sense, we will take a very hard look at them. And we can act on almost any size that we want to. Flip side to that is there are some additional internal growth projects that we could start to implement if the markets demand that coal. And then thirdly, and we have always believed this that our goal is to create shareholder value and if we can’t find good investments for that cash flow then one way shape or form, it will get returned to the shareholders.

Operator

Our next question comes from Luther Lu with Friedman, Billings, Ramsey.

Luther Lu - Friedman, Billings, Ramsey

Hello, Steven and John.

Steven F. Leer - Chairman and Chief Executive Officer

Hi, Luther.

Luther Lu - Friedman, Billings, Ramsey

Congratulations on a great quarter.

Steven F. Leer - Chairman and Chief Executive Officer

Thank you sir.

Luther Lu - Friedman, Billings, Ramsey

My question is related to the Western Bituminous coal. How much of it is a lack of contract you still have left? And how fast is it rolling off?

John W. Eaves - President and Chief Operating Officer

Well, Luther, I can’t give you an exact volume, but we do have significant roll-offs in 2008/2009. So, I think you will continue to see that margin expansion at that region over the next 12 to 24 months.

Luther Lu - Friedman, Billings, Ramsey

Okay. Great. And you gave the on…contracted volume for 2009, but what is your rough production target in 2009?

John W. Eaves - President and Chief Operating Officer

I don’t know that we have given guidance on it. It’s going to be comparable to the 135 to 140 total volume right now and you just prorate that to come up with the various regions.

Luther Lu - Friedman, Billings, Ramsey

Okay. Great. And the multiyear contract you mentioned for Mountain Laurel, is that for meth or for steam?

John W. Eaves - President and Chief Operating Officer

Well, the ones we have done thus far is meth, but we also have had some success on some multiyear agreements on the steam side. We are finalizing negotiations, but certainly, in our Western Bit region. We have had some success on export multiyear agreements.

Luther Lu - Friedman, Billings, Ramsey

And by multiyear, you mean three years or more?

Steven F. Leer - Chairman and Chief Executive Officer

Two to three.

John W. Eaves - President and Chief Operating Officer

Two to three is probably a good way to look at it.

Luther Lu - Friedman, Billings, Ramsey

Okay. Is it a large amount or 0.5 million tons, 1 million tons?

John W. Eaves - President and Chief Operating Officer

Meaningful volume, Luther.

Luther Lu - Friedman, Billings, Ramsey

Okay. Thank you very much.

Operator

And next up is Paul Forward with Stifel Nicolaus.

Paul Forward - Stifel Nicolaus

Thanks. Good morning.

Steven F. Leer - Chairman and Chief Executive Officer

Good morning Paul.

Paul Forward - Stifel Nicolaus

You gave the 19 to 21 numbers for Western Bituminous Do you have comparable all in cost expectations that you could share with us on central App and PRB.

Steven F. Leer - Chairman and Chief Executive Officer

Paul, certainly we would have been pleased with the start up from Mount Laurel and continue to expect a depth that will perform well. But I think if you look at all-in cost and as we publish those in that mid 40’s range that you would be pretty close. Obviously our cash cost will be much less than that but all-in costs I think in that mid 40’s would get you pretty close on your modeling.

Paul Forward - Stifel Nicolaus

And for the PRB.

Steven F. Leer - Chairman and Chief Executive Officer

PRB again we are 4% or 5% increase or 3% to 5% increase in costs. The one number that a lot of people kind of get confused on sometimes in the part of the model in one respect, is when you are doing all-in, you have to take the sales sensitive costs. So, as pricing improves that cost number all-in goes up dramatically or can go up dramatically, which is a good thing.

Paul Forward - Stifel Nicolaus

Right. Then I am sure we are going to see some of that over the next couple of years. Just also, with the increased capital expenditures and the development projects you are working on, your customers are seeing sticker shock, are you seeing sticker shock on equipment or anything else as you go through the process.

Steven F. Leer - Chairman and Chief Executive Officer

Yes. Depends on your starting point of course. I mean we have all seen steel prices and equipment pricing jump over the last 3, 4, 5 years, I think, I should do truck loaders spread, probably have double or maybe tripled on 4 or 5 years ago. So, and it really becomes critical when you think about those things because if time and money and the easy expansion opportunities on all basins have pretty much have been done. And it’s not to say that, some basins couldn’t eventually expand further, they can. But it takes time, and it takes additional money of a large amount to have a truck and loader spread to a PRB mine or whatever. So, we’ve seen those sticker shocks, and all we are doing is trying pass them through.

Paul Forward - Stifel Nicolaus

Okay. And thanks a lot.

Operator

We will now take a question from Gordon Howald with Calyon

Gordon Howald - Calyon Securities

Good morning guys

Steven F. Leer - Chairman and Chief Executive Officer

Good morning Gordon.

Gordon Howald - Calyon Securities

Could you maybe, what is the likelihood, or maybe you can you just discuss the opportunity, even if you’ve considered accelerating Illinois basin production given the position that you have out there. Just trying to get some color on the opportunity you might see at this point from that region.

Steven F. Leer - Chairman and Chief Executive Officer

Gordon, I've been almost the other way. As I look out and look at the Illinois basin and particularly the big reserve basins in the Illinois fix and at the very high sulfur coal and until the scrubbing base really gets established and up and running in the heat which is still several years away. I just have trouble walking into the board and asking them for $300 million or $400 million to put in a 6 million or 7 million ton a year longwall mine. I think it’s coming. But I would say it's more closer to the middle of the next decade than today because just where the scrubbers sit in the East.

Gordon Howald - Calyon Securities

Well today’s market developments, the global coal story really hasn’t changed your outlook for, at least for Illinois basin at this point?

Steven F. Leer - Chairman and Chief Executive Officer

Not at this point. I mean, obviously we're always open and we always test our views internally and through with external focus trying to look at it as well. But if we see real opportunity for Western bit I think, northern App is going to be what northern App is and they certainly have some opportunities and Central App is going to struggle to have even with today's pricing to maintain production and more likely will decline, given the reserve base permitting all the issues they face and then there’s the PRB and we really see Illinois basin as the last development not the least development.

Gordon Howald - Calyon Securities

Right. And I appreciate your comments here. Thanks very much.

Steven F. Leer - Chairman and Chief Executive Officer

Thank you.

Operator

And now we’ll go to Mark Liinamaa with Morgan Stanley.

Mark Liinamaa - Morgan Stanley

Good morning guys.

Steven F. Leer - Chairman and Chief Executive Officer

Good morning.

Mark Liinamaa - Morgan Stanley

Can you discuss any new transportation issues that you may be seeing, emerging as coal flow patterns around the country changes? Indeed you are seeing any?

John W. Eaves - President and Chief Operating Officer

Right now, I mean the railroads are running reasonable well and we could always seek better performance but, we ship on really all four of the class one railroads and I think, the big challenge where the railroads are concerned is logistically as you see more coal leave the country on export and as the domestic buyers come into the market some time in 2008. What happens to all that equipment? Can they redirect it. How and when they need to do it. So, I think, we get to see that certainly in the Eastern United States. But I think, given what the capital spends for the western railroads recently and what they’re doing on the joint line with their investments. They should have the capacity somewhere around 440 million tons to 450 million tons on the joint line. The limiting factor will be productive capacity out there. So, right now I would say overall the railroads are doing reasonable well. But a challenge with this export movement, it's something we really hadn’t seen in these volumes in probably 10 plus years.

Mark Liinamaa - Morgan Stanley

Okay. That’s great. Thanks. And just as you think about the delivered cost of Btu’s can you discuss the ability of the coal industry to share in the economic gains with the transportation people?

Steven F. Leer - Chairman and Chief Executive Officer

Well, we always think, we get the short end of that stick, but that’s probably a biased view of that but clearly right now we would argue we are sharing in it and we've seen the rails establish their contract and as new contracts come up you would have to assume that they have an old legacy contract. They are adjusting it to whatever current market is. But right now we are pretty pleased with the improvement in pricing we've seen in all of our basins and we would expect to maintain that at least in this kind of market place.

Mark Liinamaa - Morgan Stanley

That’s great. Thanks and very impressive cost performance. Well done on that. Thanks.

Steven F. Leer - Chairman and Chief Executive Officer

Thank you.

Operator

We’ll now go to David Gagliano with CSFB.

David Gagliano - CSFB

Hi. First of all, thanks for the patients and secondly, congratulations on a great quarter.

Steven F. Leer - Chairman and Chief Executive Officer

Thank you, David.

David Gagliano - CSFB

Clearly good operating results especially good outlook for 2008 too. Just a really good question and I apologize if you have covered this but mountain Laurel 2008 met coal volumes that are still open for pricing. Can you give us some more visibility into the volumes that are still left to price our of mountain Laurel

John W. Eaves - President and Chief Operating Officer

Dave this is John. We didn’t give an exact number but I guess what I would tell you it's a meaningful percentage of the overall production. We have booked some and we still have some to book. So, I think, we're well positioned and we're in well advanced discussions with a number of customers right now.

David Gagliano - CSFB

Okay. No problems. And just a follow-up. The capacity at Black Thunder after the completion of the loadout, what will that do to the capacity at Black Thunder?

John W. Eaves - President and Chief Operating Officer

When you loadout David it's replacing a 24 million ton loadout at North Rochelle and we expect it to be somewhere plus 15 to 20 million above that when it's all said and done

David Gagliano - CSFB

Great. Thanks very much.

John W. Eaves - President and Chief Operating Officer

But of course Dave that doesn’t suggest that we have the stripping capacity for that. That’s just the throughput capacity in the load out.

David Gagliano - CSFB

Okay. Understood. Thanks.

Operator

And we’ll now take a question from Mark Russo [ph] with Millennium Partners.

Unidentified Analyst - Millennium Partners

Hi, good morning guys. Great job. Two clarification questions. I thought I heard earlier in the call you mentioned 45 million tons available for export. Is that correct? Is that a mix of all the different basins?

John W. Eaves - President and Chief Operating Officer

That’s primarily in the East. We've got the ability to export a little bit more out of Western bit and the PRB.

Unidentified Analyst - Millennium Partners

Okay. And then, as far as going back to mountain Laurel, I think, you guys had said you had in the past talked about four million tons to five million tons at mountain Laurel and a good percentage of that is met. Did I hear that right as well?

John W. Eaves - President and Chief Operating Officer

That’s correct.

Unidentified Analyst - Millennium Partners

Okay. Great. Thanks.

John W. Eaves - President and Chief Operating Officer

Your welcome.

Operator

We’ll take our last question from Justine Fisher from Goldman Sachs. Please go ahead.

Justine Fisher - Goldman Sachs

Good morning.

Steven F. Leer - Chairman and Chief Executive Officer

Good morning Justine.

Justine Fisher - Goldman Sachs

I just have one quick question on PRB pricing. I was wondering if you could give us some color on the difference between prices for 8800 and 8400 because it seems that over the last few days, we've seen 8800 prices run up significantly, people talking 14, 16 but not the same for 8400, and why is that?

Steven F. Leer - Chairman and Chief Executive Officer

I couldn't explain why, I haven't looked at the indices pricing that's published for both of them I have looked at the indices for the 88, but typically it could be that there hadn’t been many trades in the 84, it is a less liquid market. But historically we found that those two products move in a relationship with each other, up and down, and sometimes the differential will widen a little bit, or narrow a little bit and typically in strong markets, we’ve seen it narrow but I couldn’t answer that question exactly today.

Justine Fisher - Goldman Sachs

I guess you guys have 8800, but are there more, is there a difference in foreign demand for the 88 than the 84? There doesn’t seem that there would be, because once they’re going PRB type instead of Northern App type, it doesn’t seem like there’d be a difference but might that account for it or do you not think that way?

Steven F. Leer - Chairman and Chief Executive Officer

It’s certainly possible. I mean, obviously, if your thinking about transportation fees that’s the you have 8800 Btu versus the 8400 Btu on a sense per million, it’s better to transport the 88 a longer distance. And historically if you look at the various markets, the PRB serves and competes with other coal basins then, the 88 is by far the most competitive and faces the most competition with all the other coal basins we go into, because it travels further.

Operator

And that concludes our question-and-answer session. I’d like to turn the call back to Steve Leer for any additional or closing remarks.

Steven F. Leer - Chairman and Chief Executive Officer

Thank you operator, and let me just thank everyone on the call. I can recall back two or three quarters ago when our unsold position and unpriced position was certainly a concern. Today, I think we’re seeing that being patient and really sticking to our guns and our views is paying some benefits for our shareholders. We feel the business looks very robust going into ‘08. Certainly the international market is something that I don’t think anybody could have foreseen the supply disruptions we're seeing in three of the major producing countries. We think Arch is extraordinarily well positioned, we will work hard to deliver the tons and to deliver any guidance we provide and we appreciate your support. Thank you.

Operator

Thank you very much. And that does conclude our conference for today.

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