Consol Energy, Inc. Q1 2008 Earnings Call Transcript

Apr.24.08 | About: CONSOL Energy (CNX)

CONSOL Energy Inc. (NYSE:CNX)

Q1 FY08 Earnings Call

April 24, 2008, 10:00 AM ET

Executives

Thomas F. Hoffman - Sr. VP - External Affairs

William J. Lyons - EVP and CFO

J. Brett Harvey - President and CEO

Analysts

Jim Rollyson - Raymond James

Michael Dudas - Bear Stearns

Luther Lu - Friedman Billings Ramsey

Paul Forward - Stifel Nicolaus

Justine Fisher - Goldman Sachs

David Gagliano - CS First Boston

Operator

Ladies and gentlemen, thank you for standing by. And welcome to the CONSOL Energy's First Quarter Earnings Release Call. As a reminder, today's call is being recorded.

I would now like to turn the conference call over to the Senior Vice President of External Affairs, Mr. Tom Hoffman. Please go ahead.

Thomas F. Hoffman - Senior Vice President - External Affairs

Good morning, everyone. Welcome to our conference call on the first quarter results for CONSOL Energy. With me this morning are Bill Lyons the Executive Vice President and Chief Financial Officer of the company and Brett Harvey, President and Chief Executive Officer.

We will be discussing the results for the quarter just ended and we will be discussing the outlook for the remainder of the year. Much of our discussion will be forward-looking in nature. Our ability to achieve forecasted results are dependent on and certain business risks as we have detailed for you in our earnings release released this morning at 7:30 there is a greater detail on the discussion of business risks in our Form 10-K filed earlier this year. With that again we welcome you and I will turn the microphone over to Bill Lyons. Bill.

William J. Lyons - Executive Vice President and Chief Financial Officer

Thank you, Tom. For the quarter just ended CONSOL Energy reported net income of $75 million or $0.41 per diluted share compared with a $113 million or $0.61 per diluted share in the first quarter of 2007. Net cash from operating activities was a $146 million compared with a $183 million for the first quarter of last year. Overall, these financial results were mixed compared with our internal expectations. CNX Gas, which we own 81.7%, had a record-breaking quarter in terms of production and earnings. Overall, CNX Gas contributed over 50% of our net income for the period. In coal operations, average realizations increased over 9%. However, lower production and higher cost resulted in a 37% reduction in margins. Let me discuss some of the details of the quarter.

Our share of CNX Gas earnings was $41 million in the first quarter of 2008. CNX Gas record production of 15.9 billion cubic feet of natural gas for the first quarter was over 10% higher than the 14.3 billion cubic feet for the first quarter of 2007. Of special note is that this record production was achieved with the Buchanan Mine longwall being done until mid March, which meant we experienced a deferral of mine related methane gas of approximately 1.2 billion cubic feet. Average margins at CNX Gas were $4.52 per Mcf, an increase of 24% over to $3.65 margins in the first quarter of 2007. CNX Gas is estimating 2008 methane production to be 72 billion cubic feet, a 24% increase over 2007 production. CNX Gas maintains its strategic vision of producing a 100 billion cubic feet of natural gas annually by the year 2010.

On the Coal side, average realization per ton was $43.57, an increase of $3.73 per ton or 9.4%. This increase in per ton realization added $60 million to our revenue line. The other major metrics in the coal side, production and cost did not meet our expectations. Production was 16.2 million tons down 1.6 million tons from the first quarter of 2007. The Buchanan mine being down for most of the first quarter of 2008 caused 1.1 million tons of this impairment. We also lost the like amount of production due to deficits in longwall development at several mines, which resulted in equipment being idled while the necessary development was completed. These production shortfalls were offset somewhat by the production at AMVEST, which we acquired in July 2007.

Average cost per ton was $37.39, an increase of $7.34 or 24% over the first quarter of 2007. There were many items causing this cost increase including lower production levels, higher cost mines in mix like AMVEST, higher prices paid for supplies and services, higher labor cost and the $33 million Combined Fund settlement benefit reflected in the 2007 quarter. There were several non-recurring items of accounting and financial significance in our press release that I would like to briefly review. These items are highlighted in a table on page 2 of the earnings release. They were first is that we received notice from our insurance carriers that we will collect the final $50 million of business interruption insurance relating to the Buchanan Mine roof all [ph]. This will bring our total recoveries provided by insurance to $75 million.

We incurred costs of $25 million attributable to the suspension of production and related startup expenses at Buchanan during the first quarter. We also bought out several contracts with customers for $16 million to release coal committed to them. We will sell this coal to other customers at higher prices. The additional profits generated by these transactions will be reflected in future quarters when the coal is ultimately sold. We also recognized a unrealized loss of $9 million on mark-to-market adjustments related to several coal sales options. We sold options for 525,000 tons of Pittsburgh seam coal at an average price of over $70 a ton. We received cash of $1.7 million for these options. This is very profitable business for us and the transaction is in accordance with our risk management practices.

The accounting rules that govern this type of transaction requires us to mark the options to the current market while the options are open. These unrealized losses will reverse as the coal sold progress as the coal sold as the options expire.

Now, looking forward we have identified several Brownfield expansion projects that we believe meet or exceed our after-tax internal rate of return hurdles. Currently you are committing capital for nine longwall phase expansions at six of our existing Northern Appalachia mines. Seven of the nine phase expansions will be completed in the next 12 to 18 months and will increase production from a particular mine by 300,000 tons to 500,000 tons per year. The company is also on schedule to have the underground haulage system at Shoemaker completed in early 2010. Shoemaker is expected to produce approximately 6 million tons per year.

CONSOL also expects to expand capacity at the Buchanan mine in Virginia to 6 million tons per year by early 2011. The capacity expansion involves upgrades to the existing preparation plan, the construction of the new raw coal silo, upgrades to the water delivery and treatment system, the installation of a new vertical coal belt to augment the existing skip hoist, and upgrades to the underground haulage system.

In addition, the company has begun the permitting process to add a third longwall mining system at the Bailey Mine. This additional longwall will increase annual production by 5 million tons to 6.5 million tons per year and is expected to be completed by 2013.

As I mentioned earlier, CNX Gas has a large inventory of high rate of return projects that will enable us to drive its 100 billion cubic foot annual production target by the year 2010. Now, if I could sum it up, I would say is that we come out of this first quarter well positioned to take advantage of the great market opportunities that are available to us.

And with that, Brett, we have your comments.

J. Brett Harvey - President and Chief Executive Officer

Thanks. Thank you, Bill. It's good to be with all of you and it's good to talk about the position of CONSOL Energy in this, I think very robust and exciting energy markets that we are in today. First of all let's talk about safety. The first quarter of 2008 was the best safety record that we have ever had in the history of the company, I want to commend our people for their attitude about safety and their ability to look after each other and get the job done. That's paramount to this company, paramount to management as well as it should be to our shareholders because the safe operation is also a very productive operation.

Let's talk about the Gas Company first. Gas had an outstanding quarter as Bill just described, higher production by 10%, higher prices by 16%, almost 17%, 50% higher profit, strong revenue growth and the ability to grow that company at a 15% or higher compound rate going forward. The 100 billion cubic feet per year for 2010 is very achievable and it is part of what we call our double-edged sword of the energy business and a very valuable piece to our shareholders.

Now let's talk about the coal business. The coal market in the first quarter changed, I think, dramatically and has lagged [ph]. In the met side as well as the seam side, I think we've seen a step change in the coal market. I think the world is building coal-fired capacity all around us, driven by China, it's driven by India, Indonesia, even Europe. Now it’s burning higher rates at the existing plants that they have as well as committing to build new plants based on their energy needs going forward.

Coal is the low-cost energy for the world and the conflict between environmental issues and coal continue to grow, but when it comes down to basic economics, coal is winning now in terms of growing the base worldwide, which creates opportunities for CONSOL Energy. Even Western Europe with their green sensitivities and their attitudes towards CO2 have now decided that coal has to be a bigger part of their base. And we think that's very interesting based on where the U.S. is under the same dynamic going forward.

Major world producer for coal have constraints. There are environmental issues about opening new mines or permitting issues. There is the availability and there is ability to move this coal around the world. So capitalized mines with long term lives of production become more valuable in the marketplace and I think CONSOL is a very good example of that.

Long-term contracts are being looked at for world markets as well as Atlantic markets with CONSOL and we're seeing a big bump in long-term markets associated with utilities just around CONSOL’s major mines. We are looking at Brownfield expansion of some of our mines as it relates to these markets and let me assure you that the Brownfield expansions match the rate of return that we need to have for our shareholders to invest capital to expand anything. Otherwise we would not do it.

In these strong markets, we're going to see acceleration of revenue growth like we have never seen in CONSOL in the last 30 years. We're going to see rapid expansion in margins and we're going to see cost stabilize with the volumes as we expand into these lower costs with Brownfield expansions and wider longwalls. So we will see stabilized costs as well as acceleration of revenue, which will expand our margin very rapidly. Let's talk about coal costs for a minute.

First quarter, we were affected in costs year to year based on a couple of things. We added a higher cost structure when we brought in the AMVEST Mine and then some of our lower cost mines for the first two months of the year we had a drop in productivity related to those mines, which when you put that mix of costs into the first quarter it shows a higher cost than we expect for the entire year. I think for the second quarter, third quarter and fourth quarter you'll see our average cost for the year decline to levels that were more reasonable and more in tune with what the guidance we have given in the past.

The other thing I would like to look at year-on-year is coal that we were selling in 2007 for 2008, on the steam side and the met side I would say in the spot market are at least a 100% higher than what they were for 2008 to 2009. And let's talk about some of those prices. As talked about mid-sulfur, Northern App coal is selling, right now we are signing contracts between $105 and $110 a ton. I saw for coal Northern App a $100 to $105. Central App coal dependent on whether on the CSX and Norfolk Southern railroad anywhere from $92 to $105 a ton. Now met coal at the spot market right now in 2008 coal that we have opened today, we think we can sell that coal for about $240 a ton at the mine at Buchanan.

In terms of what we have opened or repriced for 2008, we have 900,000 tons of met coal, high vol 400,000, low vol 500,000 Northern App, we have a million tons of reprice, Central App we have about 800,000 tons of price, and Emery Mine at Utah we have 400,000 tons of price. So that tells about 3.1 million tons to price yet for 2008.

Open for 2009, we have 25 million tons… 25.4 million tons of coal to sell and price. So I think it's important that we understand that there has been a dramatic step change in the value of both these coals and these coals are going to expand our margins were rapidly. But remember, this is a business where we contract and as we contract and move into these different types of coals, you see these jumps. The market tends to try to multiply all these numbers and ignore these existing contracts, we have to make sure that the market sinks some in when we actually deliver the coal under these new contracts. So having said that I would like to open it up for discussion.

Thomas F. Hoffman - Senior Vice President - External Affairs

Operator, if you could instruct our listeners on their procedures for queuing in.

Question and Answer

Operator

Yes. Thank you. [Operator Instructions]. And we do have a question from Jim Rollyson with Raymond James. Please go ahead.

Jim Rollyson - Raymond James

Good morning, gentlemen.

J. Brett Harvey - President and Chief Executive Officer

Hi, Jim.

Jim Rollyson - Raymond James

Brett you talked a little bit about contracting market and maybe what you're seeing. Can you maybe spend a minute in detail you signed up... it looks like about $10.5 million of price to incremental tons and almost 15 million just in total commitments for '09. Can you maybe just kind of detail how much of that's for export versus with domestic utilities and is this business you were talking last quarter about signing multi year deals kind of what you are seeing in that sense?

J. Brett Harvey - President and Chief Executive Officer

Right. I would say for export, I would say we are going to be up about 100,000 tons for 2008 versus last year and the reason we are there, even though our Baltimore shipments are higher, say it's gone up from 6.9 million to 9.8 million tons to Baltimore. Our export tons on the steam side are not moving because the domestic market is rising faster than the Atlantic market. And what's happening with our utilities, our immediate utilities around us, they are very interested in term, volume, and this rising price structure. The availability of coal is more important to them than the price at this point in time. So we are doing long-term deals with lakes, with major utilities in the area and essentially we are tying up volume with them that don't have transportation components, which is a real value to our shareholders.

Jim Rollyson - Raymond James

Very good and so a follow-up here, you guys have talked for the last couple of quarters about the ability to ramp up production over a period of time with Brownfield projects and you kind of listed some of those. Two questions on that, one, is that somewhat captured in the kind of volume growth we see in your production ranges as we go out to 2011. And secondly any thoughts to the overall capital required to complete the projects you're kind of looking at and talking about now?

Thomas F. Hoffman - Senior Vice President - External Affairs

Yeah. This is Tom Hoffman, just before Brett answers that. I'll remind everybody, as we indicated in the release this morning, the production guidance that we gave for 2009, 2010 and 2011 is only updated at the first of the year. So, that's a reiteration of what we gave in January and does not reflect any… anything necessarily that we're talking about, that's new... that might, that was not in the initial guidance.

J. Brett Harvey - President and Chief Executive Officer

But, have... to that point like the expansion of the longwall phase and so forth these are very highly productive things, it lowers our overall cost, it increases our productivity and it also replaces the wind down of mine 84 and things like that in the marketplace. So, what we are seeing here is a much better cost mixture going forward which expands our margins as well as we will not bring on it any of this Brownfield expansion unless we have the tons sold and it doesn't affect the rest of our marketplace. The last thing we want to do is bring tons on and to press the rest of the marketplace Northern App or in Central App, for that matters. So, we're really focused on that, but I would say there is a market we're going to bring Shoemaker back on in '10. We see a very strong market for that coal and what we are seeing on these expansions clearly have very high internal rate of return models that we have and we are going to see the value there as we expand some of this.

Jim Rollyson - Raymond James

And any thoughts on the CapEx, just [inaudible] now, just trying to get a sense of how much free cash flow you still have leftover?

J. Brett Harvey - President and Chief Executive Officer

I think on the CapEx side we are going to be about Brownfield expansion... I would say about on the Brownfield expansion you expect about one third to 50% capital that you would spend on a new mine. And so, if you work that out we are probably going to spend... I'm trying to put that in terms of cost per ton.

Jim Rollyson - Raymond James

I think you guys were saying new ones in the 60 range?

J. Brett Harvey - President and Chief Executive Officer

Yeah.

Jim Rollyson - Raymond James

So, 20 or 30 kind of numbers?

J. Brett Harvey - President and Chief Executive Officer

I would say so. Yeah.

Jim Rollyson - Raymond James

Great.

J. Brett Harvey - President and Chief Executive Officer

That's a good way to look at it.

Jim Rollyson - Raymond James

Thank you.

J. Brett Harvey - President and Chief Executive Officer

Yeah.

Operator

And next we have a question from Michael Dudas with Bear Stearns. Please go ahead.

Michael Dudas - Bear Stearns

Good morning gentlemen.

J. Brett Harvey - President and Chief Executive Officer

Hi, Mike.

William J. Lyons - Executive Vice President and Chief Financial Officer

Good morning, Mike.

Michael Dudas - Bear Stearns

In the step change function in the coal market, how much do you think the global market is going to be dictating supply demand fundamentals in the U.S. relative to say U.S. economic or energy policy going forward?

J. Brett Harvey - President and Chief Executive Officer

Well. I think they are coupled together, I think permanently for at least the next five years. I think this global market is so powerful in terms of the... keep in mind we are building a much bigger base for coal worldwide. And that base is directly related to all the marketplaces. So, if you look at what's not coming into the U.S. in terms of the imports this year and if you look at what's going out of the U.S. in terms of exports that is a real effect. Let alone the effect of what we call on the bubble of metallurgical coal, it could be steam or it could be met dependent on how the met go. So, these world markets in met and steam directly affect the domestic markets, especially in the Eastern United States. And we are seeing the ability to move this coal either way and I think that's why we are seeing the domestic utilities try to lock in volumes and the surety of supply rather than worry about prices or [inaudible] price down.

Michael Dudas - Bear Stearns

Regarding Central Appalachia, do you think the issues relative to chambers, relative to geology and what you're witnessing in your own business, if that’s going to continue to limit the ability of that region to fully meet the demands for the marketplace? And how much do you think out West are we going to see penetrate because of such a tightness in the East and in the coal leaving our shores?

J. Brett Harvey - President and Chief Executive Officer

I think we are going to continue to see it to be very difficult. The markets will tighten based on the ability to permit coal in the eastern United States, the safety issues that were written under the new law, all those things affect the cost and ability to get to... you'll see a productivity drop based on these two issues and so on the capitalized very valuable mines that are already in place are becoming more valuable and as the international market takes some of that coal away from the natural markets, we are going to see some coal move from west to east, but that's a very expensive haul and I think the utilities will encourage more developments around it, our plans and they will to take long haul for long periods of time.

Michael Dudas - Bear Stearns

Final question Brett, you had a pretty impressive speech back in the fall about zero accidents at your company that you put forth in the market. It seems like in your press release, you had some pretty good success. How is that going to be... relative to your company, maybe the industry given that this is going to be a big pressure to kind of bring coal to the market and expand and hire and train in this bull market that we're seeing. Could that be an issue for the industry given the scrutiny that we're seeing from regulators over the last couple of years?

J. Brett Harvey - President and Chief Executive Officer

Well, I think if you look back to when we changed generations in the coal business last time, we saw a problem associated with safety. And that's what we're trying to avoid. We are looking at bringing new people into the business as an opportunity to train them to zero accidents and the mentality of zero accidents. But it takes a lot more training Michael as you know, and we see this as an opportunity, but I think there will be an influx of new people into the business and that is going to be a challenge for the industry, but I think it is something that we can do. And we are spending money and investing in our people to the point where we think we could be at zero going forward which gives us, I think, the advantage. People want to come to mines that have good safety records and that will give us the edge because a safe person is also a productive person, and we think they go hand-in-hand. So, I think that's the watchword that we need to look at going forward and that's the model of CONSOL now.

Michael Dudas - Bear Stearns

Thank you Brett.

J. Brett Harvey - President and Chief Executive Officer

Thank you

Operator

thank you our next question comes from Luther Lu from FBR Capital Markets. Please go ahead.

Luther Lu - Friedman Billings Ramsey

Good morning guys.

J. Brett Harvey - President and Chief Executive Officer

Hi, Luther.

Luther Lu - Friedman Billings Ramsey

Brett I have a question, given that API prices are going back to 150, are you seeing the European utility buyers are coming back and perhaps wanting to sign a long term contract this time, these time around?

J. Brett Harvey - President and Chief Executive Officer

I'm pretty sure that they will. I think any time you see a dip in the market and on the shoulder months that we're seeing in Europe and other places. That puts us in discussions for longer-term prices that probably don't have spot market economics tool. But we are okay with that, as long as it dips [ph] within the step change of the marketplace that we've seen. So we are in discussions right now, in fact, with major utilities in the Atlantic looking at longer-term deals that are five years and beyond.

Luther Lu - Friedman Billings Ramsey

Okay. Great. And given that... or do you have any plans to expand the Baltimore Port?

J. Brett Harvey - President and Chief Executive Officer

Well. We have a study going on right now and we are determined that with the capital expenditures of about $20 million we think we could on a yearly basis get up to $18 million and stay there. We have another piece of that study that we are looking at. We have a big footprint there and we think maybe with some more capital we can bring it up. We know [ph] maybe 20 million tons to 25 million tons of capacity, but we won't do that unless we have the contracts to match it.

Luther Lu - Friedman Billings Ramsey

Right. And the railroad has to... I guess co-operate as well?

J. Brett Harvey - President and Chief Executive Officer

Well. The railroad, keep in mind, our port facilities have dual railroads going into it. We have access to our major mines on direct hauls. I don't think, I think they see that as very lucrative business and would be a great partner in expansion of our Baltimore facility.

Luther Lu - Friedman Billings Ramsey

Okay. And I have a question for Bill. Bill, what do you see cost... what's your cost projection for second quarter or for balance of the year?

William J. Lyons - Executive Vice President and Chief Financial Officer

Luther, we don't give those cost projections out, that’s sort of as Brett said we expect them to come down, but we don't give… we don’t give guidance on that.

Luther Lu - Friedman Billings Ramsey

Okay. And for your DD&A projection given out earlier this year is still at… little over $400 million?

William J. Lyons - Executive Vice President and Chief Financial Officer

Yeah. That should be okay.

Luther Lu - Friedman Billings Ramsey

Okay. Thank you.

Operator

Our next question comes from the line of Brian Gamble [ph] from Simmons & Company. Please go ahead.

Unidentified Analyst

Yes, good morning guys.

J. Brett Harvey - President and Chief Executive Officer

Hi, Brian.

Unidentified Analyst

Brett, when you mentioned your 6.5 million tons that you have committed but not priced based on your expectation that as the year progresses those prices will continue to improve, is that due to the customers not wanting to commit to prices that are reflective of current market dynamics and you just wanting to realize... your fair deal on that or do you actually think that you're going to increase the prices that we are seeing today over the next six to nine months and you can just be further profitable on those tons as we head towards the back half of the year?

J. Brett Harvey - President and Chief Executive Officer

Yeah, I think the latter part of that. I think we'll see... in any given moving market where we see a step change like this, it's probably not very prudent for the supplier and we understand the demand very well for the supplier to lock in prices on the early end of the move. And so, we decided there was such a need from the utilities who want to have the volume and they wanted to have it for term, we were willing to negotiate those prices later in the year. And I will give you a good example, one of the... when Bailey coal was moving at $65 a ton and this was early on in the move in the first quarter. Clearly we could have signed it up and it would have been $15 a ton higher than we kind of expected as it started to move, with that spot market for Bailey coal today is 110, so it would have been very imprudent of us... to sign that up that early. So I think it was just a function of us understanding where the market is. We are also spend a lot of time looking at forward electricity prices and seeing what their ability to pay as well is. So, if you add those together, we did sign contracts with them, they have… both of us have handcuffs on them but at market [inaudible] producer anyway. So, I think we understand the market very well.

Unidentified Analyst

Then, moving on to the cost side, when you look at what the cost increases were for the quarter, obviously they were above your expectations, but were they above your expectations on AMVEST and what you guys could do with those mines and how that cost shaped out or was it... or was it solely due to the lower production at some of those longwall in Northern App. How did that break down on a percentage basis?

William J. Lyons - Executive Vice President and Chief Financial Officer

Brian that breaks down in... there is a lot of things that are in that cost number. You are going to realize when you have all the complexes we have, they are not all the same, we tend to laniaries [ph] all this stuff. There is no doubt that reduced production hurt us in terms of the calculation of unit cost. Also AMVEST, we think is going to do better than what it did in the first quarter. So, we also think that's also going to help us in terms of the unit costs. Again, as I... we've talked about in the beginning, that first quarter of 2007 was an extremely good quarter for us and it was aided by that $33 million combined fund settlement. That was a non-recurring event, so naturally when you do the comparisons 2008, it’s going to pale by comparison. We have experienced increase in labor costs and increase in supply costs and that will show an upward trend as we continue up. But you got to realize when we take a look at these met prices for coal we're talking about that is a key ingredient in steel manufacturing. And we use a lot of steel in the mining process both for roof control as well as in equipment. So I think you're going to see increases in costs. But as we talked about before, I think the focus needs to be not so much on cost but to focus on margins. And you're going to see that margins are going to outstrip increases in cost.

Unidentified Analyst

And then one last question based on kind of that margin comment. When I'm trying to back into the 2010 committed and price volumes quarter-over-quarter I get to kind of a 3.8 million incremental tons after 2010 kind of in the low 50s. I was wondering if you guys could explain where those tons came from and why those prices don't seem as high as the realizations that you're getting on the '09 tonnage signed during the quarter?

J. Brett Harvey - President and Chief Executive Officer

I think, that's a function of the mix that we see out there. I wouldn't dwell too much on the... what you saw signed up for that. At that time frame I think it had to do with the mix that we are putting in and they were signed. There are deals that were signed in mid '07. And if you look at mid-'07 versus the market, we're seeing, say mid-'08 is dramatically different. So I think that was more of a clean up contracts that we were looking at than anything that you could compare to the new marketplace. I want little back on your other question too about AMVEST, I don't want you to get the impression because we thought the cost were a little bit high in AMVEST for the first quarter that we are discouraged about that. We think AMVEST is going to be a real winner for this company for many, many years and it's going to be one of the biggest workhorses in Central App I think for the next 20 years. So you're going to see some real value come out of AMVEST.

Unidentified Analyst

[inaudible] Brett. Thank you guys.

J. Brett Harvey - President and Chief Executive Officer

Yes.

Operator

Our next question comes from the line of Paul Forward from Stifel Nicolaus. Please go ahead.

Paul Forward - Stifel Nicolaus

Okay.

J. Brett Harvey - President and Chief Executive Officer`

Hi, Paul.

Paul Forward - Stifel Nicolaus

Good morning. Looking at the, just overall Northern App coal markets. When you talk about adding new volumes to that market you got to have a stance on what the whole Northern App coal markets are able to do over the next say two or three years and what demand is going to look like? When you look at the entire Northern App market from today through, say, three years out, how much incremental production do you think can come into that market and how much incremental demand do you see to be able to absorb that production.

J. Brett Harvey - President and Chief Executive Officer

I would say incremental demand is very limited. It would be probably 10 million tons to 14 million tons that will be max. And most of it’s us and I think you're going to find that we are not going to bring it out unless the price is right.

Paul Forward - Stifel Nicolaus

So, you say the incremental demand is limited, did I hear that right?

J. Brett Harvey - President and Chief Executive Officer

No, production.

Paul Forward - Stifel Nicolaus

Okay.

J. Brett Harvey - President and Chief Executive Officer

The production is probably 10 million to 14 million. Incremental demand I would say demand wise it could be as high as 20 million tons, 25 million tons. I think there is real pressure on demand here, that's why the prices are running where they are at the spot market.

Paul Forward - Stifel Nicolaus

Right. And just also the Northern App markets, if we are at 35 days of inventory right now, you had a... which is a number that your competitor gave. You put a line in here in your press release that said we believe this tightness in the market will intensify as we get further into the year. Where do you see... where do you see that inventory possibly go into... meaning the utilities that [inaudible] coal, how low can this get by say the end of the summer?

J. Brett Harvey - President and Chief Executive Officer

Well, it's a hot summer. I would say that the utilities is going to be in a very panic position because... and here is why, because the inventories I think are stable to low right now. If it gets real hot, at the Northern App supply will be way down as a response. So they can't respond that quickly with volumes, we have a lot of people calling us, they want coal for the summer and we don't have… we don't have the coal and there is a lot of issues around, where they are going to get it and if they burn up this 20 days supply, how are they going to resupply for the winter. I think that's a concern, so the supply response is very weak, that's why the price is the way they are.

Paul Forward - Stifel Nicolaus

And just lastly are you... you mentioned this 5 million tons of imported coal that will be lower this year than last year. Are you seeing import... former coal import customers calling you, looking for new tonnage or is that not really coming, or are they not looking to you guys for that?

J. Brett Harvey - President and Chief Executive Officer

Well, we've always been the swing suppliers for a lot of the people along the coast, because of our high-Btu travel. We have been a swing supplier for the coast guys who bring them in and play [inaudible] Northern App coal off of the Atlantic market. We are seeing them come to us and we don't have the tons they want and so it is tight. It is tight right now for them as well.

Paul Forward - Stifel Nicolaus

Okay, thanks a lot Brett.

J. Brett Harvey - President and Chief Executive Officer

All right, thanks.

Operator

Our next question comes from the line of Justine Fisher from Goldman Sachs. Please go ahead.

Justine Fisher - Goldman Sachs

Good morning.

J. Brett Harvey - President and Chief Executive Officer

Hi Justine.

Justine Fisher - Goldman Sachs

If we've already seen the step change function in Eastern prices for both Northern and Central App, but the PRB produces are arguing that we are yet to see a PRB coal and PRB coal will backfill some of the holes left by eastern coal that's exported. Are you guys looking at all at developing more in the PRB just sort of get into that market more from a production standpoint before that potential step change, do you guys not see a step change there because of different sulfur content and transportation etcetera?

J. Brett Harvey - President and Chief Executive Officer

Well, in the marketplace we have Youngs Creek that can come on in 2012, but we won't bring it on unless we have the coal sold. We're not going to use our shareholders’ money to speculate. Although I do think there is a possibility of the high-Btu coal that we have coming out of Youngs Creek and our value as a fee product versus a royalty product that the competitors have there that we can have a niche there with our sharing partners to get some things done. I think the Powder River Basin has a different marketplace in the eastern coals, and if you draw a circle around this transportation nationwide. The inventory is high at the utilities that they feed and I think that drives the price as long as the utilities in that marketplace feel comfortable, we are not going to see the push for higher prices yet. Now, if it turns out, those inventories drop or the production of the PRB is limited somewhat in the future, I think you will see prices rise pretty fast. But, right now we are not going to speculate by bringing on a lot of volume in the PRB.

Justine Fisher - Goldman Sachs

And I guess any... there is no timeframe as to when you would try and commit those new Brownfield expansions in the east, right? I mean, is there any way we can gauge how long you would wait to commit that goal [inaudible] committed at that?

J. Brett Harvey - President and Chief Executive Officer

Right. I would say a good signal is and I am trying to send this signal in this call is the utilities around us are tying up very large volumes on our base capitalized mines. That tells you the next Brownfield expansion mine like the fifth longwall at Bailey, Enlow could happen earlier than later, but I can't give you a date on that.

Justine Fisher - Goldman Sachs

And but it seems like you guys are trying to sell more to the domestic utilities, just because they are willing to accept higher prices is why you said that domestic prices are rising faster than Atlantic prices, is it part of CONSOL's goal to go back to these domestic utilities first to maintain those relationships as opposed to exporting it and then potentially anchoring or disappointing utilities that may have bought substantial amounts previously?

J. Brett Harvey - President and Chief Executive Officer

Well there is a real advantage to, I mean if you look at these power plants they are built right on top of us and there is no transportation between us. So, the economic grant of being their supplier comes to our shareholders and if we can sign long-term supplies with them, they are very powerful and the billions of dollars will do that first. And that's… we are naturally capitalized for each other so, that makes a lot of sense if our shareholders get their piece of pie, yes.

Justine Fisher - Goldman Sachs

Okay. And then one more question, asked a competitor about SO2 prices and what the potential reason for the.. for the recent lag in SO2 prices was and I was wondering if you guys haven’t yet seen on that whether it's scrubbers or how would you explain the recent dip in SO2 prices?

J. Brett Harvey - President and Chief Executive Officer

Well, I think there is two things going on. One is the scrubber build, depresses SO2 prices because there is a lot more scrubber capacity being built out there which is a natural market for us. The other thing is utilities buy heat and they are short on heat. So, the demand for heat for power mainly in the Btus that come out of coal, that becomes the priority over sulfur or anything else.

Justin Yagerman - Wachovia Securities

Okay. Thank you very much.

J. Brett Harvey - President and Chief Executive Officer

See you, thank you.

Operator

[Operator Instruction]. We will go through the line of David Gagliano from Credit Suisse. It's go ahead.

David Gagliano - CS First Boston

Hi, good morning. Hi, I just wanted to ask a couple of quick questions. First of all the... we have seen a recent spike in Eastern U.S. prices and we have seen a pullback in international prices, and it looks to me like some of the steam export prices are now at or below Eastern U.S. prices on a netback basis and so I'm just wondering are you revisiting your thinking with regards to the volumes that you want to move into the exports steam market versus selling into the domestic steam market at this point?

J. Brett Harvey - President and Chief Executive Officer

Okay. David, we think... we think that that softening in the market you're seeing is based on the shoulder months and the demand has backed off a little bit. But, if you look, we still have major problems in South Africa. The supply side, when the demand comes back it’s just not going to be there, so we think that the Atlantic markets are going to continue to be strong. In the short term I think the domestic market is a little stronger based on the inventory and they're trying to build their inventories. So, if you look at the balance between the two I think it's switches back and forth. But this is the first time I've see since I have been at CONSOL where a switching back and forth on a two or three months basis instead of a two or three year basis. So, I would say we got a balance there, we haven't changed our philosophy, we have the ability to either move it to the domestic and make high margins or move into the Atlantic and make high margins, because of the high-Btus, and the port facilities that we have. So, I think it's a matter of leverage, yes.

David Gagliano - CS First Boston

In terms of your specific volume targets into the export market that really hasn't changed in the last couple of months?

J. Brett Harvey - President and Chief Executive Officer

No, it hasn't. No we would move it consistently there and... no there has been no change in our philosophy there, no.

David Gagliano - CS First Boston

Okay and then just the other question. Just briefly, switching to your strategy as a company, Brett. Obviously right now you're basically a pure Eastern U.S. coal producer and just looking forward, I am wondering is your preference to remain primarily an Eastern U.S. coal producer or would you prefer to be more geographically diverse in terms of other U.S. regions?

J. Brett Harvey - President and Chief Executive Officer

I think it's like anything else, for the right deal we would make a bigger footprint, if we thought our shareholders would benefit. We are not bashful about going into any other region. Our move into AMVEST told us that in the Central App, we decided that was a good place to move and the southwest, more expansion in Utah, Wyoming, all of that looks attractive at the right price. And we would consider that, because there is an advantage to have the diversity over time, and we always look at that.

David Gagliano - CS First Boston

Okay perfect. Thanks very much.

Operator

Thank you our next question will come from the line of Wayne Admiral from Hudson Capital [ph]. Please go ahead.

Unidentified Analyst

Thank you. What's your lead-time on buying a longwall?

J. Brett Harvey - President and Chief Executive Officer

Right now it's about 12 months.

Unidentified Analyst

12 months. And how long would it take to... if you decided this morning you wanted to build one and you have the 12 months lead time, how long will it take to have one up and running.

J. Brett Harvey - President and Chief Executive Officer

If we wanted to develop for one, it would probably take as much as two year to develop for it and probably eight... 12 to 18 months to get it designed and purchased and... but keep in mind we run a lot of longwalls up to 15 longwalls right now, and we are buying ahead because of our buying power to replace some of the ones we have, or buying ahead two or three years. So, we do have a pipeline of longwalls coming out is because of our buying power, which gives us better pricing.

Unidentified Analyst

So if you decided this morning, it might take you two years to get one up and running at one of your different mines.

J. Brett Harvey - President and Chief Executive Officer

Yes. Yes depends on... depends on the demand for coal. But if somebody signed up with us for delivering in all eleven we could probably get one going, yes.

Unidentified Analyst

Okay. And what's your potential, in terms of your gas reserves. How much might you build up your gas reserves to over the next two or three years?

J. Brett Harvey - President and Chief Executive Officer

All right now we're at 1.3 trillion cubic feet. We are drilling right now on 3.8 million acres to prove that out. Our gas company will be at the level, they have announced in 2010, at a 100 billion cubic feet a year. And I think that will continue to grow at about a 15% compounded rate after that. I don't have any numbers to give you, but we have a lot of opportunities there, Wayne and that gas company continues to be more valuable to us.

Unidentified Analyst

Yes. If I am not mistaken, few years ago you had about a trillion and now you are at a trillion three. So I mean is this...

J. Brett Harvey - President and Chief Executive Officer

Right.

Unidentified Analyst

Yes. Is this the case where you could go to 2 trillion or 3 trillion or is it just like 1.5 trillion or 1.7 trillion?

J. Brett Harvey - President and Chief Executive Officer

I think... I think if you look at probable reserves, it could be as high as 3 trillion to 4 trillion.

Unidentified Analyst

Well and if I am not mistaken there is an area where you are really excited that you are sort of spending a lot of money and energy on?

J. Brett Harvey - President and Chief Executive Officer

Couple of areas actually. Right up here in the Pittsburgh area and two places, the Nittany project that we are working on and the Pittsburgh seam area we're enthused about as well. And we also have a pretty strong acreage position in the Marcellus Shale, which is very popular right now in the gas business. So, if you look at the combination of what we have in the 3.8 million acres, there is a lot of opportunity, yes it's works out about it.

Unidentified Analyst

And in the highest value that asset is to keep it within the [inaudible] selling it?

J. Brett Harvey - President and Chief Executive Officer

Yes. Yes, that's been determined by the Board and I agree that the value there. If there is any pushback on coal based on CO2, that extreme value comes on natural gas and that's part of the double-edged sword that CONSOL has. So that's good.

Unidentified Analyst

Great. Well, I congratulate you, I remember a few years ago when you bought it. You didn't pay much and it turned out to be a great investment.

J. Brett Harvey - President and Chief Executive Officer

Yes. It certainly did and it gets better every year as it works out --.

Unidentified Analyst

Superb. Thank you.

Operator

And at this time we have no further question, speakers. Please go ahead with any closing comments.

Thomas F. Hoffman - Senior Vice President - External Affairs

Well, thank you operator. And we thank everyone for joining us this morning. We will... Chuck Mazur and I will be available all day to get back to you with any follow up questions. And at this time, we again we thank you for joining us. Operator, if you would tell our listeners about the replay.

Operator

Thank you. And ladies and gentlemen, today's conference call will be available for replay after 12 P.M. today until midnight May 1st. You may access the AT&T Teleconference replay system by dialing 800-475-6701 and entering the access code of 918708. International participants may dial 320-365-3844. Those numbers once again, 800-475-6701 or 320-365-3844 and enter the access code of 918708. That does conclude our conference call for today. Thank you for your participation and using AT&T Executive Teleconference Service. You may now disconnect.

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