Cleveland-Cliffs, Inc. Q1 2008 Earnings Call Transcript

May. 6.08 | About: Cliffs Natural (CLF)

Cleveland Cliffs, Inc. (NYSE:CLF)

Q1 FY08 Earnings Call

May 6, 2008, 10:30 AM ET

Executives

Steve Baisden - Director, IR and Corporate Communications

Laurie Brlas - EVP and CFO

Joseph A. Carrabba - Chairman, President and CEO

Analysts

David MacGregor - LONGBOW Research

Jorge Beristain - Deutsche Bank

Mark Liinamaa - Morgan Stanley

Tony Robson - BMO Capital Markets

Meredith Bandy - BMO Capital Markets

Operator

Good morning, my name is Brace and I'll be your conference facilitator today. I would like to welcome everyone to the Cleveland-Cliffs 2008 First Quarter Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks there will be a question-and-answer period.

At this time I would like to introduce Steve Baisden, Director, Investor Relations and Corporate Communications. Mr. Baisden?

Steve Baisden - Director, Investor Relations and Corporate Communications

Thank you, Brace. Before we get started let me remind you that certain comments made on today's call will include predicative statements that are intended to be made as forward-looking within the Safe Harbor protections of the Private Securities Litigation Reform Act of 1995. Although the company believes that its forward-looking statements are based on reasonable assumptions such statements are subject to risks and uncertainties, which could cause results to differ materially. Important factors that could cause this difference are set forth in our reports on Form 10-K and 10-Q and news releases filed with the SEC which are available on our website.

Today's conference call is also available and being broadcast on our website. At the conclusion of the call it will be archived and available for replay for approximately 30 days on cleveland-cliffs.com. Joining me today are Cliffs' Chairman, President and Chief Executive Officer, Joseph Carrabba and Executive Vice President and Chief Financial Officer, Laurie Brlas.

At this time I will turn the call over to Laurie for her prepared comments.

Laurie Brlas - Executive Vice President and Chief Financial Officer

Thanks, Steve, and good morning everyone. I'll begin today's discussion with the first quarter financial review and our outlook afterwards, Joe will review our operations and provide an update on some actions the company has recently taken.

Highlights for the year's opening three months include record first quarter revenues of $494.4 million, 52% higher than the $325.5 million posted last year. A $94 million revenue contribution from the met coal business we acquired last July and a $54 million increase from our North American iron ore business primarily drove our top-line growth.

It's extremely important for everyone to understand the strong revenue growth we experienced in the quarter occurred despite the fact that some benchmark prices referenced in our various contract had not settled at the end of the quarter. What this mean thus we build our customers and recognize revenue at 2007 pricing, when the benchmarks are determined the additions are retroactive to the first of the year. So because of the recently announced 87% increases for Eastern Canadian pellets we'll recognize approximately $500 million of additional revenue in the second quarter related to the first quarter sale. Although the benchmark referenced in our Australian contracts have not settled yet there have been numerous fine settlements at a 65% increase.

If our benchmark settle at that assumed increase of 65%, we expect to recognize approximately $50 million in additional revenue in the future quarter relating to the ton sold in the first quarter. Most of this additional revenue will flow directly to operating income.

Reported first quarter 2008 operating income declined approximately 5% to $43 million, primarily reflecting higher SG&A expenses. SG&A of $45 million was significantly higher than the $19 million we reported in the first quarter of last year. However, included in that number is $6 million attributable to our North American coal segment. Because of the rock intrusion and slowed production there was no sales margin to cover the operating expenses this quarter. And Joe will talk a little bit more later about our operational outlook for coal.

In addition, we recorded a $7 million charge resulting from a legal ruling that we are currently in the process of appealing. Also included in SG&A is about $10 million related to additional management infrastructure and corporate development costs incurred in Latin America and the Asia-Pacific region. This is because we have invested in growing our international management teams and increased our focus on evaluating development opportunities and geographies outside the U.S. Joe will talk more about that later as well.

Net income for the quarter was approximately $17 million or $0.32 per diluted share versus the $33 million or $0.62 per diluted share last year. However, it is important to understand that if the settlements had already occurred we would have expected approximately $0.75 in additional earnings per diluted share, which will be recognized in the future quarter upon settlement. We also had a higher tax rate for the quarter, but we still expect our full year rate to be 26%. Frequently quarter-to-quarter blips are experience due to the size and mix of the earnings in a given quarter, but it does even out over the year.

Turning to the business segment, in North American iron ore, Cliffs' pellet sales volume for the 2008 first quarter was 2.7 million tons up 10% from last year. Average per ton price realization was 15% to $76.32 and cost increased just 2%. This resulted in significant margin expansion to $23.55 per ton versus $14.92 last year. Our higher average price per ton is being driven primarily by higher pricing for steel. Again as of the end of the first quarter the Eastern Canadian pellet price did not settle though we expect to recognize about $5 million of additional revenue related to that in the second quarter.

Cost in the quarter were impacted somewhat by a major furnace repair at Empire as well as higher energy costs for electricity, natural gas and diesel fuel. Our total energy spent this quarter was up 7% compared with last year. In the North American coal segment, first quarter product sales and service revenues were $93.9 million or 998,000 tons of sales volume. Sales margin with a loss of $2.5 million and primarily due to development and planning work as well as other fixed costs incurred to deliver future production enhancement.

Average price realization of $81.02 per ton for the three months was exceeded by unit production cost of $83.57 per ton. In our Asia-Pacific iron ore business, we reported product sales volume of 2.1 million metric tons during the first quarter of 2008, an increase of 9% from last year's comparable period. Reported average price per ton realization was $56.12 up from $52.14 in last year's first quarter. Most of our contracts with customers based in China run on a calendar year while those with customers in Japan run on a Japanese fiscal year.

Since the Australian pricing for lump and fines iron ore referenced in all of our contracts hasn't settled yet, we estimate will see $50 million of additional revenue related to the first quarter which will be booked upon settlement. This is based on an expected 65% increase in our mix of customers.

Foreign exchange, higher fuel and labor cost all continue to be challenging in Australia although we did report a modest sequential quarter cost per ton improvement. Turning to the balance sheet, at March 31, we had 5.8 million tons of pellets in our North American inventory compared with 6.1 million tons in last year's first quarter and 3.4 million tons at 12/31/07. North American coal had 87,000 tons of net coal inventory at March 31st, compared with a 100,000 tons at year-end 2007. Asia-Pacific iron ore had 1 million tons of finished product inventory at quarter end 2008 versus 900,000 tons at quarter end 2007 and 1.1 million ton at 12/31/07.

At March 31, 2008 we had $187 million in cash and cash equivalents compared with $157 million at 12/31. The company had $600 million of borrowings outstanding under the $800 million credit facility versus $440 million at year-end. Cash used in operations during the first quarter would be approximately $120 million. This was primarily inventory related and it is consistent with our historic use of cash in the first quarter of the year. Our cash capital expenditures totaled approximately $34 million in the quarter.

While we did use cash in the first quarter, for the full year we expect to generate approximately $700 million in cash from operations. This is an increase from our previous estimate of $650 million, which brings us to our outlook for 2008 we've refined all of our estimates based on the latest information that we have. And in estimating our price expectations in North American iron ore for 2008, we increased our assumptions from 65% increase in Eastern Canadian power price to the recently announced agreements for an 87% increase.

We also would share the following other factors that impact pricing in our North American iron ore contract. We've affect [ph] approximately a 3% to 4% increase among the various producer price indices and approximate 25% increase in factors related to steel pricing including hot band steel at $700 per ton. The impact of our recently negotiated amendment to our supply agreement with Severstal increases the quantity and changes to price structure. That agreement also extends our relationship through 2022. Joe will share a little bit more with you on that in a moment.

And finally, incorporated into our assumption are the traditional combination of supply agreement contractual base price increases, lag-year adjustments and various cap. So based on all those factors we are raising our North American iron ore estimated revenue per ton for 2008 to $81. We also updated the sensitivity of that to the key input assumptions as it relates to steel pricing. So now you would look at each $10 change from that $700 per ton at a certain steel making facility will change our realization by $0.24. Because of rising energy costs we're also updating our cost per ton expectation to $53 per ton for the year.

Revenue per ton for North American coal is expected to increase to $94 from our previous expectation of $91 as we anticipate the improving market from that coal will boost our average realization. As a result of the fault area we encountered at the Pinnacle Mine, we expect our cost per ton at North American coal to increase to $86 per ton for the year. In our Asia-Pacific iron ore segment we are assuming a 65% increase in Australian lump and fines although as Real [ph] and BHP continue their negotiation this is still subject to change. With a 65% increase, we expect average revenue per metric ton at $89. Our guidance for cost per metric ton is $53 and includes $3 per ton for our previously announced exploration and evaluation program.

At Sonoma, we expect an average sales price of $129 per ton as our sales mix benefits from some of the recently announced record pricing for metallurgical coal out of Australia. Cost per ton are expected to be $83 at Sonoma higher than originally expected as we recover from the flooding in Eastern Australia that occurred earlier in the year.

As previously announced start-up delays and ramping production levels at the Amapá venture are expected to produce equity losses in 2008. SG&A expense for 2008 is expected to be approximately $160 million, up from our previous estimate of $150 million and primarily due to the legal settlement that I mentioned earlier.

And with that I will now turn the call over to Joe.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Thanks, Laurie. I will begin with an overview of the operating performances for each of our segments and conclude by providing with some information on some of other tactical moves we recently made.

Our North American iron ore segment achieved equity production of 5.2 million tons for the quarter up from 4.8 million tons for the year for the period a year ago with all the mines running at or near capacity. The bulk of the production increase is attributable to Hibbing which was fully... has fully recovered from last year's weather related shutdown producing 2 million tons in the first quarter versus last year's 1.2 million tons. Idle furnace number 5 at our Northshore Mine has been restarted. I'm very pleased to announce on time and within the budgeted time allotted. We expect this operation to add another 600,000 tons of incremental pellet production in 2008 and 800,000 tons annually thereafter.

Our expected share of total production for the year is approximately 22 million tons and includes a full year share from Wabush, an increased production rate at Empire to 4 million tons and a slightly increased production rate estimate for Tilden. We also continue to move forward with our plans for commercial scale plant at our Empire Mine capable of producing 500,000 tons of iron nuggets per year commencing in 2010. We expect to produce 35.6 million tons of pellets in 2008 with the sales volume of 24 million tons as we sell down some inventory. In Asia-Pacific iron ore we produced 1.9 million metric tons in the first three months of 2008, slightly higher than the same period a year ago and we expect to produce 7.8 million metric tons of fines and lump ore with sales of 8 million metric tons for the year.

Now I'd like to take a few minutes to discuss our slowdown of our North American coal, the Pinnacle Mine in West Virginia. In April, we declared force majeure on coal shipments from this facility after encountering a fault area in the coal seam being mined. Since then we have made significant progress through the fault area, which accounts for approximately 1,200 feet of the approximate 10,000 foot coal section. We now expect the impact on our full year North American coal production will be approximately 200,000 tons. As such we reduced our 2008 production and sales volume guidance to 4.3 million tons.

Turning onto our early-stage projects, operations at our Sonoma coal project have recovered from the severe rains and flooding throughout the Bowen Basin that caused a slight delay in schedule shipments during the first quarter. We sold approximately 28,000 tons for the quarter and expect full year combined production of hard coking coal and thermal coal to be approximately 2 million tons.

Per metric ton cost was $189 for the 3 million... for the three month period. The increased cost per ton resulted primarily from high stripping rates associated with the ramp up in production and costs associated with the flooding. As the project ramps up through the remainder of 2008 and into 2009 we would expect cost per ton to come down significantly.

In regards to the Amapá venture MMX is progressing with the sale of its interest in the project to Anglo-American in the interim MMX is maintaining managerial control of the project and moving forward with commissioning and... of the concentrating facility. The reported loss for the quarter at the Amapá Iron Ore project is $6.9 million primarily reflected in pre-production cost.

Although as we've said we expect a loss in 2008, but it is currently difficult to tell to what extent particularly as MMX and Anglo work through their deal and operating plans get hashed out. MMX has provided production and sales estimates of 3 million to 4 million tons for this year and 6.5 million tons next year.

Before we take our questions, I did want to provide you some information on a few strategic and tactical moves we have recently made. As Laurie briefly mentioned in North American iron ore, we recently negotiated an amendment to our supply agreement with Severstal while we are not at liberty to discuss the specifics of the amendments in terms of our pricing or volume, it does increase the quality of iron ore Severstal will buy from us and also changes the way we calculate the price compared to the previous agreement. It also extends our supply agreement from 2012 to 2022. This is consistent with our philosophy of building mutually beneficial long-term relationships with our customers.

Turning to another North American development as you may know in December Cliffs made a strategic investment in a small green energy company called Renewafuel, the company produces high-quality, low emission biofuel in the form of dense cubes made from renewable and consistently available components like corn stalks, switch grass, grains, soybeans and oat hulls, wood and wood byproducts. In addition, to our initial R&D facility in Battle Creek, Michigan, we are in the process of building our first plant in the Upper Peninsula of Michigan. We've also recently targeted Northeast Minnesota for another facility, which we hope to have permitted and operating by early next year.

These plans take very little capital to build and produce about 150,000 tones of dry biomass cubes annually. We may eventually use the product in our mining operation as a fuel alternative but for now we are focusing on developing markets outside the company that can use the cubes as potential substitute for Western coal for natural gas. We've already conducted successful product testing including operating industrial boilers using a 100% biomass. The product has the potential to help large plant operators meet the more stringent emission requirements. Many expect they will be dealing with in the near future as burning biomass does not contribute to global climate change in the same way as the burning of fossil fuels.

Once the project is tested and scaled appropriately this could have a significant impact on Cliffs carbon footprint as well. On the corporate development side many of you heard me say the Cliffs has absolutely no lack of deal flow. Our group in Latin America continues to be very active exploring numerous potential projects. Our strategy there is to find mineral projects, with growth potential outside the influence and control of the large mining players. Countries we are considering include Brazil, Peru and Chile. In addition we are not limiting our options to just iron ore. Other steel making minerals or leveraging or know-how or relationships for downstream processing of ores are also possibilities. Many Greenfield projects in this part of the world are structured such that you must fund an exploration phase that acts much like an option intermediate progress phases and then a back-end production royalty based on output in the out years.

In Asia-Pacific we are also keeping our eye open as changes in the credit markets are providing opportunities. In April Portman Limited acquired a 14.5% stake in Golden West Resources, an Australian stock exchange listed iron ore mining company for approximately $15 million. The purchase provides us a strategic interest in Golden West and its Wiluna West project. In another creative development as we execute our exploration program at Portman we are finalizing a commercial agreement with two other mining companies that provides us the iron ore rights to a number of tenements, areas adjacent to some of our current mining operations in exchange for unencumbered access by these companies to some of our tenements. While too early to tell if this will pay dividends it allows for some tenement rationalization and access to additional perspective exploration areas. I also think it is a great example how Cliffs makes the most out of every opportunity we have.

To close out my prepared comments we are very pleased with the results of operations this quarter. We are well positioned for the expected increases in iron ore and med coal pricing in 2008 that will fuel very strong cash generation for the year.

The cash generation will allow us to continue our strategy of geographical and mineral diversification and with the recent worldwide credit crunch we expect there will be some unique opportunities to put this cash to work in projects that now carry more reasonable valuations. Should these not come to fruition we have multiple alternatives for returning value to the shareholders.

At this time we'd be happy to take your questions.

Question And Answer

Operator

[Operator Instructions]. Thank you. Our first question is coming from David MacGregor with Longbow Research.

David MacGregor - LONGBOW Research

Yes, good morning everyone.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Good morning, David.

Laurie Brlas - Executive Vice President and Chief Financial Officer

Hi.

Steve Baisden - Director, Investor Relations and Corporate Communications

Good morning, David.

David MacGregor - LONGBOW Research

Wondered if you could help me with just a couple of numbers here. If I look at the Portman revenues, the 117.5, I guess we add the 50 million to that and divided by the tonnage when we come with an adjusted sales price of $79.99 to $80. Is that a fair way to look at this?

Laurie Brlas - Executive Vice President and Chief Financial Officer

Yes.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Yes, very much so, David.

David MacGregor - LONGBOW Research

Okay. So help me understand an $80 realization versus the 89 that you expect to realize there for the year?

Laurie Brlas - Executive Vice President and Chief Financial Officer

Well you're going to have some in the first quarter that is not price at the 2008 level. So you're going to have a different mix going forward through the balance of the year.

David MacGregor - LONGBOW Research

Okay. So is it really just some carryover, some previously priced tonnage and we should we expect cost it to an $89 realization in the second quarter?

Laurie Brlas - Executive Vice President and Chief Financial Officer

Yes.

David MacGregor - LONGBOW Research

Okay. Secondly on... again a couple of pricing questions. On PinnOak you realized 81, you have been talking previously about 91and you said now 94. I guess the force majeure may have some influence on mix here, but can you help us understand that discrepancy?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

David it would have some on it, some minimal pieces that come on and I think a lot of it is just a calculation of the contracts as we got deeper into them through the year when the international contracts came on and when the domestic contracts were fully valued we have upped the estimate more on that basis.

Laurie Brlas - Executive Vice President and Chief Financial Officer

If the price increase on international contracts doesn't kick in until the first of this quarter so you have got a quarter where... again you've got some '07 pricing to look forward.

David MacGregor - LONGBOW Research

Okay. That's helpful. And then in terms of the force majeure times I realize it was relatively small but it does come of domestic business or come of export or is it proportional?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

It comes of the... it goes right back to the first contracts that we settled which most of those where domestic I'm mean it just happened to be that way but they would be in order of the contracts lives. So... but yes the majority of them were domestic.

David MacGregor - LONGBOW Research

Okay. Certainly on the iron ore business in North America, if you take the shipments multiplied by the price you get 209 million not 278. It's the difference of Amapá?

Laurie Brlas - Executive Vice President and Chief Financial Officer

That was freight and the other piece in there.

David MacGregor - LONGBOW Research

These are all numbers excluding freight.

Laurie Brlas - Executive Vice President and Chief Financial Officer

Okay.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

David, I could follow up with you on that specific question...

[Multiple Speakers]

David MacGregor - LONGBOW Research

Good, thank you. And then finally on Severstal, you mentioned the fact that with this new agreement not only is there an extension in terms of the date from 2012 by an extra 10 years, but there is also a change in calculation, I guess we would have assumed that can you elaborate a little bit on the change and I realize there is an ability on your parts to provide full disclosure or full transparency but can you just talk at least conceptually about how the change in calculation has occurred?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

We'll give you a broad answer David, but I'm sure won't satisfy but again they are consistent with what we've talked about in the past, with the way we structured contracts, they go forward obviously we think they are favorable to the marketplace that we've settled for ourselves, for Severstal again we are very happy to be with a very large and up and coming customer within North America and we think this contract allows them to grow their business and realign blast furnaces that may be in doubt. So... I can't give you much more than that.

David MacGregor - LONGBOW Research

Can you say whether the contracts now have higher levels of sensitivity to change in the sea born price market?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

No, I really can't.

David MacGregor - LONGBOW Research

Okay. Thanks very much.

Operator

Thank you. Our next question is coming from Jorge Beristain from Deutsche Bank.

Jorge Beristain - Deutsche Bank

Yes. Good morning.

Laurie Brlas - Executive Vice President and Chief Financial Officer

Good Morning.

Jorge Beristain - Deutsche Bank

I just wanted to clarify a little bit on the guidance regarding the hot rolled coil that you now quoting at a $700 benchmark for all of what's happening in the market recently with the HRC going north of $1000 of metric ton. Could you just clarify what you mean by giving that guidance or you just simply trying to update the rule of thumb and you are allowing the analyst to extrapolate from the 700 base versus what current prices are? That's my first question.

Laurie Brlas - Executive Vice President and Chief Financial Officer

Yes, we're certainly allowing you to plug-in what you would like and we're updating that I would encourage you to remember that this is not just the general spot market, it is a full year average of a specific situation, so we want to be a little bit cautious.

Jorge Beristain - Deutsche Bank

Sure. But --.

Laurie Brlas - Executive Vice President and Chief Financial Officer

It's given you the...

Jorge Beristain - Deutsche Bank

For the $81 blend that you're talking about in North America, is that using $700 interest [ph]?

Laurie Brlas - Executive Vice President and Chief Financial Officer

Yes it is.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Yes.

Jorge Beristain - Deutsche Bank

All right and I understand you are saying it's full year average and so there is some sensitivity to be there. The other question I had was just regarding the nature of this Severstal renegotiation, was this something that was up for renegotiation anyways and you took the opportunity to improve a little bit your pricing or is this something that you proactively when out to that client and you expect to do more of these types of contract renegotiations, going forward?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

I would say the contract was not up and I think it's more proactiveness on both parts certainly we have on our side for Cliffs we have large capital spends and expansions that we want to put in. So we need the solidity and the long-term nature of the contracts to go in. I would think on the independent steel producers part I think what you are really starting to reflect is the scarcity of metallics all over the world including North America and the ability to obtain those metallics for long term as they also put their capital plans in. So it's a bit of both.

Jorge Beristain - Deutsche Bank

Okay. Thanks very much.

Operator

Thank you. Our next question is coming from Mark Liinamaa from Morgan Stanley.

Mark Liinamaa - Morgan Stanley

Good morning.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Good morning, Mark.

Laurie Brlas - Executive Vice President and Chief Financial Officer

Good morning.

Mark Liinamaa - Morgan Stanley

Can you give a little commentary regarding your coking coal pricing strategy for next year? Already we are starting to hear talk of $300 plus deals being set for 2009. How long you would hold out there, are you looking for multi-year deal?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

I think, yes, Mark I'd be glad to... as we said moving into this year this was our first year in the coal business and of course everybody remembers last week when the floods occurred in Australia and the BHP pricing is, we did settle our pricing early for '08 we're new to the coal business and we weren't ready to speculate in the spot market at that point in time. And the same things for '09 we have nothing committed for '09 our group, our sales group is certainly discussing the strategy going forward and they're going to start discussions with customers later this month in regards to '09. But we would certainly look at international pricing as the benchmark for our '09 pricing.

Mark Liinamaa - Morgan Stanley

Okay. Thanks. And as far as... it sounds like you are reasonably close to doing some sort of M&A activity I think with a minority interest type things still be of interest and can you talk a little bit about how big a transaction you might be willing to take on?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

We are all sitting here stumped Mark, we're not aware of anything we are relatively close to doing. But again as we've always talked about through our strategies is we'll look for the best deal possible we're good at joint ventures, we prefer a majority share, but in the right circumstances we... it doesn't concern us to have a minority share either.

Mark Liinamaa - Morgan Stanley

Thanks, very much. Sorry I stumped you.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

That's okay.

Mark Liinamaa - Morgan Stanley

Thank you. Bye.

Operator

Thank you. Our next question is coming from Jack Frankie [ph] of Duquesne Capital.

Unidentified Analyst

Thanks for taking my question, Joe.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Sure.

Unidentified Analyst

First question is on the coking coal for '09. We are seeing 315 metric ton in the market. What is that net back to the mine would you think?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

It seems about a... it will be about a 315 we'd take it back to about 240 to 250 in the mine.

Unidentified Analyst

For both mines?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Yes.

Unidentified Analyst

Okay. That's a short ton?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

That's a short ton, yes.

Steve Baisden - Director, Investor Relations and Corporate Communications

Jack you have got to make the adjustment from metric ton to short ton and then you also have to build in the freight costs for... per mine mouth to port.

Unidentified Analyst

And then given this Severstal contract renegotiation and any other middle contract, umbrella and... contract comes up due in 2010. Are you guys starting to begin dialogue there on changes to that contract?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Well we always have constant dialogue with our very large customers as you can imagine that carries along I mean both parties are aware of the Umbrella agreement, nothing is officially started but I'm sure we are both aware of it.

Unidentified Analyst

Okay. Thank you guys.

Operator

[Operator Instructions]. Our next question is coming from Tony Robson with BMO Capital Markets.

Tony Robson - BMO Capital Markets

Good morning, guys.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Good morning, Tony.

Laurie Brlas - Executive Vice President and Chief Financial Officer

Good morning, Tony.

Tony Robson - BMO Capital Markets

And thank you for your time for this call.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Certainly.

Tony Robson - BMO Capital Markets

I will come back on the issue of pellet pricing. It strikes me that for this year the Cockatoo and Koolyanobbing fines price mostly will be actually higher than your North American pellet price and of course pellets are much more valuable than the funds. What can you continue to do to increase the price you received from the customers, that's my first question for you.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Well again as we say as customers want to engage Tony on these contracts and certainly again I think it's scarcity of supply that would drive those conversations. We are certainly as open as we possibly can be, I mean beyond that we have long-term contracts that are in place. We're going to honor those contracts, we're certainly not looking at some of which we adjusted in the past to find a way to break those contracts and we have to work with what we have got.

Tony Robson - BMO Capital Markets

Now I understand absolutely that you can't break contracts, but I guess the pricing mechanism which was suitable for if you like the 80s and 90s with the steel industry in the U.S. keeping when times were tough is no longer relevant now when we see steel companies dealing with the higher input cost make it some pretty attractive margins. And I guess you guys are aware about that of course too and I have no doubt they are fighting for better contracts, as far as also following one of the previous questions, are you trying to increase the sensitivity to the global pellet price into your new contracts, in a general sense?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

At a general sense the... we're going to do the right thing and the closer we can get to world pricing the... we're going to fight pretty hard for that if we get the chance to as in contract reopeners. But we also still in North America we like the assemblance of longevity with our contracts and tying them down for a long time.

Tony Robson - BMO Capital Markets

Okay. Two more practical questions if I could please. Can you give us guidance for 2009 for PinnOak coal production, assuming no more intrusions or a sandstone, or intrusions?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

It's just too early where we are coming out of the... I am happy to report we are coming out of the second sandstone intrusion quite nicely. I think also our credit to the management team down there, the first sandstone intrusion caught us right after we bought the mine and just stopped us dead in our tracks and to the credit of the management team, they've worked through this one and they are just now coming out of it. So we really have to get them out of it and have them moved forward, so we can focus but I'm just a little too premature to give you any guidance for next year.

Laurie Brlas - Executive Vice President and Chief Financial Officer

And we still believe it's going to increase over what we have expected this year as we've said before. We've indicated I believe around 5 million or so, certainly we will be getting in that direction.

Tony Robson - BMO Capital Markets

All right. One final question please, closure call for Cockatoo Island in the third quarter anything materially?

Laurie Brlas - Executive Vice President and Chief Financial Officer

It is all accrued for us.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Yes. There is... there won't be anything. We'll just be finishing production up there Tony, and we're still negotiating with the Environmental Bureaus in Australia on the type of closure that it will go. So I suspect it is accrued for but even the activity of it...

Laurie Brlas - Executive Vice President and Chief Financial Officer

On a cash basis, I mean we're talking low single-digit million so it's not going to be anything that going to be a significant problem.

Tony Robson - BMO Capital Markets

Okay. Great. Thank you.

Operator

Thank you. Our next question is from Zack Shribber [ph] from Duquesne Capital.

Unidentified Analyst

It's Zack Shribber just a follow up question. You talked about in terms of going forward you valued sort of long-term contracts with your customers in North America, just wanted to understand if the things you value about is having a physical home for the metal or if it's having certainty of price and given the scarcity of the metallics that you have highlighted and given the recent deal you cut with Severstal, can't you just sort to have your cake and eat it on a going forward basis and can't you have guarantee of much higher pricing going forward as well as the physical home for your product and I wasn't sure if you were trying to intimate that, you are sort forever in a situation where you have to expect a discounted price for your product relative to the global price, given what you value for certainty or if you actually can have in this environment for this foreseeable future have your cake and eat it? Thanks.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Well, it's hard to see how big that cake would be to 2022. I mean when we start looking at time contracts up that far. We think we're getting what we need to do we are moving closer to world pricing. We will not see world pricing at this point in time and again we have chosen to sacrifice some prices for longevity and security of supply in North America once again. We could take the short-term view but we don't think that's all nice right now and everybody has forgotten and we've just come into this in the last three years, when the cycle does turn it will be nice to remind people of these long-term contracts. So we are quite satisfied with our track record and where we're going with it.

Unidentified Analyst

And the 2022 is the new Severstal contract?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Yes, sir.

Laurie Brlas - Executive Vice President and Chief Financial Officer

And I think it's also important to remember that it's relatively expensive to ship... tell us out of North America. So that's an important factor to keep in mind.

Unidentified Analyst

And just to make sure I understand it how does the existing contracts roll off, I mean you've spoken about physical supply, physical deliveries between now and I believe 2016 and then also different plans within the Umbrella Agreement growing off and I believe 2011 and so forth just sort of back of the envelope a bunch of this stuff starts getting market pricing in 2010 or 11 without any new contract structure being put in place. Is that correct?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Yes, our contracts... the first of the contract do start coming up in 2010 and again those will be renegotiated prior to those states.

Unidentified Analyst

Got it. And to be clear the Weirton Plant there is no obligation to serve that plant at this contractual rate that's after 2010 right? That expires the plant no longer exists and there is no way ArcelorMittal can sort of divert those pellets to another plant and say that they are still odd pellets that are at a below market price i.e. that's clear there's no way that contract goes away?

Steve Baisden - Director, Investor Relations and Corporate Communications

Hey Zack, this is Steve. The Umbrella contract covers the three prior contracts that we had with these former entities that now make up Mittal. And all that Umbrella contract does gives Mittal some options as to where they can ship pellets. Once we come to the end of 2010, we will renegotiate that Umbrella contract and at that time we will sit down with Mittal and say this is the current state of the Umbrella contract, how do we move forward together as partners and that's really all we are ready to...

Laurie Brlas - Executive Vice President and Chief Financial Officer

The underlying contract still survive beyond that point in time.

Unidentified Analyst

The underlying contract but not with Weirton right? Because Weirton no longer exists?

Steve Baisden - Director, Investor Relations and Corporate Communications

Well Weirton no longer exists but the contract, with that tonnage that was going to Weirton still exists.

Unidentified Analyst

And so they can divert that Weirton tonnage to other facilities?

Steve Baisden - Director, Investor Relations and Corporate Communications

Under the Umbrella Agreement right now they can.

Unidentified Analyst

But the Umbrella Agreement expires in 2010?

Steve Baisden - Director, Investor Relations and Corporate Communications

That's right.

Unidentified Analyst

So then post 2010, do they have a call on the Weirton tonnage or not?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

We have really taken it to be quite honest with you Zack is the mute point with Weirton being down and debt in our eyes forever, we have kind of moved on with the Umbrella Agreement. So I don't know that we have put much thought into that to be honest with you.

Unidentified Analyst

Do you have any obligation to sell them the Weirton tonnage post 2010 under any contractual agreement?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

I really don't know at this point in time Zack I mean again I think that we'd have to dive beep into our contracts...contract experts at this point in time.

Unidentified Analyst

I actually will follow up offline guys. Thank you so much. Congratulations.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Thank you.

Unidentified Analyst

Bye, bye.

Operator

Thank you. Our next question is coming from Wayne Atwell [ph] with Pontis Capital Management.

Unidentified Analyst

Good morning.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Hi, Wayne.

Laurie Brlas - Executive Vice President and Chief Financial Officer

Good morning.

Unidentified Analyst

You seem to have accounted sandstone intrusions in your North American coal several times and my understanding was that it was not uncommon in the past. Is there anything you can do to anticipate this or deal with it more easily in the future?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Actually there is Wayne and again as I say is no one was so happy with the force majeure and the loss of couple of hundred thousand tons on this panel. It certainly beats what we fell into last year right after we bought the mines which was a dead stop and a loss of three weeks of production while we got development up and running. We have actually in the next panel, we have found that fault where it runs through again it continues to minimize as it runs through the... and crosscuts through the panels.

They have already mined through that panel and or through that fault rather with continuous miners, you know the plough just can't make it through the tough sandstone and backfilled it for support. So when we jump to the next panel and get through this one we will be able to mine right through the mine... right mine right up to it, we now where it is, we've moved the backfill and moved forward. So, yes there are some things we can do as we get our feet on the ground in this business and encounter that. So we've much better results with the next panel.

Unidentified Analyst

So, it should be less painful in the future?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Yes.

Unidentified Analyst

And what is the market price for that coal right now, if you were to sign a contract? You can... then don't to be too specific about what you would do which is coal like that, what would the price be at this point?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Well, you know what the export market is being quoted at on a spot basis Wayne right now would set somewhere in the 290 to 315 again that's metric ton, that will be on the water. And again that coal is a premium coal, it would sit in that range if we were able to do that at this point in time.

Unidentified Analyst

Okay. And then just lastly the biomass business you are getting into, how much capital is that going to require and what kind of return on investment, can you generate there?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

It's not a lot... the initial investment was about $6 million, $6.5 million in it and these are primarily cubing machines if you will for the... some crushing systems too, so we can get it and cubic as we bring it in. The real trick in this business is distribution angles and channels to bring the products into these facilities. So, there is not a lot of money when it comes into, it's more of the concept that goes around it when there is not a lot of intellectual property around the cubing as well.

That goes with it either and we're using it more strategically for the anticipation of the Greenhouse Gas Legislation that we think is coming that will be passed and we think this will give us a leg up to reduce our carbon footprint in the outer years with our plans, we're big carbon produces to go forward. So, it's more of the strategic intent to get it up and running, we have test fired it in our kilns as well and it works quite nicely and move it forward when the legislation comes in.

Unidentified Analyst

And is this will be economic though, it's not just a greenhouse gas --

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Yes, this is very economic.

Unidentified Analyst

But, this is sort of a hobby in terms of P&L. I mean this is not going to be a huge contributor, it makes a lot of sense to be positive, but they will never generate huge dollars will they?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

No, no. Listen and this business we're not going off the track of our primary business in there. It's... everybody is trying to think of defensive strategies for greenhouse gas climate change legislation. We spend like every other company in this business a lot of time on that. And we think alternate solutions are going to have to come in Wayne. I think when carbon taxes that they do hit in it 15 or $20 a ton as they are being kind of bantered around right now. This could have a nice impact on meeting our goals and not happening to buy safety valve carbon credits. So, it's a futuristic thinking.

Unidentified Analyst

Super. Thank you very much.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Sure.

Operator

Thank you. Our next question is coming from Meredith Bandy with BMO Capital Markets.

Meredith Bandy - BMO Capital Markets

Hi, guys, thank you for taking my question.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Sure Meredith.

Meredith Bandy - BMO Capital Markets

First of all on the North American coal cost, you had any 83.57 per ton this quarter? But then you guided to 86 for the year, I would have sort of thought that this year would have been heavier on the cost? But is it like... the rest of the year is going to be heavier than this quarter, is that right or am I missing something?

Laurie Brlas - Executive Vice President and Chief Financial Officer

The intrusion is rolling into the second quarter and there is very little of the intrusion in the first quarter.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Right.

Laurie Brlas - Executive Vice President and Chief Financial Officer

Most of it's in the second quarter.

Meredith Bandy - BMO Capital Markets

Okay. And then that's somewhat offset, I guess in the second half of the year you have more ton so?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Yes, that's right.

Meredith Bandy - BMO Capital Markets

Okay. And then on the revenue per ton in North American iron ore, I am just trying to get a feel for the lag-year adjustments and that sort of thing in your contracts. If we were to assume the $700 per ton average hot rolled steel for 2008 and 2009, you know, everything flat that the settlements came out flat next year, everything because in this contract is flat. Would you still say that your estimated revenue per ton in '09 would be 81 or would you have a lag and so you'd see an increase from that? Does that make sense?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Meredith, what we have said in the past is that if all things equal and all of the factors are flat because of some of these contractual arrangements that we have, we would see an increase in pricing.

Meredith Bandy - BMO Capital Markets

Okay. And can you give any sort of window or frame about, is it a 10% increase, is it still capped, would it all go through or?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Yes, we haven't at this point, Meredith I think

Meredith Bandy - BMO Capital Markets

Okay.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

I don't think you're going to see Cleveland-Cliffs getting in a habit of trying to put our guidance for 2009 after the first quarter of the year. So as we get closer to 2009 we will give guidance, but right now we're just not ready to.

Meredith Bandy - BMO Capital Markets

Right. So it will be north of 81 but you can't really say how far north?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

That's right.

Meredith Bandy - BMO Capital Markets

Okay. Thank you.

Laurie Brlas - Executive Vice President and Chief Financial Officer

Thanks.

Operator

Thank you. Our next question is a follow up from David MacGregor from Longbow Research.

David MacGregor - LONGBOW Research

Just on that question of the cost in North American iron ore, is there anything that's moving of significance outside of energy? So I mean, you've got... I guess steel costs associated with some of your replacement parts, I wondered, if you could just talk a little bit about that and how much of the cost revisions associated with energy versus non-energy?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

I think we are seeing a little bit David, in anything that is more energy related such as explosives, which you know is a big component for us and it would come in small bits and pieces around price increases on materials more petroleum related as well. Of course with the increased prices on the hot band that you see in steel obviously replacement parts are also going to go up significantly I would guess as those prices get passed through that I had already covered in our alliance agreements, but they are kind of all over the map.

Laurie Brlas - Executive Vice President and Chief Financial Officer

Because, also some impact from FX on the Wabush cost, because of the Canadian dollar that translates into an overall cost impact for the company.

David MacGregor - LONGBOW Research

Okay. Thank you. And I guess the question I wanted to ask you it has to do with the Portman acquisition of 14.5% interest in Golden West Resources. I know you've been looking at a lot of different acquisition opportunities, in a lot of different corners of the world and I guess I'm interested in why Golden West Resources why now is 14.5% kind of where you are going with this. What's the variant for this investment, and maybe just talk a little bit about why you found it so appealing?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Yes, David, I'd be happy to talk about that. The project is called Wiluna West and if you can find it on a map in Australia, it is due North about 200K of our Windarli and Mount Jackson deposits. It is a real direct shipping reserve of about 80 to 100 million tons at this point in time of iron ore of good quality. If you look out there in Southeast Australia, we are the natural miners of that deposit, given we have the infrastructure in remote location and again it's just not big enough to develop infrastructure off at a 80 to 100 million ton.

So, we've had our island for quite some again we think we are the natural processors and like all these deals as I said earlier in my remarks as this credit crunch came on... this came to us as a result of the Opes Prime collapse in Australia where they own these shares and we were very fortunate to jump with the management team over there very quickly to get that at this point in time. That just occurred in the last two weeks, of course we'd love to have control of that deposits so, we could develop it in the future years with that. But at this point in time we can't move beyond this right now without governmental approvals. So, we're pretty happy with how we ended up with it.

David MacGregor - LONGBOW Research

Is the geology such that expansion of reserves is not likely or is there an opportunity there?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

I think there is a little more but again it's like... these banded iron stone deposits in Southeast Australia we're not going to hit the mother low down there in any of these deposits. But yes, there is still a little room for some expansion.

David MacGregor - LONGBOW Research

Okay. And is this likely to I mean is this kind of acquisition we're going to see you making going forward are these types of bolt-ons do you feel like maybe you don't have the capacity for a big one right now or maybe just talk about philosophically how you're looking at deals?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

I think we run the ruler over everything from big to small. I would say at this point in time it seems like things that are going to auction are completely out of control and we've got to move past them. But now I think you're going to see us go from the best opportunity with the good return that fits with the business. So I wouldn't limit this to just deals of this size.

David MacGregor - LONGBOW Research

And would it be fair to say that the coal deals are maybe a little more accessible to you right now than the iron deals?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Well, I think that's for everybody. There is just more point of entry in consolidation, particularly in United States and in the coal industry just hasn't happened as we all know, this is common knowledge. So certainly coal has got a better point of entry.

David MacGregor - LONGBOW Research

Thanks very much, Joe.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Okay, David.

Operator

Thank you. Our next question is a follow up from Jorge Beristain with Deutsche Bank.

Jorge Beristain - Deutsche Bank

Yes, hi guys. So if I could have a follow up.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Sure.

Jorge Beristain - Deutsche Bank

I just wanted to identify the potential size of those environmentally friendly coal substitute that you're going to make from natural fibers. You said it would be about 150,000 tons, what would you want to scale that up to, would be talking 2, 3 million tons relative to your current 6, 7 million ton coal output?

And secondly if you could quantify the ownership structure in that business should we hear there you are the 100% owners of this business.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

It's a joint venture with two entrepreneurs who started it. We are 70% of the joint venture that goes with it. And by the way, we're very happy to have our partners in. One is an environmental attorney, who understands the regulations, the other is the gentleman that is kind of the father of the processing of these facilities. The scale-up of these things will not... will have to come regional and it really depends on the area or the radius that you can go out and bring waste products in.

So it's a facility hopefully in the middle of a waste byproduct, a biowaste product such as wood products. And then how far out you can go to bring these products in economically, because we will make money out of these. We won't take a loss to do that. A scale is a little unknown at this point in time, but they are not large. I mean I would think it would be on two or 300,000 tons would be pretty big to find that much waste on a continual basis to run these plants.

Jorge Beristain - Deutsche Bank

Okay, great. And just a follow up question if I might as well. On the nature of the contract, if we could again just pick up on that theme, you said that you are proactively looking to renegotiate some of these contracts. Is that something that you will be doing on a rolling basis through the next few major class that you have or just sort of maybe a once per year type of event that you see?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

No, I think... what I tried to animate was the proactiveness on both parties. We are satisfied with where we are as we've said. Yes we'd love to move to world pricing, but again I think the driver has to come from both ends when you have a contract in place. And scarcity of supply and the out years is certainly driving the proactiveness on the part of the customer. So where we can find need and the customers' willingness, we will certainly engage in these contract discussions.

Jorge Beristain - Deutsche Bank

Okay. I'm sorry just quickly last question. Have you guys looked at the maps according through the St. Lawrence Seaway and given where international prices are is this now a viable alternative for your Great Lakes iron ores to get them out of Asia?

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Asia would be very difficult. Yes of course we have looked at the maps. We have looked at the supply chain in the list. It just exchange... again it comes down more to... that would have to be a spot basis more than world price and it would come down to scarcity of need of a customer more than economic sense. So there are a few cases out there.

Jorge Beristain - Deutsche Bank

Okay. Thanks very much.

Steve Baisden - Director, Investor Relations and Corporate Communications

We are approaching the top of the hour. So I think at this time, we'll wrap the call up. I want to thank everyone for joining us. I will be available for the rest of the day to handle any follow up questions and for those of you who I have indicated I'll follow with our plan. I will be sure to get back with you. Thanks a lot everyone.

Joseph A. Carrabba - Chairman, President and Chief Executive Officer

Thank you all very much.

Laurie Brlas - Executive Vice President and Chief Financial Officer

Thanks.

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