Cloud Peak Energy CEO Discusses Q2 2012 Results - Earnings Call Transcript

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 |  About: Cloud Peak Energy, Inc. (CLD)
by: SA Transcripts

Cloud Peak Energy Inc. (NYSE:CLD)

Q22012 Earnings Call

July 31, 2012 5:00 am ET

Executives

Karla Kimrey - Vice President, Investor Relations

Colin Marshall - President and Chief Executive Officer

Michael Barrett - Executive Vice President and Chief Financial Officer

Analysts

Jim Rollyson - Raymond James

Andre Benjamin - Goldman Sachs

Brian Gamble - Simmons

David Gagliano - Barclays

Mitesh Thakkar - FBR

Brandon Blossman - Tudor, Pickering, Holt & Company

Meredith Bandy - BMO Capital Markets

John Bridges - JPMorgan

Lucus Pipes - Brean Murray Carret and Company

Brett Levy - Jefferies & Company

Michel Tian - Morningstar

Richard Garchitorena - Credit Suisse

Jamie Melzer- Bank of America

Chris Haberlin - Davenport

David Beard - Iberic

Operator

Good day, ladies and gentlemen, and welcome to the second quarter 2012 Cloud Peak Energy Inc. earnings conference call. My name is Deana and I will be the operator for today. At this time, all participants are in listen-only mode. Later we will conduct a question-and-answer session. [Operator Instructions]. As a reminder, today's conference is being recorded for replay purposes.

I would now like to turn the conference over to your host for today to Ms. Karla Kimrey, Vice President, Investor Relations. Please proceed.

Karla Kimrey

Thank you, Deana. Good afternoon and thank you for joining for us today. With me today on the call is Colin Marshall, Cloud Peak Energy's President and CEO, and Michael Barrett, Cloud Peak Energy's EVP and CFO.

Today's presentation may contain forward-looking statements regarding our outlook and guidance, economic and industry conditions, volumes, prices and demand, LBAs, business development plans, regulations and energy policies, capital resources and other statements that are not historical facts.

Actual results may differ materially because of various risks and uncertainties, including those described in the cautionary statement in today's earnings release and in our 2011 Form 10-K.

Today's presentation also includes non-GAAP financial measures. Please refer to today's earnings release for the required reconciliations and other related disclosures. Our earnings release is available on the Investor Relations section of our website at cloudpeakenergy.com.

I will now turn the call over to Colin.

Colin Marshall

Thank you, Karla. Good afternoon and thank you for joining the call. I will make some opening remarks before handing over to Mike to cover the financials and our guidance. Overall, I have pleased with the way Cloud Peak Energy has come through in the second quarter, which we said was going to be characterized by low shipments during our Q1 call.

We are now well placed for the second half of the year. We are expecting an increase in shipments as coal stockpiles come back to more normal levels. During the quarter, we completed our first main acquisition when we purchased the Youngs Creek Project and large associated land holdings that positioned us well to expand our export sales as terminal space becomes available.

During the second quarter, our nearly, 1,400 mine site employees, three suffered MSHA reportable injuries resulting in a year-to-date MSHA All Injury Frequency Rate of 0.68, a good reduction from the 1.18 last year. During the 17 MSHA site inspection days, we were issued with only one substantial and significant citation, with a proposed fine of just under $6,000.

We were proud the of Office of Surface Mining awarded Cloud Peak Energy, the National Good Neighbor Award for Excellence in Surface Coal Mining. It is always nice when our employees' hard work and dedication are recognized by external awards, particularly at the national level. I would like to take this opportunity to publicly thank our employees for their work in these areas and the value it brings be Cloud Peak Energy.

Exports for Q2 was same as the first quarter, at approximately 1 million tons. This includes our last contracted vessel through the Ridley Terminal. During the quarter, the Westshore Terminal successfully completed the first of their two scheduled outages which will increase their capacity from 29 million to 33 million tons. The second outage is scheduled for October. Assuming the outage goes as planned, we are still expecting to export around 4.3 million tons this year.

In 2013, we should be able to increase our Westshore shipments in line with the increased capacity. Considerable work continues to go into the new port projects along the Pacific Northwest. I am hopeful that we will not be too delayed by the actions of NGOs during the permitting process.

In late June, we completed the purchase of the Youngs Creek mine project and associated land from Chevron and CONSOL for $300 million. It is rare that you get the chance to purchase substantial coal deposits and a large land positioned adjacent to an existing operation, particularly when it is one with geographic and quality advantages when supplying our growing export business.

I believe the land position with low sodium coal and reduce royalty rates make this a sound investment even without additional terminal capacity. Clearly we expect additional capacity to be developed and that this will become a very valuable acquisition that can be developed in conjunction with the existing Spring Creek mine.

Last week, we announced a tentative agreement with the Crow Tribe of Indians covering a large exploration area on the Crow reservation, adjacent to the Spring Creek mine. If approved by the Crow legislature, this would further add to the development options available to us to grow our Asian Exports. We are hopeful that the agreement will be approved and are looking forward to working with the Crow tribe to bring jolt in economic development on the reservation.

With that, I will turn it over to Mike to run through the financials and our guidance.

Michael Barrett

Thank you, Colin. As we have already mentioned, the second quarter usually tends to be a slower quarter. This year, the impact was exacerbated by the warm wet winter which drove down natural gas prices and resulted in high coal stockpiles at utilities.

For the quarter, our shipments were pretty low last year in response to the lower market demand. As a result our gross revenues were 11% lower than last year, at $343 million and our adjusted EBITDA was $66 million compared to $88 million last year.

For the six months, our adjusted EBITDA was $141 million compared to $171 million last year. Again, this decline was primarily a response to the market conditions resulting in shipments which were 8% or 3.5 million tons lower than last year.

With our contracted position, we were able to increase realized sales prices for the six months, to $13.21 per ton from $12.86 last year. With the reduction in volumes, we focused on controlling variable costs. We were able to contain costs at $9.93 per ton compared to $9.09 last year. Cost controls across all of our operations helped mitigate the impact of the lower volumes as we controlled variable costs such as contractors and overtime.

Towards the end of the quarter, we started to see the benefit of slightly lower oil prices come through in our diesel costs. We were also able to make savings in other volume related costs, such as explosives, diesel and maintenance.

It is important to note that we have not changed our strategy to invest in the appropriate planned maintenance programs and capital expenditures which help keep our costs low on a long term basis and ensure the long term health of our equipment and plant.

We generated almost $30 million of cash flow from operations in the quarter and $81 million for the six months. Capital expenditures were $7.5 million in the quarter. We funded the $300 million Youngs Creek acquisition with available cash from our balance sheet. We also made lease payments on LBAs of $69 million. This still leaves us with a strong cash position with cash in investments of $222 million at June 30.

Our balance sheet remains clean, with no legacy liabilities acquired in the Youngs Creek deal and our $500 million revolving credit facility remains undrawn giving us total liquidity of $722 million. We have no debt maturities due before 2016 and our leverage remains very robust, 1.86 times the gross leverage and 1.17 times on a net basis.

Turning now to our guidance for the rest of the year. The external environment continues to create some uncertainty when it comes to projecting how the full year will turn out. It was a mild winter and low price natural gas was substituted for coal.

Coal stockpiles at utilities grew and we are now starting to see some more positive signs with a warm start to the summer and rising natural gas prices. Obviously, the weather over the remainder of the summer is important is the start to winter.

To reflect the lower volumes year-to-date, and our current estimates for the full year, we are reducing the top end of our volume and EBITDA guidance ranges. We are now assuming ton shipped will be between 90 million and 93 million, reducing the upper end from 95 million tons previously.

In line with the reduced volumes, we are reducing the top end of our adjusted EBITDA range. We now expect adjusted EBITDA to be between $300 million and $330 million for the full year, reducing the upper end from $350 million previously.

For 2012, we have 92.6 million tons committed of which 90.5 million tons are at fixed prices, averaging $13.34 per ton. We still expect capital expenditures to be in the range of $60 million to $80 million of which approximately $15 million to $20 million is for surface land deals which we hugged close in the second half.

As expected, in the second quarter, we received federal mine permit for the Maysdorf I LBA which we acquired in 2009. This means that we will no longer capitalize the interest on that LBA. This firms up our guidance on interest expense to be approximately $30 million for the year, while our cash interest cost will be approximately $55 million.

This quarter, we implemented an oil-hedging program, using costless collars for 75% of our expected usage on a rolling 12 month basis. These collars have a ceiling of approximately $105 per barrel for WTI and a floor of $66 per barrel. We have undertaken this hedging after careful evaluation and we believe the program will help us protect our diesel costs against more extreme upswings in the oil market.

Finally, we are well placed for 2013. We have 81.2 million tons already committed for 2013. Of these 68.6 million tons are at fixed prices averaging $13.83 per ton. This strategy of forward sales helps us predict our business, keeps our balance strong and helps us manage the operations to keep our cost low.

With that, I will turn it back to Colin.

Colin Marshall

Thanks, Mike. Now, if you look at the rest of 2012, we have not yet got over the impacts of remarkably warm winter and associated impact on reduced electricity and heating gas demand that it had on coal and gas prices.

We knew Q2 was going to be slow as the build-up in stockpiles that occurred in Q1, coincided with the shelter season of April, May. To add insult to injury in June flooding at the MERC terminal on the Lake Superior, delayed 400,000 tons of Spring Creek coal into Q3. However the hot stuff is some of this bid appear to be helping with the coal burn.

Looking forward to the rest of the year, we are expecting shipments to pick up to more normal levels during the second half and are encouraged by the increase in shipments that we have seen in July.

Natural gas prices rising above $3 will decrease to level of coal to gas switching. I should add that as we have managed our cost this year, we have had to make any drastic cuts that would impact our ability to meet our forecast full year production.

As reported last quarter, a small number of our customers had contacted us to discuss reducing 2012 shipments. At this time, we have renegotiated 1.7 million tons, mostly deferred to 2013 and continue discussions with the small number of customers. The deferrals in our updated 2012 tonnage guidance and are committed to position, which has reduced to 92.6 million tons.

During the second quarter 2012, our position for 2013 will increase by 6.4 million tons to 81.2 million tons due to limited customer contracting. We would have had utilities wait and see how the summer plays out and where the stockpiles end up for committing sales in future years.

I do not have much to update you with regards to regulatory environment. There is still a lot going on, not much that it is likely to increase domestic demand for coal. We still believe Powder River Basin is the best place U.S. coal basin to supply the domestic market with low cost, low sulfur coal, but leave opportunities for domestic growth will be limited.

Any upside from regulation's increasing demand for sulfur is likely to be balanced by the closure of the power plants that cannot justify the cost of retrofitting control equipment. The regulations directing coal power generation will lead to higher electricity cost that will impact consumers and hold back economic growth in future years, particularly when gas prices recover to 2011 levels.

In conclusion, we are seeing shipments week by week, and they are optimistic that second half shipments will be relatively strong. We currently anticipate, we will ship somewhere between 90 million and 93 million tons in 2012 depending on how December burn in gas prices go.

As Mike explained, we have lowered the top end of our tonnage and our guidance to reflect our best estimates of how the full year will play out. I have been impressed with the minds responds to domestic swings in the market since last October and believe we are well placed for the rest of the year.

We have strong sales additions in 2013, with got 81.2 million tons already contracted. In the next year or so, I believe natural gas prices will have to rise to above $4 to provide the return to gas producers, which should leave the sale to market with sound profitability.

We will continue to use our domestic base to build our export operations as we did with the Youngs Creek acquisition and look forward to significant growth in export as terminal space is developed.

With that I would like to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] Your first question comes from the line of Jim Rollyson, Raymond James.

Jim Rollyson - Raymond James

Colin, the first question is just kind of coming back to cost. Obviously your cost for the quarter were just under $10 a ton relates to the volume decline in the second quarter in comparison what you had been. If you kind of normalize the absolute number over better volumes like, say, what you are looking from the second half, it actually implies some pretty darn good on a per ton basis. Just kind of curious with your 90 to 93 for the year, which is second quarter 47.5, almost $50 in change for the second half. How are you thinking about unit cost in the second half?

Colin Marshall

In terms of unit cost in second half, we are expecting to come in under 10, I would say, and that's going to be driven by the volume. We are seeing the lower diesel price start to come true which is quite nice and that should do it. We did not have to do anything with our business.

I am very comfortable we have run it steadily and we'll not neglect with anything so far and we don't intend to, so I think in the second half we should get the benefit if we get those tons and I think we are well placed to get in as long as the trains turn up.

Jim Rollyson - Raymond James

If you look over the last four quarters, you've had production figures that have exceeded your sales, which obviously imply you built some inventory. By my math, it's roughly about 1.6 or1 million tons of inventory. Just curious as you go forward into the second half. How you are thinking about what inventory levels you are comfortable with and do you think we'll see basically your sales start to exceed your production in the second half and draw those down?

Michael Barrett

Okay. I am struggling a bit with the inventory number unless maybe there's some of the pool you are catching up on, because obviously the mines basically don't have any stockpiles of finished coal, only miniscule amounts, because of the way we operate, so we got the mines well placed with uncovered coal, but that wouldn't be an inventory and the stripping is in good shape to 12 hours to run at a good rate in the second half, but there's no great movement in inventory, because obviously we know it's pretty well just in time coal we produce because of the nature of the operations.

Jim Rollyson - Raymond James

Right. What I would expect as to where the numbers worked out? We'll talk about that offline later. Any appetite for export coal looking into next year, you had kind of early preliminary discussions?

Michael Barrett

We had different contracts and some of them are longer term. They are already in place and obviously then you come to the fourth quarter to fix the prices for chunk of the four-plus million tons we expect to explore next year, so thankfully at the moment last price export prices allowed us doesn't seem to integrate Russian on an our part to lock-in prices for next year. We are comfortable that the demand will be there for the amount of terminal space we have got and we just need to wait until the fourth quarter to fix on the prices. A chunk of the call and that the balance, we don't expect at the moment to have any problem pacing them.

Karla Kimrey

Next question please?

Operator

Next question comes from the line of Andre Benjamin, [Cloud Peak].

Andre Benjamin - Goldman Sachs

Thank you. First question would be, could you please talk a little bit about your strategy for both, growth in capital allocation following the two recent deals in Montana. Do you anticipate actually growing production from Spring Creek by expanding the mine or, do you look to the recent acquisitions does it means for increasing your resource life and I guess we think that you are probably done spending on reserves for the foreseeable future? What do you think about taking some of that free cash, returning it shareholders how are you thinking about all of those things?

Colin Marshall

Andre, I think what we are looking to do around the Spring Creek, the Northern PRB assets is build the position where we can grow production immensely as general space is developed.

Obviously the Youngs Creek deal, the way I would say and ask you to consider it. It's not so much as a separate mine, but it is a sort of satellite pit to Spring Creek. We have got a lot of work to do to evaluate how best to develop that. It will depend on the timing of the export terminals coming on, and what options are open to us.

Michael Barrett

Obviously the deal Crow Tribe or the potential of the Crow Tribe that we announced I think last week. Obviously, that's got a fair way to go and we'll have to see if the Crow legislature approve that or not, I think that would be a nice to have in term giving you some more options at a relatively low upfront cost because some restructuring of the deal, which should help it be developed.

So I think that we got a base that we would certainly want to put the capital in to develop those and as those capacity becomes available and obviously put money into any terminal developments that whether the opportunity to develop capacity for Cloud Peak, so those are definitely the first call.

In terms of the cash balance at the moment, we have invested a fair bit of money. We have got LBAs coming up, so I think as we are very comfortable to maintain our new reduced cash position with the Youngs Creek acquisition, but I think we are not desperate to return cash at the moment, because I think we got lots of good things that we are looking to invest in as we build this position.

Great. That's helpful and I guess on the CapEx side, it seems like the run rates are incredible. I think on my math, it's like or $0.35 or $0.40 a ton for the quarter. Where exactly have you been cutting spending from in the last couple quarters at such low rates, what are you actually spending on given it's a low and then I guess, what are the implications from such slow spending on the long-term productivity of the mines?

Michael Barrett

All right, it's Mike here. I will take that question. The run rate has been relatively low so far this year. The capital expenditure expectations for the year include a lot of relatively small jobs and relatively small items. So there is lots of moving parts within that guidance.

In the second half of the year, there is a couple of large chunks where we are hoping to do some lands deals. If those come off, then the capital expenditure will increase in its run rate. There is also some large capitalized maintenance jobs that we have got coming up with some drag line outages and a number of other major upgrades.

So we were expecting the capital expenditure run rate to increase as the year goes on but obviously we do look at the capital expenditures very carefully. They are scrutinized very well and we are only spending money on the things that we need to spend the money on.

With that said, we will absolutely spend the money to keep the equipment in very good condition. That’s part of the strategy of keeping our costs low.

Operator

Your next question comes from the line of Brian Gamble, Simmons.

Brian Gamble - Simmons

Afternoon, everybody. Question on how quickly, Colin, are you seeing shipments increase? I think you took the new point in range in the very high 40s for the back half of the year. I would assume that that would ramp up, Q3 and be better Q4. Correct me if I am wrong, but that seems to be what you are pointing to. Is that right?

Colin Marshall

Yes. What we are, that’s roughly, I said, normally, historically the second half is better than the first. So if you actually look back at what happened this year, we started off with shipping over 8 million tons in January and we were the pretty high rate through February.

That tailed off March. April was very low. May was low and so was June but July we are back at nearly 8 million ton rate and things are progressing. The trains have certainly started coming and in the last week for the annualized rate has come up quite sharply and I am comfortable that, our best guess is that guidance range we are heading to at least the middle of that and the things are actually happening already.

It certainly didn’t happen in June and as I said in my prepared remarks, we actually got 400,000 tons just at the end of June got delayed into the second half, sorry into the third quarter because of the flooding at the MERC Terminal.

So putting those things together, I think, we are certainly expecting a strong second half but it is nothing that the operations can't handle.

Brian Gamble - Simmons

Great, and then, on the commitment front, as you noted not much signs are in the quarter, utility type of large piece in that as the other side of the deal but what are you hearing from them and any change at all to the thinking that you want to be fully committed when the year starts given that floor pricing is where it is and you obviously would like to try higher if possible. Any potential that you wait a little longer than normal to get slightly better pricing given markets are trying to improve?

Colin Marshall

Well, I am very comfortable with our strategy. I think if you look back over the last three years or so, it has worked out very well for us. We will carry on contracting as they are RFPs available. One thing I haven’t pointed out before is, often when the prices are low, it’s the actual utilities aren’t, the customers aren’t actually out there contracting which is quite handy, which has been the case so far this year.

There has been a lot less RFPs out, year-to-date than we would have seen last year. I think they are waiting to see to where their stockpiles are going to end up at the end of the year and we will respond to RFPs as they come.

I am very comfortable with our position for next year and given that quite a few of the tons, unsold tons, sort of half of them are actually at Spring Creek, and include a lot of the export tons, we are actually very well placed to get to being effectively fully sold out by the end of the year without having to scramble as it were.

But I think, for us, I am still very comfortable with the strategy of aiming to be effectively fully sold out going into the year is the right one. I would point out, I don’t think if prices go up next year, we don’t miss out on them. We will add them in future years as we have done in the past, which once again lets us run our businesses in a bit more of a controlled way which then helps with the cost in the long term planning and optimization of them.

So I am still very comfortable with that strategy. I think we will let you know if we change but that’s certainly not what I would plan to do certainly having been through the experience of the last eight months.

Operator

Your next question comes from the line of David Gagliano, Barclays.

David Gagliano - Barclays

My first question is actually related to the commitments that you made during the quarter. Your press release indicates 6.4 million tons committed in price for 2013 delivery. If you just go through the simple math, I think it works out to around $10.70 per ton price. So my questions are, one, is that math correct? Or does that 6.4 million also include the 1.7 million that was deferred at presumably a higher price during the quarter?

Michael Barrett

The math I did the same number, because I knew you would and yes I got with the (inaudible) as well. It does include most of the 1.7 million ton, as I said, it also includes a fair bit of Cordero coals which is a lower 8,400 low quality coal.

So that would drag it down but we respond to RFPs during the period. We certainly didn’t win everything. We responded. That was where the market was. We were prepared to lay in that many tons and yes, we bid a different process. So I would say we lost more than we won.

Uncomfortable, but as that was where the market was and it reflects the mix of the coal we actually contracted and leases were placed for next year.

David Gagliano - Barclays

Okay, so then, let me just follow up that up real quickly. So if it includes the 1.7 million, I presume the higher price, if you could just tell us what was the price that you saw in new business at for 2013 delivery and what was the flip to 8,400 and 8,800 BTU?

Michael Barrett

I won't tell you the exact number because I honestly don’t each contract that we did but they were relative to some of the OTC pricing for next year which for different pairs was pretty low. So it is nothing that we are desperate but there were some pretty low prices and that’s why I am glad we only lopped in only 4 million or 5 million tons of new business.

David Gagliano - Barclays

Okay, if I ship out that 1.7 million, it works out to well below $10 a ton. Is that reasonable?

Michael Barrett

David, I would have to go back and get the list of each contract and line them up and did you know there is an awful lot of differences in the contracts that can make you accept a maybe a low price at the front because you have got coal in 14 and 15 at high prices. So there is awful lot of moving parts in there but I am certain, we weren’t scrambling to sell coal. We were in the market participating as we normally do and I am certainly very comfortable with our overall position for next year which leaves us well placed.

David Gagliano - Barclays

Okay, all right, I will move on. Just the other question I wanted to ask is regarding the full year sales target and the implications for the second half volumes works out to about 15% sequential increase in volumes, second half versus the first half. Obviously, the other producers are also giving us very healthy volume growth targets second half versus first half. I understand the seasonal component but considering the inventories are very high should we be anticipating more deferrals in to 2013 over the next several months or do you think the market can absorb that much volume growth for the region in the second half?

Michael Barrett

Well, certainly, I believe that given the information we have got at the moment, that certainly the mid range of that guidance and that guidance range is absolutely attainable. The pace has picked up remarkably in July. So we are closer to 8 million where some of the other months we are down in the low around 6.5 million tons a month.

Big, big difference. The infrastructure is absolutely there to do with the railways. What we are seeing is the utilities have burnt an awful lot of coal at the moment and they will see that (inaudible) come through but I think their stockpiles will come down a fair bit and they have got room to take the coal and they are planning on doing it at the moment.

It is the best information we have got. We have got one or two people we are talking to about possible deferrals but not very many and certainly any implications from that are included in any outcomes that includes in the range of our guidance. But no, we think we should have a strong second half and it's already started.

David Gagliano - Barclays

Great, that’s encouraging. I just have one more quick question. Can you talk a little bit about your 2014 position in terms of percentage committed and average price of committed price for 2014?

Michael Barrett

No, we don’t talk about that apart from the sale. We are layering in some coal for '14 and '15 and we will give you that number when we come to our January, we will give the international but that position is building as it always does. Utilities buy ahead and we sell ahead as well.

Operator

The next question comes from the line of Mitesh Thakkar, FBR.

Mitesh Thakkar - FBR

Good afternoon, gentlemen and Karla. Just a follow up question on the contracting side which they were discussing previously. You have about 12 million tons, I guess, of coal which is not priced for 2013. Is there a possibility that for example, if the PRB market don’t recover and the timing is due for negotiation, you might have to lock in at uneconomical prices for that coal?

Michael Barrett

Those are contracted tons, and they will be under some sort of index, Basel II contracts and that will be under different indexes. They will fix, where they will fix. Some actually have floors and ceilings on them, and if the process stay down then they could fix low or they could fix high. That's absolutely the nature of them and we would expect, we made a (Inaudible) just as the customers take new equipment to take them and we are both willing to live with the potential movement of the index, so prices stay low. There could be low price tons and it's the nature of the business.

Mitesh Thakkar - FBR

What is the duration by which you need to price those tons?

Michael Barrett

As we say, there's a whole range of those. Some will stick, obviously at delivered relatively through the year. Most of them they'll fix as go through the years on the previous six-month pricing. Weakened prices somewhere around the previous three months, so there's a whole range, but obviously through the year. If you average sort of the six- months average probably wouldn't be too far off.

Mitesh Thakkar - FBR

Okay. Great. Just one follow-up question on that. On the hedging strategy, I know you are upward than some cash callers this quarter. Can you just talk to us about what might. You have historically not hedged all, so what caused that change. Is it just a pullback in the pricing or is there something else?

Michael Barrett

I think we will be looking at what we could do to actually manage the business and we have always said that we don't want to pretend that we know where the oil price is going and actually so they are fixed on prices, so after a fair bit of analysis, we said look what we can do is put in something at very low cost that protects us from the danger the oil prices spiking up to $150 or something like that for period. That's what we have done, so it's more of an insurance policy against wild swings rather than pretending that we know that oil prices are high or low.

Based on that, we see it as a rolling program that we would expect to put in. We'll obviously reserve the right to change our minds if some reason, we don't think it make sense, but for now it's more about insurance policy to protect us from the cost of the price getting through the roof. Obviously the downside to that is if the price drops in this case below $66, then we pay a little bit more, but we think that's very manageable with the size of the business the impact to diesel and gives us a bit more comfort against a wild swing upwards.

Operator

Your next question comes from the line of Brandon Blossman, Tudor, Pickering, Holt & Company.

Brandon Blossman - Tudor, Pickering, Holt & Company

Colin, we haven't talked much about this and I certainly would like to. Youngs Creek and the other acquisition, obviously a very nice price for reserves. Strategically, how should we think of that, is that a call option on improvement in seaborne terminal or do you guys have a view on seaborne terminal and feel very comfortable with the acquisition and developing the acquisition which would include incremental CapEx.

Michael Barrett

Okay. The way I look at it is, we are very comfortable with the price for the reserves, and the other thing particularly the land getting 39,000 acres of land connecting the Youngs Creek limited mine and Spring Creek is really one of the best things that once you've got it, you look at the map and you think that is a great position for us, and it actually helps the spring creek operation, with their permits and other access to reserves against the Permian boundaries that would have been an issue. Had we not got around, so an awful lot of issues for us in terms of Spring Creek are just extinguished by the land position.

The way I would think about it's a great deposit. Just got some low sodium, which will help us with domestic operations. It's also got a lot of royalty rate, and we will be looking to develop it at the right time in conjunction with Spring Creek, so maybe we should think it more like a satellite pit rather than new mind.

Our ability to do that means that we should be able to develop it when we want and at much lower the CapEx, and you had come on and defy full, so the way's I would think about it's a sound investment, because there is a position in their position to help Spring Creek in the domestic market, even if there is no more terminal space, if there is a terminal space it will be a fantastic operation given any sort of normal assessment of New Castle price forecast.

So it is the ones we used when we were looking at, it went outlandish. They were in line with most of the forecast for long term New Castle prices. We are comfortable with the demands there. The big issue is the terminals, so I think it's more of an option on the upside is about when you hit as a big terminal, we got access to big terminal that's going to be built that will be. That will make you very, very valuable.

Brandon Blossman - Tudor, Pickering, Holt & Company

Good deal, so it sounds like perhaps current or recent pass forward curves that we feel like it is in the money and it's not like.

Michael Barrett

Yes. If you back, yes. Absolutely. The movements were very low, it's what? Down 95. If you go back up to anything over 100 or 110, and it will be a profitable operation.

Brandon Blossman - Tudor, Pickering, Holt & Company

Great. Very, very useful color. Then going back into detail and book keeping kind of bottoms might on the second quarter, back of the envelope where it looks like there were some incremental margins from the non-operated part of your business. Is that the case Q-over-Q?

Michael Barrett

You are talking about Decker operations?

Brandon Blossman - Tudor, Pickering, Holt & Company

Well, yes. I am seeing a little bit of incremental margin quarter-over-quarter, and non-operated items, and I assume its Decker, but I don't know.

Michael Barrett

There's nothing that jumps out to me. We had a gain on the derivative instruments that we have put in place that comes out of our adjusted EBITDA, but I don't think there's anything significant or no significant changes in Decker operations. Maybe that's when we can follow-up on.

Brandon Blossman - Tudor, Pickering, Holt & Company

Okay. We will. Thank you for pulling out the derivative gain out of adjusted EBITDA appreciate that.

Operator

Your next question comes from the line of Meredith Bandy, BMO Capital Markets.

Meredith Bandy - BMO Capital Markets

Just real quickly on the derivative gain that Brandon just mentioned, is that on the oil hedges, or there are other derivatives?

Michael Barrett

No. It's primarily on the international coal prices on the New Castle market, so we have locked in a series of tons on the international market some time ago at higher New Castle prices, therefore the New Castle price has fallen. We have recognized an unrealized gain on those instruments.

Meredith Bandy - BMO Capital Markets

All right. Perfect. Then just in terms of some other people have mentioned a lot higher sales back half of the year, what are the stockpiles looking like at some of the utilities in your view, and we see the national, but really more specific to Cloud Peak and PRB.

Michael Barrett

Well, I hate to talk about any specific stockpile. I mean, look at this a pretty much the same information that you look at Meredith, and one thing I do is look at the back of Wall Street Journal, stay and see how red the temperature map is, and it's being pretty favorable for a while now.

Certainly when I talked to the utility guys they say, they're building a lot of color now and the power stations are really fired up. Obviously, we'll have to see how December progress and how long it stays, but so far it's been sort of as favorable as we can be after a winter that really was against us as coal producers.

I am very comfortable that there's no awful lot color being burnt at the moment and that we will see the numbers which obviously like showing them coming down quite a bit. You will also see that, because it will take a little while to get the coal moving after which was what started in July, so it should probably go down a bit before you start to get them toped up with the coal that we are shipping currently, but other than that, I would say that I don't have any specifics about individual customers' stockpiles and we'll say that they are taking their coal whether it's in April-May recently where get the [project].

Meredith Bandy - BMO Capital Markets

Okay. Then in terms of your export shipments. You didn't saw additional in the quarter, because of obviously the weak pricing that we all saw. Was there a situation where the coal is actually out of the money, or you just didn't want to fill it in or could you have thought it if you wanted to, with more color on the current seaborne appetite.

Michael Barrett

In terms of seaborne appetite, we are shipping our coal. This is the stuff we contracted last year. Generally around this time of the year, it's pretty quiet and what I was trying to get across to is that, we are comfortable for it to be quite at the moment and hopefully the prices will improve more to the Q4, where most of the pricing for next year is actually fixed with our major sort of Korean customers.

So at the moment, there isn’t actually much going on, which is apart from delivery of contracted coal which is what we are doing and we will look for the major pricing season as really Q4.

Meredith Bandy - BMO Capital Markets

And are all of the longer contracts, the multi-year volumes, are they always Korean customers?

Michael Barrett

I think so. Pretty well, yeah.

Operator

Your next question comes from the line of John Bridges, JPMorgan.

John Bridges - JPMorgan

Just wanted to dig a bit more into the fixed variable and your cost control. I suppose, after some good years, then a little bit fluff gets into the cost. But, are you comfortable that these are now sustainable or is there more cost that can be brought out of these. I was just surprised by how well you controlled your costs on a more than 10% decline in production.

Colin Marshall

Well, the thing that I would say there John, is look, our costs have gone up from last year and they went up from the year before I think we are doing awful lot of stuff to make sure that we manage them as tightly as we can. Certainly I am not aware of any fluff as you put it in there. We try and run the operations very tightly but we try and do it consistently.

We haven’t done anything sort of drastic in the quarter. I think we stood down two or three trucks temporarily because there weren’t any shipments, we reduced contractors and a bit of overtime, a few overtime hours, and things like that.

But we were able to manage through. Because if you look at our full year shipments then we are not that much down from where we thought we were going to be. We are within a manageable range as it were. So we try and run steadily and consistently and that actually lets the guys at the mines focus on long term meaningful cost savings.

Whether it is increasing equipment lives, optimizing things, rather than sort of having to laying people off and then bringing them back, and stand gear down, then stand it up which is sort of very hard to do and takes your eye off the ball of running the operations for the long term.

Optimizing in the long term, which is what we are about. So I don’t see any fluff in there. If anything, I think there is a whole lot of guys doing a great job and actually bringing down and managing these are sustainable. This trajectory we are on is certainly sustainable given that we face pressure from rising workloads and increase toll distances every year.

John Bridges - JPMorgan

But surely you are on a fixed variable component to your cost structure.

Colin Marshall

Cost, yes.

John Bridges - JPMorgan

How would you split it up?

Colin Marshall

Short term, the vast majority of the costs are fixed. Obviously there are some costs that are completely volume related such as the amount of explosives we use in order to move over burden. All the volume of these what we use to move overburden but other than that, the vast majority of costs are very much fixed in the short term.

John Bridges - JPMorgan

And in the medium term?

Colin Marshall

Well, the medium term, long term, you have always the ability to change the tonnage, right. So what you are producing at the mines, so ultimately that changes the cost structure.

We really run the business on a long term basis. We use fully employed people. We don’t tend to use contractors. We don’t tend to use temporary staff. So we don’t look for significant changes in our workforce on a short term basis. We very much run the operations for the long term with a view of keeping of those costs consistently low.

John Bridges - JPMorgan

Could you tell us how much of your cost per ton is diesel so we can get a sense as to what the impact is going to be of lower prices?

Colin Marshall

I am just trying to remember the numbers off the top of my head but in the back our investor presentation each quarter we do a breakout, a pie chart of various cost for the previous year. If I can refer you to that maybe.

John Bridges - JPMorgan

That’s fine. Just wanted to guess. I am intrigued, your hedging, be it coal against New Castle. You landed best comp, the thing that, one of the Indonesian coals might have been a better benchmark.

Colin Marshall

The reason we go against New Castle is because we price off of New Castle benchmark and also that’s the one that is well traded. It's got the bets in the market, it's got liquidity and it’s a good index that we are very comfortable to hedge against.

Operator

Next question comes from the line of Lucus Pipes, Brean Murray Carret and Company.

Lucus Pipes - Brean Murray Carret and Company

Quick follow up question on your 2013 contracting. So in terms of your committed and price conscious, that evenly spread throughout 2013? Or are the majority of those volume sell off that is at the beginning of the year?

Michael Barrett

I consider that ratable through the year.

Lucus Pipes - Brean Murray Carret and Company

Ratable through the year. I appreciate that. Then, you seen a quite a bit of production curtailments in the PRB. What is your sense about how quickly this production could come back to the market?

Michael Barrett

I think it can come back as the utilities want to contract and take the coal, a tad bit of it. For us, if we were aiming for, we will see what we sell for next year as the year progresses, given off at a normal range of 90 to 95, we can produce somewhere, in the year we could expect to be somewhere in that range, if anyone have the utilities come out for the next year.

In terms of how the other guys go, you will have to ask them in terms if anything is gone permanently but for us, we are in that range which is not a very wide range really in terms of productions that any other people would face.

So we are very comfortable that we will meet the demand depending on what the utilities actually want to take for next year.

Lucus Pipes - Brean Murray Carret and Company

Appreciate it, and then you mentioned in your release that there is still a small amount of customers that are seeking some deferrals. Is there a common denominator to those customers? Are they located in the Southeast or is that from all over the country?

Michael Barrett

No there is no rhyme or reason to it. They are just different people who for some reason or other thing have got a bit of extra coal and want to have a conversation with us about what to do. I would emphasize there is not many and actually, one of the things that the phone calls about deferrals sort of stopped when it got hot, which is what you would expect.

Operator

Your next question comes from the line of Brett Levy, Jefferies & Company.

Brett Levy - Jefferies & Company

Given where coal stocks, coal equities are trading these days, at some point, you actually start thinking about maybe buying back some shares? Or is it still just much more compelling to use your cash to build reserves?

Michael Barrett

Obviously, we have put our money where our mouth is in terms of buying the Youngs Creek reserves, particularly with their export focus. So we want to maintain, add reserves to for domestic business to keep that in good shape which we have done at Antelope and we have got another LBA at Cordero probably next year now and then we have, in terms of the using that cash, we have made the Youngs Creek acquisition which is, say the upside from that is all about increased exports and I think we are very comfortable. There is great potential there and that’s the right thing to do with our cash today.

Brett Levy - Jefferies & Company

So, no thoughts about stock buyback?

Michael Barrett

No, we obviously discuss everything and put them in a priority order and stock buyback, it didn’t make the top for sure.

Operator

Next question comes from the line of Michael Tian, Monringstar.

Michel Tian - Morningstar

Well, a couple of things real quick. Couple of other coal companies in the East have mentioned that they have gotten some cost savings from concessions from mining suppliers. Have you guys seen any of that on your end?

Michal Barrett

Nothing I would say dramatic. As obviously, we carry out a through process for any contracts for letting to make sure we get the best price that is properly available and I think we are comfortable that we are getting very keen pricing. But I wouldn’t say that anyone has given us an actual concessions because times are hard but so nothing out of the normal. But normally we make sure drive a decent bargain when we buy things.

Michel Tian - Morningstar

A follow up on Youngs Creek. Well, you have talked about that to develop that reserve is the reason being much more capital efficient than developing a Greenfield mine. Is there anyway to bracket that savings in terms of the capital to develop that project?

Michael Barrett

I would just say no at the moment because we are doing the work to decide what the optimal way of doing it is. But I think if you have, whatever your estimate of how much cheap this is Brownfield rather than Greenfield start there and that would be a good rule of thumb.

Michel Tian - Morningstar

Okay, fair enough, and just a very quick one on the exports for 2013. How many tons do you have riding out under these long term contracts that will be priced later in the year?

Michael Barrett

I am sorry, I don’t actually know the number. It is actually a couple of million but that’s a guesstimate but the point is, these are long term relationships. I am pretty sure he is going to take most of the coal whether they have got a long term contract or it is the same guys you always sell to because the have got it in there blend in career doesn't actually make that much difference, and we are pretty comfortable that borrowing something quite unforeseen we know where sort of 4 million tons of coal will go next year, between same guys who bought it this year.

Michel Tian - Morningstar

Fair enough. That's all I have. Thank you.

Operator

The next question comes from the line of Richard Garchitorena, Credit Suisse.

Richard Garchitorena - Credit Suisse

Thanks for taking my question. So, I have got just one quick one. The 1.7 million tons, that was referred to mostly 2013, is that included in the 6.4 million ton increase of contracted tons for 2013?

Michael Barrett

Yes.

Richard Garchitorena - Credit Suisse

Okay. One other question is just wondering, in the past you have talked about the sensitivity you had to diesel, or to oil in terms of every 10 auction barrel oil translates into about 10 million, it's about 10 million net income. Do you have a number that we can think about given the new hedges in place?

Michael Barrett

Within the BAMS, so within $66 barrel up to $106 per barrel, that sensitivity still holds, and then once you go outside band, early 25% of that sensitivity will hold, because we have hedged 75%.

Operator

Next question comes from the line of Jamie Melzer, Bank of America.

Jamie Melzer- Bank of America

Hi. Thanks for taking my question. Given the recent acquisitions you've done in the upcoming lease sales, are you happy with where your reserve position since been? I know there's probably a handful of opportunities that make them up over the next handful of months. Would you consider doing additional acquisitions, and whether you consider outside of the PRB for any of those?

Michael Barrett

We will carry on with our strategy, which I think is becoming pretty plain of using domestically with the LBAs or existing operations to give us the capacity to grow the export business as we have done with Youngs Creek, which is really a satellite of Spring Creek or sort of adjacent. So we'll look at developing that more as Brownfield as I say.

Beyond that, it will depend what opportunities come up. As I'd say we always said, we look at things. We look at anything, but obviously anything with surface mining with export potential is more attractive than other things. So we will look. We've got to be cognizant that we spent $300 million, and so you got to be careful for what we look at to buy next, but we always want to be positioned, so we can move if something good comes along.

Jamie Melzer- Bank of America

Okay, great and then is there any updates of the timing of the upcoming lease up?

Michael Barrett

I think, we have now slipped into, I am expecting it I was like first half of next year.

Jamie Melzer- Bank of America

Okay. I think you may have mentioned Cordero.

Michael Barrett

Yes. That's the LBA at. I think the LBA at Cordero. I think of the only significant one we have got on in sort of the pipeline at the moment.

Jamie Melzer- Bank of America

Okay, perfect. Last thing, given where current exports prices are, are the volumes that you are shipping out, would those still be economic if were selling into spot market pricing.

Michael Barrett

No. As we said in the last call, the opportunity it really opened up for us last year when the prices spiked to $130 dollars in Q1, last year. We just delivered our last ship in April. I think it was. So we are sort of done with that, and at current prices it's on an economic first, so until the prices go back up to pretty healthy ones like 120, 130 then that's uneconomic for us.

Operator

Your next question comes from the line of Chris Haberlin, Davenport.

Chris Haberlin - Davenport

The volume guidance implies kind of quarterly tonnage relatively in line with what we saw during 2011, and looking at cost on average, we're about $1 per ton below where they were in Q2. Does that imply that with the increased production in the back half of the year, could we see that magnitude of cost decline? I know Colin you had said below $10 a ton, maybe just a little bit more color there?

Colin Marshall

We can't get a whole dollar back. That's not going to happen, I am afraid. (Inaudible), but given the increase in stripping ratio, the long haul distance is the increase in cost whether the labor cost or input cost, and royalties on the prices all those things add up, and I'm very pleased that we actually managed to maintain the cost where we did give in the lower tons. There will be an advantage from higher volumes, but certainly not to the tune of $1.

Chris Haberlin - Davenport

Then just to follow-up. I think you had said that the unsold tonnage for next year about half of that is Spring Creek. Is it fair to assume that the other half is primarily lower BTU Cordero coal or is there (Inaudible) coal in there as well?

Colin Marshall

There's a mixture of both of them, but I really don't want to get into exact details of which mine because that’s commercially sensitive, but then others in next year a bit of a both of them.

Operator

Your final question will come from the line David Beard, Iberic.

David Beard - Iberic

Well, ended on a good note. All of my questions has been asked and answered. Thank you.

Colin Marshall

Okay.

Operator

This concludes the question-and-answer portion. I will turn the call back to Colin Marshall for closing remarks.

Colin Marshall

Okay. Thank you very much. Thanks for your questions and your interest in Cloud Peak. We are looking forward to an improved second half after weathering what was a tough period for all coal producers and we think we weathered it pretty well.

Hopefully the increased shipments we are seeing in July will continue through the rest of the year, and we are encouraged that it is so warm and we will give you an update in October, when we release the Q3 results, but thank you very much for your time and your interest in Cloud Peak Energy. Thanks.

Operator

Ladies and gentlemen, this does conclude today's conference. Thank you for your participation. You may now disconnect and have a great day.

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