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Executives

Deck S. Slone - VP, IR and Public Affairs

Steven F. Leer - Chairman and CEO

John W. Eaves - President and COO

John T. Drexler - Sr. VP and CFO

Analysts

Luther Lu - Friedman, Billings, Ramsey

Jeremy Sussman - Natixis Bleichroeder

John Bridges - JP Morgan

Brian Gamble - Simmons & Company

John Hill - Citigroup

Brett Levy - Jefferies & Company

Gordon Howald - Calyon Securities

Paul Forward - Stifel Nicolaus

Mark Liinamaa - Morgan Stanley

Michael Dudas - Jefferies & Company

Shneur Gershuni - UBS Securities

Ann Kohler - Caris & Company

Justine Fisher - Goldman Sachs

Arch Coal Incorporated (ACI) Q2 FY08 Earnings Call July 25, 2008 11:00 AM ET

Operator

Good day, everyone and welcome to the Arch Coal Incorporated Second Quarter 2008 Earnings Release Conference Call. Today's call is being recorded. At this time, I'd like to turn the call over to Mr. Deck Slone, Vice President of Investor Relations and Public Affairs. Please go ahead, sir.

Deck S. Slone - Vice President, Investor Relations and Public Affairs

Good morning from St. Louis. Thanks for joining us. As usual and before we begin, I want to remind you that certain statements made during this call, including statements relating to our expected future business and financial performance, maybe considered forward-looking statements pursuant to the Private Securities Litigation Reform Act.

Forward-looking statements by their nature, address matters that are to different degrees uncertain. These uncertainties which are described in more detail in the annual and quarterly reports that we filed with the Securities and Exchange Commission, may cause our actual future results to be materially different than those expressed in our forward-looking statements. We do not undertake to update our forward-looking statements whether as a result of new information, future events or otherwise, except as maybe required by law.

I'd also like to remind you that you can find a reconciliation of the non-GAAP financial measures that we plan to discuss this morning at the end of our press release, a copy of which we have posted in the Investors section of our website at archcoal.com.

On the call this morning, we have Steve Leer, Arch's Chairman and Chief Executive Officer; John Eaves, Arch's President and Chief Operating Officer; and John Drexler, our Senior Vice President and CFO. Steve, John, and John will begin the call with some brief formal remarks, and thereafter, we'll be happy to take your questions. Steve?

Steven F. Leer - Chairman and Chief Executive Officer

Thank you, Deck and good morning everyone. Today, Arch reported second quarter earnings per share of $0.78 and set a new EBITDA record of $241 million, surpassing our previous quarterly record that was set in the first quarter of this year.

We are well on the way to delivering the best financial performance in Arch's history. In particular, our Central Appalachian and Western Bituminous regions and our trading arm again delivered strong operating performances. Well, our PRB operations performed well considering that the region was negatively impacted by heavy rainfall and floods during the quarter.

Looking ahead, we anticipate an improving outlook for our PRB operations, assuming more normal weather patterns as well as better market condition.

However, as noted in our earnings release, we continue to target lower volumes in the PRB this year, partly due to the impact of the flood, but most importantly because of the prompt returns offered by these valuable reserves are not sufficiently justified to increase volume level.

Given that the published pricing for the PRB is in chart of contango, we believe their market is forecast in a continued strong improvement in PRB. And this has been driven by continued strong demand for Central Appalachian and Western Bituminous coals as well as strong coal from the international coal market.

During the second quarter, our enhanced trading optimization platform had another strong performance, with an after-tax contribution of $0.23 per share. The trading group's performance was driven by record pricing level across several major U.S. coal supply basins.

We have wisely used our market intelligence gained in the trading around our assets to build position that benefited from strengthening coal market fundamentals as the quarter progress, and to protect the downside risk of this trading position.

Going forward, we expect this function to continue to enhance the company's earnings and cash flows, but the timing and magnitude of the contribution will likely vary significantly from quarter-to-quarter.

Consequently, we are currently anticipating a more modest contribution in the second half of the year, but a positive one nonetheless. Our goal for this function is remains the same as our goal for the overall company, to optimize long-term returns and to maximize margin while managing risk.

Now I'd like to shift gears and discuss key demand drivers for the U.S. coal market in 2008 and beyond. While there has been significant volatility recently in the financial coal market and they have come off their record highs, the physical coal markets remained strong underpinned by favorable supply demand fundamentals.

We continue to expect above average coal demand growth over the next several years, driven by several factors.

First, we expect to increased utilization of the existing coal fleet. Over the past 10 years, coal plants have been able to achieve a 1% gain in utilization per year on average, and we expect this trend to continue. In fact, we're seeing this pattern so far in 2008, as growth in coal consumption is outpacing overall demand growth in electric power sector.

Second, new coal fuel plants in the United States are coming online, a meaningful amount in 2009 and 2010. In fact, the Western plants in Wisconsin, a 600 megawatt plant just started up in June.

The Dominions plant in Virginia has also moved into construction since our last update and we expect to see more plants break ground over the next to 12 to 24 months.

As we discussed, new coal generating capacity will expand domestic coal demand, with the majority of this growth likely to be supplied by the Powder River Basin coal.

The domestic drivers account for a majority of the expected growth in coal demand in the U.S. over the next several years; the robust international markets are also providing significant support. We think that the U.S. has enough available port capacity in the port seaborne coal exports to reach 100 million tons by 2010.

We have already revised our forecast upward for 2008 and now believe export will reach 83 million tons. In fact exports in May, the latest data available represents the highest monthly export total since December 1995, and the highest level for the May... for the month of May, since 1992, a year in which the U.S. export is over 100 million tons.

We also believe coal imports into the U.S. are likely to decline year-to-year, as more Columbian coal is been diverted into other seaborne markets. We now estimate that imports will be down by 4 million tons in 2008 compared to 2007 level.

Of course the forces behind strong, U.S. net export trends are the structural changes we're seeing in global coal supply flows. Arch expects the growth in global coal demand to continue, driven by the expanding economies in China, India, Brazil and Russia, as well as the rest of the Pacific Rim.

Even if the collective growth rates of these countries slow, we still expect global coal demand to out script supply. In fact, we expect the global coal supply deficit to reach nearly 35 million metric tons in 2008, and we see a growing deficit over the next five years.

In particular, we're seeing supply that traditionally serves the Atlantic Basin market being pulled into the Asian Pacific market to satisfy growing demand in that part of the globe. Since 2003, South African export into the Asian Pacific markets have grown by nearly 11 million ton and that trend is expected to continue. As a result, South African shipments into the Atlantic Basin have declined, creating opportunities for North and South American coal producers to fill the gap in supply.

Interestingly, we're seeing a similar line in Atlantic Basin supply drain begin with the development of Colombia's increases of coal shipment into Chile.

Turning to the domestic supply trends, we continue to estimate that coal supply is up less than 1% year-to-date, despite record pricing levels across key U.S. coal supply basin.

In particular, overall production east of the Mississippi is approximately 0.5% while production west of the Mississippi as trending up 1.3% through the first 29 weeks of the year.

Growth in the Powder River Basin has slowed considerably since the first quarter, impacted by the flood.

At present, we estimate that U.S. generated stockpile levels have fallen in June and now represent approximately 51 days supply. Eastern stockpile levels are trending below last year's level and have dropped below five year average, while Western stockpile levels are comfortable and are approximately at target levels. Of course, as noted on previous call, we believe that generators are targeting higher inventory levels as a hedge against future supply disruption. We would also expect Western stockpiles to decline in the second half of 2008.

Shifting gears, we believe that the long-term outlook for Btu conversion technologies remains very positive. Despite some of the recent price declines, both in crude oil and natural gas, they are trading at elevated levels, providing a compelling reference point for coal.

Specifically, natural gas pricing for January 2009 delivery is currently trading approximately $10 per million Btus and crude oil is at approximately $21 per million Btu compared to the PRB which is approximately $1 per million Btu. Obviously, there is considerable arbitrage opportunity here.

In an environment of skyrocketing energy cost, advance in alternative domestic fuel particularly coal-to-gas and coal-to-liquids, is in the best interest of American consumer.

We believe that projects like the proposed DKRW Medicine Bow plant in Wyoming in which Arch is an equity partner, it enhance America's energy security and provide real economic benefit to the country by bringing to the market supplies of domestic synthetic gasoline.

We also significantly reduce... we can also significantly reduce the carbon footprint of the fuel derived from coal and further enhance domestic supply by using CO2 for enhanced oil recovery in domestic oil field.

So we expect 2008 to be a record year for Arch. Our tighter and stronger guidance is indicative of our confidence in the coal market fundamentals and then our ability to capitalize on these strong market trends.

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

John W. Eaves - President and Chief Operating Officer

Thanks, Steve. I'd like to start by highlighting Arch's price utilization and cost performance by region in the quarter. And then discuss our sales strategy in light to recent market trends.

Starting with Central App, we are pleased with our results for the second quarter and first half of 2008.

Per-ton pricing realizations were up more than 14% over the first quarter this year, and up more than 40% since the second quarter of 2007.

These strong pricing levels were driven by increased shipments in met coal as well as higher average pricing obtained on met steam sales.

In particular, met coal shipments increased to 33% of our Central App sales volume, our average price realization on those volumes, averaged nearly triple-digits in the quarter just ended.

By comparison, our average met coal price realization was up nearly 55% from last year's average met Price level and our met coal volumes has more been tripled.

Looking ahead, we now expect to ship between 4.5 tons and 5 million tons of coal in the met markets in 2008. We're also targeting met shipments above the 6 million tons in 2009, the high end of the previously communicated range.

This target reflects our ability to increase production at Mountain Laurel with the addition of discontinuous minor unit next year as well as incremental opportunities to expand production at satellite operations and to increase coal blends from Cumberland River and Laurel Mount.

We now expect our production in Central App to reach 15 million tons in 2009, with 40% of this volume headed for the met markets.

On the cost side, our per-ton operating cost in Central App rose largely due to higher sales related costs. As expected, our cost retraining at a rate of inflation plus a percent or two compared to year ago quarter.

Moving to the Western Bit region, second quarter 2008 price realization increased nearly 12% since the first quarter, reflecting a favorable mix of customer shipments and ability to capitalize on strong pricing trends with spot sales in the quarter.

Volumes were up as well despite too longwall moves during the quarter, as we drew down the inventories at are mines. Looking ahead, we expect shipments in Western Bit region to be up roughly 10% over 2007 levels, driven by attractive market conditions.

Our cost performance in Western Bit trended up modestly in the second quarter, reflecting higher sales-related cost, the impact of an additional longwall move compared to the first quarter, and a greater volume contribution from higher cost mines in the region.

Going forward, we continue to target an average cost structure in the range of $19 to $21 per ton for the full year 2008, although ongoing commodity cost pressures will likely push us to the high end of that range.

In the PRB, average price realizations rose a modest 2% in the second quarter, benefiting from higher pricing on market index price ton. However, our quarterly shipments in the region were down by about 1 million tons due to the heavy rainfall and floods, all of which adversely impacted our per ton cost. We were able to offset some of this loss production with increased higher cost brokerage activity during the quarter.

Excluding sales-sensitive cost, our per ton operating cost rose 5% compared with first quarter and were up 8% from a year ago quarter. These higher per-ton unit costs were driven by reduced shipments as well as commodity cost pressures for petroleum based and explosive products in particular. As a result, we remain focused on holding in line on cost; as we progress to the year's second half.

Looking ahead, we are targeting lower volume levels from the company controlled operations for full year 2008 compared with our original plan. Our new range of 133 million to 137 million tons reflects adverse weather impacts in the PRB during the second quarter, as well as our decision to leave tons in the ground.

Now, I'd like to spend few moments discussing Arch's sales strategy during the quarter. We reached record pricing levels in several key U.S. Basins in June and shows the selectively signed sales commitment that will provide a solid foundation for the company's financial performance in future years.

We continue to follow a layering approach that will allow us to commit coal once a sufficient return has been achieved. Yet, we have also chose to maintain a meaningful unpriced sales position heading into next year that will give us exposure to the coal markets. And we have elected to leave tons in the ground this year where sufficient returns have not been achieved. We believe this market-driven strategy is in the best long-term interest of the company and our shareholders.

Since our last update, we assigned some very attractive sales commitments during the quarter. Specifically in Central App, we committed met volumes for 2008 and 2009 delivery, at an average net back mine prices approaching $200 per ton.

We also selectively committed steam coal for delivery in 2009 and 2010 at an average pricing in the triple-digits with some contracts well above that threshold.

Additionally, some spot sales, coal sales were transacted in the gulf [ph] quarter pricing approaching $150 per ton.

In Western Bit, we layered in meaningful sales contracts for delivery over the next three years at more than 60% premium for the region's second quarter average realized price.

As a result, we now have less coal unpriced in this region for delivering in 2009 and 2010 when measured on a prorata basis compared to other operating regions.

In the PRB, we selectively committed and priced coal for delivery over next two years at a 55% premium to the region's second quarter average realized price.

More recently, we committed volumes under multi-year contracts at pricing 100% above our average realized price in the region for the quarter just ended.

Our result of our sales commitment signed in the quarter and our decision to target lower volume levels, we now have unpriced volumes of 4 million to 8 million tons in 2008, one-third of which is already committed but not yet priced. We also have unpriced volumes of 65 to 75 million tons for 2009 and 85 to 95 million tons for 2010.

Clearly, our second quarter results demonstrate that Arch's diverse asset base is a key strategic competitive advantage. We believe we have the scale and the breadth of operations to offset challenges in one region with strong performances in other regions. Additionally, managing our controllable cost and escalating cost environment remains a key priority and a core strength for Arch.

Our goal is simple. We want to maximize the value of our unpriced sales position and control our cost, all in an effort to enhance margins.

Looking ahead, we expect a strong performance during the second half of 2008, that's somewhat weighted towards the fourth quarter. We expect a strong August and September, but July will be impaired by minor vacation and an extended longwall move as we transition into our new coal scene [ph] at our West Elk mine.

I will now turn the call over to John Drexler, Arch's CFO for a discussion of our current full year expectations. John?

John T. Drexler - Senior Vice President and Chief Financial Officer

Thank you, John and good morning everyone. I would like to take a few minutes to expand on some of Arch's major financial developments in the most pleasing quarter.

As we have noted, the second quarter of 2008 marks one of the best financial performance in company history. With our national scope of operations a low cost operational profile; we believe the company is strategically positioned to capitalize on current coal market trends.

In particular, I'd like to provide an update on Arch's capital spending program and debt and liquidity positions. Capital expenditures for the quarter totaled $92 million, primarily related to the ongoing construction of the west Florida at the Black Thunder mine and the PRB, and the development of the new coal scene [ph] at the West Elk mine in Colorado.

We are on schedule to have the West Florida complete and operational late in the third quarter and expect the transition to be easing at West Elk during the fourth quarter, which will allow us to continue to capitalize on the strong demand that Steve spoke to you earlier.

For the first half of 2008, our capital spending needs total $213 million, excluding reserve additions. As you know, our capital spending program is typically weighted towards the first half of the year. Going forward, we expect our capital spending needs for the second half of 2008 to be significantly less than the first half of the year.

Turning to our debt and liquidity position, we generated a record $202 million of operating cash flow during the quarter, more than $110 million of which was used to reduce outstanding borrowings under our evolving credit facility.

At June 30, the company's total debt balance represented $1.3 billion, while our debt capital ratio fell to 44% from 47% at the end of the first quarter.

At the end of June, our borrowing capacity under our revolver totaled approximately $647 million. Although our cash and working capital needs fluctuate from quarter-to-quarter, we expect to generate increased free cash flow during second half of the year. We will continue to be judicious in how we deploy that cash, seeking ways to further enhanced shareholder value.

In April, our Board of Directors announced the approval of an increase in the quarterly cash dividend from $0.07 to $0.09 per common share. This event marks the company's fourth dividend increase over the past five years.

I now would like to share our tightened and stronger 2008 guidance range as follows. Sales volume level has been reduced in that end, now are expected to be in the range of 133 million to 137 million tons, excluding purchased coal from third parties.

Our earnings per share range have increased to $2.50 to $2.85 per share, up from our previous range of $2.40 to $2.80 per share.

Adjusted EBITDA is now projected in the range of $767 million to $853 million.

Our effective tax rate is now expected to be between 11% and 15%, given our expected higher profitability levels.

Our annual tax rate is also subject to benefits from percentage depletion as well as the utilization of our deferred tax assets.

Our capital spending projection and our depreciation, depletion and amortization forecast remain unchanged. We expect capital spending, excluding reserve addition in the range of $310 million to $340 million and DD&A to be between $285 million and $295 million.

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

Question And Answer

Operator

Yes, sir. [Operator Instructions]. We'll take our first question from Luther Lu with Friedman, Billings, Ramsey.

Luther Lu - Friedman, Billings, Ramsey

Hello.

Steven F. Leer - Chairman and Chief Executive Officer

Hey, Luther. How are you?

John W. Eaves - President and Chief Operating Officer

How are you?

Luther Lu - Friedman, Billings, Ramsey

Good, good. First question is for John, could you quantify the impact on the costs with the Midwest flooding?

John W. Eaves - President and Chief Operating Officer

Luther, we really hadn't planned to quantify the impact. I mean, the impact on Arch volume was 1 million tons. We haven't really identified the financial impact for the flooding.

Luther Lu - Friedman, Billings, Ramsey

Okay. And for... this is for the CFO, John. Why is the tax rate still at 11% to 15% given that second quarter was significantly higher than that?

John T. Drexler - Senior Vice President and Chief Financial Officer

Luther, we determine our cash rates, based on our overall annual profitability levels. So the rate actually in the second quarter was slightly stronger, reflecting our outlook for the remainder... our increased guidance. However, similar to prior years, that tax rate can become a little bit lumpy from quarter-to-quarter from the standpoint on how we utilize our deferred tax assets, in the way we're utilizing our NOLs and our AMT credit carryforwards. So we're targeting a rate that will be higher than that.

Luther Lu - Friedman, Billings, Ramsey

Okay.

John W. Eaves - President and Chief Operating Officer

To circle back just real briefly on the PRB impact, I mean certainly what we try to do because of the Midwest large, we went back and try to do any maintenance or anything we could do during the quarter, which would free us out once we get back to normalized shipments, where we could manage the mine more effectively. So, I think we've done that and hopefully you'll see some improvement in that cost number in the third and fourth quarter.

John T. Drexler - Senior Vice President and Chief Financial Officer

And Luther any quarter from... we are back to the tax rate question. For the quarter also, the trading results do not get the benefit of percentage depletion. So there is a higher corporate tax rate there that comes into play, 36%.

Luther Lu - Friedman, Billings, Ramsey

Okay, got you. And if I may ask one more question on the Colorado Western by two minutes coal that you guys signed, any for export and do you have any met coal from that region?

John W. Eaves - President and Chief Operating Officer

Luther, it's all steam coal out of the Western Bituminous region and we're currently exporting coal to Europe as well as Mexico. The sales during the quarter were all steam sales multi-year agreements.

Luther Lu - Friedman, Billings, Ramsey

Okay, great. Thank you.

Operator

We'll go next to Jeremy Sussman from Natixis Bleichroeder.

Jeremy Sussman - Natixis Bleichroeder

I just... in term of value PRB pricing, you obviously signed some business close to $22, $23 a ton if my math is correct and I assume it will be for your premium quality PRB coal. So I guess if that is the case, it's a fairly big spread between 8800 and 8400. So I guess, could you just comment on how you see that playing out and I guess how relative to your position of course.

John W. Eaves - President and Chief Operating Officer

Jeremy, your math pretty close that was for 0.8 SO2 coal for longer-term, three year type agreements. But there has been quite the spread between the 8400 and 8800 and I think it tells you that more and more the 8800 coal is moving further and further east, and it travels much better to the Eastern utilities. So I think that's why you've seen that spread kind of widen out little bit.

Jeremy Sussman - Natixis Bleichroeder

Okay, great. And then at the terms of your met coal pricing Mountain Laurel, I guess relative to the $200 number that you threw out here, do you have a sense of where you see that shaking out for 2009, I guess first part. And then second part, are you seeing any evidence that steel producers are looking to begin '09 discussions maybe earlier than normal?

John W. Eaves - President and Chief Operating Officer

Well, I will tell you we're very bullish long-term on met prices. We see steel production growing at 4% to 5%, we'd see blast furnace capacity increasing at plus 5%. So, long-term we see the fundamentals very strong for certainly high vol met coal. I will tell you, we're having a number of conversations with our international customers right now, we're reasonably close to a five year agreement with one of our international customers, in saying in a five year agreement that will be priced annually.

We do have discussions with some of our domestic met customers as well, where there maybe opportunities to do multi-year agreements there where the pricing is actually locked in. So I would tell you, we feel pretty good about where we are and where we're headed on the met side.

Jeremy Sussman - Natixis Bleichroeder

So from a multi-year potential multi-year deals, you'd have pricing locked in for the first year and then it would be sort of a reopen it up for discussion, I assume?

John W. Eaves - President and Chief Operating Officer

That's correct, that's usually done ineffective April 1 of each year and goes to March 31st, of the following year. But what we would have on the five-year agreement would be fixed quality, fixed tons for a five-year time period.

Jeremy Sussman - Natixis Bleichroeder

Great. Well thank you very much for all the color here.

Operator

We'll take our next question from John Bridges with JP Morgan.

John Bridges - JP Morgan

Hi, Steve, everybody.

Steven F. Leer - Chairman and Chief Executive Officer

Hey, John. How are you?

John Bridges - JP Morgan

I'm fine. Just digging a little bit deeper into that $22, $23 price? I'm just surprised that you went from a 50% premium to a 100% premium over that time period, what change... what led to that big number?

John W. Eaves - President and Chief Operating Officer

Well, I think what we did John; we did sell smaller volumes at that 55% level. But that was a combination; it was more heavily weighed with Coal Creek and Black Thunder. So that's kind of a weighted number. But I think if you look at the PRB prices and you look short-term, they're certainly softness in the PRB prices. But if you look at 9, 10 and 11, there is tremendous strength out there. So there's quite a spread and we expect to see that spread narrow, but like much more what we're seeing 9, 10 and 11 versus what we're seeing in back half of 2008 right now.

Therefore, that's why we chose to not only have the impact on Midwest flood in the PRB, we chose to leave some of those tons in the ground until we see better pricing.

John Bridges - JP Morgan

Interesting. Could you also remind us of how much exposure you've got through to the higher oil prices? Is that going to hurt you later in the year?

John W. Eaves - President and Chief Operating Officer

We're about 65% hedge, it about $3 for the back half of 2008.

John Bridges - JP Morgan

Anything into '09?

John W. Eaves - President and Chief Operating Officer

We've got about 30% hedged, about that $3.90 to $4 level for 2009.

John Bridges - JP Morgan

Okay. Thank you.

John W. Eaves - President and Chief Operating Officer

Thank you.

Operator

We'll take our next question from Brian Gamble with Simmons & Company.

Brian Gamble - Simmons & Company

Good morning, guys.

Steven F. Leer - Chairman and Chief Executive Officer

Good morning, Brian.

John W. Eaves - President and Chief Operating Officer

Good morning, Brian.

Brian Gamble - Simmons & Company

Just wanted to get a little clarity when you're talking about lowering the total volumes, but then also you talked about potentially speeding up some maintenance work in the PRB during the quarter. Are those volumes that you're taking off of the 2008 guidance directly from the PRB?, It seems like that's what you're saying and the only way to get to that type of volume increase, but at the same time it also seems like the operations there are probably in better shape than they were during the second quarter to produce. Am I reading that correctly?

John W. Eaves - President and Chief Operating Officer

I mean Brian, really it's mostly prorate, but yes it is pretty much ratable.

Brian Gamble - Simmons & Company

Okay. When we look across the regions, you gave some guidance by region last time on how you saw the cost trending. I think that you even included the sales related cost on the royalty side in Central App. How do you see your '08 cost shaping out over '07, and then how does that bode for the '09 increases as well?

John W. Eaves - President and Chief Operating Officer

Well by region, I think what we said that we would see inflationary cost plus one or two and I think we're seeing that what we are doing, we're looking for the opportunities for incremental expansion which typically in Central App those will be higher cost expansions.

So as we move forward you will see some of that, but certainly tremendous margins. I think if you look in the PRB, our cost were up certainly because of the million tons of volume impact. Certainly we had some other expenses during the quarter. As we move out, we hope to see those cost improve as we get to more of a normalized shipment level.

I guess in Western Bet, we had an additional longwall move during the quarter, certainly those costs are at the upper end or even above the range we communicated and I think we are going to continue to focus on that. But if you look at the commodity pressures we're seeing really in all regions, the geology challenges we're seeing and if you look at the four operating lines we have in the Western Bit, one or two those were higher cost mine. And certainly in second quarter we ship more volume from one of those higher cost mines to reduce some inventory.

So, I think that' s what you are going to see for the back half of this year as we move forward into 2009, we are certainly in the budgeting process right now and really would be a little reluctant to talk about 2009.

Brian Gamble - Simmons & Company

And then just to clarify for the PRB you think the first quarter cost number out of there is more reflective of what you're going to be able to realize in the back half of the year versus that second quarter number?

John W. Eaves - President and Chief Operating Officer

Brian, I would hope that be indicative the for the cost back half of the year.

Brian Gamble - Simmons & Company

Thank you very much,

Operator

We'll take our next question from John Hill with Citigroup.

John Hill - Citigroup

Thank you and congratulations on a strong result.

Steven F. Leer - Chairman and Chief Executive Officer

Thank you, John.

John Hill - Citigroup

Just wondered if you could dig into the $53 million income statement item on the derivative and brokerage, you did indicate that was $0.23 to net income. But, how much of that was derivative, how much it was brokerage? How much of that was physical stuff that you touched and what are some of the cash characteristics, a bit color will be great.

Steven F. Leer - Chairman and Chief Executive Officer

Good, John, we are not going on get into a lot of details there. But as John Drexler said, when you tax affected at statutory rates, it is different position then obviously there was lots of volatility in the financial coal markets and the trading group has done very well.

When we gave guidance in the... from the first quarter call, we had it... had some visibility on really how the month have started and how things were trending in the coal markets and we built that into our guidance that we provided at the end of that first quarter call and again we've posted into the guidance as we look towards the end of the year.

But we are very pleased with just how they have performed, but at the same time we'd be remised in just trying to say that we expect them to duplicate that kind of number. When you look at the $53 million, I mean it is essentially, all in an EBITDA type number and we have solidified, if you will, some of this with building in downsides by inputs those sort of things, that today you are out of the money but if the market would deteriorate then we have protection on the downside and we have also taken some of the cash, but we still have a substantial amount exposed to the mark-to-market.

John Hill - Citigroup

Great, thanks for that. That perspective really helpful. And just as a quick follow up, is there any derivatives component to some these high term deals we are talking about, plus $20 in the PRB or is that pretty much plane vanilla, very simple what we see is what we get?

Steven F. Leer - Chairman and Chief Executive Officer

Plane vanilla, but what we do do within the trading group in our physical coal sales, I mean we do it from to time to time, will make a sale and we may in the financial market by back up coal for that. So we still have an exposure out there, but on these particular deals they are just plane vanilla.

John Hill - Citigroup

That's great to hear. Thank you.

Operator

We'll take your next question from Brett Levy with Jefferies & Company

Brett Levy - Jefferies & Company

Hey guys, most of my questions have been asked. As you guys look forward, can you talk about regions or met versus steam or anything along those lines in terms of what you are looking for your priorities are from acquisition standpoint?

Steven F. Leer - Chairman and Chief Executive Officer

Well Arch has a tendency, we look at virtually everything and very few thing can pass our screens. But at the same time, when you look at where we operate at in Western Bit, PRB and Central Appalachia, there certainly we always are examining bolt-on acquisitions or positioning acquisition, we also have significant reserves in the Illinois Basin and operated there for over 30 years.

We do see a resurgence in the Illinois Basin as I've often said we think it's kind been second decade of this century not the first, the recent care [ph] overturning by court, regulations out of the EPA, we think have some interesting aspects and implications because you can certainly make an argument that it's a bit more uncertainty and is cover build out and actual half rating of some of those covers that might get build.

At the same time, SO2 allowances would likely be a overpricing. so you have a negative from our perspective as we are always been a low coal per producer principally, but we are looking in each one of our existing operating basins and we continue to look at Illinois as a future basins but it's still a few years out.

Brett Levy - Jefferies & Company

Any priority between steam and Met?

Steven F. Leer - Chairman and Chief Executive Officer

We are optimistic obviously with, let's call it, red hot met markets and we think that we are always interested in that and we are seeing continued pressure to pull high quality steam into the met markets. But at the same time, the steam markets are very, very robust and we continue to see a global shortage and so we are open to either one I guess that's what it's described as.

Brett Levy - Jefferies & Company

Alright. And the last one I mean, is the tad sensitive in some of the smaller guys have very apparently been kind of renegotiating some of their existing priced coal for 2008, particularly. Is that something that's sort of more limited to the smaller guys or is that something that sort of wide spread to folks like yourselves?

Steven F. Leer - Chairman and Chief Executive Officer

Well, I think it really... specific to customer base and individual companies, but the best way to think about Arch and we saw this market developing and really with the strong balance sheet that Arch have, we were able to position the company with a large open market position for really '07 which we may have been a little early there, but certainly '08 or '09 or '10 and beyond. And in met, it's really not an issue for us, where maybe some others have committed at different times earlier in the curve they need to do things that we don't have to.

Brett Levy - Jefferies & Company

Thanks very much guys.

Steven F. Leer - Chairman and Chief Executive Officer

Thank you.

Operator

Our next question comes from Gordon Howald with Calyon.

Gordon Howald - Calyon Securities

Hi guys. Just wondering, I guess everyone's kind of doing the math here, why don't you confirm what you said earlier about Western Bit, seeing three year deals for Western Bit 60% above second quarter price realization? Is that for all three years and as you were going through negotiations, your customers attempting to work any backwardation into your contract pricing, just try to get a sense of that?

John W. Eaves - President and Chief Operating Officer

Well, I mean certainly those agreements typically had some kind of escalation mechanism and that was... a lot of those transaction were made early in the cycle.

We continue to have contract roll off as well as open market sales in future years, '09 and '10 that we'll be able to take advantage of this even strong pricing we're seen in that market right now. So we were pleased, we think with our cost structure out there those agreements give us a very attractive margin, that we can only build along as we move forward.

Gordon Howald - Calyon Securities

So those are locked prices for three years that of Western Bit at that level?

John W. Eaves - President and Chief Operating Officer

With some kind of escalation mechanism typically.

Gordon Howald - Calyon Securities

Excellent, thank you very much.

John W. Eaves - President and Chief Operating Officer

Thank you.

Steven F. Leer - Chairman and Chief Executive Officer

Thank you.

Operator

Our next question comes from Paul Forward with Stifel Nicolaus.

Paul Forward - Stifel Nicolaus

Good morning.

Steven F. Leer - Chairman and Chief Executive Officer

Good morning, Paul.

Paul Forward - Stifel Nicolaus

On the $22 to $23 PRB contracts, I am just curious if you are talking about a three-year deal, when you sign those... these days, are you now able to add some sort of diesel cost protection into the contract or is that a just basic fixed price?

John W. Eaves - President and Chief Operating Officer

Certainly Paul, we are trying to give all the terms and conditions we can get in these new agreements, some would have those some wouldn't but I would tell you typically the agreements we are looking at these days are typically two to three years in durations so, any cost pass-throughs that we can give, we are certainly trying to do that.

Paul Forward - Stifel Nicolaus

And... okay. And on the Western Bit, you talked about I think somewhere around, you implied around $48 return average pricing realized during the second quarter. Can you go through that market now, and I know you talked forward pricing continuing the strength in that market. But what's your ability to sign multi-year contracts levels 20% above that level or let's say somewhere in the order of $60 a ton longer term deals?

John W. Eaves - President and Chief Operating Officer

Well, you know Paul; historically that's been a pretty friendly traded market. We've always said that when you look at the market dynamics, the Central App coals are first to move and that's happen this time and it's followed by the Western Bit and then eventually see a pretty significant pickup in the PRB.

We have discussions going on with customers right now, really can't talk about the pricing, but what I can tell you is I think we have opportunities to sign Western Bit coal up for more than 60% premium to the second quarter price would be. So those discussions are ongoing, and I really couldn't give out anymore information because of sensitivity of it. But that market continues to be strong. We continue to see interest in the east for the Western Bit as well as export opportunities.

Paul Forward - Stifel Nicolaus

Okay. And then also on the trading and derivative gains plus $53 million this quarter. I think you said earlier that you think that's a smaller but positive contribution in the third quarter. Can you tell us, I guess considering the rollover that we've seen in some of these paper markets for coal over the last few weeks, what's your... why do you have the comfort level that you're able to tentatively say that next couple of quarters if that... there won't be some reversal of those gains that you have already seen?

Steven F. Leer - Chairman and Chief Executive Officer

Well again, it is trading in your... you're always at some market risk and we did say we expect a positive contribution in the second half. Part of it is because we have built in downside protection in many of the position and the volatility in the market, the traders are taking positions as we speak. And they can be on both sides of the trade, or opposite side at different points of time in the cycle. So we're... our forecast includes some positive contribution, but certainly, we don't expect a repeat of the second half of what we saw in the first half, but I would love it if they did.

Paul Forward - Stifel Nicolaus

Alright. Thanks a lot.

Steven F. Leer - Chairman and Chief Executive Officer

Thank you.

Operator: Our next question comes from Mark Liinamaa with Morgan Stanley.

Mark Liinamaa - Morgan Stanley

Thanks. Can you give any color on how much PRB coal you actually left in the ground because the returns weren't there?

Steven F. Leer - Chairman and Chief Executive Officer

That's really in our range reduction, we didn't break that out. We said that the new range of 133 million to 137 million tons was due to the Midwest flooding and leaving some tons in the ground, but we really hadn't been more specific on that.

Mark Liinamaa - Morgan Stanley

Okay. In addition to the rollover in the financial markets you were just talking, a lot of people are concerned about natural gas coming in and the competition between the two. I think I know your answer to this, but could you just give us a comment?

Steven F. Leer - Chairman and Chief Executive Officer

Sure. $9 or $10 in natural gas, if that's the measurement against the coal-fired power plants coal wins in every case and when you really do the math, it still win... coal has to get down substantially lower than that $10 pricing. And the reality of it is, the nation needs all of the generation that it can get a hold of. So could we see gas dip for some reasons? Sure, I mean the markets are markets, but if you start cranking up additional gas demand or generation, it is the self correcting mechanism.

So we're very comfortable where we're sitting, both in our exposed positions to coal, and the real issue is we're seeing a global supply shortage and the U.S. has transitioned over the last five or six years from kind of a regional market to national market, to now the global market and gas plays a piece of it. But, it's interesting to watch some of the gas markets. I mean, if you look at the Texas utility market and natural gas down there in the coal-fired power plants, I mean, I would love to have a coal-fired power plant in Texas today.

Mark Liinamaa - Morgan Stanley

Okay.And just quickly, a little bit back to the financial markets. For those of us that are using those to make some sort of prediction of pricing power. How would you talk about your price discovery process and how the tough position you would take in holding out for whatever value you see fit?

Steven F. Leer - Chairman and Chief Executive Officer

Well again, we'll be the first to tell you that we don't think we're smart enough to pick the tops and the bottoms of a particular pricing cycle. But we look at the supply demand on a global basis. We look at what's happening with our customers, how they're acting, where the shipment get delayed or miss because of crane problem or a plant problem or maybe we have a prominent coal mine. Are they looking for the coal of being replaced immediately, are they looking based just added to the end of the contract, you watch the stockpiles and what we found is the financial market historically have certainly gotten the direction reasonably well, but the physical market can be very different.

And I think in the last three or four weeks, when you think about the disruption let's call it, in just the financial community and people being forced to liquidate positions or being forced to raise money because they're getting coal, we think we're in an abnormal time here. And what we're seeing in the physical market in actual natural sales are very different than say, the prototype on the industry today.

So we bring it altogether, the trading functions in there every day, minute of every day and they've add a whole new aspect to our intelligence to optimize margins. So all of that together, we would argue the fundamentals have gotten stronger as we've seen it from a supply demand basis over the last three weeks, the last quarter from a quarter ago and then which you might see in just the trading in the couple of financial coal market.

Mark Liinamaa - Morgan Stanley

That's great. thank you very much.

Steven F. Leer - Chairman and Chief Executive Officer

Thank you.

Operator

Our next question comes from Michael Dudas with Jefferies.

Michael Dudas - Jefferies & Company

Good morning, gentlemen.

Steven F. Leer - Chairman and Chief Executive Officer

Good morning, Mike.

Michael Dudas - Jefferies & Company

First question, Steve, you're pretty optimistic about export opportunities into 2009. Any thoughts to... do we need to make investment to get to that level at the ports such as maybe your interest in DTA, just comment a little bit about that. And how much you think we can see through the Gulf for out even to the West Coast as to try to get to such numbers?

Steven F. Leer - Chairman and Chief Executive Officer

We've spend sometime trying to analyze and the guys are looking up for the numbers, right now. But we think we can easily really take it above 100 million tons of export and you going to hit a wall at some point in time and one of the uncertainties is that a bit streaming in the gulf are certainly is doable, but the question is, is there any limit on that? But in walking through it, we've added... we estimate that DTA is at kind of plus 20 million ton a year terminal given the exports, we added went from 17.5% to 20%... 22% of the capacity and it's also was about $1.5 million, I mean it turned out to be a great investment, we think and it will continue to be so.

When you think through the ports themselves, DTA is that kind of 20, 21, 22 million tons depending on stockpiles. If you look at Lambert's point, it's plus 40 million tons of NS to operate both side. If you think about Baltimore, is plus around 20 million tons of capacity, we believe. You are adding in the mobile, some of the other Southern ports, you can add another 10 or so million tons and then the Gulf Coast through New Orleans.

So we can get well above 100 million tons and we think demands are up there in the global shortfall. So at some point, some additional investment won't be required. We don't see that occurring necessarily in '09 or even '010. Then you also have a West Coast where things are certainly more limited, but up through Canada, Vancouver, we think you could see 5 or 6 million ton and then maybe 2 million tons total in all of the other West Coast ports.

Michael Dudas - Jefferies & Company

Thank you for the details, Steve. My follow up question is, you made a very interesting I think very correct comment in... earlier on the call, relative to the markets in the coal markets is becoming regional to national and now certainly international. Do you think that could support higher level of industry consolidation in the United States?

Steven F. Leer - Chairman and Chief Executive Officer

I think for a long time, certainly last several years, the industry observers both and with that the industry and without the outside of the industry start consolidation was going to occur. We're certainly starting to see it and I think you've seen the announcement over the last several weeks of different combination, then you maybe the deal if done maybe they don't get done and you've seen steel company is at least now that they are buying private companies. Obviously, we just saw the approvals by the shareholders magnum patriot deals. So it's starting, we think this likely to continue and both more traditional domestic coal producers and I think you've seen some of the international players and new players, entering into the marketplace that probably wouldn't have been predicted a year or two ago.

Michael Dudas - Jefferies & Company

And when should we expect that possibly out West as well?

Steven F. Leer - Chairman and Chief Executive Officer

Well Rio made the announcement they are selling Rio Tinto Energy America, so presumably somebody will do a deal with them, and so yes.

Michael Dudas - Jefferies & Company

That's all I have. Thanks, Steve. We appreciate your time.

Steven F. Leer - Chairman and Chief Executive Officer

Thank you.

Operator

We are taking our next question from Shneur Gershuni with UBS Securities.

Shneur Gershuni - UBS Securities

Hi, this is Shneur Gershuni calling. Most of my questions have been answered and I just hate to come back to good brokerage. But I just wanted to get a clear understanding of kind of the purpose that you put forward in traders. Are they able to take negative positions so forth or was it really trying to optimize or see kind of really trying to get more from what you have?

Steven F. Leer - Chairman and Chief Executive Officer

They have, I mean within a very finite regulated position, they can take positions and have the view of the marketplace. But we start with trading around our assets, and they do have a bar that they are allowed to have that risk.

Shneur Gershuni - UBS Securities

Okay. Just a thought or the previous question was about the tax rate and so forth. Can you give us an idea of the NOLs you have outstanding and the credits you have available, you will have pricing goes up so forth, I expect your earnings grew clearly increase in obviously... they have eventually used up the NOLs and so forth. And I wanted your long-term thoughts on it.

John T. Drexler - Senior Vice President and Chief Financial Officer

Yeah, from a tax perspective, we have a fairly substantial deferred tax asset primarily in the form of NOLs and AMT credit carryforwards. As our profitability increases as we look out over the next many years, we are going to have several years where we are able to utilize that deferred tax asset, projections for the next several years. What that leaves us is, if you are looking out over the next several years is, we're essentially going to be an AMT tax payer with a rate anywhere from 22% to 25% as we utilize those deferred tax assets as we move forward.

Shneur Gershuni - UBS Securities

Okay great. And just with respect to priorities for cash flows, I mean if cash flow is coming a lot stronger than you are currently forecasting right now, I know where do you... where would be your priorities of where to place the cash. Would it be in the form of share buyback, debt repay, CapEx if its on your priority?

Steven F. Leer - Chairman and Chief Executive Officer

All of the above, but really we look at it and right now we have given the forecast. We do expect free cash flow this year and given the market place one would make some assumptions about 2009 and 10 as well.

But really we look at what will give us the greatest long-term return for our shareholders and it can be anything from organic growth, as we've evidenced over the last couple of years with Laurel moving into the EC amount, and our West Elk mine too looking forward you would have some expansion opportunity in our eastern operation.

We mentioned earlier, the industry does look like there will be consolidation; not many things can make it through our screen, but if it makes sense we would certainly look at it and be very serious about it.

I think we've demonstrated in the past that if we are not getting the proper return on our assets that we are willing to do things with those assets, that would be a buyer or seller, and we've certainly done both in the recent past over the last several years and share buyback and dividend increase, if there's something that Board looks at really every Board meeting we discuss, we look at the opportunities of cash.

Having said all that, I think it's also important to maintain a strong balance sheet because one of the things that really different in this pricing cycle. For us is that we saw it coming and we have the balance sheet that said if we've got our timing wrong or let's just face facts and then maybe we could have been wrong, we've then look like we were.

The balance sheet allowed us to knock out so much coal plays and hedged it what turned out to be much, much lower prices wherein previous cycle because of demand and commitments in the balance sheet, often we would have to enter the cycle at a much larger sold out position. So it's really all over them, I don't think about as a simple priority. I think the bottom is what can maximize the return for our shareholders over the long-term and you have our commitment that we are going to be very, very serious about each of one of those factors and it wouldn't surprise me to see us through somewhere all of them.

Shneur Gershuni - UBS Securities

Great, thank you very much.

Steven F. Leer - Chairman and Chief Executive Officer

Thank you

Operator

We'll take our next question from Mr. [indiscernible]

Unidentified Analyst

Thanks. On the cost structure, if I heard you correctly, you mentioned that average cost structure to be about $19 to $21 per ton for 2008?

John T. Drexler - Senior Vice President and Chief Financial Officer

That's correct.

Unidentified Analyst

If you look at the first half it was about $16 per ton, so you are expecting a sharp rise in the second half?

John W. Eaves - President and Chief Operating Officer

Could you repeat that?

Unidentified Analyst

If you look at the cost structure, operating cost per ton in the first half it was an average of $16 per ton. So if you are looking for the full year of $19 to $21 per ton, which means that you are looking for a sharp rise in the operating cost in the second half of 2008 of the third quarter and fourth quarter, is that a right way to put it?

John W. Eaves - President and Chief Operating Officer

Well when we look it, we are looking at cost to sales, all in cost and we are typically looking in at $19 to $21 all in cost, it will be rail cost in the Western Bituminous regions and that's we are just trying to stay within that range.

Unidentified Analyst

So then the first half also the cost including the rail was about $19 to... was in the range of $19 to $21 basically?

John W. Eaves - President and Chief Operating Officer

First quarter was $20.17 I'm sorry, yeah first quarter it was $20.17, second quarter was $22.37 all in cost.

Unidentified Analyst

Okay all in cost. So if I had to look at just at the operating cost, given the price pressures in terms of the operating the mines. Do you think that the cost in the second half will be higher than the first half or it would be flat to the first?

John T. Drexler - Senior Vice President and Chief Financial Officer

well I think, we are doing every thing we can to arrest these cost increases, but there are lot of pressures, certainly on the commodity cost and I think we'll be certainly at the top end of that range, that we gave you earlier in the year.

And we are going to do everything we can to manage within that range, but there is a lot of cost pressures out there. We have two longwall moves going on in the third quarter, and then we have two longwall moves, one of those in Western Bit in the fourth quarter, so those will have an impact on our cost.

Unidentified Analyst

Okay. And other question was on the hedge program that you talked about for oil, it's about 65% hedge for 2008 and 30% hedge for 2009 I believe. Now when you look in those numbers, the range that you are looking at $19 to $21 will obviously go high in the range of $23 to $24 probably since you are unhedged for 70% of your oil requirement in '09. Is that the correct way to look at it?

Steven F. Leer - Chairman and Chief Executive Officer

Not really, this is Steve. You are focusing on Western Bituminous region and essentially those... not essentially, those are all underground mines and they are just not a big user of diesel fuel.

If you look at our Powder River Basin operation, which have a much lower cost structure, I think for the second quarter, the operating cost per ton were $10.44 that's are biggest usage of diesel fuel in the company and that's where the largest pressure of diesel fuel would be.

Operator

We'll take our next question from Zack Driver with [indiscernible] Capital.

Unidentified Analyst

Hi guys, thanks for the time and congratulations on the solid quarter

Steven F. Leer - Chairman and Chief Executive Officer

Thank you

Unidentified Analyst

I was just wondering if you can just go over some of the numbers you have talked about in your opening prepared comments about the global market and I think you talked about 35 million metric ton on deficit in 2008 growing over the your next five years, and strong enough to absorb. I think you said some slowdown globally. Just wondering if you give those numbers again and you are talking about what kind of slowdown globally and in which key countries that forecast can tolerate that seems to be the concern is yours, so I just want to address it.

Steven F. Leer - Chairman and Chief Executive Officer

Well and again, we are not unnecessarily forecasting a slowdown in, I'll cover it the BRIC company countries. But we do believe there is enough growth and it's a slowdown on the growth is the quick way to describe and then China goes from than 10% or 11% growth 8% or 9% growth. It is still a very, very larger number in terms of demand. But what we are seeing is just almost sensational supply in the Pacific Rim, demand in the Pacific Rim, specifically China, India. If you total the other Asian economies, they're an enormous draw as well in terms of demand. I mean China is adding roughly power plant a week, and their own production is up around 2.7, 2.6 billion - 2.7 billion tons.

Globally, the estimates are that global coal demand will increase something close to 1.1 billion tons over the next five... four, five years. And if you think about that, if it's the 1 billion ton, that's kind of replicate the U.S. coal industry in call it a five year timeframe.

And it's not that they're reserved on exist on a global basis because they do, but it's a infrastructure demand and you see it in taken Colombia or in South Africa are we just talked earlier about the ports in the U.S. We can grow to a point but some point is starts eliminate us clearly you see the infrastructure issues in Australia.

So as we look at our global basis and start going through internal demand, people and some countries starting to say we're going to limit our export because we have indigenous internal demand for coal. When we do the math, it ends up being in the Middle East some countries, but that is a little bit big. That 30 million to 40 million ton shortfall this year and a continued shortfall increasing as we go forward, but it is led by India, China, the Pacific Rim and then it's compounded by infrastructure problems and the traditional supply in the country.

Unidentified Analyst

So how much do you thing this deficit grows to in '09 and by 2010?

Steven F. Leer - Chairman and Chief Executive Officer

Again, we're forecasting that it continues to increase 5 million to 10 million ton deficits compounded each year.

Unidentified Analyst

Got it. And then just talking about the export facilities in the U.S., the 100 million tons of export facility at least just a name plate. Are there any constraints to operating them at full utilization and you think this country could easily export 100 million tons or would there have to be some sort of changes in modifications to actually get that 100 million tons and how substantial and capital intensive are those changes if any?

Steven F. Leer - Chairman and Chief Executive Officer

I think the main places are actually much higher when you total all of them.

Unidentified Analyst

Oh, really.

Steven F. Leer - Chairman and Chief Executive Officer

Yes, I think as with operating any mechanical system as we get near those nameplates and really push them, I mean two things happen. One, there is ingenuity and people end up increasing the capacity with some investment and usually it starts off modestly and eventually hit a wall and have to be substantial. But right now, most of the ports are exporting and it becomes more to me the concern would be more of the logistics. Do we... can we manage all the logistics of the continued huge surge in export and what we forecast is they pretty significant surge in internal demand an it will be a challenge system I think do it but you have in opportune derailment or floods in the Midwest as an example or we break something at one of the mines. The system is well and pretty tight and the ability to make that up, it will be a huge challenge.

Unidentified Analyst

And then on the care implications, which you delves into as it relates to potentially some commoditization of your historical softer premium combined with sort of evaluating the Illinois Basin. Just wondering, if you could explore deeper in terms of i.e. does care being vacated, make you more inclined to develop Illinois Basin or does it make you less in kind of develop Illinois Basin because the uncertainty that it creates could actually slowdown some of the scrubber installations and then make, but their ultimately there will be some sort of care type rule to be more stringent actually. So I just was wondering you could share you're thinking about care? How existing portfolio have lease Illinois Basin and relatively, how many time you think common Illinois Basin in next two, three years? Thanks.

Steven F. Leer - Chairman and Chief Executive Officer

Everybody is trying to kind of... try to figure out what the care litigation and really means, but on a very preliminary analysis, you have to sit there and say, well because we'll trade... we'll continue to trade SO2 but it won't go for two emissions, from the current one in 2002, you would argue that the pricing of SO2 is more likely to be down than up from say the recent history, on scrubbers, I think the likelihood of some decisions to slowdown the build out of scrubbers are perhaps even not turn them on depending on the needs of individual units.

The scrubber has the parasitic lower than the couple percent clear on the output of the plant, and they are possibly operated. You'll see some the uncertainty creates probably some conditions where things do slowdown. So that would be a negative for the Illinois Basin.

We think people will be able to meet their emission needs now perhaps through low sulfur coal burns and the use of maybe a slightly higher sulfur coal with emission allowances because their lower pricing.

So it's really a mixed bag, but from our perspective that's all I can comment on, Illinois Basin, I think it's a negative for the development of Illinois Basin because we've often said that for us, it could end at $3 or $400 million longwall mine and takes from the decision point today till actually having it up and running would be a four to five year process to reach production.

And in total scrubbers are build, I'm not going to put that kind of shareholder money at risk, and not have the market be there because it can't burn it so that is 5% and 6% as the coal it mitigates. So, it's coming, it's going to develop, but I don't see a developing for months.

Operator

We'll take our next question from, Ann Kohler with Caris.

Ann Kohler - Caris & Company

Yes, good. Good afternoon, gentleman. I have a question which sort of follows up on all of that. And that doesn't mean... certainly Steve you gave a very strong outlook over the balance of the decade and probably into the next of global deficit that we have on the coal side. I guess how does... how do you see the U.S. is it going to be trust upon the U.S. to come with that number or certainly I would seen Australia in that mix as well and how do you foresee taking advantage of that given your reserve positions?

Steven F. Leer - Chairman and Chief Executive Officer

I don't know if we had absolute record, if we go back for 30 years of all the credit sisters companies of Arch, but we think we have record levels of export rates right now for Arch and industry will hatch 100 million ton mark here in the next couple of years likely anyway. And it's putting pressure both on the coal supply domestically and our ability to do it and every time that international market makes it a ton that is not available to the domestic market. So we think given Arch's position to export both through the East Coast, through the Gulf Coast. We think PRB will move through the West Coast. We have seen not Arch's coal but we wrote anecdotally that some coal has moved through the West Coast out of Utah as well.

I think we're extremely well positioned. And all the countries will decline to respond to the market both on the buy side and supply side, but when you look at the infrastructural requirement and South Africa in Australia import capacity perhaps then in real capacity in Colombia.

Over time those things can be put in place but its longer than a two year time. I mean we think at the most of your timeframe and someone wants to describe the Australia infrastructure to me like pretty ways in Houston.

When they started building by the time they're done the capacity needs or they need a new free way. So it's... they are caught up and I think there is some truth to that.

Ann Kohler - Caris & Company

So I mean would you envision that the U.S. there is going to be able to capture a large percentage of that deficit and I guess how would you respond in being able to capture a good share of that deficit.

Steven F. Leer - Chairman and Chief Executive Officer

I do think that U.S. is going to be able to capture a good share of that deficit particularly into the Atlantic rail market. It's going to come down to the U.S. and Colombia as the best position. In the Pacific Rim, obviously you have to stay Indonesia and Australia have the strongest position, although we'll see some U.S. coal enter that market.

South Africa can go both ways right know. India is a very logical buyer, South African coal and you're seen dramatic increases in their purchases over the last few years. From Arch's perspective, it's again as some of our legacy contract roll off in the steam market; we can push some of that coal into the black market in the current environment that can be domestic or international, and given the ownership of DTA and our ability to go through the Gulf with really of our Eastern coals and through the Gulf with... particularly at Colorado coal, MPRB coal and then you could have the Utah coal go through the West Coast or you have the PRB goes through the West Coast probably through Canada and then I can't... sometimes don't talk about it, but we exporting into Mexico today. We likely see the need there continuing and certainly the industry exports into Canada as well.

So we think we are positioned great, we are always looking to strengthen that position. But the unique position that Arch has is uncommitted coal over the next several years, and we think we can take advantage of this market, both on a domestic basis and in the international basis, and I kind of look back at the last few quarters and you are starting to see that coming to play.

Operator

Due to time constraints we have time for one last question. We'll take that question from Justin Fisher with Goldman Sachs.

Justine Fisher - Goldman Sachs

Good morning.

Steven F. Leer - Chairman and Chief Executive Officer

Good morning Justin.

Justine Fisher - Goldman Sachs

The first question I have is about comparing the current market to 2006's coal market and it's interesting because I think that we are hearing a lot of the same commentary from peer producers now that we did in 2006 which is the forward curve is very strong, the outlook is bullish but because stock prices are pretty low, we are going to... or lower than we like, we're going to leave some coal in the ground until prices reach appropriate level. So a) do we need to see a flattening of the PRB curve for Arch to decide to take those tons out of the ground and then b) what if at all different about the current market versus 2006 that might make things pan out differently that may be the last time?

Steven F. Leer - Chairman and Chief Executive Officer

Well, take the second part of that first. Really if you look at the 2006 market, it started in 2004, 2005, and 2006 and didn't end until very mild winter in '07 and that was preceded by a mild summer. The major difference in this market compared to that market is the export market. Met was reasonably strong, but it wasn't nearly as strong as it is today, and you were getting some draw of steam coal into that met market but again not nearly as much as we see today.

And you did have any export steam market in 2005 and 2006 to speak on and you see a very strong demand going on today. So in a nutshell, the net change and if you think about it, I don't have 2006 export numbers on top of my head, but they were probably down in the 40 million ton range and 2007 was in that 56 million to 57 million ton range.

We are still forecasting 83 million tons for 2008 in exports. That's a huge swing and if that continues on as we would expect, another 10 million tons or more next year crossing over 100 million ton by 2010. That is an enormous change. On top of this, this marketplace has occurred really... we've seen record pricing and we entered the year with very robust stockpile in the east and west at our utility, domestic utility base and that was unlike the run up that you saw in 2004-05 timeframe and we've seen the stockpile decline even with the record pricing, but really the utility started in a better position and so those two together I think are significant differences and have real implication on the supply demand balance moving forward.

Justine Fisher - Goldman Sachs

And at the decision part of the question?

Steven F. Leer - Chairman and Chief Executive Officer

Could you repeat --

Justine Fisher - Goldman Sachs

I' m just, I mean, you said previously, and I understand that there is no price that which I should say oh great, never mind the tonnage but --

Steven F. Leer - Chairman and Chief Executive Officer

Right.

Justine Fisher - Goldman Sachs

Are they other trends beside desperation on the part of your utility buyers that trends such as a flattening of the curve or what are things that might make us think that the coal will come out this time versus the last time?

Steven F. Leer - Chairman and Chief Executive Officer

Well Justine, we know with regards... we'll always evaluate in the market and what gives us the best returns for our shareholders and we strongly believe that on a global scale, the world is relatively short of energy and it doesn't matter if you want those focus on gas or oil or coal, and when we're in that up trend can we have a year or two therefore a year or two where they really spike and the answer of that will be yes.

One of the things we tried to think about is, what's the future cost of replacing the reserve, if you think about a PRB ton you got to do win the LBAs in the futures you got think about your pricing that might cost, the timeframe due to EISS and ultimately get the permits. And as we think about that, that goes into our view of committing the coal long-term.

Sometimes, we'll go ahead and sell the coal short-term because we need to for mine purposes or get it out of way of the drag line, but we are here to create long-term value and the biggest mistakes we've personally think we made in some of the previous run-offs as committing coal too early because we had to because of the weaker balance sheet or other needs of the corporation, and often we were not in a position to take advantage for our shareholder, of the really strong market and we see... we don' t see this as ending in energy at all.

Justine Fisher - Goldman Sachs

Okay. And then the last question is just about how you guys view your export customers versus the domestic customers because we talk about potential export capacity in the U.S. and we might be able to throughout members of additional production it maybe export it, but how do you're the coal company view serving your bread and butter domestic clients versus the export customers? I know that you are signing some long-term export customers, but would you prefer to sign contracts with domestic customers for the longer-term, maybe I just try to face but to walk into that business, I mean or would you guys send whatever you could have brought even if there isn't any incremental price point?

Steven F. Leer - Chairman and Chief Executive Officer

Again, we love all our customers, there is no such thing as a bad customer as long as they pay the bills. But what we tend to do is we want to mix because given the nature of export if you think about your current load a ship or a center ship and relatively a short period of time. And then the ships gets schedule. So if you think about a coal mine, just a single coal mine as one of Arch's great strength as we have multiple mines. But and that we kind of load the ship and we do and then we may have 15 days with nothing scheduled for an export order and then you're starting on another ship at the end of the month let say.

You need that mix to balance the production at the mine because the mine can't cycle up to huge exports, no exports, huge exports and run efficiently. So with our marketing team and again, we use the training group as well, we try to balance the mine to operate it efficiently as it possible can to meet the needs of the customer and we find that a mix. And we mix the customers, export and domestic and we mix them by qualities and we also mix them between different mines. And it is a balancing act to get absolute most efficient operations at the lowest costs. But size does matter in that case.

Operator

And this concludes the question-and-answer session for today's conference. I'd now like to turn the call back to Mr. Leer for any closing comments.

Steven F. Leer - Chairman and Chief Executive Officer

Thank you. I really want to thank everybody for joining us on the call today and your interest in Arch Coal. I think as you can tell, we are feeling very good about the business, the fundamental supply demand balance from the supplier's perspective we feel has continued to strengthen throughout the year and has continue to strengthen through the recent kind of rollercoaster ride if you will in terms of the financial coal market.

We really believe that our strong open to commitment on sales positions Arch to benefit from these stronger markets and we are looking forward to the second half of 2008 and each one of our basins that we operate in and our trading arm or contributing handsomely to the profitability. And as we look forward, we look forward to reporting the results as we move into 2008 and on into '09. So again, thank you for your time. And we'll see you, talk to you in three months.

Operator

This concludes today's conference. We thank everyone for their participation. You may now disconnect your lines.

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Source: Arch Coal, Inc. Q2 2008 Earnings Call Transcript
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