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AK Steel Holding (NYSE:AKS)

Q3 2012 Earnings Call

October 23, 2012 11:00 am ET

Executives

Albert E. Ferrara - Senior Vice President of Corporate Strategy & Investor Relations and Member of Proxy Committee

James L. Wainscott - Chairman, Chief Executive Officer, President and Member of Proxy Committee

Roger K. Newport - Chief Financial Officer and Vice President of Finance

Analysts

David Gagliano - Barclays Capital, Research Division

Michael F. Gambardella - JP Morgan Chase & Co, Research Division

Arun S. Viswanathan - Longbow Research LLC

Brett Levy - Jefferies & Company, Inc., Research Division

Richard Garchitorena - Crédit Suisse AG, Research Division

Michelle Applebaum - Steel Market Intelligence Inc

Evan L. Kurtz - Morgan Stanley, Research Division

Kuni M. Chen - CRT Capital Group LLC, Research Division

Mark L. Parr - KeyBanc Capital Markets Inc., Research Division

David Adam Katz - JP Morgan Chase & Co, Research Division

Timna Tanners - BofA Merrill Lynch, Research Division

Shneur Z. Gershuni - UBS Investment Bank, Research Division

Brian Yu - Citigroup Inc, Research Division

Justine Fisher - Goldman Sachs Group Inc., Research Division

Operator

Good morning, ladies and gentlemen, and welcome to AK Steel's Third Quarter 2012 Earnings Conference Call. [Operator Instructions] Later we will conduct a question-and-answer session. [Operator Instructions] As a reminder, this conference call is being recorded. With us today are Mr. James L. Wainscott, Chairman, President and Chief Executive Officer of AK Steel; Mr. Albert E. Ferrara, Jr., Senior Vice President of Corporate Strategy and Investor Relations; and Mr. Roger K. Newport, Vice President of Finance and Chief Financial Officer.

At this time, I will turn the conference call over to Mr. Ferrara. Please go ahead, sir.

Albert E. Ferrara

Thank you, Sam, and good morning, everyone. Welcome to AK Steel's Third Quarter 2012 Earnings Conference Call. In a moment, Jim Wainscott will offer his comments on our business. Following Jim's remarks, Roger Newport will review our third quarter 2012 financial results. And together, we will field your questions.

Our comments today will include forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. Included among those forward-looking statements will be any comments concerning our expectations as to future shipments, product mix, prices, costs, operating profit or liquidity.

Please note that our actual results may differ materially from what is contained in the forward-looking statements provided during this call. Information concerning factors that could cause such material differences in results is contained in our earnings release issued earlier today.

Except as required by law, the company disclaims any obligation to update any forward-looking statements to reflect future developments or events. To the extent that we refer to material information that includes non-GAAP financial measures, the reconciliation information required by Regulation G is available on the company's website at aksteel.com.

And with that, I'll turn it over to Jim for his comments. Jim?

James L. Wainscott

Thank you, Al. Good morning, everyone, and thank you for joining us on today's call. Our third quarter 2012 financial results, which were released earlier today reflected the continuing challenges of sluggish economies in the United States and abroad. Notwithstanding the fact that our third quarter financial results were a little better than our guidance, the quarter turned out to be our most difficult quarter-to-date this year.

In addition to the challenging business conditions both in terms of our shipment volumes and selling prices, the quarter was impacted by planned major maintenance outages that cost a total of $29 million. The outages went as expected, and completion of this work positions us well to capitalize on improved market conditions when they arise.

Speaking of market conditions, we continue to see significant strength in the automotive sector. September's seasonally adjusted annual sales rate topped 14.9 million vehicles, that's the highest level since March of 2008.

For the full year 2012, NAFTA light-vehicle production is forecasted at 15.1 million units. That's up from 13.1 million units last year. And while auto builds are about 15% higher this year than the prior year, AK Steel's shipments to automotive customers will be about 20% to 25% higher. In other words, we are gaining market share.

Based on what our automotive customers tell us, we look for continued improvement ahead in the automotive sector. And that's very good news and translates into increased carbon steel value-added shipments, and it also bodes well for our 400 series or autochrome stainless steel products.

Autochrome customers continued to prefer AK Steel's products in the third quarter, as competitors struggled to meet customer commitments and strong demand.

While the automotive market continues to improve, other markets continue to be sluggish. For example, our infrastructure and manufacturing market, which includes appliance, HVAC and general manufacturing customers, tracks housing and the general economy. Suffice it to say that demand is flat and competition is brutal for these steel orders.

The same can be said of the distributor and convertor market with short lead times. Service centers have waited on making major purchase commitments in an effort to call the bottom on pricing. On average, service centers had about 2.5 months of supply on hand of flat-rolled carbon steel products at the end of September, and that's pretty consistent with their historical level of about 2.4 months of supply in inventory.

Just last week, however, we began to see a substantial increase in our order intake rate for spot market carbon sales. In fact, our order intake rate was some 4 to 5x the rate of the prior week, and accordingly, we raised prices by $40 per ton on all carbon steel products effective immediately.

It's interesting to note that this same pattern of buying behavior was occurring for carbon spot business, although about a week or 2 earlier this year than we've seen emerge since the year 2009. But obviously, we're hopeful that a similar trend continues in 2012 as has occurred in recent years.

Moving for a moment from carbon to stainless steel. Relatively speaking, stainless steel service center inventories are in better shape than carbon steel at the end of September. Service centers on average had about 2.8 months of supply on hand of stainless steel products, and that compares favorably to the year-ago September inventory level and is consistent with the year-to-date 2012 inventory levels for those products.

Now let me take a moment to comment on what we're seeing in the electrical steel market. Electrical steel market has shown signs of strengthening in the United States, but has exhibited continued signs of weakness overseas. Due to growing transformer demand, both new and replacement transformers, our NAFTA market grain-oriented electrical steel, or GOES shipments, increased by more than 10% in the third quarter of 2012 compared to the prior quarter. The new domestic demand for GOES is resulting from the slow but steady increase in the housing market. Housing starts are currently projected to hit some 760,000 units for 2012, which is up nearly 25% compared to 2011. And all of us learned last week that new home construction in September reached its highest level in 4 years since July of 2008, as new home starts rose by 15% to an annualized rate of 872,000. That is encouraging news, indeed.

The replacement market within NAFTA for GOES benefited from a seasonal boost, which was largely attributable to activity from the hurricane season.

On the other hand, our international GOES shipments experienced a decrease of more than 10% in the third quarter. Demand has fallen as economic instability has become the norm, especially in Europe. And as most of you know, we have effectively been precluded from selling electrical steel in China since December of 2009.

For almost 3 years now, we've been fighting trade sanctions on electrical steels that had been brought by the Chinese government without any basis. A case was brought in the World Trade Organization, which we won earlier this year. However, the Chinese appealed that decision. But the United States trade representative, Ron Kirk and his staff went to work on our behalf with a very positive outcome. And last Thursday, the WTO's Appellate Body affirmed the panel's ruling that China was unjustified in imposing duties on AK Steel's products. We were obviously delighted with this finding.

From the beginning, China's case was contrary to the WTO rules and should never have been pursued. With China now out of appeals, we will, once again, look forward to offering electrical steel products to our Chinese customers.

It is important to note that a lot has happened in the past 3 years in the GOES market, including increased global capacity, as well as tougher market conditions in general. Both of which will make it more difficult to recoup our former position in China, at least right away. But that is our goal over the long run.

If China properly complies with the WTO's ruling and rescinds the tariffs that were improperly imposed, AK Steel can once again be helpful to our customers in China and participate in China's ongoing infrastructure growth.

At AK Steel, we continue to differentiate ourselves on the basis of value-added products, great quality, on-time delivery and customer service. We continue to grow our percentage of contract business, aligning ourselves with those buyers who want more than simply the lowest price.

Let me give an example of why this is the case. We have seen examples throughout this year of extreme volatility in the carbon steel spot market. Our spot market hot-rolled prices for carbon steel averaged in the high $600 a ton level for the first quarter of this year and in Q3, our spot market hot-rolled average had declined by more than 10% on a per ton basis. These steel mini-cycles, if you will, are causing unbelievable short-term volatility. This makes planning and forecasting, let alone selling and operating incredibly difficult, especially when the only variable in the low end of the market is price.

To be clear, it is not our intent to exit the spot market. But we'll be concentrating on growing our percentage of contract business. We want to align ourselves, and we will continue to align our company with those customers who want a fair price but who also place value on product quality, on-time delivery and customer service.

Speaking of quality, during the third quarter, we produced some of the highest-quality products in the world. Great operations and attention to detail turned that potential into reality. Our internal quality measures for internal rejections and retreated products continue to be on pace for another record-setting year. During the third quarter, new records for the lowest-ever plant quality losses were set at nearly every one of our plants.

Moving from internal to external quality measures. Our customers also liked very much what we were doing for them during the third quarter. During 3Q, General Electric honored AK Steel with its Continuous Quality Improvement Award. We appreciate the recognition of the business that we enjoy from GE and from all of our customers.

And on a broader basis, once again, AK Steel faired quite well in the Jacobson independent survey of our carbon and specialty steel customers for the third quarter of 2012. On the carbon steel front, AK Steel was ranked #1 in customer service, #1 in quality, and #1 in on-time delivery among our integrated competitors. These performances translated into a #1 rating in overall customer satisfaction in our carbon market, again amongst the integrateds.

On the specialty steel front, AK Steel received high marks as well, including a #1 ranking in customer service, a #1 ranking in quality and a #1 ranking in on-time delivery, all of which resulted in a #1 rating in overall customer satisfaction from our specialty steel customers as well. These outstanding performances and service to our great customers are the result of extraordinary efforts day in and day out by the best workforce in the steel business. I congratulate all of our employees on making and finishing great quality steel, keeping our customers happy and doing all of it safely.

Speaking of safety, I might add that in terms of serious accidents, we had our best third quarter in AK Steel's history, with only 3 OSHA recordable injuries. That's an OSHA recordable frequency rate for us of only 0.1-7, 0.17, which is about 1/2 of our industry-leading frequency rate for all of 2011.

With that in mind, let me offer a tip of the hard hat to each of our employees for keeping safety his or her highest priority for the third quarter and every quarter going forward.

Next, let me move from markets, pricing and quality to a brief discussion of the raw materials environment. We're encouraged by what's been happening to raw materials pricing in recent months. The European financial crisis and China's economic slowdown have created a greater balance between supply and demand for a variety of commodities. This has had the effect of lower prices on commodities such as iron ore. Given what amounts to a 3- to 4-month lag effect, we've not yet begun to enjoy the full benefits of the lower iron ore pellet pricing. The timing of this benefit will roll into 2013 for a couple of additional reasons. First, we have seasonally higher iron ore inventory levels as we enter the recent -- winter season rather, and we have a certain amount of, what I'll call, carryover tons. That is tons that were ordered and expected to be consumed in 2012 but were not taken due to a worse-than-expected market environment. So those tons will be carried over into 2013 but priced at 2012 levels.

Regarding 2013 iron ore pellets, we have lined up all of our supply needs at this point. Although these arrangements are generally indexed to the IODEX, we have secured improvements to some of the components of pricing that are not directly related to the IODEX.

Moving to coal for a moment. Our outlook for 2013 is again a very positive one. We're nearly complete with all of our negotiations. Lower market pricing combined with sourcing a portion of coal needs with our own low-vol coal is expected to result in substantial savings for the year 2013. We remain committed to our investments in both coal and iron ore that will allow us to become approximately 50% vertically integrated in the next few years.

With that in mind, let me offer brief updates on our investments in both AK Coal and Magnetation.

AK Coal continues to make progress towards our goal of supplying 50% of our coal requirements. During the third quarter, we completed the acquisition of a coal preparation plant known as Coal Innovations in Southwestern PA. That plant is now part of AK Coal's operations and it's processing coal that has been mined in the area. The plant is also supplying prepared coal to our strategic partners at SunCoke Middletown for conversion into coke to fuel our Middletown blast furnace.

AK Coal itself continues to make solid progress towards obtaining its necessary permits. Our investment in AK Coal continues to make excellent strategic sense for us, and eventually, we will supply about 1/2 of our coal needs from AK Coal. That positions us well for the future in a very volatile coal market.

Regarding Magnetation, we're quite pleased with its progress on both Phases 1 and Phase 2. On Phase 1, for example, the second concentrate plant is up and running well and operating at its expected capacity. Phase 2, which involves the construction of a pellet plant to supply 50% of our iron ore pellet needs is also progressing well. Magnetation has narrowed its site candidates, is moving ahead with permitting and has begun to order long lead-time items.

Even though the IODEX index for iron ore has declined in recent months, Magnetation remains a solid investment for our company and an important part of our strategy to vertically integrate. The volatility in iron ore prices serves to validate our desire to be 50% self-sufficient in pellets. In other words, it serves as a hedge to buffer our costs.

In a moment, Roger will provide more details on our financial results and our liquidity. In advance of his comments, let me simply say that we know what we need to do at AK Steel and we are on it. We are lowering costs wherever possible and optimizing our sales portfolios.

Eventually, however, we'll need a bit of help from the economy in terms of higher prices, higher volumes as well and certainly higher prices, and there are a number challenges still to the economy, which we all know. But in the meantime, we'll continue to manage those things that are within our control, things like safety and quality, productivity and control over costs.

Regarding liquidity, in the short run, we expect that working capital will be a significant source of cash in the fourth quarter. In fact, despite an expected net loss for 4Q, we expect to be cash flow positive. And longer term, we will consider opportunities to fund our investments in coal and iron ore, which still require more than $200 million to complete, as we remain committed to these important projects that will improve our self-sufficiency to about 50% of our total needs, lower our overall cost of production and importantly, enhance our competitive position.

In short, our focus at AK Steel continues to be on serving customers better than any other steelmaker, while expanding margins, enhancing earnings and improving cash flow, all to create value for AK Steel shareholders.

With that, I thank you very much, and turn it over to Roger.

Roger K. Newport

Thank you, Jim. Earlier today, AK Steel reported a net loss of $60.9 million or $0.55 per share for the third quarter of 2012. As Jim pointed out, our results were better than our quarterly guidance of a loss of $0.60 to $0.65 per share. Note that our third quarter results include a noncash income tax expense of approximately $33 million or $0.30 per share as a result of the change in an income tax valuation allowance. Thus, our results compare favorably to the First Call contestants' estimate of a loss of $0.36 per share, which excluded the impact of the noncash tax expense.

Shipments for the third quarter totaled 1,363,500 tons, an increase of about 28,000 tons compared to the second quarter of 2012. Our average selling price for the third quarter was $1,073 per ton or 7% lower than the second quarter and in line with our guidance.

Revenues for the third quarter totaled $1,464,000,000, roughly 5% less than the prior quarter due to lower spot market selling prices and the higher percentage of our shipments sold into the carbon spot market.

Sales outside of the United States for the third quarter total approximately $198 million. This represented about 14% of our sales for the third quarter. As previously indicated, our results for the third quarter included about $29 million in planned major maintenance outage cost compared to only $1 million in the second quarter. This maintenance cost was primarily related to a work performed at our Ashland Works blast furnace and the Middletown Works' hot strip mill.

In the third quarter, we benefited from a LIFO credit of $27.5 million compared to a LIFO credit of $18.3 million in the second quarter. The increase in the LIFO credit quarter-over-quarter was primarily due to the continued decline in raw material cost.

Taking all these items together, we incurred an operating loss of $12 million for the third quarter of 2012 compared to an operating profit of $56.7 million in the prior quarter. Again, almost 1/2 of this decline was related to the $29 million in planned maintenance outages in the third quarter and the remaining variance is due to the sales and raw material impacts I just discussed.

Moving to our results for the 9 months of 2012. Revenues for the first 3 quarters were slightly more than $4.5 billion compared to approximately $5 billion in the first 3 quarters of 2011. Sales outside of the United States totaled $648 million for the first 9 months, which represented about 14% of our revenues. Shipments for the first 9 months of 2012 were just over 4 million tons, a 6% decrease compared to the first 9 months of 2011, which reflects tougher domestic and global market conditions. Our average selling price for the first 9 months of 2012 was $1,120 per ton, a decrease of nearly 3% compared to the first 9 months of last year.

For the first 9 months of 2012, we reported a loss before income taxes of $9.7 million compared to income before taxes of $64.4 million for the first 9 months of 2011.

I would also like to provide you a comparison of our earnings before interest, taxes, depreciation and amortization, or EBITDA, as our operating results are muddied by the inclusion of SunCoke Middletown's financial results in our reported financial statements. Including the noncontrolling interest primarily consisting of SunCoke Middletown -- I'm sorry excluding them, our adjusted EBITDA for the first 9 months was $164.4 million or $41 per ton compared to adjusted EBITDA of $253.6 million or $59 per ton for the same period of 2011.

Our 2012 year-over-year decline was primarily driven by a decrease in shipments, lower pricing, along with higher coke cost, which were partially offset by decreases in other raw material and energy costs.

Now turning a moment to the balance sheet and the cash flow statement. Through the first 9 months of 2012, our capital investments totaled approximately $32 million. Our outlook for capital investments for the year 2012 is now estimated to be approximately $50 million, plus roughly $60 million to fund our strategic investment in Magnetation and AK Coal. As discussed last quarter, the accelerated schedule of our coal and iron ore strategic investments will likely result in some acceleration of a portion of our planned investments in these 2 entities.

More importantly, this acceleration allows us to benefit from the lower-cost raw materials earlier than originally anticipated, and that is good news since the pellet cost for the Magnetation facility is expected to be substantially below the current world market price for iron ore.

And with AK Coal, we expect their coal cost will be approximately 25% to 30% below current market prices for similar, low volatile metallurgical coal.

Regarding Magnetation, we completed a $25 million investment related to Phase 1 of the project in the third quarter. And based on Magnetation achieving its Phase 1 benchmarks, we expect to make the remaining $22.5 million contribution related to Phase 1 of the project this quarter.

During the third quarter, working capital was a source of cash of $23 million. We anticipate working capital will be a significant source of cash in the fourth quarter of 2012. In total, for the year 2012, we expect working capital will be a modest consumer of cash.

It is important to note that our liquidity remains solid as we ended the third quarter of 2012 with liquidity of more than $600 million. I would add that we currently expect to end 2012 with liquidity of approximately $550 million.

With this level of liquidity and our anticipated year-end inventory levels, we will be well positioned to serve the needs of our customers going into 2013.

Let me also provide an update regarding our future pension funding estimates. Earlier this year, we completed our required funding of $170 million for 2012. We currently estimate that our pension funding requirements will be about $180 million for 2013 and about $240 million for 2014. While I would acknowledge that longer-term projections are subject to various market fluctuations, we expect our pension funding requirements to peak in 2014 and decline in the years thereafter.

Now turning to our outlook for the fourth quarter. Consistent with our current practice, we are not providing detailed guidance for the fourth quarter at this time. We expect to provide detailed guidance for the fourth quarter of 2012 in mid-December.

However, in advance of that guidance, I would indicate that based on current market conditions, we expect to incur a net loss for the fourth quarter of 2012. I would also note that this anticipated net loss will include a noncash income tax expense for the fourth quarter, which we expect to incur regardless of our fourth quarter pretax financial results related to the anticipated change in the tax valuation allowance associated with our LIFO tax planning strategy.

Let me conclude by saying thank you for your interest in AK Steel. At this time, Jim, Al and I would be happy to take your questions.

Question-and-Answer Session

Operator

[Operator Instructions] David Gagliano of Barclays.

David Gagliano - Barclays Capital, Research Division

My question is regarding the cost savings. I was wondering if you could give us a little more information in terms of quantifying the raw material cost savings, if we assume the IODEX doesn't change for 2013 and if we assume met prices kind of sit like on a benchmark basis around that $170, $180 level. Can you give us more information in terms of millions of dollars of cost savings? And in terms of the timing, obviously you mentioned the inventories rolling through, and I was wondering if we could get a little more information on an annualized cost savings number and when we should expect that to start to hit the results.

James L. Wainscott

Thank you, David, for your questions. Let me maybe step back and just comment a little bit about iron ore and coal. We covered that a little bit in the prepared remarks. We are certainly seeing lower prices for 2013 with respect to iron ore. All of our contracts for 2013 are in place. And as with 2012, pricing on these arrangements is tied to the IODEX. And I think as we all know that's recently trended down in light of the global economic woes. We certainly want to see those lower costs flow through quicker. As I indicated in my quote in the press release and in my prepared comments here, the lower pricing is lagging. For example, pricing for the fourth quarter, and I think most of you are aware of this but it's probably good just to illustrate it, it's based on the 3 months that ended in August of 2012 when pricing was quite a bit higher than it is at present. So the benefit will come but it is indeed lagging. Also, in anticipation of a stronger 2012 that has played out, again we have somewhat higher inventories and certain carryover tonnage, but overall, we like the trend. In terms of if one were to try and quantify all of this just to give you some sort of sensitivity, typically, we would buy up to 6 million tons a year. If it was a number closer to 5 million or 4 million to 5 million, in that kind of range for every $10 a ton, you can do the math, it's $40 million to $50 million. So it is not an insignificant amount of money. A lot of it also depends on the direction for the full year next year. We certainly have seen prices come down. Our expectation is for a better year, for demand to pick up a bit, and that may cause prices to recover. So I think for us to give full year guidance for 2013 at this point is a little premature, except to say that we expect to save a significant amount of money in iron ore. Not to be too long winded here, but let me just take the opportunity to comment a bit further on coal as well because that's a very, very important commodity input. Again, we're seeing much lower prices in coal for 2013. Our negotiations for 2013 are nearly complete -- should be complete by the end of this month. And I would just add on top of that, SunCoke has secured its coal requirements for next year for the coke obligations they have with us for 2013. We're sourcing a significant amount of our low-vol coal needs from AK Coal through our own mining activities that we expect to begin in 2013, as well as from coal supplied from the Somerset area that are being watched at Coal Innovations. So year-on-year saving is very significant. Again, order of magnitude, it's 2 million, 2.5 million tons that we buy, every $10 is worth a lot. Savings there could approach as much as $100 million.

David Gagliano - Barclays Capital, Research Division

Great. My follow-up question, more near term. I believe in the remarks, it was just mentioned that liquidity year end would end around $550 million, which I think is down about $50 million or whatever it is from the Q3 number. But there's also working capital boost in there. I was wondering if you could just give us a couple of building blocks embedded in that. What is the assumed working capital improvement in Q4? And also what is the assumed CapEx for Q4?

James L. Wainscott

Roger?

Roger K. Newport

Yes. If you look at that, our working capital, as you saw, were about $217 million year-to-date. I see that getting cut well in half here in the fourth quarter. The improvements there, we are positioning ourselves with inventories, as I mentioned going into next year, to support shipments. We do have the iron ore coming in under our contracts that we have. So the iron ore we have purchased and have that in inventory. So we're probably sitting a little bit higher than we like to be normally. At the end of the year that will be part of it. On the capital side, if you look at it going into the fourth quarter, we do have our capital payment that I mentioned going into Magnetation, roughly $22.5 million that will be paid for the final Phase 1 of that. And then our other capital investments, I would estimate, will probably be about $20 million to $25 million range.

David Gagliano - Barclays Capital, Research Division

Are there any other big cash outflows expected this quarter?

James L. Wainscott

We have the interest in the fourth quarter, like the one interest payment. If you remember, we have the 2 bond issues, which will be about $40 million, so yet again just because of the timing of that. And further, just keep in mind, David, of course our credit facility is based upon our inventory receivables. And as that fluctuates, we can have a suppressed availability situation, so we can be cash flow positive. And yet, our liquidity may tighten just temporarily but that should reverse itself in the first quarter when we get back to a more normal level. Those are some of the building pieces and parts. I would just offer sort of as an overview comment, we're obviously very focused on it. We know a number of you have been. Again just to emphasize, we expect to generate very positive working capital. We do recognize the need, however, in the longer term that we need to increase our earnings and cash flow, increase our EBITDA. And we are all about that every day, in everything that we're doing at the company, at the senior management team level, the board focus and so forth. I would also just note that we would acknowledge that we do have significant funding requirements for AK Coal and Magnetation over the next couple of years. And that in most cases, it's best to use a longer-term financing vehicle to fund longer-term investments. In our case, for the most part, we've been using, if you will, our credit card to fund these type of investments and timing and extent of future financings, if any, is a decision for the board that will be driven by our specific needs and financial market conditions.

Operator

Our next question comes from Michael Gambardella of JPMorgan.

Michael F. Gambardella - JP Morgan Chase & Co, Research Division

A couple of questions. Jim, I thought I heard you say that the -- your average hot-rolled spot price was down 10% from, I thought you said $660. So it implied that your average price was about $600 in the third quarter. Is that correct?

James L. Wainscott

No, I think the example I gave was that we were in the high 6s in the first quarter and that it had dropped in the 10% range by the third quarter. One can do the math and still see that you're a bit north of $600 on average. We obviously saw prices dip below that into the high 5s more recently this the quarter until the price increased.

Michael F. Gambardella - JP Morgan Chase & Co, Research Division

And then just in terms of going forward into 2013 with the raw material iron ore cost decrease, do you think the industry has gotten to more of a kind of a margin business with more frequent changes and raw material pricing being more transparent to the industry and to the consumers of steel? Do you think it's likely that you could get a big drop in iron ore cost and still maintain pricing?

James L. Wainscott

Well, this is of course the great debate that goes on. And it's often misunderstood, not just by the financial community but by some customers who think that we enjoy the benefits of these lower costs immediately. As I gave an example, we're frequently 4 months and now we may be 5 or 6 because of just the extra inventory and the carryover tons. If there was an opportunity to be real-time both on pricing and on cost, we would love it. We've tried to be as transparent as we can, but I think it's often misunderstood. And the other thing that's misunderstood is even though we are going to be more fully integrated, we're not there yet. We're still a couple of years away, so we remain subject to the pricing in the open market. But I think -- and all of that will get sorted out. I think we've seen what was the up, up and away kind of super cycle for raw materials come to a screeching halt. You have seen tremendous economic despair in Europe at this point, you've seen the growth rates in China, which we suspect are going to continue to remain lower than they've been, really change the game. And now you're beginning to see for the first time, the big 3 make comments about the outlook as well. Does that mean we go back to something along the lines of annual pricing? Perhaps not. But I think you'll see a tighter period. Hopefully, we would be of interest in some sort of tighter period, sort of better matching cost with revenues, which we're just not there yet unfortunately.

Michael F. Gambardella - JP Morgan Chase & Co, Research Division

Is the other issue, just that in the U.S., you have this unique situation for the sheet market in that -- compared to the rest of the world, in that about 1/3 of it is supplied by scrap-based producers and they do see an immediate kind of drop in their costs with scrap going down. Are the cost numbers kind of prone to that?

James L. Wainscott

Yes, there's no question. This is why at AK Steel, we've never claimed to be nor do we want to be sort of the Walmart of the steel business. We're not about lower prices falling on your head every day. We are absolutely about serving the high end of the market, whether it's carbons or electrical steels. We continue to move away from sort of the low end, the down and dirty sort of market that trades on price only. I think, Mike, you know having been around the industry long enough and I think I've been, steel may be viewed as a commodity. But within the steel business, there are obviously the low end, the commodity, pure commodity plays and then there's the high end. We're going to continue to play in the high end. That's always been our vision, and will continue to be. And in this sort of an environment with the kind of enormous price swings that we've seen and particularly with the scrap-based guys being able to sort of adjust very rapidly to that, we know where we got to go, and we'll go there as quickly as we can.

Operator

Our next question comes from Arun Viswanathan of Longbow.

Arun S. Viswanathan - Longbow Research LLC

I guess, I had question. You said that you had noticed an improvement recently in your order rates. Can you be a little bit more specific? And why do you expect that to continue enough to support the recent price initiative that you announced?

James L. Wainscott

We pay very close attention, Arun, to the level of orders coming in to the business because that obviously affects our operating rates, our employment levels, our raw material needs and so forth. And so we monitor it very closely on a daily basis. And as I said, it was really early last week that we began to see a substantial increase. We took more orders in on Monday of last week than we did for the entire prior week, and that trend continued throughout all of last week. When something of that magnitude occurs, we react and we did. The pricing in the mid-5s or high-5s is really not a sustainable place for a guy like us, and so we needed to recover our higher cost. We embarked quickly. The pattern that we've seen in recent years, and this really goes back, Arun, to 2009, has been that the service center community has really reduced inventories in light of short lead times. It's kind of played us to try and get the bottom fishing on price. But they get inventories to a point where they kind of can't continue to sustain their own businesses at those levels, and that's what we think we're seeing. Again having said that, I think it's fair to say that while we've raised prices and while the intake rate, including yesterday and today, has remained very high for us, it is a very, very volatile market and it's a volatile market because it's largely an oversupplied market at this point. You have the mills operating according to AISI stats from last week at under 70%. So there's a lot of additional capacity out there. And also, we remain the freest market in the world for anyone outside of this country to try and bring their products. We need to make sure that we're enforcing our trade laws with respect to imports, particularly those that may be coming in on an unfair basis. So we're going to continue to see that volatility that has been with us for a while. But again, I would argue that most of that plays out in the true low end of the markets, the commodity pieces of these markets.

Arun S. Viswanathan - Longbow Research LLC

Okay. And I guess continuing on that theme, but maybe looking at slightly a different part of it. What are you seeing on the cost side that would support price initiative? I mean, as I recall, I think there's still -- you have quite a bit of met coal purchase, iron ore, but those are coming down. I mean, is scrap going up? And is that supporting the initiative? Or what would actually support pricing here?

James L. Wainscott

We certainly saw a drop in scrap. But the rumblings are that, that has leveled off. In fact we've already begun to see scrap begun -- begin rather to head back up. So that's an issue. I think that we're also still trying to recoup costs that we've incurred here. If you look at our raw material input costs, really, over about the last 7, 8 years, they've gone up to the tune of about $2 billion. They used to be under $1 billion. Now they're about $3 billion. That's the world that we're living in. So things, it sounds like costs are coming down a little bit, maybe they're coming down ever so slightly, not enough or not fast enough in our view. But we're still looking to recover those costs. For us, raw materials and energy account for somewhere between 60% and 70% of our cost as a company anymore. That's huge. It used to be 30% to 40%. Everything is up a hell of a lot higher than it ever was. And so we cannot be shy, and we're not shy about going out to recover those costs regardless of what happens to scrap.

Operator

Our next question comes from Brett Levy of Jefferies.

Brett Levy - Jefferies & Company, Inc., Research Division

Can you talk a little bit about, you said you wanted to move more into the contract business. Where were you in the third quarter in terms of spot versus contract? And are you getting some overtures from the car companies saying, "Now our volumes are bigger, and we can give you that bigger percentage?" And I guess lastly can you describe kind of what incrementally is the type of premium over spot that you would expect for the fact that you are customizing your work for these guys?

James L. Wainscott

Good question. Thank you, Brett. At one point, we were probably close to 80-20 in terms of our contract spot. The world changed probably pretty significantly back in the 2007, 2008 environment that caused us to move closer to, I would guess, about a 50-50 sort of level. We have inched our way back to 60-40, maybe 65-35 at this point. And we're headed back over time probably to that 75-80 again. That said, there will still be a place at the table for select players within the DNC marketplace with spot market tons, largely program-type accounts. But it really is the consistency of the business, of the orders. I think a lot of us were concerned about what was going on, obviously in automotive. And I have to give great credit to the automotive company leaders. They have gotten their houses in order, and it is a far better place to serve and a much more comfortable place for us to be in. And we are growing that business substantially, as I said before, taking a share. We're also providing all the advanced high-strength steels that our customers are desiring, and we're in discussions with them about their future needs in that regard. Price is what you pay; value is what you get. I didn't make that up, Warren Buffet did, but that's really what we try and do. We sell quality. We sell service. That is not something that everybody wants to be into. It takes an enormous commitment of resources and effort, but it's exactly how we've built our company, it's how we've invested our capital. It's the right place for us to be going forward. So it's the consistency of the order book. And again, you invest more, but you get a little bit better margin in that regard as well.

Brett Levy - Jefferies & Company, Inc., Research Division

Let's see, everybody here has been a CFO and has been involved with a high-yield market. Is it possible that the $200 million of CapEx based on the profitability of Magnetation and AK Coal could be 100% financed based on sort of if you took current pricing for both the met coal and iron ore? Is this investment on your part potentially as much as 100% financeable?

James L. Wainscott

I'd just go back to the comment I made before which is that the timing and extent of any financing, whether it's financing in the debt market or otherwise, would depend on the actions and decision of our board, depending on our needs at the time and market conditions. I think that's about as much as I could say on that subject, Brett.

Operator

Our next question comes from Richard Garchitorena of Crédit Suisse.

Richard Garchitorena - Crédit Suisse AG, Research Division

My first question, you talked a little bit about the potential resolution in terms of tariffs on electrical steel, which had been in place by China since late '09. I was wondering, can you quantify how much China would make up in terms of global demand or demand in terms of your business prior to the tariffs? And how much do you think you could get back? My first question.

James L. Wainscott

I'm not sure we ever stated that publicly. But it's certainly a double-digit percentage, 15% or so. It's a fairly meaningful slug of business. Obviously, the entire business has come down, the China opportunity may be a bit less today than it once was. But the bottom line is, again, we're delighted with the outcome. We think realistically, it could still take some time. The Chinese government has to take appropriate action. They've said that they'll do that, and Chinese customers have to be comfortable buying from us again. We're in touch with them and they're -- we're reinitiating dialogues. In the meantime, it's also important to note that a large amount of supply has come online both within, as China has begun its own electrical steel business and outside of China, and so that may make it a bit tougher. But all that said, we're delighted with the outcome of the case, moving as quickly as possible to regain a portion of this lost business. Our customers loved our product before, we think they're going to love it again. And look, as the infrastructure growth in China, for those of you that have been there, which is many of you on the call have seen, they could use our product. We could be very helpful to that development and we want to be there for them.

Richard Garchitorena - Crédit Suisse AG, Research Division

Great. And then my other question, just on the Q4 outlook. Are there any planned outages included in that? And also in terms of the LIFO credit, we saw a big one in Q3. How should we think about that credit when you factor in sort of your guidance for Q4?

James L. Wainscott

Two comments there. In regards to outages, yes, we'll have very minimal outages in 4Q. In regards to the -- it's because we had a blast furnace outage here in the third quarter, and that's behind us now. And then also on your other question on LIFO, as you saw what our LIFO was year-to-date and what it was for the quarter, so I think if you take those numbers and take the year-to-date number and annualize that, that will get you in the ballpark. The numbers are subject to change as raw material prices change. So as you've heard about -- we've just talked about what's happening with raw materials, but through the first 9 months, we're sitting at about $58 million LIFO credit.

Operator

Our next question comes from Michelle Applebaum of Steel Market Intelligence.

Michelle Applebaum - Steel Market Intelligence Inc

So yes, you're all former CFOs. That's very, very interesting, and I think...

James L. Wainscott

A long time for me by the way. It's probably a decade, but who's counting.

Michelle Applebaum - Steel Market Intelligence Inc

Well, I think it's actually not a bad thing, it's a good thing.

James L. Wainscott

Thank you.

Michelle Applebaum - Steel Market Intelligence Inc

So there were days when you -- I think 20 years ago, you could have said there was one steel company that had a CFO running it. So I was going to ask on Magnetation, and I missed some of the last answers. So if you just said this, then I'm going to feel real stupid, but that's not new. In your 10-Q, you talked about Magnetation potentially self financing. And I was wondering if they go ahead and do something like that, if that could be something that could be a source of equity for the company and as well as funds?

Roger K. Newport

Michelle, I think we have some contractual commitments that we're committed to and we've stated $150 million in addition to the $150 million that we've put up. In other words, a total commitment of around $300 million. That's somewhat independent of Magnetation financing on its own. Clearly, we're working with the Magnetation management that's come up with what's the best structure for the company or the venture, if you will, as it stands. And so the fact that they would seek debt financing, like I said, might open some opportunities for us. But our commitment for our investment is pretty fixed, and we'll go forward with that and see what transpires with respect to debenture financing on its own.

Michelle Applebaum - Steel Market Intelligence Inc

If there were financing on its own, you have equity in the venture, correct?

Roger K. Newport

We do have equity in the venture. That is correct.

Michelle Applebaum - Steel Market Intelligence Inc

So you could potentially liquefy a piece of your equity and use that to contribute, right?

Roger K. Newport

Michelle, there are a litany of options with respect to financing at Magnetation as well as the parent company here at AK. And like I said, you're exactly right. There are some options there. But at the present time, we're committed to doing what we have stated. And like I said, we'll see what transpires in the marketplace going forward.

Michelle Applebaum - Steel Market Intelligence Inc

Okay. Now I heard just something about LIFO in the last question, and that was going to be my second question. So if you already just said this, then I apologize. Did you talk about what the actual LIFO number was for the third quarter and what it was for the 9 months?

James L. Wainscott

Yes. The LIFO credit for the third quarter was $27.5 million and year-to-date, we're at $58 million.

Michelle Applebaum - Steel Market Intelligence Inc

Okay. So that means that your credit is running about $20 million a quarter right now and $7.5 million for the third quarter was associated with the first 6 months and the anticipated credit in the fourth quarter is $20 million?

James L. Wainscott

Again, that is correct. Looking at it annualized, and again what will drive that is what happens with raw material cost throughout the end of the year.

Michelle Applebaum - Steel Market Intelligence Inc

Okay. Historically, you've generally brought down raw materials the last couple of years in the fourth quarter, if I'm correct, your inventories. Is that something you would anticipate doing again this year? And would that have -- how would that have an impact in flowing through into the P&L?

James L. Wainscott

You've heard from Al, you've heard from Roger, let me just give you kind of my thought on all of that, Michelle. We want the inventories to kind of be just right, if you will, to position us to not only get through the winter months but also to serve customers in the third quarter. In hindsight, as we look back, we might have missed an opportunity or 2 this past year by being a little bit short. I don't think that's a good place for us to be. Said another way, we may carry a bit more inventories than we otherwise would have in anticipation of a little bit stronger first quarter 2013. But we are constantly, constantly looking at being as efficient as we possibly can be in carrying enough but not too much inventory across the spectrum of raw materials, work in progress and finished goods.

Operator

Our next question comes from Evan Kurtz of Morgan Stanley.

Evan L. Kurtz - Morgan Stanley, Research Division

Just wanted to drill down on iron ore. You mentioned that you locked up your contracts for 2013. Now I know Essar Steel is bringing on a 4.1 million ton pellet facility at some point next year, which they can't really use until they've kind of worked through their contracts that go through 2016. So I assume that they are selling those pellets on the open market. Just wondering if you were talking to them for 2013, perhaps buying from them next year or is that something that you foresee happening perhaps later down the road.

James L. Wainscott

We have had dialogue from time to time with the folks at Essar. We know them. And with respect to 2013, they're not in our book. With respect to beyond that, and again we're open to all opportunities.

Evan L. Kurtz - Morgan Stanley, Research Division

Got you. And then just one question on the guidance, you said that you're expecting a loss next quarter but that includes a tax charge. Is there a chance if you strip out this tax charge that you could actually break even?

James L. Wainscott

We're going to do our very, very best to deliver the best possible results. And really, the unfortunate thing about the tax results or tax piece of things is it does make comparison very, very difficult. Typically when you have a loss, as we had in this quarter, you tax effect that and you report a lower loss. Quite the opposite is happening for us. So it really does depend on sort of the order of magnitude of things. But we're talking about a loss even before the tax piece when we give our guidance at this point. We -- again, we'll do everything in our power to manage the team to deliver the very, very best possible quarter. But I think there are continuing challenges that are out there in front of us to work through.

Operator

Our next question comes from Kuni Chen of CRT Capital Group.

Kuni M. Chen - CRT Capital Group LLC, Research Division

Just a couple last follow-ups here. I guess, just on electrical steel, can you give us just an update on the market as a whole and kind of what the tone of negotiation has been like for next year?

James L. Wainscott

Kuni, I would say that electrical steel is a good news and a bad news story in this sense, NAFTA is improving, whereas international has deteriorated but seems to be holding at current levels. We're -- on the NAFTA, just to explore that for a moment, we're growing NAFTA GOES business. Within NAFTA, here's what's going on: you've got demand for power generation that's increasing as coal-fired power plants are being replaced with natural gas-fired plants. And so here we see increasing demand. And similarly, the volume and the distribution transformer market is being driven by that slow but steady housing starts comment that I made earlier. And it's really fairly steady, replacement business as transformers reach the end of their useful lives. So those are the positives, I guess, that we're seeing in terms of the NAFTA market. In terms of contract negotiations, we're well underway for 2013 but far from being complete at this point. And then there's the other side of the coin, which is international. Similar to NAFTA, 2013 negotiations with contract customers have just begun. But we've got a situation that is much different. You've got this combination of economic uncertainty coupled with oversupply as the dominant market conditions, driven by the Eurozone crisis and the lower growth rates in Asia. And all of that is really resulting in reduced demand being set by too much supply. So volume and pricing are both under pressure as a result. We will continue to increase business within NAFTA as we gain market share there and grow. But we expect sales volumes abroad to be flat to slightly down from current levels would be the cover I'd give you on that.

Kuni M. Chen - CRT Capital Group LLC, Research Division

Slightly down for the entire business?

James L. Wainscott

I think for international, I think for the overall business, we hope we can still see modest growth led by domestic activity largely.

Kuni M. Chen - CRT Capital Group LLC, Research Division

Okay, great. That's helpful. And just lastly, on the other income, I think it was almost $6 million in the quarter. Can you just remind us, is that basically all Magnetation in the quarter? It's a pretty decent run rate. Are there any other items that are -- that flowed through in the quarter?

James L. Wainscott

If you look at the change quarter-over-quarter, basically a little over half of it is benefit -- or about half of it is due to Magnetation, the other half is foreign-exchange gains that we had in there with the -- to changing the euro to the U.S. dollar.

Roger K. Newport

Keep in mind, Kuni, the last quarter we had a pretty significant foreign-exchange loss because of weakness in the euro. It was over $4 million of a loss last quarter. And that's reversed itself somewhat in the third quarter and plus the benefit of Magnetation, so you've got about a $10 million swing there.

Operator

Our next question comes from Mark Parr of KeyBanc.

Mark L. Parr - KeyBanc Capital Markets Inc., Research Division

Just a couple of follow-ons. And by the way, Jim and Al and Rog, I really appreciate all the color that you gave today. I thought this was a very helpful and very informative call.

James L. Wainscott

Thank you very much.

Mark L. Parr - KeyBanc Capital Markets Inc., Research Division

I've got just a basic question on gas injection and what sort of potential upside you have there with the recent upgrades you made to the Ashland furnace.

James L. Wainscott

Yes. I would say that we're not doing a whole lot at either of our blast furnaces at this point to really increase productivity. They are among the most productive in the world already per cubic foot of working volume. The major realignment we did at Middletown to put the copper stays in a couple of years ago really gives us increased capacity and flexibility there. So we have very high levels of capacity and we do injection that makes reasonable sense already today and would not expect much to change there. Really the other thing that we've done in recent years, I think, as you know, is we've increased our carbon slab capacity with the investment in Butler Works with the #5 EAF. So really between that and what we're able to do at Ashland and Middletown already positions us very well for a improved market, which we hope comes very, very soon.

Mark L. Parr - KeyBanc Capital Markets Inc., Research Division

And I just had one other follow-up. And there's been a fair amount of discussion on the situation with China, and congratulations on that finding on appeal. But do you have any sense of when the -- when these duties could possibly be removed? And is this something that could be a first half '13 event? I mean, is it going to be longer than that? Or any color you can give on timing would be helpful.

James L. Wainscott

Many things, dealing with matters of this sort, are really kind of in the great unknown. I would say, we're hopeful that it's in the next 3 to 6 months, something like that, but could be longer. The potential is there. It really does depend on how the Chinese government acts and how they receive this. And I guess in that sense, none of us really know, but we're hopeful. We will be vigilant. And again, we have been very well represented by our government in this regard. Unfortunately, it took a few years to get through the system and it may take a bit longer to see the effects of it, but we'll continue to fight it as necessary.

Operator

Our next question comes from Dave Katz of JPMorgan.

David Adam Katz - JP Morgan Chase & Co, Research Division

You guys talked about the total cost for Magnetation. But I was hoping that you could go over the cost timing for the vertical integration.

James L. Wainscott

We are probably still the better part of a couple of years out in terms of beginning to see the benefits of that. We're obviously narrowing our site selection process and some permitting is already in process there. But once that begins, we're probably 18 months or so from start-up. So it's likely going to be late 2014, likely all of 2015 we'll enjoy the benefits. So we've got a couple of years to kind of get from here to there. We haven't given a specific number, I would say, at this point, Dave, in terms of the benefit. But it is a very low capital cost, it is a very low operating cost and will be substantially below even where the lower prices have come in the marketplace today for the spot market for iron ore pellets. I don't know, Al...

Albert E. Ferrara

Just I was going to say, I think next year we're talking about $50 million to $70 million of capital spending potentially. But it's largely driven, David, by permitting issues and things like that. And largely our $150 million commitment over the 2013 to '15 time frame will largely be driven by permitting issues.

David Adam Katz - JP Morgan Chase & Co, Research Division

Okay. And what are you guys thinking now that your total 2013 CapEx could be including that?

James L. Wainscott

Don't know that we've really stated a number yet. Again, we'll be very judicious. We'll do what we have to do to, again, position ourselves for the future. But I think we'll save that comment, if you will, for January guidance, as we continue to finalize our plan for next year.

Operator

Our next question comes from Timna Tanners of Bank of America.

Timna Tanners - BofA Merrill Lynch, Research Division

Just wanted to touch base again on that topic of your mix given that you said you were moving more toward a value-add mix, which makes sense given your product profile. But in the third quarter, it did seem there was more hot-rolled in production than in the period mix [ph]. Can you help us understand what happened in the third quarter and kind of what's going to drive that improvement as you see it going forward, please?

James L. Wainscott

Yes. A little bit of the third quarter historically is, of course, the automotive shutdowns. And I think you'd see that reflected in the results. I think we went down to maybe an 83% value-added mix. We've been 85%, 87% earlier in the year. So I think that's good insight on your part. It should continue to return to more normal levels. Then again, we'll be opportunistic if we can make a few bucks on putting additional product in the spot market, we reserve the right to do that.

Timna Tanners - BofA Merrill Lynch, Research Division

Okay, that's helpful. And then you talked to us a little bit about the contract negotiations in coal, but can you give us any insights into the tone at least of the contract negotiations with your auto customers this time of year?

James L. Wainscott

We are -- we have negotiations that are really ongoing throughout the year depending on when the agreements expire. We have some that expire at the end of the year, some first quarter, some midyear. It really does vary, Timna, to a great degree. It used to be in the old days, most of them were at the end of the year. It's not true anymore. I would say that in those discussions that are underway, we are obviously seeking to recover prices that allow us to be profitable, which is to say we need higher prices. And in many cases, we have been successful in garnering them. It does require a fair amount of education and dialogue with respect to these issues related to raw materials, which is why we've introduced over the past few years these variable pricing mechanisms, some would call them surcharges, but they do go up and down depending on where the market goes. And so that has been enormously successful. Virtually all of our contract business that we have, automotive or otherwise, has some form of EPM associated with it.

Operator

Our next question comes from Shneur Gershuni of UBS.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

First question is just kind of a follow-up on Kuni's question on the Magnetation. I know you don't specifically break it out. You'd mentioned that there's currency adjustments in there as well, too. But I was wondering if you can sort of help direct us with how we should be thinking about it kind of on a go-forward basis and into 2013. It's done well but at the same time, there's been some weakness in iron ore. If you have some color with respect to are there some legacy contracts there, how long do they run or what percentage of contract versus spot mix that would definitely be helpful to understand the direction of earnings going forward.

James L. Wainscott

Well the comment I'd give there is that the pricing that occurs with the concentrate that is sold is based on the IODEX. So as the IODEX fluctuates, that's really going to be the driver of their earnings. They do have their plant, too, up and running to capacity. It's performing very well, and the costs are aligned to what they thought they would be. So I think the volatility that you would see going forward -- really you've seen what we did here in the third quarter. Going forward, would be based on what happens with the IODEX.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

Okay. And I guess, a follow-up question. I was wondering if you'd be able to opine a little bit on the market. You know that the ThyssenKrupp mill is allegedly up for sale, not asking if you guys are bidding. You're pretty busy, I'm sure. But I was wondering if you can sort of talk about your thoughts about the U.S. slab market, what it does if a domestic buyer purchases it. Do we end up in a situation where the entire market ends up slab short and so forth? I was wondering if you can sort of share your views.

James L. Wainscott

This is on TK?

Shneur Z. Gershuni - UBS Investment Bank, Research Division

Yes, correct.

James L. Wainscott

Yes. I think -- look, it's a very, very interesting subject. It's one we're paying close attention to. I think as you've heard and read, everybody is interested. Under the right circumstances, we could certainly have an interest as well. Where do the slabs come from? Depends a lot on who gets their hands on it. I think one of the flaws that's been acknowledged, really, by ThyssenKrupp has been bringing all the slabs from overseas. So there appears to be some merit from getting slabs here. Could the U.S. be slab short? I suppose that's a possibility. Certainly, the world is not, and there will likely be some component, it would seem to us, that would involve CSA, the Brazilian facility, as they have a say-so as a partner in all of this, at least to the tune of some 27% or so. So I guess, it is a wonderful question. It's a very hypothetical kind of situation. It's going to depend greatly on who gets that. If it's a foreigner, if they don't want to sort of step into the shoes of CSA or bringing foreign slabs in to the full extent, then that could be an opportunity for someone domestically. If it's a domestic individual, I guess that's going to fill up their plate a bit more than it is today. Again, I would just acknowledge that there'll be a lot of challenges to work through, but they're interesting assets. Candidly they're assets that are an awful lot like what we built at Rockport Works some 15 years ago. And they're assets that are of interest to a lot of folks, including AK Steel.

Operator

Our next question comes from Brian Yu of Citi.

Brian Yu - Citigroup Inc, Research Division

I have a few follow-up questions on the raw materials. Just first with iron ore, if you'd help me understand, we've seen the IODEX drop by about $30 per ton. Just based on the formula that you pay for iron ore, how much of that would drop to the bottom line? Are we looking at 1/3, maybe 40% of that $30?

Roger K. Newport

In terms of -- on a current basis, Brian, or...

Brian Yu - Citigroup Inc, Research Division

Yes. So we've got the IODEX at average, call it $142, $143 in the first half. And now it's in the $110. So it's about a $30 drop per ton, and so just based on the formula you buy it at, should we be expecting like $10, $15 drop in your cost?

Roger K. Newport

Not necessarily. I think the thing is, is what we're talking about is the IODEX is a base upon which the formula is working. Each formula works a little differently with each pellet purchaser. Again, as Jim mentioned in his remarks, the timing of this flow-through, it's all good, but it's not necessarily all going to flow through immediately to us on a current basis because of carryover tons. The idea though is that the IODEX movement in our direction is a positive for us. But the idea of dollarizing that in a specific way, I don't think we could give a particular answer other than to say that we would say a $10 change based on 6 million tons is worth $60 million. That's probably the cleanest way to look at that. Like I said, there are nuances to that, but that's probably a pretty basic benchmark for us on an annualized basis.

Brian Yu - Citigroup Inc, Research Division

Could you give us a percentage of your contracts that are directly tied?

Roger K. Newport

In terms of tied to the Vale model?

Brian Yu - Citigroup Inc, Research Division

Yes, IODEX. Yes. So for example, something like [indiscernible] they'll say, for every $10 change of seaborne they'll get $3 or $4 of it. I'm just trying to get a sense on that same type of metric. What percentage would you see? Would it be 1/3...

Roger K. Newport

I would say the vast bulk of our tonnage is based on that Vale model flowing through to us.

James L. Wainscott

I would just -- if I could, I would just say that each one is a little bit different. And while the vast majority are using the Vale model, they're all a bit different, so it's just not quite as easy for us to kind of say this and that. I think we've tried to give some order of magnitude. But I think to the point, we are seeing costs come down. It's a matter of working those through the system. We bring them in inventory, produce product, get them out and all of that may take, again, a 4- to 6-month kind of lag.

Brian Yu - Citigroup Inc, Research Division

And then just on the coal, I thought in the prepared remarks, you said you were still permitting the coal mines. Is that correct?

James L. Wainscott

Yes, indeed.

Brian Yu - Citigroup Inc, Research Division

Okay. Is there a timing on when you would expect to get that on hand? And then I think also in the prepared remarks, it was mentioned, you would actually begin to supply some of your old low-vol met coal in 2013. Is there a planned tonnage that you expect to build supply by yourself? And will you be operating those mines? Or are you contracting those out?

James L. Wainscott

It's a wholly owned subsidiary of AK Steel. We'll be operating them, although we have the ability to contract out, if we choose to do that. We have flexibility. We're certainly hopeful and optimistic that we'll be in possession of certain permits as early as the first quarter of next year and begin to ramp up throughout the year, which is why we're going to enjoy some savings there. The volumes I know Al was very closely involved both in terms of what's in the ground and what we can produce out of there.

Albert E. Ferrara

Yes. Ultimately, Brian, we expect to be producing 1 million tons a year. The run rate on that would probably likely occur sometime late in 2014, such that I don't know that we'd get 1 million tons out in 2014. But on a run rate basis, we would be producing that probably in the second half of 2014. And as Jim mentioned, 2013, we'll be getting our own coal out of the ground and again be building that as permits come through. But it's going to be a great opportunity for us, gives us a great deal of optionality there in terms of that product. And like I said, it's going to lower our cost in a significant way.

Operator

Our next question comes from Justine Fisher of Goldman Sachs.

Justine Fisher - Goldman Sachs Group Inc., Research Division

The first question that I have is on the balance sheet pension and OPEB liabilities. And I know that -- and we appreciate your giving guidance for what you think the pension payment will be in 2014. But if people are still focused on the liability beyond that, my question is, is there anything creative that you guys can do to reduce the size of that long-term liability? Sort of like a VEBA program. I know that you guys, I think, are pretty much full up on what you can do with a VEBA. But is there any way you could go back to you retirees or your workers or somehow chip away at that liability amount, either just if you want to or if the payments become just too much of a tax on liquidity?

James L. Wainscott

It's a beautiful question. We think about those things all the time. So let me just give as concise an answer as I can. Today, we're 73%, 75% funded, something like that. We would be fully funded, Justine, if one were to use a different discount rate, of course. We've seen the discount rate drop dramatically. And every 0.25% change in the interest rate or discount rate is worth about $75 million. So it would take a 2% to 3% kind of change in the discount rate, and all of a sudden, you find yourself fully funded. So we think that phenomena, you can pick your own time as to when and if interest rates will rise, but at these historic levels, certainly goes a long way. Our payments, we believe, peak -- our contributions rather into the pension fund, we think peak, really, after the 2014 kind of time frame and really begin to head down. It is a frozen benefit plan. No one new is getting into it. I'm not into it. It is what it is, and we've done that intentionally. And so the liability will decline as a function of mortality and as a function of interest rates. We expect to be fully funded, really, on that obligation within the next 5 years. We're, under the Pension Relief Act, really required to do that. So that's the direction we're moving in. So from our perspective, while it's fairly significant contributions of 180 and 240 in the next couple of years, they're manageable, they're meaningful, but manageable. And after that, it really does start to improve. So that starts to improve as does our raw materials position and cost position, and we really look for a substantially better outlook from that point going forward. Same is true with OPEB, and we continue to look at opportunities beyond what we've done. But we've taken what was an OPEB liability. It was north of $2 billion, brought it well under $1 billion, and we'll continue to look at opportunities on both of those long-tailed liabilities to bring them down. Just one last editorial, it's sort of amazing to me that we measure the -- these 30- and 40- and 50-year-tailed liabilities with a bullet point in times -- in time rather, at the end of the year to measure what the obligation is when we're looking at long-term investments and we're making assumptions there on what we'll earn, as well as even under the Pension Protection Act here. We had a situation where we're using sort of 30-year investments or 25-year averages so. Again, I think you can do a lot if you look at the numbers. We're happy and proud of our ability to continue to meet those obligations and to honor those obligations to those folks that counted on them. But we're doing everything we can as you'd expect us to be prudent as a management team, to work through them just as quickly as we can.

Operator

This concludes our question-and-answer session. I would now ask Mr. Wainscott for his closing comments.

James L. Wainscott

Thank you very much, Sam. I would just say before signing off, we want to thank all of you again for joining us on today's conference call and for your interest in what we still believe is one of America's premier steel makers, AK Steel. We look forward to having you join us again in January of 2013 for our fourth quarter and year end conference call. In the meantime, we wish all of you a good day, a great autumn and a happy holiday season ahead of a better year in 2013. Good day, everyone.

Operator

Ladies and gentlemen, this concludes our conference call for today. Thank you for participating, and you may now disconnect at this time.

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