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CONSOL Energy (NYSE:CNX)

Q3 2012 Earnings Call

October 25, 2012 10:00 am ET

Executives

Dan Zajdel - Vice President of Investor Relations & Public Relations

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

J. Brett Harvey - Chairman and Chief Executive Officer

Robert F. Pusateri - Executive Vice President of Energy Sales & Transportation Services

Nicholas J. DeIuliis - President

Analysts

Shneur Z. Gershuni - UBS Investment Bank, Research Division

Lucas Pipes - Brean Murray, Carret & Co., LLC, Research Division

James M. Rollyson - Raymond James & Associates, Inc., Research Division

Michael S. Dudas - Sterne Agee & Leach Inc., Research Division

Andre Benjamin - Goldman Sachs Group Inc., Research Division

Mitesh Thakkar - FBR Capital Markets & Co., Research Division

David Gagliano - Barclays Capital, Research Division

Paul Forward - Stifel, Nicolaus & Co., Inc., Research Division

Meredith H. Bandy - BMO Capital Markets Canada

J. Christopher Haberlin - Davenport & Company, LLC, Research Division

Richard Garchitorena - Crédit Suisse AG, Research Division

Operator

: Ladies and gentlemen, thank you for standing by, and welcome to the CONSOL Energy's Second Quarter 2012 Earnings Conference Call. As a reminder, today's call is being recorded. I would now like to turn the conference call over to the Vice President of Investor Relations, Mr. Dan Zajdel. Please go ahead, sir.

Dan Zajdel

:

Thank you, John. I'd like to welcome everybody to CONSOL Energy's Third Quarter Conference Call. We have in the room today Brett Harvey, our Chairman and CEO; Nicholas DeIuliis, our President; Bill Lyons, our Chief Financial Officer; Bob Pusateri, our Executive Vice President of Sales, Marketing and Transportation; as well as David Khani, our Vice President of Finance.

Today, we will be discussing our third quarter results. Any forward-looking statements we make or comments about future expectations are subject to the business risks we have laid out for you in our press release today as well as in our previous SEC filings. We also have slides on the website that I should make you aware of, as well as a table that we just posted today in Excel called Historic Coal Results by Category Table. We have recast our data in that table today in the press release, and the Excel spreadsheet has the historic data in the same recast format.

We will begin our call with prepared remarks today by Bill Lyons, followed by Brett Harvey. Nick, Bob and David will then participate in the Q&A portion of the call. With that, let me start the call with you, Bill.

William J. Lyons

:

Thank you very much, Dan. Good morning to everyone. As you've seen in our press release, CONSOL Energy posted weaker-than-normal operational and financial results. We incurred a loss of $11 million or $0.05 per diluted share for the third quarter of 2012, compared to a net income of $167 million or $0.73 per diluted share for the third quarter of 2011.

Total sales revenues for the third quarter of 2012 were $1.2 billion compared to $1.5 billion for the year ended earlier quarter. We generated operating cash flow of $162 million and adjusted EBITDA of $210 million.

The reduced profitability was due to several factors: lower demand for both metallurgical and thermal coals cut our sales volumes and caused us to temporarily idle some facilities, the most notable of which is Buchanan, our flagstaff low-vol met mine. The lower demand for metallurgical coal also had a significant impact on met coal prices. Average realized price for low-vol met declined by $72 per ton, which is 35%.

On the gas side, average realized price for gas declined by $0.73 per Mcf or 15%. And finally, the infinite at the Bailey Preparation Plant, where newly constructed conveyors that move coal from both the Bailey and Enlow Fork mines collapsed, which caused 4 longwalls to be idled for 3 weeks and reduced the operational efficiency at these mines for several other weeks.

Now the planned idlings from the weak steel markets will have some residual effects on our fourth quarter also. We expect our low-vol Buchanan Mine to be idle until November 5, while we expect our mid-vol Amonate Mine to be idle for the remainder of the year. By idling Buchanan and Amonate, we are communicating to the steel producers that we will not sell into a market that is experiencing an inventory destocking. It is financially difficult for us in the short term, but our actions will contribute to a fast rebound in demand for met coal.

The temporary shutdown of Buchanan resulted in our incurring $7 million of idle mine cost in the third quarter. The one unplanned item that we announced in late July was the collapse of the 2 newly installed conveyor belts that move coal from the Enlow Fork and Bailey mines to the Bailey Preparation Plant. The collapse resulted in idling the longwalls at both mines for a period of about 3 weeks. For much of the remainder of the quarter, this complex ran at only about 60% of normal. This incident reduced our production sales and net income for the third quarter. We estimate the net income impact of this incident to be $53 million.

For the quarter, Bailey and Enlow Fork mines produced approximately 1/2 their normal tons, and we incurred $42 million in costs, for which we had no commensurate production. We're exploring avenues of recovery from both our insurance carriers and the responsible party.

Meanwhile, from an accounting perspective, we excluded the Bailey Preparation Plant incident cost of $42 million and the $7 million of Buchanan costs from our Coal division results table. In excluding these costs, the Coal division, across all of its tons, had 2012 third quarter fully loaded costs of $55.84 per ton. This represents an increase of $1.46 per ton from the year earlier quarter. The increase in unit cost was volume-related. CONSOL had 4 additional weeks of longwall idlings in the third quarter in addition to those I already mentioned. We believe that coal cost per ton should decrease as production returns to normal levels.

In the Gas division, we achieved net income of $7 million. In a quarter of low gas prices, we think this is a noteworthy achievement. Our improvement in gas earnings was driven by higher production and lower costs. The production growth was led by our Marcellus Shale program, where we achieved 140% increase in production quarter-over-quarter after adjusting for the sale of some production last year to Noble Energy and Antero Resources. Gas cost in the 2012 third quarter were $3.38 per Mcf. This is down $0.22 per Mcf from the year earlier quarter. Their improvement was led by our growing Marcellus Shale program, where unit costs in the just ended quarter were $2.95 per Mcf. This is an improvement of $0.10 from the year earlier quarter.

There numerous contributors to the unit cost improvement, which we will detail in the 10-Q, but the basic drivers that CONSOL is drilling longer laterals, which increased production rates per well. This, when coupled with more wells per pad, is helping us achieve what could be industry-leading results.

So overall for CONSOL, we did not have any meaningful asset sales in the third quarter as we did earlier in the year, but we did receive our scheduled $328 million annual installment from Noble Energy. We will receive another $328 million installment from Noble in the third quarter of 2013.

We have no borrowings against our credit facilities at September 30, 2012, and I expect this will also be the case at the end of 2012. In a year of great difficulty in the coal and gas spaces, we believe our financial strength is a key differentiating factor between CONSOL Energy and many of our competitors. Brett will have more to say on this shortly, but when times are tough, as they clearly are now, CONSOL Energy will do okay. But as good times return, we believe that CONSOL Energy will do very well.

And finally for the calendar year 2012, is we are on track to invest $1.5 billion in our company's future. This is consistent with our earlier projections as we continue to complete our coal and gas projects. And with that, let me turn the call over to Brett.

J. Brett Harvey

:

Thank you, Bill, and good morning to everybody. As Bill outlined, we're coming off a quarter that wasn't what you've expected and wasn't what we've expected from CONSOL Energy. If you look at the quarter, we restrained ourselves from building -- using our shareholders' money to build inventory and showed some restraint in the marketplace. That was in effect and was working very well. Typically, a third quarter is a soft quarter for us.

When we had the problem with Bailey/Enlow, it really shows that these large well-capitalized mines have high production and when they're interrupted, it hits the bottom line pretty hard. That shows up in the third quarter. The fact that we are a low-cost operator is based on these large well-capitalized mines. And the fact that when we have a problem, it shows up in the bottom line very quickly.

So when I look at the third quarter, I look at it 2 ways: one is restraint of production to adjust to market so our shareholders don't have cash on the ground, so to speak; on other side of it is that we had a problem, we've addressed it. We're fixing it and we're in full operation right now and we'll get the value out of that through the process of what we need to do with those who built the belt system at Bailey.

In weak markets, CONSOL does okay. But in good markets, our shareholders do really well both -- in both divisions, coal and natural gas. We proved it in fact, in the past 6 quarters, CONSOL Energy has earned $882 million of net income. We're consistent and we will be consistent in the future.

Let's go to Chart #7 that we have on the website. I'm going to talk about markets at this point. Low-vol demand has gone through destocking. Our customers are beginning to take to coal although at reduced levels. This is why we will restart Buchanan at a reduced work schedule for the remainder of the year beginning on November 5 or during that week. This is not -- there is not yet enough demand of Buchanan to run 7 days a week or to restart our Amonate Mine before the end of the year.

When we're running at 5 days a week, it gives us a cost structure that has more pressure because it's all about volume. But this is a low-cost mine and we think we'll do just fine running at that level until the demand is there.

On the high-volume side, demand in Asia is also very weak. As the Chinese economy slows, we see that demand slow as well. We expect stimulus in China to help that over time, and we think that the high-vol market will turn around in early 2013.

On the thermal side, the demand seems to be very stable. Our high Btu coal is being distributed in the natural markets that we have, and we will look at signs of inventory builds throughout the shoulder season. But right now, we think that is pretty strong and stable, and we believe we're in a good place there.

CONSOL continues to invest in the future. Let me refer you to Chart #8. In gas, we announced record well results in each of our 3 dry gas producing areas in the Marcellus Shale, and that is record production as we've cut capital 3x this year, so that tells you the value of these assets and the strength of these assets as we build out the Marcellus. In rising gas prices, our shareholders will benefit dramatically from higher volumes that we've invested in.

We also have better-than-expected results in the liquids-rich portions of the play. And on the Utica Shale, we've had good results from a well in Noble County.

With gas prices rebounding from a decade lows, CONSOL's long-term production ramp will create excellent value for our shareholders as the production will reflect higher margins on gas being a low-cost producer. In coal, CONSOL will open our new BMX Mine in early 2014. If coal markets strengthen, our shareholders will do really well. If coal markets stay weak, the cost structure of the BMX Mine will likely displace one of our competitor's mines in the marketplace. And in the worse case, it would displace one of our own high-cost mines. We don't believe that will happen. We think we will capture market with the BMX Mine. We will finish these coal projects but we won't invest in further coal projects until we see market improvement.

If you look at our capital structure and our MOP capital, about 45% of the capital of our earnings per year is in MOP. We choose to take the 55% difference and reinvest in these low-cost, high-valued assets for the turn in the marketplace, and our shareholders will see that value going forward.

By 2014, with production from BMX, higher gas prices, higher volumes and a shift toward more liquids, CONSOL could be in a position to generate more meaningful extra cash than we've been doing in the past 2 years. We've also been successful, looking at Chart 9, in bringing value forward. You've seen our slide, including $224 million in 2012 asset sales so far. We're working to bring more value forward to our shareholders in a soft worldwide energy market, and reapply them to a growing valuable asset base for the turn in the energy markets.

In summary, I want to talk a little bit about volume and low cost. Our mines are in very, very good position right now in terms of longhaul capabilities and our ability to run. Volume and low cost go together. When we pull back volume, you'll see our costs rise a little bit. That's constraint that we've done to the mines purposely to not build inventory on our side of the ledger. We would rather do that on the side of the customer side. And we will continue to show that constraint. As the volume increases, our productivity will show, and our costs will be where they're expected.

While it's too early to roll out 2013 capital budget, we continue to look at monetizing noncore assets. The hardest question I have as CEO is how to strike the balance between investing in these great resources that our shareholders have and be -- and look at the cash and stay within our cash flow going forward in these tough marketplaces. Right now, we're getting pulled from shareholders from both directions. That would be normal in this type of environment, but we're being very prudent of where we put our shareholders' cash, we move to the sweet spots and where we think we can create long-term shareholder value.

No matter what the conditions are, the macro look at CONSOL is we're a low-cost producer in both divisions, in gas and coal, and we'll create very good value in the short term as gas prices rise and as coal markets stabilize. I thank you for your time, and then we will now open it up for questions now.

Dan Zajdel

:

John, can you please instruct the callers on how to dial in for questions?

Question-and-Answer Session

Operator

: [Operator Instructions] And first, from the line of Shneur Gershuni with UBS.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

:

Maybe I should -- I'll ask my first question just based on the last comment you made about asset monetizations and something that you're looking at. There's been a lot of value being paid for assets that can be dropped into MLPs these days. Is that something that you're thinking about when it comes to asset monetizations or even alternatively even thinking about the structure itself as well as a way to sort of monetize some of these assets?

J. Brett Harvey

:

We are. And in fact, we've looked at this as a vehicle to add value to our shareholders over time. We have an asset base inside of CONSOL that I think the things that are -- we don't get value for, I think we can bring some of that value forward, looking at these kind of structures whether it's through a MLP or whether it's through an outright sale of some of these assets depending on whether they're core or not inside the company, we are looking at that and we do that on a regular basis.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

:

Great. And maybe I can follow up on gas. I understand you -- it's too early to basically put out what your capital expectations are for next year in terms of CapEx for the business. But I was wondering if we can think about this directionally, how much is it related to contracted rig count? Is that heading down at the end of the year? Does that sort of play into this, how we should be thinking about how the capital is going to be deployed? Do the lower day rates, for example, sort of play into this as well too? I was wondering if you can sort of at least give us a little bit of color in that respect.

William J. Lyons

:

The rig situation are associated services that we would be committed or not committed to leaves us a lot of flexibility to set a pretty wide range of drilling rates for 2013, anywhere where we want to go with our criteria, and our criteria remain the same, which is we'll look at the rate of return metrics that would be for everything from dry Marcellus gas areas to wet Utica areas and look at those rate of returns versus our cost of capital and the opportunity cost of other things, other uses of that cash flow, as Brett said. But the main point there is when you look at what we're contracted for and what we need to do on the gas side for 2013, there remains a lot of flexibility to come up with a pretty wide range of drilling schedules.

Shneur Z. Gershuni - UBS Investment Bank, Research Division

:

And one final follow-up, if you don't mind. The contract with Noble on the asset sales sort of have that $4 floor in there and so forth, and the markets have definitely changed since that deal was signed and so forth. My understanding, it's not a suicide pact and you don't necessarily have to agree to drill anything in theory. Does that give you some leverage to sort of revisit that floor and maybe bring that down a little bit? Is that something you've thought about or potential discussion base because your ability to not drill in theory can hold it hostage?

J. Brett Harvey

:

Well, there's 2 things. We're seeing great value in the drilling that we're doing, and especially as gas prices rising. And we also have a deal that over $4 that carries ours. And we think we're going to get that over time. And in terms of reevaluating, I think in both cases, as we see gas prices rising, even though the cost structure is a lot better than we thought 2 years ago, we think that $4 is probably a pretty good number, and we think gas prices are going to be over that, we'll get to carry. In fact, we plan on getting that carry next year.

Operator

: Our next question is from Lucas Pipes with Brean Capital.

Lucas Pipes - Brean Murray, Carret & Co., LLC, Research Division

:

My first question is on your met coal guidance for 2013. And I wondered if you're conservative there given the current market conditions. And when you talk to your met coal customers, kind of what type of interest are you seeing both from the domestic market, Atlantic market and then also the Pacific market?

William J. Lyons

:

Sure, Lucas. We believe that we can walk the market up as it improves. This is not an operational issue with our coal mines but rather a market issue. We believe in this quarter that there still is an oversupply of low-vol coal in the world. And we're forecasting that while we're at the bottom now, we'll bump along. And at the second half of 2013, that the demand for low-vol coal will improve, and at that point in time, we have the productive capacity to be able to meet that demand.

Lucas Pipes - Brean Murray, Carret & Co., LLC, Research Division

:

That's helpful. And then on the gas side, I wondered what you have learned so far from your drilling in the Utica and where you expect to deploy your resources going forward based on what you've learned?

William J. Lyons

:

It's been an interesting journey as we expected it would've been when we embarked on the Utica and working in conjunction with Hess, our partner. If you look at our experience to date for '12, we're basically going to end up drilling 12 wells total gross basis amongst the 2 partners in 2012. And looking at what we've seen on the cost side with the Utica, I would say not a lot of surprises there in that we knew that the vertical portion of the well is going to cost more, we knew that the completions were going to cost more because of use of gel in the Utica when you compare it to something like the Marcellus. Now the horizontals, if anything, have actually been a bit easier, and we expect some cost efficiencies in that relative to the Marcellus because the additional depth helps you. We're doing a lot of science upfront. We agree with that with Hess, our partner, from the get go to put the science ahead of the drill bit. So the types of things we're doing, we're taking the whole bore cores for the entire Utica zone along with a couple 100 foot above and below the Utica zone to get a good picture on what's going on there. We're doing a diagnostic fluid injection test to try to get a gauge on things like reservoir pressures and other parameters. And we're also assessing whether or not and at what rate or what time period it makes sense to cook the wells to see how that might help things like permeability and other things associated with it. So a lot of science upfront that's driving how we're going to end up drilling and completing these. When you look at our 2 wells, we've got results on to-date, the TUSC 3 was our first one, of course. The production data weren't as good as we were hoping for on our well-type curve but also, our first well and maybe more importantly, it was very analogous what we did in Northern West Virginia on the Marcellus. We drilled this well on the extreme western border of Tuscarawas County, which is the fringe area of where our consolidated footprint sits. And we saw the same thing with when we drilled our first Oulton well in the Marcellus in Northern West Virginia, and those results have improved steadily over time. So we are very conservative on our frac design. We were very conservative on where we drilled that first well and learned quite a bit coming off of that. You compare that to our second well with Noble County, much better. That also is on the fringe of our Noble County acreage so our expectation there is that even with the improved results in Noble County, our future Noble County wells will be even better. So I guess that it's been a journey, we knew that going in. So far so good. We're still very optimistic on the Utica, and I think tweaking -- or taking the risk, and speaking for our partners I think they're optimistic on it as well.

Operator

: And next we'll go to Jim Rollyson with Raymond James.

James M. Rollyson - Raymond James & Associates, Inc., Research Division

:

I think one of the comments, Brett, you guys had talked about earlier was as production into next year starts to come back up to, hopefully, more normalized levels, your costs should come back down. Just kind of if you could maybe bracket that in terms of maybe by the time you get into the second or third quarter of next year, should we think of costs being back down to where they were in the first, second quarter of this year? Or is there some other things that might linger? Just kind of trying to think about how to model this as you progress from the market we're in today to, hopefully, a better market next year?

William J. Lyons

:

Jim, this is Bill Lyons. I think that's a fair assumption. As we said, when we take a look of the increase in costs, quite frankly, we're a little bit of $1, $1.50. We're very pleased with this. When you consider the -- all the issues we had in terms of reduced production levels. We feel very confident as when we return to our normal production levels, you'll see those costs decrease because we have -- our mines are large, they're well-capitalized, and as a result, they have large fixed costs. And just like when production goes up, that gives us a lot of leverage to reduce the cost. When production goes down, you see that increase in cost. So as Brett mentioned earlier, our mines are in very good shape operationally, and quite frankly, we're very anxious to put the pedal to the metal and see what they can produce.

James M. Rollyson - Raymond James & Associates, Inc., Research Division

:

And from a Buchanan-specific comment, maybe what's the cost outlook there just running at 5 days a week ballpark?

William J. Lyons

:

I think when you take a look at the 5-day a week, I think some like $85 to $90 a ton would be something we expect. Again, you've got to realize that when we went all out and had just a tremendous operational year last year at Buchanan, you saw costs in $70, $75 range. But that's operating on a 7-day week schedule. On that lower schedule, 5 days a week, I think $85 to $90 is something that would be reasonable to expect.

James M. Rollyson - Raymond James & Associates, Inc., Research Division

:

That's helpful, Bill. And maybe switching gears, I guess, first, good job of pricing more thermal coal in the 60s given the market we're in. Brett, I'm wondering how conversations are going with your customers as far as heading into next year looking at the gas market strip holding here in the $4-plus range. Just kind of what some preliminary conversations are like as you go into next year?

J. Brett Harvey

:

Well, I can tell you this. Bob's working hard on that. I'm going to have him make a couple of comments about that.

Robert F. Pusateri

:

Sure. Jim, obviously, favorable natural gas price trends have enabled us to conclude several large thermal coal agreements for 2013. Since we were here on the call at the end of the second quarter, we finalized nearly 11 million tons of business for '13 at an average price of $56. But I need to point out to you that within that 11 million tons, there's a sale of roughly 4.1 million tons of high sulfur coal containing a Btu of 12,000 and an SO2 value of 6.6 pounds. I need to say that in a recent conversation that I had with a fuel buyer, he commented that with the recent uptick of natural gas pricing, that this was making him rethink his coal purchase strategy for 2013 so that he didn't get himself caught short as gas prices continually trends up. We take a look at our key market area of power plants that are east of the Mississippi River. And Jim, we estimate that for 2013, we could see as much as 42 million or 45 million-ton a year additional burden on those power plants. Most of that is caused obviously by higher gas prices as well as improved economic conditions.

James M. Rollyson - Raymond James & Associates, Inc., Research Division

:

Great. And last one, Bill. You mentioned in the press release that you expect to end the year basically pretty much with roughly no cash, which for one I suspect implies that your goal at the beginning of the year was to be cash flow neutral or what you generate versus what you spend. And then obviously, you've ran into some issues like Bailey/Enlow. As you think about going into next year, I know you haven't sat down fully on the budget, but just generically, do you think you'll be cash flow neutral to cash flow positive as you think about it?

William J. Lyons

:

I think it's -- a lot depends on what happens in the markets next year and our profitability. But let's take a look at this. I think sometimes, people put too much emphasis on what the absolute cash number is as opposed to focusing on the liquidity, okay? We're talking about having $2.3 billion to $2.5 billion of liquidity. We can draw on that anytime that need that and I think that's the key number. Take a look at the actual cash balances for the year. We started out with $376 million, which was, quite frankly, in a high number. We don't need that much to have cash on hand there. We had $200 million at the end of June. We had $231 million at the end of September. The point I'm trying to make is that we are staying within cash flow, and I think we're managing our cash and our liquidity very well, and that's enabled us to weather difficult economic times. So again, I don't think people should get hung up with what the absolute cash balance is. I think they should focus on the total liquidity.

James M. Rollyson - Raymond James & Associates, Inc., Research Division

:

Yes, it wasn't a concern on liquidity. Just more of trying to figure out whether you thought would be free cash flow neutral to positive next year.

Operator

: Our next question is from Michael Dudas with Sterne Agee.

Michael S. Dudas - Sterne Agee & Leach Inc., Research Division

:

Brett, as you look into 2013, does your gut tell you we're on the cusp of seeing a better overall energy demand environment here and globally? Or is it maybe going to be delayed a bit further because of either political or economic or regulatory issues going into '13?

J. Brett Harvey

:

Yes, I can tell you this. Planning is a little bit tougher in '13 because we're seeing -- we're bouncing along the bottom on the Asian markets. The domestic market seems to be pretty stable so we think there's upside on the domestic markets. I would say that on the met side, and you know this, we don't spend a lot of capital chasing the met business because BMX is really a mine that can go either way. And because its heat and its value and it's low-cost so it can go into thermal or met. So the way we look at it, we think met is going to be a third and fourth quarter bounce next year, pretty strong. We think we're going to bump along in the first quarter. We hope the second quarter looks pretty strong on the met side. The steam side, I think, is going to be pretty stable for us, and we'll set some prices that we think are at the bottom of the market and they'll continue to grow as the economy strengthens. But we don't think the economy is going to strengthen, in the United States much beyond where it's at until the second quarter or the third quarter of next year.

Michael S. Dudas - Sterne Agee & Leach Inc., Research Division

:

Now relative on your thoughts on natural gas in pricing and hedging, do you characterize your very low-cost, very well-run operations as a natural hedge and you're more willing -- and because of the $2.4 billion in liquidity that CONSOL controls, are you more willing to leave more upside into the markets for natural gas in your growth phase over the next 3 to 4 years even as the strip improves here?

J. Brett Harvey

:

Well, when you look at our whole asset base, the diversity is powerful. You've got the diversity of the met coal, diversity of the steam coal. You've got -- you are moving into the oil and the liquids plays, and you've got that dry gas is very, very powerful as well. I think when you look at it going forward, we're going to grow rapidly on the gas and liquids side, and we'll invest our capital in the sweet spots there. Like I said, we're not going to build any more coal projects till we see a real turn there, but we do believe gas prices will strengthen. The government, our dear government, has decided that gas is a winner and we're going to produce gas for them. So I'm okay with that because we diversified our base and not chase met with our balance sheet.

Michael S. Dudas - Sterne Agee & Leach Inc., Research Division

:

And my final question is your comments about exports and being off, I guess, in '13 versus '12, what you guys are thinking. Is it more just a cyclical pullback or are there -- have we peaked out on the export side or is the U.S. really going to be a contributor to the global markets once we normalize into second half of '13 and the '14 and '15?

J. Brett Harvey

:

I think when the markets come back, we're going to be a big contributor. You saw that we expanded our port facilities this year. We'll be ready for higher volumes, but right now, it's a market cycle. The government pushed back on what we could do domestically. We went to the international markets, and we did well with that and when it turns, we'll come right back swinging. We're a low-cost producer. We have 2 railroads into all of our mines. And we have 2 railroads going into Baltimore and we have the ability to move this coal worldwide because of its value in terms of Btu as well as met structure.

Operator

: And next we go to Andre Benjamin with Goldman Sachs.

Andre Benjamin - Goldman Sachs Group Inc., Research Division

:

A few questions for you. First on the E&P side, you have a significant amount of acreage in West Virginia, which you have to be pretty focused on just a few counties. How much of your acreage do you think you're going to be realistically focused on derisking over the next 12 to 18 months? And then, what do you plan to do with the acreage that you're not focused on?

Nicholas J. DeIuliis

:

Northern West Virginia on the Marcellus acreage footprint was the riskiest, I'll call it, or least identified area when we did the Dominion acquisition a couple of years back. And through the last couple of years was our exploration and delineation program, not only do we know in order of magnitude more information about Northern West Virginia but we're, in order of magnitude, more excited about it based on those results that we've seen. So the rate of the delineation exploration phase from our perspective is pretty much completed based on the results that we saw from the first well that we drilled on the Oulton pad to the recent results we put out there for the third quarter on a Philippine [ph] and another Oulton pad, 6-well Oulton 2 pad in Upshur County. And now we're moving into an arena or a time period where we are looking at the rate of drilling simply being a function of gas price and going back to those rates of returns. So the way to think about Northern West Virginia and Marcellus is a function of gas price. As the gas prices climb, as the futures climb because of increasing gas demand, then we ramp up drilling, and a big area of the ramp up in drilling on the dry gas side would be Northern West Virginia. It's there, ready to go, the science is completed and now it's just a question of how much and when.

Andre Benjamin - Goldman Sachs Group Inc., Research Division

:

Got it. And then I mean, all those met prices should, hopefully rise from the fourth quarter benchmark. But for some reason they don't and they stay in this $1.70 to $1.75 range throughout next year, what should we expect you guys to do with the Buchanan volumes, given it would make money at that level but you already chose to shut it in for part of the third and fourth quarters?

Robert F. Pusateri

:

Yes. Andre, the benchmark price of $1.70, you're correct. CONSOL can certainly make money at that level. What concerns us is that the spot market price could drop as low as $1.40 to $1.50. As some of the U.S. suppliers are running for not even cash, positive cash, that's a real concern to us. CONSOL has the right cost structure even running at the 5 days a week, we can sell this coal into the marketplace. We're optimistic that the demand from European steel mills will improve certainly the second half of 2012, and we're talking to a number of mills here in the United States and looking to sell additional volumes to those mills. So we're optimistic about the demand for 2013 and beyond.

Andre Benjamin - Goldman Sachs Group Inc., Research Division

:

But if the prices don't move, that's just a known factor. Should we expect Buchanan to be closed or will it run?

J. Brett Harvey

:

No, no. Here, let me clear that up in terms of that. When the customer is not taking coal that's under contract, we will not build inventory on our balance sheet. We close the mine. When there's a marketplace where customers are taking coal and there's a flat to gradual buildup, we're going to take market share. The mine will run.

Operator

: And next we go to Mitesh Thakkar with FBR.

Mitesh Thakkar - FBR Capital Markets & Co., Research Division

:

Bill, can you talk a little bit about export market on the steam coal side? And do you think you can sell some export coal for next year? How should we think about our volumes on the export side for next year?

Robert F. Pusateri

:

The export thermal coal demand, Mitesh, remains strong in Europe. Electricity generation in Europe is only down less than 1% from last year. Natural gas prices are high. Key suppliers of gas from both Algeria and Russia remain a reliability concern. There's -- we're very excited about the opportunities for thermal coal, and in fact, that's why we elected to spend the money to increase the capacity of our Baltimore terminal. Coupled with this, we balanced the demand for thermal coal here in the United States with the demand overseas for thermal coal, and we're continuing to do that. And we've had really good success here in the United States. Our mines are certainly poised to run for next year. As the demand increases on both sides, we have the capacity to meet that demand.

Mitesh Thakkar - FBR Capital Markets & Co., Research Division

:

And how should we think about year-over-year change in the steel coal export number?

Nicholas J. DeIuliis

:

Right now, with our projections, we actually show less coal being exported next year because we believe the domestic price for our large underground coal mines will be better here in the United States. If we're wrong about that, then we'll focus our demand on the export thermal business.

Mitesh Thakkar - FBR Capital Markets & Co., Research Division

:

Great. And just a follow-up on the gas side. How should we think about your incentive price to mobilize additional gas rigs? I know your $3.38 gas cost probably is -- Marcellus costs are much lower than that given it's kind of an average cost. How should we think about your incentive price?

Nicholas J. DeIuliis

:

This goes back to the rate of return metrics, and the way to think about the gas opportunities in very general terms would be the Utica, the Marcellus -- I'll call it the wet gas area in the Marcellus dry gas area, which Marcellus dry gas area, of course, encompasses a pretty broad region or acreage position. Right now, with the spreads being where they are, the least attractive for a number of reasons is the Marcellus dry gas opportunity. And that's where you saw the reduction in drill rigs and well counts over the course of 2012. I think we've reduced it now 3x over the course of this calendar year. The opposite is also true. What I mean by that is the most increase or upside would exist incrementally when gas prices rise from the dry gas Marcellus region. So the way we think about it, we're basically drilling at a rate that's aggressive on the wet gas opportunities for a range of reasons from permitting to infrastructure and everything in between, at least in the short term. And where you see the most upside incrementally when gas prices [indiscernible] dry gas drilling fields as an example, that Northern West Virginia field we were talking about a little earlier.

Operator

: Our next question is from Dave Gagliano with Barclays.

David Gagliano - Barclays Capital, Research Division

:

A lot of them have been covered. I did want to just break down a little bit more on the thermal volumes that were locked in during the third quarter. Was there any -- I just wanted to clarify, was there any switching between the high-vol crossover tons into the thermal? It looked like the guidance for 2013, you had a reduction in your high-vol assumption but an increase in your thermal assumptions.

Robert F. Pusateri

:

Yes, David, that is correct. We had 2 opportunities presented themselves to us, and we just moved the tons from one category to the next. That's the beauty of having flexibility, with being able to take our high Btu Bailey/Enlow for coal and move it either into the steam market or the high-vol met market.

David Gagliano - Barclays Capital, Research Division

:

Okay, okay, good. That's helpful. Was it about 2.5 million of that?

Robert F. Pusateri

:

That's correct.

David Gagliano - Barclays Capital, Research Division

:

Okay. And then on the breakdown between the 7 million and 4.1 million tons that you mentioned earlier, on the average price of $56, can you just tell us what the number was -- what the price was for the 7 million tons that were more relevant in terms of the quality?

Robert F. Pusateri

:

David, I don't have that.

Dan Zajdel

:

Dave, we'll come at you. Yes, we'll call you offline and give you that answer instead of having to shuffle papers.

David Gagliano - Barclays Capital, Research Division

:

All right, all right, good. And then the last question I had, given everything that you're seeing in the market, I was wondering if you could share your views with regards to the first quarter of 2013 met settlements. Obviously, benchmarks at $1.70, you mentioned spot $1.40, $1.50. What's your view to that -- with regards to the benchmark price, higher or lower do you think versus that $1.70 number that we have in Q4?

Robert F. Pusateri

:

I think in the quarter, it will be somewhere between -- I think it will be coming out of $1.70 to $1.80 for the fourth fiscal quarter.

Operator

: And next we'll go to Paul Forward with Stifel, Nicolaus.

Paul Forward - Stifel, Nicolaus & Co., Inc., Research Division

:

I Just want to follow up on that question on the high-vol guidance for next year, where you went from previously 5.2 million tons of expected high-vol shipments into '13 and that's now 2.7 million. Just wondering if you could give us a little sense of -- obviously, the commitment levels are pretty low, only 0.3 million tons. Could that go all the way down to 0.3 million tons and you've move everything into the thermal markets? And if that happens, can you talk a little bit about the reduction of some availability of up to 5 million tons? How do your high-vol customers look at the reduction of those volumes? And is that at all threatening? Or it's just -- they're just in destocking mode and not necessarily thinking about what happens to that market later in 2013?

J. Brett Harvey

:

I'll let Bob give you the specifics but if you remember, we said that the first 2 quarters of next year would probably be pretty soft on the international markets, and that's where transition to high-vol really happens. So with our flexibility that steam market is going to be, we think, pretty strong in the United States. So we could move back and forth quite a bit in the first 2 quarters, and then probably a buildup at the end of the last 2 quarters of next year. But Bob can give you some specifics now.

Robert F. Pusateri

:

Yes, Paul, our Chinese customers have reentered the market to build inventories. And although the prices have increased by some 12% to 15% from the July, August lows, we believe that those prices need to increase by another 15% to 20% in order to make U.S. coals compete on a sustainable basis. We haven't seen that yet. And we were fortunate because we have -- again, we have the flexibility to move those coals into other markets. And we're pleased with what we see in the domestic market. We have several opportunities in front of us now. We're in negotiations for tons. We'll have considerable volumes and we will place those tons where they offer us of the highest margin possible.

Paul Forward - Stifel, Nicolaus & Co., Inc., Research Division

:

Okay. And maybe just following up on that. You talked about BMX Mine coming online early 2014 and the potential -- most likely, you'll be able to place that into the market without having to sacrifice volumes elsewhere. Can you talk a little bit about the utility inventories in Northern Appalachia and what do you expect -- and what scenario you think will play out in a way that really won't force just the cannibalization of other volumes and instead the market will actually need that coal?

J. Brett Harvey

:

Yes. Keep in mind that BMX production can go into the international market. So you got to look at the entire world in terms of taking on BMX. And if that doesn't happen, it's going to be the low-cost producer, the entire world of the United States market. And so if you pull -- pick one or the other, BMX is going to play. What will happen is it will push out the marginal players. We do know that some of our competitors in the Northern App area are running into higher costs and probably are having some reserve problems over time. So we think BMX is hitting the sweet spot, not only in our own portfolio, but in the world portfolio. So we -- I think BMX is going to do very, very well and whether it's met, crossover or whether it's steam low-cost.

Robert F. Pusateri

:

Added to that, as Central Appalachia production continues to decline, we believe those utilities will replace that with higher Btu Northern App coal that doesn't have a chlorine issue and that has a good railroad transportation. And so we're not expecting to have to cut production from our existing coal mines in order to shoehorn that production in.

Operator

: And next we go to Meredith Bandy with BMO Capital Markets.

Meredith H. Bandy - BMO Capital Markets Canada

:

So a lot of my questions have been asked. I'm going to take a stab -- forgive a poor mining analyst, these are oversimplistic oil and gas questions. But in the Marcellus, if you could give us any update on the sort of like your 30-day IP and also the drilling complete cost?

Nicholas J. DeIuliis

:

On the drilling complete costs, let's go there first. Right now, and again, this varies quite a bit across our Marcellus field because it's a very large field, so I'm generalizing with an average view, and the actuals will be variations off of that on the high and low end, but the drilling complete cost is going to be somewhere around, I'll call it, $6.5 million per well, and that should get us on average somewhere around 8.5 Bcf per well. So when you do the funding and development math, it should be around $0.75, give or take, on our average type curve. Now the data to-date or a lot of the data to-date have beaten those type curves, but that's our average for the entire field on an assumption basis moving forward. When you look at IP rates and how these wells have done, we do a pretty good job, I think, at least of the quarter-by-quarter operational updates, specifically saying out the new wells in each of our Marcellus subregions. So if you go back to the quarterly earnings or I'm sorry, operational earnings releases, the most recent one we've put out about a week ago, you'll see over the third quarter for example, in that release what new well came on in Central Pennsylvania, what were those IPs at, what new wells came on in our Northern West Virginia, Marcellus region, what were the IPs, what came on Southwest PA and what came on in what I call the wet area that Noble, our partners operate in. So there'll be a history there throughout those operational releases to give you a feel, and generally, the trend has been longer laterals, better IPs, better economics.

Meredith H. Bandy - BMO Capital Markets Canada

:

Right. And then I know it's extremely early innings for Utica. Maybe if you could just talk about like Utica compared to the similar stage of Marcellus? Or how can we -- obviously, Utica seems very exciting from everyone's initial drilling results, yours and other producers as well. But how should we think about the Utica longer term?

Nicholas J. DeIuliis

:

The Utica is -- you're correct in thinking that it is earlier in its development than the Marcellus. A lot of similarities in the 2 when you compare them and some differences as well. The drilling complete costs for Utica are going to be higher than what I just quoted for the Marcellus, and they're going to be significantly higher because of the deeper depths on the vertical section of the well, as well as the use of gel in the completions, which is more expensive than the slip fracs that we use in the Marcellus, but we're also expecting higher EURs. So the way I would think about the Utica, the finding and development costs, instead of that $0.75 number we have for the Marcellus, something closer to $1.25 as an average type curve moving forward would probably be a better assumption. And as we discussed earlier in the call, a lot of data now is starting to hit not just for ourselves but for the industry overall. And you're going to see that learning curve change in terms of the rate of speed very quickly because we're just seeing orders of magnitude more data coming into the field, than we saw as little as 6 months ago, let alone a year ago. And that's going to change everything from frac-ing techniques to where we are going to drill and that's why we try to spend a lot of time articulating what we're seeing in the Utica play.

Operator

: And we'll go to Chris Haberlin with Davenport & Company.

J. Christopher Haberlin - Davenport & Company, LLC, Research Division

:

Most of my questions have been asked. But, Bob, I think you said that Chinese price offers were probably 15% to 20% below what it would take to really move U.S. exports into China sustainably. And I just was wondering kind of what's your view on what it will take to get those price offers up into that range?

Robert F. Pusateri

:

Chris, I wish I knew for sure what that answer is that will get it up. I'm sure that it will be driven by production cuts. There's still a surplus of coal I think. We saw over the last 30 days there were a number of vessels that were floating from a number of companies. Those vessels have pretty much all disappeared. There's been production cuts in Indonesia. Australia has cut back, they can't sustain it when prices -- when the BMA goes below $1.70. So we need to get a price for our U.S. coals. On the met side in there at numbers that are plus-$200 a metric ton. So where we see $200 a metric ton next year, I think it's possible. I think we'll break the psychological barrier maybe for a quarter or 2. My guess is, is that the average next year will be somewhere between $190 and $200. So I think that improves, get all this spot sales out of the marketplace and drive up the price for the coal that's left.

J. Brett Harvey

:

Well, one thing that I want to make clear to people on the call is the Australian cost structure is rising rapidly. So the ability to drive it much below $200 going forward is probably less apt to be based on the rising cost structure of major suppliers. So and we also see the Indonesian quality dropping that's going into China in terms of BTUs and over time. So I think our low-cost position and high BTUs will strengthen over time. Is it going to happen in 2013? I guess we can tell you more in 2013. But at this point in time, we think that's a long-term valuable market for us, and it will grow and we're not showing the price is going to cross but until then, we'll be taking care of the Atlantic market and the domestic market.

J. Christopher Haberlin - Davenport & Company, LLC, Research Division

:

That's very helpful color. And then just as a follow on. One of your competitors recently said that they expected seaborne met demand to be up on the order of 10% to 15% next year. And they said that they're seeing in China met coal production being shut in because delivered cost domestically in China are above current prices in the seaborne market. And obviously, you all have a very good view of China given your relationship with Xcoal. I just wanted to kind of want to see what your thoughts are there.

Robert F. Pusateri

:

Yes. Chris, a recent conversation with members of our sales team in China indicates a much stronger metallurgical coal demand in China since the middle of September. When we looked at the numbers, we came up with an estimate of 4 million to 4.5 million tons of additional coking coal was taken into China since the first couple of weeks in September. But again, we still think that for U.S. coals, we still need to see another 15% or 20% increase in the price of those imports in order for U.S. coals to be sustainable. The problem that we worry about is that China comes into the marketplace and they rebuild their stocks for 4 to 6 months, and then all of a sudden, Chris, they disappear, like they did in 2010. So as we get ready for this buying spree in 2013, we can't lose sight of that possibility.

J. Christopher Haberlin - Davenport & Company, LLC, Research Division

:

Okay, and that makes sense with your view that things don't pick up material until the back half of last -- of next year.

Operator

: And that will be from the line of Rich Garchitorena with Credit Suisse.

Richard Garchitorena - Crédit Suisse AG, Research Division

:

Just -- all my questions have most of it answered. The one question I had was, I guess, given where nat gas prices are today, what's your view, given the fact you do have both nat gas and coal exposure, how much gas to coal switching, do you think, we could see? You said that you're seeing some strengthening in thermal demand. Just some thoughts on that would be great.

Robert F. Pusateri

:

Yes, again, we look at the area of where CONSOL targets its coals. And for the first 9 months of 2012 over 2011, we've seen about an 80 million-ton reduction in burn. And for 2013, as I said earlier, we see that increasing by 40 million tons, not increasing from a positive standpoint. So we think at the $3.75 gas and above, coal-fired units become base loaded again. They run harder at night than they have in the past. We think all the CTs come off and that gets replaced with a coal burn and we're very excited. Our conversations with our customers, Rich, indicates to us that with higher gas prices on the horizon, we're going to see a lot more coal burn in 2013.

Dan Zajdel

:

Okay. Well, that concludes today's call. John, could you please instruct our callers on the replay information please?

Operator

: Certainly. And ladies and gentlemen, this conference is available for replay. It's starts to 12:30 p.m. Eastern, will last until November 1 at midnight. You may access the replay at anytime by dialing (800) 475-6701 or (320) 365-3844. The access code 267143. Mr. Zajdel, any closing comments?

Dan Zajdel

:

No. We just thank everybody for attending. David and I and Tyler Lewis will be around later today if anybody has any follow-up questions. Thank you.

Operator

: Ladies and gentlemen, that does conclude your conference. Thank you for your participation. You may now disconnect.

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