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Cloud Peak Energy, Inc. (NYSE:CLD)

Q3 2012 Earnings Call

October 25, 2012 5:00 p.m. ET

Executives

Karla Kimrey - Vice President, IR

Colin Marshall - President and CEO

Michael Barrett - EVP and CFO

Analysts

Jim Rollyson - Raymond James

Shnur Gershuni - UBS Securities

Andre Benjamin - Goldman Sachs

Mitesh Thakkar – FBR

Lance Ettus - Tuohy Brothers

Brandon Blossman - Tudor, Pickering & Holt

Brian Gamble - Simmons & Company

David Gagliano – Barclays

Chris Haberlin – Davenport

Richard Garchitorena - Credit Suisse

Lucus Pipes - Brean Murray

Wayne Atwell - Global Hunter Securities

Mark Levin - BB&T Capital Markets

Operator

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

I would now like to turn the conference over to Ms. Karla Kimrey, VP of Investor Relations.

Karla Kimrey

Thank you, Senao. Good afternoon and thank you for joining for us today. With me are Colin Marshall, Cloud Peak Energy's President and CEO, and Michael Barrett, Cloud Peak Energy's EVP and CFO.

Today's presentation may contain forward-looking statements regarding our outlook and guidance, economic and industry conditions, volumes, prices and demand, LBAs, business development plans, regulations and energy policies, capital resources and other statements that are not historical facts. Actual results may differ materially because of various risks and uncertainties, including those described in the cautionary statement in today's earnings release and in our 2011 Form 10-K.

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

I will now turn the call over to Colin Marshall.

Colin Marshall

Thanks Karla and good afternoon and thank you for joining the call. I’ll make some opening remarks before handing over to Mike Barrett, our CFO to cover the financials and our guidance.

I am happy to report that Cloud Peak Energy had a great quarter with strong shipments and cost controls producing record adjusted EBITDA of $108 million. We’re now well placed for Q4 and for 2013 when we’ll hopefully see prices rising to more sustainable levels.

Looking at the internal environment we are facing, Q3 has play out as we had hoped with a hot summer and rising natural gas prices moving each of us to burn coal in the last few months. DRA reported that coal generated 39% of U.S. electricity in August, up from the low of 32% in April. The increased burn brought PRB stockpiles down to around 90 million tons which is back within the five-year average range. Obviously coal demand for the rest of the year will depend on the intensity and timing of the winter season and the price of natural gas.

Since mid-July the hot summer and the associated increase in coal burn have led to increased shipments to our customers of 24.4 million tons for the quarter. The increased shipments and cost good control were major factors in our cash costs coming down to $9.14 for the quarter.

We exported 1.5 million tons of Asian customers through the Westshore Terminal during the quarter. This is up slightly from the 1.4 million tons exported in third quarter last year. Moving to our safety performance which has continued to show consistent improvement over last year, in the first nine months of 2012 Cloud Peak Energy had an MSHA all injury frequency rate injury of 0.73 with three minor reportable injuries to employees during the quarter.

During our 75 MSHA inspection days, we were issued 11 substantial and significant citations. I am very pleased with our improved safety performance this year which is a credit to our employees and goes hand-in-hand with a good operational performance.

Looking at exports, while current pricing for export coal is very low, Asian demand for subbituminous coal from the Spring Creek mine continues to be steady. Our Asian customers continue to express their desire for long-term supply from Cloud Peak Energy and they’re as focused as we are on the development of additional West Coast terminal capacity.

Report of the significant increase in capital and operating costs of Australian coal mines is basically changing the international cost curve in North America’s favour. With that in mind, I'm pleased that the Westshore Terminal is currently undergoing the final outage that will increase its annual capacity from 32 million to 36 million tons. We are planning to increase our future Westshore exports in proportionate to this expansion to around 4.5 million tons from next year.

We’re continuing to work on several other potential export opportunities and we’ll keep you updated as things develop.

With that, I will hand over to Mike to run through the financials and our full year guidance.

Michael Barrett

Thanks Colin. In operational terms and in financial terms, we had an excellent third quarter. A number of factors came together to generate the record adjusted EBITDA of $108 million. For the nine months, we are now at adjusted EBITDA of $250 million and we’re slightly writing-off full year guidance ranges.

I will start by reviewing the financials for the quarter. As anticipated, shipments was strong and we were able to realize gross coal averaging $13.28 per ton, approximately 3% higher than this time last year. As a result, our gross revenues increased to $426 million. We continued our focus on cost controls across the entire business. This enabled us to hold operating costs largely fixed while shipping 20% more tons than the second quarter. As a result, cost per ton from our three mines was $9.14 for the quarter.

It’s impressive to note that this is also a year-on-year improvement from $9.17 last year when we shipped to some of the tonnage. This resulted in operating margin from the three mines of $4.14 per ton for the quarter.

SG&A costs were little higher in the quarter as we investigated a number of business development opportunities and invested in programs to support coal and the benefits of port developments in the Pacific Northwest. We generated $121 million of cash from operations, invested $14.5 million in capital expenditures and completed the last of our 2012 LBA installment payments of $60 million.

At the end of the quarter, our cash and investments totaled $266 million, up from $222 million at the end of the last quarter. Our balance sheet remains strong with our $500 million revolving credit facility continuing to be undrawn, giving us available liquidity of $766 million. We have no debt maturities due before 2016 and our leverage remains robust at 1.7 times the gross leverage and 0.97 times on a net basis.

Switching now to the accounting associated with our annual update to the tax receivable agreement. You will recall the tax basis of our assets was stepped up following our IPO and secondary offering. This allows us to take additional tax deductions primarily depreciation.

Under the tax receivable agreement, each year we owe to Rio Tinto 85% of the resulting cash tax benefits. And under U.S. GAAP we recognize an undiscounted liability of the total future amounts that we estimate as owed to Rio.

During the third quarter each year we update our life of mine plans and we use these to update the TRA liability estimate. Our updated projections showed a decrease in the expected overall taxable income of the business, primarily due to updated price forecast curves, reflecting current market conditions. As a result, our estimated TRA liability was reduced by $29 million to $141 million. The $29 million reduction in the liability is a non-cash non-operating P&L benefit which is recorded to other income.

The update also affected the income tax expense line on the P&L with a net reduction in income tax expense of approximately $6 million. Most of these benefits are removed from our adjusted EBITDA and adjusted EPS metrics to better reflect the underlying performance of the business.

Turning now to guidance for the rest of the year, for 2012 we continue to expect a shift between 90 million and 93 million tons. We’ve remained focused on capital expenditures throughout the year and prudently invested in operations, plant and equipment. We’ve consistently said that we will not compromise integrity of our equipment and maintenance programs to achieve short-term cost savings. Our operations continue to focus on condition based monitoring and this approach has once again paid dividends with low operating costs and extended equipment lives. As a result, based on equipment condition, we have been able to defer a number of capital projects to future periods. And we are improving our expected capital expenditure range to between $50 million and $60 million.

In line with our strong third-quarter and continuing cost controls, we are increasing our adjusted EBITDA guidance. We now expect to generate between $310 million and $340 million for the year, up from the previous range of $300 million to $330 million. This range includes a benefit from our export sales hedging program.

As we highlighted earlier this year, we put in place a series of hedge positions when Newcastle prices were higher than they are now. As a result, we expect to benefit from these hedges as they close out during the fourth quarter. The exact benefit will depend on Newcastle prices of the date the hedge is settled.

We’ve also continued our oil hedging program using costless collars to help protect against our diesel costs, against extreme price swings. You can find full details of these hedging programs in note five of our Form 10-Q which we expect to file soon after this call. Neither of the programs qualified the hedge accounting under U.S. GAAP and that value is marked to market each quarter. We removed these mark-to-market adjustments from our adjusted EBITDA and any guess metrics.

To wrap up, we’re well-positioned to finish 2012 strongly. We continue to maintain a strong balance sheet with available liquidity of $766 million, ample headroom under our debt covenants and no debt maturities due before 2016. This enables us to run the operations and invest in the business appropriately even in tough market conditions.

With that, I will hand back to Colin.

Colin Marshall

Thanks Mike. Looking forward to Q4, we’re expecting steady shipments through the end of the year. Annualized shipments from our three mines increased over to a 90 million ton rate recently. We've not seen any decrease in shipment rates in the last few weeks.

The level of shipments we see in 2013 will depend on the winter heating season. Assuming we get a normal winter and gas prices should stay above the levels with significant PRB coal at displace and utilities will take that contract of tonnages. We are currently talking to a handful of customers about deferring contracted shipments into next year which is normally the case at this time of year. Our shipment guidance reflects our estimated of the total tonnage that we expect to be carried over.

Given the very low 2013 prices during the quarter, we limited our contracting to 3.4 million tons for next year, bringing our total 2013 committed tonnage to 84.6 million tons, of which 74.6 million tons have fixed prices that average $13.58. We’re not excited about the prices of 3.4 million tons with contracts at that but are comfortable with the benefit of having committed sales that let the mines run certainly through the year justify making them.

This year’s low prices will also come through in our 10 million tons index contracts next year. The overall result is that if prices remained at the current low levels, then we’re not expecting any increase in our average realized domestic price over this year. We do still have some uncontracted tons for next year most of which relate to our planned export sales for Spring Creek. As I said previously with the expansion of Westshore we’re targeting around 4.5 million tons next year.

As export prices for next year are currently pretty low, we have only fixed prices for the first quarter shipments. This does give us the chance of benefiting from any rise in export prices during the year. Looking further ahead to 2014, we currently have 54.7 million tons committed of which 43.3 million tons are in the fixed price commitments with a weighted average price of $14.49. Assuming a normal winter with natural gas prices around current levels, I would expect it to take into a mid-year for our coal prices to attain the 2011 levels.

Optimistically, if we have a cold winter, it is quite possible to have a gas price spike that could wash through to coal prices as many utilities could be looking for new tons. We will have to wait to see how the winter turns out.

To sum up, we’re very pleased with our third-quarter performance and are encouraged by the outlook for the full year. Natural gas prices have risen to a level at which they do not displace much PRB coal and accordingly coal share of total electricity generation has risen from April’s lows. Improving shipments and good operation performance have allowed us to raise our adjusted EBITDA guidance slightly. While we will not be giving 2013 guidance until February, I would caution that as you consider your projections make sure you take into account that we’re not forecasting any increase in next year’s realized domestic prices and then current export prices will reduce our export margins next year. At the same time cost will rise due to increased workload at the mines.

That said, I am comfortable that Cloud Peak is coming through a tough 2012 very well and that we’re well placed for 2013. We have a strong balance sheet and we will benefit from any upturn in domestic and international prices that will hopefully occur next year. With that, we’d like to take your questions.

Question-and-Answer Session

Operator

(Operator Instructions) Our first question comes from the line of Jim Rollyson from Raymond James.

Jim Rollyson - Raymond James

Colin, fantastic job on the quarter and again really good cost. Question for you on that, at least as you go into the fourth quarter, because I know next year is still not the – still a little bit hazy. But from the combined guidance the 93 million tons where the three mines you operate kind of implies you’re going to see fourth quarter volumes somewhere in the neighborhood of what you saw in the third quarter plus or minus. Do you think you can hold cost per ton somewhat similar to what you saw in the third quarter or do you expect those bounce back up a little bit?

Colin Marshall

I think Jim, when we look at cost, you’ve got to be very careful with the final quarter costs in that they can jump around by a few things in year end and so I am very comfortable if we get those tons the performance of the mine should be good. I think when we are projecting for that EBITDA range, they are slightly higher per ton but there is – we’re very comfortable that those volumes will help. So I will ask Mike if there is anything you’d add to that.

Michael Barrett

Jim, let’s say fourth quarter costs would probably be along the lines of our year to date numbers so, we’re around about 964 on a year to date basis, and I’d expect that when we look at the full year we will be around about there – for the full year.

Jim Rollyson - Raymond James

And Colin, obviously it depends on gas prices holding up in the winter weather but if those both come to fruition, and as you think about things going into next year, how do you think about demand for PRB coal or with gas prices having recovered are you thinking you will see a pickup in domestic burn for PRB and do you think that, that will lead to an actual increase in volumes coming out the PRB or do you think your customers are more looking to just draw inventories down?

Colin Marshall

Well, I think they are already drawing inventories down. I think we’ve seen that they have come down, so this was down. I think the estimates I last saw were about 90 million tons, which is within the five year range as it were. I think clearly the coal burn has gone up as well with gas prices as we expect because that something is pretty dynamic.

In terms of when it will come through to PRB prices, my guess is that it will take a while because people have got to get through there – they get comfortable with our stockpile positions coming down from a high level which is obviously different to this time last year when they are rising from the low levels. And I think so I am thinking maybe mid-year if it’s just the normal-ish winter. But I would flag that it’s quite possible that if it’s cold winter, then with the amount of drilling rigs coming off of the gas prices could drop appreciably, and that would certainly drive some people to look at and you’re buying of coal. And that will happen at some stage, exactly when I'm not sure but it should happen I guess over the next 18 months, hopefully sooner rather than later.

Operator

Our next question comes from the line of Shnur Gershuni, UBS Securities.

Shnur Gershuni - UBS Securities

First question I wanted to chat about was about your export opportunity. You sort of through cautionary statement at the end of your prepared remarks, I guess where I wanted to focus on, you’re trying to gain more exposure through Westshore. How dependent is it on you on maintaining volumes through there to maintain your overall position in the port, if you run into a scenario where you could have a negative margin, let’s say if Newcastle stays at $75 throughout all next year, would you still be forced to ship just to make sure that you maintain your position, and have to tolerate the loss or you’d be able to manage around that?

Colin Marshall

Well I think if you look at the way we put in place the financial hedges, which I think currently got a sort of pay for benefit to us about $11 million the next year. That’s one of the things that helps it, helps us keep the tons going through Westshore. Obviously the agreements we have do have some take or pay elements within which obviously motivates you to keep shipping coal. And with the rail as well which is quite normal for these sorts of agreements. But I am very comfortable given our cost position, our ability to manage around that the financial hedges, that we're in a good position. I'm encouraged by the evidence, anecdotal and sort of real that the Australian guys costs have really gone up and are changing the dynamic. And certainly seeing the interest in keeping our coal going from our utility customers and their understanding that we only work to lock in the first quarter of the year because of the pricing, all points made to that we will be able to as we did in 2009 get through this period in a way that is lost it. It’s tough market, we might not make much money. I don’t think we’re going to lose our ships.

Shnur Gershuni - UBS Securities

Follow up question just more about the PRB market in the U.S., you contracted tons for 2013. We see gas prices going up and so forth, the volumes are coming down and what not. Is there a hesitation on your part to try and hold back as long as possible to try and gain some sort of leverage with the utilities? And as you discussed that, if you can tell us what your thought process is on the RFP market right now, is it picking up all again, is it average for this time of the year?

Colin Marshall

Well, if you look at it, of the 84.6 million tons, most of those are actually sort of three quarters worth of export tons that we are looking at. So the actual amount we’ve got to sell domestically. I think we are pretty sure we’ve got to identify homes for it. I like to get to a position where we effectively sold after the end of the year. I’d actually like to be oversold if it were, but I don’t think that’s realistic given where the market is. So that we can then run the mines effectively and efficiently, and I think that gives you a bigger benefit than trying to chase – leaving yourself out than trying to chase new tons which every now and then induce spike. But I think we can – we realized those in the forward prices we achieved.

So when we look at it, it’s definitely a trade-off between holding back and going for a base level of tonnage that will let us know where we are running the mines. I am comfortable that we will always have the ability for to get 1 million or 2 million tons out if the price spiked. But often the smart thing to do is actually to let the prices go up and contract that in future years. So there is – every now and again – I am happy we only locked in a few tons this quarter. I think there were tons we felt we needed and some of those actually came with contracts in 14 and 15 which made them more attractive to us. Given where we are, when price is low, you always tend to about locking in certainly for long periods unless they are attractive in out-years. So there is lot of different things going into but I am comfortable with the position we are in and that let us run our mines in a stable manner next year.

Shnur Gershuni - UBS Securities

And in terms of the RFP interest out there right now, is it –

Colin Marshall

There is some out there. It’s actually pretty thin. The utilities aren’t putting out massive amounts of our fees because they’re burning off their stockpiles and they are also, I think, hesitant given the swings in the gas price to lock up too much. Obviously that leaves them exposed if there were to be a cold winter and a lot of gas going to domestic heating. But we will have to wait and see how that plays out. Equally they could be waiting to make a killing on low-price gas if there is a similar winter to last year which hopefully there won’t be.

Operator

Our next question comes from the line of Andre Benjamin, Goldman Sachs.

Andre Benjamin - Goldman Sachs

My first question would be, could you please discuss your plans for the recently acquired reserves, any evolution in plans of kind of when you are thinking about when that mine will get probably developed? And is it really still just a binary issue of whether or not the Asia export terminal gets built or are there some other opportunities you’re seeing as you are talking to your customers?

Colin Marshall

In terms of the Youngs Creek reserve and the way we are certainly looking at it is more of as adding reserves to what will become a Spring Creek complex. Obviously when we’re looking at developing that, the key drivers for us are the port terminal capacity. First of all, we will likely take a few years even to get permit, we said we want to go today, it’ll actually take a few years to get everything lined up to get coal coming out of there. So we are using that time to make sure we match it with terminal development. If the significant terminal capacity coming on in four or five years, then it would drive us to go in there with, I don’t know, 10 million ton mine or so, and we’ll be able to optimize it.

If things are lower, we are actually looking for the quality, the lower sodium coal there to supplement our domestic market, then we would go in with a smaller operation in three or four years. This is when we get a permit. So I am afraid it does depend, it will evolve. The one thing I am sure is even if there's no additional terminal space, it was a good purchase in that it gives us options on quality air permit, location and quality options at Spring Creek. So all of those things underpin the purchase in our mines and there is tremendous upside given that -- it gives us the ability to match our production and capital spend to more development as that comes along.

Andre Benjamin - Goldman Sachs

And then I guess the fact that you have been pre-asked about the long lead time and given that develops, so it’s effectively I would say kind of sunk capital now. How do you think about where you need to think about PRB prices being long term as you continue to bid on these LBAs and look at other development opportunities you think like near term – I mean additional mid-cycle price of $13 to $14, is this good enough or do you need to see something higher than that to continue to try to move forward with some of these projects?

Colin Marshall

The first thing, I would – if you think about the Youngs Creek acquisition as similar to LBA, which typically we buy on a 5, 10 years before we mine the coal and there is no difference to that. So the timing isn’t any different for this one. I just want to say well basically it's like an LBA that has the upside of being ideally placed for the export market, you wouldn’t be far wrong, the decent way of thinking about it.

In terms of the pricing, obviously it’s 13, 14 bucks, certainly the weather curve is going forward a few years. Yeah we got a good business. And if you look this year what we got, realized prices at just over 13 bucks and we had record EBITDA. So the business works at those levels. Obviously it's a lot better if it’s 15 and 14. But going forward that we are on a sound footing.

Operator

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

Mitesh Thakkar – FBR

My first question is just on the cost side of the equation, great job on the cost this quarter. When I look at year over year again, costs were holding pretty steady. How should we think about long term changes to the stripping ratio, and how should we think about annual inflation playing into the picture to –

Colin Marshall

Well, I think the way we normally characterize it, as you know in the Powder River Basin coal basically drips away to the west in the southern Powder River Basin and therefore your costs go up steadily, and as you hold this, this gets longer as you mine away from your load outs. And that’s true for everybody. I think you have those workload costs that increase, and then you also have other things that go, whether it’s labor, health costs. I think next year explosives are going to go up a chunk more than inflation. So you have different things going up.

The way we try and give sort of guidance I guess for when you're looking forward Mitesh too, is if you look at our underlying costs without the royalties which is about 30% of the selling price, then you take out what you would've assumed for diesel, typically about 9% of our costs, I think in our presentation. The rest of the underlying costs are going to go up somewhere between five and 8% typically if look back over several years. That sort of trend going forward, we will obviously try and push you down towards the fives but we’re not always successful. So I think it's somewhere in that range is the way we consider it. And if we are holding there, then that bundle of things, workload and other inflation tends to work out, that’s what we face.

Mitesh Thakkar – FBR

And just a word on the contracting side, you mentioned you had some indexed contracts. Can you give us a sense of what kind of quantity we are looking at and what is the timeframe you're looking at to lock in those contracts? Is there a specific time by which you need to finish contracting those in that sense?

Colin Marshall

Domestic contracts, I said there is 10 million tons of those for next year. There is a range of different pricing there but I think for your assumption that they take some fixed on the last quarter’s average OTC prices of other on six months. And so there is a range of different things in there. Typically if you look at the previous six-months OTC prices, average OTC price is roughly our too far along. So unfortunately that doesn’t mean that at the moment some of those are being – the weighted average is being drawn down by the low prices in the last six months. And that's – just this last year they were being ramped up by $17 we were seeing, this year, they are being drawn. I am afraid that's just the way the index contracts work. So it will be weighted average of what's going on this year. We will see in next year.

Operator

Our next question comes from Lance Ettus, Tuohy Brothers.

Lance Ettus - Tuohy Brothers

Just wanted to ask you the more reports that’s being developed by Embraer Energy, I think it’s 8 million tons, and I think that’s on track to kind of be ahead of the other two larger ports because there is a little bit of difference in the environment assessment. Just wondering I guess if you guys are already currently involved with talks, I guess more wondering if how these talks progress, do they have to sort of – once they get the permitting done and they speak to a coal producers and look for a long term contract, or is it early in the process I guess? How does that kind of the timetable work?

Colin Marshall

Okay. Lance, if you forgive me, I won’t say anything about the Embraer pool, because you would not be aware, we are actually in litigation with them. So I think it’s probably best if I don’t go anywhere near that. In terms of ports and how they go, look, the different port developers at different stages as they go forward, they want to talk to potential throughput customers, they’re obviously talking to the utility and they are putting the pieces in place as we move forward. So there is a lot going on as you get sort of – as things firm up and people tend to want to start rising the MO commitments, always everything depends upon when you get terminals and the ability to actually go ahead and when you do, we’d expect to get into agreements more likely to have, make sure that the term and take or pay and sort of fixed costs with escalated, I am not – we’re not at that stage with anyone yet because that ports haven’t developed that far. But we are – we and others that I am aware of are all in talks as these ports are being got out to move forward.

And you can see all the effort that’s going into the port development and overcoming or countering some of the opposition because there is a lot of effort from all the producers, the railways and the port developers going on at the moment.

Operator

Our next question comes from the line of Brandon Blossman, Tudor, Pickering & Holt

Brandon Blossman - Tudor, Pickering & Holt

Let’s see. How about – just on the 14 contracting, Colin, could you give us some color as to when that was done, what if any was done incremental quarter to quarter?

Colin Marshall

I don’t actually have the numbers in front of me for that. But there has not been that much activity for ’14. And I think what you are actually seeing is that we got what 55 million tons contracted for ’14. What we’re actually seeing particularly with the very low gas prices and the uncertainty regulations is that utility customers are less comfortable buying forward over several years than they used to three or four years ago. We used to sell forward over effectively five years. I’d say now it’s more like three and certainly this year we have not contracted the full sort of 90 odd million tons that you’d obviously want to contract each year to sort of make sure we sell 90 million tons in the next year.

And that we expected given the uncertainty in the market and the very low prices, the ability to switch to gas. So I think we are obviously adjusting our strategy to fit with that. Eventually the utilities do actually have to come out and buy the coal, and they are still very well-placed. So there will have to be activity at some time. One of the things that sort of sometimes quite nice is that when the price is the lowest often is when the utilities actually go out to lease coal which seems counterintuitive but it sort of happens that way. As they go out to some more than quite possible prices will rise, and in some stage they will have to for a bit of coal for ‘14 and ’15.

Brandon Blossman - Tudor, Pickering & Holt

How about on the cost side? It looked CapEx trend again for ’12, is that going to recoil to some degree in ‘13 and then kind of a offshoot question on SG&A, little bit of spike in this quarter, is that the new run rate or should we see it back down another couple million dollars on a go forward basis?

Michael Barrett

Yeah, Brandon, I can take those. On the CapEx side, we have been able to push a number of project out this year. So we have watched CapEx very, very carefully and the rise in the operations and maintenance groups are doing a tremendous job from the perspective of the condition monitoring and maintenance programs that they run, which has extended equipment lives and enable us to push some of those projects out. As we look forward to next year, we always look to start off with the CapEx numbers based on all of the projects that we expect and then as we go through the condition monitoring what we are generally able to see extended equipment lives and CapEx being able to be more controlled as the year goes through.

So it is an evolving process and one that we will watch again very carefully next year. But it certainly reflects very, very well on the operations. In terms of the SG&A costs, we have seen a little bit of a spike in the third quarter. A few things have gone into that. We put some particular support around the port development opportunities in the Pacific Northwest and also up into Canada as well, where there is a number of different port opportunities around the Vancouver area. So there is a little bit of additional money going in there which we are very comfortable with given the importance and the leverage of the port opportunities for all the business. Overall as we look at the year for SG&A I expect it’s going to trend up a little bit compared to where we were last year and I would expect that trend will probably continue, but it's certainly not blowing out by any stretch of imagination. And we are continuing to watch those costs carefully.

Colin Marshall

The other thing I would add on the SG&A is the extra work – the extra money really is going into development things that could tail very big. So I would hope that you'll trust us on that and somebody you will spot the smartest money we spent in long time.

Operator

Our next question comes from Brian Gamble, Simmons & Company.

Brian Gamble - Simmons & Company

Wanted to kind of follow on that thought in regards to increased export opportunities outside of Pacific Northwest, you mentioned Vancouver but obviously really it’s still up there to some degree. Has there been any change in attitude with the rails because of either the softer end markets or the availability and prices of PRB coal, and have you seen them change their tune as to what they are asking for to get coal up, or north of its current destination?

Colin Marshall

I’d have to say certainly not enough to overcome this year distance up to Italy. So when we got coal through there, it’s good prices on there way up to 120 bucks or whatever and obviously now that near term plus 280. We overcome that with the rail. So I think we’re optimistic that – we put the coal through though. We didn’t make a great deal of money on it because – but we learn an awful lot about logistics in there and that happens. I think we will be ready to go in when the prices rise to a certain level assuming that three rail whole, they want to do it and that – as the port’s got capacity. But at the moment, I’d say that unfortunately the Newcastle sort of makes that, it’s not something that’s they’re close to being in the money.

Brian Gamble - Simmons & Company

And then little bit of a speculation question, Colin, I know you don’t necessarily elect those, but when you looked at market this quarter and thought about what you guys that actually got price for next year, do you think that was a normal share of what was actually priced, what do you think, because you may have been asking for higher prices than some, but there may have been some coal that was priced that you would normally have shot at, and maybe some people were under cutting you because of various stuffing into next year?

Colin Marshall

I suppose I will give you the sort of same flavor, my answer is normal. We bid on – obviously we didn’t have the RFP that came out, some of them we won and some of them we lost. And on a couple of them we got – through the process we found out what we’d understand the price was that you are under cut – I don’t want to go there. So there is a range of different prices, presumably we were the lowest bidder on some but far from all, and I am comfortable with that. And I’d say we sold those tons that to put us in a good position for next year, we’re very nearly there. And that’s where I like to be at this time of year.

Operator

Our next question comes from David Gagliano, Barclays.

David Gagliano – Barclays

I wanted to ask just a bit about – couple have already been asked. So on the unit cost line, I am just curious – I think I thought I heard you say near term the costs are going back into that 69, 70 range for Q4. And I am just wondering if that’s correct. I am wondering what’s behind that if volumes sequentially are going to be flat?

Michael Barrett

David, as we look at the Q3 results we obviously had a very, very good quarter to come in at $9.14. Part of that reflects the fact that we had a slow second-quarter, so we had some good uncovered coal available as we started the third quarter. That enabled us to be shipping coal with some low cost surrounded. We’ve obviously just had a very strong shipping quarter in the third quarter. So we are starting with a little bit less inventory as we come into the fourth quarter.

We’re also seeing that whether the level of volume actually stays quite as good as it was in the third quarter. We'll obviously have to see how the year end plays out. But as we look at the full year costs to be around the 960 mark for full year is a roundabout where we’re expecting things to flow out at the moment, yes.

David Gagliano – Barclays

And along the same lines, for 2013 your costs, based on what Colin said you kind of do the math on 60% of 5, 8% somewhere, flat to little recovery on the 30% on the obviously the tax if prices do come in lower all in average basis. That result call it 3% or 4% increase, is that based on that 960 number and is that math about reasonable for next year’s unit cost?

Michael Barrett

We obviously haven’t given guidance for 20 13 yet but I think that the logic that you are using make sense, yes.

David Gagliano – Barclays

The only other question I had for the 14 contracts. Just to follow up on the questioner earlier. How much of that 43 million tons that’s committed in price, how much of that – I know you don't have an exact number but just ballpark. How much was actually signed this calendar year versus say last year?

Colin Marshall

I can honestly say I haven’t got that information in front of me. I would say probably not that much because this has been a slow year for contracting. Sorry, I just don’t have it.

Operator

Our next question comes from Chris Haberlin, Davenport.

Chris Haberlin – Davenport

Given the weak price environment that we’re in currently, I know you’d all like to go into your fully committed but would you consider going into 2013 less and fully committed if you see pricing rising in order to realize some of that upside?

Colin Marshall

I think the way I would characterize it is that we’ve only got a – domestically most of our un-contracted tons are export ones which is I am very comfortable with that position. And then domestically we’ve only got a few tons and a few million tons to go. We’ve sort of got a home for those. We’ve identified not to depend on the pricing at the time of those get contracted. But we do have the ability ideally, I’d like to go into year over -- over sell and then manage that through the year. We’re not going to do that, I wouldn’t think this year because of the environment of 2013. And so that does give us some ability to sell a million or two of tons and manage the operations around that. But as we said many times we think as long as you get to a position where you’ve got a pretty idea where you’re going to run your mines and they’re going to run steadily and smoothly from quarter to quarter in terms of production, that gives us tremendous advantage on the operations we believe and that the outweighs trying to hold tons back for price spike that may or may not occur.

Chris Haberlin – Davenport

And then on the interest expense you had a pretty nice step-up in Q3, can you talk about what’s going on there and then just kind of give us an idea of is that a good run to use or should we see a step-back lower to kind of levels that we saw in Q1, Q2?

Michael Barrett

Not certainly Chris. The interest expense for the third-quarter is a good run rate to use as we look going forward. You will recall that prior to that, we were capitalizing a certain amount of the cash interest. So some of that was going to the balance sheet which is the previous quarter was that much lower, because we have put one of the projects that it was being capitalized against because we put that into service, we’re not longer capitalizing that interest which is why you see the step-up in interest expense. So yes the third-quarter is a good run rate to use going forward. And not if that makes any change to cash interest side of things.

Operator

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

Richard Garchitorena - Credit Suisse

My first question, just on – you mentioned hedges I guess have some on Newcastle, and I want to touch, you’ve also put hedges on in the oil. Can you remind us how much you have in each and then also I know in the past you give us sensitivity around your – with the oil every time there was change in the oil price was roughly 10 and that became I believe – how is it that today?

Michael Barrett

On the oil hedging, what we've done is continued our program with costless collars. So we’ve got floors and ceilings in place. The ceilings are roundabout $107 on average and the floors are roundabout $67 and that’s based on WTI oil price. So as long as the oil price is floating within those ranges we’re not actually seeing any need to exercise any of the hedge positions that we’ve got in place. So from that prospective, we are seeing exactly the same sensitivity of our diesel costs to the oil price within those ranges. If we step outside those ranges, then obviously we will start getting benefit from the hedges.

Richard Garchitorena - Credit Suisse

And then I guess one other question it looks like that you have 6 million tons additional fixed priced tonnage in 2013 versus last quarter. And when you back into it and it implied in the press about just under $11, around $10.70. Is this – are there some contracts that that’s just the rollover or is that a function of where pricing ends right now?

Michael Barrett

That’s a function of three things – well the pricing for 84 and 8800 and also we have some fixed contracts that during the quarter would have fixed for next years. So it’s a mixture of those things and if you look at where – and obviously the ratio of 84 to 8400 Btu coal if you look at those things, then yes that outweigh the weighted average – the average of it turns out for those 6 million tons.

Operator

Our next question comes from the line of Dave Patch, JP Morgan.

Unidentified Analyst

Just coming back to the prior question, with the 10.70 – I mean it was 10.70 in the quarter before that. So what would actually cause to move up? Is it the coal winter or is there something else that would lead to that increasing?

Colin Marshall

Obviously little cold caused to go up, our prices to go up. And yes, for that I think you need a normal winter, we actually do need a cold winter. A cold winter could do it soon, a normal winter I think the prices would start moving steadily up and one of the things that’s quite interesting to consider Dave, you think back to exactly the time of the year the PRB price was $16 or $17, gas was $30.80, it was entirely different. And stockpiles were actually about the same level. That stage that we’re going up rather than coming up.

At the moment, the bid big difference is the coal price and that's because we’ve gone, we went through that extraordinary warm winter stockpiles went up and gas went down. We all know what happened. But I think if you actually look, things are actually set to support lot higher coal prices. You just actually got to work through winter – the utilities should see the burn, obviously with people reducing their coal production, there’s been plenty of announced reduction cuts. That all the things are in place for the price to go. Now we just need it to work through and the factor there that would make – would speed that up would be a cold winter but a normal winter will make it happen.

Unidentified Analyst

Payments on the federal coal leases, you have 129 million scheduled for this year, what would that be in 2013 and ’14 based on just current holds?

Colin Marshall

The payments for 2013, it will be $79 million in instalments and in 2014 it will be $69 million.

Operator

Our next question comes from Lucus Pipes, Brean Capital.

Lucus Pipes - Brean Murray

Colin, you mentioned the possibility of appreciably higher natural gas prices, PRB coal price et cetera. Now let’s say these were to happen, would you be able to increase production in response to such pricing movement? If so, by how much and if you can’t, how would you expect to capture the price appreciation in your forward contract?

Colin Marshall

Lucus, as I said before if prices go up, we will – we might be able to find another million or two tons for next year because obviously we’ve reduced production from what 96 million or something like 95, 96 couple of years ago. So we’d be able to see how we do them. But the real way we capture the price is not on one or two million tons in year, it’s on the hopefully 90 million tons we sell spread forward over the full years. And what you typically see is when the PRB prices near term go up, the forward years go up, sometimes more dramatically, we would be selling into those. And as I often said I’d rather than throw, sort of me having enough try and chase a million tons in here with associated disruption to the operations and increased operating costs, I’d rather chase a higher price on 90 million tons in after years and that’s why we capture the leverage and that’s what we have done in previous years.

Lucus Pipes - Brean Murray

And then as we think about kind of the use of your cash back, could you walk us through your priorities on that front?

Colin Marshall

Sure, as we sort of said in the standard investor presentation, the first thing to do is run the operations as well as we can to maximize the cash, which we are trying to do. Then obviously the next thing is looking at the LBAs, the residence we need to position ourselves to maintain that cash flows, I sort of consider buying the raw materials of business that we are. Beyond that, we are looking for anything to do with export opportunities, which is where with the particular traction of Youngs Creek reserves around Spring Creek to actually position us there. Anything to do with exports, whether it would be those reserves, other opportunities and then beyond that we look at noncontiguous things. Typically we are comfortable in northwest, the U.S., the west surface mining, lines track mine operation. But obviously we look at an awful lot of things, and we just make sure that we think we can capitalize and maximize the value of anything that does come along.

But like everyone else, we look at many things and you’ve just got to be disciplined to grab the ones that make sense and obviously Youngs Creek makes great sense to us.

Operator

Our next question comes from the line of [Arjun Pai], Morningstar.

Unidentified Analyst

I am going to ask about something that was asked earlier about the CapEx projections that’s coming out to about $0.60 per ton for 2012 which is pretty low by industry standards and lower than your historical average. So is this reduced CapEx for 2012 just a temporary measure to deal with the low prices and is that the type of CapEx spending we can expect going forward?

Michael Barrett

Gene (ph), we’ve been able to reduce some of the CapEx this year as we have extended equipment lives and pushed some projects out to next year. But I’d also point you to the previous couple of years, we brought quite a lot of CapEx forward into last year, so we had two additional shovels that came in last year and also a truck fleet that we paid for in in last year as well. Some of those were quite opportunistic, particularly one of the shovels we were able to buy in the second hand market and when you see good quality equipment like that coming out at a good price and with our maintenance guys saying that we’re able to refurbish and get equipment into good shape, then we like having the strength from the balance sheet to be able to go-ahead and make those parcels of acquisitions. So that puts us in good shape.

So I think it’s a little bit misleading to take CapEx on just one-year basis and if you look at over a three-year average we’re very comfortable with where we are.

Unidentified Analyst

And my second question is have you guys seen any – has burns by utilities maybe using some more expensive chord that we’re looking to shift their mix more towards PRB during the quarter?

Colin Marshall

I think this year, given where we are coming from that, there haven’t been many domestic tests but we’ve had some international ones, obviously we are encouraged by those. But realistically what’s happening now is where people who were looking – who are burning a lot of PRB coal is set up for it, the impact this year was switching to gas, when it was half the price it was now or lot lower. And they are now switching back which is what we are seeing. But in terms of actually going forward, and putting more new tests announced now, and to me that’s not a surprise. I am very encouraged that actually people who can burn PRB cheaper actually are doing and that’s reflected in the stockpile measures. So I will take comfort from that just now.

Operator

Our next question comes from Wayne Atwell, Global Hunter Securities.

Wayne Atwell - Global Hunter Securities

Actually all my questions have been answered.

Operator

Our next question – our final question comes from Mark Levin, BB&T Capital Markets.

Mark Levin - BB&T Capital Markets

Just two very quick questions, the first is, is if Newcastle prices remaining at current levels, how much margin per ton contraction would you expect on the export tons for 2013?

Colin Marshall

Look, the export tons say, for ’13, there were about $93 and last year we were doing 110, 115. So you’d get that much times out percentage which we typically get which we don’t disclose. But you’d be looking at a significant amount, which is what I was lagging that lower Newcastle prices do make a difference.

Mark Levin - BB&T Capital Markets

And then second question is just when you look at kind of forthcoming LBAs in 2013, what is – is there anything out there – there are a few that are out there that could be of interest to you guys?

Colin Marshall

We’ve got the – if you look in our investor presentation, you can see we’ve got the two LBAs which is being split into north and the south. We are currently expecting that to come up sometime next year and that won’t reflect for a long time. So that’s – the thing is they certainly want this sort of adjacent to our business, our mines and all the details are in the investor presentation.

Operator

Now I’d like to turn the call back over to Colin Marshall for closing remark.

Colin Marshall

Okay. Well, thank you very much for your interest in Cloud Peak Energy. Obviously we’re very pleased with the quarter and where we’re positioned to go forward into ‘13 and obviously beyond. Our business is well placed for the rest of this year and next. We’ve got the strong contract position and the balance sheet. So quickly frankly we look forward to updating you in February and hopefully we'll have a cold winter and quite a bit of skiing and things will go in our favour that we are well placed regardless of how the winter turns out. So once again thanks for your interest. And good afternoon.

Operator

Ladies and gentlemen, that concludes the presentation. Thank you for your participation. You may now disconnect. Have a great day.

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