Arch Resources Inc (ARCH) 2009 Q2 法說會逐字稿

Good day, everyone and welcome to this Arch Coal Inc. second quarter 2009 earnings release conference call. Today's call is being recorded.

At this time, I would like to turn the call over to Mr. Deck Slone, Vice President of Government, Investor and Public Affairs. Please go ahead, sir.

Good morning from St. Louis. Thanks for joining us. As usual and before we begin, I want to remind you that certain statements made during this call, including statements relating to our expected future business and financial performance, may be considered forward-looking statements pursuant to the Private Securities Litigation Reform Act. Forward-looking statements by their nature address matters that are to different degrees uncertain. These uncertainties, which are described in more detail in the annual and quarterly reports that we file with the Securities and Exchange Commission, may cause our actual future results to be materially different than those expressed in our forward-looking statements.

We do not undertake to update our forward-looking statements, whether as a result of new information, future events or otherwise, expect as may be required by law. I'd also like to remind you that you can find a reconciliation of the non-GAAP financial measures that we plan to discuss this morning in our press release. A copy of which we posted in the Investor section of our website at archcoal.com. On the call this morning we have Steve Leer, Arch's Chairman and Chief Executive Officer, John Eaves, Arch's President and Chief Operating Officer, and John Drexler, our Senior Vice President and CFO. Steve, John, and John will begin the call with some brief formal remarks, and thereafter we'll be happy to take your questions.

Steve?

Good morning, everyone. And thank you for joining us this morning. Today Arch reported a net loss of $0.11 per share, and generated $76 million in EBITDA in the second quarter. As expected, our financial results were impacted by four long haul moves during the quarter, as well as further volume reductions due to the unprecedented decline in coal demand. However, we believe that we have reached the bottom of the current coal market cycle. Looking ahead, we're beginning to see signs of life in the economy, and expect industry fundamentals and our performance to improve as we progress through the remainder of the year. These signs of life began to show up during the second quarter, and our results were better in the last half of the quarter, due to continued progress on cost containment efforts, tight management of the operations, and small incremental sales to some customers. And we would expect to build on that performance in Q3 and Q4.

Of course, even with those encouraging signs, we expect a significant overall decline in coal consumption for electric generation in 2009. Unfortunately, coal has suffered the full brunt of this economic recession. Weak industrial activity in the Midwest and in the South has driven down base load power demand considerably while performance of other base load fuels, namely hydro and nuclear, has been relatively strong through May. As a result, coal has been affected disproportionately. Natural gas has also displaced some coal at the margin. But we expect this to be relatively a short-lived phenomenon, as the rig count continues to decline from the peaks of last Fall and as investment across the space pulls back. We would expect the natural gas fundamentals to correct as well.

The good news is that just as coal has underperformed the other fuels to date, we believe it sets the stage for coal to outperform the other fuels once manufacturing activity even marginally begins a sustained increase. Supporting that fact is a significant underutilization of the coal generation fleet at present. We currently expect 2009 utilization at the coal plants to fall below the 2001 level of 69% versus a high water mark this decade of 74%. That drop of 5 percentage points equates to roughly 80 million tons of coal consumption. But once base load power demand reasserts itself, as we expect it inevitably will, the existing coal fleet should quickly ratchet up output and reclaim lost market share. Moreover, the build-out of 16 gigawatts of new coal fueled power plants in the US continues, and will add an additional 55 million tons of coal consumption annually by 2012. With the PRB particularly well positioned to supply these new plants.

Needless to say, our optimism about coal's outlook isn't confined to US shores. More than 150 gigawatts of new coal fired capacity is being planned around the world. These plants should further expand global coal use significantly. In the past eight years alone, world coal has grown by 41%, making coal the fastest growing primary energy source on the planet. Over the long term, energy fundamentals remain firmly intact. Global population is projected to reach 8 billion people by 2030 with 75% living in emerging economies. US population growth is forecasted to be significant as well, increasing by nearly 25% to reach 375 million people over the next 20 years. Even with significant energy efficiency programs, population growth will drive the economic activity around the world, resulting in long-term demand pull on all available energy sources.

Turning to the metallurgical markets, the green shoots of the recovery are particularly apparent. It is increasingly evident that the global and domestic steel markets are beginning to recover. For the first time since last November, US crude steel capacity utilization rose above 50% for the last two weeks. These data are encouraging, especially when you consider the inventory destocking that took place during the first half of the year. Also, China's crude steel production has been growing since April, with June's production levels representing close to a 40% increase from the low experienced last October. It's also promising to see the signs that the end demand may be driving the increased steel output, as strong vehicle sales in China for the first half of 2009 have put the country on pace to surpass the US as the world's largest auto market this year.

Looking ahead, a sustained recovery in the Asian economy will increase demand for sea born coal. In particular, China, who was once a net coal exporter of more than 90 million short tons of coal, as recently as 2003, is on track to become a net importer of this year of more than 40 million tons in 2009, given record coal imports in May and June. Also, well recognized constraints on sea born supply growth in Australia, Indonesia, South Africa, and Vietnam are still there, including shipping cues at the port of Newcastle, [Reins] and other issues at many of the other countries. As shifts in global supply flows continue, the US can step in and fulfill the potential shortfall in the sea born coal market.

Moving to supply, one of the most encouraging signs of this year has been the swift pace of supply rationalization. Domestic coal production has declined 5.6% year-to-date, and that rate of decline is accelerating. In fact, we expect US coal production to fall by more than 100 million tons in 2009. The closure of some of the industry's highest cost mines should result in a far healthier supply demand picture moving forward. Rationalization in Central Appalachia is particularly noteworthy. According to EIA estimates, Central App production fell by 8 million tons in the second quarter of 2009, compared with the same quarter of 2008. This drop is much larger than the 2.5 million tons production decline that occurred in the first quarter of this year.

We also expect the ever more difficult permitting landscape in the region to take a toll. Our internal forecast suggests that Central App's annual production run rate will decline from 235 million tons in 2008 to approximately 180 million tons by the fourth quarter of 2009, with potentially further run rate declines into 2010. Additionally, southern PRB production came in at below 100 million tons for the second quarter of 2009, implying a run rate that is more than 50 million tons below 2008 levels. In fact, the last time the PRB's quarterly production fell below 100 million tons level was in the fourth quarter of 2005. As a result, we expect domestic production to undershoot consumption over the next four to six months. With stockpiles poised to come down more aggressively as we cross into 2010.

Let me close by commenting on some recent developments in Washington, namely, the recent passage of the Waxman-Markey bill in the US House of Representatives. We have significant concerns about this bill, but we are encouraged by the fact that it contains more than $100 billion worth of funding for carbon capture and storage technologies, which hold the key to using coal, natural gas, and oil in a more climate-friendly way. This level of funding shows a real commitment by Congress to the future of coal and demonstrates an increasing awareness that coal must play a critical role in meeting American, and indeed, the world's future energy needs. That being said, we believe there is a great deal of of work still to be done in the Senate in order for this Congress to address climate concerns while protecting our nation's jobs, our economy, and security interest and the American consumer. I believe the Senate is well aware of this fact, and I believe the policy discussion is moving in a more constructive direction. Arch remains supportive of reasonable and prudent climate legislation, and we will continue to offer our support and input wherever possible and appropriate.

On that note, I will now turn over the call to our President and COO, John Eaves, to discuss Arch's quarterly performance in more detail. John?

Thanks, Steve. We believe that we're currently bouncing along the bottom of the market and are taking steps to prepare operations for better days ahead. As indicated in our release, we have further reduced our sales volume expectations for full year 2009. This slight reduction reflects our decision to reduce production at West Elk, due to continuing coal quality issues and the impact of pushback of tonnage under existing sales agreements. Since generator stockpiles were high heading into the summer, and with the relatively slow start to the summer weather thus far, we've had a few requests for deferrals or delays in deliveries. In some cases, we worked with customers to add length or tonnage to contracts or have found other mutually beneficial ways to preserve value occurring to Arch. Looking ahead, we believe the potential for additional customer pushback should diminish in the second half as coal production and consumption come back into balance.

Also during the quarter, we executed on our previously announced plan to scale back production in each of our regions. We idled another drag line and associated equipment in the PRB, and in Central App we eliminated or reduced ship links, and reduced the workforce. And in Western Bit, we reduced head count at all our operations was the majority of the cuts coming at West Elk due to decreased demand for mid-ash coal in a weak market. We believe the decision to reduce volume targets and capital spending levels are in the best interest of the Company and our shareholders over the long term to preserve value of our low cost reserve base until the market conditions recover. From a marketing perspective, we're starting to see a modest pickup in interest from our met coal customers, both domestically and abroad, and have placed a small amount of tonnage in the last month. We remain on target to place between 1.5 million and 2 million tons of met in 2009.

We're also expanding our relationships with customers in Asia-Pacific rim who are interested in diversifying their supply sources to include PRB coal. While some planned shipments to Asia have been delayed due to the weakness in global markets in the first half of the year, we have lined up another boat off the West Coast for the third quarter and continue to be encouraged by this developing market's long-term growth potential. Based on our current rates of production, Arch has close to 85% of this volume committed in 2010, and roughly 40% committed in 2011. During the quarter, we signed some contracts in the PRB and Central App for 2010, 2011, at significant premiums to second quarter average spot pricing. While not wildly exciting, these commitments will reduce some of our sales exposure in the near term. However, we have retained the capacity necessary to capitalize on the next market upturn in a significant way.

On the cost side, we continue to focus on aggressive cost control and mitigation efforts across the organization. Overall, we've been successful in reducing our total dollar cash costs across all regions by nearly 12% during the quarter, a significant and positive achievement. However, it was not enough to offset the impact of lower volume levels in some regions. In the PRB, we lowered our cash cost per ton in the quarter, despite an 8% reduction in volume. In particular, we reduced all variable cost inputs of production in line with our lower volume levels. We've also reduced labor cost through attrition, contract reduction, shortened work schedules, and the elimination of traditional summer labor. In addition, we've made cuts to major expense categories, such as parts and supplies, and repairs and maintenance to calibrate our reduced volume expectations. All these efforts have helped to offset the impact of reduced production at the mine and higher hedged diesel prices during the quarter.

In Central App, costs are clearly being affected by reduced volumes across our operations. We also incurred severance costs related to the workforce reduction at [Cumberland] River during May. In Western Bit, our highest cost primarily reflects the impact of three long wall moves in the quarter. Looking ahead, we anticipate that our all-in cost in the region will trend down in the second half but do expect the full year range to be between $26 and $28 per ton driven by lower volumes at West Elk. As discussed, the challenges at West Elk are market related. portion of the mine's production is higher ash content, and cannot adequately placed, given the weak market conditions. In the near term, we are addressing this issue by slowing the advance of the West Elk long wall to manage the amount of mid-ash coal that currently does not have a market and must be blended into our primary product. Slowing production at West Elk will cost Arch an estimated $50 million to $75 million in operating profit during 2009. At the same time, a slower advance rate will grant us time to design and build a small preparation plant at the mine, which we believe is the best long-term solution. Currently we are completing the planning and design phase of the project with a goal of having a small plan up by mid-2010 at a capital cost under $30 million.

Looking ahead, we expect improving financial performance in the back half of the year. Our low cost and geographically disbursed mining operations as well as our strategic reserve base will help us weather the market trough and position us to capitalize on the inevitable turnaround in energy markets. Let me close by congratulating our operations for another strong performance in safety and environmental stewardship. Even in the midst of all this challenging market environment, the men and women of our operations have remained sharply focused on these essential areas of performance.

I will now turn the call over to John Drexler, Arch's CFO, to provide an update on Arch's consolidated financial results. John.

Thank you John, and good morning everyone. As we discussed in our first quarter call, we have taken steps to match capital spending levels with our reduced volume levels and recession driven weak market demand. This judicious approach to our capital program was clearly evident in the second quarter as capital expenditures totaled just $55 million, Arch's lowest quarterly CapEx level in more than four years. We continue to sharpen that focus still further. In fact, we've cut our forecasted 2009 CapEx levels by roughly $190 million from last year's levels, and believe we can maintain these reduced spending levels for as long as current market conditions prevail.

Turning to the balance sheet, cash on hand increased nearly $23 million during the quarter, and debt levels declined approximately $8 million. Our debt-to-capital ratio at June 30th was 45%, essentially the same as the March 31st ratio and consistent with our expectations. Liquidity at the end of June was $476 million, consisting of cash on hand of approximately $51 million, and availability under our revolving credit facility of $425 million. Next, I'd like to briefly discuss income taxes and how they impacted the quarter. As indicated in our guidance range, we anticipate recording a tax benefit for the year, primarily resulting from the effect of percentage depletion on our income taxes. The accounting literature for income taxes requires us to apply our forecasted annual effective tax rate to the year-to-date results. And in this case, the result was counter intuitive for the quarter. A small expense recorded in the second quarter despite the pretax loss. We expect that the expense recorded in the quarter will be reversed over the second half of the year.

Finally, let me now discuss our outlook for 2009. We expect the following. Volumes from Company controlled operations to be in the range of 114 to 118 million tons. EBITDA in the range of $403 million to $462 million. Earnings of $0.25 to $0.55 per share. CapEx of $160 million to $170 million. Reserve additions of $130 million to $150 million, including our final LBA payment in the PRB. And with respect to income taxes, based on a midpoint of our guidance range, we would expect a small tax benefit for the year, primarily due to the impact of percentage depletion on our pretax income levels.

Going forward, we plan to further intensify our efforts to control costs, minimize our capital spending, and tightly manage liquidity. We expect to maintain our strong financial footing and to emerge from the current market environment as a significantly stronger company. With that, we are reading to take questions. Operator, I will turn the call back over to you.

(Operator Instructions). And we will take our first question from Shneur Gershuni with UBS.

Hi, good morning, guys.

Good morning.

I'm not sure if you can answer this question, but I was wondering if you could sort of give us an update the respect to Jacobs Ranch and kind of where it sits and where you are with Rio and so forth.

You're right, we can't answer much. The FTC continues with their review of the second request. We think we've substantially meeting all of their information requests, and we continue to be optimistic that they will determine that the transaction is pro competitive and are hopeful for a third quarter close.

And so both parties remain committed to the deal?

As of today, I know Arch is committed.

Okay. Just a follow-up question. You guys have shown some great discipline. You've taken down production in the PRB and so forth, and I do recognize from your opening comments that you expect demand to outstrip supply kind of in the second half. But under a scenario where, whether it's weather or whether some other factors keep it a little bit lower, and/or when you consider the fact that inventory levels are just so high at this point, kind of what's your appetite to take production down if pricing appears to be weak in the first half of 2010? Just given the fact that you've got some tons still to contract at this point.

I think we've demonstrated that Arch will continue with its market-driven philosophy, where we've been for almost a decade now, and it works, and it's the right way to really conduct, at least for Arch, conduct our marketing and production efforts. So, we'll analyze the market as it continues to develop. Obviously, weather as you indicated can have a near term impact, a plus or a minus on energy demand and skew things and stockpiles are high. But what a lot of people haven't focused on is the stockpile build, for instance, in the western part of the US, our traditional areas, really kind of has slowed down, and the entire marketplace now for what might be considered more of a PRB type customers are more like 75 days, which is still high. But the build has slowed down considerably, whereas the stockpiles for I think Central App and Illinois basin customers and Northern App have continued to build. So it's always moving. It's always developing. And the real key to what's going on out there is I think looking at the supply rationalization in Central App and what's happening there. And it's a dramatic story, and we can get into that more at another time if you'd like, but -- so long answer to we will meet what the market requires.

Fair enough. If you don't mind, just one last question. You talked about green shoots with respect to the met coal market. I was wondering if you could just sort of talk about high vol coal, if some of those impacts have flowed through into the US and if you see high vol coal being sold into the met market or if it is still going to go into the steam market.

We're starting to see it. We've seen an increase in inquiries for high vol met. We have made some additional sales here for delivery into the second half of the year. So the beginning signs are there, would be the best description. I think John mentioned our target remains kind of a 1.5 million to 2 million tons of met coal sales and Arch is all high vol met and we're still sticking with that number for 2009.

Our next question comes from Jim Rollyson with Raymond James.

Good morning, everyone.

Good morning, Jim.

Steve, just to follow up on that last part, the 1.5 million to 2 million tons, how much have you shipped already and kind of just how does that play out for the second half in terms of volumes?

Jim, this is John. We shipped about 700,000 tons of met first half of the year, breakdown would be 400 first quarter, 300 second. So obviously the second half of the year is going to be a little bit heavier volume-wise, but we've got about 75% of that sold and placed right now. So as Steve said, given the inquiries that we're getting from our domestic and international customers, we feel pretty good about it, quite frankly. I think you'll see the second half volume pick up on the met side. As we move into 2010, we'll continue to evaluate the market. But we certainly have an opportunity to increase that volume pretty significantly as we move into 2010. So it just depends on what the opportunities are, but we're real encouraged by what we're hearing right now from a lot of our customers. When you go from production capacity on the steel side from high 30s, low 40s and you're up around 51%, 52%, that's a significant move that we've seen. So we're pretty encouraged.

Given that we always seem to hear the spot quotes on the higher end, met coals, can you give us some sense of just ballpark ranges of what you're seeing for pricing?

Jim, I really would be reluctant to do that, given all the conversations that we have going on with price negotiations right now. So it certainly makes sense to go in the met market versus the steam when we have that opportunity. But really wouldn't want to get into it any more than that price-wise.

Okay. Just as a follow-up, Steve, you mentioned signing up some coal in the PRB at premium prices, which is something I think [Peabody] said. Can you give us an idea of what a significant premium to 2Q price? You look at the forward curve and it's pretty weak pricing, and you guys have always maintained that you sell contract coal at a premium. Just trying to get a ballpark directionally where things are.

It's anywhere from 25%, 30% premiums to 50% premiums. It just -- but you're right, the spot price indices are pretty ugly numbers, and so even though that percentage sounds nice, it's still not a number that we're totally happy with, but it's something that directionally we feel was the right thing to do.

Our next question comes from Michael Dudas with Jefferies.

Good morning, gentlemen.

Hey, Michael.

Maybe for John Drexler, second half of 2009 maybe a ballpark on free cash flow generation, given where your capital spending trends are, and obviously you've put the reserve acquisitions behind you. Considering minor vacations and working capital issues, how much improvement could we see in second half cash flow bottom line generation?

Michael, obviously as you alluded to, the first half of the year from a CapEx spend is fairly significant for us as we talked about previously. We, as indicated, expect to have significant discipline as we move forward on the CapEx front, and as we look forward with our expected earnings levels and projected cash flow, we would expect to maintain similar levels of liquidity or have marginally positive cash flows in the back half of the year as we look forward.

Thank you. My second question, is I guess Steve or John mentioned in their prepared remarks about shipments out west of PRB coal. Could you talk about potential any discussions relative to putting in the terminal out in the West and what might be required to do that? And given there is a pretty big lull in the market right now, would it be good -- better to start thinking about that now to meet the demands out in the future?

Michael, I think we would be enthusiastic about increasing the infrastructure on the West Coast. We've had conversations with various folks about doing that, and we certainly see the long-term potential in the Asian market to do that. We think initially, though, to get shipments going, there's about 5 million tons of capacity right now on the West Coast that will allow us to get tested and kind of get a foothold in that market but longer term I think it could very well make sense to build new capacity on the West Coast. So certainly we would be interested as a Company in participating in that.

And customers are thinking from a diversity of supply standpoint, is Indonesia the concern, given the light pipes of coal that might be shipped, is that where some of the Asian customers are thinking to look elsewhere?

I think Indonesia is part of it. Certainly the quality is deteriorating in Indonesia. They have a bigger appetite for more of the Indonesian coal domestically. I think you've seen a falloff in Vietnam as well. It is a couple reasons. We certainly think the PRB can be competitive with some of those coals long-term. It's not only China, but it's India. If you look at their inventories and their appetite for imported coal, we're excited about that as well. I mean, as I mentioned in my opening comments, we just confirmed our second boat to China that will load the second half of this year. So we clearly see some opportunities over there for our PRB coal.

Thank you, guys.

And we'll take our next question from Brian Singer with Goldman Sachs.

Thank you. Good morning.

Good morning, Brian.

Switching to West Elk, in the past you seemed to have had some expectations, correct me if I'm wrong, that there would be fewer geologic issues in the second half. And I guess I was just wondering more secularly once the prep plant is up and running, how should we think about output levels, price discounts, and cash costs?

Well, certainly we've had our challenges the first half of 2009 and first quarter we had some geology issues that were resolved, et cetera. We've moved beyond that. It's basically a market issue right now. We're trying to segregate the coal, but longer term we think the plan is definitely the answer. Shorter term we had to cut the advance rate back on the long wall. Certainly will impact cost. Longer term when we get the plan in we think we'll be in very good shape to service the market as we've been servicing it. In terms of cost, we think for the region we're going to be somewhere between $26 and $28 the Western Bituminous region for the year. Obviously we've got to improve the back half of this year versus what you saw the first half. We had three long wall moves second quarter. We don't have any third quarter. So we're exciting that we can improve on our cost structure certainly in Western Bit going forward. What I would tell you short-term, we've slowed the advance down. Longer term, we're designing and building a preparation plant to deal with it. We did that several years ago in Utah with a plant, and it's worked out very well from a customer standpoint. So we think it will work well in Colorado as well.

Thanks. On the thermal outlook overall, there's some healthy debates on how good or bad the thermal outlook will look in the second half, and I was wondering beyond the comments that you made, if you're hearing any specific evidence from your customers on demand improvements or inventory reductions beyond the PRB stabilization point you made earlier?

Well, what I would say is Steve and I have met with various larger customers in the last several weeks, and there certainly is a concern on their part on the supply situation in Central App, and they see major deterioration in Central App from a supply standpoint going forward. And obviously that gives them concern. I mean, they have adequate inventories right now, but the customers that really understand the supply situation have got to deal with that sooner than later. So we would hope supply and demand would come more into balance as we move into the third and fourth quarter of this year.

And I think, again, a point I tried to make was if you look back at the first half or really even into the last half of 2008, the nuclear plants all ran very, very well over the last six to nine months, and we have had a good hydroyear and obviously everyone knows that natural gas has taken some market share with its pricing. So if you look at the decline, while electric demand is off maybe 4% nationally, coal declines more like 9%. So we in the coal industry have absorbed this recession. Now, that's certainly not any fun, but in the same statement, as the economy begins the initial stages of a climb-out, and it's certainly I think most observers would agree we're bouncing along the bottom, if not climbing out, it's no longer getting worse, and we're actually seeing signs it's getting better, but not robust. The thing about a nuclear plants, if nuclear plants are running at 91% capacity factor, well, they're not going to suddenly average 97%. They're basically at their practical max.

So even though we've suffered through the recession, we really think coal gets a lion's share of the rebound as a result. So it will be balanced. It will take some time. The stockpiles certainly mitigate the speed of the recovery. But the real story is in the supply response and in what's happened in Central App, and for those of you, many on the call, anyway, we talked about that on the extensive modeling Arch has done since 1999 of Central App and all of the reserve base and really what was driving production costs there and it is all coming true. And as I said, we expect a run rate, not the annual production in 2009, but the run rate to be down around 180 million tons at the end of -- during the fourth quarter of this year, and it's something we can all track from the data and the EIA data and that's a big swing when you consider 235 a year ago. So you're looking at 55 million ton reduction, and much of that reduction is permanent, just given the nature of the reserve, the difficulty of all the regulatory environment there. So the market's correct and they are correct.

Thank you.

Thank you.

And we will take our next question from David Lipschitz with CLSA.

Good morning, everyone.

Hey, David.

Hey. Question for you on the Western Bit pricing. Are we going to see the $30 plus type of pricing, because pricing right now is in the high $30s, low$ 40s for that region. Are we going to see that come through any time this year or is it going to be a next year type of phenomenon?

I think I indicated the last call that we see this year somewhere in that $30 to $32 range and we do have roll-off as we move forward. The challenge we had David in mid-to-late 20007, we booked a lost business for about three years before the prices really ran up. So you're going to see a big chunk roll off at the end of 2010. Prior to that you're going to see some opportunities, but it's not the significant levels we would like to see. But clearly, that market has stayed pretty firm, and as we have tons roll off, we're going to be replacing them at much higher prices.

A follow-up on your cost in the East were up pretty significantly, I understand production was down. What's the outlook for production in the East and also your cost in the East?

If you look at the East, I think we were down about 800,000 tons, quarter-over-quarter. And we did have a long wall move during the quarter, so certainly the reduced volume has an impact on our cost, and I think you try to model out our cost for the balance of the year, I think that range that we're seeing in the second quarter may be a little bit lower, is probably a good place to look. Obviously, when you start pulling volume out, it really has a big impact, given the fixed cost nature of our business. So we're certainly trying to do everything we can to manage our cost in this tough period, but I think what you saw in second quarter may be indicative for the balance of the year anyway.

Okay. Thank you.

And we'll take our next question from John Bridges with JPMorgan.

Good morning, Steve, everybody.

Good morning, John.

I'm fascinated by the export of PRB. Excited by it too. Could you -- just wonder what the pros and cons of shipping it as is as compared to upgrading it using some of these technologies. Any thoughts on that?

You know, always just comes down to the economics. Everybody probably in the industry and even those who are not directly involved in the industry have played with and looked at and certainly thought about how do you upgrade PRB coal to in essence usually it's removing the water content or lowering the water content, and we continue to look at that as well. But right now the market in the Pacific Rim and the projections of the market led by India and China for demand, we think there's going to be a great little steady market develop that will take meaningful tonnage of the Powder River Basin, the southern PRB and the northern PRB over the next five or 10 years. I mean, it's just the nature of the beast and we'll do that, and if we can get good technologies to upgrade it, we'll do that too.

And any critical drivers of technology? Is it just the freight rates that drive that?

Well, the freight rates have the typical -- for a customer, they're always looking at their delivery cost and usually per million BTUs, so obviously if you have a technology that enhances the BTUs, that gives you a better price point, and then world freight rates, either in shipping or in rails are also critical to the ultimate competitiveness of the coal.

Okay. Thanks, Steve. Good luck.

All right, thank you, John.

And our next question comes from Brian Yu with Citi.

Great. Thank you. With regard to PRB pricing in the quarter, I think in the prepared remarks you talked about these market index tons. Can you give us a sense of how much of your overall shipments are covered under these market index pricing mechanisms?

Yes, annual basis it's about 9 to 10 million tons.

Okay. And what are they indexed to? The OTC markets or is it kind of what we see in the physical markets in the trade prices?

It would typically be indexed to the trade price indexes, they're all a little bit different, but for the most part that would be the case.

Go it. Just a clarification on new contracts you signed for 2010. Are these extensions of old contracts or new customers that you're winning?

Well, it's a combination of market reopeners, new sales, et cetera. So I'd say it would be a little of both.

Great. Thank you.

Thank you.

And we'll take our next question from Paul Forward with -- I'm sorry, we'll take our next question from [Curt Woodworth] with [Macquarie Bank].

Hi, this is [Warren Chang] on for Curt. In a worst case scenario, let's say stockpiles remain extremely high, gas stays at $3, $4, maybe $5 and demand improves a little bit but stockpiles still remain pretty high next year. Can you talk about how you manage such a process, what the cost levers are you can pull and how this would impact your cost structure?

We have some positive developments in cost. We're hedged in diesel fuel at relatively high rates this year, certainly very high rates compared to the current price of diesel. That rolls off in 2009 and 2010. I think our average hedge rate, we're about 50% hedged on diesel as an example, and it's about $2,00 a gallon. And I think the current pricing for diesel's $2.15 or something like that. So it's a little bit below the market. But it's a big move when you consider the Company uses 40 million to 50 million gallons of diesel fuel in kind of a full production mode. I don't know it off the top of my head at current production levels.

And that impacts, when you look at natural gas, so you get some further cost reductions that are pretty much built into the system, and we would make the argument that Arch very aggressively took steps to match its production to market demand early in the first half of this year. We certainly have paid the price in terms of overall cost going up and some of the other indications. So we're prepared to weather this storm, and as John Drexler indicated, our capital spending's at a level that we can sustain for as long as the market really stays in a depressed state. I think, again, the key point here, and one never knows, but we're seeing signs of the economy slowly starting to rebound. We've seen manufacturing starting to improve, not -- it's still negative from a year ago, but as I think in June it was down 9%, but it was down 30% in January. So the trends are the right way, and we're prepared to take advantage of any positive movements and we can weather any storms if something else comes along and really just makes the market bounce along this bottom for a much longer period of time.

Great. And also, what is your -- what is the maximum met capacity you have in terms of the amount of steam in a really strong met market that can be converted to met?

I'm just thinking about it here. Our normal production of met is kind of that 5 million to 6 million tons in a very strong met market, counting our PCI we could move that up to 6 million or 7 million, maybe a shade above 7 million tons. The sales guys always get nervous when I say that we're going to produce above 7 million tons, but I was a sales guy. And I understand what we can do. So that's probably a good round number to look at it at our current max where we sit today.

Great. Thanks.

All right, thanks.

And our next question comes from Paul Forward with Stifel Nicolaus.

Good morning.

Hi, Paul.

Hi there. I know you don't want to comment too much on Jacobs Ranch but just one question there. In your April press release you had a line about the financing of it and talked about using cash from operations, revolver borrowings, and other debt related instruments. You didn't include that line in this release. Just wondering if you could give us a sense of your current views on including possibly an equity component for this or any other transaction.

As you indicated, at the time the deal was announced the those were the items that we indicated were are our preference. Obviously markets do continue to be dynamic. Pretty much all I can say is that we'll continue to evaluate all financing opportunities and execute on was we think at the appropriate time is the appropriate transaction to finance Jacobs.

Okay. Thanks.

And our next question comes from [Mark Caruso] with Millenium Partners.

Hi, just a quick clarification question. John, you mentioned earlier that you thought Western Bit costs would be I want to say $27, $28. Were you referring to cash costs or total operating costs?

Total operating cost, $26 to $28 for the year.

Okay. Great. And then as far as the met goes, you say that you guys have been getting more inquiries in your 75%, but yet you guys kept the met tonnage for the year about the same. Are you seeing enough demand where you could be at the high end of that, or is there opportunity for you to do more with Mountain Laurel tons?

Certainly if the market opportunity's there, we'll evaluate it. I would hope at this point we would be towards the higher end of that range.

Great. Thanks so much.

Thank you.

And next we'll go to [Sanil Daptardar] with [Sentinel Investments].

Thanks. You talked about the committed volumes in 2010 and 2011, 85%, 75%, I think 80% is committed for 2010, 85%. What are the outlook numbers we are talking about?

I'm sorry, what was the last part of that question?

What is the absolute number that we are talking about for 2010?

We're assuming at current run rates, so, I think in the last call we talked some about it. Our view is in a market downturn, where we tried to position Arch so that we can be profitable throughout the market cycle, and the reasonable returns on the downturn and very good returns on the upturn, and right now we're seeing signs of the upturn, but we're making the assumption that production will stay relatively low because of the marketplace and as it develops, we can add, if required. But we would be very reluctant to bring some of the parked equipment back into production without solid contracts and signs that the market's really taken off.

Okay. On the fall-off, basically, so if you're looking at a profitable operations in 2010, so there is a possibility of further reduction in the cost on an absolute level from where we are today? So you talked about Western Bit going to $26, $28 per ton. So for that absolute level might go down further from here for all the three regions?

Well, I would think the PRB the cost you saw for second quarter is pretty indicative of what you'll see for the year. Obviously we've got a lot of initiatives going on. We're trying to do everything we can to reduce those costs. I think that 1180 number is a pretty good number for the year. In the East, as I indicated the number I saw there in the third quarter is in the $57 range. We hope to be in that range, if not a little bit better for the year. So if you're modeling that, I would look at those two numbers for the second quarter and model it for the year and I think you would be pretty close.

Our next question comes from Justine Fisher with Goldman Sachs.

Good morning.

Good morning, Justine.

So the first question I have is regarding your guidance. I see that you tightened the reins slightly, but we're seeing costs at West Elk still pretty high and cost at Central App you said would stay around $49 a ton. If the pricing environment subdued, I'm wondering how the range come tighter but no lower.

It's the booking of tons and it's just looking at, John said we have a little heavier met coal shipments second half than first half, and hopefully we'll be at the top end of our numbers on met coal shipments. And it's a mixture of additional cost reductions that we expect to obtain, so it's just we loaded it into our model and that's where it comes out.

Okay. And then on the Jacobs Ranch financing, I'm not going to ask what you would do. But I am going to ask -- I know a lot of people are looking at the debt and the equity markets. They seem to be open and they have been. Would you guys consider doing a deal while the markets are open and potentially putting the money in escrow so that you would have it, or would you actually wait until the transaction closes?

Justine, this is John Drexler. I obviously can't get into too much detail on what our plans are, but we'll continue to watch these as you indicated these very dynamic markets, continue to watch developments related to the Jacobs transaction and at the appropriate time at some time in the future make a decision on what we think is the best execution route to be able to finance the transaction.

Okay. And then the last question is on your revolver. I know that 2011 seems like a long way away, but in the debt markets we're seeing companies come already to refinance bonds or revolvers that mature in 2011. Are you guys thinking about that at all now, and would you potentially combine that with any financing for Jacobs Ranch?

Justine, obviously we'll continue to watch all these markets and we still do have a little bit of time on our revolver. We're comfortable with where our revolver's at, and we'll continue to explore all opportunities as we look to long-term financing and positioning of the Company.

Our next question comes from [Tom Molner] with [Sandler Capital].

Hey, my question has been answered. Good job, guys.

Thank you, Tom. That was an easy one. Operator?

Yes, sir, apparently we must have lost Mr. Molner. We'll take our next question from Mr. [Wes Sconce] with Morgan Stanley.

Good morning.

Good morning.

I think for Mr. Eaves, I'm curious if you can comment, how far away are we from reaching maximum coal storage capacity at US utilities and could you comment on that by region, and possibly in tonnage?

Well, I mean, obviously it depends on a particular customer, but I think Steve alluded to it earlier. We see our PRB customers with 76, 77 days. Central App customers are a little higher, approaching about 90 days. Northern App and the Rockies are somewhere in that 75, 76 days. Can they put more inventory? Absolutely. I think it depends on the particular utility, how much coal they can and are willing to store. Hopefully, we will see the supply and demand balance out as we forecasted for the balance of the year, and you'll quit building these inventories and start drawing on them.

Do you have a sense as to whether there's excess storage capacity for one region versus another?

I think it probably gets back to the customer and what they're willing and able to inventory. I wouldn't want to speculate any further than that.

I mean, I'm not sure that one region is particularly better than another region. Average utility in every plant would have different capacities and intellectually you would make an argument that maybe rural plants probably have more capacity to do things than, say, an urban type setting plant. But I just don't see that as the issue that we're facing at the moment. And right now, the summer weather hasn't been great but we've had some heat and certainly a lot of heat in the Texas kind of south and the Southeast has had a little bit of weather. So in our modeling, actually right now we're starting to see stockpiles probably peak for this year and again we expect to see an acceleration of the production declines in the third quarter, extending into the fourth quarter and likely on further than that. Right now internally at this very point we're probably at the stockpile peaks.

Thanks, guys.

Thank you.

And we will take our final question from [Luther Lu] with FBR Capital Markets.

Good morning, guys.

Hi, Luther.

Hi. This question is for John Eaves. Kudos to you guys to control the costs in PRB really, really well. And I was just wondering if you can give me some guidance for Q3 and the rest of the year and see if you can keep that level or perhaps show improvement.

Well, Luther, thanks for your comments. I mean, it's really a credit to [Paul Lang] and his team that they've worked real hard on managing cost in a very difficult session and really have done a good job, so thank you for recognizing that. I think as we look to third quarter as I mentioned earlier, we don't have any long wall moves in the third quarter. We're expecting much better performance operationally, certainly in Western Bit as we move forward. So I think cost-wise, that $26 to $28 in Western Bit is a number that we're comfortable with for the year. I think in the PRB, that 1180, 1184 is a number we are comfortable with for the year. In Central App that $56 to $57 number is something that I think we would be comfortable with for the year. Now, obviously we're going to do everything we can to improve on those numbers, but I think we can manage to those levels for the entire year. So what it says is we've got to certainly show some real improvement in Western Bit the second half of the year, and we fully expect to do that.

Okay. And just some clean-up questions. What should we expect for trading operation for the balance of the second half?

Luther, this is John Drexler. Obviously during the quarter we had some income there in our trading operation, and as we indicated previously, we expect that operation essentially to be positive contributions to the Company as we look forward and have talked about the significant run-up last year with the very volatile markets. It's built into our guidance. Markets aren't as volatile as they are last year, so we continue to expect to be profitable, but won't give specific guidance but we'll make a contribution over the back half of the year.

Okay. And the last question is noticed that in 2010, 2011, each year you have 10 million tons of committed but not priced. Are those the indexed tons that you guys were talking about?

That's correct, Luther.

Got it. Thank you, guys.

Thank you, Luther.

At this time, I would like to turn the call back over to Mr. Steve Leer for any additional or closing remarks.

Thank you. We certainly appreciate all of your time and your interest in Arch Coal. I think you can tell by the tone of the conversation today that we see the second half developing slowly in a positive way. We think we're very -- we don't think, we know we're very focused on cost. As we looked at the second quarter, we took steps. We did have severance costs. We did have idling costs. Those probably totaled $2.5 million, $3 million. Right now, we think we've slimmed the Company down from a CapEx perspective and from an overall supply perspective to meet expected demand, and really we're positioned that if the markets will move up, Arch will see some real meaningful advantages, and if we continue in the doldrums we've slimmed the Company down to be profitable on the down side of the cycle. But right now the signs are that we're just starting the initial phases of the upswing. So it will be something that we all look forward to talking about at the third quarter call. So again, thank you for your time.

This does conclude today's conference. We thank you for your participation.