Peabody Energy Corp (BTU) 2007 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by. Welcome to the Peabody Energy quarterly earnings conference call. For the conference call, all the participant lines are in a listen-only mode. However, there will be an opportunity for your questions and instructions will be given at that time. If you should require any assistance (OPERATOR INSTRUCTIONS).

I would now like to turn the call over to Mr. Vic Svec. Please go ahead, sir.

Okay, thanks, John. Good morning, everyone. Thanks for taking part in the conference call this morning for BTU. Today CFO and Executive VP of Corporate Development Rick Navarre will review our results and outlook. President and CEO Greg Boyce will discuss the markets as well as significant Peabody initiatives that we have underway.

Forward-looking statement should be considered along with the risk factors that we note at the end of our release and, of course, our 10-K. We also refer you to peabodyenergy.com for additional information. And Rick?

Thanks, Vic, and good morning, everyone. Thank you for joining our earnings review. I'd like to begin today by noting that those of you who have followed Peabody for a number of years know that we have a history of performing in a variety of market and operating conditions thanks to our diverse portfolio and earnings model coupled with a strong management commitment to performance.

In the second quarter, we dealt with a confluence of external events related to weather, transportation logistics and a weakening US dollar; yet our overall portfolio approach enabled results from trading and brokerage and resource management to offset lower than expected results for our mining operations. We continue to aggressively work through these near-term challenges and we're also taking action to lower production to encourage utility stockpile reductions. More importantly, we are making significant progress on projects that will strengthen our operating base and enhance our ability to meet long-term global demand.

Now let's review the quarter's performance. Moving to our income statement, our second quarter revenue growth reflected improved US pricing and higher Australia volumes. These were partially offset by a change in product mix and a $13 per ton reduction in met coal realization with the start of the new Japanese fiscal year on April 1.

Our operating profit increased 7% for the quarter and EBITDA rose 9% to $305 million. Our results also reflected higher DD&A of $52 million as well as interest charges related to the Excel acquisition. These operations, as you will recall, are expected to reach higher production levels over the second half of 2007 and into 2008. Drilling down into the supplemental schedule, our US revenues per ton grew 12% for the quarter led by a 25% price improvement for our PRB products.

In Australia, our revenues reflect higher volumes associated with the Excel acquisition, and our Australian revenues per ton reflect lower fiscal year 2007 met prices, as I mentioned earlier, as well as mix changes as we expand our thermal export production. As Greg will discuss later, we are seeing record thermal export demand and it looks like the met market pricing could return to the highs of two years ago.

Overall, our US cost per ton approximated last quarter. The year-over-year increases are a result of higher sales taxes and royalties, higher energy costs, mix, and the selected operational challenges. Cost in both the East and West were affected by suppressed volumes. In the East, we recently idled one unit at our Rivers Edge mine due to difficult geology, and we're working through a challenging seam condition at our Harris met mine.

In the West, we were impacted by higher revenue related taxes driven by the 25% increase in PRB sales price that I mentioned earlier. This accounted for 1/3 of the cost increase. In addition, higher fuel costs were a major factor. Also, in the Powder River basin heavy rainfall and the carryover impact of the late March winter storm lowered our shipments and impacted our volume.

Our major capital projects were also affected by the availability of contractor, labor and materials that has affected really all capital projects around the mining sector. These same issues led to higher maintenance costs as equipment deployments were extended throughout the project delays. This lowered our expected productivity as we had to use more and less efficient equipment in overburden removal rather than in coal removal and recovery as we had planned. We're pleased that we've now finished both the dragline and the infit conveyor system in the Powder River basin. These two projects totaled $110 million in investment and will be significant to the future of those operations.

The new dragline has been exceeding our expectations since it began operating. In its first month, it moved 300,000 more yards of overburden than expected at a cost of 75% lower than the truck shovel fleet that it replaces. We believe the new dragline will be the most productive of its class in the world.

Now let's review EBITDA from our other business activities. Both trading and brokerage and resource management turned in strong quarters as we had good contributions from our expanded global trading operations and completed several resource management transactions that have long been in the pipeline.

In Australia, extreme storms in New South Wales created the worst flooding in 36 years which reduced our operating capability. The storms also aggravated the highly congested Newcastle Port. The queue management system put in place in Newcastle in the second quarter had been working to reduce the queue to as low as 50 ships. Unfortunately, the storm drove the port queue back up to a record 79 vessels with wait times as high as 45 to 46 days. We are encouraged, however, that the recent queue has come down nearly 30% over the last several weeks.

The effect of high vessels and long wait times at Newcastle is now more than 30 days. These wait times create demerge costs that can be as high as $100,000 per vessel per day. So consequently, as we look forward, our demerge is likely to total $80 million for the full year with $50 million of those impacts yet to come in the second half.

Our ongoing rail and port issues continue in the north at Dalrymple Bay where we have more than 50 vessels waiting to load. For the year, the queue management systems that have been implemented at both ports will reduce our overall shipping entitlement some 20% from our original estimates at the beginning of the year. Greg will give you some additional comments on the Australian coal sector and the coal chain in his remarks.

The US dollar continues to weaken against all major currencies. More specifically, the Australian dollar reached an 18 year high against the US dollar with an 11% increase since the start of the year. Fortunately, in the first half, our hedging program offset all transactional effects of currency, limiting the impact of currency to a non-cash balance sheet accounting remeasurement charge of about $10 million. The rapid change in exchange rates this year has provided few opportunities to add new hedge positions to our growing international operating exposure. In the second half of 2007, we were hedged at over 40% and estimate that the full year currency impact at that hedge position will be about $70 million; $60 million of which will occur in the second half of the year.

Turning to our capital, we are now targeting 550 to $600 million versus our prior levels of 450 to $525 million, excluding any capital associated with the Prairie State equipment commitments. This new level reflects about $85 million of higher project costs driven by escalations, delays and currency. The remaining increase relates to a new $20 million preparation plant that we are building at our Twentymile mine to improve quality.

Our major PRB capital projects will also be completed and represent $165 million of investment over a multiyear period that will be completed this year. These projects are aimed at higher productivity and lower costs and ultimately will increase our capacity as demand warrants. In Australia we are nearing completion of the new mine developments that we have reviewed with you in past calls.

Now let me give you a brief update on the strategic review of our eastern US assets. We've laid the groundwork for a possible tax-free spinoff or other strategic transaction with the filing of a Form 10 with the SEC and a private letter ruling application with the Internal Revenue Service. We expect to conclude this review within the next several months and of course we will keep you posted on any major developments.

Turning to our outlook, Peabody has revised its annual targets. You'll recall that last quarter we signaled $135 million in expected declines from planned production cuts, reduced transportation throughput entitlements, demerge in currency that would possibly cause us to come in at the lower end of our original guidance. As we indicated in our press release, we now believe it is more likely that the full impact of these items and current events will approximate $275 million. This amount consists of more than $80 million in demerge charges and lost shipments and storm recovery costs in Australia; $70 million related to currency, as I mentioned; $100 million related to the planned production cuts and suppressed volumes of nearly 10 million tons in the US; and higher fuel charges of approximately $25 million.

At this point we're focusing on annual versus quarterly targets given the timing around project completion and recovery from the transportation and weather issues in Australia. Our expectations are that because of these events and the impact of taxes, we expect results to be significantly weighted toward the fourth quarter.

So moving forward, we are very encouraged by the strong Asian market, demand in the improving US price platform as our investments in Australia and capital projects in the western United States position the Company to capitalize on our future open sales position, which Greg will discuss in more detail.

So now, I'll turn the call over to our President and CEO, Greg Boyce. Greg?

Good morning, everyone, and thanks, Rick, for the review of the quarter. It strikes me that our industry's challenges and opportunities flow from the same source. Both are really a function of the strong global economy and the unprecedented demand for coal that we are seeing. In all respects, the macrolevel case for coal has never been better.

It's in this context that now is probably a good time to remind everyone of the transformation Peabody has had underway. When our restructuring and asset enhancement program is essentially complete by the end of this year, we will have completed major productivity and cost projects totaling $165 million benefiting our flagship Powder River basin operations. We will have finished the buildout of our new Australian growth platform, tripling our long-term capacity there. We will have expanded our global trading locations to four continents with trading activities that now span the globe. We will have positioned Peabody to participate in the tremendous growth in China and Mongolia, and we will have concluded our strategic evaluation of eastern US operations.

These initiatives are aimed at managing costs, focusing on the highest growth markets and dramatically reshaping and expanding our global operations and earnings base. And I would add that all of this is occurring against a backdrop of global markets that have improved substantially just since we last talked.

Given the world's increasing demand for energy and the real limits on the supplies of competing fuels, it comes as no surprise to us that for the fifth year running coal is the world's fastest growing energy source. Global coal demand growth is centered around the Pacific Rim and China is firmly a net importer of coal. And we view this as a long-term position for China and this marks a fundamental change at the Pacific Rim markets. At the same time, exporting nations like Russia and Vietnam now plan to retain more of their coal supplies for their own domestic use.

These dynamics mean that the world's largest coal importers -- Japan, South Korea and Taiwan -- are now in the market attempting to secure additional supplies. These events place significant positive pressure on global coal demand and prices, creating very favorable implications for 2008 and beyond. This demand also strains the global shipping system. And frankly, the pace that Australia's rail and port system is managing through the growth and recovering from the recent flooding in New South Wales is a disappointment.

Australia has the potential to satisfy much more of the world with its quality coal products. I can tell you that this issue has now risen to a national imperative with significant economic loss cited by the Australian Treasurer and the Premier of Queensland. Peabody is taking a number of steps to manage through the Australian coal chain issues. We are supporting accelerated rail and port buildout at the two most challenged ports, and look forward to new capacity coming online as early as 2008 at Dalrymple Bay.

We have encouraged a return of the queue management systems that were showing success prior to the June storms. While reducing throughput entitlements won't improve capacity, it will immediately begin to diminish demerge costs. And we are reviewing our production targets and approach to nominating vessels to optimize our shipments and profitability. While the exact timing of the recovery is difficult to predict, we are confident that Australia's near-term port capacity issues will be resolved.

It is worth noting, however, that Australia remains the world's largest coal exporter with production up some 8% this year even with these issues. Also with Australian thermal coal pricing as much as 50% higher than when we completed the Excel acquisition, our rapid growth in thermal production is very timely. The new Wilpinjong mine is now complete and we anticipate the new North Wambo underground operation coming online later this year.

Metallurgical coal pricing is also increasing from already strong levels and the new Millennium mine in Queensland will complete the commissioning of its preparation plant during this quarter. Peabody is also capitalizing on the strong global markets through our new London trading office and expanded trading activities in Newcastle and Beijing.

Now, within the United States, we're seeing a forward market that has improved this year. Near-term, coal use is up and coal production is down. And while we're beginning to see those dynamics reduce coal stockpiles, we also believe more balancing in production to demand is necessary. Even though we're now entering the best part of the year for coal consumption, Peabody is again reducing its production plans for the remainder of this year.

Within the US, Peabody is taking a number of steps. As I mentioned, we're voluntarily trimming 5 million tons of production growth in Appalachia, the Midwest and Colorado for the second half of this year. We continue to be very prudent in contracting for new business. We have three major capital projects at our largest PRB operation targeted at improved costs. We have begun to move overburden at the El Segundo mine in New Mexico which will serve a long-term Southwest contract. We are progressing on the evaluation of strategic alternatives regarding our eastern assets, as Rick described, and we're making good progress on our generation in BTU conversion activities.

Peabody is frequently asked about our view on the pace of new US coal generating plant development. The fact is the pace of new plant developments is about what we expected, with a new plant being placed in service this past quarter and dozens more either being built or close to beginning construction. We have always put probabilities on the 160 or so various plant proposals that were announced. Yet we are clearly seeing the largest buildout of new coal plants in the past three decades. Those plants in the building stage include the Prairie State Energy campus, and we had a solid quarter which saw the project sign with Bechtel as construction contractor, agreed to purchase major equipment, expand current partner equity interest and add 300 megawatts of demand from AMP-Ohio. The Prairie State partner group now includes rural co-ops and municipal utilities from Missouri to Virginia. And they all see what we see -- a nation quickly running out of spare baseload generation capacity.

Now, in addition to our generation work, Peabody has made significant progress on BTU conversion projects in recent months. We made an investment and agreed to supply coal for what will be the first coal-to-liquids facility in the US. And you will all notice just yesterday we announced that Peabody has entered into an alliance with ConocoPhillips to evaluate a major coal-to-gas plant in the Midwest sited on our reserves.

In summary, we're navigating through some near-term volatility, taking steps to match market conditions and focusing on and improving long-term picture. You know Peabody for performance and portfolio management. We are dramatically reshaping our operating platform and global portfolio to manage costs, improve productivity and satisfy the strongest growth markets around the world. I want to thank our employees for their hard work and for what has been a record safety performance for the first half of this year. I also thank all of you for your interest, and Rick and I would be pleased to answer any of your questions.

(OPERATOR INSTRUCTIONS) Michael Dudas, Bear Stearns.

Good morning, gentlemen. First question either for Rick or Greg. Could you characterize a little bit more color relative to stockpile levels at your customer base and maybe at your old mines? Are you surprised that they haven't maybe come down as much in the early part of the year? And how aggressive do you think that the market needs to be going forward in this production cutback to certainly get utilities to feel a bit more -- or less comfortable relative to future operating stockpiles?

Well, Michael, a couple of things in there. As we look at the stockpiles today, and the vast majority of those are held at our customers, the mines typically don't hold much in the way of inventory stocks here in the US. But we view it as about 10% above the five-year average in terms of average stockpiles in the US. And that varies a bit depending on the Southeast versus PRB; PRB stockpiles perhaps a bit more closer to normal.

But in reality, our view was that the stockpiles would have been lower at this point in time. Part of that reflection really is when you look at the major burning centers, the weather patterns so far this summer have been relatively cool. While electricity generation is up about 3% for the year, we all have to remember that's over last year when it was flat from the year before. So over a couple of year average we're still behind where normalized levels would be. The reduction in volumes in terms of production have been about what we expected but it's pretty clear to us that going through the back half of this year some additional reductions in order to meet the demand levels were needed. Of course a lot depends on what happens over the course of the next six to eight weeks, which is typically a critical burn period for the summer season before we enter into the shoulder season later in the fall.

And do you think -- just to finish on my first question, do customers feel like they need to have a higher level of quote/unquote normal inventories than they've had in other cycles?

We have a number of customers that have indicated to us that they are moving towards carrying higher levels, a combination of mine issues, rail issues, weather impacts. They're just getting more comfortable carrying a higher level of stock than they would have in the past.

And my second question, turning to Australia, can you characterize first half '07 contract pricing relative to your own committed thermal and coking that you've been able to negotiate from December until now? And given the issues with ports and allocations, would you anticipate changing dramatically what you currently have for your Australian production outlook into '08 and '09, given what you've put out in public?

I'll take the second part of the question. In terms of '08 and '09, we're not really in a position to make any changes at this point. Obviously the situation with capacities in Australia still are somewhat fluid. We'll watch what happens over the course of the next couple of quarters and provide guidance for '08 clearly at that point in time and we'll try and do the same for '09 once we see how the port and rail systems stabilize in Australia.

The first part of your question really related to, I think, what opportunity have we had to sell into the spot markets in Australia in order to see some of that price increase. Actually those opportunities are pretty limited. Particularly when you take what little bit of volume that we might have had and with the port and rail constraints, we were shipping almost solely under our contract base in Australia. So we would have been receiving our contracted pricing or the reference pricing that we would have seen starting April 1.

Very good, Greg. Thank you.

Jim Rollyson, Raymond James.

Just actually following up on Michael's line of questioning. You've got I think 13 to 15 million tons in Australia that are open for next year, and I think the comment (inaudible) about half of that is net. So, obviously that will happen later. But on the steam side, are you comfortable in starting to try and contract that out given where prices have gone right now? Or is it more of an issue of kind of waiting to see how the infrastructure rail and particularly the port plays out before people are comfortable actually signing commitments?

I think people are starting to sign up for commitments now and a lot of that price is at the same time as the overall met market as well. But some of it does sell earlier than that. But the price levels are strong and we feel very comfortable that we've actually laid some hedges in with respect to some of those contracts already at prices that are in the mid '60s.

Perfect. And then just as a follow-up, you've got a couple of projects going on in the US out West which you noted that hopefully maybe help out capacity at some point but also help out the cost side that got delayed. Do you see that starting to kick in as we move through the rest of this year and next year on the cost side, recognizing I guess the diesel part is what it is but at least it is productivity. Should we start to see an improvement on the cost side of things?

Absolutely. I think we'll start to see a lower cost. Obviously less usage of diesel fuel. The two projects that we mentioned, there's three projects in total, but of the two projects we mentioned, we'll save almost 3 million gallons annually in diesel fuel. And the cost of remove overburden with the dragline as I said earlier is 75% less than it is in the truck shovel operation. So we should start to see that right now because that dragline is in operation. The truck shovel has been removed and be moved to another location. So we should start to see that improvement right now.

Great. Thank you, guys.

Pearce Hammond, Simmons Company International.

When you look at -- and I know it's hard to, but when you look at US production and peer into 2008, given the changes with the mine safety rules and the judicial rulings that have taken place, do you think we're going to be in the same sort of situation in the US on the supply side that we're in for 2007 where production is down?

That would be our view, Pearce. When you look at the challenges that arise out of all of the new safety regulations, how they are now being embedded into the cost platform, particularly in all of the underground operations going forward and in Appalachia in particular, and then you look at just what we have said for years is the geologic challenges that thinner seams requiring and greater depths requiring a different roof faulting regime, bolting of ribs, meshing, not only is the cost that we have seen across the entire eastern platforms for everyone increase and staying at very high levels but we are also seeing the same with the production challenges as well. And then you couple into that the permitting challenges. Our view would be that we will continue to see decline in particularly central [lap] over time.

If you put that on top of the seal issue that's really yet to be determined exactly and what is going to be required because of the new seal requirements, I think most in the industry would be surprised if there aren't several coal mines that have to shut down just because of the cost associated with that seal issue.

Great. And then as it relates to Australia, some of these issues that you are witnessing right now, do you think they will continue on into 2008? Or do you see them gradually getting better?

Our view is it will all gradually continue to get better. I mean I guess an analogy of what we're seeing in Australia is probably what we have seen in the West, particularly out of the PRB relative to the rail. You've got -- everything is running at capacity. You get investments at the mines which create more mine capacity than rail and port. Right now we're seeing investments in the port and the rail systems, and at some point that will then grow to exceed what the mines can produce. And it will jigsaw back and forth over the next five to ten years, similar to what we will probably continue to see in the Western rail system.

So we are already starting to see improvements, clearly a recovery back from what was occurring in the second quarter. As you look -- as we look at the delivery of new rail cars in Australia, there is a significant fleet of cars planned for '08 in Newcastle and its Queensland rail system, they're taking delivery of cars in October of this year, in March, June and later in 2008. So again it's a buildup process that we should see incremental increase continue through this period of time.

[Shinir Kashuni], UBS.

Just a couple of quick questions. A lot of mine have actually been asked already. But I was wondering if you can talk about your US hedging strategy a little bit further. It kind of seems to me with the cutback you announced today as well as (inaudible) yesterday announcing a cutback in some of the central [app] producers have already reduced their production. Combined with just general generation in (inaudible) growth it would seem that this market could come into balance fairly quickly. Does it not make sense to hold back hedging anything for 2008 to allow the market to return into balance and to capture certainly a stronger pricing environment that's probably around the corner?

When you talk about hedge, you're talking about contracting?

In terms of contracting production.

Contracting. Yes, and I think you'll see that we have a reasonably robust open position pretty similar to where we were last year when we weren't as comfortable with the pricing levels. So I think our open position is strong across the board both in Australia and in the US that allow us to capitalize on the improving fundamentals in both those markets. And we see continued strength in Australia for sure as well as strength in the US market. So I think we are in good position to capture that going forward from a contract standpoint.

I think the other aspect I might add to that is these projects that we are completing in the Powder River basin while in the near-term we are focused on using those to reduce cost and improve productivity, they also give us capacity when the market conditions change that we can capitalize on as well.

Well noted. I was noticing in your press release this morning about -- you had noted that you'd sold forward for next year PRP production [at a] 49% premium to '06. Can you remind us what the price realization was for last year?

For '06 it was -- just give me a second -- we can give you -- I mean we'll always breakout as a reminder as our total Western realizations, we don't break it out by product in the West. But you can go back to our release and see that -- you can get a general idea.

Understood. Okay, thank you.

John Hill, Citi Investment Research.

Good morning and thanks for a very detailed presentation. It's definitely great to see your company taking leadership on production cuts as well and stitching together some great views of the international markets.

Just curious, the big picture question out there, very strong international and seaborne markets. What is it going to take to force normalization in the US? Do you ever think that there's the status of the shipping and the rail infrastructure and customer behavior will be such that those markets will cause a normalization of values with the US?

When you say normalization values, when do we think we will start to see this (multiple speakers) --

What would it take? Is it possible or do you think we will always stay at pricing island?

Well, I think we have seen in the past and certainly for instance in the case of met coal we are no longer an island. We are affected by what happens on an international basis. In the case of thermal coal, we will see -- because of the sheer volumes of the US internal market and really the only places that we can get much interaction between the export and the imports is on the coastal side. We will see an impact as for instance, Colombian coal, Venezuelan coal, is getting diverted into Europe as South African coals are getting diverted into the Pacific Rim, which is starting to occur now, which we will see some impacts in coal on pricing as that continues to occur. But and then at some point in time, once we see the pull in the Southeast pricing say from central app because of that, then that begins to then trickle through into Illinois basin and then ultimately will trickle through to the Powder River basin. I mean those are the similar type dynamics that we would have seen several years ago. So, it's just -- it's got a longer lag time than what you would see on a purely open marketplace like the international markets in the Pacific Rim.

Great, great. Just switching gears a bit over to the Forex and diesel cost side. Can you refresh your memory what the hedging picture looks like out into '08 or whether we should use that $70 million number, let's say on the currency side and run with that on an annualized basis?

Well, obviously, let me try to give you a picture on both sides. When you look at our fuel hedging picture for '07, we were 60 to 70% hedged throughout the year; yet prices continue to ramp up. I think our average hedge price is probably in the $56, $57 range for '07. As we look into '08 we're going to be about 40% hedged. And that number is going to be at a price that's probably in the low to mid '60s because of obviously you not having many opportunities to go back and buy in the $50 range. So that will give you a sense of where we are on about 100 million of gallons of fuel a year for fuel, okay? And you can do the math from there on that as it relates -- and put your own forecast for what you think diesel prices will be going forward.

As you look at FX rates, as I said earlier in my remarks we're essentially 100% hedged for the first six months of the year and about 40% hedged for the back half of the year at rates in the '70s, (inaudible) dollar. As we look into '08, we're probably only a quarter, be about 26% hedged in the '70s and it tapers off. Obviously our portfolio has grown significantly than when we first acquired Excel. We put on some positions that got us essentially almost 100% hedged in the first half because the rates were attractive in the low to mid '70s. Consensus was that the rates would stay in the '70s; that hasn't happened of course because of the weaker dollar and the strength of the Australian economy.

So if you look forward and you want to predict what's going to happen in the Australian/US dollar relationship, which is now in the mid to high 80s, it doesn't look like a lot of things out there that are significantly change in the near-term. I don't see the dollar strengthening against that currency very much.

Great. Thank you very much for that. I don't want to hog the call but hopefully before we end it at some point today we could talk a little bit or you could discuss a little bit the objectives in the trading and brokerage group, which obviously is generating a much bigger impact than it used to.

Sure. Just get back in line and we'll do that.

Paul Forward, Stifel Nicolaus.

Yes, thanks. The international markets could be transport constrained for quite awhile. Do you see any attractive opportunities now to add another region to Peabody's coal mining portfolio? Or do you think the expectations on valuations for potential acquisition targets are too strong here?

I'd have to say that I think -- well, the answer to both of those is yes, we continue to look for additional regions. But in most cases expectations are a bit high, particularly for anything that would be feeding the international markets and particularly the Pacific Rim. But having said that, you know we continue to be very opportunistic and anything that we might do from an acquisition base. And we clearly would have a focus right now on the international side, not only in Australia but if we could expand into other regions outside of Australia we'd go to opportunities, we would love to do so.

I think just domestically, I think you'd mentioned a new project at Twentymile. Could you maybe go over a little bit of that detail? And where do you think Twentymile -- where is the eventual capacity of that mine and how long does it take to get there?

Twentymile, if you break it down and you the start with the underground capacity at Twentymile, obviously with the new longwall that we installed out there ultimately the capacity of that longwall if it was fully pushed and run is 10 plus, 11 plus million tons a year.

But what we are doing right now is what we have found as we have gone deeper at Twentymile, the characteristics have changed geologically to where we are building a wash plant so that we can wash a much larger fraction of the [run a] mine coal from Twentymile so we can control the ash levels in our product. And once we get that in place then it's really going to be dependent on the ability to what the market reach is for Twentymile, which will be the limiting factor in terms of its capacity. Rail capacity, (inaudible) plant capacity, underground capacity is all designed to potentially nameplate, get up to 12 million tons per year but that's not where we have it planned this year.

Jeremy Sussman, Natexis Bleichroeder.

Regarding the $120 met coal number that you mentioned earlier, if we continue to see some port constraints throughout the year, is that a realistic number that we could see during contracting season? And especially given the positive first-half developments in China? And has the met market strengthened quicker than you all would've expected at the end of last year?

I think it's very likely that we will see from all projections a number that's very close to the $120 level. I think what most people will tell you is that the number that was put out last year was an anomaly and should not have been as low as it was, because there were port constraints that went unreported by the independent expert at Dalrymple Bay. And that capacity wasn't there and the prices should have been higher. So that's one of the issues as we go forward.

Even without the port constraints, you're still seeing significant demand for the product. And you've also got currency impacts. Everything is sold in US dollars. But we're seeing a price increase that has exceeded the currency. So we believe the number will be back to where it was two years ago at the record levels.

Thanks, and then just if I could, following up on the earlier [period B] question, you did sign a fair amount of business at what seemed to be some pretty good prices, at least in the $13 to 14 range by our estimates. Is this a good sign that utility is sort of despite the high inventories and cooler weather in coal burning regions as you have alluded to are still really actively seeking a fair amount of new contracts, especially for '08 and beyond?

Yes, I think it's a good sign that they're certainly willing. I mean I think there's always been this concern by the marketplace and the investors that the utilities are just signing one year contracts or whatever. I think there's a -- we're mutually looking at the forward markets and the demand out of the PRB and both of us have the same kind of forecasts that see significant growth out of that region. And anything in the midteens is a pretty good number for both parties at this stage of the game. We think they can be higher as you get total parity with the Eastern markets and that will come with time. But it's something that we continue to watch and we're pretty selective on booking new business.

Thanks. Very helpful, as always.

David Gagliano, Credit Suisse.

I have a couple of questions about your full year volume targets in the US. When I compare it with the first half actuals, it looks like your full year volume targets still imply that you plan to increase your second half output by about 16% or about 16 million tons versus the first half. So, my questions are first of all, where should we specifically expect to get that higher volume in the second half versus the first half? And then as a bigger picture question, just assuming that we have normal demand and given the increase that you have in your production for the second half, do you think overall inventories in the US will be higher or lower by the end of December versus current levels? Thanks.

A couple of things. Starting from the back end of the question, our expectation would be that inventories would be lower by the end of the year than they are now. Hopefully that's the outcome of not only going through the rest of the burn season but also the changes in the production volumes. Most of the -- I mean a fair portion of the volume changes in the back half of the year relate to the Powder River basin, the second half of our Powder River basin because we have now completed these construction projects. And we were behind in terms of rateable shipments to a number of customers in the first half of the year. We plan to make up our contractual commitment in the back half of the year. Again, these are all sales that are firm and contracted. And that causes an uplift in our PRB volumes in the back half of the year versus the front half of the year. When you look at where we are primarily making changes to our volumes, it would be in Appalachia and in the Colorado and then Australia for our total production portfolio.

Okay, so the PRB's going up and the cuts are coming out of the other regions, is that --?

And Australia increases as you know because of the fact that we're bringing on those projects that are -- you've got the Wambo underground mine coming online in late third quarter. We're ramping up Wilpinjong and Millennium will start to hit its full stride or near its full stride as its [prep line] gets commissioned. So those are all part of the plan in Australia to continue to ramp up. And even despite what we've seen with the poor congestion we think this will still be able to move an additional 3 million tons more than we moved in the first half out of Australia.

Okay, I was specifically focused on the US, so that [222, 225] and the 103 in the first-half. But that's really out of the PRB then? That 16 million incremental?

Greg gave you the answer to the PRB, which was primarily Powder River basin and a little bit out of Twentymile as well.

John Bridges, JPMorgan.

Just following up on the allocation thing. You've got this big growth in production over the next sort of two odd years. How does these changes at the ports fit in with that and your comments about this sort of jigsaw thing about growth in production and growth in ports, growth in production of ports and so on?

Well, you have to remember that the way the allocation system works is everybody is -- based on contractual commitments that you have with the ports, you're allocated an entitlement for shipping during the course of the year. So as these new mine have been coming on, they had contractual commitments in place at the time that they were coming into production with the ports. And the ports had been growing and the rail systems had been growing to satisfy that volume.

Now, to the extent that there's full fluidity with the rail and the port system and there's no constraints, then everybody's allocation will equal their commitments or their entitlements. To the extent that there are problems at the port like there is now and they put in place these management systems, everybody on a pro rata basis is curtailed back down and off of their contractual commitments or entitlements to their allocation. And that's why when we say we have been cut back I think the number on average is about 3 million tons that's really related to the infrastructure and everybody. That's our pro rata share of the total.

So as we go forward to next year and into 2009 as that capacity improves, that percentage reduction for everybody will reduce. But these new operations had entitlements and contracts that will fall into the total pool that gets allocated port capacity and rail capacity.

It's by -- it's totally by the available tons? There's no preference to existing producers?

It's totally by available tons. I mean all of these systems have to be approved by the ACCC in Australia. And the ACCC's primary responsibility is to make sure that it's fair and open access to all producers that had entitlements.

A follow-on, a couple of years ago Earl spoke about Peabody plans to be a big gas producer. This decision to sell off the gas rights, significant gas rights, to CNX Gas, does that mean that that portion of your strategy as detailed by Earl has fallen away?

I think what you can read into that is where we had been moving along a path of trying to develop a gas business, we now are focused on -- and we have retained the pieces of our gas business that were producing methane gas ahead of our active operations particularly in the Powder River basin. And so our focus in the gas side will be just to make sure that we can manage the interface with our coal properties.

In terms of this prospective property that sold and traded for coal reserves at Federal and then also in Western Kentucky, we felt that those were better suited for another party that had gas as its core business not as a part of its business. So we are focusing our gas activities on our coal interface. I would say the other thing that our focus is -- like as we saw with the ConocoPhillips announcement -- our focus is now coal to gas versus development and prospecting for coalbed methane.

Leslie Rich, Columbia Management.

My questions have been answered. Thank you.

Justine Fisher, Goldman Sachs. Justine Fisher, your line is open. Please go ahead. And we'll move on to Dhaval Patel with Columbus Hill. Please go ahead.

I just wanted to ask a little bit about the Australian pricing. I wanted to know were there any product mix related issues that led to substantial decline from the first quarter in prices? Or can you comment a little bit more on the Australian pricing?

Sure, absolutely. And we said this earlier at the end of last year as well as on the last conference call. As we expand our portfolio with the Excel acquisition, we took on thermal export coal, which is a different pricing structure than metallurgical coal. And we also took on some contracts that were, I'll call them legacy domestic contracts to domestic utilities that are at certainly adequate margins but are at low prices compared to met coal or export at thermal coal. So we knew that our overall realization was going to drop down into the $50 plus range as a result of that. But from a margin standpoint we were still comfortable with where we were headed.

So, if you think about it, so we brought in more thermal coal -- significantly more thermal coal -- and we've also had a drop in met pricing which went into effect April 1, which was about $13 a ton from last year's realization on the met product. So -- that was fully expected. Our realization was in line with what we expected.

Do any of those legacy costs -- well, legacy prices roll over at some point?

Well, it's a smaller cut -- we have a thermal contract where we were able to -- essentially it's a contract that's very similar to getting a lease analysis in the Powder River basin. We needed to do this contract to get access to a significant reserve block that will allow us to export coal. This was done by our predecessor. We acquired the operation knowing full well that this was going to be a low realization contract, but it's also a very, very low cost reserve.

It's a domestic contract. It's not going to index with the export market and frankly, the coal quality is a little bit higher in ash and it wouldn't be a good export quality coal anyway.

But the other side of the question is that the export contracts, the legacy export contracts will roll over.

Yes. Those will roll over.

Great. Thank you.

Justin Birkner, Gabelli & Co.

I have a few questions. First of all I wanted to ask you about the prospect of exporting coal westward out of the Powder River basin. Is that something that you are discussing? And if so, kind of what are the major hurdles for that to happen?

Well, I think a number of parties continue to look at it. The number one hurdle right now is Western port capacity. The second hurdle would be the freight capacity and the cost of moving the coal from the Powder River basin to a Western port. And then lastly, I would say you've got the competition getting into the Pacific Rim. There might be some opportunities there depending on where ultimately the pricing in the Pacific Rim goes to, but the logistics of port capacity is a bit of an issue. I mean, when it was done previously, the port of Los Angeles had a fairly large port that has now been converted away from coal shipping. Really the West Coast ports are out of Vancouver or there is a small port in Stockton, California. That's really the only Port capacity that exists out of the West Coast.

Okay. Can you ballpark the type of rail costs that you'd incur to get that coal to the port on the westward coast?

That might be a better question to ask one of the rail carriers.

Okay. The other area I had some questions about was the Australian business, just following up on some of the questions that have been asked. With regards to the realization that you saw in the second quarter and I guess to a certain extent in the first quarter, how much higher would those realizations have been if you could have gotten all of your coal out of the ports?

There would have been a bit higher but once again, remember that we're talking about the metallurgical business rolled over to a new contract year on April 1, which drove that price down $13. And then we had the mix issues. It may have been several dollars higher because we would've been able to get a little bit more export thermal coal out that we weren't able to get out as well as some of the met coal that we didn't get shipped out that still would have been in the $90 range we didn't get out the door. So, it would have moved the number up. I can't give you a precise number but it certainly would've been a bit higher.

Michael Goldenberg, Luminous Management.

Just had a quick question on Western US. I know you don't disclose pricing within Western US but is there a way that you can maybe explain to us if the change in realized price has more to do with change in prices or it has more to do with change in mix between PRB and other Western coals?

Now, while we don't give you the specific actual pricing, if you'll notice, we only reference that percentage increase for our premium PRB product, which is basically the 8800 type products. So there's not a mix component in that increase.

So you're saying what I'm looking at on page 9 of the release when I see [1270] for Q1 and [1280] for June '07, that's all premium PRB?

No, no. That is 100% Western mix.

So that's the part that I wanted to --

That's with it, includes Colorado, New Mexico and Arizona, Arizona products as well. A way to think about that would be to go back to June of '06 numbers that you're looking at is [1032] compared to the [1280], and what you see there is a percentage change that's roughly 24% in total. The Powder River basin products in general which make up most of the volume there are up 25% for all products, 28% for the premium products. And in the press release, I think it's like on page 9, where we talk about a percentage increase for our premium product, that would just for a [NARM], North (inaudible) or shell type product or an 8800 type product.

Got it. And finally, as it relates to production costs, am I correct in estimating even with production cuts, the PRB production will be at least on par with 2006 production?

Our 2007 will be -- actually will be slightly up. But that's because our contractual commitments as we started the year were higher than last year.

As it relates to say 2008 since you are more open there, if you -- if the pricing does not improve, are you open to further reducing that production to let's say below 2006 levels if that's what it takes? Or is it more of well, it's still on a marginal basis still a profitable ton?

Well, let's just maybe step back and talk and reiterate what our marketing and sales philosophy has always been. And that is to have a program of continuously layering in profitable business through the various market conditions and market cycles. We don't try and time the peaks and we don't expose ourselves to the drops. So, right now I would say that we are comfortable where we are at relative to our 2008 early views of production versus what we have sold. And obviously we'll have to watch that through this third and fourth quarter and we will provide that full guidance with the 2008 guidance.

Yuri Maslov, Nevsky Capital.

I just wanted to confirm your forward pricing. So when you talk about a 49% increase above 2006 realized prices, when would you actually see this price realized? Is that 2008 or 2009 or is that the kind of average over the next three or five years?

It's an average over a three to five year period of time.

Right. And is that sort of front loaded or is that backloaded or --?

I don't have the details (multiple speakers)

It's more of an index price and the index is in [contango] and I'd say it's probably a little bit more heavy on the first couple of years and then it may level off in the out years as most energy curves would.

Right, and as of now if you look at the total contracted volume for 2008 in the US, how does that compare to, I don't know, 2006 prices or 2007 prices, roughly? Are we 30% above or 20% above? Is there any guidance you can give on that?

Yes, that's a tough one to give guidance on at this stage of the game because of what's happening because there's so many different markets and so many different products. It would really be complicated for us. It'd take a lot of -- quite a bit of time to go through all that.

Okay, and then the final question. When you talk about current 2009 published prices and you're talking about them being 55% above 2007 prices as I understand. Is that the -- again, the price which you would realize in 2009? Or is that the support price for a typical three to five year contract, let's say 2010, 2015 or how does that look?

That's 2009 deliveries.

Yes, and those are the public [indus] -- public published pricing. If you just went back to the first of this year and you looked at say an 8800 price on the OTC and then you now go and look at the 2009 delivered price, that's just a comparison of those two numbers. Obviously when we contract for business, we contract our business at prices that are higher than those quoted public prices because those are just for small volumes and typically in near-term deliveries.

[Ian Sina], Ecofin.

Just a quick question, more on SO2 pricing and kind of how that has been factoring into some of the new contracts and discussions you guys have been having with the utilities and your other customers; especially when you think about what kind of value might get baked in with some of that real premium product out of the PRB. And then also how that's -- what kind of impact that's having on some of your discussions in Illinois?

I guess all I could really say is our view as we look forward and see what's happening in the scrubber market, which to a certain degree has a big impact on where the SO2 values are going to be, is all of the planned scrubbers -- the ones that are in construction and frankly, for a large number that have yet to start -- our view is with the pressures on capital projects for materials, for labor, means that a number of those and the implementation curve ff those is going to be delayed and stretched out in time. We believe that's positive over, say, the next three to four years for allowance pricing. And that's the basis upon which we would be making our decisions.

Got you. So that should flow through to a little extra value into some of that ultra low sulfur coal you're producing out of the PRB, right?

Yes.

And then do you think as we move forward if we do enter -- and this kind of opens a whole 'nother can of worms -- but if we move into more carbon regulations and such, do you think you see some of those plants that hadn't decided to go through and put on scrubbers and all that, are they going to end up scaling back on what they're burning in terms of coal? I mean do you think you start to see a little bit of quicker retirements when you'd already be a bit uncompliant on the SO2 and NOX does raise another question in terms of CO2 regulations into the future, but --

I would just tell you that as we kind of look at and I think the [NERK] study really confirms the fact that we have a significant generation capacity in balance over the next five years in this country. And any facility that has the ability to operate and meet the regulations at that point in time in our view is going to run at a certain level. And overall capacity will likely continue to increase across the entire coal fleet in this country. And it's going to be a period of time before the spare capacity required to make the great operators comfortable that they have got reserve capacity. It's going to take awhile for that to get built. And that's why projects like Prairie State and I mentioned in my remarks, we've had great demand for that power because baseload spare generating capacity has virtually disappeared in this country.

Ladies and gentlemen, due to time constraints we'll be taking just one more question. And that's from the line of Wayne Cooperman with Cobalt Capital.

Can you guys hear me? Oh good. You keep starting, you're talking about laying in profitable business and I'm just kind of curious how you'd actually define profitable business? What costs are you looking at when you think about that versus what you might be able to sell that for a year or two out?

Wayne, you've followed us for a number of years. And you know that one of the things that we try to do is obviously look at the market and take a view of the market and at the same time not try to catch the top and not try to catch the bottom. We have a profitable business. It has to meet certain criteria with margins and if our cost structure supports it, we'll layer in strong good business and based upon where our view of the market.

For example, if you look at last year, we didn't like the PRB prices. We had to load some business in but we didn't put much in the way of long-term contracts on because we weren't in a layering mindset at that point in time because it wasn't the right pricing. But at the same time I can tell you that if you go back and look at our portfolio how we took advantage of and we're disciplined when the market was high, putting on the right prices. And when it was -- you can see that we've had continued increase in our realization year over year on a steady basis.

I guess my question was a little bit more just look at what it cost you to get the ton out of the ground or do you sort of use replacement pricing and figure out do I got to go out, if I sell a ton today I've got to go buy another ton, I got to go permit it, I've got to do all this other stuff so why should I sell a ton for $9 if it's going to cost me $10 to replace it.

Sure, we're obviously going to look at that of course in the context of everything. Obviously the last ton is always the cheapest ton but if that was our philosophy we wouldn't be cutting tons. So as we look at it, what we do is we balance our trade book when it gets to those type of situations, Wayne, and we will go out and buy the coal in the market and use our trade book to optimize our contract position.

You probably won't answer this but what is your cost -- what do you think your costs are in the PRB for example? I mean fully loaded replacement cost economics?

You're right. Your first part of your question was exactly accurate -- you won't probably answer that question at this point in time. But we think we are the low-cost producer in the basin.

Wayne, I guess I would kind of summarize the discussion by saying we really focus on driving a return from all parts of our business. We don't chase the last penny of cash flow. We don't chase the endless game of an incremental dollar. We look at our portfolio and all parts of our portfolio and we expect them to give us a reasonable return for the assets that we have deployed. And that's probably the number one criteria that we look at in an overall context when we look at how we are going to participate in the market.

And that will conclude the question-and-answer session. I'll turn it to Mr. Boyce for any closing comments.

Well, thank you very much for your continued interest in BTU. Hopefully we've been able to show the strong international component of what's happening in the coal markets as well as our view that in the US markets we do see the fundamentals beginning to change. And we look forward to providing our results next quarter and then of course our 2008 guidance at the end of the year. Thank you.

Ladies and gentlemen, this conference is available for replay. It starts today at 3:15 PM Central time. It will last for one month until August 24th at midnight. You may access the replay at any time by dialing 1-800-475-6701. International parties please dial 320-365-3844. The access code for the call is 876545. Those numbers again 1-800-475-6701 or 320-365-3844; the access code 876545. That does conclude your conference for today. Thank you for your participation. You may now disconnect.