CNX Resources Corp (CNX) 2008 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by, and welcome to CONSOL Energy second quarter earnings conference call. As a reminder, today's conference call is being recorded. I would now like to turn the conference call over to the Senior Vice President of External Affairs, Tom Hoffman.

Morning, everyone. Welcome to our conference call and the second quarter results. With me this morning are Bill Lyons, Executive Vice President and Chief Financial Officer, and Brad Harvey, President and Chief Executive Officer of CONSOL Energy. We'll be discussing the results for the quarter just ended as well as discussing the outlook for the remainder of the year.

Much of our discussion regarding the remainder of the year was forward-looking in nature. As you know, our ability to achieve forecasted results dependent certain business risks. We've talked about those business risks in our release this morning at 7 a.m. and there is a more detailed discussion of those risks in our form 10-K filed earlier in the year. With that, we'll begin with Bill Lyons.

Thank you, Tom. For the quarter just ended, CONSOL Energy reported net income of $101 million or $0.54 per diluted share compared to $153 million or $0.83 per diluted share for the second quarter of 2007.

Now in the second quarter of 2007, we had two major property sales that resulted in after-tax gains of $59 million. For our coal business, average realizations were $48.50 per ton for the second quarter, an increase of $6.86 per ton, or nearly 17% period to period. However, financial margins declined $1.38 per ton.

Total costs for company-produced coal increased $8.24 per ton period to period. Specific mine productivity issues and global commodity inflation were the main drivers causing the cost increases. Let me cite some examples.

We have been running with very little cushion company-wide in our long wall development. If we fall behind in development it potentially hurts us when we have to do [long wall] moves. We are addressing that by implementing work schedule changes, the result of which will be more people and more time to apply against the problem. Over the next six months, this should allow us to get caught up and build some cushion in our development timetables.

During the quarter, the Buchanan mine was still in the process of completing the major changes in the mine plan that will allow us to avoid the kind of problem we had that resulted in the mine being idled for nine months last year. We anticipate that Buchanan will be running at expected levels by the middle of August.

The addition of the AMVEST mines to the production mix also contributed to higher costs. Now, we acquired AMVEST in the third quarter of last year. CONSOL's AMVEST operations are located in Central Appalachia where operating costs are normally higher when compared to our [long wall] mines in Northern Appalachia.

In addition, our [full] surface operations encountered an unexpected area where the coal seemed thinned. This impacted stripping ratios and, hence, costs. We have instituted a more intensive drilling program to ensure that we avoid such situations in the future.

Our [McElroy] mine located near the Ohio River in northern West Virginia had some development issues that took nearly the entire quarter to resolve. Although it took some time to resolve, we believe these development issues at McElroy are behind us.

Also is that we did not previously plan to restart the Schumacher mine during the second quarter. However, due to the development issues at McElroy, we decided that tactically it was in our best interest to restart this mine before all the major productivity improvements have been completed, even though it would lead to higher costs.

Approximately $2 per ton increase in costs was attributable to the AMVEST acquisition and the previously unscheduled startup of the Schumacher mine. And also there were increases in commodity prices that contributed to about $0.76 per on the ton of our total cost per ton. To summarize, our cost per ton were affected by lower than expected production, higher labor costs and higher supply costs. The lower production was the result of adverse geological conditions, changes in mine plans and requirements related to safety compliance.

Our CNX gas business, which we own 81.7%, had an outstanding quarter and produced a record 18.8 billion cubic feet, up 18% from the previous quarter and up 26% from the year-ago quarter. Let me first discuss a few of the quarterly financial details for the gas company.

During the quarter, the gas company's net income accounted for about half of our net income. Average margin at CNX gas were $5.48 per MCF, an increase of 31% or $1.29 per MCF versus last year's second quarter. Sequentially, margins at the gas company increased more than 21%.

Now, let me look forward to our leverage to higher contract prices for the next three years. During the quarter, we priced approximately 10.3 million tons of coal for 2009 delivery of which approximately 6.6 million tons were at market prices and the remaining 3.7 million tons were legacy contracts subject to collars. Our average realized pricing for 2009 now stands at nearly $56 per ton with 15 to 19 million tons of coal yet to be priced.

For 2010, we have between 48 and 52 million tons unpriced. For 2011, we have between 60 and 64 million tons unpriced. Yesterday, CNX gas increased their production guidance for 2008 to 73 billion cubic feet, which represents a 25% growth in production from last year's production of 58.2 billion cubic feet. Nearly 60% of the 2008 production guidance is hedged, an average price of $9.25 per MCF.

CNX gas maintains its goal of producing 84 BCF and a hundred BCF by 2009 and 2010 respectively. For 2009, approximately 42% is hedged at an average price of $9.74 per MCF, and for 2010 approximately 20% is hedged at an average price of $9.73 per MCF.

Now, let me give you a brief update on our coal and gas capital projects. To further capitalize on what we believe was sustainable higher coal prices, we are moving forward with the high return [Bronfield] coal projects that we identified earlier this year. These projects include six long-wall face extensions at four of the company's mines in Northern Appalachia, and will be completed at various times between 2009 and 2013. Each long wall face extension is expected to take 12 to 18 months once development work begins, and it can increase production between 300,000 and 500,000 tons per year per project.

The company also continues to proceed with the permitting process for a third long-wall mining system at the [Bailey] mine in Pennsylvania. Full completion of this project is expected in 2011 with an entire year of production in 2012. The additional long-wall mining system is expected to increase production by 5 million to 6.5 million tons per year.

In addition, the upgrade, the underground hauling system at the Shoemaker Mine near the upper Ohio River in West Virginia is on schedule with the previous (inaudible) completion date of early 2010. This upgrade is expected to increase production at Shoemaker to approximately 6 million tons per year. And next on the capital project front is also related to the Shoemaker Mine.

CONSOL announced plans earlier this week to develop a coal gasification, liquification plant in West Virginia through a joint venture with Synthesis Energy Systems. The plant is expected to be a mine (inaudible) facility with feedstock being supplied from the Shoemaker complex.

Mechanically speaking, we will capture the coal tailings from our preparation plant and convert that waste along with some raw coal into what we believe will be a profitable business endeavor. The end product will be 72,000 metric tons of methanol, or approximately a hundred million gallons of gasoline per year.

And finally, CNX gas, which achieved record production from its coal bed methane operations in Virginia, West Virginia and Pennsylvania is also expanding its production portfolio into various other areas.

During the quarter, CNX gas substantially increased its Chattanooga shale acreage position from 132,000 net acres to 235 acres primarily by buying out its 50% partner, Knox Energy, and acquiring several additional lease holds.

In addition, CNX gas has chosen to drill its Marcellus shale acreage directly beneath its mountaineer coal bed methane operations where it already has an extensive gas-gathering system. This will enable it to avoid processing costs by blending shale gas with its CBM production.

During the quarter, the gas company began dealing a vertical well in its Marcellus shale acreage. The company has also another site permitted at a nearby location with those results expected in the fall. The company also acquired an additional 24,000 net acres of Marcellus, raising its total position to 185,000 acres in that play.

And finally, the gas company is exploring and drilling in the [Yuron] shale in Eastern Kentucky and the New Albany shale in the Illinois basin. The combined businesses have generated $324 million in cash and $265 million in EBITDA for the quarter.

For the first half, we have generated $470 million in cash and $480 million EBITDA all of which, when combined with our low debt levels, puts us in a very strong position to manage and grow the business going forward. We believe that our coal assets and our unpriced coal positions for 2009 through 2011 place us in an excellent spot to capture the upside in the global coal markets over the next several years.

Furthermore, we are pleased with the growth of CNX gas and their successful execution of their strategic plan. We believe they are well positioned to profit from several conventional and unconventional areas in gas exploration and development. And with that, Brett, let me turn it over to you for your remarks.

Okay. Thank you, Bill. It's good to be with you again and discuss the quarter -- the second quarter of 2008. First of all, let's talk about, in any given quarter, there are good things and not so good things, and we'll talk about both of those right now.

First, let's talk about the good things. Bill talked about the great performance of the gas company that is on track to doing well. The long-term coal market fundamentals are solid in both met coal and steam coal. We're enthused about how that's opening up for '09, '010, '011 and '012.

We see higher energy prices on the spot side and we are starting to see that revenue flow into our company starting the second quarter, more robust in the third, and more dramatic in the fourth quarter.

Our earnings for the quarter were in excess of a hundred million dollars net income. Those are good things from where we've been in the past and where we've seen the coal business over the last five years. Still we have things to work on clearly.

Costs.Costs are a concern. If you looked at the two quarters, '08 and '07, you couldn't have two quarters more diametrically opposed than those two quarters. One in '07, all cylinders were running and we were doing very well on the production side in the second quarter of '07. And in '08 we had some problems and I'll talk about those problems right now.

We spent a lot of time looking -- analyzing this quarter, just seeing exactly where we were at. What we saw was a drop in productivity in tons per man hour related to long wall development. We made some adjustments there. We have actually made some personnel adjustments as well as adjustments in our planning processes. We've seen that come on track in the late part of the second quarter, but not enough to affect it.

And going forward, we would see -- if you look at the third quarter, because of minor vacation period, we don't see a big extent change in the third quarter, but the fourth quarter we see from a production standpoint, a very strong production surge and costs will come down and margins will expand as we see the revenues rise against cost dropping as productivity comes back.

Clearly, we focus, especially in underground mining, on tons per hour and development of our long wall panels. Those two things have given us problems, and part of the first quarter and probably two-thirds of the second quarter we have addressed that and are moving forward.

When productivity drops, these quarters tend to be fixed costs in terms of mining. And we spend and the tons don't come out, and that's what droves our costs. I would say that the second quarter is clearly not indicative of where we're going be for the year but it shows that if there are problems, that the costs can rise very quickly.

Having said that, I think that when we look at the total year, our costs are going to be in line with our budget that we put to the Board and our productivity should be a little bit down but not too far off where we plan to be for the year.

Let's talk about the market. Market fundamentals, they remain very strong. World demand for coal has remained strong as it continues to influence the domestic coal markets. US exports are reported to be up. We can see that at our own port facilities and while imports to the US are down. It appears to us the supply continues and will continue for a long time to be behind demand on a global basis.

No new projects are really coming on in a big way on the coal side. Countries are restricting exports in some case out of their own, to use their own resources, and bottle necks we see in delivery in countries where they are producing.

The US coal-fired power plants are running well and are running hard. New plants are being approved and some are coming online. So we do see some growth on that side. Global steel demand continues to create robust demand for all grades of met coal.

Mine inventories remain very low. I can talk about our inventories, we being the biggest -- one of the biggest companies in the east. We are at about 2% of production for the year at inventory at the mines. And that's in two main places. In some cases, in our big (inaudible) Pittsburgh mines, we're probably down to 600,000 or 700,000 tons of inventory, which is very tight.

When we look at the utilities, when we look at the northeast, we see 15 to 22 days of supply at some of our big customers. In some cases we're seeing less than a week of supply at critical power plants. In the southeast, we're seeing a little broader range of 25 to 35 days of supply, but that is, in both cases are down substantially from where they were at this time last year.

Higher prices for coal are starting to impact our numbers, as we look at our revenue side and we see some real value coming from that. I talked last time about a step change I believe we see in pricing. I think we're right in the middle of the step change and you're going to see expanding margins, especially as you'll see our productivity come back online towards the end of the year. Rapidly expanding margins that we really haven't seen before as we report quarter by quarter.

Having said that, I would like to open it up for questions, and some more specific questions about concerns. So let's go ahead and do that.

Thanks, Brett. Operator, would you please give our listeners their instructions on getting into the question queue?

Thank you. (OPERATOR INSTRUCTIONS) And we'll go to the line of Michael Dudas with Jefferies. Please go ahead.

Good morning, gentlemen. First question, Brett. You mentioned in the first quarter about a 6-1/2 million tons that you're holding off negotiations in the second half. Have you begun those negotiations and could you maybe elaborate on what type of discussions you're having with US and also international utilities for your steam coal?

Okay. Well, about 3 million of the 6-1/2 has been priced. Most of that has been over $100, between 100 and 115, and that's well under negotiation. And if you look at our unpriced tonnage for '09, we have about 14.5 million tons that are open right now.

What's real significant there is about 4.1 million -- excuse me, more than that, 3.7 of low vol and 1.2 of high vol are open on the met side. So we're real excited about where we see the market for the met coal and what's going on. The rest of it breaks into steam and Moundsville and Central App.

My second question, Brett, is relative to your Bailey expansion. Have you started to base-load discussions with utilities on that additional tonnage, or is it too soon?

We are into baseload discussions right now with major utilities, and they are domestic utilities. The domestic utilities seem to be stepping forward for long longer-term shared supply tons of which I think CONSOL is unique in supplying. And we're looking at a long-term contract with them to start the BMX portion of the Bailey mine.

Thank you, Brett.

Thank you.

And next we'll go to the line of Shneur Gershuni with UBS. Please go ahead.

Hello?

Mr. Gershuni, your line is open.

Hello. Can you hear me now?

Yes.

Hi. Sorry about that. Just a couple of quick questions here. Just, I guess, wanted to clarify the cost side that you had would kind of expect the productivity improvements to come back into line towards the second half, and you don't have the unanticipated Shoemaker costs and so forth.

So would it be fair to say that you kind of expect, excluding commodity cost, increases that you would expect that your costs should back down a little bit from the elevated levels that we're currently at right now?

Oh, yes. We expect them to come back in line with what our guidance was in the first quarter.

We are seeing pressure on the commodity side. If you look at diesel costs and steel, basically, roof support as well as replacement parts, I would say the commodity side of it is running with diesel. It is about 12.5% what we're seeing for the year.

If you take diesel out of it, which is diesel is not a big player but it has become more significant with our surface mining that we added with AMVEST. It's about 9% otherwise on all of these commodities.

Productivity really is the key. When we get that productivity back, and we see signs of it already moving back that direction, we'll see our cost per ton drop dramatically as we add more tons at the same dollars.

Okay. My follow-up question is with respect to CNX gas or CXG. Just in listening to their conference call yesterday, they seem to have a ton of exciting opportunities and potential for significant reserve growth and so forth. And I guess my question is, how do you see your role in trying to get that value recognized for CONSOL shareholders?

I guess, are you looking at options to try to push them further to expand their capital program rapidly so they fill faster and add to reserve bookings? And/or are you also looking at your current stake in the company in the capital structure and its impact on the marketplace, and whether a wider float would be able to push more value through to both the CONSOL shareholders and to the CXG shareholders as well, too?

Let me take a shot at that question. Certainly CNX gas has had a tremendous quarter, and it's just been a tremendous asset for us. We take a look at capital projects as the whole company. And we do the projects that have the greatest net present value or internal rate of return as we look at it really at about the same calculation because we look at different ways, but obviously we're going to get the highest rate of return. If that means more gas than coal, then that's the way we're going to go.

If you take a look at our capital expenditures for this year, we are spending more on gas than we are on coal and probably that spend rate is 3 to 2. I think for every $2 in coal, we're probably spending $3 in gas. Again, we see those projects right now to have the greatest net present value.

So certainly we're going to do nothing to pull back the gas company. We're going to continue to expand and invest in places that increase earnings and as a result increase shareholder value.

We announced in the first quarter that we have changed our view of CNX gas. Prior to that time, whenever we went out with part of the company on an IPO, we said we just didn't have an opinion as to what we were going to do. We wanted to put them out there and just see how well it would perform as a publicly traded company.

In the first quarter we said we changed our view, meaning that we're going to keep that part of the gas company, 81% of the gas company, and we would also take a look at maybe buying some more of those shares back. We haven't changed in our thinking there. Again, it depends on how the market goes and the rest in the future, but I can tell you that we will do nothing to hold back that gas company. It's a very, very valuable asset for the CONSOL Energy company, and they're going to continue to do great things, along with our coal business.

Definitely agree on the value of the gas business as well. Great. That takes care of my questions. Thank you.

Next we'll go to the line of Brett Levy with Jefferies & Company. Please go ahead.

Hey, guys. In terms of making additional acquisitions and where you'd want to build your reserves, can you talk either venue or preference for steam or met? Can you talk a little bit about what you're thinking about in terms of acquisitions?

Okay. Well, clearly, we look at all acquisitions, and we think that's well capitalized mines in any mining-type market, especially with the way permitting is. Probably the best way to increase value is to consolidate and buy mines that are already in operation. We did that with the AMVEST acquisition last year and Central App. We're always looking for opportunities. But our reserve position is very strong, too, and we can also invest internally.

We've talked about the BMX mine fifth long wall at Bailey [Enlow]. And on our met side, we haven't talked much about this, but on our met side our reserves are about 500 million tons. We think over the next five years we can increase our met production at about 5 million, excuse me, 3.5 million tons per year depending on what we do.

And on the resource side -- and we're drilling this out now, we think we have another 480 to 500 million tons of reserves that's not considered reserves, but on the resource side of met coal as well. So that's where we're focused right now.

And on the acquisition side, we would acquire opportunistically where we think we can add value, whether it's east or west or to the south of us. So that's the way we look at it.

So sort of stuff that's like neighboring mines is particularly attractive to you?

Yes. They're typically, they tend to be priorities, because there's a lot of synergy in the region with that. But we wouldn't hesitate to go to another region if it made sense and we could add value there.

Got it. Also, can you just give a little bit more detailed update at sort of what's going on at Buchanan?

Okay. Buchanan, in terms of the production of the mine, when we opened the mine up, we actually opened it up and we went into a long-wall panel that was 500 feet in width instead of 1,000 thousand feet in width. and it changed our productivity cycle. So Buchanan is up and running and doing well but not at full productivity. We think by the middle of this quarter we'll be up to full productivity in another long-wall panel that's 1,000 feet wide.

It's producing well. And the gas side of it, we're pulling a lot of gas off the gas side as well as drilling out in front of it. And we're getting -- we'll be repricing those tons into some very high prices in '09. The numbers that I'm seeing now on the low vol side is 325 per metric ton in the vessel, which gives us very high margins at that mine for '09. So we're really enthused about it. And it's running well. And we're sealing the places where the government asked us to seal, and that's moving along as scheduled as well.

Thanks very much, guys.

And next we'll go the line of Luther Lu with FBR Capital Markets. Please go ahead.

Yes, good morning, guys.

Hi, Luther.

With API price recent coming down, I was wondering, Brett, if you can give us a sense of this what's going on in the export market for steam coal?

Okay. Well keep in mind that we've kind of broken ourselves away on the negotiations from that market in terms of we don't follow the API index. We negotiate directly with customers. We see the market as very strong over there. We are exporting 3.7 in '08. We're looking at 3 million tons for '09. And we're looking at the value between the export market and the value for the domestic market, which is probably stronger right now than the export market.

So if you look at both of them, they're both very strong, and the physical deliveries tend to drive the price more than what you see the paper deliveries in terms of the traders at that index that we're talking about.

Okay. So given that European market is still very strong, have you considered more about port expansions at the Baltimore facility?

Well, we have capacity there as well. We'll probably -- we believe we'll be at 10 million this year, at 12 to 12.5 million tons next year, and we are also finishing up a study to see if we can expand beyond the 15 million tons of capacity capitalized. That study is coming in. Believe me, if we see the long-term economics, we'll invest more into that port for export if it makes sense to us.

Okay. And given the recent pullback in your stock, do you have a stock buy-back program, or would you be willing to lever up to buy back more?

We're having discussions on those financial alternatives with the Board, and we will be discussing that with the shareholders at the appropriate time.

Okay. One more question on diesel hedge. Are you hedged for '09?

Well, we are hedged in a sense. With 40% of our diesel, and that would be the river diesel. We're hedged because we passed that through. And on the operating mining side, since we picked up AMVEST, the price has been rising rapidly and that affects us more at AMVEST.

Keep in mind, 85% of our coal is underground, which is driven by electricity. But where we do use diesel, we haven't had a chance to hedge because since we bought that mine the price keeps running up, and it's hard to hedge it on the rising side. So we're looking at that all the time, and when we see an opportunity, we will do that.

Okay. Great. Thank you.

Yes.

And next we'll go to the line of John Bridges with JPMorgan. Please go ahead.

Hi John.

Hi, Brett, everybody. Just wanted to go a little bit more into this -- into the cost issue.

Okay.

I remember a couple years ago there was a spillover of capital for long walls that got into operating costs. I just wondered to what extent that is happening now with all the expansion of long wall extension and that sort of thing that you're seeing.

Well, I think you have got a spillover from the opening of the Shoemaker mine. So that was a one-time event. And you also got some -- where the productivity is really hurting us, and it hurt us for the first six months, was development of long wall panels and being ready for the long walls to move to the next panel, and so we've accelerated that.

So probably what you've seen in the first two quarters is a surge in development to make sure we're ahead at every long wall and to give us a better cushion so we didn't have long walls sitting, waiting for development before they could get running again. Because, as you know, those long walls have to run, and so we're -- we have a higher percentage of development that you're probably seeing in the numbers that will probably level out. In fact, I'm sure it will level out in the third and fourth and even the first two quarters of next year. We accelerated that.

So how many days did long wall stand idle during the quarter?

Well, we have long wall that was idle at McElroy for almost 45 days. And part of it was geology and the other part of it was some management issues that we corrected. We've gone through both of them.

So this catch-up of long wall development you refer to, is that just McElroy or is that elsewhere?

It was mostly focused on McElory, but what I've advised the operations people to do is give me a plan to show every one of long wall on schedule and ahead of schedule. They've worked on that, so we've seen some increase at every place, but it was really serious at McElroy and we corrected the issue. In fact, McElroy in June was back on track and produced over a million tons itself.

John, you will certainly understand this, but when you go through the whole process of mining coal, you have CM units, you have long walls, you have haulage systems, you have preparation plants and you have shipping. And the engineers call it the theory of constraints -- is that you have improvements in probably your constraining factor and all of the sudden now your constraining factor now becomes something else.

With the CM units, it's not that they're doing poorly compared to before. It's just that there's just tremendous productivity gains in long wall technology and our haulage systems, as well as we're putting in some steady (inaudible) preparation plant. So again under this theory of constraints, we need to start focusing on CM development and that's what we're doing right now.

Yes, I'm just confused because, you know, a couple of years ago, we had this same problem. And there was a big -- as I understand it, a big investment in getting these tunnels out ahead of the long walls and now we seem to be back in the same problem.

Well, no. I wouldn't put a broad brush across that. It was more related to the McElroy mine and a little bit because of geology at Bailey. The other mines, if you look at them, have done very well and are ahead of schedule. So, on average, most mines are ahead. But when you have one behind it, it slows you down.

Okay. And to what extent did people problems interfere with -- or lead to this productivity issue?

I would say -- well, I will tell you straight out. We've had some changes at the officer level as well as at the mine manager level. So we felt like it was enough to make some pretty major changes.

Right. And the shortage of miners in particular? Are you getting people hired away?

We don't get a lot of pressure on the hired away in the Northern App. We see that in the Central App. So manpower-wise, we're probably training 150 to 200 miners all the time to fill in for people there are retiring. On the northern side, we have a tendency for people to come towards us rather than away from us because of our capitalization of long-term mines and our advertising. We're doing pretty well, John.

Okay. Best of luck.

Thank you.

And next we'll go the line of Jeremy Sussman with Natixis Bleichroeder. Please go ahead.

Hi. Good morning.

Hi Jeremy.

I guess -- I was wondering if you could give us sort of a breakdown, maybe a regional breakdown of where you see long-term contracts getting signed maybe recently or going forward. I guess what I'm getting at is it's a little tough to discern because of the some of the legacy contracts that were there.

Right.

So I was hoping -- you've kind of given us a helpful breakdown in the past. Maybe we could see that here?

Well, what I'd like to do is talk about the legacy contracts a little bit. We put more out. We thought that was creating confusion in the market place, so we put more information about the legacy issues. The legacy issues were 2003 and 2005 contracts that were written with bands on them with 15% growth and escalation. If you look at the -- look through what we put out in our press release, you'll see those.

But going forward, things that are open -- let me talk to you about the open positions. I talked earlier about 14.5 million tons in '09 totally open with no bands.

And the pricing we see forward, like in Northern App for '09, mid sulfur pricing would be $125 to $140 a ton. High sulfur would be 120 to 130. Moundsville type coal, which is more right on the river and tends to be a little less BTU, 100 to 110. On Central App on the CSX railroad, we see 125 to 140. On the Norfolk southern, 135 to 150. And if you get to the met coal, which is really interesting, the low vol we see 325 metric ton, I talked about that earlier. But high vol we're seeing about 315 metric ton in the vessel.

So those are numbers that we're looking at. And that's why we're looking so hard at are there other met reserves we can open up and add to our portfolio, but they have to come with contracts. We're not going to chase that business unless we see customers that want to do longer-term goals.

That's very helpful. This was just to be clear. This was for 2009 contracts for what you'd be -- ?

That's right.

Okay. Great. And then, I guess so then for 2010, I just want to make sure I'm interpreting this correctly. Looks like you have 26 million tons or so, I'm ballparking, completely unhedged and unpriced, and another 24 million tons that are committed but unpriced. So to some extent you have 50 million tons unpriced.

I guess do we have a sense of how much of that is truly unpriced or versus what would be maybe subject to some reopeners or -- ?

I don't know how you got the 50. Maybe you talked to these guys offline. What I've got here is, I've got 42 million unpriced tonnage for '010, 42 million and it breaks down with 4.1 met, 1.2 high vol, Northern App at 20.5, Central App 7.6, AMVEST 2.8, Moundsville 4.5, and other meaning [Emery] and other places, 1.3 million. And that adds up to about 42. So those are the numbers.

I think what we have collared for '010, which is collared, may help you out a little bit. At 52 -- excuse me, $53 is about the average price. There's about 8.7 million tons for '010 that are in that collar situation. But typically you haven't it seen it spelled out like that. That will help you.

And Jeremy this is Tom, the 42 has no collar, so it's 42 at the breakout that Brett gave plus 8.7 collared at 52.91, plus 28 million tons roughly that is in the guidance already priced at 48.27.

Okay, so the 42 plus the 8.7 was how I was getting to 51, 50 or 51. So basically that 42 completely unhedged and unpriced.

That's right.

Okay. So subject to market prices. Great. Thank you very much. That's very helpful.

And next we'll go to line of David Gagliano with Credit Suisse. Please go ahead.

I guess the follow-up question is, Brett, if you could give us a little bit more detail on how you are expecting the cost pressures to ease a bit in the second half outside of McElroy.

Okay. The cost pressures. It's almost as easy, but it's not easy to do. What you have to do is get your productivity. If you look at productivity per man hour over the year, we're very accurate.

When we have problems like we had in the second quarter and even part of the first quarter, that made the productivity per man hour drop. The adjustments we made is seeing that all long walls are at top volume for the last two quarters per hour and when your productivity rises like that, you're really getting more tons for the same dollars spent. And so we're going to see it rise probably 10% to 12% in the second to -- the last two quarters versus the first two quarters.

Okay. Was productivity already at that level at this point?

Oh, yes.

Okay.

David, what we've emphasized over the last several quarters is margin expansion. As we said, we knew costs were going to go up just because of commodity issues as well as the mix of the mines. But, again, our focus is on margin expansion, and we're disappointed in the quarter is that we did not achieve margin expansion in this quarter, but going forward we certainly believe that we'll see substantial margin expansion. Part is because of we'll have a better control over the costs, but also we're going to increase our production and obviously the increase in market prices.

Yes.

So I would say the problems associated with that productivity issue and the long wall development, the adjustments we made took us about three or four months, but they are behind us now.

Okay. Thanks.

And next we'll go to the line of Justine Fisher with Goldman Sachs. Please go ahead.

Good morning.

Good morning, Justine.

The first question is about a comment that you made earlier about the fact that you may see more value in the domestic value now than the export market. Can you give us a bit more color on what the value means? Is that in terms of better long-term contract terms or why is the domestic market more attractive?

Well, because the domestic market -- because of our unique location in terms of being the fuel right in the middle of the highest generation in the world in terms of coal. The fact that there's no transportation component that is dominant, our shareholders tend to pick up the value of locations.

So if we're doing long-term contracts with utilities or capitalized to match our coal, we can extract more value on a delivered BTU basis than we can if we're shipping it all the way to Europe where we're sharing railroads and freight costs. So in terms of price and term on the steam side, we extract a lot of value there.

On the met side, we extract a lot of value just based on being a very high rate of production at lower costs because of long wall mining against a good price worldwide. And so that brings the real value back to the mines. So we'll tend to push steam more towards the -- excuse me, met coal towards more of the Atlantic market, and we'll lean towards the domestic markets if the price is right on our steam side just because of location. Is that helpful to you?

Yes. No, it is. And to follow up on that, so granted it may be a little bit different for CONSOL because of size and particular positions, but do you think that for other producers it might be the same that if they got a price domestically that was somewhat comparable to what you've got abroad? Obviously, there's a huge price differential trying to export it, but if the price domestically ran up because as you said utility stock piles are low, do you think that more companies would see that value domestically rather than sending it abroad?

Yes, I think they would do that. And the other thing that is unique to this thing, any time the utilities step up and start to do term deals, companies will always deal with the power plant that's in the region because it's better, it's lower risk, and it's not -- if you look back in the history, the eastern United States has been a swing supplier to the Atlantic market rather than a long-term supplier like Columbia or South Africa. So if you look over time, a lot of value has been created by feeding the generations that's built around you rather than trying to play the swing markets.

Okay. And then you gave some excellent color on the breakdown of available coal for 2010 and I just have two questions on that.

Sure.

First is, do you get the 42 million of open tonnage by just taking -- if I add 42 to the 28 that's committed in price I still don't get to the production estimate so I was wondering on that math. And can you give us the breakdown for '09 as far as what type of coal is available of your unpriced tonnage?

Okay. Where you're missing on '010 is I think you're missing the collar tons of 8.7, which the average price is $53. And if you add that in to the 28, the 8.7, and the 42, I think you get to the estimate.

Okay.

Okay. And on the unpriced for '09, you get met at low vol at 3.7, high vol at 1.2, Central App at 3.4, AMVEST of 1.2, Moundsville less than a half a million, and other that would be general like Emery and others, about three-quarters of a million, which gets you to 14.5.

Okay.

And there's no collars on any of that. That's open priced coal.

Thank you so much.

Thank you.

And next to the line of John Hill with Citigroup. Please go ahead.

Great, and thanks for the detailed presentation as always. Just following up on Justine's question. I mean, do you think that this change in behavior of domestic utilities throws some of the high end of the export forecast into question? I mean, there's been a lot of talk about 80, 85 million tons plus, but if we're in a situation now where the domestic versus export net backs were equivalent a few months ago, now it looks better domestic. There was a tremendous European demand. Now it's looking like the domestic utilities want to go long-term. How do you think we should look at these overall export numbers on this new side?

I would say it's seasonal, and you're in a low right now in the market from the European demand. I would say that would get very robust going into the winter. And you'll see -- that will probably push the domestic guys to do more term business and -- but that's in a very high price deck compared to what they're used to being in.

So you'll probably see the domestic utilities come to the realization that the world market is very influential on their fuel supply more than it has been in the last 15 or 20 years, and so I think that you're going to see -- and we're seeing it right now. The domestic guys want to do the longer-term deals, but we're tending to do them at market prices rather than at fixed prices or even with collars. The old collar concept has again by the wayside right now.

Great perspective. And then, just following up, you talked in great detail about productivity and really shed some light on that light on that, and thanks very much for that. You talked through geology and turnover issues. The one that hasn't seemed to have gotten as much attention is the safety and regulatory mandates. Is there any way to quantify what that's costing you in terms of tonnage or dollars or how that affects the way you are doing -- How should we look at that impediment relative the those opposed by the former two categories of geology and turnover?

Well, we definitely see a change in the way the government approaches safety and regulation. And that is much tighter because of other incidents we've seen in the nation. If you go back -- clear back into when the act was put in the 70s, you saw a drop in productivity just based on these new regulations, but then you saw a response from the companies to adjust to them, and then productivity rose.

I would say that we're probably -- we're making improvements. We see where we're being held back somewhat in productivity, like walking people out of the mine by mandate. We're not running the machines as much per hour as much as we used to. So we're making adjustments to offset the productivity losses, but that tends to adjust itself over one or two years rather than -- it's hard to get your hand around a number right now, but we do sense it because we're seeing a little bit less in each mine, but we're adjusting our way around it.

Talking the other CEOs, they're seeing a drop in productivity based on the same issues, especially on the underground side.

Great perspective. Thank you.

We'll adjust our way around it, yes, and not compromise safety.

And next we'll go to the line of Pearce Hammond with Simmons & Company. Please go ahead.

Good morning.

Hi, Pearce.

If we go back to the cost issue for the first half of this year compared to the first half of last year, we're up about 25%. What should we be thinking on a percentage increase for the full year '08 versus the full year '07?

I would say for the full-year '08 I think -- I would say about 12% -- 10% to 12%.

Brett, are you seeing any Pittsburgh (inaudible) coal going into the PCI market?

Yes, we are.

Significantly?

But it's about 500,000 tons and it's our tons that are moving that way.

And what kind of pricing are you getting on those?

Let me look at -- it's about 220, 210, 220, depending on the quality and that's on a metric ton.

Do you see that expanding over time, or is that -- is there a great deal of interest for that material?

Well, I think -- think if the market stays tight, Brazil seems to be very interested in that type of coal right now, and it's a good alternative depending on how they want to blend. A lot of it depends on what kind of facilities they have on the other end to blend, and their ability to produce some coke and so forth.

And then, Brett, looking at the AMVEST acquisition, now that you've essentially got it in your fold so to speak for almost a year. If you were to grade that acquisition, what's performed better than what you expected and what's maybe underperformed relative to what you expected?

I would say -- I would say the performance of the surface mines have been under, but it was more geologically oriented, and the performance of the underground mines are improving because of our own technology being brought into them.

I would say on the front end though, it took us a while to adjust, maybe two quarters, to adjust to it but I think maybe we've got some momentum there now.

What I have been very enthused about was the reserve base and our ability to mine there for longer periods of time is greater than we anticipated and we're enthused about that.

Great, and then sorry one last question. On this productivity, which I appreciate all the good color you've given there today. If you were to break that into two buckets, geology being one, and I'll call it labor and managerial issues in the other, what sort of percentage allocation would you give to each one as far as the short fall you've had in productivity? Is it a little bit more weighted towards that managerial issues or is it more weighted to the geology side?

I would give it a 50/50 right now. The nice part is the 50% piece on the managerial side you can correct quicker. Geology is what mother nature gave us.

Great. Thank you very much.

Okay. Thanks.

And next we'll go to the line of Sam Martini with Cobalt Capital. Please go ahead.

My questions have been answered, guys. Thanks.

And next we'll go to the line of [Franklin Roth] with the [Lynch] Foundation. Please go ahead.

Hi, guys.

Hi Franklin.

I guess my first question is, on average, what did your inventories look like in the past?

If you go back there, it wasn't unusual. I'm talking three or four years ago for our inventories to be between 3 and 3.5 million tons. Right now we're operating between 1.5 and 2 million tons.

And when you look at the legacy contracts, how long should these last, the 8.3 million tons that go out --

That's a good question. At end of '010 we see the legacy drop from 8.7 to 6, and then the 6 million tons are going be out there maybe even probably about 10 years, and -- but they escalate year to year and have a collar of 15%. I would say if the market stays robust, it'll have a cap on it but it will grow very fast.

And what are you suggesting to the utilities that have a weak or lesser supply? I mean, what's their position, I guess?

Well if they're long-term customers our suggestion really is we'll work with them to try to get them coal, but we don't want to see anybody let the lights go out, and we were very focused on that. We have critical mass to try to move some trains around. But if it's tight in the spot market, and part of the function of a real high spot market is the lack of supply, and we're seeing huge lack of supply in the east. There's just limited coal available, and people plan their fueling plan based on a lot of spot coal. They're in a tough situation right now.

Yes. And when you look at your legacy contracts, you got the high end of that reup, you got the full increase on the call, right?

Yes. We got the whole thing. Plus the installation in between the reups, yes.

All right. Well, great quarter, guys.

Thanks.

And next we'll go the line of [Bill Egen] with Raymond James. Please go ahead.

Hi, guys.

Hey Bill.

I just wanted to follow up on the coal gasification project.

Sure.

Talk about your CapEx that might be involved.

The way it's set up is we are -- we've moved forward on the 50/50 joint venture. We think it -- the top end of it is 800 million which would be 50%. And that 50% would give us half of the product and half the value. And so -- the interesting part about it is it takes coal into a whole new marketplace in terms of value with gasoline and ethanol.

Great. And any idea on the timing and potential revenue impact?

We think 2012, and we're -- part of this whole commitment with our partner is to get the revenue and impacted value out of it. But it looked valuable enough for us to take the next step with our partner, and a great location. We have the coal. The coal is already capitalized. It's a Shoemaker mine coming back. The state of West Virginia is very excited about it. The chemical companies are very excited about domestic supplies of ethanol, and we all -- if gas prices stay up, we could make -- we could make some bucks on turning coal into gasoline.

Great. Thank you very much.

And next we'll go to the line of Paul Forward with Stifel Nicolaus. Please go ahead.

Thanks.

Hi, Paul.

Hi. On the -- couple things. On the 3-1/2 to 5 million tons of incremental met coal production that you think you'll be able to do.

Right.

Can you give us maybe the type of met coal and the location that you think that that would be coming from?

Okay. First of all, we're going to expand the Buchanan mine to the tune of about 1 to 1.2 million. And then we've got some production of mine 84 that we can access -- when we shut the long wall down there, we can do some minor section work there. We have a property called [Falofield] which we believe we can bring up 1.5 to 2 million tons, and that would be, I think, high vol met coal, and we have another mine that was low vol met coal, 0.5 to a million tons. It's called [Ipman], and that's a mine we mined years ago. We think we can reenter that mine and do a half a million. These are all minor section mines, but if you add them up they're pretty substantial. Another called Squire Jim is, I think, mid (inaudible), half million tons.

All right. That's good. And maybe when we look at the 325 per metric ton in the vessel right now, when you back into what your realization is at the mine is, would that be something on the order of the 265 if you assume something of a $30 rail cost? Is that about right?

Yes. If you spend $30 you hit it right on the nose.

Okay.

It's a nice number.

It's not bad. On the -- just thinking of the utility discussions that you 're having right now. If your customers are rolling off contracts at $40 and they're being presented with Northern App price between 120 or higher than that, what is their receptiveness to signing deals at anything longer than a year at that level?

If you look at what we're doing, we're signing, and these are new-type contracts. We're signing term deals at market prices, meaning they're tying up the volume to where both of us are committed, and putting systems together to assess market price year to year and sometimes every two years depending on what the customer wants. And we're okay with that because being a low cost producer, market prices are always good for us.

So they don't throw you out of the office when the price is tripled from the old contract?

No, they don't, because if you look at supply, we know utilities have gone out for bid with multiple suppliers and maybe one guy comes back with a third of the tons they wanted. So the availability is not there. So we're more in a supply driven issue than price driven issue right now, and those things tend to shift become and forth, but having been a coal buyer in my past myself, there's one thing to have the right price and there's a bigger thing to not have the coal, and not to have the coal, I think, is the concern of most of them right now.

And is that question about -- well, going back on one of the previous questions, you're suggesting 3.7 million tons of steam coal exports this year, maybe 3 next year.

Yes. From us. Yes.

From you. Is that lower number in '09 partly reflecting the alarm that you're starting to see among customers domestically over their low stock piles, and I guess that is a way of asking, can you really be shipping much steam coal overseas when you're going by plants that have a week of coal on the ground.

I think you hit it right on the nose. I think when the trains leave to go to export, they tend to be soaked up by the domestic market.

Okay.

And that's part of the strength of CONSOL, that we have the ability to do that and we become a high BTU supplier in the region because we're well capitalized for this market and we have been for a long time, and they built their plants to match this market. So I think the realization that we're large, dependable, high BTU company is coming to the realization of some of those who played the spot market for 20 years.

And maybe lastly on this -- on the collared tons per 2010 is that toward the low end of your quality spectrum for let's say your Northern App coal that you have collared on price caps on 2010?

Yes, it is. You would find that what you see on the river, the Moundsville-type coal.

Okay. Great. Thanks.

Thank you.

And next we'll go to the line of [Zack Scriber] with [Ducane Capital]. Please go ahead.

Hi, guys. It's --

Hi.

Just a question on the cap deals. I missed that. They were done in 2003 or 2005. They expire when? I thought I heard 10 years.

Okay. Let me give that to you. They were done in '03, '05. One of them rolls off at the end of '010, and then two of them -- one goes through '015 and the other one goes clear through '18. But the cap deals are capped at with the band at 15% with escalation in between.

15%.

This is Tom Hoffman.

Hey, Tom.

That price that we're showing in a footnote to the table is just cap at '09, I'm sorry, 2010. The next time it opens up, it will be a higher number than that. So don't model that only.

No. We agree. Is it 15% per annum cap?

It depend -- it depends. It's a three-year deal.

Okay.

The biggest one is a three-year deal. So that will be the one that affects you the most. So it opens up to three years and escalates between.

But is it a 15% per annum.

No, not per annum, no.

So it escalates every year based on inflation, when it opens up that annual increase is capped at 15%.

That's right . That's the way

Okay. And just on the ports. It does seem like one of the major structural forces that was able to take cake care of some of the inventory in the east last year was some of the stuff related to accessing the your European export market? Clearly the domestic power companies are more realistic about the global supply and demand situation and are going to enter into long-term contracts at open kind of market-based pricing, if you guys start turning away from the export market, what happens to the sort of respective bargaining position with vis-a-vis the power companies, and are you willing to just give up the export market in totality.

No, no the no, no. We have always export. We export contracts and relationships we've been doing for 25 years. We're not giving up on anything. What we're doing is maximizing the value to our shareholders. So wherever we can get the best value deal, that's what we 're going to do. So that's why we have the capacity at the facilities themselves and we can surge ourselves or we can pull back depending on where we see the prices, so don't feel like we're going to tie it all up and walk away from the market because we won't.

All right. And then, just on the port I think you said 10 to 12 million tons.

Right.

The capacity to do 15, exploring possibly expanding it. At what kind of capital cost would it take to expand to Baltimore port facility and by how much could you expand it? And when you look at the Baltimore facility, how much do you lease out to other people? How much of it do you retain for your own account.

Okay.

The economics of maintaining for your own account versus sending it out to other people. How do you think about that? How do you model that? And when we think about the company going forward, should we scribe some value to just that facility or just think about it in terms of the net backs embedded in the exports?

Okay. A lot of good questions there. But here's the philosophy. We own it. We want the capacity we need first. So we take reservation first. That's based on our marketing strategies as well as our plan. Then we -- how that ends up is about a third CONSOL, two-thirds others, but we have the call on the other two-thirds as we need it. To expand the capacity 68 million more tons a year, it would take about 25 million -- excuse me, $25 million investment and that would put us in a position to expand the value of that, assuming there were term deals that justified the investment.

And how long would it take to make the expansion?

Probably two years.

Seems like a no brainer to do, just the auction value of it is --.

Well, it 's like anything else. It's got to come in the food chain of a high rate of return projects, and it's competing with gas and long wall expansions and all those kinds of things as well .

Sure. And on the two-thirds that goes to other people, you guys have first coal on that so are basically selling them and the second call you can cut them off on a moment's notice?

I would say not cut off, but not doing term deals where people are locking up -- usually 45 to 60-day deals.

At what kind of rate?

Rising rates, is what I tell our guys. I don't have those on me. It's about $12 a ton right now.

Okay. And just in terms of the dynamics that you're seeing between the financial markets for coal and the physical markets for coal, I mean, it seemed like sort of Nymex financial coal got crushed as everyone played the global slowdown trade. And now you're seeing sort of short covering and the gap and the spread between Nymex coal and more physical-type coal in the CSX got to historical wides, did that occur on any volume? Was that a real indication of market? Did that sort of contemplate any of your structural negotiations or was that just noise?

Those were -- that's a good question. What we see is people trying to tie the paper side to oil and other forms of energy. When you go to the physical and we give you this pricing it just keeps rising or it gets real tight at these higher prices, so, no, we're not seeing any connection between the two. Because people need the coal, and I think -- you and I have talked about that in the past. I think you're right on. It's a supply problem.

And our next question is from Sam Martini with Cobalt Capital . Please

Hi, guys. I'm sorry to jump back in. Just a couple of questions. On -- just back to the collars, and I don't mean to beat this to death, but the release gives the color that the -- I had assumed that the collars were included in the tons committed. You're saying this is not the right way to look at this because the tons committed added to the unpriced doesn't get you to the production targets?

Okay. You add the committed tons of 28.2. We're talking 2010, right?

Yes. 2010.

Okay. And you've got 28.2, and add that to 8.7, and then you add 42 on top of that.

Okay. So the 52.4 does not include the collars, the collars are on top of that 52.4 which are the committed tons.

Right.

And just a follow up to Paul's --

Wait. The collars are separate. They're 8.7 million tons, and they're at about 52.91, and you add that to 28.2 million tons at 48.27. And then you've got 42 million tons on top of that.

Okay.

Wide open pricing.

And to Paul's question. It's safe to assume that if I thought about -- if I thought about your Northern App production and sort of three flavors with the Bailey ML fork and then the leverage and the McElroy and declining sort of -- declining price range, we can talk about the grade, but it sounds like the brunt of these are going to be more towards the McElroy flavor as opposed to --

More like the river coals, yes.

Okay. And then if we look at the drop on the cost side, what do you think -- we took about 600,000 tons year over year off Northern App and added about 800,000 tons in Central App. Do you have a rough estimate of just the cost per ton differential that it will cost between -- is $15 a ton incremental cost for the Central App coal production versus --

The Central Apps will always run about, I would say, 50 to 60% higher cost per ton. And that's just a good average to use. So, say, you're at $20 at Northern App. That is going to be 60% higher for Central App. That's just -- that's just the average we're using. And that -- now that's with our coal. If some other projects it could be much higher than that. Could be as much as twice or three times.

And then our last question is from a David Lipschitz with Merrill Lynch . Please

Hi David.

Hi. How are you? Good. A quick question. I'm confused on the cost. You gave a percentage increase of around 10% to 12%. That means for the rest of the year you'll be below what you did in the first quarter? For cost per ton.

Yes. On ask productivity side, I would say that's going to bring us in. I'm not sure what these inflation numbers are going to do. Those are more of the unknown, but yes, I would say as our productivity rises our costs are going to level out and I think when it's higher in the fourth quarter it will actually go down a bit.

Yes. But, again, as we talked about we're going to be focused on margin expansions, so it could very well be that costs go up, and we're okay with that as long as we expand our margins.

Okay. And a quick -- in terms of depreciation what are you looking for this year?

Quickly, I mean, you could say well we have the first step of to multiply, that would give you a good estimate.

Okay. Just checking.

Operator, thank you. I thank everyone for joining us this morning. Chuck Mazur and I will be available the remainder of the day and, operator, if you would let people know how to hear the replay.

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