美國鋼鐵 (X) 2011 Q2 法說會逐字稿

Ladies and gentlemen, thank you for standing by.

Welcome to the United States Steel Second Quarter 2011 earnings call and webcast.

At this time all participants are in a listen-only mode.

Later we will conduct a question-and-answer session.

Instructions will be given at that time.

(Operator Instructions) As a reminder this conference is being recorded.

I'd now like to turn the conference over to Dan Lesnak, Manager of Investor Relations.

Please go ahead.

Thank you, Linda.

Good afternoon and thank you for participating in United States Steel Corporation's Second Quarter 2011 earnings conference call and webcast.

We've included slides in this quarter's presentation that we believe will be helpful to you as well as a few additional slides in the appendix that you may find of interest.

For those of you participating by phone, the slides that are included on the webcast are also available under the investor section of our website at www.USsteel.com.

We'll start the call with some brief introductory remarks from US Steel Chairman and CEO, John Surma.

Next, I'll provide some additional details for the Second Quarter and Gretchen Haggerty, US Steel's Executive Vice President and CFO will call out on some financial matters and the outlook for the third quarter of 2011.

Following our prepared remarks, we will be happy to take any questions.

Now to begin the call, I'll turn -- before we begin I must caution you that today's conference call contains forward-looking statements and future results may differ materially from statements or projections made on today's call.

For your convenience the forward-looking statements and risk factors that could affect those statements are referenced at the end of our release and are included in our most recent annual report on Form 10-K, an update on our quarterly reports on Form 10-Q in accordance with the Safe Harbor provision.

Now to begin the call here is US Steel Chairman and CEO, John Surma.

Thanks, Dan.

Good afternoon, everyone.

Thanks for taking the time to join us today.

Yesterday, we reported second quarter net income of $222 million or $1.33 per diluted share.

Excluding the impact of foreign currency remeasurement on a US dollar denominated intercompany loan, our adjusted earnings per share was a significant improvement over our first quarter loss, and was more than double our earnings for the second quarter of 2010.

Now before I discuss our results in detail, I would like to comment on something we consider more important, which is our safety performance.

We continue to make significant progress in the elimination of injuries and illnesses in our Company.

From 2005 forward we have reduced our OSHA reportable rate by 48%.

On an annual prorated basis, this represents nearly 300 employees who have not sustained a medical treatment injury in 2011 that would have if we had not shown such improvement over the last 5 plus years.

We've also reduced the number of days away from work injuries by 63% when compared to 2005, again on an annual prorated basis this improvement represents nearly 90 of our employees who have not sustained injury in 2011 serious enough to result in missing a day or more of work.

While still some distance from our ultimate goal of 0 injuries, the performance improvements noted are the collective results of the focus of our leadership team, our joint efforts with our trade union colleagues including the USW in North America, and the collective safety commitment of each and every employee of our Company.

As I say to our employees, someone we know was not injured today because of our collective commitment to the safety and health of our employees, and I'm very proud of each and every one of them.

Now, turning back to our second quarter results.

Operating income for the flat-rolled segment was $374 million in the second quarter.

This was the best quarter for our flat-rolled segment since the third quarter 2008; and in fact, it was one of our best quarters ever.

Our operating income was $95 per ton, an improvement of more than $100 per ton from last quarter, and more than 3 times our operating income per ton in the second quarter of 2010.

Our improved results were driven primarily by significantly higher price realizations on both our spot and contract tons as the benefits of the sustained increase in spot market prices throughout the first quarter will reflect it in our market based contract pricing for the second quarter.

Although spot market prices began to fall and lead times shortened in the second quarter, order rates were sufficient to maintain shipments at first quarter levels.

We had a strong operating performance at our steel making facilities in the second quarter.

Excluding Hamilton Works, which remains idle due to an ongoing labor dispute, our raw steel capability utilization rate was 90%.

Operating efficiencies from running at these levels lead to a very solid cost performance as well.

For US Steel Europe, we had an operating loss of $18 million.

That is the benefit of increased Euro based transaction prices driven by improved contract prices and higher swap prices early in the quarter was more than offset by higher raw materials costs and significantly lower shipments.

We also reported a lower cost of market charge of approximately $10 million in the second quarter.

As increased volumes of low priced imports and increased production entered the spot market -- entered the market, spot prices trended downward later in the quarter and demand weakened, particularly in Southern Europe where our hot rolled oriented product mix leaves us more exposed to the spot market.

The economic recovery in the Balkans area has been slow, and we continue to face challenges in Serbia where we rely completely on relatively expensive merchant coke and have a less favorable product mix.

As a result, we decided to keep a blast furnace in Serbia that was idled early in the quarter for planned maintenance down rather than chasing hot rolled orders that were few, low priced, and far away.

It remains idled.

Tubular income from operations was $31 million in the second quarter.

Tubular results were in line with the first quarter as higher average realized prices resulting from both higher product prices and a favorable change in product mix were offset by increased costs for hot rolled bands supplied by our flat-rolled segment and purchased rounds.

Although margins were comparable to the first quarter on a total quarter basis, the continuing increase in price realizations during the quarter combined with falling hot rolled ban prices resulted in margins improving throughout the quarter.

With steadily increasing rig counts and the oil and natural gas liquid rich shale formations, we have good momentum heading into the third quarter.

Last quarter, we commented on some of the strategic projects we have in progress, as well as some potential opportunities we're considering as the environment we operate in continues to evolve.

We have a strong resource base here in North America with significant iron ore reserves and pellet production capability.

With our wholly owned operations at Mintak and a Keytac as well as our joint venture interests at Hibbing and Tilden, we have access to approximately 25 million tons of high quality pellets annually and we are currently pursuing permits at Keytac that could add in excess of 3 million tons of additional annual pellet capability.

The current development of the abundant natural gas reserves in North America is providing excellent opportunities for our Tubular segment, and we are exploring options as critics stand the benefits of a long term competitively priced natural gas environment to our flat-rolled segments as well.

Considering the significant increase in the cost of metallurgical coal and coke in recent years, one option that we are evaluating is producing direct reduced iron or DRI, using our own iron ore and competitively priced natural gas.

DRI produced using our own iron ore could be used to improve our blast furnace yields and could be a cost effective substitute for scrap in our steel shops or in an electric park furnace if we were to supplement our integrated production route with this type of facility.

And EAF could also enhance our operating flexibility over a broader range of market conditions.

In the current raw materials cost environment, the cost of producing a ton of steel by combining scrap and hot charged ERI into an AEF would be significantly lower than a cost of a ton of steel produced by an integrated producer using market based raw materials and would mostly -- most likely be lower cost than scrap produced in an EAF using a 100% scrap charge.

Last quarter, we also discussed our strategic projects to improve our coke short position.

We're pursuing 2 paths to improve our position and substantially reduce or eliminate our exposure to the merchant sea-borne coke market.

Our projects to add additional coke and coke substitute production capability at our Clariton plant and Gary Works are on track, and we currently anticipate both will start production in 2012 and will reach full production capabilities in early 2013.

We're also increasing our use of natural gas as a substitute fuel for coke in our North American blast furnaces, as the current cost of natural gas makes this a very cost effective option for us.

Our coke rate per ton of hot metal in June was approximately 60 pounds lower than our average coke rate in 2010, and we are pursuing additional reductions of 35 to 40 pounds per ton of hot metal by the beginning of 2012.

If you assume that natural gas is $5 per MMBtu and purchased coke is $500 per ton for simplicity, each pound of coke that is replaced with natural gas results in a $0.16 per ton reduction in hot metal cost.

At these assumed natural gas and coke prices, replacing 50 pounds of coke with natural gas would reduce raw steel costs by $6 to $7 per ton.

The cost to increase our ability to inject greater quantities of natural gas into our blast furnaces is minimal and the potential savings are substantial.

Longer term, further coke rate productions are possible from other sources such as increasing our hot blast temperatures capabilities although some capital would be required over the medium and long term.

While we continue to focus on reducing all of our cost on a continuous basis, we felt it was important to highlight some of the bigger impact items we're pursuing.

Now, I will turn the call over to Dan for some additional information about the quarter results.

Dan?

Thanks, John.

Capital spending totaled $221 million in the second quarter.

We currently estimate the full year capital spending will be approximately $860 million.

Depreciation, depletion, and amortization totaled $171 million in the second quarter and we currently expect to be approximately $685 million for the year.

Pension and other benefit costs for the quarter totaled $149 million, and we made cash payments for pension and other benefits of $120 million.

For the full year, we expect both our pension and other reference costs and cash payments for pension and other benefits to be approximately $595 million.

These estimated cash payments exclude any voluntary contributions we may choose to make to our main Defined Benefit Pension Plan in 2011.

Net interest and other financial costs were $13 million for the quarter and included currency gain -- a foreign currency gain of $41 million.

Excluding foreign currency effect, net interest expense for the second quarter was $54 million, and we expect to be approximately $57 million in the third quarter.

For the second quarter 2011, we recorded a tax provision of $65 million on our pretax income of $287 million.

The tax provision does not reflect any tax benefit for pretax losses in Canada and Serbia, which are jurisdictions where we have recorded a full valuation allowance on deferred tax assets and do not reflect any tax provision for foreign currency gains that are not recognized in any tax jurisdiction.

Now, Gretchen will review some additional information and the outlook for the third quarter.

Thank you, Dan.

To begin, I'd like to provide some insight into our pension and OPEB expense, which as some of you have noted has had a significant impact on our profitability.

As Dan mentioned, our total expenses for 2011 will be $595 million, $436 million for pension expense and $159 million for OPEB expense, which in total is an increase of $170 million or 40% from 2010.

While our OPEB expense has remained relatively flat over time, our pension expense has increased from 2009 to 2011 due to the sharp decline in the equity markets in 2008.

These 2008 investment losses were recognized in the calculation of the market related value of assets over a 3-year period.

This decrease in the market related value of assets resulted in a lower than expected return on assets and higher investment loss amortization charges, thereby significantly increasing pension expense in 2011.

By comparison, our pension expense for 2011 is almost $250 million higher than our pension expense was in 2006, a period when we were recognizing investment gains in our calculations.

Another significant factor impacting pension and OPEB expense in recent years has been the general decline in discount rates, which increase the service costs and the projected benefit obligation and causes additional unrecognized actuarial losses that must be amortized to expense in future years.

The discount rate is now 5% for both domestic and international plans and was 6% in 2004.

A 1% increase in the discount rate as of January 1, 2011, would have resulted in a decrease of $65 million in our 2011 pension and OPEB expense and a $1.3 billion improvement in the funded status of our benefits plans.

Assuming for illustrative purposes, the discount rates remain unchanged, our actual market performance -- and our actual market performance equals our expected rate of return on assets, our total pension and OPEB expense should trend down over the next several years as the 2008 asset loss impact diminishes.

Now, in the second quarter we changed our segment allocation methodology for post-retirement benefit expenses, which consists of pensions and retiree, healthcare, and life insurance.

Historically, we directly attributed all service costs and amortization of prior service costs for our active employees and allocated a portion of interest cost, expected return on planned assets, and amortization of actuarial gains and losses to our segments.

Under the revised allocation methodology, active service costs and amortization of prior service costs, which represent the cost of providing these benefits to our active employees continued to be attributed to our segments.

Interest costs, expected return on planned assets, and amortization of actuarial gains and losses are included in post retirement benefit expenses and are no longer allocated to segments.

We've revised prior period segment information to conform to the current period presentation.

The change resulted in an increase in US Steel's reportable segments and other business income from operations with an equal and offsetting increase to post-retirement benefit expenses of $24 million and $14 million for the first quarter of 2011 and the second quarter of 2010 respectively.

The change did not affect consolidated income from operations or net income.

The change in our allocation methodology was made to focus on the recurring costs of the operating segments without the volatility of the financing and interest components of net periodic benefit costs and to improve the comparability of our segment results to our peer Company.

Second quarter cash from operations excluding working capital changes was $492 million, more than doubling from a year ago and up significantly from the first quarter.

Second quarter working capital changes reflected a modest increase in accounts receivable and a much larger build in inventory.

The inventory build reflects restoring inventories that were depleted in the first quarter and our decision to carry higher steel inventories designed to improve our service position with our automotive and other customers and position us to take advantage of future business opportunities.

In addition, we're currently carrying higher than anticipated raw material inventory in part due to lower than planned steel production and our decision to keep one of our blast furnaces in Serbia idled.

We have ample liquidity to carry these inventories that we will need in future periods, and we will adjust our raw material purchases and inventories going forward as appropriate.

Having modestly higher reasonably priced inventories should be an advantage for us and our customers as we continue to navigate through the many cycles that a slow and uneven economic recovery can produce; and as we have demonstrated repeatedly and most recently in 2009, we can convert these inventories to cash if necessary.

We ended the second quarter with $393 million of cash and total liquidity in excess of $1.8 billion.

Last quarter, I mentioned that we were considering taking advantage of favorable lending markets to extend the maturities of our domestic liquidity facilities.

You may have seen our 8-K filings from last Thursday.

We extended the maturities and increased the size of our facilities by $225 million with the strong support of our lenders.

We increased our $750 million inventory backed revolving credit facility to $875 million and extended its maturity from May of 2012 to July of 2016.

We also increased our Accounts Receivable securitization facility from $525 million to $625 million extending its maturity to July 2014.

The increased availability resulting from these amendments is not included in the $1.8 billion of liquidity where we reported at the end of the second quarter.

Now, turning to our outlook for the third quarter of 2011.

The United States and Europe continued to face an uneven economic recovery.

The continuing fiscal uncertainty in the US and Europe are not helping the situation.

Reflecting the effect of a slowing economy, we expect to report an overall lower operating profit in the third quarter; however, we expect significant improvement in our Tubular operating income compared to the second quarter of 2011.

Flat-rolled results for the third quarter are expected to decline compared to the second quarter 2011 reflecting a lower average realized prices on our monthly indexed base contracts and our spot market business as increasing capacity and imports have placed pressure on current transaction prices.

Raw materials costs are expected to remain relatively stable reflecting our iron ore, coke, and coal positions.

Shipments and raw steel utilization are expected to be in line with the second quarter.

We expect the third quarter results for our European segment to be in line with the second quarter 2011.

Although we expect an overall decline in average realized prices, we expect seasonal effects to result in increased demand late in the quarter.

Raw materials costs are expected to be in line with the second quarter.

Tubular third quarter results for 2011 are expected to improve significantly compared to the second quarter driven by both increased shipments and improved average realized prices.

Demand for energy related Tubular Products is projected to increase during the third quarter, primarily due to the continued strength of horizontal and oil directed drilling, and we believe our Tubular facilities are well positioned to serve our customers growing needs for premium Tubular products.

In addition, substrate costs in the form of hot rolled bands supplied by our flat-roll segment are expected to be lower throughout the quarter.

That completes the outlook.

Dan?

Thank you, Gretchen.

Can you please queue the line for questions?

Certainly.

(Operator Instructions) And our first question comes from the line of Luke Folta from Jeffries & Company.

Please go ahead.

Hi, good afternoon, guys.

Hi, Luke.

I apologize if you've gone through this.

I wasn't able to make it to the first part of the prepared remarks; but in your presentation I see that you made some reference to some alternative steel making options that you're looking at, and I just wanted to get a sense of what the timing or the scale of a potential DRI facility or electric art furnace could be?

Luke, this is John.

We didn't cover it yet so I'll just comment on it now.

We just acknowledged those are things that we're considering.

Really no specific dates or time periods to give you yet as far as scale and scope.

They typically come in a million tons per year type of increments, maybe half a million, something like that; and our timing will be driven by a number of things, the availability of investment capital would be one of course, and -- as well as where our opportunities may be based on our schedule to do work on blast furnaces.

At some point we may decide to reroute to part of our production path from blast furnace technology to DRI.

Keep in mind that the DRI EAF decisions, for us at least, are completely independent and we can do one without the other because DRI with our own ferrous inputs with competitively priced gas is quite attractive and we could use the output of that DRI to either improve blast furnace utilization rates, dump out scrap in the steel shops or if we chose to go the DRR route.

So still in the conceptual phase, we're trying to frame a couple different approaches and I can't really have a time frame, but it's not something we'll announce next week.

But I don't expect us to be having the same conceptual conversation like this next year.

Okay, and also just in that presentation as well you talk about a potential expansion to Keytac, about 3 million tons a year.

I remembered we talked about that before the downturn.

Is this just a restart of that plan or it would be something in conjunction with a DRI facility?

Again, separate -- good question, separate decision.

It is the same project that we generally spoke about back in mid to late '08 probably, just before the downturn; and we have continued to pursue in a very methodical way the necessary permits that would enable us to go ahead with that project if we decide to and we've continued that throughout, working very closely with all of the relevant agencies.

And we've made good progress and I don't want to prejudice our outcome here by saying too much about it, but we're hopeful of coming to the conclusion in the near term and we'll be able to make a decision but it's the same general project.

We have plenty of resource.

We have some mining to do that largely would be the crushing and flotation and then duration we have to go through, and that's a big manufacturing process that would take some time; but at the same project working on the permits, more to come we hope soon.

And just one more quickly.

Just in regard to Tubular, it looks like we're seeing pretty encouraging trends there with metal spreads expanding and shipments increasing.

There's some new capacity in the market now so I think imports have ticked up a bit.

Can you give us a sense on how you think that's going to play out for the back half?

Is the increases in spreads more a timing issue because hot band prices are pulling back, or is this a trend that you think will continue?

Well, it is certainly part of it.

For us at least the hot band, of course, only affecting the well decide, which is about half of our book, plus or minus.

And the movement in hot band prices certainly affects it, but the movement on the price side has also been pretty good on both welded and on seamless.

So I don't want to look so far into the back half that we talk about the fourth quarter, but at least in the next quarter coming up as our outlook indicated, things are going pretty well there.

I think the last rig rate I saw was 1907 or some number like that, quite a healthy rig rate.

Better rigs, bigger rigs, more wells from the pad, and what we're making, high strength alloy, 5.5-inch, heat treated is just what the doctor ordered for those projects, so it is competitive.

There are imports, but we think we'll be able to do pretty well and we've given you that indication in the third quarter.

Fourth quarter hard to tell.

I guess it all depends what happens in the market.

And there occasionally is a bit of a slowdown in order rates at least for us in the fourth quarter for a variety of reasons that I've never really been able to understand.

So we hope to be able to do better on that in the fourth quarter; but third quarter things look pretty good and it's for the one reason you indicated, but overall I think things in that sector are moving in the right direction.

Thank you.

Next we'll go to the line of Kuni Chen from CRT Capital Group.

Please go ahead.

Hi, good afternoon, everybody.

Hi, Kuni.

I guess can you just give us a status on Fairfield, give us some color on what's going on there and any impacts that you see up and down through your system, either on the mill side or as that feeds downstream into Tubular?

Sure, you mean what you've read about in some of the publications?

Correct.

I'll just remind you, you're basically reading Archie comic books on that, so I wouldn't pay too much attention to what you get there.

With too, somebody said someone close to a reported source and all that.

We're amused by all that.

But about a week ago or so, we had a bit of an upset in the furnace there, these things happen regrettably occasionally, not too often anymore, but occasionally.

And we cautiously took the furnace down and have been diagnosing it, doing some clean up work and we're actually back making iron, and have been for the last day or two and we'll be back in the steel shop fairly quickly.

And I think we're using caution to bring it back up, which we always do but I think we'll be just fine.

There's no permanent issue there or anything like that.

So whatever you read, I think you should always discount and only believe what you hear from us; but in general, I think things are okay there.

On the flat-rolled side I don't know that we'll feel any particular ill effects because we have some duplicative capabilities on would have made there anyway for the most part, so no real issue on the flat-rolled side and our inventories are such that I think that will tide us over.

It will make things a little tighter on the round side; and as soon as we get going, we'll preference the rounds cast and we'll get back in business there very quickly.

So we don't expect that any of our customers will have any difficulties whatsoever.

If we do, of course, we'll tell them first and we haven't done that so far.

So I think these things happen on occasion.

This one got a lot of notoriety for reasons that escape me, but we think we'll be just fine.

Okay.

All right.

Good deal and then just a quick follow-up.

There's been some talk about changes in emission allowances over in Europe.

Can you talk about longer term impact to your operations?

Do you see that as material to cost down the road?

We don't think so, Kuni.

I think Europe was a little more advanced.

EU Europe is more advanced in terms of carbon regulation than US or anywhere else in the world for that matter, so we've had to live with that system now for a number of years.

Hasn't had a huge effect.

We have a long disclosure in the 10-Q in the next day or two, you can read all the updated stuff.

But the latest thing was just there was some Slovak related tax initiative that we weren't wild about and we describe that in some detail and that's still subject to some consideration.

I think the European parliament recently chose not to take the next step, which would have been a more aggressive carbon reduction strategy in Europe, and we view that positively.

So if anything, it seems like there was probably some greater recognition of the importance of trade sensitive energy intensive manufacturers like us need to be considered so as not to drive out good high paying manufacturing jobs that actually make things and create wealth too quickly at the expense of importing products that are unregulated with much higher emissions profile.

So in general, maybe the European view is kind of more of a wave, but so far not a big deal in our investment horizon, I shouldn't say this but I don't think it's a huge deal.

We'll continue to monitor it, of course, and our 10-Q will have all the details in it.

Great.

Thanks.

Thank you.

Next we'll go to the line of Dave Katz from JPMorgan.

Please go ahead.

Hi.

I know that you guys have the slide in there which addressed your coke strategy, but I was hoping you could go into a little more detail perhaps looking farther out.

With some of the increased environmental regulations that have applied to the industry, how does that impact any of your plans on a longer term basis; and as the existing ovens, they just haven't been refurbished and need refurbishment?

It's a good question.

I think if you just think about where we are, we're part way through building a new battery in our Clairton plant, which we cleverly call C-battery, which is next to B-battery near Pittsburg.

That is the most regulated coke battery in the world I would guess, but we're going to be right there on the best possible ability to comply.

And we're doing a variety of other things that the other batteries in Clairton including some new quench towers that allow us to stay in compliance and to keep our compliment running for some time.

We may choose not to do that for different reasons but I think that's something that we're certainly intending to do at the moment.

We have a new non-recovery battery in Granite City.

We have refurbished existing battery in Granite City, and we have a project going on in Gary to have the new carbonics technology come onboard.

So all of our movement has been sensitive to environmental considerations and wanted to be stable and able to operate for a long time.

So I feel pretty good about that, and then everything else we're doing on [twear] injectants, whether it's PCI or natural gas supplemented by oxygen, of course; or if it might be moving towards DRI to some degree of our iron make, which completely cuts out the coke and coal-based element, we're sort of moving in a direction that would be more environmentally favorable if you want to view it that way.

So I feel like we're in pretty good shape.

Now, there will be some batteries that will hit the finish line at some point, and our plans though to get back to a level of relative self-sufficiency encompass that.

So it was an issue of great concern to us a few years ago but by virtue of the projects we have under way and by virtue of figuring how to use a lot less coke, we think we're on the right track.

Okay, thank you very much.

Thank you.

Next we'll go to the line of David Lipschitz from CISA.

Please go ahead.

Good afternoon, everyone.

Question on the way you're doing your contracting in spot.

It seems that you never seem to get the full upside of spot prices but you always seem to get hurt when things start to come down.

Is there any thought of changing the way you do your contracts and things like that?

Well, not really.

At least not that I would talk about here probably, Dave.

We would take a look at our overall commercial relationships and how we can best meet both our needs and our customers, and I'm not sure I agree with your basic premise that we don't.

It maybe isn't as visible because of other things that go on in our product mix, but we track very carefully how well we do against what the spot market has to offer as evidenced by three or four, five different indices and we typically are right on top of them, some customers were a little lower, some were a little higher.

So we've taken a look at that and over time we think we're doing okay.

We might tinker with it a bit over time.

We've had more variability, less firm just because we thought that flexibility was good even though our cost structure is relatively stable.

So I think we're getting what the market offers in a reasonable way that also meets our objective to have some stability in our order book with commitments of volumes that allow us to run our facilities at a steady rate.

So we consider all the time, I've had some thoughts about whether we should make changes and they typically are quite slight; but I think in general, we are probably satisfied with where we are.

And just a follow-up.

In terms of the substitutes, DR and things like that, if you made a go let's say tomorrow to make this decision to go, what's the timing from that perspective in terms of permitting, all that type of stuff, what would you think the time frame would be?

We don't have a schedule laid out or anything, but I'd just be guessing based on what other projects have.

It's a couple years worth at least at least by the time you go through the permitting and engineering and construction, it might be a little shorter or a little longer; but that's a couple years would probably be a good round number.

Okay, thank you.

Thank you.

Next we'll go to the line of Jeff Kramer from UBS.

Please go ahead.

Hi, good afternoon.

Just going back on the coke side, the projects you have under way right now, minus what the cost is of those, and have you seen any cost inflation so far?

The projects that we have underway, Jeff, our C-battery is order of magnitude about $500 million; and the carbonics units that we are installing at Gary Works are about $125 million each.

So we've got $750 million between the two of them and that's been spread out over a couple of periods, a couple of years.

I would say we really haven't been seeing any significant change.

I mean we've had these projects underway and set in motion for some time so we're working -- I don't think we expect a change really significantly from those amounts.

Yes, the carbonics projects Gretchen mentioned are sort of contemporary construction market projects.

So I think we're reasonably well situated there and I was just there recently and I think they're proceeding on schedule and look to be in pretty good shape.

The C-battery we kind of engineered and began in a very slight way just before the crisis, and so we had a chance to go back and redo some of those things and I think get into a more contemporary construction market structure as well.

So I think on both we're competitive and on both we're more or less on schedule and in line with what the estimates were.

We're not done yet but so far so good.

Okay, and just you touched on the higher inventory levels and you're operating at 98% capacity utilization in North America last quarter.

Just given the pricing trends in the market, do you think you need to hit the brakes a little bit on production or any thoughts around that?

We may, really it depends on what our order rates are.

We don't much like the quick up and down stuff.

Our facilities tend to be better on a longer term adjustment basis.

So we have a few relatively minor maintenance projects to do during the quarter.

Whether that balances us with what we see in the order book, I don't know.

The order book in April and May was sort of so-so and we had a better order rate -- order intake rate in June.

The order rate was good enough for us to run the whole time; and in July, it's hard to tell because you got the 4th of July in there kind of fouls things up, but it seems like we're on the better trajectory, and not the earlier not so good trajectory.

Now whether that continues through the rest of the year, whether this difficulty in Washington and in Europe creates some other condition that doesn't sustain the business, that's hard to say; but at a current level, we're not going to say how much we're going to produce necessarily but we don't have any big projects scheduled.

Small upset in Fairfield, of course, takes out a small amount not a lot; and I think we've got one project in Gary and a small project we did somewhere else, but not large and so we'll have to wait and see and play it by ear.

Keep in mind that we don't just adjust things by having a furnace on or off.

We may have a steel shop that's scheduled to make 31 heats at full capacity, we say, let's just make 24 heats.

We can do that, it's not great from a cost standpoint but we can throttle things back if we need to try to balance it out.

So we'll have to wait and see.

Thank you.

And next we'll go next to the line of Arun Viswanathan from Susquehanna.

Please go ahead.

Yes, thanks.

I guess my question is similar.

I just wanted to kind of get some sensitivity going through your contracts and so on.

It looks like pricing and flat-rolled could be in the range of $50 to $75 down in third quarter.

Is that a fair assumption?

Well, I think if you just follow the indices are, I think in the first index that I saw in July is down about $40 some over the June index; and I think the weekly one that comes out is right around 700, so I think the direction's pretty clear that that's the direction we're going in.

We do though have on the other side of that, we have some benefit from our quarterly contracts that will actually adjust up for the third quarter so that moderates a little bit.

There is some mix effects etc.; so I think the direction is down.

We're going to try to minimize the down direction to the maximum extent possible.

In our pricing mix, we do have some semi-finished business that we do and when that is at a higher level, as I think it was in the second quarter, that has an effect on the realizations.

When it's at a lower level as it might in the third quarter -- might be, that's a shorter business, so it's hard to tell; but if it was lower, the difference between the two would appear to have a better price result although the margins on flats could be quite good.

So those factors all work to say that if you just do the overall price decrease, it might not be quite that far; and we've done some -- we've had some other commercial activities that might also go at a positive direction.

I don't want to be too specific because there's some proprietary knowledge there but I think your directions right.

We're going to do our best to keep that as low a number as possible.

Okay, and then I guess similarly, maybe you can just comment across if there's any chance that you think volumes could be better than expected and especially in Europe and what's really going on there as far as is it just economic, or is there any hope of a turnaround there?

Okay.

Two different questions.

In North America, hope for volumes.

We have a lot of hope but whether we get the orders is up to the customer.

So we have a lot to book yet and I'm just reluctant to predict that if the economy does a little bet better and confidence returns and order rates pick up, maybe we can -- we can make more I think but whether we can actually have that happen in this quarter who knows.

I think in Europe, the shipments effect remember we made a conscience decision to take down one of our two furnaces in Serbia for what I guess was a majority or at least a lot of the second quarter, I forget the exact date.

And that furnace is down today.

So, and I think as we said in our comments, we are trying to reorient our Southern European commercial strategy to try to have a more sustainable commercial position where we can get decent realizations without have chasing things too far away with too much freight and a very competitive price environment throughout Southern Europe.

To try to have a more sustainable position in Serbia, that's really where more of the volume decreases come from.

There is, and I think we say, there is usually after the return from the European holiday season, some uptick in orders in September or in August for September and in September and October and we're expecting that to happen but whether that provides a real big tail wind it's hard to say.

It's normal that that would happen but how much remains to the decisions of the European customers.

Gretchen, you want to add to that?

Okay, thanks.

Thank you.

Next we'll go to the line of Brett Levy from Jeffries & Company.

Please go ahead.

Hi, guys.

If you were to sort of put together all of the cost saving programs that you've got combined and put a target on sort of where you want that to be in one year or two years, where does it come out?

And again, it sounds like you guys are starting to look at something that's more of a sea change type of cost cutting program.

I just wanted some sort of targets for it.

Which I mean, on an ongoing basis, Brett, every year we'll have dozens and dozens and dozens across our plant locations of cost reduction programs that would be on the order of $5 or $10 a ton, always targeted trying to do that, so we always have those targets.

We don't talk about them a lot publicly but it's just a continuous cost improvement mentality that we have at all of our locations.

The project that John discussed, I think you're right.

There is a bit of a sea change potential particularly on if you look specifically at the coke reduction strategy.

That coke being -- we are still somewhat short coke and to the extent that we can reduce that through injectants or natural gas or PCI, it's a very significant amount of money.

There's the one slide I think we put in the deck that compares the cost on a per pound of coke I think is where we ended up doing it of natural gas as an injectant, PCI as an injectant and coke, purchased coke;, and the disconnect between metallurgical coal and coke and methane, natural gas, is a really big thing and it's a change that quite honestly we don't see those kind of things that often; and we are taking some haste to try to get gas injectant capability where we don't have it right away because the delta there is pretty big.

And I think there's a slide where we gave you some numbers on a per pound basis and even a look ahead as to what the per pound savings might be.

If you put that into your calculator and start running through how many tons it might be, you get a sense of what that number would be like.

I talked about then longer term coke cost savings and that would come from stove rebuilds and hot blast main rebuilds, things that we have now in our plans over the next several years.

And to take our hot flash temperatures from X to Y where they need to be.

And there are similar fairly good sized numbers there as well.

So when you're talking about a commodity that is an expensive commodity whether it's coke we manufactured from what we think is expensive coal these days or it's purchased coke, the delta is really big.

We don't get this too often and we are taking some haste to try to get there as fast as we can.

And then on the Tubular side, you guys referenced higher volumes and higher pricing.

Can you give some sense as to quantifying the percentage up in terms of volumes?

And then sort of break it out a little bit between seamless and welded in terms of what you're seeing in Q3 pricing relative to Q2?

Well, I think we're expecting some decent pricing across both product ranges; and in fact, I would say all of the product ranges and that would include I think line pipe as well as the standard pipe welded and seamless.

So I think we're expecting to do fairly well on both of those.

In terms of volume, I think it also would be both.

I don't want to get into specific numbers on volume; but if you look back in time, I think our biggest year of post Lone Star we shipped about 2 million tons, about 0.5 million tons a quarter and we're going to try to close in on that pretty quickly.

So directionally that gives you like a target.

Whether we get there or not depends on a lot of things, but that would give you some way to sort of square what the potential would be and we're going to be chasing that number as hard as we can.

Pricing I think you see the indices there.

That depends on where you start from but we think we've got some room to do pretty well price wise also.

Thank you.

Next we'll go to the line of Brian Yu from Citigroup.

Please go ahead.

Great.

Thanks, good afternoon.

Hi, Brian.

John, on the -- I'm going to ask a pricing question a little bit differently.

In the quarter you had a realized price of $803; and if we look at where spot average and first half, it's just a little bit above those levels and you have quite a bit of value-added mix in there.

So is it because of the sales of the semi-finished product that brought that number down on an absolute basis?

Yes, that would be one.

I think that would be one reason and I don't know which indices you're looking at, but I understand your question.

But that one reason that our apparent price realizations would have been lower than what somebody might anticipated or what you might have seen just from indices would be indeed that would be one element of it that we did have some semi-finished, quite a bit lower prices although again can be very decent margins so that's not a bad thing.

We think it's a good thing, otherwise we wouldn't be doing it.

So that would be one reason.

Another reason would be the period during which the high spot prices prevailed was relatively brief, and we didn't get every ton there necessarily.

We have customers that take a little longer time to go through that with and some larger customers make it all the way there so you shouldn't necessarily assume that we get exactly what the indexes show necessarily.

Remember this goes back and I should have mentioned this earlier in one of the earlier questioners.

In the first quarter we had a disruption at our industrial gas supplier at our Great Lakes Works and that got us sort of behind the eight ball on inventory coverage.

So we didn't have as many tons available in the spot market in the second quarter as we might have liked.

So those all sort of deal to make our price realization what it was.

One last one I'll just mention in passing is we do have some business that runs to joint ventures that we have one pricing mechanism, but we get some of our value through the value realized on the ultimate sale by the joint venture through equity income.

And if we brought that all the way back to the price calculation that we would publish, it would be a higher number.

It's way too complicated to do but there's a variety of reasons, but the single biggest one probably that quarter was the semi-finished I would think.

Okay, great.

And then second question just on the Tubular products.

If we look at what that business did in the last three quarters of last year, it was at about $100 million run rate.

With you guys taking care of some of the pricing issues, substrate costs, any other control, is that a reasonable expectation of what you hope to do going forward?

Well actually, to be honest about it, I'd like to do better than that.

And we may at some point do that, but I think that's a pretty good goal and the price question I think is the one upon us.

We've got some pretty heavy imports from the certain importers that we're concerned about, and there is competition but that's the way of life.

So I think we probably have a shot at those kind of numbers, we're going to be chasing them as hard as we can.

Thank you.

Thanks.

Thank you.

Next we'll go to the line of Michael Gambardella from JPMorgan.

Please go ahead.

Yes, good afternoon and thanks for giving us a little bit more data this quarter.

Thanks, Mike.

The Keytac expansion project of 3 million additional tons of pelletizing, how much would that cost?

Oh, it would be between this is a very gross estimate, between $500 million and $1 billion.

And if I was going to put a target, it would be half way in between there, but without the benefit of detailed engineering that's just a point estimate.

So $700 million plus or minus, could be less, could be more.

It's actually a competitive place to do it for us because there was an old line there that was used many years ago and there are some things there we can actually reuse so we get a bit of a break, but it's a fairly expensive project and the work is all really in the pelletizing, not so much in the extraction.

And what kind of iron feed would you have for the DRI facilities that you're looking at?

We would most probably do pellets, and as I understand it would be the most normal.

Our pellets are okay.

They're a little higher on the silica end perhaps; but we can adjust that if necessary, including through the expansion project although it's not necessary to do it that way so it would be pellets and the pellets we have are fine.

And in your normal process with the blast furnace, you use about 0.7 tons of met coal per ton of steel?

Oh, let's see 0.7 tons, if you take one-times 0.7, yes, that's about right.

And if you were to substitute a ton of DRI, would you basically be saving about 0.7 tons of met coal per ton of steel that you produced using the DRI route?

If we go DR--

And I understand you aren't going to do just strictly DRI steel.

If the objective -- if the tradeoff is blast furnace versus DRI; well DRI, you don't use any coal at all so whatever you use, you wouldn't use at all.

And then my understanding is these DRI facilities you have the permits already in the application process?

Well, not really.

I mean, we've been thinking about this for some time.

We have some idea of what we would have to do and we would get about it pretty quickly when we decide what and where; but those decisions, both what and where haven't been made yet.

So, but it's something we would get after pretty quickly but we aren't really that far along yet.

Just one last question more on the commercial side on the pricing structure.

The industry just globally has gone through this massive change in going from an annual iron ore price to a quarterly.

It seems like the industry still hasn't adjusted to it yet, but some people have suggested going to more of a cost plus base pricing system for steel.

I understand most steel producers, oxygen blast furnace based guys overseas have pretty much the same iron ore pricing and the same coal pricing.

In the US, it's more of a tiered iron ore input cost.

With you guys owning your own obviously at the low end of the iron ore cost spectrum all the way up to guys who may have to buy all the sea-borne pricing.

Do you think a cost plus system could work in the US, because of that tiering of iron core costs; and in a sense, could you go to your customers and kind of get a cost plus on some iron ore reference price, the contract price say even though you have your own iron ore?

Oh, I don't know, Mike.

That's a great hypothetical respectfully, but I don't really know.

I mean that's not anything we've ever thought about or talked about quite frankly.

We have made some commercial arrangements where certain costs are referenced in periodic adjustments in different ways according to each customers' interest that we would agree with; but that particular one is not something we've contemplated at all, and to my knowledge, not something our commercial folks have heard anything about from our customer base.

So I don't really know how to react to that question.

Dan, if you guys do, feel free to.

I'll just give you my quick reaction.

From our standpoint that seems like a lot of work for a very questionable benefit from our standpoint.

Thank you.

Next we'll go to the line of Timna Tanners from Banc of America.

Please go ahead.

Yes, hi.

Good afternoon.

Hi, Timna.

So just a few follow-ups.

I think a lot of the questions have been asked.

Just on the inventory issues, so we would expect your inventory levels should be more or less sustained at this level going forward as part of a new practice then?

Well, let me get just a little finer on detail.

Gretchen may want to jump on this one too, but we have some higher inventories in Europe; and that's partially because we had -- we were sourcing for a higher level of production.

That can get worked off through the normal course of human events relatively easily, and so if we stay at the current configuration in Europe, inventories near probably come down through the year, Gretchen, I think you would say, right?

Yes.

And then steel inventories in Europe would get adjusted accordingly as the process carries on.

In North America, we have slightly higher raw materials inventories; but in some ways actually less than the inventories we had back in' 07 and '08.

So we aren't in a huge inventory position and that becomes more of a commercial decision as to how long and short we decide to be, so we'll manage that around; but on raw materials, we probably will stay somewhere in a zone where we are maybe man it down a little bit if the opportunity presents itself, but it really depends on our forward view and I'm not prepared to say what that is just yet.

On the steel side North America we are tonnage wise not too far off where we were back in '07 and '08.

Value wise higher because costs are higher, of course; but we will probably run with slightly higher inventories to support our customer commitments, which is what we intended to do in the original plan for this year but just weren't able to because of the disruptions we had, and we're sort of getting where we want to be now and we'll play that by ear.

I think as Gretchen points out, we can pull the lever back and liquidate that if we need to; but I'm really interested in keeping our customers well served and really understood in giving our operators a little more stability in their daily life and that's allowed us to do that so far.

Gretchen, anything you want to add?

No, I think that really says it, John.

So along those lines that I was trying to get at with that question is also to understand when you think about the environmental revenue bonds you've talked about, are you still thinking about maybe by the end of the year thinking about refinancing that or approaching that maturity?

Yes, we do have that facing us at the end of the year and its been my intention to refund that in the capital markets somehow, some way, tax exempt or taxable; and we would still like to and intend to do that.

It's just that there's been a lot of disruption in the market recently, and I'd just assume that would settle out a little bit and then we'll think about what to do; but that's our maturity at the end of the year.

You'll note though, we have plenty of liquidity to manage that otherwise, but I just think that that's a good way to manage that maturity.

I'd like to do that if I can.

Got you and if I could just one last one.

I feel like a broken record on this when we talked about it in the past, but on the new supply any new thoughts about the competitiveness as it starts to kind of show up more in the market?

Are you seeing them in the market, your commercial guy is talking about that kind of market share situation.

Can you share any thoughts there, please?

Not much we can say, Timna.

Our commercial folks hear about it more than they see it, if you take my meaning there.

Sure.

And competitiveness is up to you.

We actually have one of the slides we had in our deck here give some assessment of where we think cost structures are today, and we have some idea of what the cost would be if you sort of start from zero with a set of materials; but it's up to each individual party to be competitive if they choose to, but we haven't had a lot of issues there from our standpoint so far.

That's not to say it won't happen though.

It's new volume and when you're in the market, new volume is not necessarily a good thing.

Thank you.

Next we'll go to the line of Mark Parr from KeyBanc.

Please go ahead.

Thanks very much.

Hi, Mark.

Hi, John, Gretchen.

One thing I was curious about, your cost situation in the second quarter on the domestic side was I think significantly better than what you had guided towards; and I was wondering, I don't know, John, I may have missed some of this or Gretchen, I don't know of you commented on specific things that unfolded that allowed your cost to come in even on slightly lower volumes.

And I'm wondering if you can provide some color on the potential for sustainability or further acceleration of operational improvement activity.

Just a couple things, Mark, off the top of my head.

I think the, of course, our iron ore position is relatively well looked after and our carbon position was well looked after, coal and purchase coke, we've managed to keep our purchases in a better zone this year and then our natural gas prices, of course, have been quite competitive as well so that suite of inputs has been pretty stable for us.

Our plants ran well.

We didn't have a lot of major maintenance to do and that's sort of episodic, but what we did was right on schedule and on the cost budget.

So our operators did a really good job of operating, so I think those were all positives.

And then this injectant change that we've talked about where we're trying to optimize the injection of gas, coal, PCI, supplemented with oxygen in place of purchase coke, it's the real deal; and there's a pretty substantial number in there that also helps to keep our costs stable, and we think there's more to come there.

So I think that's a significant impact, reluctant to say how much because it can change a bit from time to time and there's more to come when we get a little bit more capabilities.

So all those things, I think, suggested that we had a pretty good cost performance and I'm glad you saw it and it's good.

Just to follow-up, is it fair to say that all your blast furnaces in North America are utilizing PCI technology at this point?

Not everyone necessarily.

We -- just for different reasons, not everyone; but we have pretty good injectant capability in almost every furnace and whether it's coal or gas they're to some degree interchangeable depending on some other things in the furnaces so we potentially could do more coal but I doubt that.

I think at the moment my sense would be we would head more towards gas.

I understand, and what inning do you think you're in as far as the gas injectant deployment is concerned?

Oh, I'll respond and as you might expect with a hockey term.

So you use hockey, however you'd like it.

We think and we just came back from the first intermission and we're probably getting ready to drop the puck or something like that.

We're into it but we're not all the way there.

Okay.

Any thoughts, just one last question, any thoughts about the timing of spot carbon steel price inflection?

No.

I wish it was yesterday.

No, not really.

The only thing I'd observe though is that the most recent MSCI figures were, I think, relatively favorable from most observers including ours.

So there isn't -- it doesn't seem at least a great build up of inventory.

If the economy continues to chug along, demand in most of our sectors, ex-construction is pretty good and energy is one of them, and I think we had some data in the appendix about automotive expectations and those expectations, this is third party assessment are pretty robust for the rest of the year.

So if the overall demand continues in a relatively good place, then that may be in front of us, not too far away but it's just really hard to say right now.

Thank you.

Next we'll go to the line of Michelle Applebaum from Steel Market.

Please go ahead.

Hi.

Hi, Michelle.

I like the out of the box thinking that this management team has had starting with things like Lone Star and even Stelco, which right now doesn't look so good; but I think it paid for itself the first year, and the talk about the electric furnace, etc.

So I have two other kind of out of the box, I missed one of those things, and I don't want to be behind you again.

So I had two thoughts along those lines.

We talk a lot about Thyssen and the impact in Alabama.

They get their slabs from Brazil and I think a lot of us have talked about how non-economic that situation is but there's a separate issue.

The Brazilian government has made a lot of noise about pollution and there have been all kinds of threats of closure and it's not necessarily a stable situation and Thyssen has this finishing mill that I've been told looks kind of like Disney World.

It's in great shape and it's beautiful and it's in Alabama, but it may have a source of supply that maybe under some pressure from time to time; and they want to sell automotive where you have to partner with people.

And so it seems illogical to me that they will be able to make even with gorgeous rolled steel, I'm sure it's beautiful, it seems illogical to me that with the hot end offshore they will be able to make a lot of progress with automotive.

Is that potentially an opportunity for you to help them with that?

That's an out of the box question.

It is.

I'm not sure what kind of help you might be thinking about, Michelle, but we have our own position in that particular sector.

And we from time to time have been slab long although we aren't slab long in a huge way right now; but when someone calls we usually answer the phone, but I'll take note of that potential out of the box thought.

And it's not one that's been any one we've given any thought to, and so we've been trying to just stick to our own knitting and make sure we maintain our levels of partnership, used a good word with our key automotive customers, and we think we're doing a pretty good job of that.

Okay.

Then my other question is your 10-K, this year and then last year both said that -- and, so that's the 2010 and 2009, we continue to assess North American and international expansion and divestment opportunities and carefully weigh them, etc.

And that was in your 2010 and 2009, the word divestment hadn't been used before.

I don't see as much how Europe fits into your business and there's a lot of M&A going on in that area.

Might you be interested potentially at some point in selling that business?

Gretchen?

Well, Michelle, we've had those disclosures in there because I think that we realistically, consider any opportunities that are presented to us; and I think among, we've sold one of our railroads for example, so I think it's kind of a living, breathing, disclosure.

I wouldn't say that we would, yes, I mean we have considered significant investments in all of our business segments, and we'll consider things that divestitures, should they make sense to us; but I'm not sure that we're announcing a strategy of what we're going to be doing there.

We're doing our best to try to turn Serbia around right now, and do the best we can with a pretty weak market situation in the markets that were best served by our Slovakian and Serbian Mills.

And I think over time, we will -- I think those markets will come back to us and I think we're well positioned to serve them, just that we're struggling a bit right now given the market environment and where our facilities are positioned.

Thank you.

Next we'll go to the line of John Tumazos from John Tumazos' Very Independent Research.

Please go ahead.

Thank you for taking my call and the good black ink.

Thanks, John.

I wanted to ask a little more about the poor market conditions in Serbia or southeastern Europe.

My impression is that measured in GDP, Turkey has been the most rapidly growing economy or large economy in the world, although their steel output has grown a great deal.

Could you just elaborate as to whether their competitive dynamics of mills in your region increasing output or mills from some other region like Germany or Ukraine or Russia exporting Southern Europe.

I doubt the Greeks use much steel, but there has been obviously a lot of disorder in various Mid Eastern economies.

That's just if you could elaborate please.

That's a very complex part of the world, John, as your question demonstrates and you obviously have studied it; but speaking of Serbia, our principal market, our home market would be the Ex-Yugo countries and the current parent steel consumption in those countries, that region is half of what it was pre-recession, pre-crisis.

So they really haven't come back nearly to the degree that the rest of even Central Europe and certainly no where near what Northern Europe has come back.

And so our home market, our local market has really been hit hard by the recession and really hasn't made a good come back, whether it's available capital or otherwise, who knows, but it's going to take some time.

We do -- we have traditionally done some business heading South.

We actually have a couple of good customers in Greece by the way and into Europe or into Turkey as you point out, but Turkey's had substantial flat-rolled capacity additions.

A lot of that was flowing into the Middle East and with the disruptions there that flow has sort of backed up and there have been pretty heavy imports coming from the East where there are some cost advantages that maybe make that more accessible.

So those factors have all conspired to make our part of the world that we serve from the Serbian market a very difficult marketplace for us right now; and rather than try to compete in the broader market, which our higher capacity required us to do, and we did fine back in the pre-recession days, we're trying to concentrate more on our local market.

But I think your assessment of it being a complex area with the biggest country being Turkey with new capacity is exactly right.

Thank you.

And our next question comes from the line of Charles Bradford from Bradford Research.

Please go ahead.

Good afternoon.

I understand that at least some of the automakers are facing a possible strike in six weeks.

Usually at least in the past, when we got to a period like this when they were facing (inaudible), they would try to build inventory of vehicles ahead of the deadline.

Have you seen any signs of that?

No, Chuck.

First, I'm not aware of the potential events you mentioned; but more specifically, I think as we track it the last figures that I saw and I may not have them in my head, but we think our view would be that finished vehicle inventories are in a relatively low level at the moment, among lowest they've been in some years.

So, and that reflects pretty brisk sales earlier in the year, and also the difficulties that some of the manufactures have supply chain wise.

I'm not an expert on that, but I think in general we feel that the overall day supply of vehicles, which is 50 some days or something like that if I recall right is pretty competitive to where it has been almost any time in the last few years.

So I don't think that's something we're experiencing, but again, I'm not familiar with the situation you're talking about.

Thank you.

Next we'll go to the line of Richard Garchitorena from CSFB.

Please go ahead.

Great.

Good afternoon.

Thanks for taking my call.

Just a couple quick questions.

One on Europe.

The step-up in cash costs in Q2, part of that was driven by the Serbian facility being shut and then also raw material costs.

Can you quantify exactly how much?

And then going forward I guess, how much will continue to remain as Serbia remains shut in?

Well, I'm not sure we can quantify it much more, Gretchen unless you want to take a stab at that.

I think the higher raw materials costs that we purchased are going to take longer now to run through.

We try to do that on a basis that matches it up with the prices we expect to have in front of us.

We're going to be a little dislocated now because it's going to take a bit longer to chew through it because we're not consuming as much in Serbia; but I think overall, our materials costs in the third quarter probably ought to be relatively competitive with what they were in the second quarter.

So I think if anything, it's probably more likely than what we're going to have happen is some cost inefficiencies from running the Serbian operations at a somewhat lower level but we've made some progress there in reducing sort of the fixed employment level; but that isn't quite as difficult an issue as it used to be.

I think for us in Serbia, cost is one thing, but I think the market is and the pricing is more the issue for us.

Great.

Thanks and then on the US side, in terms of met coal, just wanted to just look at -- I know that you have multi-year contracts in place for your met coal locked up.

What percentage is going to be rolling off next year or in 2012 that maybe up for renewed pricing?

Well, effectively all of it and I'm going to use 10 million tons or 9.5 million tons or a number like that, North American met.

We do have some volume commitments that go into 2012 and even into 13.

They're substantial volumes.

They aren't all we need but they aren't small but very little of that actually has a price fixed with it.

Most of it would be subject to negotiations so whilst we have a volume position, we don't have a very large price position that's already done.

So we'll have effectively virtually all of our 2012 needs subject to some negotiation later on this year.

Thank you.

Our next question comes from the line of Sal Tharani from Goldman Sachs.

Please go ahead.

Thank you.

Hi, John, how are you?

Hi, Sal.

I'm looking at your slides; and first of all, thank you for putting the slides this way.

Very helpful.

I think it's the first time I saw the slides for the earnings.

On slide 27 you have broken down your exposures to different contracts or spot market business and looks like you still have firm contracts in USSC where you have variable raw material price, so I was wondering if -- and also in the US, you have 20%; but US obviously you have iron ore at least locked in.

Is that going to change over time as your coking coal prices perhaps may change next year to quarterly, who knows?

And also on Tubular, you still have a significant program contract, which my guess is about six-month contracts.

Are those going to go more towards spot over coming months or coming years?

Okay, I'll take it segment by segment, those are three good questions.

On the flat roll, we do have some firm pricing.

Keep in mind that we control a lot of our cost structure there and where we don't, we -- gas for example, we can buy forward, zinc we can buy forward.

So we take a good bit of the risk out of that firm pricing and it may be that that trends down a bit because all things being equal, we probably would prefer to have that trend down in the cost base.

That is to say some cost based adjustment for those things we do have exposure for trend up and that would help us on coal.

You mentioned the potential change in coal pricing that I'm not aware of and not looking forward to, so we'll see what happens there.

Working across that slide on Tubular, programs which is a word we choose carefully is designed to suggest that a situation where we and end use customer commit to a certain amount of volume for a certain period of time, which could be quarterly or annually, six months I guess; and then within that structure, there could be just spot pricing where you sort of struggle each quarter over it, we could have indices, we could have something fixed for a period of time, so the actual commercial terms inside of that could vary quite a bit and program doesn't necessarily mean firm pricing.

It can mean that but we prefer to have some either index or negotiated price so as things change, we can each feel like we're getting a decent deal.

And then in Europe, the firm, they are firm but they're fairly short.

They aren't long contracts and as I said, we try to match that up reasonably well and there is some business that we've made in combinations with our customers that will do that and then we talk about it again next quarter or the next six months.

So they're firm but they aren't long and we try to match them as closely as we can with what our raw materials costs are.

Thank you.

And we have time for one final question and that goes to the line of Aldo Masafar from Burke & Quick.

Please go ahead.

Hi, thank you.

John, how are you?

Aldo, it's nice to hear from you.

Yes, same here.

Thank you.

On the -- this is kind of a theoretical question on market strategy, John.

If you look at your Company relative to others, you've always had that raw material advantage and it seems like you're enhancing that with the gas injection and the coal -- coking coal avoidance; and that might be giving you the ability to keep some selling pressure or some aggressive pricing on the market without suffering the same margin penalty that some of your competitors might.

And at the same time, it would address your volume considerations in terms of covering your fixed costs, which some people might argue that might be the area where you might have a little disadvantage to some of your competitors and I'm wondering if that theoretical strategy is maybe something that you're really trying to implement as a Company.

I mean, I see the 90% operating rate excluding the Hamilton, that seems to imply that you are going counter to the industry in terms of raising your run rate and I'm just wondering if I'm reading too much into that or is that something we should be looking for going forward?

Well it's an interesting question, Aldo, and I for obvious reasons won't give you an explicit answer; but it's a very thoughtful question and we sort of trade around those variables you mentioned in our commercial thinking from time to time.

We do have a fixed cost position, Gretchen pointed out the pension situation where costs are $300 million higher than they were five years ago, so we do have to be mindful of that, and we want to make sure we keep our operating position the way it allows us to absorb some of that and we are mindful of what our cost position is.

We're mindful of our advantages are in terms of market positions and our view has been we would prefer to keep our facilities full and running and we want to have arrangements with our good friends and our customers on terms that are okay to them but allow us to do that.

So that's been our objective that you, I think, see as you point out the 90% rate ex-Hamilton was pretty good for us and it gives us good cost benefit.

So let's just say we're aware of all that.

We trade around those different things and we end up going to the spot market and fighting it out like everybody else does; but on the contract side we like to have larger positions, deeper positions, that run a longer time with the best customers.

And that's really been our objective and I think we've done okay on that.

Right, if you wouldn't mind just two quick follow-ups, John, on that.

Sure.

That 90% operating rate, is that a rate that could theoretically go higher or you know how steel companies will a lot of times get to 92% and 93% and they kind of top out?

I don't think I've seen an industry operating rate higher than that for a long time.

Is 90% pretty much full ran rate for you?

Not necessarily, no.

I mean there are going to be times when we're not going to get at 90% because of some maintenance project or another; but during the last month or two, we had some periods where we were well above that and things were -- we were hitting it really hard for a lot of reasons and we were well above that.

Whether we would be well above that for a long period of time, I guess that remains to be seen.

We have done it for quarters at a time, but I wouldn't encourage you to view the 90% as an upper limit.

We don't view it that way.

Great.

One final quick one.

As you -- back to the hockey analogy, as you move from the first period to the second period and third period, in terms of the gas injection, is that something you need a long lead time permitting for or is that something you just kind of can hook up?

Yes and no, or no and yes I guess.

For the first wave that we're working our way through, yes, there could be some piping and things like that; but relatively simple, low cost and not hard to do.

There may be some pipelines that we need to get to make sure we can get access to those kind of things; but generally speaking, that's relatively low capital and relatively quick.

Further out, there are some additional -- to optimize our injectants, which could be some additional coal as well, we probably need some additional oxygen and that could require a little more time, a little more capital, some visits with some of our colleagues.

And then over the long term again, with our hot blast going up that gives us another step change; and that's going to be just rebuilds and hot flash maintenance, those kinds of things.

So several different elements to the strategy.

The quick ones we're going to do right away because that spread between methane and coal is a big spread, and then the medium term things we're going to work on as fast as we can.

Great.

Thanks very much, John.

Thanks, Aldo.

Good talking to you.

All right, thank you for your help, Linda.

I'd like to thank everyone for joining us and we appreciate all your interest and we'll talk to you next quarter.

Thank you.

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