Jan 30, 2009
Executives
Deck Slone – Vice President Government, Investor and Public Affairs Steven Leer – Chairman and Chief Executive Officer John W. Eaves – President and Chief Operating Officer John T.
Drexler – Senior Vice President, Chief Financial Officer
Analysts
John Bridges - J.P. Morgan [Luther Lou] – FBR Capital Markets James Rollyson - Raymond James Brian Gamble – Simmons and Company Shneur Gershuni - UBS Paul Forward - Stifel Nicolaus & Company Meredith Bandy at BMO [Mark Lenama] – Morgan Stanley Jeremy Sussman - Nataxis, Inc.
Gordon Howald - Calyon Securities Michael Goldenberg - Luminous Management [Sanil Dastadar] – Sentinel Investments Justine Fisher - Goldman Sachs [John Flanagan – Integrated Equities] [Wayne Atwell – Pontius Capital Management]
Operator
Good day everyone and welcome to the Arch Coal, Incorporated fourth quarter 2008 earnings release conference call. Today’s call is being recorded.
At this time I would like to turn the call over to Mr. Deck Slone, Vice President Government, Investor and Public Affairs.
Please go ahead sir.
Deck Slone
Good morning from St. Louis.
Thanks for joining us. As usual and before we begin I want to remind you that certain statements made during this call including statements relating to our expected future business and financial performance may be considered forward-looking statements pursuant to the Private Securities Litigation Reform Act.
Forward-looking statements by their nature address matters that are, to different degrees, uncertain. These uncertainties which are described in more detail in the annual and quarterly reports that we file with the Securities and Exchange Commission may cause our actual future results to be materially different than those expressed in our forward-looking statements.
We do not undertake to update our forward-looking statements whether as a result of new information, future events or otherwise, except as may be required by law. I’d also like to remind you that you can find a reconciliation of the non-GAAP financial measures that we plan to discuss this morning at the end of our press release, a copy of which we have posted in the Investors section of our website at archcoal.com.
On the call this morning we have Steve Leer, Arch’s Chairman and Chief Executive Officer; John Eaves, Arch’s President and Chief Operating Officer; and John Drexler, our Senior Vice President and Chief Financial Officer. Steve, John and John will begin the call with some brief formal remarks and thereafter we will be happy to take your questions.
Steve.
Steven Leer
Thank you Deck and good morning. Thank you for joining us on our conference call this morning.
Today Arch reported earnings per share of $0.44 on the fourth quarter of 2008 and earned $163 million in EBITDA representing our third best quarterly performance and our best fourth quarter performance in the company’s history. Before we begin our current outlook, I’d like to spend a few moments highlighting our strong 2008 results.
The foundation of this company was built on three key pillars; safety, environmental stewardship and financial performance. We’ve always felt that excelling in these core areas would insure the success of the company over all, and it has.
We just finished Arch’s best year on record in 2008. In terms of safety performance we made 26% improvement over last year, surpassing our previous safety record set in 2006.
In terms of environmental stewardship, we finished the year with an 8% improvement over our previous record set in 2007. And in terms of financial performance, we excelled, earning $2.45 per share and $753 million in EBITDA, all with only a slight increase in volumes.
As you can see, we’ve positioned Arch to shine in strong market cycles as demonstrated by our 2008 results. But we’ve also set the company up to succeed in weak market cycles which is where we find ourselves today.
The relatively swift market downturn in the second half of 2008 was triggered by the unprecedented crisis in the financial sector and the subsequent global economic slowdown. Since you are already aware of the challenges faced in this uncertain economic environment, I will spend a few moments discussing the specific actions that Arch is taking to profitably ride through this market trough and to prepare ourselves for the next market up cycle.
As we discussed in our earnings release, we are reducing our production targets in response to weakening market demand. We’re lowering our projected volume levels by around 10 million tons in 2009.
This reduction is spread generally pro rata by region. Specifically, we’ve idled one of our highest cost increments of production at Black Thunder and Coal Creek, parking a drag line and two shovels in the process.
We’re also ratcheting back our lowest margin production in central Appalachia. Besides reducing volume levels, we’re also adjusting our capital spending to better align with market demand expectations.
We estimate that our maintenance capital needs to be between $215 million and $245 million for 2009, with an additional $40 million to complete the E seam transition to the West Elk – at our West Elk mine. Our land reserve acquisitions should total between $155 million and $185 million for 2009.
We firmly believe that rationalizing production targets and exercising tight fiscal discipline in the current market are the best long term – are in the best long term interests of our company and our shareholders. Turning to the market demand, we’re seeing the impact of the weakened industrial and commercial activity in electric generation trends.
According to the Edison Electric Institute, U.S. generation demand has declined approximately 1.4% through the first four weeks of January, admittedly off of a very tough weather comp in 2008.
Also aggressive steel industry production cuts around the world have reduced demand for met coal. While some inventory de-stocking has no doubt occurred, and proposed government infrastructure spending boosts future electric, steel and coal demand, we can’t predict with certainty when these conditions might improve.
So we’re taking a conservative view of our coal sales. During 2009 we have the capability to supply up to 6 million tons of metallurgical coal into either the met coal or the high quality steam coal markets, depending on demand.
Or we may choose to leave some of those tons in the ground if market conditions warrant. On a global basis, supply rationalization is underway, both in the steam and met coal markets.
Clearly while the economics of the market are forcing the supply response, the market is also setting up for a strong upswing when the U.S. and world economies start to improve.
In addition, we expect more global and domestic supply cuts in the near term, driven by geologic and regulatory hurdles, lack of access to credit, as well as cost structure. At current pricing levels, future coal supply growth is just not sustainable in many regions.
The Energy Information Administration data supports this, with U.S. coal production trends declining 1.4% so far this year.
Switching gears, I’d like to spend a few moments mentioning some of the positive signposts we have seen in the market, as I have always believed the market is forward-looking. First we have successfully completed test shipments to China in January and have reached agreement to ship 2 million tons of coal from our Black Thunder mine to the Asia-Pacific market.
This development is significant in that we’re gaining traction and building a relationship with Chinese and Indian customers to serve as an additional source of supply in a region that relies heavily on coal for its growing electric generation needs. We believe that these first agreements are really only the beginning.
We’re also seeing interest from other non-traditional users of PRB coal despite a world economic slowdown, driven by growing global demand for coal and supply constraints from traditional export nations. We also believe the pull from Asian markets as demand recovers will create market opportunities for PRB coal over time.
Expanding the PRB reach internationally will help to unlock the additional value for this region going forward. Second, new coal plant build-outs remain on track despite significant hurdles.
Since our last update, we’ve seen two new plants, one in Arkansas and one in Montana, move into the under construction phase and we now expect 16.5 gigawatts to start up by 2012, with half of the source tonnage for those plants to likely be supplied from the PRB. Also it is important to remember that the long term fundamentals of coal markets remain very favorable.
Coal has been the fastest growing fuel on the planet since 2000, with consumption growing rapidly in emerging economies. This trend is likely to continue despite or perhaps because of the weaker economic conditions around the world.
Coal remains one of the most affordable energy sources for many people around the world. We believe that supply rationalization in 2009, coupled with the restart of the global economy economic activity later this year and demand from new coal plants coming online should start markets to dynamically rebalance over this year.
Lastly, I’d like to reiterate that Arch is strongly positioned in the current market cycle to deliver solid results, to generate shareholder returns, and to pursue opportunities to transform the company. Clearly assets are much more attractively priced than they were 12 months ago.
And Arch has historically grown via acquisitions by buying assets during periods when valuations were depressed and below their long term replacement values. It is extremely difficult to forecast 2009 given the uncertainties surrounding the economy and the state of the steel markets.
And as a result we are committed to reducing our production target and capital spending programs in light of the near term weak market trends. I will now turn the call over to our President and COO, John Eaves for discussion on Arch Coal sales and operating performance.
John.
John W. Eaves
Thanks Steve. Let’s spend a few moments discussing key developments in each of our operating regions during 2008 and provide a preliminary outlook of our expectations for 2009.
In the PRB our 2008 volumes increased 3 million tons while price realizations thanks to stronger pricing on contract and open market tons. Operating costs per ton increased as well, driven by higher sales sensitivity and commodity costs in 2008.
Looking ahead, as Steve mentioned, we are targeting lower volume levels due to weak market conditions. This approach insures that our value of our low cost reserves is preserved until markets are more attractive.
At the same time, we continue to layer in contracts that are attractively priced. In the fourth quarter we committed an aggregate 20 million tons of PRB coal for ratable delivery in 2009, ’10 and ’11 at prices that reflect more than a 40% weighted average premium to the regions fourth quarter realized price.
We’ve also agreed to ship 24 vessels to the Asia-Pacific market through Vancouver’s port in 2009, laying the groundwork for future market growth opportunities for the PRB. On the cost side, we’re entering 2009 with 70% of our diesel consumption hedged at an average price of over $3.50 a gallon.
As you can see, these hedges are above the current market price but we expect to benefit from the current depressed oil prices through the un-hedged portion of our portfolio which will help to lower the average hedge cost in 2009 and through the hedges that we are layering in for 2010. Taking into account the expected impact of the reduced production levels as well as the increase in diesel costs, we estimate that our operating costs in the PRB excluding sales sensitive could increase between 5 and 10% in 2009.
Of course we are working hard to control these increases. Additionally, we’re always looking at process improvement initiatives designed to reduce our cost structure.
We’re idling our highest cost increments of production at our mines and with the start up of the new west load out at Black Thunder, we’ve begun to realize savings on diesel consumption due to shorter haul distances. In Central App, full year 2008 volumes increased thanks to a full year contribution from Mountain Laurel.
Per ton price realization rose more than 40% year-over-year given the strong met and steam markets that prevailed in the first half of 2008, while operating costs per ton increased largely due to higher sales sensitive costs. In 2009 as Steve mentioned we’re scaling back lower margin production in the region in response to weak market conditions.
We’re also shipping some of our met coal volumes back to the steam market as our cost structure allows us to profitably do so. As mentioned in our release, we’ve committed 2 million tons of Central App coal for 2009 delivery at an average price exceeding the region’s fourth quarter blended realized price.
On the cost side we’re focusing on significant cost control, including reducing overtime hours and shift lengths. Taking this into account, along with the expected impact from reduced production levels and higher diesel costs, we estimate that our operating costs in Central App, excluding sales sensitive could grow 5 to 10% in 2009.
In Western Bit, volumes grew in 2008 due to increased shipments from Arch’s Utah operations. Per ton price realizations grew 11% over 2007, benefiting from contract roll-offs and attractive open market sales, while operating costs averaged $21.77 per ton in 2008.
In 2009 we expect our volumes and price realizations in the region to be significantly impacted by the adverse geological conditions encountered at the West Dale Mine that has slowed our initial production and reduced our coal quality. These problems are projected to diminish as we mine through the panel, with the greatest impact in the first quarter.
Offsetting the volume impact at West Elk to some degree will be the increasing production at our Elf Mountain Mine in southern Wyoming. We are increasing production at this mine to satisfy diligence requirements, but we also believe there’s currently an attractive market for this coal.
Our all in costs in Western Bit will take a step function up this year as a larger percentage of production will come from the higher cost mines within the region; in particular, the addition of the Elk Mountain Mine will boost costs in the region around $1 per ton. Additionally, our costs will be impacted by the current issues at West Dale and more frequent long [mall] moves while moving forward as compared with years past.
As a result, we are targeting average cost structure in the $24 to $27 per ton range for 2009. As a result of our sales commitments signed in the quarter and our decision to target lower volume levels, we now have un-priced volumes of between 14 to 18 million tons in 2009, with half already committed but not yet priced, 55 to 65 million tons un-priced in 2010, and 95 to 105 million tons un-priced in 2011.
Lastly I want to recognize Arch’s outstanding accomplishments in safety and environmental performance. We earned six national and 12 state awards for achievements in safety and environmental stewardship.
Last year also marked Arch’s best year in history for safety and environmental compliance. We’re very proud and would like to thank the 4,000 employees that made this achievement possible.
I will now turn the call over to John Drexler, Arch’s CFO to provide an update on our financial achievements in 2008. John.
John T. Drexler
Thank you John and good morning everyone. I would like to highlight Arch’s key financial achievements in 2008 and discuss our current balance sheet and liquidity position.
From a financial perspective, 2008 was the best year in Arch’s history. We set company records for revenues, EBITDA, net income and earnings per share.
Each of our key operating regions contributed to these results, including Arch’s expanded trading function that added $55 million of pretax profits in 2008. We converted approximately one-third of those trading profits into cash last year and expect almost all of the remaining existing positions to convert to cash during 2009.
Perhaps even more importantly in this tight credit environment, we earned a record cash flow from operations during 2008, more than doubling our 2007 level. This record cash flow allowed us to fund all of our capital requirements in 2008 and still grow our cash position by year-end.
Also, we returned more than $100 million to shareholders last year by repurchasing nearly $54 million of Arch Coal stock and by increasing the quarterly dividend in April. Turning to credit markets, since the crisis began to unfold last fall we have continually focused on bolstering our strong balance sheet and protecting our liquidity.
We ended the year with our balance sheet in excellent shape. Cash on hand exceeded $70 million, debt totaled $1.3 billion and debt to total capital finished the year at 43% down from 46% at the end of 2007.
Our liquidity position also remained solid. At December 31, committed and available liquidity totaled $712 million, consisting primarily of cash on hand as well as availability under our revolving credit facility and accounts receivable securitization program.
The revolving credit facility, which is the company’s primary source of short term borrowings, does not expire until June of 2011. In short, despite the problems in today’s financial markets, Arch’s financial condition is quite strong.
With that, let me now discuss our outlook for 2009. We expect volumes from company controlled operations to be in the range of 120 to 127 million tons; total CapEx of between $255 and $285 million, which consists of roughly $215 to $245 million for maintenance capital and roughly $40 million to complete the transition to the e-seam at West Elk.
Reserve editions of $155 to $185 million including our final LBA payment for the little funder lease reserve in the PRB; typically we expect a significant portion of our CapEx and reserve edition spending to occur in the first quarter. And DB&A is expected to be in the range of $300 to $310 million.
By focusing on cost control and capital containment on reducing production targets, on maintaining liquidity during this market trough, we are taking the appropriate actions to position ourselves during this market downturn and more importantly for when the market recovers. With that we are ready to take your questions.
Operator, I will turn the call back over to you.
Operator
Your first question comes from John Bridges - J.P. Morgan.
John Bridges - J.P. Morgan
Could you give us a little bit more detail on what’s going on with the West Elk? I saw that piece of machinery, it’s very impressive at the equipment show in the fall, but what’s the problem there?
John W. Eaves
As we transition in the E same with the new long wall, we started to encounter some problems in December and as we’ve progressed into January it got a little bit worse, basically driven by a sandstone channel that was a little bit thicker than our drilling showed. So we’re working through that.
It’s causing a little bit higher ash. It’s impacted our production volume.
We had an outage of about ten days here recently, but if you look at our future drilling on our development panels it really doesn’t show the problem in those future panels. So I think it’s something that we’re managing through.
We’ve got a couple more weeks in this thinner coal and then we get out of it. And then we touch on it a little bit again in the late March timeframe and then it should be progressively better.
We actually move in the next panel, the E-2 panel sometime in the third quarter. So we think things are progressively going to get better.
We’ve worked shipping plans out with our customers, but it certainly is going to have an impact on quality, cost, and our financial results for the first quarter.
John Bridges - J.P. Morgan
And the $24, $27 a ton is that an average for the year or is that going to be [queued]?
John W. Eaves
That’s a range for the year and I would hope that we would see the higher end of that early and then as we progress through the year those costs would get better. But clearly while we’re in this problem in the E seam our costs are going to be up.
And then you know we had the addition of the Elk Mountain Mine which we’re actually mining to satisfy some diligence that allows us to maintain a lease. And that’s a little bit higher cost production, but we are developing a new customer base there.
Those are development tons. But longer term, if we found some customers I think we could bring those costs down over time.
So those two factors are really going to drive up the costs earlier in the year in Western Bit and hopefully will improve on that as we move out.
Operator
Your next question comes from [Luther Lou] – FBR Capital Markets.
Luther Lou – FBR Capital Markets
I noticed that in Central App, first quarter the price realization came down quite a bit. Is that because some of the met coal shipped into the steam markets?
John W. Eaves
You know I think it was a couple of things, Luther. I think it was more steam shipments and just really kind of product mix.
We still had some met tons that really didn’t get sold in the market in the fourth quarter like we had planned, and I think it just drove the overall realizations down because of the higher percentage of steam shipments.
Steven Leer
It was more product mix than any real issue there, Luther. But overall it – looking at the metallurgical coal really deliveries more or less went on schedule and we haven’t seen a lot of deferrals as a result of that either.
Luther Lou – FBR Capital Markets
On the Central App costs, costs also dropped quite a bit. Is that because of the surcharge of fuel, those costs coming down?
And is that trend going to continue in this coming year?
Steven Leer
Well, I think it’s a couple of things. It was the black lung excise tax benefit as well as sales sensitive costs were probably a little bit lower.
Operator
Your next question comes from James Rollyson - Raymond James.
James Rollyson - Raymond James
Steve you talked about I guess last quarter was when you announced the drag line and shovel idle at Black Thunder and then I think this morning you mentioned another shovel operation at Coal Creek. We didn’t see a huge drop in volumes from 3Q to 4Q, just have you not got to the time of when that started impacting your production?
Or were you shipping some coal out of inventory? Or just trying to understand how this plays out over the next 12 months.
Steven Leer
Well when you’re parking equipment you really let the mine park it at the best optimal point in their mining sequence. And really they ended up parking the equipment near the end of the fourth quarter and it’s fully parked as we go into the 2009 timeframe.
James Rollyson - Raymond James
So volumes ought to kind of come down, a step change down in first quarter basically.
Steven Leer
We would expect it but it’s always dependent upon market conditions.
Operator
Your next question comes from Brian Gamble – Simmons and Company.
Brian Gamble – Simmons and Company
I wanted to walk through the met coal assumptions for the year. I know you talked about a range of near 6 million tons of met quality and then you kind of gave some quantification as to how that could be a little bit lower.
I was hoping if you could possibly put some ranges around what you think is likely to shift into the market and also obviously market dependent, but what could possibly be left in the ground? And then as well maybe what you’ve already signed up so we can kind of see how all those numbers tie together.
John W. Eaves
I think as you look at our met opportunities, I mean, as Steve indicated we have the ability to ship up to 6 million tons. Given current circumstances I mean we don’t see those opportunities but those could play out over the year.
We haven’t really had any material settlements thus far. We expect those to probably start taking place sometime in April or May.
You know coming into the year if you look at where we are committed on our met we’re probably a little bit less than a third of that total opportunity of met. So we’ll continue to monitor the market.
We think we’re fortunate. We have a cost base that allows us to participate in the steam market, if that’s what we choose to do.
If we don’t think we can get the appropriate return on the steam side we’ll leave those tons in the ground. So you know we have the flexibility to look at those, evaluate the market and determine what makes the most sense for the corporation.
Brian Gamble – Simmons and Company
But just to clarify, 2 million tons roughly signed already; you didn’t see much push back in Q4 so maybe assume those are firmer than not; and then the additional between 2 and 4 – excuse me, between 2 and 6 so the 4 million is all in the ground and is market dependent.
John W. Eaves
That’s correct. It’s probably a little bit less than the 2, Brian.
We think we’re solid on those. As Steve indicated we hadn’t had a lot of deferments.
We feel pretty good about what we’ve got booked and getting those tons shipped, but it’s probably a little bit less than the 2 million.
Brian Gamble – Simmons and Company
If you could quantify what you think of the remaining is high quality versus low quality?
Steven Leer
Well, I think most of it would be high quality. I mean we sell a high vol met product.
And you know when we make that transition in the steam market, we can put that in the high BTU steam market or we can blend and blend that down. So I think we’ve got the ultimate flexibility there.
Operator
Your next question comes from Shneur Gershuni – UBS.
Shneur Gershuni – UBS
I was wondering if you can sort of walk us through how the production cuts will impact I guess labor costs. I mean you did mention pulling back some shifts and so forth.
When you think of productivity on tons per shift or ton per man hour and so forth, is that effectively going to go down? I mean historically when we’ve seen production costs, usually you see costs skyrocket on a per unit basis and so forth.
Or are you taking off expensive shifts? If you can sort of give us a little bit more color with respect to that.
John W. Eaves
I mean we’re looking at everything and obviously trying to manage our costs. As I indicated in my comments that we thought we could see costs go up 5 to 10%.
But obviously we do have a lot of fixed costs at these operations, so as we drop the volume it could very well raise our costs. So we’re looking at shift links, contractors, we’re doing everything we can to manage our costs.
And we’ve managed in tough conditions for many years and we think we can do a good job. We’ve got a number of initiatives that I really can’t talk about for competitive reasons that we think will have a positive impact on our costs.
But our best guess right now is that 5 to 10% range in the PRB in Central App.
Shneur Gershuni – UBS
Do you anticipate any more like reclamation work being done as a result as you try to keep these guys on idle or?
John W. Eaves
When you look at the labor force, we were pretty thin in 2008 so as we came into 2009 as we look at our workforce we think we’re going to be able to manage our workforce through attrition, whatever. So at this point we’re really not scheduled to have any layoffs per se.
So we’ll manage it. I mean, can we do additional reclamation from time to time?
We usually do some of that with contractors, so given the fact that we’re cutting back on contractors we’ll just have to play it by ear.
Shneur Gershuni – UBS
With respect to your outlook, what if we have a situation where generation is down greater than 1% or approaching 2, maybe even 3% and so forth. How many levers do you have left to pull to bring production if you find that the outlook continues to deteriorate further?
John W. Eaves
Well, that’s something that we’ll continue to monitor really on a week-by-week basis and we’ve always said that we’re a market driven company. And I can tell you we can manage our mines at smaller levels than we’re forecasting right now.
So it’s something we’ll continue to monitor. We’ll evaluate the met market, the steam market and make those determinations.
But I think if the market’s not there we will pull these mines back further if that’s required.
Steven Leer
We have really focused over the last 4 or 5 years on trying to take more of our costs into the variable category where we recognize coal business is a cyclical business and that where we want to be successful in the trough and excel in the peak. And I think as we look back over the last 3 years we’ve been very successful in it.
We’ve gone through a complete market cycle here and we’ve had the best 3 years in total in the company history. So we’re feeling pretty good about it.
And the large part of it is exactly what we’ve been talking about, pulling back capital and managing capital on the balance sheet so you’re just not getting killed when you have to pull back production. And have a good sense of what’s your highest cost increments and given the diversity of the company and the range of our products, I think it’s playing now very very well and frankly I’m looking at ’09, I think there’s going to be some significant opportunities for Arch to seriously evaluate our acquisitions in terms of reserves or companies of some of our other competitors that may not have the same position.
Operator
Your next question comes from Paul Forward - Stifel Nicolaus & Company.
Paul Forward - Stifel Nicolaus & Company
On this guidance of 120 to 127 tons produced your own coal production that you’re planning to sell in 2009, what’s the comparable number in 2008? Because you gave a total coal sales number but some of that is not your own production.
What’s the comparable number so we can see exactly how much production in 2008 is being taken offline? And if you could also give us a sense of if possible toward the low end of that range, if you’re 120 then what are the mines that would be most impacted by this?
John W. Eaves
Well, I think the apples to apples comparison is about 134 per.
Paul Forward - Stifel Nicolaus & Company
So potentially you’ve got 14 million tons coming offline. Can you quantify where that might come from?
John W. Eaves
Obviously we’ll look at all regions and we’ll determine the markets in those regions and where we need to pull back. But I think obviously you can look at it on a pro ration basis and come up with a number.
The one market quite frankly we haven’t seen a whole lot of deterioration in right now is Western Bit market. So we look at each market and make those determinations and we’ll make the production cuts accordingly.
Operator
Your next question comes from Meredith Bandy at BMO.
Meredith Bandy – BMO
You talked a little bit about the improvement you’ve seen in exports going out of Canada. What are you expecting – how are you expecting exports to be next year?
I know there’s a lot of talk about them coming off.
John W. Eaves
It’s open. It’s kind of interesting if you look at – I was talking to some transportation people this last week and they’ve actually seen a little resurgence in January from a pretty quiet December.
And but we would expect to see exports on a U.S. basis across the entire industry to drop 15 or 20 million tons from the record 2008 levels.
And it remains to be seen I guess because of the world economy. It is hard to predict.
But that’s kind of a working number as we see it today.
Operator
Your next question comes from [Mark Lenama] – Morgan Stanley.
Mark Lenama – Morgan Stanley
You attribute most of your expected 1Q weakness to the problems at West Elk. Can you talk about sequentially how you expect the PRB in Central App to perform from an operating contribution perspective?
And I would also be interested in your comments on how much of a supply overhang you think the industry has to deal with given the various production cuts that have been announced. Thanks.
John W. Eaves
You know as we look at Central App and the PRB both, the mines are running well. Obviously we’re layering in some of these production cuts at different operations and they’ll have to make their adjustments.
But we’re pretty pleased with the overall operations of the mines. And even West Elk when you look at it.
I mean they’re dealing with a temporary problem here that we think the worst is actually behind us at the moment. But they’re going to fight it for the quarter.
I mean it’s just coal mining when you get down to it. So I expect more of the same in our PRB operations and in our Central App operations except for as they address production issues.
Mark Lenama – Morgan Stanley
So overall a little bit better than what 4Q was?
John W. Eaves
I wouldn’t say that there’ll be better or worse. It’s – I wouldn’t expect a great deal will change except for as they deal with declines in production because we’ve chosen to leave some tons in the ground.
In the overhang we’re sitting there in that 30 to 40 million ton range as we look at it today. And I think if you’re fair about it you’d have to look at another 15 or 20 million tons of de-stocking that needs to occur to really rebalance the entire market.
Operator
Your next question comes from Jeremy Sussman - Nataxis, Inc.
Jeremy Sussman - Nataxis, Inc.
I’m talking about acquisitions. Is there any particular area that you’re looking at where valuations are particularly attractive?
Steven Leer
Well, I think given the pricing of assets that have occurred here or the decline in the pricing of assets that we’ve seen from in every region we’re interested in, we are not going to really isolate our discussions on one area or the other. But we are actively looking and we see opportunities out there.
And there’s a lot of companies that are just stressed in the credit markets or in the permitting markets or even in reserves that might be bolt on for Arch. And then there’s larger opportunities too.
So again if you look at our history, traditionally it’s been in the depressed markets where we’ve made some of our best strategic acquisitions and moves. And we see it setting up again as we progress through 2009.
Jeremy Sussman - Nataxis, Inc.
You signed a fair amount of tonnage in the quarter at some nice prices, $16 or so in the PRB. Was that signed basically throughout the quarter or was there a particular time where you signed more coal?
John W. Eaves
Really Jeremy it’s pretty much throughout the quarter.
Jeremy Sussman - Nataxis, Inc.
Trading results, can you break those out in the fourth quarter and then what should we expect in ’09?
Steven Leer
Let me just touch on it. John can give you the fourth quarter results here.
We were really happy with our results for the year from a trading function. Certainly with the volatility we saw in 2008.
I’m not sure we’ll see that volatility in 2009, but I will tell you it’s still going to be a critical piece of our marketing function. I mean we’re going to use it for optimization, market intelligence, but I don’t think you’ll see one the volatility in the market and two the kind of numbers that we saw in 2008.
John T. Drexler
For the fourth quarter we ended up with the ongoing decline in the markets that we saw, we ended up with a loss position of about $10 million. However, I will say that as we looked at our positions at the end of the year we felt comfortable that we’ve done a good job of locking in the vast majority of what we have experienced for the year.
As I indicated in my prepared remarks we expect the majority of that remaining mark-to-market to convert to cash throughout 2009.
Operator
Your next question comes from Gordon Howald - Calyon Securities.
Gordon Howald - Calyon Securities
This is kind of related to China and India. It’s a series of questions if I could.
What kind of PRB volumes are you seeing going out to China and India at this point for the industry? What kind of capacity is there on the West Coast at this point?
What is the opportunity for Asia over the next say 5 years? And who are the current and targeted customers at this point?
John W. Eaves
Certainly we know the 2 million tons that we have committed for China and India. I wouldn’t speculate on others, but I do know that there have been test shipments out of the West Coast.
We currently think that there’s about 5 million tons of available capacity at West Shore in Vancouver. We think over time that what you’re seeing going on in countries like Indonesia where there’s tremendous growth domestically, they forecasted pretty significant increases in their exports.
At the same time they’ve got a major deterioration in quality. We see a real opportunity for PRB coal in that market.
Really we’re talking to all the utility customers in China and India and have gotten tremendous interest in our PRB coal, so I would say over the next 3 to 5 years some real opportunities for some significant volumes going off the West Coast.
Steven Leer
And there could be an expansion in the West Coast ports. We have had discussions with some of the Canadian ports along those lines and it’s not a tremendous amount of capital that would allow that number to grow.
And it’s always a tradeoff from the Canadian port perspective because they’re looking at their met coal shipments, again to the Pacific Rim and depending on where those stand it affects the volume for additional steam coal shipments. So we see the opportunity.
The important number here – point is that I think we’ve established the product into the marketplace and it will grow. When you look at the need over a 5 year timeframe of the developing Pacific Rim, I mean the limit could really ultimately be the port capacity because the demand is going to be there, which we think has great implications for PRB as a secondary market.
And it’s just one more development that I think really helps realize the true potential of the entire Powder River Basin.
Gordon Howald - Calyon Securities
What kind of quality is the Indonesian export coal? Is it comparable to a PRB type of product?
John W. Eaves
You know a lot of it’s a sub-bituminous coal but as I said it’s deteriorating pretty significantly over the next couple years.
Operator
Your next question comes from Michael Goldenberg - Luminous Management.
Michael Goldenberg - Luminous Management
I want to focus on Central App and Mount Laurel. It seems if I look back at press releases from previous quarters, when you stated signing contracts at percentage higher than realized and so on and so forth, at least from where I sit it seemed pretty clear that part of the stuff that was being signed was met coal.
So I thought that at least a portion of 6 million tons of Mount Laurel entering 2009 was under contract. Am I wrong in that?
Did you not sign any in the met space? Did those contracts get abrogated or what?
John W. Eaves
Well I mean when we opened up Mount Laurel we felt like we had a very attractive cost structure that’s going to allow us to move in both of those markets. But I will tell you the majority of that volume was put into the met market.
We had some agreements that went into 2009. We also have the ability to ship met coal from some of our other locations such as Lone Mountain in Cumberland River.
So our met products ship from a combination of locations, but the majority of Mount Laurel for 2008 was shipped as a metallurgical product.
Michael Goldenberg - Luminous Management
No, for 2009 did you not have – do you currently not have many contracts for metallurgical coal?
John W. Eaves
We’ve got less than a third of our overall opportunities that’s 6 million tons committed in the met market, with a portion of that being shipped out of Mountain Laurel; a portion out of Cumberland River and maybe a lesser extent out of Lone Mountain.
Steven Leer
Unlike the steam coal markets which often have one, two, three or five year, ten year contracts even, the metallurgical market for almost all sales tend to be one year contracts. And they tend to run on the Japanese fiscal year, April 1 to March 30.
So you always have an overlap of course in the calendar year. And there are from time to time agreements, and we have some too, where you might do a two or three year deal but often the pricing will be open in the metallurgical sales or it’ll be [towered] or something like that.
And we don’t have many of those but there are some of those. But they are a distinct minority in the traditional way met contracts are signed.
Michael Goldenberg - Luminous Management
But you didn’t sell any Mount Laurel into it? U.S.
Met which generally runs much closer January to January of ’09? January ’09 through January ’10 you didn’t sell any?
John W. Eaves
We have sold some. Yes.
We have some of those.
Michael Goldenberg - Luminous Management
But not significant if I understand it that only a third of overall production is signed up.
John W. Eaves
I guess a third is significant we think in the met market, but all of the U.S. steel companies and the international steel companies in the fourth quarter’s years we’re looking at their steel markets and we had discussions going on at the end of the third quarter.
They basically just stopped for 2009 because they said we want to talk to you, we think we’ll be buying metallurgical coal but we have no clue what our market looks like. And until we do, we’re not prepared to move forward –
Michael Goldenberg - Luminous Management
But you have no contract abrogations where people signed and then said oh, we can’t pay you or we went on another contract. You’ve had absolutely none of those.
John W. Eaves
We’ve had none of those.
Michael Goldenberg - Luminous Management
And also on Western Bit, I’m also trying to reconcile previous press releases on pricing to the current tone that I’m hearing on the call. And I understand costs are going to be up but once again if I go back to previous press releases, it would imply that pricing in 2009 should be well above 10, 20, 30, 40% higher than $27 realized in 2008.
Should there be a considerable step up from $27 into 2009? Or is that also not generally happening?
John W. Eaves
We do have a step up in 2009 and I don’t want to get into exact numbers because we’ve got some sensitive discussions going on with our customers. But I think as you move through 2009 and get to the end of 2009 you’re going to see a significant step up as we move in 2010 out of Western Bit.
Operator
Your next question comes from [Sanil Dastadar] – Sentinel Investments.
Sanil Dastadar – Sentinel Investments
You mentioned about the Western Bit costs, $24 to $27 per ton. When you look out into a year ahead of that, do you think that the costs may come back again or it might remain in this range?
John W. Eaves
When we put the range together we were looking at what the possibilities were, the impact of the first quarter at West Elk, the additional production from Elk Mountain, but as I indicated earlier I’m very hopeful as we move out through the year that we can improve on those costs. And hopefully we’re hitting the higher part of that range in the early part of the year here and we’ll see that drop throughout the year.
But certainly I mean we’re going into more and more challenging reserves. A lot of the cost for the input materials and supplies has gone up.
So it’s something that’s a challenge but we’re doing everything we can to manage those costs and bring them down where the opportunities exist.
Sanil Dastadar – Sentinel Investments
On the diesel hedging program an average price of $3.50 a gallon, is that 100% hedged for 2009? And what are the hedges for 2010?
It’s what, 20% of your operating costs? Is that –
John W. Eaves
We’re about 70% hedged for 2009 at prices that are north of around $3.50. And for 2010 our diesel hedging program, which is just a consistent layered in approach, goes out about 12 months so we’ve started looking into 2010 primarily in the first quarter.
Right now for all of 2010 we’re about 10% hedged in the $2.25, $2.50 range, somewhere in there.
Sanil Dastadar – Sentinel Investments
So you’ve got a lot of lever basically for the costs to fall in [inaudible] I guess, current prices.
John W. Eaves
Yes. Yes.
Sanil Dastadar – Sentinel Investments
And fuel occupies if I remember correctly 20% of your operating costs, is that correct?
Steven Leer
I’m trying to think. John says yes so I’ll take that –
John W. Eaves
In the 15 to 20% range for fuel.
Operator
Your next question comes from Justine Fisher - Goldman Sachs.
Justine Fisher - Goldman Sachs
You guys mentioned that the first quarter would be the weakest based on the West Elk situation and then also that the lease payments are also made in the first quarter, right?
John W. Eaves
That’s correct.
Justine Fisher - Goldman Sachs
So the most pressure that I guess we might see from a cash flow perspective is in the first quarter, too?
John W. Eaves
I guess that’s –
Justine Fisher - Goldman Sachs
Cash use I guess.
John W. Eaves
Yes. I mean we’re just looking at the year very comfortable with our cash flow and free cash flow projections, but obviously that’s market dependent.
But the first quarter is always our largest outflow.
Justine Fisher - Goldman Sachs
And working capital in the first quarter? I mean, would that part be pretty negative, too, just given the operating issues?
John W. Eaves
I wouldn’t expect that to change that much.
Justine Fisher - Goldman Sachs
And then your commercial paper facility matures in the summer I believe of 2009. It’s $100 million.
Are you guys planning to roll that or to pay that down?
John W. Eaves
We’ll expect to roll that. That commercial paper program is rolling every day but we expect to take that out another year with [M and I] Bank as we move forward.
Justine Fisher - Goldman Sachs
And you guys haven’t seen any issues regarding rolling that just given the commercial paper market is just generally – I mean because the fact that you guys have one and are [highly] rated is impressive. So you guys haven’t seen any issues with that?
John T. Drexler
We ended 12/31 at about $68 million. If you remember we were indicating in our third quarter conference call we were beginning to see some weakness there.
We kind of flattened it in the $60 million range and have been comforted that things seem to be rolling there pretty consistently now. So something we watch every day but right now continue to feel fortunate with the position we’re in.
Justine Fisher - Goldman Sachs
And the AR facility, when does that mature?
John T. Drexler
The AR facility, the entire program runs through 2013. However the credit back-up matures on March 31.
It’s similar to the CP program. We expect that to roll as well.
Justine Fisher - Goldman Sachs
And then on the cost guidance front, I just wanted to clarify when you say costs up 5 to 10% is that total dollar amount cost? Is that unit cost in 4Q versus what it was in 4Q ’08?
Or is that like the average of unit cost for ’09 versus the average of unit cost for ’08?
John W. Eaves
That would be the per ton cost forecasted for 2009 versus 2008.
Justine Fisher - Goldman Sachs
And it’s the average for the year, right?
John W. Eaves
Yes.
Justine Fisher - Goldman Sachs
The last question I had was just about share repurchases and acquisitions. It looks like you guys bought back a little bit more stock in the fourth quarter and then you’re mentioning acquisitions.
But – and I’m realizing that you do have significant liquidity available, but just given the pressures in the credit environment, I mean do you guys expect to continue to buy back shares? Because you may have to draw on your revolver to do it.
And then would those acquisitions be debt financed?
John W. Eaves
Justine, on the share repurchase portion of that question, we did not have any physical activity in the fourth quarter. We had some that was acquisition in the third quarter set up payables on the cash flow then flowed through.
So our activity ended in the third quarter with what was developing in the fourth quarter we felt it was prudent to preserve liquidity. See that what was developing in that area and we were comfortable in growing our liquidity and preserving everything on our balance sheet that we had.
So as we look forward as Steve indicated we do have tremendous opportunity and we continue to look at it from a position that we’re going to focus and be diligent in how we look at liquidity, how we look at our debt position and try to put ourselves in a position where we’re ready and able to act on opportunities.
Steven Leer
And obviously Justine it depends on the size of an acquisition. A small one would be from cash flow, a large one would be from perhaps its own cash flow and our own and may involve debt or may not.
So it’s dependent on what the deal is.
Operator
Your next question comes from [John Flanagan – Integrated Equities].
John Flanagan – Integrated Equities
Can you give us kind of an overview, Steve, of where the industry is at this point with our new administration and new Congress? Do you feel the coal industry picture has looked brighter or unchanged or any insights there?
Steven Leer
Well, I think it’s open to debate from a lot of different perspectives. I think it’s really clear and it’s not the change of the administration driving it as much as the general trends that our view is that the regulatory environment will always get tougher as we move forward into any particular year and ’09 will be no exception and may get tougher.
We think that favors companies like Arch that excel in safety and environmental performance. The same in safety regulations, safety inspections.
Again we think that it favors the bigger, stronger companies that are able to put the appropriate resources on those issues. And we look at this as again one of these things that are starting to differentiate different coal companies which we’ll come out in pretty good shape on that.
As we look to policies that would come out of the Congress or the administration, I think again it’s one of these things that there’s going to be a great deal of debate on carbon, on climate change. I think that with the economy and the priority the economy takes that those debates will be very intense but action – you know no one can predict the Congress but actions probably not going to occur this year.
But who knows? And the devil’s in the details and I don’t think anybody can really respond one way or the other.
But the reality of it is that 50% of the nation’s electricity is generated by coal. I think the goal of growing renewables is a good goal.
We’re going to need that power when the economy recovers, but even going setting aside hydro, going from 2% renewables to 4% is an enormous undertaking. And the president has said that he wants to try to achieve that.
We’ll see. And the first step has to be the smart grid and to really rebuilding the grid system because when you look at wind power which probably has the most potential, when you look at where wind blows the people aren’t and that’s because people didn’t want to live where the wind blew all the time.
So we have to connect those areas. And it’s a long term deal, but right now as we see it in the next four years, the next eight years, the next 15 years coal will continue to do the heavy lifting in generating electricity.
And I think the other interesting thing that’s going on and we didn’t really get into it on the call, but when you look at natural gas on the margin there’s probably some natural gas displacing perhaps, some of the worst performing oldest coal plants in the nation. We’re not entirely clear on that.
But in our modeling we kind of assume that to occur. Again I’m not convinced that it actually is to a great deal, but we’re assuming it does occur.
But you look at natural gas rigs right now and they’re down 38% I think, 35 to 38% over 800 rigs from their peak back in September. And it’s below 1,500 rigs.
So the natural gas industry is responding very aggressively to the economic environment that we’re all seeing. So I think all of energy is looking at the economic environment and saying we’re going to live within our cash flows and by doing that I think as the economy recovers the upsurge in energy demand and the ability for industries to respond is going to be an interesting dynamic.
So frankly it’s kind of scary to say but I can see ’09 as having tremendous opportunities for companies like ours. And I think as we enter ‘010 given the resetting of some of our contracts that are well below today’s stock market pricing and if they just come up to where market pricing is today that I guess I’m pretty encouraged as we look out at ‘010.
And we’ll weather the down cycle and come out again to excel on the up cycle.
John Flanagan – Integrated Equities
So you think 2010 will be a better, a higher year gross than 2009?
Steven Leer
Almost certainly. Again you can never be guaranteed things but just looking at our contract mix, looking at I do believe the world economy starts to recover in the second half of this year or the fourth quarter of this year.
Even the downturn here I guess GDP was a little bit less or the decline was a little bit less than people were forecasting. That came out this morning.
I think there’s more pain to come but clearly governments around the world are implementing stimulus packages. There’s a great debate on how effective some of them will be, but there’s a lot of money flowing into the system.
And I think the previous question from Justine on the credit markets, I mean we have seen the credit markets starting to function again. And to me that is one of those signposts that are critical for business to start climbing out of the depression environment that they see today.
Operator
Your last question comes from [Wayne Atwell – Pontius Capital Management].
Wayne Atwell – Pontius Capital Management
And you sort of touched on this before, but if you could just sort of give us a quick overview of the market steam and met and as I said again you’ve sort of gone over this, and when you think demand might be picking up? It seems like a lot of the coal has been placed by yourself and others for the year.
And you can sit back and maybe be patient in terms of committing coal. And then also how much capacity do you think has to come off both here and overseas?
John W. Eaves
Well, again if you’re looking at the met markets I think on a global basis we saw a real freeze might be the best description of it in the fourth quarter, where people were just uncertain what the ’09 and really the fourth quarter looked like. And there has been a certain amount of de-stocking.
I mentioned the conversation I had with transportation companies that they were starting to see a little bit of – a meaningful resurgence here in January. Maybe that was some deferred shipments or maybe it was just timing.
I wouldn’t want to read too much into that. But I think as we project forward and listening to a couple of the steel companies press releases, that they’re anticipating coming off the low perhaps that occurred in the fourth quarter and kind of a steady build, but certainly not projecting a steady build through 2009, not projecting a return to the 2008 first half.
But maybe 20% or so decline year-over-year in total steel production might be a realistic assumption. In steam markets I’ve said before that overall when you look at recessionary periods in the U.S.
domestic steam market that it’s not recession proof but it is recession resistant. I mean people still heat their homes.
Commercial buildings still turn on the lights. And where you see the decline typically is in the industrial markets.
And when you look at the mix of electricity it’s about one-third residential, one-third commercial, one-third industrial. And the annual 1.5, 2.5% growth in electric generation flattens to slightly decline and we’re projecting a 1% decline in electric generation.
But it doesn’t go to the floor like you see in say a more typical manufacturing facility of automobiles or maybe chemicals. So we expect a slow down.
I think we mentioned earlier we’re kind of in that 30 to 40 million ton overhang today. When you take de-stocking maybe it’s another 15 or 20 million tons added to that.
And what’s interesting is we read press releases from the industry and obviously we don’t get it from the private sector that the cost structure, the reserve structure, the regulatory structure, the 404 permitting questions and delays, I think we’ll see a major reduction in overall global and domestic production as a result. And it looks like industry is taking those steps.
Either forced upon them or they’re doing it voluntarily. And the other issue is credit.
I mean in pass recessions the weakness you could kind of ride through it because the credit markets would support you, particularly smaller or weaker players. And today while we’re seeing some positive movement in the credit markets, we don’t see a robust credit market support for weaker credit.
So again I see ’09 as a transformation year and an opportunity for companies like ours.
Wayne Atwell – Pontius Capital Management
So conceivably we could be setting up for a pretty good 2010, 2011 with obviously coal being cut back, no expansions being put in place. There should be some growth I guess which will be muted here for awhile but as time passes more people have homes and they need to heat.
So conceivably production capacity could be falling off here. Some companies will hit the wall and have to close.
So we could end up setting ourselves up for reasonable 2010, 2011.
Steven Leer
Really that’s exactly how I see it. That is the classic cycle in a commodity business and as I said we’ve positioned Arch to do well and be successful in the down cycle and excel in the up cycle.
And I think you just described it. And if you look at the last two cycles, the 2001 cycle, the 2004-5 cycle, the 2008 cycle, I think there’s a couple observations that are fair to make is that each peak was higher than the previous cycle’s peak in terms of pricing and demand and each valley was better or higher if you will than the previous valley.
So the general trend line in the secular trend and coal demand and energy demand is an upward trend. But if the sign waves up and down on it, it’s not a straight line.
Deck Slone
So with that, you know I would like to thank everyone for joining the call, obviously your interest in Arch. I think I’ve said many times privately 2009’s going to be an interesting year.
It will have its challenges. I think companies like Arch and some others will come out the other side much stronger and in a better competitive position than we are even today.
You know liquidity, low cost operations will always serve companies the best whether they’re in the up cycle or in the down cycle. And that’s how we’re managing Arch.
So thank you for your interest. Thank you for your time and we look forward to joining all of you in our April call for the first quarter.
Thank you.
Operator
That does conclude today’s conference call. Thank you for your participation.
Have a wonderful day. You may now disconnect.