Arch Resources Inc

NYSE:ARCH

Earnings Call Transcript 2022-Q1

[Operator]

Good day and welcome to the Arch Resources, Inc. First Quarter 2022 Earnings Conference Call. Today's conference is being recorded.

I would now like to turn the call over to Deck Slone, Senior Vice President of Strategy.

[Deck Slone, SVP of Strategy]

Good morning from St. Louis, and thanks for joining us today. Before we begin, let me 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 according 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 SEC 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 archrsc.com.

Also participating on this morning's call will be Paul Lang, our CEO; John Drexler, our COO; and Matt Giljum, our CFO. After our formal remarks, we'll be happy to take questions.

With that, I'll now turn the call over to Paul. Paul?

[Paul Lang, CEO and President]

Thanks, Deck, and good morning, everyone. We appreciate your interest in Arch and are glad you could join us on the call this morning.

I am pleased to report that during the quarter just ended, the Arch team once again executed at a high level delivery and record earnings, despite the pervasive drag of rail related challenges. It was our second straight quarter of record earnings, and more importantly, a quarter of significant progress against each of our key strategic priorities.

Among the highlights, Arch achieved a record gross margin in our core metallurgical segment. We paid more than $280 million of indebtedness and restored the balance sheet to a net debt neutral position. Reached a $100 million or almost 80% of the targeted balance in our thermal mine reclamation fund, putting us well along the path towards completing this effort by July and finally, announced a second quarter dividend of more than $135 million or $8.11 per share payable in June.

While these are all significant events, I think the relaunch of the capital return program deserves particular focus because it signals an inflection point in the evolution of Arch's long-term value proposition. As you know, we have viewed a robust capital return program as a central tenant of our long-term strategy for creating shareholder value.

Toward that end, we launched the initial phase of our capital return program in May 2017. Hit pause on that program in early 2020 at the start of COVID in order to drive forward with the construction of a more powerful cash generating portfolio through the build out of Leer South.

Finally, we relaunched the new program in February 2022, less than six months after the commissioning of the Leer South. Today, we demonstrated just how powerful the combination of our upgraded operating portfolio in our new capital allocation model [ph] by announcing the first substantial dividend under the new program.

We realized it's atypical for a company to commit to returning effectively 100% of its discretionary cash flow to shareholders, but it's also atypical for a company with our cash generating capabilities to have such modest cash requirements going forward. In short, we've now accomplished what we set out to achieve when we initiated our strategic pivot, more than 10 years ago.

We have a world-class cooking coal portfolio that is well positioned to compete on the world stage for decades to come. We have a legacy thermal segment that generates significant levels of cash, requires very little capital and can be systematically wound down in a responsible manner. And just as importantly, we have a well-fortified balance sheet with as much cash as debt effectively, no refinancing risks, as well as a newly constructed asset in the form of our thermal mine reclamation fund that counterbalances the principle concern associated with these operations.

When we made the decision to move forward with the build out of Leer South back in February 2019, we made it clear that we planned to enhance the capital return program, once that project came online. Consequently, the board views our new capital return model as making good on that commitment and more broadly, rewarding shareholders for their years of support during our strategic pivot towards steel and metallurgical products.

Before passing the call to John, I'd like to share a few thoughts on the coking coal markets, which remain at historically high levels. At present Arch's primary metallurgical product, high High-Vol A coal is being assessed at $470 per metric ton on the US East Coast, which needless to say translates into attractive net back for our low cost and highly competitive coking coal operations.

As we repeatedly said in the past though, markets work and thus, we don't expect these elevated prices to last indefinitely. We do, however, continue to view coking coal markets as fundamentally well supported. Of course, the macro environment is complex at present, due in part to two disrupted trade flows stemming from hostilities in Europe, coupled with the Chinese importation ban of Australian coals. Even with this, steel continues to trade at highly profitable price levels in both Europe and North America and the outlook for steel markets in Asia is positive.

Economic development remains a sharp focus. Steel intensive stimulus efforts are underway and the build out of new integrated steel capacity has resumed in India as well as other parts of Southeast Asia. Even more significantly coking coal supplies remain persistently constrained. Exports from Australia, the United States and Canada are undershooting 2021 levels year to date and lagging pre-pandemic levels even more dramatically.

As we've noted many times in the past, the industry is filling the effects of years of underinvestment and the pipeline of new coking coal projects remains light. While a protracted period of high prices could ultimately prove the remedy for such under-investment, capacity additions require long lead times have yet to get underway in any meaningful fashion.

At the same time, the maturing of the existing mining operations continues to take its predictable toll. Along with this, current strong seaboard thermal demand and elevated prices are also acting to support coking coal markets. Thermal coal is currently trading at prices of about $300 for metric ton in both the Pacific and Atlantic basins, which is acting to pull lower quality coking coal into the thermal markets. Such crossover volumes are further pressuring and already straying seaboard coking coal supply and demand balance.

Looking ahead to the second quarter, we anticipate a significant step up in our financial results given the current pricing levels across all our products in conjunction with an expected increase in coking coal volumes as rail service continues to slowly recover. Additionally, we expect further strength in our results in the back half of the year as shipment levels return to normal and we have the chance to monetize our currently large and highly valuable coking coal inventories.

The most important takeaway, however, is that all of these positive catalysts in aggregate should translate into high levels of discretionary cash flow and thus high levels of capital return for our shareholders as the year progresses.

So today the Arch story is by design a relatively simple one. We've developed a world-class metallurgical asset base with a premium High-Vol A product slate, forged an industry-leading ESG proposals and cultivated top tier marketing and logistics expertise. On the strength of these attributes and keeping with our clear and well defined strategy, we believe we're in an excellent position to generate substantial long-term value for our shareholders through the deployment of our new capital return program, while at the same time positioning the company to capitalize a renewed global economic development and the transition to a low carbon economy.

With that, I'll turn the call over to John Drexler for further details on our operational and marketing performance. John?

[John Drexler, COO]

Thanks, Paul and good morning, everyone. As Paul just discussed, the Arch team maintained excellent momentum during the quarter just ended delivering yet another record setting earnings performance and driving tremendous progress on our key strategic priorities. Perhaps most impressively, the team accomplished all of this while managing through poor rail service, widespread inflationary pressures and higher sales sensitive costs.

As I've stated in the past, Arch is fortunate to have such a high performing workforce. The team continues to prove that it is well equipped to adjust to almost any eventuality, employees to carry the organization to even greater heights in the future.

Let's turn now to our operating performance; as indicated, our core metallurgical segment delivered exceptional results, despite a range of cost-related pressures, anaemic real service chief among them. Despite a nearly 25% decline in coking coal shipments quarter-over-quarter, the team was still able to hold unit costs relatively stable. That's particularly noteworthy when you consider that the average sales price for our coking coal volumes increased by more than $63 per ton or approximately 30%, which in turn drove a nearly $5 per ton increase in our sales sensitive costs.

In addition, inflationary pressures continued to mount during the quarter, driving up the cost of materials, supplies and consumables in areas ranging from labor to equipment parts, to roof control products. While the team continues to do an excellent job of managing the impact of these cost pressures, they are real and likely to be with us for a while.

Before moving on to our legacy thermal segment, let me spend a few minutes on the single biggest challenge we faced during the quarter, which was inadequate rail service. To give you a sense of the magnitude of the issue, we only received approximately 60% of the trains we needed during the quarter. While there was progress over the course of the quarter, we received less than half of the trains we needed to match production levels in January, 60% of the trains we needed in February and approaching 70% of the trains we needed in March.

The upshot of this poor rail service was a significant shortfall in our normalized coking coal shipments in Q1, along with the stockpile build to nearly a million tons during the period. While all that high quality coking coal now constitutes a highly valuable asset for the company, particularly in today's coking coal market environment, it's a far from optimal situation.

Somewhat encouragingly, we have indeed seen modest incremental improvement in April when compared to March and are now receiving approximately 80% of the trains we would typically expect. But that means we're still adding coking coal to already swollen stockpiles. To stabilize at current stockpile levels, our coking coal mines need to load around 75 trains per month, which is consistent with their 2.5 million ton per quarter productive capacity.

In order to begin to drive down and monetize existing stockpile levels, we need something north of that 75 train per month figure. That's entirely doable on our end, mind you, we can load a 100 car unit train in around four hours at each of our mines, which means we can accommodate multiple trains per day at each of our minds, but we need for the railroads to prove it's also doable on their end and of course there's no reason why it shouldn't be.

As indicated, we are guiding to a 50% increase in shipment levels in Q2 when compared to Q1, which anticipates incremental improvement in services as the quarter progresses, but which is still shy of our actual productive capacity and long-term needs.

Let's transition now to our legacy thermal assets, which continue to benefit from a very significant book of contract business as well as a highly attractive export market environment. In Q1, the thermal segment generated more than $100 million in segment level EBITDA while expending approximately $4 million in CapEx. That means that since launching our harvest strategy 5.5 years ago, we have now generated an aggregate total of more than $1 billion from these assets while expending just $114 million in capital or to put another way, we've generated nearly nine times more cash than we've expended and we expect more of the same as we progress throughout 2022 and beyond. We view that as hugely value creating for our shareholders.

Now let's shift our focus to the marketplace. As Paul discussed, global coking coal markets continue to be impacted by a combination of solid steel market fundamentals and persistent and perhaps even structural supply constraints. These global market fundamentals are helping Arch's financial performance as we would expect.

During the first quarter as I mentioned earlier, we captured an average coking coal price at the mine of nearly $270 per ton. As we discussed on the last earnings call, there were approximately 200,000 tons of lower priced coking coal shipments commit edit in early 2021 for Q2 2021 through Q1 2022 delivery the European steel year.

When you factor in those tons, you can see that we were securing for the remaining tons prices fully reflective of prevailing price indices and assessments. It's also worth noting that we committed incremental North American sales volumes during the quarter as well at a fixed price well in line with the 2022 price curve. I'm pleased to report that we were rewarded for our patients, our logistical flexibility and our significant geographic market reach in securing this attractive business.

Let me also take a moment to highlight yet again, the tremendous asset we created in 2021, when we bill out our thermal contract book for 2022, 2023 and beyond at highly attractive prices. As indicated in our guidance table, we have a committed and price position of 77.9 million tons of thermal business for delivery in 2022 at an average price ton of $17.96.

Included in our committed position is nearly 3.5 million tons of thermal coal we expect to ship into the export market during 2022, both from Black Thunder and West Elk, which given current market conditions should average up that price significantly. While we aren't ready to share details about our 2023 contract position, I will say that we have a very solid foundation in place at prices that will not -- while not yet reaching 2022 pricing levels are well above historical averages.

Moreover, we currently expect 5% to 10% of our 2022 volumes to roll into 2023, given Western rail struggles. And those rollover tons should serve to further boost our 2023 contract position in terms of both volume and price.

Finally, I want to highlight the work we continue to do to ensure that Arch maintains its well established position as an industry leader in the ESG arena. As you know, Arch has set the standard in mine safety among large integrated coal producers for some two decades now. And we continue to view behavior-based safety as the centerpiece of our corporate culture.

That deep and overarching value was evident yet again in April as the state of West Virginia bestowed our metallurgical operations with a total of four Mountaineer Guardian awards for safety excellence. Similarly, the team's tremendous focus on environmental stewardship was also on full display during the quarter as we secured two awards for reclamation excellence. We are tremendously proud of these honors and view them as emblematic of Arch's overall commitment to excellence across the full range of ESG metrics.

With that, I will turn in the call over to Matt for thoughts on our financial performance. Matt?

[Matt Giljum, CFO]

Thanks, John and good morning, everyone. For the second straight quarter, we are reporting record earnings with net income, earnings per share, metallurgical segment margins and EBITDA, all at new highs. In addition, operating cash flows for the quarter were also at record levels and essentially double the fourth quarter level. Getting further into the detail, operating cash flows totaled $293 million, even as inventories grew by nearly $50 million as a result of the poor rail service and as we contributed $20 million into our thermal reclamation fund.

Capital spending was just $22 million in the quarter as Q1 will be our lowest CapEx quarter of the year. This results in discretionary cash flow for the quarter as we've defined it of just over $270 million. As we discussed in last quarter's call, we prioritized debt reduction in Q1, repaying over $280 million of our term loan and other indebtedness over the course of the quarter and decreasing our total debt to $323 million.

Taking into account our cash balance of $319 million, we delivered on our objective of returning the balance sheet to a net debt neutral position. Total liquidity at March 31, was $386 million, including cash on hand and availability under our credit facilities. We continued to view this level of liquidity is appropriate in light of the volatility of our markets and geopolitical and macroeconomic uncertainties.

Next, I'd like to add a bit more detail around our thermal segment reclamation fund. As we previously discussed, we broadened our focus late in 2021 from the accelerated reclamation work at Coal Creek to include pre-funding future reclamation, primarily for Black Thunder. That funding began in the fourth quarter with the contribution of $20 million and we matched that in the first quarter.

In light of our strong thermal cash flows and the continued positive market conditions, we have already contributed an additional $60 million in April bringing the total fund to $100 million. Our plan is for the fund to match the Black Thunder asset retirement obligation liability on our balance sheet. Currently that liability is approximately $130 million and we would expect the fund to reach that level early in the third quarter.

Going forward, we would expect to keep the fund at the level of the ARO increasing with the ongoing accretion of the liability, but offset by reclamation work as completed. In any event, we would expect additional contributions after the third quarter to be no more than $5 million quarterly.

Finally, as a reminder, we expect to draw money from the fund as we complete final reclamation at Black Thunder several years from now. Over the past two quarters, we have meaningfully strengthened our balance sheet and reduced risk, something we view as necessary for long term success in our industry. In the more immediate term, we are now positioned to resume meaningful capital returns with the first variable dividend under our new return program.

The board has approved a second quarter dividend of $8.11 per share, which was determined based on 50% of our first quarter discretionary cash flow. The dividend will be paid on June 15 to stockholders of record on May 31. With regarding the other 50% of the program, we expect that to begin in earnest in the latter half of this quarter, subject to board approval as debt and liability reduction have been our priority thus far.

Turning back to the quarterly financial results, earnings for the quarter included a mark-to-market loss of $15.5 million associated with our coal hedging activities. That loss is related to hedges that we have in place for planned thermal exports over the remainder of 2022 and we expect the mark-to-market losses to reverse as the hedge positions settle.

Our hedging strategy is to lock in attractive prices and margins for a portion of our planned export shipments while continuing to have exposure to the market. It is also important to note in today's volatile markets, that these hedges are not subject to margining requirements and as such the cash flow impact of the hedges will be closely aligned with the actual sales.

Briefly turning to our outlook, although rail service remains a challenge across our business, we expect increased coking coal sales volumes in the second quarter. That improvement along with continued high prices should result in even stronger financial performance and cash generation in the second quarter and the opportunity for significantly increased capital returns.

With that, we are ready to take questions. Operator. I will turn the call back over to you.

[Operator]

[Operator instructions] And we can take our first question now from David Gagliano of BMO Capital Markets. Please go ahead.

[David Gagliano, BMO Capital Markets]

Okay. Thanks for taking my questions, obviously there's quite a bit to dig into here. I guess in a couple clarification questions from my side. First of all the order on the thermal commentary, it was mentioned 3.5 million tons that are going into the export market, I just want to clarify is that included in the 77.9 million committed and the $17.96 per ton price or is that different?

[John Drexler, COO]

David? This is John Drexler. The export opportunity that we have for both our Black Thunder and West Elk operation is significant. So that constitutes the 3.5 million tons. It is all incorporated into the overall guidance of our commitments. Some of that export is not priced. Obviously it's floating with where market indices are and that will provide us an opportunity for very attractive net backs at both of the operations. So I hope that clarifies a little bit of what's included in the guidance.

[David Gagliano, BMO Capital Markets]

Well, it does a little bit, but yeah, that's exactly where I was going with that. I appreciate the color. How much is not included and yeah, I'm trying to figure out that $17.96 price, how much of that volume is included there?

[Matt Giljum, CFO]

So, Dave, what would be included in there would really be what shipped in the first quarter and then a small amount of additional hedge position for the rest of the year. But the lion's share of it is not reflected in that number. So clearly there's some upside to that realization as the year rolls on. If these prices that Paul quoted earlier, stay as strong as they are for both on the Atlantic side, as well as on the Pacific side. Dave in the guidance, the committed and unpriced that 2.5 million tons, that's a good reflection of a lot of that being the export opportunity.

[David Gagliano, BMO Capital Markets]

Okay, understood. Thanks. And then just switching over to the cash cost guidance, obviously for the year it's much lower than Q1, obviously makes sense given volume are increasing. I just have a multipart question on this one. What's a reasonable assumption for 2Q met cash costs and what's the met price assumption for 2022 cash cost guide?

And then lastly, is that relationship that you mentioned earlier, $63 per ton price increase resulted in a $5 cash cost increase, is that a reasonable rule of thumb for overall price sensitivity, to cost changes moving forward? Those are -- those are my cost questions.

[Paul Lang, CEO and President]

Yeah. So, Dave good questions. I'll make sure if anybody, if I don't hit them all, I'll make sure, we come back to them for somebody to step in and make sure we get them all answered. From the cost kind of cadence for the quarters, once again, we're encouraged that we're seeing an improvement in volumes and we've guided up, 50% in volumes from the first quarter, but it's still going to be below what we need on a regular run rate basis.

So, once again, as you look over the course of the year, yes, we do expect a step down in unit costs as reflected in our guidance. But our second quarter volumes are still going to be below where we would ideally like them to be. So maybe that gives you an indication that the expectation would be costs could still be elevated during the second quarter as well.

As far as the increase in the sales sensitive costs, one of the real opportunities that we have is the majority of the mineral reserves that we're mining on in the met segment are owned in fee. So we don't have royalty expenses associated with them. So we've typically guided kind of in a 6% to 8% type royalty, our sales sensitive cost range for our sales in our met segment. And so I think that's kind of reflective of the guidance that we just indicated a $5 per ton sale sensitive cost increase on the $63 increase in realization. So hopefully that makes sense and if I missed any of the questions.

[Deck Slone, SVP of Strategy]

Dave, I'd say it's Deck again, and look, I'd say that that's a complex question as to what is sort of assumed from a pricing perspective, because obviously there's some backwardation in the market, etcetera, but the range we provide does encapsulate a range of different prices as well.

So obviously if the prices stay as strong as they are, you'd expect us to be higher in that range. And now, having said that, clearly it suggests that we could have, much lower cost in the second half then we had in the first, and as John said, we would expect to see some improvement in the second quarter on those coking coal costs, but again, still a high priced environment, and again, still volumes being constrained but in the second half of the year with the volumes that are intimate by the guidance for what we provided for guidance of the 9.4 million tons of the midpoint, that certainly suggests that if we're shipping at 2.8 million tons, 2.9 million tons per quarter in the second half, we should get significant benefit from that higher volume.

[Paul Lang, CEO and President]

Yeah. Dave, the only last piece of color I would add is that when you look at the East or excuse me, look at the West, you remember our sales sensitive runs about 30% or 35%. So when we talk about these higher export prices, that's one of the things that's really pushing the cost up in the West and, I think leads to your question on the impact to some of these higher prices.

[David Gagliano, BMO Capital Markets]

Okay. That's helpful. Thank you very much for that detail. And then just the last one for me for now, just on the capital returns, obviously nice start to the harvest mode and then more to go, just on the other 50%, I believe there was a comment made during the prepared remarks that the other 50% execution on the other 50% would start later in 2Q.

Can you expand on that comment? What is, I think in the past it's mostly been about buybacks or anything else other than buybacks that we should be thinking about now that the debt is reduced, now that the surety bond sinking fund is effectively funded or almost funded? Is there anything else we should be thinking about other than buybacks?

[Matt Giljum, CFO]

Hey, Dave, this is Matt. I guess just the other thing that we've talked about, obviously we do have the convertibles outstanding and whether those are something that the board may choose to want to address, that's an alternative as well. We sort of view that as very akin to a buyback given where the share price is today and the amount of in the money that those bonds are. So that is another alternative that we could do.

And then, we have talked about some level of capital preservation. I don't know that that's the priority at the moment, but clearly, the buybacks and the converts would be the two logical places that we could see the board decide to go.

[David Gagliano, BMO Capital Markets]

Okay. That's helpful. Thanks very much.

[Paul Lang, CEO and President]

Thank you, Dave.

[Operator]

And we can now take our next question from Lucas Pipes of B. Riley Securities. Please go ahead.

[Lucas Pipes, B. Riley FBR]

Thank you very much and good morning, gentlemen. First I wanted to touch on rail logistics in a bit more detail. In the prepared remarks, you mentioned that you anticipate rail improvements as the quarter progresses and what gives you the confidence in that improve movement and to what extent does that rely on Curtis Bay getting back up to full capacity? Thank you very much for your perspective on that.

[Paul Lang, CEO and President]

Hey, Lucas. Great question. Obviously rail performance has been extremely disappointing as we've worked through the quarter and has been our biggest challenge and created a host of issues for us to be working through and dealing with. However, over the course of the quarters we indicated, we have seen improvement month to month January, February, March, we've been working obviously extremely close with the railroads. We've seen improvements for some of the commitments they've indicated would be coming.

We indicated that through the majority of April here month to date, we're at an 80% level. So that just once again continues that improvement. As we listen to their earnings call, this is a major focus for them across their network. It's primarily labor crew driven. It was further impacted very early in the year by COVID, but now what they need is additional crews.

So it appears in the discussions that we're having and in the public remarks they're making, they're very committed to getting that crew situation fixed and so we expect ongoing improvement as we work over the course of the year. We'd like to see that improvement sooner, but obviously any crew that comes on needs to go through an extensive training program brought online.

And so we are shaping our views appropriately as we work through the course of the quarter, but we've got high confidence that the rails will execute. They're incentive to execute with us in this environment, a great opportunity for them to move the coal and so, we expect that to improve as we move forward.

[Paul Lang, CEO and President]

And look as, John pointed out, look, in January, we've got about a third of the trains we needed and in February about 50% and in March around 75%. So around 70% and part of it is just trajectory and clearly we're not expecting them to get all the way back in Q2. So we hope we're being reasonable here in our assumptions, but you're right, we certainly, don't have control over it.

You did ask about Curtis Bay and look, we really view this as more an issue that's just sort of endemic and it's really a real system issue overall. We have not had too much difficulty finding opportunities to get tons into vessels. The issue really has been moving the tons to the port. So really it has been a rail issue. We don't think it's specific to Curtis Bay. Although we welcome the work that's being done there, and we think that will certainly add to overall fluidity on the line, but really it is we believe what John sort of highlighted as sort of overall rail congestion crew issues, etcetera.

[John Drexler, COO]

Yeah. As Curtis Bay continues their repairs, we are shipping through them at a very reduced capacity and we expect to see improvement at Curtis Bay as we move forward. But as Deck indicated, we've got plenty of alternative opportunities for export and so not significantly impacted by that immediate issue.

[Lucas Pipes, B. Riley FBR]

Very helpful, really appreciate all the detail. My second question is first and foremost, a market related question, and I'd like to shift a little bit to the domestic market. We've seen natural gas prices in North America spike as well and what sort of impact have you seen on demand for spot volumes from domestic utilities, what have been the implications for 2023? And I believe in the prepared remarks, it was a comment about a significant amount of rollover into 2023, but I didn't catch all of that if you could maybe elaborate on that as well, I would appreciate it. Thank you very much.

[Paul Lang, CEO and President]

Yeah, Lucas, look in the back half of 2021, the thermal markets strengthened considerably, as we discussed on the last call and as it's carried through in the first quarter, the marketing team did an outstanding job of capturing that opportunity. Markets have continued to stay strong. You look at where natural gas pricing is at. It definitely puts coal in the money.

The team continues to have a lot of discussions with our customers as they're evaluating their needs as they move forward. One of the biggest opportunities that we've been able to realize with the strength in the market is not just getting coal put to bed for '22, but also in future years and as we indicated, we're not providing guidance yet in those future years, but the book of business has built out well.

The pricing once again, in the prepared remarks and we were being specific here, is not to the levels that we're seeing for '22, but well above what the historical averages have been prior to '22 in those outer years. So we feel real good about that.

The logistical issues that we've seen in the East are really across all of the rails, including in the West as well. So we see rail challenges there. We need those rails to perform at a higher rate and so as we look at our book, we're sold actually above the guidance range that we've provided, but our expectation is that we're going to see pushback kind of in that range of 5% to 10% potentially. That pushback will allow us to roll those tons into future years, obviously with the pricing that we have right now on those tons in '22 that's just fine with us if those roll into '23 as well. So hopefully that gives you some additional color on the markets.

[John Drexler, COO]

Yeah, Lucas, I, guess I'll stand back take kind of a higher view of this. And a little bit of this is muted by the rail situation, but, as you stand back and look at the domestic thermal prices, obviously what's driving it's high natural gas prices, the utility inventories are low, but they're not going out for RFP because they don't have rail service.

And frankly there's been a slow response for the producers mostly because that's just due to under investment and we could argue, the transition to renewables and all that but, at the same time, we have higher price export options and, I think these things collectively have kind of changed the macro environment at least for the short term.

[Deck Slone, SVP of Strategy]

Look and it's Deck and just let me a add a final thought here. So, obviously if we do in fact have rail deliverability issues and we lose some of those volumes, they don't get shipped rather in 2022, we're really quite comfortable with that. We got a very significant, book of business and so if we do in fact, see 5% to 10% role in 2023, again, that is -- that's a non-issue for us as we see it. And quite frankly, as you look at where we are, then if the 5% to 10% rollover that John discussed, we're getting close to sort of our budgeted volumes for 2023 and what we anticipated what we previously anticipated, we would produce in 2023.

We don't want to be too granular about that. And we certainly do have the ability to flex up, somewhat from that level, you know, but we are building a very strong book of business and in terms of sort of interest look, it's only Tuesday and we've already committed a meaningful volume did a deal already this week.

So there is good appetite out there. These gas prices are getting the attention of the utilities. While we've seen certainly a lot of closures of coal plants over the years, the remaining fleet is only operating at about 50%. So there is the potential for some of those plants to operate at higher levels and so look, we're very attuned to that. We continue to take advantage of that market and feel really good about where we are.

[Lucas Pipes, B. Riley FBR]

Super helpful. So, if rail were to improve in the West, would you consider raising production volumes?

[Deck Slone, SVP of Strategy]

Well, I, think Lucas, we'd raise them above sort of our, again, we had budgeted a level that we believe would be very profitable for the organization. We generate a lot of cash. Certainly today the level we had sort of targeted probably seems a bit conservative given the level of interest. So again, this is a level that would've been below what we're currently anticipating for 2022, but a level that would deliver good cash flow.

So we'll be very market responsive. We will gear our production levels and our sales to the market. But again, we have a solid foundation. We also continue to see meaningful potential for additional volumes.

[Paul Lang, CEO and President]

Yeah. The only thing I'd add to what Deck said is that we'll be smart about whatever we do, Lucas. We're not going to invest in capital that chases some incremental ton in the thermal side anymore, that's over with.

[Lucas Pipes, B. Riley FBR]

Really appreciate all the color and good work and continued best of luck.

[Paul Lang, CEO and President]

Thanks, Lucas,

[Operator]

We can now take our next question from Nathan Martin of The Benchmark Company. Please go ahead.

[Nathan Martin, The Benchmark Company]

Hey, good morning guys. Congrats for the quarter. Thanks for taking my questions. I would say, probably most of my questions have been addressed, but if I go back real quickly to the 50% discretionary cash flow bucket, I know ultimately it's a board decision. Sounds like maybe we'll hear something late in the second quarter, but, do you guys have a preference kind of between the share buybacks, obviously stock and risk market under pressure here the last few days, or addressing the convertible, as you mentioned earlier too, and what would you estimate the cost is to fully repurchase that convertible and maybe talk about any benefits from that action. Thank you.

[Matt Giljum, CFO]

And Nathan, this is Matt Giljum. I guess first thing I would say, buying back the entire convertibles, not really an option at the moment, the first call date doesn't come into play until 2023, but obviously there are things you can do in a one off manner related to that. I would argue, from our perspective, there's at this stock price and where the converts are in the money today, there's not a significant difference, I don't think as we view it between the buybacks and the convertibles. You do get a little benefit by addressing the convertibles, reducing the debt piece and the interest but, that's fairly marginal with where the rates are on that today.

So I would say for management's perspective, there's not a significant difference between the two and look, if the stock price continues to be under pressure, there may be some benefit to going, to the straight buyback method our approach, because that does give you maybe a little more bang for your buck. But again, there's not really a significant difference in, in the way we're viewing the two of them.

[Deck Slone, SVP of Strategy]

And Nathan, this is Deck. And if you think about where the price is right now, you'd say that with the cap call feature taken into consideration, it's about 75% of any dollar would be going towards avoiding future dilution and about 25% would be towards debt reduction. So really heavily weighted towards the equity side of things and as Matt said, very much similar to simply buying back the shares with that small incremental piece being associated with reducing debt.

[Nathan Martin, The Benchmark Company]

Got it. Makes sense. Thanks Matt. Thanks Deck. And then maybe just kind of a modeling question, I think Matt, you mentioned 1Q CapEx was going to be the low for the year. Any comments on kind of cadence throughout the year, just as we look at trying to calculate discretionary cash flow and with the potential 50% variable dividend could look like in the coming quarters.

[Matt Giljum, CFO]

Yeah, Nate, I don't believe that there's going to be a lot of variability over the remaining quarters. I think it should be fairly ratable the rest of the way. So, in terms of a modeling, that's probably the easiest way to look at it.

[Nathan Martin, The Benchmark Company]

Got it. And then maybe kind of shifting to the macro obviously you guys mentioned, what's going on in Eastern Europe, between Russia and Ukraine. Just curious how, maybe that's affected your business? Do you guys ship any coal to that area and then maybe it would be great to get your thoughts on how COVID lockdowns in China might be affecting things and how you see that play out? Thanks.

[Deck Slone, SVP of Strategy]

Yeah Nathan, it's Deck, and I'll start with that and certainly, we're seeing disruptions associated with the hostilities in Europe without a doubt. There are a lot of quite frankly, if you look on the coking coal side of things and really, we view that as kind of the heart of the matter and the biggest driver behind the is elevated coking coal prices is just supply pressures and supply constraints. And, this isn't a new story. It's a story that's been underway and ongoing for many years now. It's just a function of under investment largely, but that also means then there's just no resiliency in the logistics chain of the operations change.

So when you do see these sorts of disruptions; it exacerbates the situation pretty profoundly. The biggest thing is that look, Russia supplies about 15% of global coking coal supply and right now there's a big question market as to how many of those tons are actually going to make it into the seaboard market this year.

Now you've got a whole lot of issues around that and around that question, you've got the challenge of just getting ships to load in Russia right now, you've got the challenges around financial transactions, you've got rail infrastructure issues and congestion moving those additional tons to the east since a lot of the European tons, the 10 million tons or so that Russia ships to Europe likely aren't going to be going to the West. They're going to be heading East.

So lots of challenges there and lots of question marks, but in the end, the 50 million tons or so that Russia sends into the seaboard marketplace is probably not going to be 50 million tons. Its probably going to be something less and again, that's going to just put additional supply pressures and when you add that to the fact that look Australia year to date is once again down after peaking in terms of exports at roughly 190 million tons in 2016, falling to 172 million tons of exports in 2020, a 168 million tons in 2021. They're down again and Russia is more than 50% of supply. The US and Canada look flat and really have lagged and are well below pre-pandemic levels. All of that means that, it doesn't take a lot of change associated with the hostilities in Ukraine to translate into meaningful pressure. So I'll start there and see if others want to jump.

[Paul Lang, CEO and President]

Yeah. Just, a little more color and it's hard to talk about this, just outta the absolute tragedy that's going on in Ukraine right now, but we historically had shipped to some of the plants in Eastern Ukraine that unfortunately were damaged three, four years ago and the first Russian incursion ended the Ukraine. So we haven't shipped there. I don't think since 2018 or '19.

The other interesting data point, I think I put out there is we have had interest for a European utility on term business, out of the Gulf that we have not seen in frankly, I don't know that I've ever seen anybody wanting multiyear contract, but I think it's indicative of what's going on and frankly, they're looking for sure is supply and diversity and supply,

[Nathan Martin, The Benchmark Company]

Very helpful color guys. I appreciate that. And then maybe Paul, I have you just love to get your thoughts, maybe high level in the space. We've talked about lack of investment in coal the last few years. Maybe there's a depressed pipeline projects out there. Any thoughts there, or even on the front of M&A and further need for a consolidation, are you guys, finding that you're hearing more discussion on this today? Thanks.

[Paul Lang, CEO and President]

Yeah, Nate, I think the basic answer is the same. I think we can all agree consolidation that lowers costs overall makes sense, but those are extraordinarily difficult deals to put together and, frankly we'll kick every tire and we'll look at everything, but I just don't know how some of these deals get put together with any ease and I don't think there's any appetite for anybody borrowing any money and there shouldn't be.

This business I think, is going to have to go forward running on a cash basis, but look the general concepts spot, there's no question the underinvestment is starting to manifest itself and we're seeing it on the coking coal side, but I also think you're seeing it on the thermal side. There's a lot of minds that are getting along in the tooth and the ability to respond is just not what it used to be and I think as I stated earlier, as I look at the domestic thermal prices, there's an aspect of that in there that, we just haven't seen the reinvestment particularly out West. So Nate, I'm not sure that completely captured it or if anybody else has anything to add to that.

[Nathan Martin, The Benchmark Company]

No, Paul, that was still helpful. I appreciate that as always. I'll leave it there and thank you guys for the time.

[Paul Lang, CEO and President]

All right. Thank you, Nate.

[Operator]

We can now take our next question from Michael Dudas of Vertical Research. Please. Go ahead.

[Michael Dudas, Vertical Research Partners]

So you have -- was interesting, the Europeans wanting term business out of the Gulf. That's -- it's pretty crazy. How does that, so maybe towards the coking coal side and giving the tightness and the scarcity that appears to be being priced in the market are you getting different customers reaching out? Are you in share you trying to help the ones you already have. When we think about marketing your coal to the export market, which I assume is going to be, continue to be a vast majority of what you book over the next several years.

Is it different regions is because of what's going on in India? Is that something that's more thoughtful relative to other areas just want to get a sense of where that's driven and what's sustainability on those customers given that I'm sure when we ever -- got a correction, it could be shake some things out in the market.

[Paul Lang, CEO and President]

Yeah Michael good question and I I'll start here. I'm sure others will follow in. Going back in history a little bit here, we have with the addition of Leer South, we're growing our opportunity from essentially 7 million tons to 10 million tons on an annual basis, as we normalize run rates etcetera.

So traditionally, if you looked historically at where we were shipping a lot of our exports, predominantly a lot of those exports were going into Europe. However, with Leer South coming online, we've been very focused on the developing opportunity that's occurring in Asia and so that's been a primary focus for us. That's where we've seen most of our export growth as we move, forward and where we would expect that to continue.

From the perspective of the development of customers, we've got a very unique product in the high vole [ph]. We've worked really hard in the Asian markets to help those customers understand the qualities of that coal. It's been well received and so, we think we're building durability and sustainability into those markets and those customers as we move forward.

So, we're always going to look to optimize the portfolio of our high quality coal between the North American markets between the European markets, the Asian markets, the South American markets but, we've seen a significant increase in the Asian markets. As we sit here today and look forward, at least for '22 of the exports that we have ultimately, we may see kind of a 50-50 split between the European South American markets and then the Asian markets.

[Paul Lang, CEO and President]

And Michael it's Paul. So, Michael, as John said, we've already penetrated, really most of the major markets that there are several large international steel producers who've signaled that they don't plan to take Russian material, but we already have strong relationship with those who've signaled that. So again, we already have a pretty strong platform there.

We'll say that we recently shipped coal for the first time into Vietnam. So, we are finding those opportunities in Southeast Asia. Certainly India continues to be a target, and we've been expanding our presence there and then we've referenced this several times before, but the fact is that, we did have a successful term contract in China that really has gone very well and we'll see if that becomes a more durable part of the order book.

So again, we continue to evaluate all these opportunities. We do believe Asia, is going to be the center of growth on the integrated steel side. So, we expect to be competitive there. We've been building those relationships with the expectation and now the realization of Leer South coming online. So Asia will become a bigger part of the business and as you can see, we are in fact expanding out those relationships.

[John Drexler, COO]

Yeah. The only other thing I'd add Michael is, and it's more a philosophical approach to the way we've marketed our coal is look, we focused on major steel producers globally. We have avoided the broker business and kind of the selling of disparate blends. That works for others. But, we have preferred to set up relationships with major steel producers globally.

Having said that, when people approach us now about coal, our first preference will be to take care of the customers that have been loyal to us and we'll continue to do that. And if we can we'll others, but first and foremost, our business model says stick with the people that you've been working with.

[Michael Dudas, Vertical Research Partners]

That makes a lot of sense. I appreciate that -- those thoughts, and just quick follow up, turning to your, on the thermal side, despite your term gas and shortage of higher prices and inventories being low, are thermal customers or the utilities changing the way they're thinking about going forward over in the next several years? Are they still, are you read about, utilities, accelerating coal plant closures, but is there any thoughts of slowing that down in some case, or in a sense, maybe utilizing up picking that 50% utilization that you cited deck to generate the electricity required, given where gas and the inability of renewables be?

[Paul Lang, CEO and President]

Michael, I'll start. I'm sure others will have thoughts as well, but, from a long term perspective, the ultimate outcome here is likely the same, where we're going to see continued closures domestically of coal fire generation. I think with what's happened here in the last year in, you have seen publicly some discussion and announcements of delaying closures, postponing closures. We've seen that anecdotally play itself out over our discussions with the utilities,.

However, and we indicated this. We knew there might be pockets of opportunity here and that we wanted to be in a position to be responsive to that. So those opportunities have presented themselves. We've gotten into books of business here and extended our portfolio of sales into future years at attractive prices. So we'll take advantage of that.

But at the end of the day, what's important for us is to operate responsively. That's why it's important that we're setting aside money into the reclamation fund and diffusing any obligation that we have well into the future. But in the meantime, we'll take advantage of what this market is offering.

[John Drexler, COO]

And Michael, we started, 2011, so we started the last decade with about 315 gigawatt of installed capacity, power generation capacity, coal based power generation capacity in the US. At the end of this year, we're still going to have about 200 gigawatts still installed and a lot of the closures that occurred early on were, older plants. Now, clearly, we are going to continue to see this window down, and yes, they're going to continue to be closures and we expect, that to roll on through the next five years, but there is still meaningful installed capacity.

The lack of investment even in the remaining fleet is starting to take a toll as well. So, the capacity factors that can be achieved probably aren't what they once were. But, as indicated, we do believe the fleet can run at higher levels. We do believe we're positioned to take advantage but as John said, I think, in the end result, we do believe that, you're going to see the end result's going to be the same.

I would say in terms of how utilities are buying, it does feel like it's changed to us over the last year or so and some of this with the higher gas prices. I think we've gotten to point where, utilities were probably buying 35% or so, or even more of their, the volumes they needed for a given year intra year, within that year.

Suddenly we're seeing much more interest in longer term contracts and we've even signed some sort of five-year deals here. And so, we are getting some link and I think that is a function of uncertainty around natural gas, concerns about not having availability, the underinvestment in thermal supply as well that Paul referenced. So we are seeing a change there and seeing what appears to be some rethinking of how utilities go to market.

[Michael Dudas, Vertical Research Partners]

Encouraging. Thanks gentlemen.

[John Drexler, COO]

Thank you, Michael,

[Operator]

And we can now take our final question from David Gagliano of BMO Capital Markets. Please go ahead.

[David Gagliano, BMO Capital Markets]

All right. Great. Thanks for taking my follow-up. It's actually related to what you were just talking about actually. It sounds like the utilities rethinking strategy potentially over time. What about Arch? The strategy I thought not too long ago was, is basically wind down the thermal business, cut the footprint by almost 50% over three years. Now, I realize that's been pushed out, but what is the strategy now for the thermal business within Arch?

[Paul Lang, CEO and President]

David it's unchanged? You stand back and look, the current events have maybe changed the glide path of the decline, but we all, I think know where this end and what we're tasked with, I think is figuring out how to take what's going on and the global thermal markets and figuring out how to play them best here at home and, I think we'll continue to generate cash out of these assets, but we're simply not going to put any more cash into them.

We'll do what we have to, to feed them and keep them going, but any thought of increasing production, beyond what we have the ability to do with the equipment on hand is completely out the door. I just, I can't see it. It's not what our shareholders want, and I don't think it's a good investment for us.

Frankly, there's just better options out there, but at the same time, with the setup of this thermal reclamation fund, you think about it, we can run this as long as it's profitable and as long as it makes sense, but the second it stops, I have no hesitation in doing, we have to do ultimately, which is close these operations.

[David Gagliano, BMO Capital Markets]

Okay, that's helpful. And then you mentioned something there, not increasing production beyond what the equipment is capable of doing and obviously volumes are roughly 17% this year. The target is up 17% year over year. 2023, what's the equipment capable of doing? Are we looking at more incremental volume growth in 2023 and if so, how much?

[Matt Giljum, CFO]

David, we're reaching max capacity of what the operation's capable of with the fleet of equipment that we have. And so there's not an ability to increase production from where we're at today's loans.

[John Drexler, COO]

I think we do think in 2023, it's potentially replicable to do what we're doing this year in 2023, but again, the constraint will be, we're going to do it only with the same kind of subsistence level sort of capital spending that we've been doing. We're certainly not going, as all said, we're not going to chase the market, but we are going to try to ring out all the value we can. And really the harvest strategy was always about that, which was about expending, just the maintenance capital only and taking the cash that we could continue -- that we could recover, recovering as much of the remaining value as possible.

And quite frankly, when you look at the reserve base, they'll come a time when we've mined out the reserves as well. We still have more than 500 million tons, but that we don't plan to invest further. So I think that continues as Paul said, there's real clarity here in terms of where we're going with this thermal strategy. But ultimately, we are going to continue to try to take advantage and be opportunistic with changes in the marketplace that occur between, the lip and the cop.

[Matt Giljum, CFO]

Dave, the last thing I'd say and it's the comments I made, I think a year ago that is look as we narrow the liabilities down by doing reclamation and building the sinking fund, but there is an opportunity or an increasing opportunity to sell these assets. I don't -- I think I was hesitant to say it was a very strong chance a year ago, but look, that opportunity still exists. We've had a lot of interest, but frankly we've drawn the line first. We got to get the full value that we think are left in the assets. And second, it has to be a clean sale. We're not going to do something that can haunt us five, 10 years down the road.

[Matt Giljum, CFO]

All right. That's very helpful. I appreciate the additional color. Thanks.

[Operator]

We have no further question. This now concludes our Q&A session. I would like to hand the call back to Paul Lang for closing remarks.

[Paul Lang, CEO and President]

I'd like to thank you again for your interest in Arch. Today's announcement of the first substantial dividend under our new capital return model represents a milestone in the evolution of Arch's value proposition and reflects the board's vision for creating value for our shareholders.

While commodity markets are inherently volatile, we believe the fundamentals for coking coal are well supported, which should set the stage for further meaningful capital returns as the year progresses. As I noted earlier, Arch's story is by design an increasingly simple one. We've completed the hard work and taken the necessary steps to build a world-class coking coal portfolio with a very compelling cash generating potential. Having done so, we believe we're well positioned to capitalize in the current more market in a way that benefits our shareholders.

With that operator, we'll conclude the call and we look forward to reporting to the group of July. Stay safe and healthy everyone.

[Operator]

This concludes today's call. Thank you for your participation. You may now disconnect.