Arch Resources Inc

NYSE:ARCH

Earnings Call Transcript 2020-Q2

[Operator]

Good day. And welcome to the Arch Resources Incorporated Second Quarter 2020 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. Please go ahead.

[Deck Slone, Senior Vice President, Strategy]

Good morning from St. Louis and thanks for joining us today. As an April the team is conducting this call from Arch’s boardroom, but we want to assure you that we are widely spaced here and following CDC guidelines.

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.

With me on today’s call, we have Paul Lang, our CEO and President; John Drexler, our COO; and Matt Giljum, our CFO. We will begin with some prepared remarks and following those remarks, we’ll be happy to take your questions.

With that, I’ll turn the call over to Paul.

[Paul Lang, President and CEO]

Thanks, Deck, and good morning, everyone. I hope you and your families are staying safe and I appreciate you taking time to join us on the call this morning. Let me begin by extending my gratitude to the entire Arch team for their tremendous contributions during this unique time, a time when many of us are finding it challenging to balance the dynamic, personal and professional obligations.

On the professional front, the Arch workforce has adjusted quickly to the new reality in an impressive fashion. Throughout the organization, employees have embraced rigorous new protocols that they and we believe can help safeguard the health of our communities, our colleagues and ourselves.

More notable still, our people are adopting these new routines, while advancing key strategic objectives and executing their daily tasks in the same exemplary fashion as always. On behalf of the entire senior management team, I want to thank the arch employees for their efforts on this front, as well as for their resilience, their professionalism and their dedication.

I’m pleased to report that these qualities are on display over the last three months. During the second quarter, our coking coal franchise continued its strong operational momentum, delivering another first quartile cost performance, despite lower than anticipated volume levels, stemming from customer deferrals. We racked up another quarter of excellent progress at Leer South, where we’re laying the foundation for future value creation and growth.

We significantly enhanced our financial position through a $53 billion tax exempt bond offering that we completed on July 2nd, thus enhancing our liquidity and helping with our continuing progress at Leer South.

We moved quickly and aggressively to address the highly challenging market environment for thermal coal by adjusting our cost structure to match lower expected volume levels. Included in this, we conducted voluntary separation and furlough programs at each of our thermal operations that were in addition to the program we offered in the corporate office in the first quarter. We took steps to further preserve liquidity by trimming another $10 million from our capital budget, bringing the total reduction to $30 billion as compared to where we started the year with.

And finally, we completed the name change of the company to Arch Resources. This is yet another example on how we have deliberately and systematically built out our metallurgical franchise over the last 10 years and have crystallized our path forward. Along with this, we launched a new website that provides a robust accounting of our significant achievements and ongoing efforts in the areas of safety, environmental, social and governance.

In short, we stayed focused and advanced many of our strategic objectives, despite the highly challenging macro environments. With this, we believe we positioned the company for an improved performance in the second half of the year. We’re expecting higher volumes and continued strong costs performance from our core coking coal franchise and a cost structure at the thermal mines that is better aligned with volume expectations.

Turning now to the coking coal markets, we’ve been encouraged to see some early steps towards recovery in recent weeks. Although, we’re almost certainly several quarters removed from anything resembling normalcy.

At the macro level, we’re pleased to note that manufacturing activity appears to be on the upswing around the globe, with the U.S., China and Brazil, all reporting June manufacturing PMI indicating some level of expansion.

As for the steel complex, while steel prices remain severely depressed, steel producers are moving forward with the restart of some of their idle capacity. In North America alone, there have been three blast furnace restarts announced in recent weeks.

Moreover, the average capacity factor at North American mills has inched up steadily since early June and now stands at 59%, 8 percentage points above the recent bottom. The resumption of manufacturing activity by the automotive sector is a critical developments as well, particularly for blast furnaces, which provide a majority of the high quality steel required by the automotive sector.

China, which is the source of more than 50% of global steel supply is arguably furthest along in the recovery process. In fact, the world steel association is projecting that China will experience a modest year-over-year increase in steel output in 2020, which is encouraging.

While the coking coal markets remain very much in a trough, there are some positive signs. Chinese seaborne imports are up strongly year-to-date. North American buyers have just issued RFPs on their usual timeline and sales inquiries are on the rise.

On a less positive note, coking coal prices remain at levels we view is unsustainable, even after a modest bounce in recent days. Premium High-Vol A coal our primary product is currently being assessed at $109 per metric ton, which is a $65 metric ton lower than the average in 2019.

On the supply side, production is coming offline fairly quickly. Although, we believe more cuts will be required to balance the market. Many of these cuts will likely come from the higher cost producers in North America, which represents the high end of the global cost curve.

We believe that more than half of the U.S. output is cash negative at the current coking coal prices and at least one analyst has suggested that half of all global coking coal production may fit that same description.

In addition, we’re seeing supply cuts in every other producing country, including the largest supply source, Australia, where weak prices, high profile operational outages and limited capital spending in recent years is constraining outputs.

Moving to the legacy thermal business, the market environment remains intensely challenging. Arch expects U.S. thermal demand declined by 130 million tons in 2020, following the nearly 100 million ton decline in 2019. Making the situation still more challenging, stockpiles at U.S. power plants are at an all time high based on days of supply.

Along with this, anemic international pricing is preventing most of U.S. thermal producers from participating in the seaborne market in a meaningful way. As I noted, Arch has taken aggressive actions across the organization to drive down costs and compete in this new market reality.

Looking ahead, we believe we have the right mix of attributes to weather attractive period of market weakness, including low cost coking coal assets, a skilled workforce, high quality products, a solid book of metallurgical business and a proven track record of operational execution. Moreover, we believe these same attributes will put us in a strong position to capitalize as the global economy recovers and as the world returns to an expansion mode.

Last Friday, testimony concluded in the preliminary injunction hearing with the Federal Trade Commission in St. Louis related to the FTC’s attempt to block our proposed joint venture with Peabody Energy.

I want to thank the customers, the employees and the team of people that have supported us through the process. Closing arguments are scheduled to take place on August 10th and we hope to have a decision from the court by the end of the quarter.

I remain confident in the ability of the joint venture to deliver significant cost savings and to position the JV to better compete with natural gas and subsidized renewables. This would benefit all of the stakeholders, including our customers and employees. Given the ongoing litigation, we’ll be unable to answer any questions regarding the matter.

Moving forward, we have plan to maintain our sharp focus on driving operational excellence across our portfolio, protecting our solid financial footing and forging ahead with the Leer South development, which we believe will greatly enhance our already strong cash generating capabilities down the road.

With that, I’ll turn the call over to John Drexler for further thoughts on our operational performance and outlook. John?

[John Drexler, Chief Operating Officer]

Thanks, Paul, and good morning, everyone. Let me begin by echoing Paul’s comments about the Arch team’s exceptional performance during the current global health crisis. Arch employees have embraced the challenge of the pandemic head on and are doing an outstanding job of taking extensive health related precautions while still executing their usual duties at the highest level.

We appreciate their ongoing efforts to ensure a healthy workplace for their colleagues and themselves, and we applaud their continued sharp focus on every other critical area of performance, including mine safety, environmental stewardship and operational execution.

Moving forward, we plan to continue to respond quickly and aggressively to new developments on the virus front and to implement enhancements to our already rigorous distancing and hygiene related protocols at every turn.

While we have worked hard to minimize the impact of our COVID-19 protocols on our results, we have incurred additional operating costs related to the virus. We estimate that the new protocols have reduced productivity and increased spending on health and safety related products by a total of $5 million in our metallurgical segment and by $1 million in our thermal operations. We expect these costs to moderate moving forward, as we become more efficient at managing these change protocols.

Turning now to the operations. I am pleased to report that we are maintaining our strong operational momentum at our core coking coal franchise. Of particular note, we achieved per ton cost of $61.95 during the quarter, despite lower than expected sales volumes resulting from more than 300,000 tons of customer deferrals during the quarter. If not for the impact of direct COVID-19 costs impacting our quarter, our per ton costs would have been approx -- would have approximated $58.50 per ton.

Our flagship Leer mine again set the pace with costs in the low 40s per ton, further underscoring why we are so focused on getting its companion operation Leer South up and running as soon as possible.

On the Leer South front, we continue to make excellent progress and remain on time and on budget. During the second quarter, we expended $46 million in capital at Leer South, bringing the total investment on the project to-date to $211 million.

Looked at another way, we have now expended 56% of the total projected capital needed to complete the project at the midpoint of the guidance. That’s an exciting milestone to reach, one that keeps us well on course to commence longwall production in the third quarter of 2021.

Let me add here that we view our ability to drive forward with this transformational project even in the current market environment and as a key differentiator for Arch. We also believe that pushing forward now, when the market is in the trough, could well mean that we are ramping up our initial longwall output into a strengthening market environment, thus positioning us to capitalize to an even greater degree on the market turn when it comes.

Before turning to thermal markets, let me comment briefly on our Beckley Low-Vol and Mountain Laurel High-Vol B operations. Beckley remains cash positive in this market environment and is providing a small but meaningful contribution to cash generation. Mountain Laurel continues to move in the right direction and we will progress into reserves we own in fee [ph] during the fourth quarter, which should lead to further improvements in its cost structure.

We view both of these mines as important components of our portfolio, components that are cost competitive and normalize markets, and that round out our coking coal products light. At the same time, we have flexibility to adjust volumes at these operations as necessary and appropriate in ways that aligns with changing market conditions.

Let’s turn now to our expectations for the metallurgical segment in the years back half. Well, forecasting is quite obviously a tricky business in this environment, we nevertheless anticipate a solid shipping schedule for Q3 and Q4.

As indicated, our customers requested deferrals on more than 500,000 tons of expected 2020 shipments. However, I’m pleased to say that we were successful in layering in approximately 500,000 tons of incremental 2020 commitments during the quarter, which I consider to be a significant accomplishment. As well as a testament to our sought-after product qualities, carefully cultivated customer relationships and excellent reputation for logistical support and customer service.

We also continue to be encouraged by increasing inbound inquiries regarding volumes in the back half of the year, as well as ongoing requests to accelerate volumes from the fourth quarter to the third quarter.

As we currently see the book, we are expecting increased metallurgical shipments in the back half of the year. From our committed position alone, a position we continue to gain more confidence in, we would ship 3.1 million tons of met coal in the back half of the year versus the 2.8 million tons that were shipped in the first half. We would be hopeful to see improvement on that level from the inquiries we continue to feel.

While we remain extremely cautious and at the ready to respond to all market developments, we believe we are seeing some signs of improvement in the metallurgical markets and are positioned to capitalize on such strengthening moving forward.

I would also note that the North American RFP processes is shifting into full gear at present. As always, we are engaging in that process in a careful and strategic manner as we seek to determine how best to direct our 2021 volumes in order to optimize value for our shareholders.

Turning now to our legacy thermal segments. The second quarter was tough clearly as volumes declined significantly in the face of historically weak natural gas prices and substantially reduced power demand. The upshot was negative cash margins in both the Powder River Basin and other thermal segments.

As discussed, however, we mobilize quickly to adjust to the new reality, overhauling our cost structure to align with the lower volume levels. As Paul indicated, we conducted voluntary separation plans at all of our thermal operations that eliminated approximately 200 positions.

All told, Arch has now reduced its combined corporate and thermal workforce by approximately 516 positions or roughly 25% over the course of the past 12 months and we are prepared to continue to make whatever adjustments are needed going forward to compete. The significantly reduced headcount has allowed us to reorient our thermal operations, including idling certain equipment fleets to better align our production with sales.

As a result of our recent moves, we expect an improved performance in the year second half across a range of volume scenarios. And while those volume levels are hard to predict, I will say that we are currently -- I will say that we currently have second half commitments of 33 million tons in our PRB segment, that even with the risk of modest pushback, should translate into actual shipments significantly in excess of the 25 million tons we shipped in the first half of the year.

Before closing, let me reiterate that our extensive efforts to manage health risks stemming from the virus have not dimmed our focus on mine safety and environmental stewardship in any way. In particular, I want to highlight the exceptional environmental performance across our entire portfolio during the year’s first half.

At the midway point, in the year, our subsidiary operations had not recorded a single smack or violation and they had in aggregate precisely one water quality exceedance over more than approximately 100,000 parameters tested.

We are immensely proud of our leadership in these critical areas of performance and are committed to driving further progress through a highly disciplined approach to continuous improvement.

With that, I will now turn the call over to Matt Giljum for some additional comments on our financial performance. Matt?

[Matt Giljum, Chief Financial Officer]

Thanks, John. Good morning, everyone. I’ll begin my remarks with a brief discussion of the second quarter results, which as John discussed, were significantly impacted by the reduced shipment volumes across the business. The shortfall in volumes was the primary driver of lower margins in our metallurgical segment and cash losses in the thermal segments.

Additionally, although not impacting EBITDA, the quarter included charges of more than $7 million related to the voluntary separation plans with the thermal operations and $8 million of costs related to the proposed joint venture.

From a cash flow perspective, we were able to offset the operating losses, realizing over $66 million of benefits from tax refunds, insurance recoveries, deferred payroll taxes and receipts from the previously disclosed federal land settlement. As a result, we were able to continue with the Leer South development, while maintaining cash and liquidity largely in line with the levels at March 31st.

At quarter end, we had cash of $217 million and liquidity of $303 million. Shortly after quarter end, we put in place another source of funding for Leer South, with a $53 million tax exempt bond offering.

Working with the West Virginia Economic Development Authority, we were able to qualify certain of the mine development expenditures to be financed in this manner and executed on a very successful offering.

We receive proceeds of approximately $30 million at closing and we’ll receive the remaining funds over time as the qualifying expenditures are made, with approximately $15 million expected over the remainder of 2020. We want to thank the EDA and Governor Justice for facilitating the transaction and supporting the Leer South project.

Combined with our first quarter equipment financing, we have now raised over $100 million of capital to-date in 2020, at an average rate below 6%. We believe that our ability to access capital at very competitive rates has been a significant advantage for Arch and a testament to the quality of our operations and our solid balance sheet.

As we look at the remainder of 2020, we currently expect improvement from first half levels in both earnings and cash flows. Our operating results should benefit from higher volumes in the metallurgical segment, improve financial performance in the thermal segments and lower SG&A costs.

With respect to cash flows, in addition to the proceeds from the tax exempt bonds, we expect an additional benefit of $30 million to $35 million from payroll tax deferrals and receipts from the federal land settlement, as well as an improvement in working capital as we sell inventory that built up over the first half of the year. These improvements are expected to be sufficient to allow us to continue the Leer South development while maintaining adequate cash and liquids -- liquidity. With that said, given the ongoing uncertainties in the macro environment, we think it is prudent to continue to evaluate alternatives for additional financing.

Before taking questions, I’d like to briefly recap the first half of 2020. It is no secret that industry conditions were challenging and Arch’s cash and short-term investments before the impact of any financing declined by more than $120 million over the course of the period.

However, to put that amount in perspective, that is less than the total of the investments made in Leer South, the costs related to the proposed joint venture and the various severance programs that we undertook.

In other words, absent these strategic investments in non-recurring items, we would have increased cash through the period, due in large part to the positive cash margins earned in our metallurgical segment margins that will only be further enhanced when Leer South starts up.

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

[Operator]

Thank you. [Operator Instructions] Our first question will come from Scott Schier with Clarksons.

[Scott Schier, Clarksons]

Good morning, everyone.

[Paul Lang, President and CEO]

Good morning, Scott.

[Scott Schier, Clarksons]

Good morning, everyone. If I could start on the lower CapEx guidance, could you walk us through where those savings are mainly coming from, is it more timing on Leer South expenditures or seeing cuts on sustaining CapEx?

[John Drexler, Chief Operating Officer]

Hey, Scott. This is John Drexler. As we discussed in the guidance, we reduced our CapEx by $10 million from the previous quarter that was in addition to the $20 million that we achieved in the first quarter.

So, we’ve taken our CapEx guidance on the maintenance side really from $90 million down to $60 million. And we look at these lower volume expectations, we look at how we’re utilizing our equipment fleet across the Board and while there may be some element of deferral of some of that CapEx we think a lot of what we’ve been able to remove, is essentially pushed out for a very long period of time once again, just given our revised volume expectations.

I’ll provide some further color on that maintenance CapEx, where we sit here right now with the $60 million of maintenance CapEx, 80% of that really is directed at the met portfolio, 20% is directed at the thermal portfolio.

So, as we’ve moved forward, the focus has continued to be on the met operations. As we’ve indicated in our prepared remarks and in the release, we’ve taken significant steps across the thermal portfolio and that’s where I think we’ve seen a lot of the benefit in the reduction in the CapEx.

From the Leer South perspective, clearly, we’re moving ahead. We think it’s an excellent opportunity. And so we continue to move forward the CapEx with that operation, which since the beginning of the year, we’ve identified about $220 million to be spent over the course of 2020 at Leer South.

[Scott Schier, Clarksons]

Okay. That’s very helpful. I appreciate that color. Switching gears a little bit to the 300,000 tons of deferrals that you mentioned that you experienced in the second quarter. Could you provide a little bit more color around this, specifically, I guess, where the deferrals came from, more so domestic or seaborne markets? And are you beginning to see some of the demands come back and what are your expectations around any potential deferrals in the third quarter, is that kind of all behind us?

[John Drexler, Chief Operating Officer]

Yeah. So, Scott, I think, clearly, we’re coming through a period of tremendous volatility and the markets responding to what’s happening around the world with the global pandemic. And as we indicated on the first quarter call and then playing itself out over the course of the quarter, we knew we would see some pressure and we have.

We engaged where we needed to with our customers in any requests for deferrals. I think we’ve indicated in total over the course of 2020, we’ve seen deferrals to the tune of about 500,000 tons. While I won’t get into the details, it does include both domestic and international deferrals.

One thing, I think, we indicated on the first quarter call, I want to reiterate here as well, these are for contracted volumes. And so we fully expect that we’re going to realize over time the full value of these requests for deferrals. We’re going to work with our customers in a way. Hopefully that creates a win-win situation for both us and the customer, and we think we’ve been able to accomplish that with these deferrals.

In relation to the markets themselves, one of the things I’m most proud of is, over the course of the quarter despite the deferrals that came, and I’ll say, that most of those came earlier in the quarter, what we saw play out especially later in the quarter has a lot of inquiries.

As we indicated, we saw requests for acceleration of shipments from the fourth quarter into the third quarter. But probably more importantly, we actually saw inquiries for new volumes. And so we were able to place 500,000 tons of new commitments that essentially offset the referrals that we saw during the quarter and we continue to be encouraged by what we see in the marketplace.

We don’t like the pricing that’s out there, but we are getting a lot of inquiries and we think that’s going to give us confidence as we move forward. We also think it’s a testament to customer’s view of Arch’s is our ability to produce in very challenged markets and our ability to deliver a quality product on time and when requested. So, we’re encouraged with what we see.

[Paul Lang, President and CEO]

Scott, I think, John did a great job of summarizing, I just kind of stand back and look at a little broader. Look, I think, the deferrals in Q2 were not entirely surprising, maybe a little bit more than what we thought.

But at the same time, I think, we’re taking a lot of comfort in the inquiries that we’re hearing now, as well as these new commitments. I think our customers are really trying to rebalance what they’re taking and try and get a grip of their own market. And look, I think, it’s way too soon to call this the bottom, but it clearly has been some good sides.

[Scott Schier, Clarksons]

Okay. Thank you. That’s all great commentary. I think that’ll do it for me. Thanks for taking my questions and best of luck going forward.

[Paul Lang, President and CEO]

Thank you, Scott.

[John Drexler, Chief Operating Officer]

Thanks, Scott.

[Operator]

Thank you. Our next question will come from David Gagliano with BMO Capital Markets.

[David Gagliano, BMO Capital Markets]

Hi.

[Paul Lang, President and CEO]

Good morning, David.

[David Gagliano, BMO Capital Markets]

Hi. Thanks for taking my questions. I just have a couple of quick ones. First of all, on the unit cost of the met side closer to $62 ton this quarter. Obviously, the volumes impacting, I’m guessing, the cost, but any reason to expect those cost not to be below $60 as we go into the second half?

[Matt Giljum, Chief Financial Officer]

So, David, that’s a good question. I think we’ve been encouraged despite the challenges on the volume side of how our operations have been able to respond to manage and control costs. We’re proud of the results that we delivered during the quarter.

We also noted in the prepared remarks that we did have about $5 million of COVID-related cost impacts from productivity and just pure dollar outlays for things such as cleaning supplies, having to maintain guard checks with temperature controls and all the other things that we’re doing across our operations.

As we indicated, from a committed volume perspective in the back half of the year, we do expect improved shipment levels in the back half. And I think that with moderating COVID costs as we move forward and kind of getting more into a rhythm of managing with the kind of COVID environment around us, we would think we would be able to maintain costs going forward.

Can I predict that will be below $60 a ton, there’s a lot of play there. But I think, we indicated on the last call that kind of wherever the volume is going to come in at, we should be able to keep within kind of the range that we put out there at the beginning of the year and that was anticipating higher volume. So there’ll be a lot -- that continues to play out in the back half of the year. But rest assured, we think we’re going to continue to have a very good cost structure that we’re going to report quarter-to-quarter.

[David Gagliano, BMO Capital Markets]

Okay. That’s helpful. Thanks. And then just slightly longer term, obviously, Leer South is the key project, and I think, it’s $211 million of the total $360 million to $390 million since spent. Can you just walk us through some of the next big expenditures, the timing and also from an execution perspective, what are the main, I guess, risks associated with Leer South at this stage in terms of getting to where you want to be by 3Q ‘21? Thanks.

[John Drexler, Chief Operating Officer]

Yeah. So, Dave, I think, we remain incredibly encouraged with what we see with the Leer South development. It’s on time, it’s on budget. I was there a few weeks ago and continued to be impressed with the ongoing development there.

Many of the major milestones related to the project have already been achieved. We’re on coal. We are actually developing the longwall -- first longwall panel with continuous miners on both the headgate and the tailgate.

I think, as we look forward, we’re in the process now of obtaining a lot of the equipment between now and through the first quarter, and the most significant piece of that is, obviously, the longwall, all of the shields, the pan line. Those seem to be on time. The shipment process is beginning there as well.

So those are major things that we’ll continue to move forward with. There’s some healthy upgrades that have to occur to some of the other infrastructure such as the belting and conclusion of some things at the plant.

But all of those are ongoing and we remain very encouraged with what we see and the milestones that we’re hitting. We’ll continue to push forward hard. In any major project, you’re always concerned about falling behind anywhere, but the team is very focused.

One thing we’ve said before in the past and I’m very proud of our team at Leer South. The Leer operations, a very successful complex, 11 miles away that we’re working to replicate. A lot of the experience that we’ve gained in building out that complex and operating it here for some period of time is that same experience that we’re leveraging and developing the Leer South project now and why we continue to be confidence that we’re going to deliver it on budget and on schedule and that we’re going to deliver the type of performance that we’re indicating that we’re going to deliver from it. So we feel good about it.

[Paul Lang, President and CEO]

Yeah. David, I guess, just kind of the simple view is, the two big things that are out there are the tie another plant and the slope and the delivery of the longwall equipment. Those are all on schedule and we expect to have them in Q1. Then it’s just the development of the headgate, tailgate for the first panel and the good news is the bad news, those are long panels. This is over a mile, and yeah, but we’re on it and moving well.

[David Gagliano, BMO Capital Markets]

Okay. That’s helpful. And then just my last question, obviously, big shifts coming in cash as the spending line is down and the lines ramp up. And then you just mentioned, obviously, sustaining CapEx all the way down to $60 million. As we peer into 2022, is there any meaningful expenditures that we should be thinking about over and above that $60 million sustaining CapEx number?

[Paul Lang, President and CEO]

No. David, as we wind down the spending on Leer South in the back half of next year, we’re down to basic maintenance CapEx, which has been running that roughly $90-ish million a year. From there forward -- there is really nothing big on the horizon.

[David Gagliano, BMO Capital Markets]

Okay. That’s helpful. Thanks very much.

[Paul Lang, President and CEO]

Thank you, David.

[Operator]

Thank you. Our next question will come from Mark Levin with The Benchmark Company.

[Mark Levin, The Benchmark Company]

Yeah. Great.

[Paul Lang, President and CEO]

Good morning, Mark.

[Mark Levin, The Benchmark Company]

Great. Thank you. Yeah. Good morning. Great. Thanks very much for taking my call. A couple questions. One on met pricing. When you kind of look out to Q3 versus Q2, and just assuming all else equal, if we just kind of set a flat met price Q2 to Q3. Any reason why the realizations would be either materially higher or lower than what they were in Q2? What you can tell?

[John Drexler, Chief Operating Officer]

So, Mark, yeah, I mean, I think, what we achieved in Q2, if -- and that’s going to work off an average hard coking coal price that was what $118 at High-Vol A price average Q2, which was $116, I believe. If you hold those flat once again, it’ll come back to mix of what we’re shipping versus domestic and international. But I don’t think you should expect a significant meaningful difference if you’re holding pricing flat. Although, the pricing won’t be flat. We expect volatility here and we’ll continue to manage as we need to manage moving forward.

[Mark Levin, The Benchmark Company]

Okay. Great. And then the second question, John, I think, this one is for you. So, in the PRB, obviously, you guys have been generating negative margins in the first half. Clearly, there is a lot of headwinds out there. You mentioned, the shipment schedule in the second half being materially better or at least, hopefully, will be materially better than the first half. What is your confidence level that you guys are going to generate positive cash out of the PRB in the second half of the year?

[John Drexler, Chief Operating Officer]

So, Mark, I -- as Paul and I indicated in our discussion, we’re very proud of what our thermal operations have done to respond to the market environment and there were a lot of tough things that we had to do. We had to realign headcount in a very significant way, which we did. We’ve had to go and look at the equipment fleet and how we best optimize it in a lower run rate environment.

As we stepped into 2020, if you remember, our original guidance would have had us at 70 plus million tons coming out of the PRB. And as a result of challenges in the marketplace, and then combine that with the global pandemic and what we’ve seen, we’ve had to significantly realign that to a much different footprint, currently showing commitments at 58 million tons.

So if you just do the math, we shipped 25 million tons in the first half of the year of those 58 million tons of commitment that leaves us with 33 million tons to ship in the back half of the year. Now that we’ve realigned the operation from a production standpoint to be ready for that, I think, it does give us comfort that we should see significant improvement in our results.

And then the question becomes, what are we seeing from -- and our confidence level and our ability to ship the 58 million tons. I think it’s no secret, whether it’s on the met side or the thermal side there have been discussions around pushback and deferrals.

And even on the thermal side, I would say, we probably have 2 million tons to 3 million tons of current discussions on pushback that we see. And as I indicated in the met discussion, those are contracted volumes. We do expect our customers to honor those commitments, albeit if there are opportunities to realize benefit for both us and the customer in a win-win situation, we’ll pursue that.

So even if we did see some deferral or pushback of some volumes from ‘20 into ‘21, it should still indicate that we’re shipping levels that are meaningfully higher than the 25 million tons we saw in the first half of the year.

[Paul Lang, President and CEO]

Mark, the only thing I’d add is that, the bottomline is, we’re going to react and we’re going to do we have to do, because what’s happened in the first half of the year we can’t sustain. So, we’re going to make the hard calls and try and bring this back to something more positive.

[Mark Levin, The Benchmark Company]

Got it. Got it. Got it. And I guess, the same question sort of applicable for other thermal, like, is that a business in the second half of the year that can at least breakeven from a cash perspective?

[John Drexler, Chief Operating Officer]

Yeah. Same principles apply there as they do and what we discussed it in the PRB. We’re working hard at those operations to make sure that the production is aligning with expected demand and so we’ve made big steps in that direction over the course of the quarter.

We were further challenged at our Viper operation as we indicated in the last quarter call with its primary customer having some issues with its generating fleet. Those have been resolved. And in the Midwest, we’ve had hot summer at least in the Midwest, so we’ve seen some demand pick up there. But we’ll work very hard to make sure we’re getting all of our thermal operations to a point where we’re seeing them generate some cash over the course of the year.

[Mark Levin, The Benchmark Company]

Okay. That makes sense. Then my final question just on the domestic met market, I know you guys are in negotiations and I don’t want to either put you in a difficult spot? You did a great job contracting in 2020. I think, you guys were at or near the top of the market. Obviously, going into this round of negotiations, the met market is a bit of a different state, and obviously, steel companies aren’t doing quite as well? So I guess the question is this, you gave -- if you did let’s say, I think, it ended up being about 75% export, 25% domestic this year. How wedded are you to that percentage, if you don’t get the pricing that you want? I mean, how much at this point, would you expect that that makes the change and maybe what’s your early thought process on how the domestic met market will shake out?

[Paul Lang, President and CEO]

Mark, I’ll start and see if Drexler wants to add anything. But I think as we head in the 2021. My assumption is that, at most we’re going to do about a similar percentage domestic as we did this year and last year, which is about 20% or 25%.

And I think the reason is pretty simple, if we’re bouncing along the bottom of the market and that’s where we ended up fixed price North American business is, we’ll probably limit our exposure to it, because I think, there’s more upside on the index on the seaborne market. So, look, I think ideally, we’re somewhere around 20% or 25%, but I could see it going down a little bit. John?

[John Drexler, Chief Operating Officer]

Yeah. No. I think, Paul, that’s a great commentary and I agree with that. Mark, the other thing is, you have to look at where producers are in this market. And that’s one of the benefits for Arch right now is where we can compete in the cost structure and give comfort to any of the customers, whether it’s domestic or international that we’re going to be able to deliver on volumes that we’re committing to.

And I think, with the expectation that potentially half of domestic U.S. productions underwater at these prices, it’s a whole another dynamic to insert into the discussions and considerations for consumers of metallurgical coal.

So, it’s an interesting setup right now. As Paul indicated, we’re going to make sure that we’re doing everything we can to maximize the value that we see out there. Given our low cost structure, it does give us the ability to evaluate a lot of different things here as we move forward.

[Mark Levin, The Benchmark Company]

Great. Thanks very much. Appreciate the time.

[Paul Lang, President and CEO]

Thank you, Mark.

[Operator]

Thank you. Our next question will come from Michael Dudas with Vertical Research.

[Michael Dudas, Vertical Research]

Good morning, everyone. I want to -- good morning, everybody.

[Paul Lang, President and CEO]

Hey, Michael.

[Michael Dudas, Vertical Research]

Yeah. Maybe the follow-up on your last comments, John or Paul, the fact that domestic producers, your competitors are underwater half of them and some of the new business that you picked up some of the loss of deferrals. Yeah, how much in the next six, 12, maybe as you go to starting to place the Leer South coal will the ability for Arch’s capitalization and their ability to deliver relative to the competitors? Because I got to think that in this pricing environment and the lack of capital, you’ve been able to attract capital to build your plants as competitors in such difficult shape. Is that something that you want to hold towards as you’re trying to negotiate your positioning for ‘21, looking ahead towards when this market hopefully picks up in 2022 that you’ll have that much more -- of a more structured long-term significant supplier, internationally and domestically?

[John Drexler, Chief Operating Officer]

Yeah. So, Michael, clearly, we’re very cognizant of what the opportunity is with Leer South and what it’s going to do to our overall met cost structure, and the quality and suite of products in the High-Vol A market especially. That’s a back of ‘21 type of analysis for us.

But as we indicated, we feel that as we move forward through the remainder of ‘20 and into ‘21, we’re going to see steel markets improve, the global economy improved. It’s going to set up a pretty dynamic environment for us. And right now from a Leer South perspective, we’ll be very careful in the types of commitments we’re making with what we see kind of for the markets in the back half of ‘21 especially.

[Matt Giljum, Chief Financial Officer]

Michael, we certainly see a significant stack and we certainly see a significant shakeout playing out right now I’m sure for you do. Clearly, as you say liquidity is becoming more and more an issue. John mentioned that maybe 50% of all U.S. supply is underwater at these prices. But the fact is that there are those who were saying 50% of all global production is underwater and cash negative at the current prices.

So it does feel unsustainable tasks. We do think there’s going to be continued pressure. We do think that shakeout. In the long run it is going to create meaningful space for Leer South. Not that Leer South can’t come into the market and compete and take share if it needs to be, but quite frankly, at the pace at which we’re seeing rationalization, we could easily see 30 million tons of supply come out of the market over the course of the next 12 months or less.

So, we absolutely believe that that’s going to create opportunities for us. And as John pointed out, given our cost structure and maybe that sort of $60 cost structure of finance or something less as Leer South comes online. We get half a year of Leer South next year and then a full year of Leer South in 2022, certainly positions us to place our volumes effectively and profitably going forward.

[Paul Lang, President and CEO]

Yeah. I -- Michael, clearly, the U.S. position on the cost curve as well understood. But I think what’s more interesting is, you look at Mozambique, which was supposed to be one of the saviors of the future market -- that’s really turned out to be a disappointment all around, both in terms of quality and cost and volume, that’s failed.

And what -- I think we’re all trying to understand is what’s going on in Australia. There has been a number of mine issues that are rather high profile and whether -- you try not to read too much into it, but clearly, are those mines getting a little longer in the tooth and even we thought they were look. And I think at the end of the day they’ve been great assets and they’ve been run very effectively, but there’s been some interesting developments out of Queensland.

[Michael Dudas, Vertical Research]

Yeah. And certainly currencies is not helping at all, it should be helping Arch’s as a domestic user little bit more the dollar has been doing. And just finally, my follow-up would be relative to your prepared comments regarding alternatives looking for second half liquidity, et cetera. Given the numbers you’ve put forth and your liquidity and where you are with Leer and maybe Leer South development? It appears you have some very good coverage, just want to get a little more understanding of that process? And then can I assume that alternatives would be if the market really fell out of better things got really worse from here that certain there’s other things on the table to complete the build outs? I just want to get a better sense of that from your viewpoint relative to your thought process on where cash flow and where the generation could be? Thank you.

[Matt Giljum, Chief Financial Officer]

Michael, this is Matt. And we would agree as we kind of look at the rest of this year and into next year, as we talked about with the expectations of improvements in profitability and cash flows, feel like we’re in a very good place liquidity wise.

But as we sit here thinking about getting to the finish line of Leer South and having a year to go here still, obviously, planning for all sorts of scenarios and alternatives. And frankly, as we sit here today, if we happen to see first half of next year that looks anything like the first half of this year, we really would probably wish we had taken some more opportunity to get capital on the books today.

So that’s kind of the planning that we’re looking at is really trying to make sure we understand what the various scenarios are and that we’re prepared for even the worst of those scenarios so that we’re able to get to the finish line with Leer South as we’ve talked about when we get there.

The profile of the company changes dramatically in terms of both the earnings potential and the cash needs for spending. So trying to do everything we can to make sure we get there regardless of what the scenarios are that we might face.

[Michael Dudas, Vertical Research]

That’s proven. Thanks, gentlemen.

[John Drexler, Chief Operating Officer]

Thanks, Michael.

[Paul Lang, President and CEO]

Thanks, Michael.

[Operator]

Thank you. Our last question will come from Lucas Pipes with B. Riley FBR.

[Lucas Pipes, B. Riley FBR]

Hi. Good morning, everyone.

[Paul Lang, President and CEO]

Good morning, Lucas.

[John Drexler, Chief Operating Officer]

Hi, Lucas.

[Lucas Pipes, B. Riley FBR]

Hey. Good morning, everyone. So I appreciated the earlier comments in regards to kind of PRB and other thermal looking better for the second half of this year with the committed times. Kind of looking further out into next year and beyond, and obviously, we’ll see what will come out of the joint venture. But what’s the tolerance for shouldering losses in that segment? And I think we all agree that the more should substitute kind of continued met build out and not vice versa. So kind of how do you think about thermal in the event that did you may not go through and there continued losses in that segment? Thank you.

[Paul Lang, President and CEO]

Lucas, this is Paul. I think, clearly, we’ve been executing on a strategy where we’re pivoting towards metallurgical markets. And that’s been going on for 10 years. Frankly, I think, it’s been the right course and one we adopted early.

As you look at it, we’ve assembled some great assets on the metallurgical side or we’ve built them. We have high quality, low cost assets. And I think regardless of what happens with the JV, we’re going to continue down this course.

The way I would frame it is, the JV is the best path forward, and I think, simply as we’ve said it will lower the cost of the combined operations and compete better with natural gas and subsidies renewables.

But absent that, I can’t see us going back to where we’ve been and we’re surely not going to continue to lose cash. If we can’t come up with a more value way of creating -- creating value out of these assets, we’re going to have to consider whatever steps are necessary.

And frankly, I think one step is to continue to shrink down the operations and drop production at some of the mines and look around phase closures of the operations. I think that’s just the reality of what we’re facing.

And if you think about it, it’s no different than what we did in 2018. If you recall, at Black Thunder, we had done a revised mine plan and revised sequence, and we cut about $100 million out of the ARO cost of the operation. Those are the type of things we’re looking at, but my guess is, it’s going to be a much smaller footprint going forward.

[Lucas Pipes, B. Riley FBR]

That’s very helpful. I appreciate that, Paul. And then just a number of questions here on the met coal market. I want to follow up this one. And in terms of reduction to U.S. output, you have a sense, A, kind of what amount of context actually has been taken offline from the U.S., and then, B, what percentage of those cuts have been permanent versus temporary? Thank you.

[Deck Slone, Senior Vice President, Strategy]

Yeah. Lucas, this is Deck. I’ll start with that. So the high watermark here recently 2018 U.S. produced around 80 million tons of coking coal, as we counted. Last year 2019 that had fallen into the mid-70s, 74 million tons, 75 million tons. We certainly could see a scenario where we fall all the way to 60 million tons this year.

So, production is coming offline and we see that continuing. Quite frankly, before the virus even sort of struck, we’d already seen 6 million tons to 8 million tons of supply in the U.S. come offline, simply because the market turned down about July 1, 2019. So July 1, 2019 High-Vol A prices were still around $190. So really the decline started in earnest thereafter and in a period of just eight months, as much as 8 million tons of supply came out of the market.

That’s continuing, obviously, and we think could accelerate, we are looking at real liquidity concerns for a lot of producers. It’s possible that we’ll see an additional shakeout post the North American settlements. There might be producers who are sort of holding on to see if they can lock in some business that will keep them profitable.

But, certainly, we think that the moments coming here where there are going to producers, the producers that simply have to shutdown. So right now, I mean, if you look at first quarter of 2020, production was down about 15% relative to the second quarter of 2019. So relative to the last sort of strong quarter on pricing.

We certainly could see that 50% decline -- 50% reduction a whole for the full year and quite frankly expect that to be higher. So the cuts will continue. There simply is no one who has liquidity to simply, say, we’re just going to lose cashier indefinitely and hope for the market to turn. So that’s our expectation.

[Lucas Pipes, B. Riley FBR]

Any sense on what is permanent versus temporary?

[Deck Slone, Senior Vice President, Strategy]

Yeah. So really we would expect a lot of it to be permanent. Once these operations shutdown, equipment gets pull, power gets shut off. It’s hard to bring those minds back. And again, there aren’t going to be producers who are thinking, what we’ll just spend some cash to keep an asset on hot idle that really wasn’t very competitive in the first place. So once they shutdown -- you might hold on for as long as you can at a certain price, but once you shut down, you need a much higher price to bring that production back online.

And so if you’ll recall Lucas, I mean, if you go back to sort of the last cycle that the high watermark for the U.S. was about $92 million tons, it took three years of strong pricing to get us back to 80 million and even there that 80 million tons, we were clearly defying gravity because production came off almost instantaneously as soon as the market turned down.

So, we would characterize the vast majority of this production as that’s shutting in as being permanent. It’s not to say that some of those reserves couldn’t go back into production, but it’s going to take capital. It’s going to take time. It’s going to take a meaningful change in the market and one that’s persistent.

[Paul Lang, President and CEO]

Yeah. Anecdotally, Lucas, I’d indicate that we do see the equipment in the Eastern coal fields that’s being sold and I think that’s a testament to some of these closed and idled operations having to look to move things. So, I think, it just further points to Deck is highlighting as the challenges that we’re seeing in production across the portfolio.

[Lucas Pipes, B. Riley FBR]

I appreciate the color. Thank you and best of luck.

[John Drexler, Chief Operating Officer]

Thanks, Lucas.

[Operator]

Thank you. And at this time, that’s all my questions we have time for today. So now I would like to turn the call back over to Paul Lang for closing remarks.

[Paul Lang, President and CEO]

I’d like to thank everyone again for their interest in Arch and taking the time today to participate in our quarterly call. Well, I think, it’s too early to make any prediction on the slope of the industry’s recovery. My general feeling is things are at least incrementally better than when we talked three months ago. Clearly, though we have a long way to go before we’re back to something that resembles the old normal.

I expect things will remain challenging in the short-term. But, I think, Arch is well-positioned. We have world class metallurgical assets and it’s at this very point in the cycle that costs matter most. On the thermal side, we’ve taken strong steps to adjust the operations and we’ll continue make the hard calls if required.

With that, operator, we’ll conclude the call. I look forward to reporting to the group in October. Stay safe everyone.

[Operator]

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