Arch Resources Inc

NYSE:ARCH

Earnings Call Transcript 2021-Q3

[Operator]

Good day, and welcome to the Arch Resources, Inc. Third Quarter 2021 Earnings Conference Call. Today's conference call is being recorded.

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

[Deck Slone, SVP, Strategy]

Good morning from St. Louis, and thanks for joining us today. While we're conducting this morning's call for Arch's boardroom, I want to assure you that the team is widely spaced and following CDC guidelines closely.

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, President & Director]

Thanks, Deck, and good morning, everyone. We're glad you could join us on the call today. I'm pleased to report that the Arch team continued to deliver across a wide range of strategic and operating objectives during the last quarter. In our core metallurgical segment, we commenced longwall production at the Leer South mine after a well-executed 2.5-year build-out; capitalized on strong market dynamics, generating $118 million in gross margin, which was nearly 100% increase for the segment from the prior period.

We achieved another strong shipping quarter and maintained our highly competitive cost structure despite the planned pre-start-up outage at Leer South and an increase in sales-sensitive costs related to higher sales prices.

In our legacy thermal segment, where we're focused on simultaneously harvesting cash and paring down our long-term closure obligations, we generated approximately $58 million in gross margin or a 43% improvement from the prior quarter. We further reduced our Powder River Basin ARO with additional final reclamation work at Coal Creek, flex up production to capitalize on strong pricing in both domestic and international markets, and leverage those near-term volumes into a greatly expanded book of higher-priced business, not only in 2021, but also in the latter years.

In short, we continue to execute on our clear and actionable strategy for long-term growth and value creation throughout the quarter. In doing so, we set the stage for upward momentum in sales volumes, operating margins and free cash flow yield this coming quarter and in 2022.

Turning to our rapidly evolving capital allocation plans. With the Leer South longwall now commissioned and in ramp-up mode, we intend, as previously stated, to prioritize the restoration of our balance sheet to its pre-2020 level. Central to that effort, we intend to pay down debt and/or build cash in order to return to a minimal net debt position. At the same time, we plan to maintain our sharp focus on simultaneously reducing and defeasing the long-term closure obligations at our thermal assets through the establishment of the sinking fund. Fortunately, given the excellent near-term cash generation outlook, we believe we can make excellent progress on all of these objectives over the next few quarters, even as we take the first steps towards resuming a modest capital return program.

In keeping with this view, the Board has initiated a $0.25 per share quarterly dividend beginning in the fourth quarter. Should circumstances continue to merit, the Board plans to evaluate more robust capital return mechanisms in the coming quarters.

Overall, we continue to progress in our strategic pivot towards steel and coking coal markets and away from power and thermal coal markets. With the start-up of the Leer South longwall, we took a quantum step forward in our transformation into a premier global producer of high-quality coking coal. At the same time, we continue to drive forward with our efforts to reduce the operational footprint of our thermal assets while simultaneously unlocking their still significant value. Central to this effort, Arch expects to reduce the asset retirement obligation for its Powder River Basin mine by about 15% during 2021, principally through accelerated reclamation of our Coal Creek mine.

Year-to-date, we've driven the ARO for roughly $190 million to approximately $170 million and expect to reduce another $10 million by year-end. At the same time, we intend to direct a small portion of the free cash generated by the thermal segment during 2021 to a sinking fund that will serve to set cash aside to prefund the final closure obligations for these mines. Given the strong committed book of thermal business we now have in place for 2022 and beyond, we should be in an excellent position to continue to build this fund during future periods in a smart and systematic manner using cash generated from our thermal assets. Longer term, we still expect the cash generation from these assets to far exceed their closure obligations with the balance available to fund other corporate priorities and objectives. With this, we continue to drive forward with our efforts to unlock the significant remaining value in these legacy thermal assets. Towards this end, we leveraged our hard-earned capacity to flex up our production in 2021 during a period of intense market tightness to secure commitments for the outer years.

Over the last 5 months, we've made thermal coal commitments totaling more than 100 million tons for shipments in 2022 and beyond, and we've now built a strong contract base for both our Powder River Basin and Colorado operations for several years in the future. Most importantly, of course, this strong book of business should ensure robust and predictable cash flows from these assets in the near to intermediate term.

As we've stated many times in the past, Arch's objective is to transition into a pure-play metallurgical producer. However, we're intent on winding down our thermal assets in a careful, orderly and responsible way and in a manner that takes into consideration the interest of our many stakeholders, including our thermal segment employees, the communities in which we operate and U.S. power consumers.

Before I turn the call over to John, let me share a few comments on the coking coal markets. The ongoing rebound in global steel production in the wake of the pandemic continues to drive strong demand and robust pricing in the seaborne metallurgical coal markets. Through August, world steel production was up more than 6% versus the pre-pandemic year of 2019, which is an incredible snapback. Meanwhile, global coking coal supply continues to lag with exports from the world's largest suppliers, Australia, the United States and Canada, down more than 20 million metric tons when compared to 2019. As you would expect, that mismatch in supply and demand has put significant upward pressure on the market, lifting the prompt price of our principal product, High-Vol A coal, to $390 per metric ton FOB the vessel. While volatility is a fact of life in the commodity business, we believe the overall dynamics appear constructive in the near to intermediate term.

In short, we see this as an exceptionally opportune time to be ramping up our Leer South mine and in doing so, greatly expanding our overall coking coal volumes. Looking ahead, we expect global steel demand to continue to increase around the world, supported by the ongoing build-out of large new integrated steel mills in Asia as the world gears up for the new green economy. With our world-class metallurgical asset base, premium product slate, industry-leading ESG performance and top-tier marketing and logistics expertise, we're confident that we're well positioned to generate substantial long-term value for our stockholder base and other key stakeholders.

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

[John Drexler, SVP & COO]

Thanks, Paul, and good morning, everyone. As Paul laid out, we made excellent progress on virtually every one of our key operating, marketing and ESG objectives during the third quarter. On behalf of the entire senior management team, I want to commend the Arch Resources workforce for yet another quarter of tremendous dedication, exemplary work and consummate professionalism. I'm proud to be associated with such a high-performing and talented group, and I fully believe that the team's unwavering focus on operational excellence sets the stage for even greater success in the future.

Let me start with our core coking coal segment, where the most momentous development of the quarter, quite obviously, was the startup of the Leer South longwall. As Paul noted, the operations team did a spectacular job of bringing that world-class asset to completion in the face of the pandemic, supply chain constraints, an inflationary environment that collectively stress the cost and availability of key goods and services at all of our operations. Of course, because of the team's Herculean efforts to keep the project on schedule and on budget, we are currently in the process of ramping the longwall in an environment that should deliver exceptional shareholder value and shorten an already rapid payback period still further.

As indicated, the Leer South longwall started up on August 27, and we have spent the first 2 months of operation lining out the technology and integrating the various systems. I'm pleased to report that we are making excellent headway in that effort that the Leer South operating team is moving up the learning curve very quickly with the assistance of key personnel from Leer and our other metallurgical mines, and that we are well on our way to achieving a strong sustainable run rate by early 2022.

While the 30-day outage in advance of the longwall start-up, the gradual ramp in production at Leer South, early inflationary pressures and about a $2 per ton increase in sales-sensitive costs associated with higher realizations all weighed on our average per ton metallurgical segment costs, we nevertheless executed efficiently during the quarter and maintained our strong position on the low end of the U.S. coking coal cost curve. Of course, we expect to achieve steady improvements in our operating performance at Leer South going forward, which should act to counterbalance many of the inflationary pressures noted earlier. We also achieved a solid shipping quarter despite seeing 2 vessels with late quarter late cans slipped from Q3 into Q4.

Given the systematic ongoing ramp at Leer South as well as logistics chain-related challenges in several late-year late cans, we have adjusted our coking coal volumes for full year 2021. We hope to outperform against the midpoint of the guidance, but there are a number of moving parts here, and we think a more conservative approach is warranted.

As previously indicated, Arch is focused on obtaining the best price for its high-quality products, whether in the 350 million-ton seaborne coking coal market, where we expect to ship 75% of our volumes in 2021, or in approximately -- or in the approximately 20 million-ton North American market. In recent weeks in keeping with past practice, the North American steel producers have begun to lock in their coking coal requirements for 2022.

We have participated in these tenders and have committed approximately 400,000 tons of 2022 business to date. Of these awards, we have committed Low-Vol and High-Vol A coal at both fixed prices of approximately $230 per ton and prices linked to the U.S. East Coast indexes. We are pleased with these commitments and view them as a good fit for our overall contract book and are continuing to participate in the remaining North American tenders.

As the North American business concludes, we will continue to focus our attention on the international arena where we plan to leverage our significant terminal throughput capacity, strong brand awareness, logistical expertise and where the outlook for both demand and pricing remains robust.

Looking ahead to the fourth quarter, we expect a modest increase in coking coal sales volumes when compared to Q3, followed by a more significant step-up in quarterly volumes beginning in the first quarter of 2022. While markets will continue to be volatile, we project significant improvement in our fourth quarter realizations with an expectation that 25% of our metallurgical output will be shipped to North American customers and 75% will be exported. Of the 75% to be exported, 1/3 will be shipped into Asian markets, with a total of 3 vessels into China. The remaining 2/3 of our export volumes will move into Europe and South America.

I'm also pleased to report that our thermal team continues to deliver exceptional results as well despite the ongoing pressures associated with the declining domestic marketplace. As you know, our focus on the legacy thermal side of the house is to exercise extreme capital discipline and to systematically shrink and offset our long-term closure obligations, while at the same time, optimizing the still significant value of these assets in a smart and responsible manner.

Paul detailed the strong progress we continue to make in shrinking our operational footprint. What was most impressive in Q3, in my view, was the fact that we accomplished this while at the same time flexing up our production levels to serve the near-term needs of our utility customers, who are grappling with the rapidly rebounding domestic economy and escalating natural gas prices. The upshot was a 25% sequential increase in our third quarter thermal shipments to a level that we expect to be sustainable in the fourth quarter as well. Perhaps most significantly, we leveraged these incremental 2021 commitments into a significant expansion of our book of business in 2022 and in 2023 and even beyond.

Through today, we've committed more than 70 million tons of PRB coal for delivery in 2022 and at an average price across all those tons at approximately $16 per ton. As a reminder, of course, we typically provide guidance for the thermal segment as a whole, which includes West Elk in the mix. Based on our existing domestic commitments as well as already locked in, but not necessarily priced export volumes, our expectation is that West Elk will produce more than 4 million tons in 2022 with roughly half of those tons going into the export market.

As indicated, we intend to provide more explicit guidance for the segment as a whole in February, but hopefully, that provides you with some useful building blocks for modeling purposes. That effectively leaves our Powder River Basin assets sold out for 2022, and our West Elk mine is fully committed domestically for 2022 with only a small amount of export business yet to be finalized for next year's back half. We believe that we have locked in volumes and pricing in 2022 alone that should deliver a gross margin dramatically in excess of our entire asset retirement obligation in the Powder River Basin.

Now let's turn to a quick recap of our ESG execution. As those of you who have followed the company for some time know, the Arch team's deep commitment to excellence in safety, environmental stewardship, community engagement and the highest business ethics is a hallmark of our corporate culture. During the third quarter, Arch once again demonstrated our overarching commitment to safety as our single highest value, achieving a lost time incident rate of 0.98 per 200,000 employee hours worked, which is roughly 3x better than the industry average.

While we aren't satisfied with that result and won't be until every one of our operations achieved a perfect 0 every single year, we continue to set the industry standard for safety performance among large integrated coal producers. In addition, we maintained our perfect record in both environmental and water quality compliance during the first 9 months of 2022. When you consider that we have tested over 100,000 water quality parameters at more than 570 water outfalls during the course of this year without even a minor exceedance, you begin to understand the level of precision and care that is being applied by the Arch operations team every single day.

In summary, we are pleased with the ongoing transformation of our already advantaged metallurgical franchise and remain constructive on the near to intermediate term outlook for global coking coal markets. Moreover, we believe that our legacy thermal assets are better positioned than ever to contribute significant excess cash and substantial complementary value for our shareholders even as we execute upon our careful, responsible and well-funded long-term wind-down plan for these assets.

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

[Matthew Giljum, SVP & CFO]

Thanks, John, and good morning, everyone. Again, as usual, with the discussion of liquidity and cash flows, we finished the third quarter with unrestricted cash of $210 million and total liquidity of $254 million, both slightly higher than June 30 levels. While earnings were much improved in Q3, not all of that improvement was converted to cash in the quarter.

Operating cash flows totaled $65 million, well below our reported EBITDA. We experienced another significant build in accounts receivable totaling $66 million, primarily due to the increase in seaborne metallurgical prices that accelerated in the back half of the quarter. Additionally, we were required to provide $19 million for margin requirements related to export thermal hedge positions that are tied to Newcastle pricing. And lastly, we spent $8 million in the quarter for reclamation as we continue to aggressively reduce our closure liabilities in the Powder River Basin. Capital spending was $64 million, including the final development expenditures and capitalized interest for Leer South.

Looking ahead to the fourth quarter, cash flows will increase significantly as market conditions in both segments remain extremely favorable and capital expenditures return to maintenance levels. And while we may see continued growth in working capital if prices remain elevated, margin requirements will reverse as the hedged physical sales are completed. Additionally, reclamation spending is projected to decline from the levels seen earlier in the year as we near completion of our planned near-term efforts at Coal Creek.

Next, I'd like to elaborate on a couple of topics that Paul discussed, starting with our approach to reducing the liabilities at our thermal operations. We have always viewed this effort as having 2 prongs. The first prong and our priority is to perform reclamation work when possible. And as Paul and John have both discussed, that is exactly what we've done this year on an accelerated basis. The second part of our approach acknowledges that there will be times in the mining sequence that don't allow for significant reclamation. Given the progress made at Coal Creek to date, we will reach one of those points in the fourth quarter. And we now plan to shift to the second prong by directing some of the cash flows from our thermal mines to a sinking fund.

We have collaborated with our surety partners to develop a program for building this fund to pay for future reclamation. As part of that program, we have agreed to contribute minimum amounts of $15 million in the fourth quarter and $30 million next year to this fund. And given the solid thermal outlook that John just outlined, we will likely make contributions above those minimum amounts. In short, we plan to prefund the mine's closure obligations, and we expect the funds to build to the ARO amount over time, in advance of drawing down the funds in future periods to pay for final reclamation as it's performed.

I also wanted to provide some additional thoughts around capital allocation. As just discussed, fourth quarter cash flows will be much improved, and we expect that strength to extend into 2022. We have been clear that our initial priority is to strengthen the balance sheet, and in the fourth quarter, that will primarily be in the form of increasing liquidity.

As we move into next year, we plan to pivot to reducing debt. And while we have not settled on the specific mechanism for that yet, we will consider both the term loan, which, while low cost is also the nearest maturity as well as the convertible bonds. As a reminder, our intent with respect to the convertibles is to utilize cash for the principal amount at a minimum in order to minimize dilution.

Finally, the improved outlook, along with the Leer South startup and reduced capital spending makes this an appropriate time to resume a recurring quarterly dividend. For the fourth quarter, the Board has approved a dividend of $0.25 per share to be paid on December 15 to stockholders of record on November 30.

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

[Operator]

[Operator Instructions]. We'll take our first question from David Gagliano with BMO Capital Markets.

[David Gagliano, BMO Capital Markets]

Okay. Great. Obviously, we could take this a lot of different ways. There's a lot of information here. A lot going on. I think I'm going to try and focus in on the thermal side first. On the PRB, I think you said -- or maybe not PRB. You said 70 million tons of thermal committed at $16 a ton for 2022. Is that correct? And if so, does that include any of that West Elk volume? And how much? And what was the price for that West Elk volume?

[John Drexler, SVP & COO]

Dave, this is John Drexler. You're exactly right. There's a lot going on, and it's an exciting time. So happy to report on all of that. And let me clarify, the 70 million tons that we discussed in the prepared remarks, that's PRB, and that's PRB that we said is priced at approximately $16 per ton. As you know, we reported as a thermal segment, and we indicated that we've got 4 million tons that we expect to ship from West Elk next year, which is higher than it has been previously, given the market dynamics there. Of the $4 million, about half of it will go into the domestic market and half of it will go into the export market. And at this point, we're not ready to provide any specific pricing guidance for that. But I wanted to give you the basic building blocks, especially with the PRB foundation, to lay out there. Obviously, that's a good piece for us as we move forward.

[David Gagliano, BMO Capital Markets]

Okay. And then a couple of related questions. The remaining volumes in the out years, can you give us the breakdown of how much you have committed in 2023 and at what price, same numbers as 2022? And then also, if you could, bigger picture, speak to the previous plans, I believe, were to kind of wind down the business 50% roughly from, I think it was like 2020 and to 2023. Obviously, with this guidance, 70 million, it's kind of flat year-over-year, it's actually up a little bit in 2022 versus 2021. What's the slope after 2022 of the wind down as we go to '23 and 2024?

[John Drexler, SVP & COO]

So Dave, I'm sure others will jump in here, but I'll go ahead and start. I think from the beginning, as we've looked at our strategy in the PRB and in the Thermal segment, specifically, I think we're very clear eyed that over the long term, we're going to continue to see pressure as plants close down over time. It's why we've had such a tremendous focus on reducing and managing the footprint there. That doesn't change for us.

But what we've said from the beginning is that we would be responsive to whatever market conditions present themselves and do it in a way that doesn't require us to provide significant and meaningful CapEx to the segment. And I'm real proud of the team that is managing all of the thermal segment to and how they're responding to the opportunity that we have here. So as we sit here today, we'll continue to be responsive to a very positive market environment.

Longer term, as that market will shrink, we'll be responsive as we have been. We won't change our focus on managing the footprint. But I think one of your most important questions is kind of the path going forward. We're not going to provide specific guidance for years beyond '22. But as we indicated in our prepared remarks, in this market environment and with what we're seeing from utility interest, we are layering in significant volumes into '23 and '24, which once again just gives us more confidence in our ability to generate cash as we move forward in multiple years, and we've already talked about a portion of that cash being set aside for final reclamation as we go forward.

[Paul Lang, CEO, President & Director]

David, this is Paul. I think the bottom line is nothing has changed kind of in the macro picture in our view. What you saw us do in the last 5 months was take advantage of kind of a unique situation. The market got tight, but we still have the ability to flex up and respond to that market. In order to provide short-term volumes, we leverage those into long-term volumes from '23 to '25, and we were able to do it at some very good prices.

But at the end of the day, the glide path down, we're going to do exactly what we said. We're going to shrink this footprint. We're going to do it in a logical way. We're going to be systematic about it. if the opportunity arises, where we can generate a little extra cash, we will. But I think we're pretty sober about where this is heading and how we should be addressing it. And the best example of that is Coal Creek. We'll keep mining at Coal Creek in a limited fashion as we complete reclamation. But the end game is the same. We're working towards closing the operation permanently.

[Deck Slone, SVP, Strategy]

Dave, this is Deck. And just to reiterate what both John and Paul have said. Look, the harvest strategy for us for the thermal assets was always principally about one thing, which is minimizing the amount of capital spend. So our objective there continues to be to invest as little capital as possible really just sort of subsistence levels and continue to operate at current run rate to the extent possible. As Paul said, it was an opportunistic move here to take advantage of the market that we saw.

And so, look, our goal is to meet consumer requirements, is to generate cash for final closure. That continues to be a strong focus of ours. Paul indicated that at Coal Creek, we will continue to mine there in a limited fashion as long as there is demand or at least in the near term, but we still are skinny that footprint down dramatically. And by the end of this year, the total ARO at Coal Creek will be less than $20 million. So we've done what we said we would do, which is, again, skinny down the footprint, reduce the asset retirement obligation. But we still want to generate as much cash as we can as we look to long-term closure obligations and also to avoid leaving meaningful stranded assets. So we'll continue to be opportunistic, but the focus will be to maintain as little capital spending in the basin and at West Elk, as we possibly can and simply harvest the cash that's still available for an asset and assets that are still -- have significant value.

[David Gagliano, BMO Capital Markets]

Okay. Just two -- yes, just two quick follow-ups. One on -- so first of all, on the thermal, just to round it out, I think in the prepared remarks in the press release, or wherever, I think you said a total of 120 million tons sold forward at this point in future years. We've got 70 million for 2022.

[Deck Slone, SVP, Strategy]

David, we said more than 100 million tons, and we haven't really broken it out. We obviously -- the 70 million that we've committed for 2022, only a small portion of that was actually committed this year. So there's a lot of volume in the out years. So if you assume that we were sitting at whatever, 50 million tons or so and we've done additional 20 million for 2022, that would mean there's another 80 million tons or so for the out years.

And just to reiterate what John said, it's a substantial book for 2023. So we are in a very solid position really strong foundation for 2023. So at least into 2023 and even into 2024, you're looking at meaningful continuing cash flows from the thermal assets that are already at this point locked in.

[David Gagliano, BMO Capital Markets]

Okay. And then just -- okay. And then relative to the $16 price for the 70 million that's been locked in for 2022, 2023 and the volumes, the $80 million that's been locked in the out years, up or down versus that $16 price. And if you want to just tell us the number, that would be great.

[John Drexler, SVP & COO]

Yes. We're not going to give specifics in that number. But as you look at what's happened in the market here recently, Dave, and you've seen all of the near-term pricing indications in the market and those that follow the market, there's been a real opportunity here near term, and we've seen substantial improvement in price. And so beyond that '22 period, it might be a little bit backwardated from there. But however, rest assured, we're building a very strong book in those outer years, and at levels and then prices for new commitments in those outer years that have been above where you've seen those outer periods from a historical perspective.

[Deck Slone, SVP, Strategy]

And the price in the outer years are moving up, Dave. So we've seen some lift here, continue to see lift. The reality is there's just been very limited investment in new coal production really everywhere domestically and as well as internationally. And as a result, there's a bit of a scramble right now as generators look to find additional volumes with gas prices as high as they are at around $5. There's just been a strong level of burn. Inventories have come down. And so look, we're very focused on meeting the requirements of our customers. They have a need, and we are doing what we can to respond. And that goes beyond just 2022. We're trying to help them build out their needs and requirements for '23 and '24 and beyond as well.

[David Gagliano, BMO Capital Markets]

Okay. And then just really quickly, and then I'll get back in the queue because I've got more. But just turning to the other -- a vast majority of the business on that side. The one thing I wanted to ask, the 400,000 tons committed, I think, at $230 a ton with the U.S. steel producers for 2022. Can you just give us a sense as to what was that number last year for that same quality of coal?

[Paul Lang, CEO, President & Director]

$90, $85.

[John Drexler, SVP & COO]

The pricing was $90.

[Deck Slone, SVP, Strategy]

The average we gave was $91. We did 1.8 million tons with $91 last year. And that was last, meaning the fall of 2020 for shipments in 2021 in North American customers.

[David Gagliano, BMO Capital Markets]

Okay. Understood. But this 400,000 tons that was priced at $230 is sort of average quality.

[John Drexler, SVP & COO]

So Dave, what we indicated was of the 400,000 tons committed, there's a portion of that, that was fixed at that $230 price, and there was a portion of that, that was actually indexed into the domestic market. So maybe split those -- that 400,000 tons in 2, half of it at the $230 price, half of it is an index. We indicated that the volumes were Low-Vol and High-Vol A. High-Vol A being our largest product, obviously, from Leer and Leer South, and then Low-Vol from our Beckley operation.

[Operator]

We'll take our next question from Lucas Pipes with B. Riley Securities.

[Lucas Pipes, B. Riley Securities]

First, the good news is Dave's questions remind me of his questions from 2011 to 2015 when he asked the -- one of your peers about pricing every single quarter, and they wouldn't quite answer it either. But anyways, good job. And I wanted to maybe hone in a little bit on Q4. You mentioned, John, 75% is going export, if I recall correctly. And Obviously, there are a few moving parts here in this market. We have lags, different end markets, Europe, Asia. If you had to give us a range for netback pricing on those export tons in Q4, I would really appreciate it. Just a rough ballpark.

[John Drexler, SVP & COO]

So yes, Lucas, that's always one of the hardest question to answer, especially in a market that's as volatile as it is now. If you look at average pricing for the East Coast markers for the third quarter, and you compare it to where we are today on a prompt basis, the markets are 50% higher than they were for the average for the third quarter. And then there's backwardation that comes off of that. So predicting where that's going to go is virtually impossible.

But I think what it tells everyone is we expect a substantial increase in our pricing as we move forward. We can talk offline a variety of ways to try to net all of those back to the mine. But if you just take High-Vol A, which is our most important metallurgical product and take a price today that's at $390 East Coast Platts, convert that to short, so back $39, so you're at $350. Backout transportation at these prices, and there's variability in that price, depending on where costs are. But for the third quarter, it's $35 a ton roughly. You're at $300 a ton netback pricing. But once again, that's changing every day. It's been volatile. And so very difficult to give you a specific number. But once again, we are expecting a meaningful improvement in fourth quarter pricing from the third quarter.

[Lucas Pipes, B. Riley Securities]

But plus or minus $300, kind of on your export tons, is that reasonable?

[Deck Slone, SVP, Strategy]

Yes. I mean I'm giving you the prompt daily price today. As you know, that's probably come up from where we even started the quarter at. So there'll be volatility in that. And that's East Coast Platts. There's a variety of pricing mechanisms as well. There's different markets and differentials for all of the variety of products that we have going into Asia, into Europe, into South America. So once again, hard to triangulate for you around those numbers.

[John Drexler, SVP & COO]

But Lucas, we are selling at the index. We're not -- so the numbers that you're seeing reported are the numbers we are receiving, as John said, there are different markers out there. There's a Queensland price when we talk about our Asian business, et cetera. But as you look at those markers, that's what you would expect us to be receiving except for that 25% of North American business that, as we indicated earlier, was locked in last fall at $91. So that's ongoing through the course of this year, but the remaining 75% of the international business is, in fact, at those markers that we've just discussed.

[Lucas Pipes, B. Riley Securities]

Got it. Very helpful. The Chinese vessels, would they be above or below that rough marker?

[Deck Slone, SVP, Strategy]

Lucas, really, we've been selling -- mainly we've been selling the Chinese volumes FOB the vessel U.S. East Coast. So while there's a delivered in price in China that gets quoted, really, the Chinese have come to sort of look to buying based really on that U.S. East Coast price, so they buy what will be the vessel and they manage the logistics. And that's fine for us that works well. And obviously, that additional sort of that additional activity on the East Coast is useful and tends to add some upward lift to pricing there as well. So we've been happy to have the Chinese buy in that manner rather than on a delivered in basis.

[Lucas Pipes, B. Riley Securities]

Got it. I know you'll issue 2022 guidance at the appropriate time. But obviously, there are a few moving pieces here with the ramp-up of Leer South. And I wondered if you could remind us kind of ballpark what you're looking for on met coal volumes for 2022 and then the potential cost impact. And obviously, on the cost side, you have this low cost -- super low-cost mine coming online, but then also, you noted the inflationary pressures. So qualitative quantitative comments would be superb.

[John Drexler, SVP & COO]

Yes. Thanks, Lucas. I think as we look here, and sometimes better to be lucky than good, but we couldn't have brought Leer South on at a more exciting time in the marketplace. And as we've indicated, the opportunity for a rapid payback for our investment in that asset just shortens with the market environment that we have.

I think we've been pretty consistent on what we expect as we step into a normal ramp and get to Leer South up to a full production rate, which we expect by the beginning of to incrementally add about 3 million tons of additional metallurgical coal into our portfolio. So taking us roughly next year to 10 million tons. Now we've not provided specific guidance yet. We're still looking at all of our budgets, and we'll provide that. But nothing has changed from kind of our views on how we've been communicating the addition of Leer South into the portfolio.

Obviously, our expectation once we get it up and ramped with the volumes that you'll get from that asset is you'll have a very constructive cost environment that will help us with the overall portfolio. You referred to some of the inflationary pressures that the industry is facing, some of those same pressures are the ones that we're benefiting from on the top line, right? So part of us wants to see steel pricing at all-time record levels, and quite frankly, energy costs high. That helps on the thermal side significantly as well.

But clearly, we use a lot of steel in our business. We use a lot of diesel fuel across our portfolio as well. So those inflationary pressures will be out there. We'll manage them. We haven't provided any specific guidance yet, once again, going through the budget process. But especially with the additional volumes at Leer South, we think that we're going to be able to manage that effectively going forward as we step into 2022.

[Deck Slone, SVP, Strategy]

And Lucas, remember, one advantage of our asset base, our coking coal portfolio is that we own the vast majority of our reserves at Leer and Leer South in fee. So our sales-sensitive costs are lower and tend to be lower. We also increasingly own the vast majority of our reserves at Mountain Laurel that we're currently mining and the #2 gas team. So it's really only exactly where we're paying a royalty of consequence. We do have about a 5% severance tax we pay based on the top line and the netback in the state of West Virginia. So we do have sales-sensitive costs. Clearly, we're going to have some upward pressure from the sales-sensitive cost, but I would say that we are, on a relative basis, advantaged given our reserve base and the fact that we own so much of our own reserve base.

[Lucas Pipes, B. Riley Securities]

Terrific. No, that really makes a difference when you're selling for $300 at the mine. My last question, and then I'll turn it over. You commented on the tightness in the thermal coal market. What would it take to increase your 2022 thermal coal production?

[John Drexler, SVP & COO]

Lucas, I think if you look at the run rate that we have in the third quarter that we say is sustainable into the fourth quarter and beyond, that gets you back into some of the numbers we were reporting for the Thermal segment. So as we look at our portfolio without significant and material additional capital investment, with the fleet of equipment that we have, we had scaled down the utilization of that fleet to be responsive to the market environment, to bring some of that back online, it's minimal levels of capital. It's -- we're making sure that we're managing it prudently. But we think that at these levels, we can sustain through '22, and we'll continue to evaluate then moving forward where the market is at and what type of capital is required. But once again, in the overall portfolio of our CapEx requirements, it should be insignificant.

[Paul Lang, CEO, President & Director]

Lucas, this is Paul. I guess the bottom line is you just -- we're not going to get back on that treadmill. The -- we had an opportunity to ramp up production in Q3 and Q4. We leveraged that into sales of '22 and beyond. We did that without spending any capital to speak of and without really having any issues with people. And you're just not going to see us spend cash and try and ramp this mine back up. We're going to be smart about what we do. And as Deck said, this -- the intent here is to harvest cash and, probably more importantly, set aside the cash for the ultimate closure -- and we do that. We have lots of flexibility when that cash is sitting in the sinking fund. We'll make the right decision at the right time to close that mine.

[Lucas Pipes, B. Riley Securities]

Got it. Terrific. Well, I really appreciate it and continue best of luck.

[Paul Lang, CEO, President & Director]

Thank you, Lucas.

[Operator]

We'll take our next question from Nathan Martin with Benchmark Company.

[Nathan Martin, The Benchmark Company]

Pretty good discussion already. So one of my questions have probably been addressed. Maybe just a couple of quick points of clarification. Obviously, with the PRB guidance of around 70 million tons for 2022, we've seen a little bit of a ramp up there, and I heard John's comments just saying the 90 million tons, plus or minus, in this quarter is kind of a good run rate to think about.

Just confirming, I think you guys had mentioned that Coal Creek as you're kind of winding it down, but it sounds like maybe you could run that some in '22 as well. Just kind of curious where you expect the bulk of the increase there in the thermal side to come from?

[John Drexler, SVP & COO]

Yes, Nate, good question. And as we've indicated, Coal Creek, our expectation continues to be that we'll close that down. And we talked about the significant progress that we've made there even through where we sit today. Our expectation is through the end of the year, of all of the disturbed yardage there, we'll have essentially reclaimed about 70% of all of that disturbed yardage. So you can see we're dramatically and significantly shrinking that footprint. And so that has been ongoing.

What's left is and where the opportunity lies for us is a very small piece, one pit that, quite frankly, continues to have outstanding cost structure and it's a small piece of the overall footprint remains. And so in this market environment, if prices continue to indicate that, that coal is needed, we have the opportunity to continue to evaluate that and move that forward. we wouldn't expect a significant increase in volumes from Coal Creek. That's a lower quality product. It's an 8,400 product. And we've been at very minimal levels of production there. And while we may flex that up a little bit, the vast majority of the opportunity that we have is going to come out of Black Thunder, the 8,800 Btu product.

[Deck Slone, SVP, Strategy]

So Nate, it is also very low cost though. So it's a nice margin, and it's worth it to us. It's worth maintaining that small footprint, again, a bit of a postage stamp with just the active pit if, in fact, there's a need for that quality. And so far, we're seeing some level of need. So we'll see where we go with the ultimate closure. But again, the objective with Cold Creek was always to reduce that reclamation obligation, and we've done a tremendous amount of work, we'll continue to do over the next couple of quarters.

[Nathan Martin, The Benchmark Company]

Got it. Yes. I mean that makes sense. I just wanted to clarify if that 70 million tons for next year kind of assumes a little bit of Coal Creek, and it sounds like it. I mean -- and then Deck, you just kind of touched on the cost side, which is where I was going to go next. And Lucas touch someone on the met side of things. Maybe with the thermal business, again, higher tons looks like, which is usually positive for -- on a cost per ton basis, but maybe some pressure from inflation labor. I mean, any commentary on where thermal costs kind of could go next year also with West Elk, I guess, ramping up from, let's call it, 3 million tons, plus or minus this year, up to 4 million plus, it sounds like?

[John Drexler, SVP & COO]

Yes, Nate. So an interesting dynamic. You've got increased volumes that are occurring. One thing, and Deck talked about it in the Eastern portfolio or the met portfolio, where sales-sensitive costs we have less impact given the ownership of the reserves. In the PRB, as a reminder, 1/3 of the sales price is in the form of sales-sensitive costs. So as you see the ramp-up and for us, that's a good cost pressure to have, but it's one that you need to factor into any type of projection and cost. Outside of that, you look at, at least in the PRB, the types of cost pressures we have, one of the biggest ones will be diesel fuel. We consume about 30 million gallons on an annual basis, where our average diesel price has been over the course of 2021 to date. Where we are today, it's a 25% increase on those costs alone.

As we've looked at the overall kind of portfolio and tried to at least maybe give you guys a little bit of direction. And once again, this is not formal guidance at this point. We'll update that post our budget as we report our fourth quarter numbers for next year. But it wouldn't be outside the range to expect a 5% to 7% type increase inflationary pressures outside the sales-sensitive costs.

And once again, you look at fuel costs such as diesel, you can look at steel pricing. We use a lot of steel. And obviously, steel costs have doubled from 2020 to 2021. And so those are the types of things we'll continue to look at and manage and we think we can manage effectively, but we will be affected by that.

[Nathan Martin, The Benchmark Company]

Just to confirm, I think you said for thermal specifically, and again, not formal guidance, I completely understand that, but up 5% to 7% next year outside of that 1/3 sales price sensitive piece. Is that correct?

[John Drexler, SVP & COO]

That's correct.

[Paul Lang, CEO, President & Director]

I think that's a good way to look at it, Nate.

[Nathan Martin, The Benchmark Company]

Okay. Perfect. I appreciate that, guys. Maybe just one other housekeeping type thought. I mean transportation-wise, with net prices being where they are today, any thoughts on: a, how is transportation health service for you guys to the export markets? Was that -- obviously, the vessels slipped about 200,000 tons, I should say, from the third quarter to the fourth quarter with some of that transportation-related, labor-related, et cetera. And then what are you guys seeing on the cost side right now from a rail transportation perspective?

[Paul Lang, CEO, President & Director]

Yes, Nate, I'll start it off. This is Paul. I'll tell you that Q3 started off a little rough for rail transportation and kind of plained out as the quarter we're on. So in general, not a lot of complaints about the Eastern railroads. The Western railroads also struggled in the early part of the quarter, particularly out of Colorado, the West Coast because of the fires. Set that aside, rent service is -- I think it's tight. We're all concerned about what's going to happen on these vaccine requirements and those issues and how that all plays out between the big railroads and their employees.

On the cost side, particularly in the East, obviously, as you know, we've talked many times in the past, our rail rate is tied to the East Coast indexes, and it's usually a 1 quarter lag. So we'll see, as we saw the prices step up in Q3, we'll see that increase in rail in Q4. And it's relatively substantial. If it's just round numbers, it could go from the low to mid-30s to the upper 40s, low 50s. That is what it is on these rail rates.

[Deck Slone, SVP, Strategy]

And Nate, just to add one point on that. Ultimately, that rail rate does get capped. So it doesn't just continue to climb beyond those levels. But as Paul said, could see that kind of level in Q4 and probably worth considering. And then we also say that, look, on the rail service, well, as Paul said, it's been very solid, we are ramping at Leer South. So one of the cautions here on Q4 for volumes has been we need to make sure that as Leer South ramps, we get sufficient service to make sure that we are able to deliver those higher volumes, and that will happen, whether it's a little slower in Q4 and not remains to be seen.

[John Drexler, SVP & COO]

Nathan, where those cap at, as you kind of once again look through all the modeling, its probably around $60 is kind of that level. And so at these prices, ultimately, we could see that.

[Nathan Martin, The Benchmark Company]

John, you read my mind. That was going to be my next question. So I appreciate that. Thank you guys as always for all your color and appreciate the time and best of luck through the end of the year.

[Paul Lang, CEO, President & Director]

Thank you, Nate.

[Deck Slone, SVP, Strategy]

Thanks, Nate.

[Operator]

We'll take our next question from Alex Hacking with Citi.

[Alexander Hacking, Citigroup]

I apologize, I missed the first few minutes of the call. So if this was already addressed, then I apologize. In terms of the sinking fund, I mean, back of the envelope, 70 million tons, $16 price, even conservatively $4 margin. That's going to more than cover -- that cash generation is going to more than cover the existing ARO. So I mean, are you looking to fully fund that next year in terms of how you're thinking about it today?

[Matthew Giljum, SVP & CFO]

So Alex, this is Matt Giljum. I'd say the ultimate timing for when that sinking fund really fills is going to be dependent not only on the thermal cash flows, but the other priorities we've got in terms of debt reduction and balance sheet strengthening as well. So in certain scenarios where cash flows are strong across the business, I don't think it's unreasonable to think that you could see it be completed in the time frame of next year, but probably, it's more likely to maybe think about it in terms of the next couple of years, given the strength on the thermal side. Again, if met prices stay where they're at, clearly, that could accelerate. But if we see those come off, it's probably better to think about over a 1 to 2 year time frame.

[Paul Lang, CEO, President & Director]

I mean at the end of the day, Alex, if you think about it, there's the argument about how fast you do this, but if the faster it's done, we take this issue off the table, and it's -- you basically ring-fence the thermal assets. And to the extent we could do that without breaking a sweat is what we need to strive to do.

[Deck Slone, SVP, Strategy]

And Alex, just one point on modeling. I wouldn't think about a $4 margin for the PRB anyway. We're probably -- remember, a $3 increase, $3.50 increase translates into another $1 of sales-sensitive cost. So you should factor that in. Now we'll see what West Elk does. And clearly, West Elk could push that margin up meaningfully. So if you're talking broadly, that makes sense. But from a PRB perspective, that might be.

[Alexander Hacking, Citigroup]

Okay. And it makes sense. And then just on the CapEx side, for next year, any change to kind of your previous thoughts around CapEx next year? You've obviously got the additional thermal volumes coming through. But as you mentioned, that's really CapEx kind of light volume. But any commentary around CapEx next year would be helpful.

[Paul Lang, CEO, President & Director]

Alex, we're sticking with -- we're heading into maintenance CapEx and -- The only thing I'd say is the inflationary cost pressure we're seeing on the capital side is real. And if you model somewhere between, I think, next year, given the inflation and what's going on, $125 million to $150 million. Those are still pretty loose numbers as we work through the budget, but I think that gives you the ZIP code of where things are at.

[Operator]

We'll take our next question from Michael Dudas with Vertical Research.

[Michael Dudas, Vertical Research Partners]

The big northeaster's here in the New York area, but we're surviving. No leaks in the roof yet. So can you remind on Black Thunder, like what's -- how long does the lease run? And what's the recoverable reserves left in that mine as you're operating it today, just to give a ballpark because I think that question will help people out here.

[Paul Lang, CEO, President & Director]

Yes. Michael, I'll take a shot, and I don't track it as good as I used to. It's about 700 million or 800 million tons, and the lease runs, it's reduced automatically every 5 years.

[Michael Dudas, Vertical Research Partners]

Right. Okay. So 700 million tons. And what would be the -- and then the run rate this year would be...

[John Drexler, SVP & COO]

What we just indicated for 2022, it's 70 million tons kind of sold out in the PRB would be decades of work, right? But we also indicate and I think, acknowledge that we expect that to come down over time while markets are strong right now, as we've done in the past, will responsibly shrink production if markets aren't requiring that, so that would extend the opportunity there as well. Once again, if the markets are giving the opportunity to continue to sell coal.

[Deck Slone, SVP, Strategy]

And Mike, let me -- reminder, obviously, we've come down from 1.1 billion tons of thermal coal consumption in the U.S. in 2008 to about 500 million tons this year. So clearly, with about 20 gigawatts additional closures for the next 2 years, our expectation is the market continues to shrink, and we will continue to manage down our production appropriately. But the opportunity is long-lasting, should this continue to be the market.

[Michael Dudas, Vertical Research Partners]

Right. Now that's why I kind of wanted to point towards given what's been going on. And things have happened so very quickly here in the last several months. Any chance to accelerate that value creation in the marketplace? Is anybody paying attention?

[Deck Slone, SVP, Strategy]

I mean, Mike, if you mean -- I mean, obviously, we have taken advantage of the opportunity, obviously, by selling into 2022 aggressively. So that's been the goal is to take advantage of what you've described, which is this energy crunch that we're seeing here in the U.S. and, really, internationally as the world economy has really snapped back, and there's been underinvestments in coal production really everywhere. And we talked a lot about the thermal assets here on this call that has been really profound on the coking side as well, which creates a really attractive opportunity and potentially an attractive supply-demand balance even with that downward pressure on consumption that we just discussed.

[John Drexler, SVP & COO]

What we said all along, Michael, is we've got a great asset in the PRB, great quality, great cost structure, great people running the operation. And what we've seen in the marketplace as we've seen with what's happening in the marketplace, we've seen utilities come and they're interested in multiyear deals. We've tried to take and leverage the near-term opportunity, as we've indicated and build out our book of business to give us some stability in cash flows well beyond '22. And so those are the types of things we'll continue to look at and evaluate as we move forward.

[Michael Dudas, Vertical Research Partners]

Do you think this is cyclical? Is there a little bit of like structural kind of shortage given what's going on in the world. It's amazing how much you've seen the word coal in the news over the last particularly 45 days.

[John Drexler, SVP & COO]

Look, we've said it for some time. There's been a significant lack of investment in new supply. And we think there'll continue to be a lack of significant new investment in coal supply. And so we think the future is going to look interesting as we move forward.

[Deck Slone, SVP, Strategy]

And obviously, Mike -- go ahead, Paul.

[Paul Lang, CEO, President & Director]

I'd just say, Michael, at the end of the day, it's not dissimilar to what we talked about last quarter. I think you asked me a similar question. We got high natural gas prices. We have low utility inventories. The ability for the producers to respond is not what the utilities, I think, thought it was. It just doesn't exist anymore. The investment has not been there. And throw in higher-priced exports, look, some of these things will work themselves out. And as we said, we saw an opportunity, and that's what we did. We took advantage of it.

[Deck Slone, SVP, Strategy]

And Mike, obviously, we're not equipped to talk about the oil and gas side of things. But right now, clearly, with domestic natural gas at $5, with gas trading at the equivalent of $30 in Europe, that certainly feels like the oil and gas side is experiencing somewhat the same pressure. So if the alternative fuels continue to be really quite expensive, and we've seen some sort of shift here, then, yes, I mean, obviously, the opportunity could be longer lasting.

I think it's important that we continue to point out that regardless of what we see here, our strategy is really quite clear. We're not going to deviate from that. Our plan is to continue this pivot towards coking coal markets, but continue to be opportunistic with the assets we still have in place, which are great assets, as John said, tremendous cost structure, high quality and all of that, but not to start to chase, not to start to put additional capital into those assets, instead just harvest the remaining value potentially over many years, but harvest the remaining value.

[Michael Dudas, Vertical Research Partners]

And I guess the bottom line is going to have well capitalized assets to own these days in the energy market.

[Deck Slone, SVP, Strategy]

Absolutely.

[Michael Dudas, Vertical Research Partners]

One final question for me. On the coking coal side, observation from Paul or John on the ability to meet the world's needs for this coking coal on the ground labor productivity. You read stories you hear anecdotally about retention, getting minors. Do you get a sense -- I'm assuming you guys are pretty locked down given your long life reserves and quality. But maybe some thoughts on what's happening around you. And is that something that could lead to some more dislocation as people are anticipating some flows coming out of the U.S. over the next several quarters?

[John Drexler, SVP & COO]

Yes, Michael, I think, quite frankly, labor is an issue, and you've heard us talk about our views on that. So just to reiterate, we feel good. And clearly, our most important asset is our people. And given the long-live nature of our assets and the cost structure, the fact that we operate them very safely and have a competitive wage and benefit structure is always something that our team -- it minimizes the impact to our operations, but it's something we're paying close attention to, right? Because we are seeing that labor in some of the challenges around it or around us, especially. I mean you've seen wage opportunities present themselves in other industries. We've heard stories where someone can go out and work for the cable company as alignment and make equivalent money to what they're making underground or even drive a bus, a school bus.

Those are the types of stories, anecdotally, we're hearing. Those didn't used to be challenges or opportunities for someone to step out and make that kind of money. So those will be things that we continue to look at and evaluate. We're seeing it across a lot of the industries that we work with, but we'll continue to manage it, and we don't see any issues from our perspective as we move forward.

[Paul Lang, CEO, President & Director]

Michael, the only other thing I'd add to what John said is, if you think about it, if we were to bring Leer South online or start that construction today, we debate this number, but the cost of that project, if you could get the financing, is probably, I don't know, John, 25% increase over what it was for us.

Look, as John said, maybe we were just good as lucky, but the fact is this incremental response, my guess is it's going to be higher cost and require some capital. And those aren't good recipes for long term.

[Michael Dudas, Vertical Research Partners]

I remember this was some controversy and you guys actually announcing that you're going to do this in the midst of a difficult market and the patience you showed. So great decision on that, well done.

[Paul Lang, CEO, President & Director]

Thank you, Michael.

[Operator]

Due to time constraints, that concludes today's question-and-answer session. At this time, I will turn the conference back to Paul Lang for closing remarks.

[Paul Lang, CEO, President & Director]

I'd like, again, to thank everyone for their interest today. These are exciting times at Arch. We delivered Leer South into a robust market environment, capping off our transformation into a premier producer of metallurgical coal for global markets. We sold our thermal segment production forward at historically strong prices and in a manner that ensures healthy levels, cash generation, well in excess of their final closure obligations.

We've taken the first step towards resuming a healthy capital return program through the reinstatement of our quarterly dividend, and we've laid the foundation for returning our balance sheet to its historically strong status, which we view as an invaluable point given the inherent volatility in the markets. In short, we've maintained our clear, consistent and actionable strategy and in doing so, have set the stage for ongoing value creation and future growth.

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

[Operator]

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