Core Natural Resources - Earnings Call - Q2 2021
August 3, 2021
Transcript
Operator (participant)
Good day, and welcome to the CONSOL Energy second quarter 2021 earnings conference call. All participants will be in a listen-only mode. Should you need assistance, please signal a conference specialist by pressing star then zero. After today's presentation, there will be an opportunity to ask questions. To ask a question, you may press star then one on a touchstone phone. To withdraw your question, press star then two. Please note this event is being recorded. I would now like to turn the conference over to Nathan Tucker, Director of Finance and Investor Relations. Please go ahead.
Nathan Tucker (Director of Finance and Investor Relations)
Thank you, and good morning, everyone. Welcome to CONSOL Energy's second quarter 2021 earnings conference call. Any forward-looking statements or comments we make about future expectations are subject to some risks, which we have outlined in our press release and our SEC filing, and are considered forward-looking statements within the meaning of Section 21E of the Securities Exchange Act of 1934. We do not undertake any obligations of updating any forward-looking statements for future events or otherwise. We will also be discussing certain non-GAAP financial measures, which are defined and reconciled to comparable GAAP financial measures, in our press release and furnished to the SEC on Form 8-K, which is also posted on our website. Additionally, we filed our 10-Q for the quarter ended June 30th, 2021, with the SEC this morning. You can find additional information regarding the company on our website, www.consolenergy.com.
On the call with me today are Jimmy Brock, our Chief Executive Officer, Mitesh Thakkar, our Chief Financial Officer, Dan Connell, our Senior Vice President of Strategy, and Bob Braithwaite, our Vice President of Marketing and Sales. In his prepared remarks, Jimmy will provide an update on the recommenced development of the Itmann Metallurgical Project, a recap of our key achievements during the second quarter of 2021, and specific insights on operations and sales. Mitesh will then provide an update on our liability management initiatives, our financial performance during the quarter, and 2021 guidance. In his closing comments, Jimmy will lay out our key priorities for the remainder of 2021. After the prepared remarks, there will be a Q&A session in which Dan and Bob will join us as well. Finally, we posted a supplemental slide deck on our website this morning, which we will refer to on this call.
With that, let me turn it over to our CEO, Jimmy Brock.
Jimmy Brock (CEO)
Thank you, Nate. Good morning, everyone. We capped off the first half of 2021 by delivering another strong quarterly performance in Q2. On the operations front, despite two longwall moves in the quarter, we delivered a solid cash cost performance. Additionally, we once again demonstrated our ability to achieve strong cash flow performance by generating north of $50 million in pre-cash flow in Q2 of 2021 and increasing the unrestricted cash on our balance sheet by more than $50 million as well. We reduced the leverage on our balance sheet and reaffirmed our ability to raise a significant amount of long-term capital through the recently completed tax-exempt financing on the PAMC refuge expansion project.
On the marketing front, we continued to execute our strategic shift into the export markets, and we also strategically layered in some financial hedges in the API2 market to secure revenue visibility and capture some of the recent export market strengths for 2022. On the safety front, our Bailey Preparation Plant, CONSOL Marine Terminal, and Itmann project each had zero recordable incidents during the second quarter of 2021. However, our total recordable incident rate, or TRIR, at the PAMC finished Q2 2021 higher than what is typical for us. Although the severity level on each of these incidents was very low, we strive to perform each day at zero incidents, and our year-to-date TRIR at the PAMC remains significantly below the national average for underground bituminous coal mines. Now, let me start with our most exciting news this quarter and provide an update on our Itmann Metallurgical Coal project.
We have been very clear that one of our major strategic goals is to diversify our revenue streams and reduce the percentage of revenues associated with power generation markets. This project is a very important step in that direction. As most of you know, in early 2019, we announced the commitments of the development of our Itmann Mine project, which is a low-volume metallurgical coal mining operation in Wyoming County, West Virginia. However, due to the unprecedented demand and earnings decline associated with the COVID-19 pandemic in 2020, we made the capital allocation decision to pull back spending on this project in order to focus our discretionary capital towards repurchasing our second-lien notes in the open market, which were trading well below par value at that time.
Now, as our debt has continued to trade up to near par levels and as our free cash flow generation has significantly improved, I am very pleased to announce our decision to recommence the Itmann project. Despite the significant pullback in project expenditures, the past 12 months-18 months were instrumental in repositioning the project. We used this time to complete initial development mining to shore up our confidence in the reserve, and we optimized plans for the preparation plant to create an additional upside potential. We evaluated several options for the preparation plant. First, build a brand new facility from scratch. Second, purchase an existing plant at a nearby location and truck the coal for processing. Or third, identify an existing preparation plant for sale that could be relocated to our Itmann site.
Based on our analysis, the third option made the most economic sense, and we are moving forward with relocating a higher capacity and state-of-the-art preparation plant to the Itmann Project site, which is expected to start up in 2022. By relocating the plant, we eliminate potentially long lead times on equipment and avoid inflationary pressures from steel and other construction materials. We expect to produce 900,000 plus tons of high-quality low-vol coking coal annually from our Itmann number five mine once we're at full run rate production. We expect this to be a low-cost operation with a long reserve life of 20+ years of production at maintenance capital levels.
While the overall project capital cost has increased slightly due to the reoptimized plans for the prep plant, we believe this can be more than offset by the expanded capacity afforded by the prep plant and improved cost structure due to the inclusion of a highly efficient rail loadout. The prep plant we are relocating will have a processing capacity that is nearly double that of the plant originally envisioned for Itmann, opening up the opportunity for us to process up to 750,000-1,000,000 product tons of third-party coal in addition to the coal from our Itmann mine. We expect this will create additional growth opportunity and higher revenue potential compared to the original project plan. With that, now let me provide an overview of the coal markets.
We continue to execute on our multi-year transition of diversifying our sales mix and increasing our exposure to non-power generation markets. Following a record export sales volume in Q1 of 2021, we successfully placed a near record 3.2 million tons in the export market in Q2 of 2021, representing nearly 55% of our total shipments in the quarter. Additionally, 47% of our tons sold were used in the industrial or metallurgical non-power generation applications as we continue to diversify away from traditional power generations. As you can see on slide five, we have continued to steadily diversify our global customer base and end-use markets since our spin in 2017. In the second quarter of 2021, our overall export volume as a percentage of total sales volume went up roughly 22 percentage points versus full year of 2017.
This improvement was driven by a sharp increase in the portion of our tons going into the industrial markets, which has risen by 33 percentage points versus 2017. We continue to focus on our strategy of further reducing our exposure to a declining U.S. coal market for power generation with a heightened focus on increasing our industrial business. We believe that with our quality of coal and cost structure at the PAMC, coupled with our ownership of CONSOL Marine Terminal, we are very well positioned to take advantage of developing and sustaining opportunities in the export market. Demand for our product continued to strengthen in the second quarter of 2021 on the back of economic recovery and improved electric power and export demand. Henry Hub Natural Gas spot prices averaged $2.95 per MMBtu during the quarter, a 73% increase compared to Q2 of 2020.
Additionally, average PJM West day-ahead power prices continued to improve, ending Q2 of 2021 61% above the year-ago quarter. Spot pricing trends were especially encouraging given that we were in the shoulder season. Pricing has continued to improve since the end of the second quarter. Henry Hub Natural Gas prices are now in the $4 per MMBtu range for August deliveries, with calendar year 2022 now well above $3 per MMBtu. Prior to 2021, you'd have to go back to 2018 to find the month in which Henry Hub averaged $4 or more, and prior to that, all the way back to 2014. We remain optimistic that overall market conditions will continue to improve due to accelerating global economic recovery and a relatively muted supply response.
On the export front, we have seen sustained improvements in the seaborne thermal coal market since the end of the third quarter of 2020. Petcoke prices continue to remain supportive as a result of reduced oil production, propping up demand and pricing for [Northern App] coal in high CV markets. API2 spot prices also continued to rise in the second quarter of 2021, largely driven by hot and dry weather, strong LNG pricing, and a limited supply response, and ended the quarter improved by 82% compared to Q2 of 2020. As such, we layered in commodity derivative contracts in the API2 market for calendar year 2022, which Mitesh will provide more color on shortly.
Additionally, we completed four term deals in the export market during the quarter with durations from one to two years in length, and we recently contracted a cargo of PAMC coal to China for the first time since 2018. From a marketing perspective, it is encouraging to see that demand for our coal has continued to improve since the low point in Q2 of 2020. We continue to maintain the vast majority of our core customer base and continue to see improvement in our customers' contracting appetites. Our sales team remains opportunistic in its marketing strategy and increased our contracting position by 9.4 million tons since our last earnings release, bringing our contracting position to 24.6 million tons in 2021 and 10.9 million tons in 2022. Now, let me review our Q2 2021 operational performance in detail.
Coal production at the Pennsylvania Mining Complex came in at 5.9 million tons in Q2 2021 compared to 2.4 million tons in Q2 of 2020. The vast improvement, despite the aforementioned multiple longwall moves in Q2 of 2021, was due to a continued increase in demand for our product since the COVID-related trough in demand that bottomed out during the year-ago quarter. As a result, productivity at the PAMC, measured as tons per employee hour, improved by an impressive 46.7% in Q2 of 2021 compared to Q2 of 2020. On the cost front, our average cash cost of coal sold per ton was $28.02 in Q2 of 2021 compared to $25.90 in Q2 of 2020. Although this seems impaired, keep in mind that the $25.90 per ton did not reflect the $32 million in mine idling cash cost incurred during the year-ago quarter.
When adjusted for that, Q2 2021 cash cost significantly outperformed the prior year period. Even without accounting for that idle cost, our year-to-date average cash cost of coal sold per ton was improved by nearly 15% versus the first half of 2020. Our operations team continues to focus on maintaining tight control over cash expenditures as we move forward. The CONSOL Marine Terminal achieved a throughput volume of 3.8 million tons during Q2 of 2021 compared to 1.6 million tons in the year-ago period. The significant increase was again due to improved demand in the seaborne markets compared to the trough of the COVID-19 related decline in coal demand in Q2 of 2020. The terminal throughput volumes reflect a pace of over 15 million tons per annum and marks the second consecutive quarter with an annualized run rate north of 15 million tons.
Terminal revenues for the quarter came in at $17.4 million compared to $15.9 million in the year-ago quarter. Despite the major increase in throughput tonnage, the impact on revenue was somewhat lessened due to the take-or-pay contract that was in place in the prior year period. Cash operating cost came in at $5.3 million versus $3.8 million in the year-ago quarter. With that, I will now turn the call over to Mitesh to provide the financial update.
Mitesh Thakkar (CFO)
Thank you, Jimmy, and good morning, everyone. I will start with an update on the progress we have made on our key financial priorities. I will then review our second quarter 2021 results and our full year 2021 guidance. As we have discussed in the past, our financial priorities remain maximizing free cash flow generation, maintaining strong liquidity, and reducing outstanding debt.
While these remain our north star, we are now also selectively allocating capital towards strategic initiatives such as our Itmann project. After accomplishing a significant milestone of achieving a net leverage ratio below two times at the end of 1Q 2021, we further reduced our leverage to 1.7 times at the end of 2Q 2021. This was despite our recently completed tax-exempt bond offering, which we previously highlighted would increase our leverage in the near term due to the treatment of restricted cash under our credit agreement. However, if we include the restricted cash, our leverage ratio as of June 30 would have dropped to 1.54 times. While we have more work to do on our balance sheet front, we have several initiatives underway or recently completed that we believe will create long-term value for our shareholders.
First, we continue to make strides on our overall debt reduction goal as we made total debt payments and repurchases of $18 million in 2Q 2021. This included open market repurchases of outstanding second-lien notes, where we spent $4.8 million to retire $5 million at a slight discount to par. We view these buybacks as a good use of capital, even as the market price of our second-lien notes has rallied back to trade at near par levels. Second, we made the discretionary decision to execute an $18.4 million early buyout option on an existing operating lease for a set of long haul shares. This decision not only saves us nearly $900,000 per month in operating lease expense for the next 12 months, but also eliminates the buyout requirement in 2Q 2022 at fair market value.
Given where steel prices are currently, this fair market value would most likely have been elevated and could have been close to or more than the $18 million fixed early buyout amount we executed. The early buyout also reduces the operating lease liability on our books, which rating agencies include in their leverage calculations. Third, as highlighted last quarter, we continue to find ways to tap alternative sources of capital by successfully securing $75 million of tax-exempt solid waste disposal revenue bonds at the beginning of the second quarter. We received reimbursement from qualified expenses in the amount of $21.5 million in 2Q 2021, which dates back to the initial inducement date in mid-2020. Additionally, we have $53.5 million in restricted cash associated with this financing that will be used to fund future spending on the refuse disposal areas at the PAMC and will reduce our leverage ratio over time.
From a strategic standpoint, this transaction gives us additional financial flexibility and helps to de-risk a portion of our future refinancing efforts by pushing $75 million of maturity in 2028. The transaction is also a testament to our ability to access long-term capital. It gets even more exciting when you consider that the commodity environment and our balance sheet have only strengthened since the closing of this transaction. We also expect this as a future financing avenue that could be available to us. Fourth, to capitalize on the strength in the export market, we initiated a targeted revenue hedging strategy during the second quarter of 2021. So far, we have layered in 2 million metric tons of commodity derivative contracts in the API2 market for calendar year 2022 at a weighted average price of $79.34 per ton.
These financial hedges ensure strong net back core prices for us for the approximately 2 million tons of physical contracts we signed during 2Q 2021 for 2022, which are also tied to API2 prices. The good news for us is that API2 prices and other export market pricing indicators continue to strengthen, and we still have an additional 13+ million tons of coal sales uncontracted for 2022. We anticipate a significant portion of these sales will go into the export markets. Fifth, on the legacy liabilities front, under our current actuarial assumptions, we have a fully funded status on our defined benefit pension plan. At this point, we do not have any funding requirements for the foreseeable future and have significantly lowered our exposure to equity market volatility. As we move forward, we will continue to focus on strengthening our balance sheet while implementing our targeted growth and diversification strategy.
This includes our commitment to completing the Itmann project. We expect this project to require an additional $65 million-$70 million of CapEx to complete, given the increased processing capacity and new train loadout at the preparation facility. This is in addition to the $24 million already spent on the project to date since its inception in early 2019. Recommencing this project is not an either-or decision relative to our debt reduction priority. We still expect to continue to reduce our outstanding debt on our balance sheet and build unrestricted cash. This project, like all financial decisions, went through a rigorous capital allocation process.
Excluding any third-party revenue, we expect it to generate a rate of return north of 25% over the life of the project, assuming an Australian premium low-vol coking coal price of $160-$170 a ton, which is consistent with the actual trailing 10-year average price and the current forward strip for 2023-2025. We believe the returns on the Itmann project will exceed our weighted average cost of capital, even at long-term average Australian premium low-vol prices of $130 a ton. We are very excited about this project and its earnings and free cash flow potential. With that, let me now recap the second quarter results before moving on to our 2021 guidance.
Resources reported a very strong financial performance for 2Q 2021 with net income of $4.2 million or $0.12 per diluted share, which included $20.4 million of unrealized mark-to-market losses related to commodity derivatives and adjusted EBITDA of $84.4 million. This compares to a loss of $18 million or $0.69 per diluted share and adjusted EBITDA of $34.2 million in the year-ago quarter. In 2Q 2021, we generated $94.6 million of cash flow from operations, which included $25.6 million of positive working capital changes driven by a significant reduction in our accounts and notes receivable balance. Additionally, we spent $43.7 million in capital expenditures, which included the previously discussed $18.4 million for the discretionary operating lease buyout, and we received $3.4 million in proceeds from asset sales. This resulted in free cash flow generation of $54.4 million in 2Q 2021.
This highlights the ability of our business to generate free cash flow in challenging markets and capture a meaningful upside in strong markets. As a result of our free cash flow generation, we have increased our unrestricted cash position by nearly $56 million in the quarter and now have an unrestricted cash position of $146 million, which is the highest level since 2Q 2019. Including the restricted cash position of $53.5 million, our cash and cash equivalence balance is over $200 million. Now, let me provide you with our updated outlook for 2021. Due to our strong first half 2021 operational performance and outlook for the remainder of the year, we are increasing our expected sales volume for 2021 to 23.5 million-25 million tons, up from our previous guidance of 22 million-24 million tons.
Additionally, due to the efforts of our operations team to drive costs down despite inflationary pressures so far this year, we are adjusting our expected average cash cost of coal sold per ton to a range of $27-$28 per ton, down from our previous guidance of $27-$29 per ton. On the pricing front, we currently have a 2021 contracted position of 24.6 million tons at an expected average price of $44.02 per ton. The improvement compared to our prior guidance reflects the strength in the current pricing environment on the additional contracted volumes we have layered in, as well as an improvement in the assumed PJM West power forwards. Finally, we are increasing our capital guidance due to the decision to recommence the Itmann project and the completed lease buyout to a range of $160 million-$180 million.
As always, we'll continue to reassess our guidance ranges each quarter and adjust them as necessary. With that, let me turn it back to Jimmy to make some final comments.
Jimmy Brock (CEO)
Thank you, Mitesh. Before we move on to the Q&A session, let me take this opportunity to provide a recap of our accomplishments in the second quarter and reiterate our priorities as we move forward. First, we continue to prioritize strengthening and enhancing our balance sheet by improving our liquidity and financial flexibility. Despite shrinking access to capital for coal companies, we have had good success in identifying and tapping alternative sources of capital. Second, despite significant inflationary pressures, we continue to keep costs at our operations under control through efficiencies, reduced discretionary spending, and creativity in our supply chain management program.
The team continues to look for ways to effectively drive costs down without sacrificing the effectiveness of our operations. By right-sizing our operations, we've taken some slack out of the system, allowing our four operating long hauls at the PAMC the ability to essentially run full out. This drives efficiency and results in a sustained reduction in our average cash cost of coal sold per ton compared to our historical averages. Third, CONSOL Marine Terminal is one of the most strategically valuable assets in our portfolio. The terminal will be essential for executing our longer-term strategic shift into the export market, which we expect will de-risk our domestic exposure and allow us to capitalize on growing international demand for our high CV product.
Year to date, we've shipped more than 50% of our total sales volume into the export market, which highlights the value of owning our own terminal and is a huge differentiator for us compared to our peers. Finally, we're extremely excited to be in a position to restart the Itmann project. We view this project as the next phase of our strategy, which focuses on targeted growth and diversification as an additional avenue to increase value for our shareholders. This project is strategically important as it will diversify our portfolio by adding a new metallurgical coal product stream to the mix, and it aligns well with our current operations by being low-cost, high-margin, and high-quality.
Before handing the call over, I want to reiterate that we are extremely proud of our accomplishments to date and believe we have a lot of opportunity in front of us to build upon our strategic priorities. Our capital allocation process, world-class asset, and employees have helped us to come out of 2020 primed to excel in 2021 and beyond. There's always more work to do, but we continue to focus on our goal of strengthening our balance sheet and creating long-term value for our shareholders. With that, I will hand the call back over to Nate for further instructions.
Nathan Tucker (Director of Finance and Investor Relations)
Thank you, Jimmy. We will now move to the Q&A session of our call. At this time, I'd like to ask our operator to please provide the instruction to our callers.
Operator (participant)
We will now begin the question-and-answer session. To ask a question, press star then one on a touch-tone phone.
If you are using a speakerphone, please grab your handset before pressing the keys. To withdraw your question, press star then two. At this time, we will pause momentarily to assemble our roster. The first question comes from Nathan Martin with The Benchmark Company. Please go ahead.
Nathan Martin (Equity Research Analyst)
Hey, good morning, guys, and congratulations on the first half performance.
Jimmy Brock (CEO)
Thank you, Nate.
Mitesh Thakkar (CFO)
Good morning.
Nathan Tucker (Director of Finance and Investor Relations)
Good morning, Nate.
Nathan Martin (Equity Research Analyst)
Maybe I'll start on the cost side first. You guys obviously lowered your guidance by, I guess, $0.50 per ton at the midpoint. Even if I run costs in the second half flat with your second quarter result of $28, which is the high end of your revised full-year guidance, you end up right at the low end of that new guidance range.
Is there something that pushes costs higher here in the second half, or maybe is there a chance you could possibly outperform there?
Jimmy Brock (CEO)
Nate, if you remember on the last earnings call, I said that we expect to come in at the lower half of our cost guidance. As we look forward, there are still some uncertainties in the market out there. I mean, we have a contracted position for 2021 that is up significantly from when we were on the last earnings call. Still, we have two longwall moves in the second half of the year, one in each quarter, whereas in that first quarter, we did not have any. Inflationary pressures from some of the commodities that we produce with, we see those could come to us. As Mitesh mentioned in his comments, we will reevaluate and look at it.
Our goal is to keep a tight lease on costs where we can and then let the operations team do what they do best, and they figure out ways to lower costs as we continue to produce. The reason that we lowered it $1 is because of our performance to date. As we look forward with one longwall move in each quarter, we think we'll have an opportunity to still come in toward the lower end of that guidance, and that's what our goal will be.
Mitesh Thakkar (CFO)
Yeah. Nate, I think inflation is a big part of a little bit of cautiousness here. As you know, all raw material prices have been higher since the beginning of the year. I think that is something that we continuously monitor. I think our supply chain team has done a good job of managing that so far.
There's always some buffer related to inflation as we go through the year as things continue to be very strong in the commodity landscape.
Nathan Martin (Equity Research Analyst)
Got it. I appreciate those thoughts, guys. Maybe shifting over to the pricing side, looks like you're essentially fully contracted for this year, maybe an additional 400,000 tons or so at the high end of revised guidance. Should we assume those tons would likely go to the export market? If we look forward to 2022, I think you layered on an additional 5,000,000 tons or so there. Can you talk about the mix of those tons and give us an idea of what prices they were layered in? Thanks.
Bob Braithwaite (VP of Marketing and Sales)
Yeah, sure, Nate. This is Bob. Just to kind of highlight 2021, as we mentioned earlier, we have now 24.6 million tons sold.
The additional volume we have to get to the upper end of the guidance, I would suggest that that's likely going to go into the export market. There's still about a $5-$10 arbitrage versus what the domestic prices are today. Even at $4 gas, I would suggest that the prices you're seeing in the publications Coal Desk reference, and they call it the mid $50 range, we're still seeing an arbitrage in the export market. It is likely that those volumes will go there. As far as 2022 is concerned, we did contract an additional 5.3 million tons since our last earnings call. About 80% of those volumes were contracted into the international market. Sitting here today, of the 10.9 million tons, a little over 4,000,000 tons of those are contracted to go exports.
Based on where we sit today, I would suggest that our export volumes will be pretty much similar to, if not a little bit higher in 2022 than what we expect to export in 2021. That goes based on Jimmy's comments of our strategic shift and also, again, based on the price arbitrage that exists today.
Nathan Martin (Equity Research Analyst)
I appreciate that call, Bob. Just any early thoughts on potential production levels in 2022, given the positive forward view of the market?
Jimmy Brock (CEO)
Yeah. I think, as we've always said, we'll run to the market. Thus far, we've been able to run our four longwalls full out. We would want to continue that into 2022. Depending upon what future forecasts we see there, we could run some additional shifts or something.
I would expect our tonnage for 2022 to be very similar to what we have in 2021 with possibly some upside.
Nathan Martin (Equity Research Analyst)
Got it. Thanks for that, Jimmy. Just real quick, I wanted to shift to Itmann. Appreciate all the color you guys have given on the project and the updates there. I guess, how would we think about production ramp? I'm assuming we'll have to wait for the prep plant completion before we see any meaningful production, which I think you guys would say maybe mid to second half 2022. Can you kind of talk about that? Maybe your decision to relocate the existing prep plant with additional capacity, maybe just any thoughts on the appetite you see to fill that excess capacity. Thanks.
Dan Connell (Senior VP of Strategy)
Sure, Nate. This is Dan.
Regarding the first part of your question on the production ramp, we have been fortunate in being able to continue our development mining here at a reduced rate for the past number of months, and we will continue that as we build out the plant. That puts us in a really good position when the plant becomes available, targeting kind of the Q3 2022 timeframe to very rapidly ramp up and bring both of the additional sections on that we will need to scale up to full production. I think our plan would be that during the second half of next year, we can move from kind of the controlled development mining that we have been doing to something very close to, if not achieving, full production during 2022. The decision to relocate the plant is one that, as Jimmy mentioned, we ran a lot of analysis on.
We had time to give that a thorough look, given kind of the pause in the project during the last couple of months. We feel like we've vetted that plan very well. There are a number of reserves kind of in the vicinity of where this prep plant is being built that have yet to be developed. We actually have some development mining going on nearby Itmann and some of the upper seams as we speak that will likely be looking for a home. We feel optimistic about the opportunity to pull third-party tons into the plant based on economics. It should help to improve the product blends that we can produce coming out of Itmann. To be clear, the economic numbers that we've been reporting do not assume any upside from those third-party tons.
We based our decisions on just kind of an Itmann base case, and we view the third-party tons as upside to that plan. Yeah. And Nate, just to add to that, one of the things when we were looking at the preparation plant, which is a big decision, as far as us ramping up to full production, the 900,000 tons plus that we had mentioned, we would not want to do that until we are processing our own coal and we can get that through. When we looked at the preparation plant, one of the key factors there on our initial plan, we were going to build a much smaller plant that would be somewhere around 350 tons an hour. Then we were going to, if we got all the third-party business, everything, we would add that second piece on.
By buying this plant and relocating it, we have that from day one. Some of the increase in capital was because of the train loadout that we are going to have that is going to give us the ability to not only move our coal very efficiently on the rail line, but also any third-party coal that we have coming into there. I remain very, very excited about the Itmann project. I am happy that we have put ourself in a position to where we can recommence it. I think it is going to be a nice return and be a nice project for our shareholders.
Nathan Martin (Equity Research Analyst)
Got it. I appreciate that. Those additional thoughts, it makes sense. Just finally, I think, Mitesh, obviously, you went through some quick IRR numbers for Itmann, and I might have missed some of those.
Have you guys done kind of any payback period calculations for the project and what that might look like at various net price decks? Thanks.
Mitesh Thakkar (CFO)
Sure. I think it depends on what net price you use. I mean, some of these cases, the payback period could be as little as two to three years. I'll let Dan address some more specific payback periods, if you will.
Dan Connell (Senior VP of Strategy)
Sure. No, I mean, I think, as we mentioned, Nate, during the remarks, we've kind of run the project economics using a price strip that's consistent with both the 10-year average historic net prices and the current forward strip. That puts you kind of in the payback range that Mitesh mentioned, I think, that in terms of ROI numbers, we said north of 25%.
Obviously, if you run the numbers at the current market and assume that it holds out here for a couple of years, payback period becomes quite short. These are paybacks. The ROI numbers, just to clarify, are based on total project capital costs since inception. If you look at the numbers on a go-forward basis, they become more attractive than what was before.
Mitesh Thakkar (CFO)
I think that is an important point that I want to highlight, that all these economics that we ran are on total project cost basis. It is not just a go-forward CapEx that we used for analysis. Even though today, if you are making that decision, you should look at go-forward because that is more applicable. We wanted to make sure that the project economics hold.
Nathan Martin (Equity Research Analyst)
Got it. I appreciate all that information, guys. Thanks again for the time today, and best of luck in the second half.
Jimmy Brock (CEO)
Thanks, Nate.
Operator (participant)
Again, if you would like to ask a question, press star then one to join the queue. The next question comes from Lucas Pipes with B. Riley Securities. Please go ahead.
Lucas Pipes (Managing Director)
Thanks very much, and good morning, everyone.
Jimmy Brock (CEO)
Thank you. Good morning.
Lucas Pipes (Managing Director)
I may have missed it earlier, but Jimmy, you mentioned the spread between the international and the domestic market. I wondered, can you elaborate on what that spread is today, i.e., what is pricing for export tons, what is pricing for domestic tons? Do you have a view on what might trigger these prices, which obviously would be great to see the domestic pricing move up? Appreciate your thoughts on that. Thank you.
Bob Braithwaite (VP of Marketing and Sales)
Yeah, Lucas, this is Bob.
Right now, I'd say the arbitrage versus kind of the published marks, the published marks are, call it, mid $50 levels for prompt, right around $50 levels for [coal strip] 2022. The volumes we've locked in to date on the international side, the arbitrage is roughly around $5 or $10. That does not include any, again, terminal revenues that we receive as well. That's kind of the level we're at today. Going forward, I still view that this market has legs for at least another 12 months-18 months. I mean, the supply response just is not there, not only in coal, but gas space as well. Inventories are significantly below their averages. In fact, I read an article just last week that gas reserves in Europe are the lowest they've been in over a decade.
When you look at petcoke, prices continue to trend upward and now 90% up year-on-year. I think this market has legs on the back of a continued post-pandemic recovery and just a relatively muted supply response.
Jimmy Brock (CEO)
I would add, Lucas, going forward, when we're looking at gas prices where they are today, and I can't reiterate enough, the supply response just hasn't been there. I agree with Bobby. I think the market does have legs into the coming years, particularly on the international market, and that'll help drive some of the domestic pricing as well. We feel like it does have legs with demand increasing for electricity, gas prices where they are, and a muted supply response.
Lucas Pipes (Managing Director)
Thank you. Thank you very much, Bob and Jimmy, for that perspective.
In terms of your capital allocation, you're clearly shifting, you're shifting towards growth with Itmann. Good to see that. I wondered from here on out, kind of what are your priorities? Is it more so on the capital? Is it more on the debt side, buying back maybe more debt there? We saw your transaction on the capital lease side. What are some of the opportunities? Mitesh, maybe if you could speak to any limits or restrictions you may have, would very much appreciate your perspective. Thank you.
Mitesh Thakkar (CFO)
Let me start by saying that we are in a very strong position today and are constantly reviewing our capital allocation priorities to ensure that they are consistent with changing market conditions and provide us the best risk-adjusted return.
In line with our strategic priorities and the attractive rates of returns that we just talked about for Itmann project, we relaunched it. Makes a lot of sense for incremental dollars that we are spending. Also, as I mentioned in my prepared remarks, we still have some wood to chop as far as deleveraging is concerned. Now, debt repurchases are not as attractive as they used to be before, but given that we want to delever and the fact that we still have an 11% paper out there that allows us to be opportunistic in that area, I think you'll continue to see us pay down our debt or repurchase in the open market because, as I said earlier, it's not an either-or decision for us as far as deleveraging is concerned and Itmann is concerned.
The steps that we are taking with deleveraging and growing our [met coal] business are all geared towards one goal, and that is really to create significant value for our shareholders, whether it comes from growth or from having larger equity value in the enterprise. The good news is that the market is offering us the opportunity today to launch and execute on multiple of these initiatives, and returning capital to our shareholders is one of them, right? We are constantly reviewing it and hope to provide you an update in coming quarters as we execute on our near-term goals as well. With respect to the operating leases, I do not see any big opportunities right now on that front.
We saw one in the second quarter and executed on it, which I feel was one of the best projects, so to speak, when you think about from a rate of return perspective. We ran the DCF sub. It was a very easy decision to make. I think those are the opportunities we'll continue to look at and continue to deliver on some of our strategic priorities.
Jimmy Brock (CEO)
Yeah. The good news is for us, it's not an either-or, as Mitesh mentioned earlier in his comments. With us generating free cash flow at the rate we are per quarter, we'll have an opportunity to do all of these things. I want to reiterate, really excited about the Itmann project. It gives us that diversity in our product stream of having the low-vol metallurgical coal in the mix.
I think we're going to continue to do the things that we've done in the past, which enhance the balance sheet, provide great liquidity, and add a new product mix to our stream.
Lucas Pipes (Managing Director)
Thank you. Thank you very much. Yeah. When I saw those capital lease numbers, I thought I should get into the business of lending to you guys. Really appreciate all the color. Continued best of luck. Thank you.
Jimmy Brock (CEO)
Thanks, Lucas.
Operator (participant)
The next question comes from Michael Dudas with Vertical Research Partners. Please go ahead.
Michael Dudas (Equity Research Analyst)
Good morning, everyone.
Jimmy Brock (CEO)
Good morning.
Mitesh Thakkar (CFO)
Good morning, Michael.
Michael Dudas (Equity Research Analyst)
First question, maybe you can elaborate a little bit more on your domestic customer base. Again, certainly inventories down, demand up. How urgent do you feel they are right now, especially as we've had better economic activity going forward and where gas prices are?
Any update on your customer base relative to potential coal power plant closures and your exposure there and how that may impact maybe some of your competitive suppliers as those things work through the system?
Bob Braithwaite (VP of Marketing and Sales)
Mike, right now, we are in discussions with several domestic customers, not only for the balance of 2021, but 2022 as well. Without a doubt, utilities are realizing that spot coal is not readily available as it once was. With that being said, I do believe that there will be opportunities to lock in some longer-term volumes to ensure they have supply going forward. With that being said, stay tuned there. As you mentioned, inventories are, I would say, near critical levels for many of the domestic utilities that we do serve. When I say critical levels, I am saying sub-10 days of inventory on the ground.
With gas price at $4, I do not see that this will change in the very near future. It should bode very well for us and our contracting abilities for 2022. As far as closures are concerned, as of right now, within the next 10 years, we have very minimal of our customer base that has announced that they will retire. I would say it is in the neighborhood of 500,000-1,000,000 total tons that we view at risk. Obviously, as Jimmy talked about before, is Reggie. We do have to be concerned about Reggie, which we are keeping a close eye on. That could have some additional impact on us in Pennsylvania. We are continuing to look and focus on shifting some of those volumes already in the export market. That is kind of where we stand today.
Michael Dudas (Equity Research Analyst)
I appreciate that.
Secondly, moving internationally, say to your important market in India, and you mentioned about petcoke. Maybe just a thought on just the dynamics going on in the Asian coal market, especially with some of the shifts in coal in and out of China and the lack of supply response. Again, not to predict future markets, we got pretty strong curves out there. Relative to, say, and Jimmy mentioned you have 2014 and 2018 coal price spikes internationally, how different is it dynamic in what you're seeing here, especially as you guys have evolved into a much more important and solid provider of coal into those export markets?
Bob Braithwaite (VP of Marketing and Sales)
Yeah. One thing that benefits us, as we mentioned in our remarks, our coal being a high Btu, high calorific value coal does transport very nicely into these markets, especially into the Asian markets where there is additional transportation.
As far as this time around versus what happened in, call it, 2014, as we mentioned, the supply response isn't there. I mean, if you look at the production, not only in the U.S., but look at the production in Colombia, I mean, it's significantly down, and those production bases just aren't coming back as strong. Plus, not only that, there's additional buildouts internationally. I mean, India, obviously, is a targeted market for us. They have been going through and continue to go through industrial revolution. Then, again, with the whole Australia and China tensions continuing, it is opening up doors for us to get Bailey coal into China as well. As Jimmy mentioned, we did contract our first cargo there this year, which is our first since 2018.
I think a lot of this is based on just, again, a post-pandemic recovery and muted supply response that we just do not feel is coming back.
Michael Dudas (Equity Research Analyst)
Understood. Finally, I guess, Mitesh, on your derivative book that you're creating here, is that something that is—I assume it's opportunistic, but do we see that as you manage the pricing markets, a little bit more exposure to that as you move forward? Is that something that's going to be part of how you on the marketing and hedging side going forward, especially with your more exposure into those export markets?
Mitesh Thakkar (CFO)
Yep. Mike, you're absolutely right. I think what we did in the second quarter was more opportunistic, but it also demonstrates a tool that we have in future.
I think one of the things that we have noticed is there was interest in doing [API tooling] contracts by some of our suppliers, by some of our customers. We wanted to manage that risk. In hindsight, you look at it, it almost looks like we could have waited three more months, and we would have been a lot better off. I think the goal there was to mitigate the risk, and I think we used it appropriately at that time. It also gave us another tool to do some of the things where if we want to, if we are seeing that we are not making progress on improving our contracted position, but the API2 market is there, we can lock in tons there and hedge some of that book.
Right now, that's not the case, but that doesn't mean it's not going to be in future. I think our marketing team is very successful in layering in some contracts here in the export markets, even on a term basis and not just spot basis, which is really good. We like that approach much better than using the derivatives, but it's a tool that we have we can use.
Michael Dudas (Equity Research Analyst)
That sounds great. I appreciate your thoughts, gentlemen. Thank you.
Jimmy Brock (CEO)
Thanks, Mike.
Nathan Tucker (Director of Finance and Investor Relations)
Thanks, Mike.
Operator (participant)
This concludes our question and answer session. I'll now turn the conference back over to Nathan Tucker for any closing remarks.
Nathan Tucker (Director of Finance and Investor Relations)
Thank you, Tom. We appreciate everyone's time this morning, and thank you for your interest in and support of CEIX. Hopefully, we were able to answer most of your questions today, and we look forward to our next quarterly earnings call. Thank you.
Operator (participant)
The conference is now concluded. Thank you for attending today's presentation. You may now disconnect.