Ohio-based AK Steel is doing planning work right now for a new coal mine in Pennsylvania as part of an effort to secure at least some of its long-term metallurgical coal needs in what many expect to be a tight market for that coal over the next few years, said parent AK Steel Holding in its Feb. 27 annual Form 10-K report.
In addition to making strategic investments in iron ore and coal, AK Steel also wants to reduce the risk of future supply shortages through other means. To the extent that multi-year contracts are available in the marketplace, the company has used those contracts to secure adequate sources of supply to satisfy key raw materials needs for the next three to five years, the Form 10-K noted. Where multi-year contracts are not available, or are not available on terms acceptable to the company, AK Steel continues to seek to secure the remainder of its raw materials needs through annual contracts or spot purchases.
AK Steel historically has produced most of the coal-based coke it consumes in its blast furnaces, but in 2008 the company entered into an agreement with Middletown Coke Co. LLC, an affiliate of SunCoke Energy (NYSE:SXC), to construct a new heat-recovery coke battery contiguous to the company’s Middletown steel works in Ohio. The new facility will supply approximately 550,000 tons of coke per year and about 45 MW of electrical power to Middletown Works. The facility began production in the fourth quarter of 2011.
In 2009, AK Steel also entered into a long-term supply agreement with Haverhill North Coke, another affiliate of SunCoke, to provide the company with coke from the existing Haverhill coke battery in southern Ohio. Under that agreement, SunCoke Haverhill provides AK Steel with up to 550,000 tons of coke annually, and electricity co-generated from the Haverhill facility.
In June 2011, the AK Steel permanently closed its Ashland, Ky., coke plant because it was no longer cost competitive due to increased maintenance and increasingly stringent environmental regulations. To the extent, if at all, that the company cannot satisfy all of its needs through its remaining coke plant at the Middletown Works and its arrangements with SunCoke, the company enters into supply contracts with third parties to provide coke at negotiated prices.
AK Coal, a new subsidiary, controls, through ownership and lease, metallurgical coal reserves in Somerset County, Pa. The company currently estimates that AK Coal owns or leases existing proven and probable coal reserves of over 20 million tons of low-vol met coal. At the present time, AK Coal leases about 5 million tons of its estimated reserves to third-party miners and collects royalties from that production. The balance of the coal reserve is not currently being mined.
In an October 2011 deal, AK Steel acquired 100% of the stock of Solar Fuel, which AK Steel subsequently renamed AK Coal. AK Steel has commenced development of a mining plan and will seek the necessary permits to mine the coal. AK Steel will determine in the future whether it will mine the coal itself or whether it will use contract miners for all or some of the mining operations, the Form 10-K noted. AK Steel expects to put $60m in capital investments in AK Coal, most of which it expects to spend between 2012 and 2015, to develop its mining operations and begin coal production.
AK Coal currently anticipates commencing production “in earnest” in the first half of 2013, though commencement of production is contingent upon, among other things, obtaining all necessary permits. The company presently anticipates that AK Coal’s reserves will benefit it through direct consumption by the company and/or sales to third parties as a financial hedge to the market price of met coal. The company is doing exploratory drilling on the property controlled by AK Coal and is seeking access to additional reserves, primarily through leasing arrangements, near the reserves that it already controls.
AK Steel was somewhat late to the game when it comes to a steel company securing met coal reserves for the future. Competitors OAO Severstal and ArcelorMittal bought met coal reserves and existing mines several years ago in states like Pennsylvania and West Virginia in an effort to secure their own coal positions.
CONSOL lawsuit lingers on, Massey dispute settled
AK Steel is also involved in litigation with coal producers. In August 2009, the Consolidation Coal unit of CONSOL Energy (NYSE:CNX) filed an action against AK Steel and Neville Coke LLC in the Court of Common Pleas of Allegheny County, Pa. The complaint alleges that Consolidation and Neville entered into a contract whereby Consolidation would supply met coal for use by Neville in its coke making operations. Consolidation said that Neville breached the alleged contract when it refused to purchase coal from Consolidation. The complaint also alleges that AK Steel tortiously interfered with the purported contractual and business relationship between Consolidation and Neville.
Consolidation seeks monetary damages from AK Steel in an amount in excess of $30m and monetary damages from Neville in an amount in excess of $20m. AK Steel tentatively has agreed to indemnify and defend Neville in this action pursuant to the terms of a contractual agreement between AK Steel and Neville. AK Steel said in the Form 10-K it is still investigating the facts underlying this matter, and has reserved its right to change its position should facts establish that it does not have an obligation to indemnify or defend Neville.
In October 2009, AK Steel filed preliminary objections to plaintiff’s complaint on behalf of itself and Neville, seeking to dismiss the action. In response to the preliminary objections, plaintiff filed an amended complaint in November 2009, adding an additional count under the theory of promissory estoppel. In December 2009, AK Steel and Neville filed preliminary objections to plaintiff’s amended complaint, again seeking to dismiss the action. The court overruled the preliminary objections, and in March 2010, AK Steel and Neville filed their answers to the complaint. Discovery has commenced, but no trial date has yet been set. AK Steel said it intends to contest this matter vigorously.
In another legal case, in May 2011, Massey Coal Sales filed under seal a complaint against AK Steel in the U.S. District Court for the Eastern District of Virginia. The case involves a dispute over the price of coal for contract year 2011 under a coal sales agreement originally entered into by Massey and AK Steel in November 2003. Massey was acquired in June 2011 by Alpha Natural Resources (NYSE:ANR). In August 2011, AK Steel and Massey/Alpha reached an agreement which resolved all of the claims in the litigation and subsequently signed a formal settlement agreement. AK Steel said it believes that the settlement will not have a material adverse effect on its consolidated financial condition, results of operations or cash flows. In September 2011, the court dismissed the case with prejudice.