Arch Coal says its Patriot Coal exposure looks manageable

Patriot Coal’s effort in its bankruptcy court to get out of a contract to sell coal to Arch Coal (NYSE: ACI) for resale to another party is subject to options, none of them particularly harmful, Arch said.

On July 9, Patriot Coal sought Chapter 11 protection at the U.S. Bankruptcy Court for the Southern District of New York. In December 2005, Arch entered into an agreement with Magnum Coal Co. to sell certain assets to Magnum. In July 2008, Patriot Coal acquired Magnum.

On Sept. 20, Patriot filed a motion in the court to reject a master coal sales and services agreement entered into on Dec. 31, 2005, between Arch and Magnum that was established to supply coal for a sales agreement with an unidentified customer that did not consent to the assignment of its contract to Magnum. The motion is pending before the court.

“The underlying coal sales agreement provides the coal supplier with the ability to either ship coal or to elect to buy out of its monthly obligations at amounts that are predetermined for the remainder of the agreement,” Arch said about the matter in its Nov. 8 Form 10-Q quarterly financial report. “The remaining monthly buyout election payments total approximately $64 million, payable if elected through the end of the contract in 2017. If the Bankruptcy Court approves the rejection of the master coal sales agreement, the Company believes it would have the right to source the underlying contract from a variety of alternative sources, including the potential of sourcing it from its operations. The Company could elect to buy out of the contract obligations, depending on market conditions. The Company does not expect that, if elected, the monthly buyout payments would have a material impact on the Company’s liquidity.”

Patriot, in its Oct. 30 Form 10-Q report, said in apparent reference to this same matter: “In December 2005, Magnum Coal Company (Magnum), which was acquired by Patriot in 2008, entered into a coal sales and services agreement pursuant to which it agreed to sell the coal required to satisfy the buyer’s independent obligations under enumerated agreements with third parties. Effective March 27, 2012, Magnum entered into an agreement with the buyer that provides Magnum with a monthly option to make buyout payments in lieu of delivering the coal required for the buyer to satisfy its obligations under one of the enumerated agreements. In aggregate, over the next six years, the maximum potential buyout amount totals approximately $64 million if Magnum makes no deliveries during that period. In September 2012, we filed a motion with the Bankruptcy Court to reject these agreements and are awaiting a ruling. As of September 30, 2012, this sales related liability of $64.1 million reflecting this option has been reclassified to ‘Liabilities subject to compromise’ in our unaudited consolidated balance sheet.”

Patriot’s Sept. 20 court motion shows that this deal for Magnum to sell coal to Arch Coal Sales is “required to satisfy Arch Sales’ independent obligations under enumerated agreements with third parties, including the April 8, 2003 coal supply agreement between Cardinal Operating Company (‘Cardinal’) and Arch Sales (the ‘Cardinal CSA’). None of the Debtors is a party to the Cardinal CSA and no Debtor has any direct obligations under the Cardinal CSA.”

The Sept. 20 filing indicates that the Cardinal CSA, involving coal shipments to the Cardinal power plant in Ohio, is administered by American Electric Power Service Corp. Buckeye Power and American Electric Power (NYSE: AEP) co-own the Cardinal plant and AEPSC buys the coal for the partnership.

Said the Sept. 20 Patriot rejection request: “The [Arch Master Coal Sales and Services Agreement], executed on December 31, 2005 by and between Arch Sales and Magnum, together with the Arch MSA Letter Agreement, executed on March 27, 2012 by and between Arch Sales and Magnum, provide that Magnum will sell coal (or make payments in lieu of selling coal) to Arch Sales in amounts sufficient to allow Arch to perform its obligations under the separate Cardinal CSA. The Debtors have determined, in the sound exercise of their business judgment, that the Arch MSA Agreements provide no ongoing benefit to the Debtors’ estates and that rejecting the Arch MSA Agreements would benefit the Debtors’ estates by terminating uneconomic ongoing obligations under the Arch MSA Agreements. Although the actual savings to the Debtors’ estates from rejecting the Arch MSA Agreements will ultimately depend on, among other things, changes in the price of coal over time, the Debtors believe that such savings will be tens of millions of dollars and a net benefit.”

Arch agrees to keep providing bond coverage for Patriot

Also in relation to the Patriot bankruptcy case, Arch has agreed to continue to provide surety bonds and letters of credit for certain Magnum obligations, primarily reclamation. The surety bonding amounts are mandated by the state and are not directly related to the estimated cost to reclaim the properties. As of Sept. 30, Arch had $35.3m of surety bonds remaining related to Magnum properties, however Patriot Coal has posted letters of credit of $16.7m in the Arch’s favor.

Also, a predecessor of Arch entered into a guarantee for the delivery of coal under a contract assigned to Magnum. Patriot’s motion to reject the contract has been approved by the bankruptcy court. “If the guarantee is enforceable against the Company, then it may be required to fulfill Magnum’s delivery or payment obligations,” Arch noted. “The Company does not expect that fulfilling the guarantee would have a material impact on the Company’s liquidity. Because the Company does not believe that it is probable that it would have to purchase replacement coal to fulfill the customer contract or perform under the guarantee, no losses have been recorded in the consolidated financial statements as of September 30, 2012.”

Should Patriot not emerge from bankruptcy, or is incapable of paying retiree medical benefits under Section 9711 of the Coal Industry Retiree Health Benefit Act of 1992 (Coal Act) to a certain subset of retirees, Arch said could become responsible for their retiree medical obligations. The retirees were employees of certain subsidiaries sold to Magnum and their predecessor entities who retired prior to Oct. 1, 1994. Arch said it does not have the information necessary to determine the potential amount of such obligations, but does not expect that the annual benefit payments would have a material impact on its liquidity.

About Barry Cassell 20414 Articles
Barry Cassell is Chief Analyst for GenerationHub covering coal and emission controls issues, projects and policy. He has covered the coal and power generation industry for more than 24 years, beginning in November 2011 at GenerationHub and prior to that as editor of SNL Energy’s Coal Report. He was formerly with Coal Outlook for 15 years as the publication’s editor and contributing writer, and prior to that he was editor of Coal & Synfuels Technology and associate editor of The Energy Report. He has a bachelor’s degree from Central Michigan University.