How does Arch Coal earn revenue and free cash flow?
Like every coal mining company, much research has to be conducted before mining can begin at each location. Arch Coal has to first conduct studies to estimate the coal reserves in the location and the environmental factors that might hinder their operations. From there, they develop a mining plan which details the entire process of mining and land reclamation after mining is completed. As Arch Coal has a strong belief in integrating land reclamation into every phase of mining, they take responsibility for redeveloping the land after mining has been completed. Past examples of mining complexes have been converted into an 18-hole golf course and state parks. Extensive land redevelopment projects undertaken by the company lowers their cash flow and increases their capital expenditure. After developing the mining plan, Arch Coal then has to overcome the hardest part of obtaining the legal rights to mine in that area. They have done this by either purchasing or leasing the land from private or public entities. It is only after all these steps, where Arch Coal is able to mine the coal which is then shipped to their customers via ship, rail or trucks.
Long term supply agreements
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Arch Coal is able to maintain its commodity price risk for their non-trading, thermal coal through the use of industry customary long-term supply agreements with their customers. As of 3Q 2013, approximately 70% of their revenue was derived from long term supply agreements. These agreements allow both the company and customers to fulfill their future shipments or supply needs. The long term supply agreements stipulate either a fixed price or a pre-determined rise in price over each year. Such clauses often include a price re-opener clause which allows the two parties to renegotiate the price should coal prices change drastically. The company is also committed through these agreements to provide coal that meet certain quality standards at the specified prices. This historical average length of each agreement for the company is 2.77 years. The prices of coal in the Appalachia Region are attributable to more challenging mining conditions, diminishing reserves and higher transportation costs.