Warrior Met Coal Inc (HCC) Q3 2021 Earnings Call Transcript

Warrior Met Coal Inc (HCC 5.19%)
Q3 2021 Earnings Call
Nov 2, 2021, 4:30 p.m. ET

Contents:

• Prepared Remarks
• Questions and Answers
• Call Participants

Prepared Remarks:

Operator

Good afternoon. My name is Chad, and I will be your conference operator today. At this time, I would like to welcome everyone to the Warrior Met Coal Third Quarter 2021 Financial Results Conference Call. [Operator Instructions] This call is being recorded and will be available for replay on the company's website.

Before we begin, I have been asked to note that today's discussion may contain forward-looking statements, and actual results may differ materially from those discussed. For more information regarding forward-looking statements, please refer to the company's press release and SEC filings. I have also been asked to note that the company has posted reconciliations of the non-GAAP financial measures discussed during this call in the tables accompanying the company's earnings press release located on the Investors section of the company's website at www.warriormetcoal.com.

In addition to the earnings release, the company has posted a brief supplemental slide presentation to the investor -- to the Investors section of its website at www.warriormetcoal.com. Here, today, to discuss the company's results, are Mr. Walt Scheller, Chief Executive Officer; and Mr. Dale Boyles, Chief Financial Officer. Mr. Scheller, you may begin your remarks.

Walter J. Scheller -- Chief Executive Officer & Director

Thanks, operator. Hello, everyone, and thank you for taking the time to join us today to discuss our third quarter 2021 results. After my remarks, Dale will review our results in additional detail, and then you have the opportunity to ask questions. During the third quarter, we were pleased to deliver our most profitable results since the onset of the COVID-19 pandemic driven by the resiliency and efficiency of our operational base. As we have discussed over the past several quarters, our priority during the COVID-19 pandemic has been to focus on the things that we can control, our operations and cost base, to set us up for success when market conditions outside of our control improved. This work has already been fruitful with the company maximizing its potential despite generally tough conditions during that period. But now, with macro factors having become tailwinds instead of headwinds, we can see just how meaningful our work over the last 20 months has been for our company in delivering strong results and creating value for our stakeholders. This quarter, we saw record high pricing, enabling us to leverage the strong global economic recovery to increase our average net selling prices.

Steel and met coal demand has continued to increase, which, when combined with the Chinese ban on Australian coal imports, has created an ideal environment for our operationally strong enterprise to demonstrate our resiliency. Even with the current upswing in the macro environment, however, we continue to focus on managing expenses, enhancing liquidity and increasing cash flows with the objective of remaining well positioned to meet our customers' long-term commitments in the face of any potential future market volatility.

Throughout the third quarter, our customers continued to experience strong demand for the steel products, which translated into strong demand for our premium quality coal. The combination of solid market fundamentals across the world, and ongoing geopolitical tensions between the world's largest met coal consumer and the world's largest met coal producer, have elevated pricing for our products to levels we have never seen before. China remains locked in a self-imposed supply constraint due to the continued ban on the import of Australian coals, it’s rigid COVID-19 protocols at the Mongolian border crossing and due to policy measures, and limited output of domestic met coal production. In addition, the Chinese government's mandate to keep steel production growth at 0% compared to 2020 has led to drastic cuts in steel production.

As such, Chinese producers have been able to absorb higher met coal prices as their margins have remained quite healthy due to higher steel prices and lower iron ore costs, both direct consequences of the aggressive steel production cuts mandated by the government. In the short term, we see these trends continuing. As recently reported by the World Steel Association, global pig iron production increased by 3.4% for the first nine months of the year, with China decreasing 1.3%. Excluding China, the rest of the world's production grew at an impressive rate of 13.9%. We were expecting our markets to remain strong as they did during the third quarter. However, we were surprised by pricing levels achieved by our main indices.

During the third quarter, the Platts PLV, FOB Australia index price experienced a meteoric rise of $191 per metric ton, rising from $198 on July 1 to a high of $389 per metric ton at the end of September. Likewise, the PLV CFR China indices increased by $295 per metric ton from $309 to a high of $604 per metric ton. However, the majority of the rapid rise in pricing occurred in the final six weeks of the quarter, during which the PLV FOB Australian indices rose by $162 per metric ton, equivalent to 85% of the total increase for the third quarter.

This also occurred with the PLV CFR China indices rising by $232 per metric ton in the final six weeks, equivalent to 79% of the total increase for the third quarter. Sales volume in the third quarter was 1.1 million short tons compared to 1.9 million short tons in the same quarter last year. Our sales by geography in the third quarter were 47% into Europe, 4% into South America and 49% into Asia. The higher, the normal sales to Asia were primarily driven by Chinese demand that we capitalized upon during the third quarter while capturing 100% of the CFR China index price on the day of the sale.

Production volume in the third quarter of 2021 was 1.1 million short tons compared to 1.9 million short tons in the same quarter of last year. The tons produced in the third quarter resulted from running both longwalls at Mine 7 plus four continuous mining years.

By running the four continuous miner units, our lead days, or float times, have not materially changed since the strike commenced in April and are still several months out into the future. Mine 4 remained idle during the third quarter. Our gross price realization for the third quarter of 2021 was 81% of the Platts Premium Low Vol FOB Australian index price, and was lower than the 90% achieved in the prior year period. The lower gross price realization was primarily due to the previously mentioned rapid rise late in the quarter of both the Australian and Chinese price indices. Our spot volume in the third quarter was approximately 30% of total volumes and 38% year-to-date. Our normal expectation of spot volume is approximately 20%. The highest spot volume is primarily attributed to the sales to China. I will now ask Dale to address our third quarter results in greater detail.

Dale W. Boyles -- Chief Financial Officer

Thanks, Walt. In the third quarter last year, we saw the ongoing impact of COVID-19 and its downward impact on the steel and met coal industries including our company, even as we continue to run both mines at near capacity. In contrast, this year, our third quarter results were negatively impacted by the UMWA strike in which we idled Mine 4 and significantly reduced operations at Mine 7. As we execute our business continuity plans to meet our contractual commitments to our customers. We took advantage of strong market conditions to generate strong results of adjusted EBITDA and free cash flow. In the third quarter of 2021, the company recorded its largest net income in over two years on a GAAP basis of approximately $38 million or $0.74 per diluted share compared to a net loss of $14 million or $0.28 per diluted share in the same quarter last year. Non-GAAP adjusted net income for the third quarter, excluding the nonrecurring business interruption expenses, idle mine expenses and other nonrecurring income was $0.97 per diluted share compared to a loss of $0.28 per diluted share in the same quarter last year. Adjusted EBITDA was $105 million in the third quarter of 2021, the largest in over two years as compared to $17 million in the same quarter last year.

The quarterly increase was primarily driven by a 108% increase in average net selling prices, partially offset by a 45% decrease in sales volume. Our adjusted EBITDA margin was 52% in the third quarter this year compared to 9% in the same quarter last year. Total revenues were approximately $202 million in the third quarter compared to $180 million in the same quarter last year. This increase was primarily due to the 108% increase in average net selling prices, offset partially by 45% lower sales volume in the third quarter versus the same period last year. In addition, other revenues were negatively impacted in the third quarter this year by a noncash mark-to-market loss on our gas hedges of approximately $6 million which were entered into earlier this year before hurricane season and gas supply deficits. The Platts Premium Low Vol FOB Australian Index price averaged $129 per metric ton higher, were up 130% in the third quarter compared to the same quarter last year. The index price averaged $264 per metric ton for the quarter. Demurrage and other charges reduced our gross price realization to an average net selling price of $189 per short ton in the third quarter this year compared to $91 per short ton in the same quarter last year. Cash cost of sales was $91 million or 46% of mining revenues in the third quarter compared to $151 million or 86% of mining revenues in the same quarter last year.

The decrease in total dollars was primarily due to a $68 million impact of lower sales volume, partially offset by $8 million of higher variable costs associated with price-sensitive transportation and royalty costs. Cash cost of sales per short ton, FOB port, was approximately $86 in the third quarter compared to $78 in the same quarter last year. Cash costs and price-sensitive items such as wages, transportation and royalties that vary where met coal pricing were higher in the third quarter this year compared to the same quarter last year.

Depreciation and depletion expenses for the third quarter of this year were $29 million compared to $28 million in last year's third quarter. The net increase of $1 million was primarily due to two things. First, the immediate recognition of $8 million of expense related to Mine 4 depreciation that would have normally been capitalized as inventory as it was produced. However, since Mine 4 is currently idled, it was instead directly expensed. Second, these expenses were lower by $7 million due to the 45% decrease in sales volume. SG&A expenses were about $7 million or 3.7% of total revenues in the third quarter of 2021 and were lower than the same quarter last year, primarily due to lower employee related expenses and lower professional fees.

During the third quarter, we incurred incremental nonrecurring business interruption expenses of $7 million directly related to the ongoing UMWA strike. These nonrecurring expenses were primarily for incremental safety and security, legal and labor negotiations and other expenses. As a result of the ongoing UMWA strike that began April 1, we idled Mine 4 in the second quarter. We incurred $9 million of expenses in the third quarter associated with the idiling of Mine 4 and reduced operations at Mine 7. These expenses for electricity, insurance, maintenance, labor, taxes, and are primarily fixed in nature. Net interest expense was about $9 million in the third quarter includes interest on our outstanding debt, interest on equipment financing leases, plus amortization of our debt issuance costs associated with our credit facilities, partially offset by interest income. The slight increase quarter-over-quarter was primarily related to new equipment financing leases. Other income represents proceeds received as a result of the settlement of a lawsuit. We recorded income tax expense of $5 million during the third quarter of this year compared to a benefit of $8 million in the same quarter last year. The third quarter tax expense was primarily due to pre-tax income, offset partially by benefits for depletion and additional marginal gas well credits.

Turning to cash flow. During the third quarter of 2021, we generated $52 million of free cash flow, which resulted from cash flows provided by operating activities was $63 million less cash used for capital expenditures and mine development cost of $11 million. Free cash flow in the third quarter of this year was negatively impacted by an $18 million increase in net working capital. Increase in net working capital was primarily due to an increase in coal inventory due to the lower sales volume.

Cash used in investing activities for capital expenditures and mine development costs were $11 million during the third quarter of this year compared to $28 million in the same quarter last year. However, we do expect to spend more in the fourth quarter than we did in the third quarter to keep the mines well capitalized. Cash flows used by financing activities were $51 million in the third quarter of 2021 and consisted primarily of payments on our ABL facility at $40 million, payments for capital leases of $8 million, and the payment of the quarterly dividend of $3 million.

Our total available liquidity at the end of the third quarter was $356 million, representing a 24% increase over the second quarter and consisted of cash and cash equivalents of $268 million and $87 million available under our ABL facility. This is net of outstanding letters of credit of approximately $9 million. Our balance sheet has a leverage ratio of 0.6 times adjusted EBITDA. And notably, we have no near-term debt maturities. We believe our liquidity position and strong balance sheet, combined with our low and variable cost structure, has enabled us to weather this period of uncertainty. It gives us the flexibility to continue to manage through a continued volatile global marketplace.

Now turning to our outlook. Due to the ongoing uncertainty related to our negotiations with the union, the COVID-19 pandemic, the Chinese ban on Australian coal and other potentially disruptive factors, we will not be providing full year 2021 guidance at this time. We expect to returning to providing guidance once there is further clarity on these issues. We continue to appropriately adjust our operational needs, including managing our expenses, capital expenditures, working capital, liquidity and cash flows. In addition, we have delayed the development of the Blue Creek project. And our stock repurchase program also remains temporarily suspended. I'll now turn it back to Walt for his final comments.

Walter J. Scheller -- Chief Executive Officer & Director

Thanks, Dale. Before we move on to Q&A, I'd like to make some final comments on our outlook for the fourth quarter and next year as well as the ongoing UMWA strike. We continue to execute successfully on our business continuity plans in response to the UMWA strike, which began on April 1, allowing us to continue to meet the needs of our valued customers. While we continue to negotiate in good faith to reach a new contract, UMWA unfortunately, remains on strike. Despite incurring incremental costs associated with the strike, we've been able to manage our working capital and spending to deliver strong results in this market. Looking ahead, we understand there are questions about the status of the UMWA negotiations, estimates of potential outcomes and possible time lines. Unfortunately, we cannot speculate at this time on any of those topics for various reasons. Let me just say, we value and appreciate the hard work of our hourly employees.

Our priorities have always been keeping people employed and working safely with long-lasting careers and ensuring the company remains financially stable in a particularly volatile coal market. While we are disappointed that the union continues with the strike, we continue to negotiate in good faith to reach a resolution. We expect the current strength in the steel markets to continue in the fourth quarter and into early next year, supported by our forecasted sales orders and ongoing discussions with our valued customers. Likewise, we anticipate supply to remain tight in supportive of favorable market conditions. We expect pricing for our products to remain strong due to the positive demand and supply dynamics but recognize that the likelihood of a pricing reset is high. However, when a reset does occur, we expect pricing to remain above historical averages due to the strong market fundamentals.

We believe we are well positioned to fulfill our customer volume commitments for 2021 of approximately 4.9 million to 5.5 million short tons through a combination of existing coal inventory and expected production during the fourth quarter. While we have business continuity plans in place, the strike may still cause further disruption to production and shipment activities, and results may vary significantly. We're in the early stages of planning our budget for 2022, including updating our business continuity plans. There are various scenarios that may play out depending upon our negotiations with the union. If we're able to reach an agreement soon with the union, we believe that we could ramp to a run rate of production of approximately 7.5 million short tons in about three to four months. We would like to capitalize on the current market strength of met coal pricing in support of steel and met coal environment that exhibit strong demand and tight supply.

Currently, we believe our customers will purchase every ton that we can produce for the remainder of this year and next year. If we are unable to reach a contract with the union in the near term, we believe our production and sales volume to be between 5.5 million and 6.5 million short tons. This could possibly include restarting the Mine 4 longwall as early as January with a small number of crews working on limited shift schedule. We have recently started in the fourth quarter one continuous mining we did at Mine 4. As we finish up the fourth quarter results, we expect to have further clarity into 2022 volumes and expectations, which could change from those that I've just outlined.

With that, we'd like to open the call for questions. Operator?

Questions and Answers:

Operator

[Operator Instructions] And the first question will come from David Gagliano with BMO Capital Markets. Please go ahead.

David Gagliano -- BMO Capital Markets -- Analyst

Okay. Great. Thanks for taking my questions. I'm going to cut to the 12-month volume insights for a minute. Just some questions around those two insights. The 5.5 million to 6.5 million, if the strike continues, how much of that would include -- or includes Mine 4 restart? And what, if any of the costs associated with restarting Mine 4 embedded in that assumption? My first question.

Walter J. Scheller -- Chief Executive Officer & Director

No. it includes restarting Mine 4 longwall running at not full speed, but maybe, I don't know, 25% or 50% throughout the year, getting it ramped back up to that level and just seeing how we do from there. This year, as I said, we'll end up -- we set up 5.5 million and that included a full quarter run in Q1 of last year. So we're pretty happy with where our production rates are and where we're headed right now, but we look to begin ramping Mine four early next year.

Dale W. Boyles -- Chief Financial Officer

Dave, there's no incremental start-up costs there. It would basically just be your normal, you’re just ramping up slowly. So you're not getting the bang for the buck and that's the higher cost, continuous miner units rather than the longwall. So -- but there's no special start-up.

David Gagliano -- BMO Capital Markets -- Analyst

Okay. And just if we were to try and frame out in that scenario, thanks for that sort of cost part. But in terms of the cash cost -- overall cash cost, without giving you specific information there. But just like in general, should we assume cash costs overall higher than current in that 5.5 million to 6.5 million tons, including Mine 4?

Walter J. Scheller -- Chief Executive Officer & Director

Cash cost of production should have remained pretty steady. We're going to see cash cost of sales potentially increase because of -- we've talked about the variable part of that, which includes transportation and royalties with prices where we are and the quarter lag that we have with transportation costs. You're going to see transportation and royalties go up.

David Gagliano -- BMO Capital Markets -- Analyst

And that's in any scenario, correct, including the other 7.5 million ton scenario?

Walter J. Scheller -- Chief Executive Officer & Director

Yes.

David Gagliano -- BMO Capital Markets -- Analyst

Okay. And then if we could switch over to that scenario, if there is a resolution, can you frame out sort of if there's any incremental meaningful start-up costs or capital costs in that scenario? And what, if any, meaningful changes we should be thinking about on the cash cost side in addition to what you just mentioned?

Walter J. Scheller -- Chief Executive Officer & Director

There should not be any additional start-up costs. It would take us I think we've said three to four months to get it ramped back up to what the expected production levels would be. And no, there's not any -- there's no real incremental cost of doing that or additional capital cost to getting started back up. The contract costs with the union, I -- we don't know. That's an unknown at this point.

David Gagliano -- BMO Capital Markets -- Analyst

Right, of course. Okay. Understood. And then just in the near term, for the fourth quarter, just a couple of quick questions there. Obviously, reaffirm the -- the plan to hit the 4.9 million, 5.5 million of customer commitments -- 5.5 million tons of customer commitments, and you're at 4.8 million now. So -- what's the -- that's obviously not, I don't think, a 4Q volume expectation. Can you give us a little more color on what you expect your overall shipments to be in the fourth quarter? And how much of that, if any, do you expect to send directly into China?

Dale W. Boyles -- Chief Financial Officer

Yes. Well, I'll answer that one, Dave. So yes, so we should be at the higher end of the guidance, the 5.5 million. There, we could exceed a little bit depending on what happens in Q4. But I wouldn't expect a tremendous amount of our volume to be China. We sold down the majority of our inventory levels in the second quarter, and most of that went to China. And now we’re really into our contractual side. So I think we've sold about 350,000 short tons to China in the third quarter, and I don't expect nothing significantly different than that probably in the fourth quarter.

David Gagliano -- BMO Capital Markets -- Analyst

Okay. Sorry. So the last point you said was about the same 350,000 into China in the fourth quarter. Is that what you said?

Dale W. Boyles -- Chief Financial Officer

Yes. Somewhere in that range, yes..

David Gagliano -- BMO Capital Markets -- Analyst

Okay. All right. Thanks. I’ll turn it over to someone else. Thank you.

Operator

[Operator Instructions] The next question will be from Lucas Pipes with B. Riley Securities. Please go ahead.

Lucas Pipes -- B. Riley Securities -- Analyst

Hey. Good afternoon, everybody. Thanks for taking my questions. So I wanted to get a little bit better understanding of kind of what the difference is between the 5.5 million to 6.5 million environment and the 7.5 million environment because I assume both would include ramping up Mine 4. So if you could -- if you could kind of share a little bit more color as to what difference a resolution on the labor front would make kind of 12 months from now, I would very much appreciate your perspective from that. Thank you.

Walter J. Scheller -- Chief Executive Officer & Director

It depends on how quickly that resolution occurs. If we don't have a union resolution or a contract resolution early in the year when we go throughout the year, and we've talked about a 5.5 million to 6.5 million that allows us to get Mine 4 started. And we're not -- as I said, we're not running at 24 hours a day like we had been. If we had a contract resolution at the end of this year or very early next year, our expectation would be that we are running Mine 4 24 hours a day throughout the year. So it would be basically once you ramp back to full production levels.

Lucas Pipes -- B. Riley Securities -- Analyst

Understood. Thank you. Thank you very much for that. And then in terms of kind of more broadly, costs, like there's -- many of your peers have commented on inflationary pressures, be it from labor, raw materials, and such. And I wondered if you could comment a bit on where you're seeing it in your operations, to what extent are hourly labor rates going up. I would appreciate your perspective. Thank you.

Dale W. Boyles -- Chief Financial Officer

Lucas, overall, we're experiencing a little bit of inflation, but not to a significant degree at this point. And the mines are running well and efficiently. So we're really not seeing any net inflation yet that's hitting us, but we do hear from suppliers about cost going up for next year and expectations around price increases. Obviously, steel prices are well up. And we use a lot of roof bolts, and we have a lot of machining equipment that we buy every year. So we’re probably going to looking – we’re facing that going into the fourth quarter as well as early next year. But at this point, we're not experiencing any significant inflation in total.

Walter J. Scheller -- Chief Executive Officer & Director

And unlike the maturity of our competitors who use relatively little diesel fuel. We don't expect a big impact from fuel cost.

Lucas Pipes -- B. Riley Securities -- Analyst

Got it. Okay. Appreciate it. Thank you very much, I’ll turn it over for now.

Walter J. Scheller -- Chief Executive Officer & Director

Thank you.

Operator

[Operator Instructions] Our next question is a follow-up from David Gagliano with BMO Capital Markets. Please go ahead.

David Gagliano -- BMO Capital Markets -- Analyst

Okay. Just the -- one of the challenges now given all the volatility in pricing, is really sitting down a near-term realized price. I'm wondering if you can just give us a little more color. And I know that's a difficult question. But we've got 350,000 tons going directly into China. Pacific Basin benchmark price have been all over the place, but have rallied quite a bit like you said at the very end of the quarter. So is there a way to just give us a sense, frame it out a bit more percentages or something like that, how we should be thinking about the fourth quarter realization? Thanks.

Walter J. Scheller -- Chief Executive Officer & Director

Well, David, I don't know what's going to drive the price down significantly in the fourth quarter. I think that it could easily settle some. But I don't know what would have to happen in order for the price to really have a significant adjustment. So we're thinking the fourth quarter remains strong, but strong is relative. Now will it stay at where it is. I'm not quite sure, but we still think it's going to be a real strong pricing. And as we look into next year, we think the first half of next year probably has relatively strong pricing. If you look at all the forecast, the back half of the year looks like it would start to settle out. We just don't have any clue when that will occur.

David Gagliano -- BMO Capital Markets -- Analyst

Okay. That's fair. I understood. Just in terms of Warriors realized price, historically, the relationship was 90 -- well, actually higher than that, right? 95% of kind of a Pacific Basin benchmark reference price. Is that still a reasonable assumption to make in this environment, very close to an average price in specific for the quarter?

Dale W. Boyles -- Chief Financial Officer

Well, it is a normal stable price environment, Dave. As we noted in our comments, look, the rise in the third quarter, 85% of that increase came in the last six weeks. So we're going to capture very little of that in the last six weeks. We've already pretty much sold the entire quarter. So you got to think about it that way as well is that was just a rapid increase. So it could be 81%. That's really not telling the true story. But in stable price environment, yes, we're going to be in that 97%, 98% range, somewhere in there across -- just across the cycle, too, if you think about it. Because right now, you're just looking at a very skewed quarter, and how dramatically pricing went up.

Walter J. Scheller -- Chief Executive Officer & Director

And we've talked before about how our pricing for a vessel follows the last 30 to 40 days of the spot pricing. So we're kind of chasing it. And you'll see -- if and when the price starts to settle, you'll see us end up well above 90% for that period while the price is starting to settle some. So really that 81%, while we'd like to see it at 90% of these prices. It's an indicator that the price has gone through the roof.

Dale W. Boyles -- Chief Financial Officer

Yes. And another good point here is on the trailing 12-month basis, we're at 97%. And that includes COVID, when we were down in the low 90s. We're over 100% -- and we were in the 81%. So that's got a lot of the volatility over the last year.

David Gagliano -- BMO Capital Markets -- Analyst

And just to clarify the commentary around the 81%. That all was in reference to the third quarter, correct?

Dale W. Boyles -- Chief Financial Officer

Correct, yes.

David Gagliano -- BMO Capital Markets -- Analyst

So in the fourth quarter, prices have kind of stabilized after they shot up. So should we be expecting closer to kind of 95%-ish zone for realizations relative to Pacific Basin benchmark pricing?

Dale W. Boyles -- Chief Financial Officer

I'll answer that question. So as you tell me what pricing is going to be over the next 60 days, by day.

David Gagliano -- BMO Capital Markets -- Analyst

A 30-day lag. That's the other thing I want to ask, do you still assume a 30-day lag on price.

Dale W. Boyles -- Chief Financial Officer

Pretty much, yes. That's the best way to view it is if you look back 30 days. And that average price stays the same for the fourth quarter, we should be doing pretty well.

Walter J. Scheller -- Chief Executive Officer & Director

We're not trying to avoid your question. It's just so hard to predict it. I mean, if you look at the last six weeks of the quarter, I mean, just unheard of pricing on an Australian basis over $400 a ton. I mean who would have thought, right, if that would ever happen.

David Gagliano -- BMO Capital Markets -- Analyst

Right. No, absolutely. And it actually is very helpful information providing. It is actually quite helpful. So I appreciate it. Thanks again.

Walter J. Scheller -- Chief Executive Officer & Director

Thank you.

Operator

Next question will come from Nathan Martin with the Benchmark Company. Please go ahead.

Nathan Martin -- Benchmark Company -- Analyst

Hey. Good afternoon, guys. Congrats on the quarter. Thanks for taking my questions. And then maybe just real quick on the cash cost per ton side of thing. Can you give us an idea as we see prices likely heading up here in the fourth quarter sequentially as you guys were just discussing, maybe what portion of that is kind of sales price sensitive?

Dale W. Boyles -- Chief Financial Officer

Well, about two-thirds are mine cost and you do have some variability there, a little bit of a small portion, but the other two-thirds is transportation and royalty costs, and that's variable. That's all variable..

Nathan Martin -- Benchmark Company -- Analyst

Okay. So Dale two-thirds is transportation, and royalty?

Walter J. Scheller -- Chief Executive Officer & Director

No. No. It's one-third is transportation and royalty. Yes. The way to look at that is, we average -- if you look at us over the last five years, our cost of sales has averaged in the 80s to the mid-90s. And what we've said is at that price range, about two-thirds of that -- or call it $60 a ton is cost of production. And the other one-third of that is variable because of cost of sales up, production cost remains relatively constant within a few bucks. And what you're going to see is with prices like this, you're going to see transportation prices though they lag a quarter. They're going to spike and royalty prices costs will go up as well because they are a percentage of coal sales price.

Nathan Martin -- Benchmark Company -- Analyst

Got it. Makes sense. Very helpful, guys. I appreciate that. And then maybe again on the transportation costs, you just mentioned, Walt. Can you comment and give a little more color on that? I mean what kind of rail rates are you guys seeing right now or even barge rates, how has service been? Have there been any difficulties procuring transportation, whether it's barge, rail or even ocean carriers? Thanks.

Walter J. Scheller -- Chief Executive Officer & Director

We're never happy with our transportation. We're always complaining no matter how good they're doing. But we're managing to get our coal move down to the port in a timely fashion. And of course, there's been a delay or two here and there on vessels. Part of that is due to weather though. We had a couple of vessels get stranded over New Orleans and that cost us a couple of weeks in getting them loaded through some of the storms. But by and large, you know what, it's -- the transportation has gone fairly well. And it continues to do well. We're moving coal, continue to move coal by barge. And that system is working well.

Nathan Martin -- Benchmark Company -- Analyst

Got it. Well, I think that’s about all I have left. Again, thank you guys for the time. Best of luck for the fourth quarter.

Walter J. Scheller -- Chief Executive Officer & Director

Thank you.

Operator

And the next question is a follow-up from Lucas Pipes with B. Riley Securities. Please go ahead.

Lucas Pipes -- B. Riley Securities -- Analyst

Thank you very much for taking my follow-up question. I wanted to ask about your contracting strategy, obviously, you're exposed to spot prices, but you can choose between Europe, South America, Asia as you look out to 2022, how do you look to position yourself? Thank you very much.

Walter J. Scheller -- Chief Executive Officer & Director

Well, typically, we have contracted out about 80% of our production volumes. And in the markets that we've seen, it just works better for both our customers and us for us to move more coal to the spot market. And I think as we go into next year, we'll approach it much the same way, try to make sure that both us and our customers are getting the coal they need and at the prices that we can achieve.

Lucas Pipes -- B. Riley Securities -- Analyst

Are you targeting...

Dale W. Boyles -- Chief Financial Officer

I can't tell you other than 80/20, I don't know what it will be aside from 80/20. It just all depends on the market.

Lucas Pipes -- B. Riley Securities -- Analyst

There's not a specific percentage that you're looking to earmark for Asia or China, for example.

Dale W. Boyles -- Chief Financial Officer

No.

Walter J. Scheller -- Chief Executive Officer & Director

Because they're all spot volume, they have been unwilling to talk about any long-term contracts. So we have to stick to the contracts with our natural market customers. And look, if we do get a correction, and prices kind of start becoming more correlated between those two indices then it doesn't make sense for us to see up to China because if we have to pay the freight, we're going to have a net loss on the transaction. So that's why we've never really sold to China until all of this Chinese ban started. So it's all going to depend on what the market is, and where prices are relative to the Australian index.

Lucas Pipes -- B. Riley Securities -- Analyst

Got it. Thank you very much and then second follow-up question in terms of kind of your capital priorities, once the strike is resolved, Blue Creek is still on hold, investors in this space have been sharing capital returns. What are your thoughts on allocating your precious dollars? Again, thank you very much for your perspective.

Dale W. Boyles -- Chief Financial Officer

Well, I mean, while we’ve suspended Blue Creek at this point. We've been working through some issues over the last year, the pandemic and we’ve evolved into the strike, and obviously the Chinese band. We've been to try to preserve capital. As we move forward and start to ramp the operations back up, if we get a contract and we're going to have to revisit when we start the Blue Creek project. But as we've said, look, we will look at what excess cash we do have and try to make a priority to return cash to shareholders as well as build our gross project Blue Creek. And how we do that? Right now, we just haven't come back and address that yet, but I imagine we'll be doing that over the coming months.

Lucas Pipes -- B. Riley Securities -- Analyst

Thank you very much and best of luck.

Operator

Thank you and the next question will be from Luther Lu from Millennium. Please go ahead.

Luther Lu -- Millennium -- Analyst

Hi, Walt. Thanks for taking my question. Can you remind us like how many continuous miner you need for full operation and Mine 4?

Walter J. Scheller -- Chief Executive Officer & Director

At Mine four, we typically run three continuous miner units along with the longwall.

Luther Lu -- Millennium -- Analyst

Okay. And that's how many people?

Walter J. Scheller -- Chief Executive Officer & Director

That depends, Luther. I mean you can run it with -- you can run a continuous miner unit with as little as seven or eight per shift. If you're running pretty lean. We prefer to have more than that, but you can run at that line.

Luther Lu -- Millennium -- Analyst

Okay. So this one unit right now that you're operating, is the crew new? Or is it from Mine 7?

Walter J. Scheller -- Chief Executive Officer & Director

We have well over 200 hourly people that are currently working. And I believe most of the folks working at Mine 4 were experienced people from Mine 4.

Luther Lu -- Millennium -- Analyst

Okay. So essentially, they cross the picket line. Is that what it is?

Walter J. Scheller -- Chief Executive Officer & Director

Yes.

Luther Lu -- Millennium -- Analyst

Okay. Okay. So that's an interesting development. And so can you give us a reminder of what the longwall change schedule is?

Dale W. Boyles -- Chief Financial Officer

What? The longwall what schedule, longwall move schedule?

Luther Lu -- Millennium -- Analyst

Longwall change. Yes, longwall change.

Walter J. Scheller -- Chief Executive Officer & Director

Let's see, if we will have, I think, one more move at Mine 7 this year. I believe it's a zero day move though. And I believe next year, we'll probably have -- my expectation would be a couple of moves at Mine 7 and at least one longwall move at Mine 4.

Luther Lu -- Millennium -- Analyst

Okay. Great. Thank you. That’s all my questions.

Walter J. Scheller -- Chief Executive Officer & Director

Thank you.

Operator

Ladies and gentlemen, at this time, there are no further questions. I would now like to turn the call back over to Mr. Scheller for any comments.

Walter J. Scheller -- Chief Executive Officer & Director

That concludes our call this afternoon. Thank you again for joining us today. We appreciate your interest in Warrior Met Coal.

Operator

[Operator Closing Remarks]

Duration: 45 minutes

Call participants:

Walter J. Scheller -- Chief Executive Officer & Director

Dale W. Boyles -- Chief Financial Officer

David Gagliano -- BMO Capital Markets -- Analyst

Lucas Pipes -- B. Riley Securities -- Analyst

Nathan Martin -- Benchmark Company -- Analyst

Luther Lu -- Millennium -- Analyst

More HCC analysis

All earnings call transcripts