Federal Coal Lease Obligations

9 Months Ended

Sep. 30, 2011

Federal Coal Lease Obligations

Federal Coal Lease Obligations

5.  Federal Coal Lease Obligations

During the three months ended June 30, 2011, we were the successful bidder on certain mining rights in the West Antelope II North (“WAII North”) and West Antelope II South (“WAII South”) Coal Tracts in the PRB.

On May 11, 2011, we successfully won the lease sale of WAII North with a bid of $297.7 million, or approximately $0.85 per ton, based on the Bureau of Land Management’s (“BLM”) estimate of 350 million mineable tons.  We submitted a payment for $59.5 million on May 11, 2011, and four additional payments in the same amount will be payable annually on July 1, the date of the lease award, beginning in 2012.

On June 15, 2011, we successfully won the lease sale of WAII South with a bid of $49.3 million, or approximately $0.875 per ton, based on the BLM’s estimate of 56 million mineable tons. We submitted a payment for $9.9 million on June 15, 2011, and four additional payments in the same amount will be payable annually on September 1, the date of the lease award, beginning in 2012.

Accordingly, during the second quarter of 2011, we recognized $293.9 million of mineral rights in our long-term assets along with a corresponding liability of $224.5 million, representing the discounted amount of the future lease payment obligations.  Interest is capitalized, resulting in a reduction of interest expense, as activities occur necessary to get these assets ready for their intended use, and generally will cease when all permits necessary to mine are received.

The successful bids were also a triggering event for updating our estimates of our asset retirement obligation and tax agreement liabilities in the second quarter.  The addition of the new mining rights impacted the asset retirement obligation as our Antelope mine’s life is now expected to be approximately 12 years longer, which reduced the discounted value of the future liability.  The resulting non-cash credit reduced depreciation and depletion expense on the unaudited condensed consolidated statements of operations by $15.7 million for the nine months ended September 30, 2011, as the change exceeded the carrying amount of the related asset retirement cost.

Fair Value of Coal Lease Obligations

The approximate fair value of our federal coal lease obligations was $317 million at September 30, 2011.  The fair value estimates for federal coal lease obligations were determined by discounting the remaining lease payments using a current estimate of the credit-adjusted, risk-free interest rate based on our current credit rating.

CPE Inc.

The addition of the WAII North and WAII South Coal Tracts also impacted our estimates of future taxable income.  The increased estimate of future taxable income will allow CPE Inc. to realize increased portions of the tax benefit generated as a result of the IPO and Secondary Offering transactions.  See Note 6 of our notes to unaudited condensed consolidated financial statements for additional discussion of the impact of these transactions.