Commitments and Contingencies

9 Months Ended

Sep. 30, 2011

Commitments and Contingencies

Commitments and Contingencies

9.  Commitments and Contingencies

Commitments

In April 2008, we entered into an agreement to purchase land adjacent to our Antelope mine, whereby the seller will require us to pay a purchase price of up to $23.7 million which will close between April 2013 and April 2018.

In the second quarter of 2011, we entered into agreements with remaining terms longer than one year for the shipments of coal for future periods.  The cumulative minimum payments for these agreements entered into during the second quarter were $117.0 million.

In the third quarter of 2011, we entered into agreements with remaining terms longer than one year for the purchase of materials and supplies for future periods.  The cumulative minimum payments for these agreements entered into during the third quarter were $5.8 million.

As of September 30, 2011, we had outstanding capital purchase commitments of $25.5 million and coal purchase commitments of $10.8 million.

Tax Receivable Agreement (CPE Inc. only)

In connection with the IPO, CPE Inc. entered into a Tax Receivable Agreement with Rio Tinto and recognized a liability for the undiscounted amounts that CPE Inc. estimated will be paid to Rio Tinto under this agreement.  The amounts to be paid will be determined based on a calculation of future income tax savings that CPE Inc. actually realizes as a result of the tax basis increase that resulted from the IPO and Secondary Offering transactions.  Generally, CPE Inc. retains 15% of the realized tax savings generated from the tax basis step-up and Rio Tinto is entitled to the remaining 85%.  Periodically, CPE Inc. will adjust the estimated liability to reflect an updated forecast of future taxable income and these adjustments, which could be significant, will be reflected in CPE Inc.’s operating results.  The assumptions reflected in CPE Inc.’s estimates involve significant judgment and are subject to substantial uncertainty about future events.

During the three months ended June 30, 2011, the successful bids for the WAII North and WAII South Coal Tracts were considered triggering events for updating our estimates of the tax agreement liability.  This resulted in an increase in the undiscounted estimated future liability due to Rio Tinto under the Tax Receivable Agreement, resulting in a $42.7 million charge to non-operating income for the three and six months ended June 30, 2011.  Related adjustments of $15.4 million to the net value of deferred tax assets were recorded through income tax benefit at June 30, 2011.

During the three months ended September 30, 2011, CPE Inc. completed its 2010 federal income tax return filing process, which included a final determination of the amount of CPE Inc.’s increased tax basis in CPE Resources’s assets recorded as a result of the Secondary Offering.  By operation of the partnership income tax rules following Rio Tinto’s exit from the partnership under the Secondary Offering, the future value attributable to the additional tax basis has been recalculated and reduced.  Correspondingly, the liability CPE Inc. expected to owe under the Tax Receivable Agreement at the time of the Secondary Offering decreased, resulting in a $29.9 million credit to additional paid in capital as of September 30, 2011.

Additionally, during the three months ended September 30, 2011, CPE Inc. completed its annual update of its most recent operating plans and calculation of the resulting estimated future taxable income.  Because of the reduced future tax value expected to be received as explained above, there was a decrease in the estimated liability due to Rio Tinto under the Tax Receivable Agreement, resulting in a $22.9 million benefit to non-operating income for the three months ended September 30, 2011.  Related adjustments of $8.2 million to the net value of deferred tax assets are recorded through income tax expense.

As of September 30, 2011, CPE Inc. recognized a total $180.0 million undiscounted liability for its estimated payments to Rio Tinto under the Tax Receivable Agreement, of which $9.4 million and $170.6 million were classified as current and noncurrent, respectively.  The estimated liability was based on forecasts of future taxable income over the anticipated life of the mining operations and reclamation activities, assuming no additional coal reserves are acquired. The amounts to be paid will be determined based on a calculation of future income tax savings that CPE Inc. actually realizes as a result of the tax basis increase that resulted from the IPO and Secondary Offering transactions.

The assumptions used in CPE Inc.’s forecasts are subject to substantial uncertainty about future business operations and the actual amount and timing of payments that are required to be made under the Tax Receivable Agreement could differ materially from our estimates.  Based on our estimates as of September 30, 2011, CPE Inc. is expected to make payments of $9.4 million in 2011 and annual payments averaging approximately $20.0 million during 2012 to 2015.  CPE Inc. is obligated to make these payments and expects to obtain funding for these payments by causing CPE Resources to distribute cash to its owner, CPE Inc.  CPE Inc.’s payments under the Tax Receivable Agreement would be greater if CPE Resources generates taxable income significantly in excess of its current estimated future taxable income over the anticipated life of its mines, for example, because CPE Resources acquires additional coal leases beyond its existing coal leases and, as a result, CPE Inc. realizes the full tax benefit of such increased tax bases (or an increased portion thereof).  Required payments under the Tax Receivable Agreement also may increase or become accelerated as a result of certain asset transfers outside the ordinary course of business, a change in control of CPE Resources, or a default by CPE Inc.

Contingencies

ONRR Litigation — Decker Mine

The Office of Natural Resources Revenue (“ONRR”) (formerly the Mineral Management Service), a federal agency with responsibility for collecting royalties on coal produced from federal coal leases, issued two disputed assessments against Decker Coal Company (“Decker”): one for coal produced from 1986-1992, and the other for coal produced from 1993-2001.  Both assessments concern coal sold by Decker to Big Horn Coal Company (“Big Horn”) and Black Butte Coal Company (“Black Butte”), and in turn resold by those entities to Commonwealth Edison Company (“Commonwealth Edison”) to satisfy requirements under long-term contracts between those entities and Commonwealth Edison.  The ONRR maintained that Decker’s royalties should not be based on the prices at which Decker actually sold coal to Big Horn and Black Butte because ONRR did not believe those prices represented the results of arm’s length negotiation.  ONRR based this conclusion on the facts that those entities were both affiliates of KCP, Inc., formerly known as Kiewit Coal Properties, Inc., which is also a 50% owner of Decker, and that the sales were contingent on Big Horn’s and Black Butte’s ability to resell the coal to Commonwealth Edison, which did not leave Big Horn and Black Butte at market risk.  Instead, the ONRR assessed Decker’s royalties based on the higher prices set under Big Horn’s and Black Butte’s separate long-term contracts with Commonwealth Edison.

With respect to the period 1986-1992, the ONRR assessment did not contain a specific dollar amount.  Decker appealed the assessment through the administrative process with the ONRR and that appeal was unsuccessful.  A further appeal was filed before the United States District Court for the District of Montana.  In March 2009, the District Court set aside the ONRR assessment and entered judgment for Decker (“Decker I”).  The ONRR did not appeal the ruling.

With respect to the period 1993-2001, the ONRR assessed approximately $7.5 million plus interest, which was estimated to be approximately $11 million inclusive of interest.  Decker appealed the ONRR assessment through the administrative process with the ONRR and that appeal was unsuccessful.  A further appeal was filed before the United States District Court for the District of Montana.  In February 2010, the District Court vacated the administrative order from the Interior Board of Land Appeals affirming the ONRR assessment.  The District Court remanded the case to the ONRR for further review and noted that the remand would not unduly prejudice Decker in light of the District Court’s opinion in Decker I.  There is no ONRR assessment currently pending against Decker for the 1993-2001 period.

We have not accrued a liability in our consolidated financial statements with respect to this matter as any potential losses are not considered to be probable and reasonably estimable.  If the ONRR issues a new assessment for the 1993-2001 period, Decker believes it will have substantive challenges to any such assessment in light of the District Court’s decision in Decker I.  Decker also believes that it has contractual price escalation protection from any increased assessments for 1993-2001; and that, in addition, Commonwealth Edison has indemnified Black Butte with respect to the 1993-2001 assessment, and that in furtherance of that obligation, Commonwealth Edison or its parent company, Exelon Generation, Inc., has therefore agreed to indemnify Decker directly for such matters.  If a new assessment is issued by the ONRR for the 1993-2001 period and is upheld and the indemnities and/or price protections were ultimately not available to Decker, the resulting Decker liability could be material.  As a result of our 50% ownership interest in Decker, our financial results could in turn be materially adversely affected.  We consider Decker’s conclusions to be reasonable; however, we have not relied upon Decker’s conclusions in reaching our decision that any potential losses are not considered probable and reasonably estimable.

Caballo Coal Company Litigation — Spring Creek

In September 2009, Caballo Coal Company (“Caballo”), a subsidiary of Peabody Energy Corporation, commenced an action in Wyoming state court against Spring Creek Coal Company (“Spring Creek”), our wholly-owned subsidiary, asserting that Spring Creek repudiated its allegedly remaining obligation under a 1987 agreement to purchase an additional approximately 1.6 million tons of coal, for which it seeks unspecified damages.  Spring Creek believes that it has meritorious defenses to the claim, including that Caballo breached the agreement by failing to make required deliveries in 2006 and 2007.  Spring Creek also believes that it has meritorious counterclaims against Caballo.  If, however, the case was determined in an adverse manner to us, the payment of any judgment could be material to our results of operations.

Other Legal Proceedings

We are involved in other legal proceedings arising in the ordinary course of business and may become involved in additional proceedings from time to time.  We believe that there are no other legal proceedings pending that are likely to have a material adverse effect on our consolidated financial condition, results of operations or cash flows.  Nevertheless, we cannot predict the impact of future developments affecting our claims and lawsuits, and any resolution of a claim or lawsuit or an accrual within a particular fiscal period may adversely impact our results of operations for that period.  In addition to claims and lawsuits against us, our leases by application (“LBAs”), permits and other industry regulatory processes and approvals may also be subject to legal challenges that may adversely impact our mining operations and results.  For example, the BLM’s process of environmental review related to the WAII North and WAII South Coal Tracts is subject to pending legal challenges filed by environmental organizations against the BLM and the Secretary of the Interior.

Tax Contingencies

Our income tax calculations are based on application of the respective U.S. federal or state tax law.  Our tax filings, however, are subject to audit by the respective tax authorities.  Accordingly, we recognize tax benefits when it is more likely than not a position will be upheld by the tax authorities.  To the extent the final tax liabilities are different from the amounts originally accrued, the increases or decreases are recorded as income tax expense.  We are not potentially liable for income tax contingencies related to periods prior to the IPO, as the income taxes recognized in our consolidated financial statements for such periods were reported in Rio Tinto America’s consolidated income tax returns, and Rio Tinto has agreed to indemnify us for any claims related to such income taxes.

Several audits involving our taxes other than income taxes are currently in progress.  We have provided our best estimate of taxes and related interest and penalties due for potential adjustments that may result from the resolution of such tax audits.

Concentrations of Risk and Major Customers

Approximately 82% of our revenues for the nine months ended September 30, 2011 were under multi-year contracts that specify pricing terms compared to 84% for the nine months ended September 30, 2010.  While the majority of the contracts are fixed-price, certain contracts have adjustment provisions for determining periodic price changes.  For the nine months ended September 30, 2011 and 2010, there was no single customer that represented more than 10% of consolidated revenues.  We generally do not require collateral or other security on accounts receivable because our customers are comprised primarily of investment grade electric utilities.  The credit risk is controlled through credit approvals and monitoring procedures.

Guarantees and Off-Balance Sheet Risk

In the normal course of business, we are party to guarantees and financial instruments with off-balance sheet risk, such as bank letters of credit, performance or surety bonds and indemnities, which are not reflected on the consolidated balance sheet.  In our past experience, virtually no claims have been made against these financial instruments.  Management does not expect any material losses to result from these guarantees or off-balance-sheet instruments.

U.S. federal and state laws require we secure certain of our obligations to reclaim lands used for mining and to secure coal lease obligations.  The primary method we have used to meet these reclamation obligations and to secure coal lease obligations is to provide a third-party surety bond, typically through an insurance company, or provide a letter of credit, typically through a bank.  Specific bond and/or letter of credit amounts may change over time, depending on the activity at the respective site and any specific requirements by federal or state laws.  As of September 30, 2011, we had $10.5 million of standby letters of credit and $570.6 million of performance bonds outstanding (including our proportional share of the Decker mine) to secure certain of our obligations to reclaim lands used for mining and to secure coal lease obligations.