Earnings Call
Cleveland-Cliffs Inc. (CLF)
Earnings Call Transcript - CLF Q3 2022
Operator, Conference Facilitator
Good morning, ladies and gentlemen. My name is Maria, and I'm your conference facilitator today. I'd like to welcome everyone to Cleveland-Cliffs Third Quarter 2022 Earnings Conference Call. All lines have been placed on mute to prevent any background noise. After the speakers' remarks, there'll be a question-and-answer session. The company reminds you that certain comments made on today's call will include predictive statements that are intended to be made as forward-looking within the safe harbors protections of the Private Securities Litigation Reform Act of 1995. Although the company believes that its forward-looking statements are based on reasonable assumptions, such statements are subject to risks and uncertainties that could cause actual results to differ materially. Important factors that could cause results to differ materially are set forth in reports on Form 10-K and 10-Q and news releases filed with the SEC, which are available on the company's website. Today's conference call is also available and being broadcast at clevelandcliffs.com. At the conclusion of the call, it will be archived on the website and available for replay. The company will also discuss the results excluding certain special items. Reconciliation for Regulation G purposes can be found in the earnings release, which was published this morning. At this time, I would like to introduce Celso Goncalves, Executive Vice President and Chief Financial Officer.
Celso Goncalves, CFO
Thank you, Maria, and thanks to everyone for joining us this morning. Before going through our Q3 results, let me start by highlighting the $1.8 billion improvement to our balance sheet that was outlined in our earnings release this morning. During the quarter, we signed two new labor agreements covering approximately 14,000 USW-represented employees, encompassing more than half of our workforce. These agreements also cover benefits for over 22,000 retirees. The ratification of these labor agreements triggered a remeasurement for the associated pension and OPEB plans, essentially requiring a refresh to all assumptions that go into calculating the value of those liabilities, including primarily interest rates, asset returns, and most importantly, the premiums that we pay for retiree healthcare expenses. With interest rates higher last year, and asset returns lower, those two factors effectively offset each other. But the third factor, the updated healthcare premiums resulted in a significant reduction to our overall liabilities. Using our size and scale to our advantage, we were able to proactively renegotiate significantly lower premiums with our health insurance providers at much lower costs. All in all, these updates reduce our net pension and OPEB liabilities on our books by $1.8 billion relative to the end of 2021, a 63% reduction. Our pro forma net liability for pension and OPEB is now only $1.1 billion, compared to $2.9 billion at the end of 2021 and $4.2 billion at the end of 2020 after we acquired ArcelorMittal U.S.A. In less than two years, we have reduced this liability by over $3 billion. As you may recall, the pension and OPEB liabilities we assumed were by far the largest piece of the enterprise value of the AM U.S.A. acquisition. And now most of those liabilities have moved over to equity on our balance sheet. Going forward, these changes will also reduce our OPEB cash funding obligations by more than $100 million per year, cutting this use of cash by more than half. Since the larger of the two labor agreements was not ratified until October 12, meaning after the end of Q3, the full impact of this change was not reflected on the actual Q3 balance sheet. That's why we provided the pro forma calculation in our press release this morning. Furthermore, the impact of these renegotiated healthcare premiums is also applicable to other plans that will not be remeasured until December 31. As a result, when we report the Q4 and year-end 2022 financials, we expect these liabilities to be even lower on the December 31 balance sheet. To be clear, the benefit we have gotten just comes from reduced premiums from healthcare providers and does not reflect any reduced benefits for our retirees. This was truly a win-win for both the company and the union, and we thank the USW for their partnership to make it happen. Now moving on to our results. In Q3, we generated $5.7 billion of revenues, $452 million of adjusted EBITDA, and $288 million of free cash flow. On the revenue front, steel sales volumes of 3.6 million net tons held roughly steady with the prior two quarters, as lower demand from service centers and distributors was offset by higher automotive volumes. Very importantly, Q3 of 2022 was our best quarter to the automotive market since the semiconductor shortage began. But it's still well below what we would consider normalized compared with the period from 2014 to 2019. Going forward in Q4, we expect total volumes to increase as a result of further improved automotive service center and slab demand. On the pricing side, our sequentially lower average selling price was driven by the index-linked portion of our business with declines in the hot rolled, cold-rolled, and slab indices. We also had declines in EBITDA for our third-party pellet and scrap businesses as a result of lower pricing. Looking into the fourth quarter, the improvements we achieved on the contractual fixed prices that reset in October will help to mitigate the lagged impact of continued falling index prices, but a product mix heavier in slabs and hot-rolled coils will be a negative factor on our realized price. Our adjusted EBITDA performance was also impacted by higher reported operating costs, which on a unit basis, trended upward in Q3 due to the lag effects of higher cost inventory that we foreshadowed on our previous call. Compared to 2021, our 2022 costs have been up meaningfully due to inflationary pressures on input and energy costs, as well as lower production volume and higher repair and maintenance spending. From a cash cost standpoint, these costs peaked in Q2, but the impact on our results was not fully flushed through EBITDA until Q3, a dynamic that can be seen once impairing the Q3 and Q2 cash flow statements. With all big repairs behind us, our repair and maintenance expenses have begun to decline rapidly here in Q4. Going forward, increased production volumes will also further dilute our fixed costs. From a free cash flow standpoint, we generated almost $300 million of free cash flow in Q3, largely driven by a significant amount of working capital released during the quarter. Price declines, combined with lower cost of inventory should lead to a continued release of working capital in Q4 and into next year, supporting strong free cash flow generation, and partially offsetting the cash flow impact of declining EBITDA. Our capital expenditures should decline in Q4 and even further into next year, where we expect total CapEx to be between $700 million and $800 million in 2023. We expect cash taxes to be negligible for the rest of this year, with a substantial refund coming in early 2023. Of course, pension and OPEB cash needs will decline substantially as discussed earlier. Consistent with our previously stated capital allocation priorities, we continue to use the majority of our free cash flow to pay down debt. During Q3, we've reduced that debt by $200 million. And on a year-to-date basis through today, we have reduced our net debt by $1 billion, bringing our current net debt level below where it was before we completed the acquisition of ArcelorMittal U.S.A. Our capital allocation priority remains to continue reducing our overall debt. Beyond that, we still have around $800 million remaining under our current share repurchase authorization. With almost $2.5 billion of liquidity, a much cleaner balance sheet with meaningfully reduced pension and OPEB obligations, lower operating costs going forward, less CapEx next year, minimal cash taxes for the remainder of this year, cash coming in from working capital and no major bond maturities until 2026, we are in great shape to navigate any potential recessionary environment. Very importantly, our automotive shipment levels in Q3 have indicated that our largest end market has been counter-cyclical due to the massive backlog from lower production over the past two years. The strength of our automotive franchise with our unique product offering and ability to lock in fixed price contracts will reduce volatility, especially now that our major maintenance, repair, and capital expenditures are behind us, and costs begin to trend meaningfully lower.
Lourenco Goncalves, CEO
Thank you, Celso. And good morning, everyone. Throughout my several years with Cliffs, our company has transformed and adapted to several different challenges. But two elements have remained constant throughout: our commitment and full support to manufacturing in the United States is one; and the importance we place on our people is the other. This is not just a speech; we have backed this up with actions. Our latest labor agreement with our USW-represented workforce is the most recent demonstration of that. The deal provides increased wages, offers better insurance, gives improved patient benefits, and enhances the vacation holiday provisions. We also agreed to continue to invest in our facilities with $4 billion over four years, combining CapEx and OpEx, which is consistent with typical spending on this type of investment for our footprint. We also kept the retiree benefits strong and were able to negotiate lower rates across the board as Celso has already explained. Together with our union partners, we have integrated into a standalone company in a span of just two years, where we overcame a difficult pandemic, completed the construction of a state-of-the-art direct reduction plant, invested to keep our muse at an automotive level standard, paid down a significant amount of debt, and drastically reduced our pension and OPEB liabilities, which we assumed two years ago, in order to make the entire transformation possible. Our third-quarter results were unique in that they reflect abnormally elevated costs, the largest portion of which was incurred in the second quarter, but did not flow all the way through until Q3. We have been preemptive since day one that the set of assets we acquired, particularly those from AM USA, were a bit under-invested and at some point would need some catch-up repair and maintenance. We got great value on these assets from these two acquisitions. In fact, over the past two years, we have already paid ourselves back with profits from the business, even with the persistent underperformance of the automotive industry during that timeframe. That said, embedded in the low acquisition price was an implied catch-up repair and maintenance cost, which is now behind us. As a major supplier to the automotive sector, the quality standard for our equipment must be pristine. We wrapped up repairs, beginning the fourth quarter of last year, reinvesting a portion of our record profits earned throughout the year. Around that time, we were assigning new fixed contracts with our automotive customers at higher prices, so it was even more important that our equipment capability was taken care of. As our spending picked up both CapEx and OpEx in many cases, we found more work to do than we initially anticipated. The best example of this was at the Cleveland works facility with losses from March through August. The original scope of the blast was realigned and expanded to effectively include the rebuild of the wastewater treatment plant and the powerhouse located on site, as well as several other smaller projects. Fast forward to the present moment, we are now at the point where the major maintenance cycle has been concluded. Due to the work we have done, our equipment is in great shape, and we are primed to meet the unique needs of our customers, particularly in automotive. The most common feedback we consistently hear from these automotive customers is about our perfected steel quality and our ability to keep them supplied during a time that the entire automotive sector has been deeply affected by underperformance from several suppliers throughout their supply chain. That is not the case with what they buy from Cleveland-Cliffs, and these clients know that. Throughout this year, and particularly during the big repairs, we have seen the negative impact of lower production volume, reducing our ability to dilute our fixed costs. In the first nine months of 2021, we sold 12.5 million tons of finished steel compared to 10.9 million tons of finished steel so far this year. That being said, automotive steel demand has started to improve in Q3, and we expect our volumes to increase further in Q4, which will result in improved costs going forward. The remaining drivers of higher costs, including increasing natural gas, electricity, and alloys, are not unique to us, and we have also seen some relief in these areas. All in all, based on our inventory status and current outlook for input costs, we expect our reported unit cost in Q4 to fall at least $80 per ton compared to Q3, with further reductions into the first half of 2023, even after factoring the increased wages in the USW labor agreements that were recently ratified. As for demand, we are encouraged by the 100,000 tons volume improvement from our automotive customers from Q2 to Q3. While they still are not back to normalized levels, the worst impact of the chip shortage seems to be behind us. In our view, automotive is now in a position to carry the market. Despite the Fed's best efforts to damage the job market, unemployment at 3.5% is at a 50-year low, meaning people both need cars to go to work and can qualify to buy cars because they have jobs and paychecks. Inventory levels at car dealers remain remarkably low that even if there is a consumer slowdown at the end-user level, there will still be a lag as there's a buffer until the slowdown in the production of cars, SUVs, and trucks eventually falls. The current average age of light vehicles on the road is over 12 years, which is the highest on record. For those who have rented a car in the past year, there's clear evidence that fleet inventories need to be replenished, as well as a meaningful 20% of the light vehicle market with a healthy backlog. Our October fixed contract renewals were another success, and the weighted average of the price increase we achieved would represent the second-best October renewal cycle in our legacy company's history, only behind last year. As we come to the table for our renewal cycle in January, our customers are being reminded that what we offer them cannot be compared to a CRU spot price. The difference between what makes up a CRU price and how we do business in automotive is night and day. We manage our production schedule based on our OEMs' needs. We have to reserve our available capacity to align with their production forecasts, as we hold their inventory if they have production issues, which, by the way, happens a lot. We have a fully dedicated customer service group that manages this complicated just-in-time inventory system to the point that our customers don't even have to think about steel when they need automotive. It is all before we even consider the constant technical support, research and development, and of course, the quality of materials that we provide them. In sum, in the United States, automotive steel means Cliffs. Now that they have microchips, we want each one of our automotive clients to be successful in 2023. They have a unique opportunity in 2023, as automotive may be the only sector with pent-up demand to take care of. The last thing they need now is not having access to all the specs of steel they need to produce cars. That can be a lot more devastating than not having microchips. On the distributor and service center portion of the business, customers have been following the typical herd mentality and buying hand-to-mouth in recent months. The strengthening of the dollar has not helped price either, but the economics of overseas imports no longer makes sense, supporting demand from domestic suppliers, as we close out the year. Our August price increase announcement brought some buyers off the sidelines, and we secured additional Q4 orders as a result. As long as underlying demand stays this way in the coming quarters, a restock will need to happen. Our green-oriented and non-oriented electrical steels continue to see very strong demand, as we anticipate rapid price increases in the fixed price for those products. We have an infrastructure build that should finally start to drive steel demand in the next year. We expect automotive to take up more of our share, and we have manufacturing being reassured. When these things turn around, they will turn around sharply. With an ongoing war, multi-decade-high rising inflation, rapidly rising interest rates, and a focus on mitigating climate change, we are living in a difficult time as a world in transition. However, we have already proven that Cleveland-Cliffs is capable of overcoming difficulties. The key to that is having the right people. People are the foundation of ESG. You cannot pretend to care about the environment if you neglect your people, and Cleveland-Cliffs will never do that. Several companies, the vast majority actually, fight through their ESG challenges with MoUs, letters of intent, and press releases, while Cleveland-Cliffs and very few others take concrete action. We built a direct reduction plant before it was trending. We have gone HBI using blast furnaces and we will remain on the cutting edge. Next for us will be the use of hydrogen, first in our direct reduction plant, and then in our blast furnaces. Blast furnaces have always been at the forefront of technological innovation in iron making and steelmaking; our current utilization of HBI as part of the burden in our blast furnaces confirms that. The future use of hydrogen and carbon capture will be the next examples of American blast furnaces leading in CO2 emissions reduction. Other companies in the United States and abroad are building new plants. New plants add CO2 emissions, regardless of the process utilized. Cleveland-Cliffs is not adding capacity, and we will not add capacity. We are reducing emissions within our existing installed capacity, and that is our ultimate goal. After we completed a transformational, once-in-a-generation consolidation of the amendments to the industry two years ago, some outsiders were fixated on the resulting pension and OPEB liabilities. Fast forward, in less than two years, those liabilities have become irrelevant. With our major repair and maintenance impact behind us, no ongoing or planned new construction project, and an improving automotive sector, and most importantly, labor peace throughout our organization, we are ready to continue to execute like we have been doing for eight years. With that, I'll turn it over to Maria for Q&A.
Operator, Conference Facilitator
Thank you. We will now begin the question-and-answer session. Our first question comes from Lucas Pipes with B. Riley Securities. Please proceed.
Lucas Pipes, Analyst
Hey, good morning, everyone. Congratulations on the OPEB obligation reduction. Lourenco, I remember during COVID, you used some common sense incentives to drive vaccination participation. I imagined that maybe you'd use similar common sense approaches to drive this. There is a really significant reduction in healthcare premiums now. We'd appreciate it if you could comment on some of the factors that drove that. Thank you very much.
Lourenco Goncalves, CEO
Thanks, Lucas. Look, this is a negotiation that is extremely complex. It's not just about the scale; we go in and propose because that requires cooperation with the unions to get accomplished. The majority of what was done, we consider partners, and we consider it better because we have them with us. With all the machines, all the unions know a company, and that gives us the ability to include the non-union personnel as well. So we present a very unified front when we negotiate with these healthcare giants. I think it's a first in a lifetime that a company of our size was able to accomplish what we achieved. It's a cost per person that was cut in half. This isn't just about the steel industry; I'm talking about companies in general. This is a unique thing. This is called management. Of course, I know that everybody is looking to the quarterly results, and I am looking too, and I like it, but costs are necessary, and prices are what we fight with the weapons we have. We accomplished the best we could. Eventually, we're going to have a quarter like Q3 that was not fantastic in terms of profitability. If you take a step back and see what we have accomplished—not just having the contract done with the union, but using the fact that we have ratification to accomplish a much bigger picture type of thing that will change the landscape in terms of our healthcare at Cliffs, and maybe later in a broader steel industry, and maybe later broader into the United States. I think that's how investors should really look into this.
Lucas Pipes, Analyst
That's very good to hear. Lourenco, switching topics, you touched on pricing. Three months ago, you were able to comment on the October contract resets with the auto customers. For January, do you have an indication at this point on what direction pricing might take on the fixed portion? Thank you very much for your perspective.
Lourenco Goncalves, CEO
Thanks, Lucas, for the question. As you know, the result of our October negotiations are not reflected in the numbers just yet because we are reporting Q3. Of course, we know that. What we are going to have going forward is a much better number coming from our October tranche that we negotiated, and the accomplishment is good. Of course, I'm not going to give any numbers, but we are in good shape. Remember, we're the only ones supplying exposed parts, for example. We know that; they know that. We compete very little with those that can produce the more standard grades. We remind car manufacturers that the car is a complicated puzzle, and we are the only ones that have all the pieces of the puzzle. That gives us leverage in the negotiation—can't stress that enough. In the past, we had Bethlehem, LTV, AK, Armco, and several others that are now Cleveland-Cliffs. They know that. This is a very important part of our negotiation. I think I have given enough color for you to see the picture.
Lucas Pipes, Analyst
I appreciate the color very much. I'll turn it over for now. But continued best of luck. Thank you.
Lourenco Goncalves, CEO
Thanks.
Operator, Conference Facilitator
Our next question comes from Emily Chieng with Goldman Sachs. Please proceed with your question.
Emily Chieng, Analyst
Good morning, Lourenco and Celso. Thank you for taking my questions. My first one is just around costs. Understandably, you're looking at $80 a ton lower costs into the fourth quarter. But perhaps could you share what you're seeing in the moving pieces to drive 2023 costs below that mark as well?
Lourenco Goncalves, CEO
Yeah, I'll let Celso answer this one. Celso, please go ahead.
Celso Goncalves, CFO
Yeah, sure, Emily. As we stated in our prepared remarks, there was a lot of repair and maintenance that we had to do here in 2022. As we look to next year, a lot of those repairs and maintenance costs are going to come down significantly. You can expect them to be down by around $400 million for next year. We'll have a lot lower idle costs next year relative to this year. We don't have any major outages like we did this year. So there are a lot of tailwinds that are going to start driving our costs down rapidly. As we increase our volumes, we are really pushing to get up to 3.8 million to 4 million tons again, and that's going to further dilute our fixed costs going forward as well. And then you have other things like energy costs—natural gas has come down a lot—and things like that, which are also going to be a tailwind next year.
Emily Chieng, Analyst
Great, thanks, Celso. And just a follow-up. Can you remind us of your gas and coal costs? On the gas side, are you still hedging 50% of that and the remaining 50% is spot? And with the coal piece of it, how should we think about the upcoming contract renegotiations there? Thanks.
Celso Goncalves, CFO
On natural gas, you're correct; we're hedged 50% through the end of next year at this point. If you look at the futures curve for gas, it's around $5 per MBTU compared to almost $7 that we're realizing this year. So those costs are coming down. And then on the met coal side, you can probably model coal costs to be up about 5% to 7% next year, so it's still not meaningful.
Emily Chieng, Analyst
Great. Thank you.
Operator, Conference Facilitator
Our next question is from Tristan Gresser with BNP Paribas. Please proceed with your question.
Tristan Gresser, Analyst
Yes, hi. Thank you for taking my question. The first one is on the plate market. Can you discuss a bit the market dynamics there, the premium elevated compared to HRC, but also the sustainability of that? Moving forward, with Nucor, a competitor wrapping up capacity, how do you prepare for the arrival of increased competition in the market? How strategic are plate shipments for Cliffs? Thank you.
Lourenco Goncalves, CEO
Tristan, the sustainability in pricing of the plate market is driven by fewer participants, all of whom are responsible. In the light flat rolled market, we have at least one in the United States that is totally responsible, and two in Canada that are completely irresponsible. Irresponsible players can destroy the market. The market destruction affects everybody. In situations like that, management matters. Don’t believe that we are here on the receiving end of this bad behavior. We are not going to retaliate and create issues for them. The plate market doesn’t have that because everybody is in the market to make money. That’s why we have a much better market in plate than in light plate roll. As far as new capacity, the new capacity that’s coming is overdue. Plate has been a playground for imports for a long time, and I’m happy that Nucor put capital into deploying capacity where it’s needed and pushing imports out. That mentality will be good for us, Cleveland-Cliffs, going forward, especially in military. This is not just U.S. military; we are receiving orders from lots of countries that are friends of the United States, all stepping up their expenditures on plate-related business. We are the ones in the United States out of Coatesville, mainly out of Coatesville, but also Weirton, that can produce quality military-level plate. That will be one of the superstars of 2023. I hope I gave you the picture you were asking for.
Tristan Gresser, Analyst
Yes, that's very interesting. Thank you. My second question is more on something you touched on regarding decarbonization in general. We're starting to see steelmakers in Europe receiving large sums of money to decarbonize and build DRI capacity and electric arc furnace capacity. How do you view that in a global perspective, as those steelmakers can be competitors at times? Is that a signal for you to go to the U.S. government and do the same, or do you believe there may be room for more aggressive trade actions regarding Europe?
Lourenco Goncalves, CEO
Yeah. Decarbonization in the United States has not been done through subsidies so far; it has been done through action and a few responsible companies that are doing very serious things. As you may know, we built an HBI plant and we use it in our blast furnaces. Because we use our HBI in our blast furnace, our coke rate is 50% of the coke rate in Europe. The lower coke usage means 50% less CO2 from coke. It’s a straightforward relationship. We are really decarbonizing in the United States. In Europe, there’s a lot of talk about decarbonization, but I think that the problem there right now is currency, heating homes, and finding a way around the lack of gas from Russia. I believe Europe has more important issues to address. Decarbonization will be left to those who can do it. In the United States, we are doing it and will continue to do it our way.
Tristan Gresser, Analyst
Alright, thank you.
Lourenco Goncalves, CEO
No question about pension or OPEB? Your institution—the financial institution out of Europe—is the most concerned about pension and OPEB, and you don't even ask me a question?
Tristan Gresser, Analyst
Well, it's pretty clear, so we take note. Thank you.
Lourenco Goncalves, CEO
Good. Alright.
Operator, Conference Facilitator
Our next question is from Curt Woodworth with Credit Suisse. Please proceed with your question.
Curtis Woodworth, Analyst
Thank you, good morning. I wanted to follow up with respect to the cost guidance for next year, around the $400 million. This year, you outlined $200 million of reline costs and other inventory absorption issues from high-cost inventory. I believe in the P&L, I saw another $100 million to $150 million. To make sure I understand correctly, would the apples-to-apples comparison for next year be more like $100 million down? I just want to make sure I'm understanding the cadence of costs relative to this year.
Celso Goncalves, CFO
Yes. Let me add some more color there, Curt. Thanks for the question. As we tried to explain in the prepared remarks, costs that we're seeing here in Q3 were largely a function of elevated spend from Q2. I think everyone kind of understands that, right? You can see in our cash flow statement that inventory was a $250 million inflow at this time, and it was a $250 million outflow last time. Almost everything that drove costs up this year is coming down, including the inflationary pressures we’re seeing on input costs. Repairs and maintenance, as I stated, are expected to be lower by $400 million next year. Everything that has driven costs up this year is starting to materially drop. We are going to see the benefit of that in the quarters to come. I don't know if I specifically answered your question, but I'm happy to add more color if needed.
Curtis Woodworth, Analyst
Okay. So MRO apples-to-apples will be down $400 million. Should we assume then that because of— I don't think you have a major reline next year, that would give you another $200 million to $300 million. So the total cost down potential for next year would be about $700 million, correct?
Celso Goncalves, CFO
That's correct, yes.
Curtis Woodworth, Analyst
Okay. Just a follow-up on trade policy in the United States. There's still Russian pig iron coming into the country. I'm curious about the communications you've had with the Department of Commerce and any updates on your view of trade policy in the U.S. Thank you.
Lourenco Goncalves, CEO
Yeah. Look, Curt, this is Lourenco here. We communicate with them. But the pig iron that comes into the country, either directly or indirectly through rerouting and transshipment, doesn’t happen without notice. It happened because there was that import of pig iron, and they know what they are doing. We are not the cops. We can inform and we do inform, but that’s pretty much it. If a company imports pig iron from Russia, don’t play the nice guy. You are supporting a dictator. You are supporting a butcher that, 50 years from now, will be put at the same level as Hitler. Companies in Germany still pay the price for supporting the Nazi regime. The ones that import pig iron are setting themselves up for future scrutiny. It might look good for the quarter; it might not look good in 5, 10, or 20 years.
Curtis Woodworth, Analyst
Understood. Thank you.
Operator, Conference Facilitator
Our next question is from Alex Hacking with Citi. Please proceed with your question.
Alex Hacking, Analyst
Yeah, thanks. Good morning, Lourenco and Celso. On the automotive side, the U.S. autos seem to be running maybe 20% below where they should be, around 13 million versus 16 million to 17 million vehicles. Is that how we should think about the impacts on your volume? Because if I run that through your auto volumes, it appears you've been shipping 300,000 to 350,000 tons below what you would normally expect. That would potentially be the amount of volume we could see recover every quarter as the automotive market recovers. Is my math correct?
Lourenco Goncalves, CEO
You are directly correct, yeah. We are still in the 13 to 14 range—not over 14. We did the 13s in automotive, and it was expected that this level would be a lot closer to what was the normalized level between 2014 and 2019. So we are still running behind. They are still running behind. That being said, it is encouraging to see that we have something concrete to show: a 100,000 tons improvement. It's nothing to throw a party over, but it is a step in the right direction. Car prices are increasing to the end user, so car manufacturers are making money. Therefore, the biggest supplier of steel to the car manufacturers is making money as well on those sales and plans to continue to make money from those sales. We might have too many car manufacturers in the U.S., which is something to consider in our strategic analysis.
Alex Hacking, Analyst
Okay, thank you. Celso, you mentioned earlier that you would not be paying cash taxes for the rest of the year. Would you expect to pay full cash taxes in 2023? Thank you.
Celso Goncalves, CFO
That’s right. In Q4, cash taxes will be minimal. For 2023, it will depend on profitability. Depending on how things play out, we could even have a significant tax refund coming in, which could be a source of cash early in ‘23 as well.
Alex Hacking, Analyst
What would be the driver of that tax refund? I apologize for asking.
Celso Goncalves, CFO
We made some overpayments this year, so some of that would be reversed back, and we would get some cash inflow from that.
Alex Hacking, Analyst
Got it. Thank you very much.
Celso Goncalves, CFO
No problem.
Operator, Conference Facilitator
Our next question comes from Carlos De Alba with Morgan Stanley. Please proceed with your question.
Carlos De Alba, Analyst
Thank you very much. Good morning. Regarding prices, I know that you don’t want to give us a number, and that’s understandable. But maybe just talking about the outlook for the January reset of your contracts; if I’m not mistaken, that is a bigger chunk of renegotiation for you guys. How is that progressing, given the trend we have seen in the spot market down but the recovery in auto sector volumes that should potentially offset that, maybe more than offset that? Any color on the January reset of contracts would be great.
Lourenco Goncalves, CEO
The trend will remain the same. We are just beginning, so there aren’t many specifics available regarding the automotive contract renegotiation like we have for October. However, you are correct that it represents the vast majority. The groundwork has been established. Our discussions with the January clients should be facilitated by the fact that they tend to be more reasonable, and because they are aware of what we are achieving with others. Interestingly, while all these prices are highly confidential, they know significantly more than we disclose as we maintain our respect for our SGH. At this point, they understand we are serious; they recognize our credibility. Initially, there were questions about who we were, but now they know us, so I believe the process should be smoother.
Carlos De Alba, Analyst
Alright. And in terms of volumes, just to clarify, it’s clear that production in the fourth quarter is going to improve. Shipments to the automotive market—sales volumes to the automotive sector will also increase. But just to double-check, do you expect overall volumes, shipment sales volumes in the fourth quarter to also be higher?
Lourenco Goncalves, CEO
Yes, we are. We no longer have major repairs in place, so we expect to recover our usual 4 million tons of shipments a quarter—3.9 to 4 million tons a quarter. It all depends on how many slabs we are going to add to the mix. That’s why it’s 3.9 to 4 million. More slabs, even though they help dilute the fixed costs, aren’t exactly our best money makers. There’s a balancing act between the mix and the volume. The higher volume helps cost, but eventually, the higher volume comes from products with a lower margin impact.
Carlos De Alba, Analyst
Right, that's clear. Okay. One final question. With costs coming down, CapEx in the $700 million to $800 million range next year, even considering lower steel prices, it seems that your free cash flow generation is going to be quite interesting and strong. Any changes on your capital allocation front, or do you continue to prioritize debt reduction and potentially some share buybacks but not dividends yet?
Lourenco Goncalves, CEO
Look, the priority continues to be paying down debt. We continue to do that quarter after quarter. Even though the underlying EBITDA is lower, cash flow was not. Remember the priority. The priority is not to impress the street; the priority is not to add subscribers like these unicorns. Our product is to pay down debt. We will generate cash. We did not renegotiate with our healthcare contracts because we wanted to be nice or to reduce costs; we did it to generate cash to pay down debt. We are doing exactly what we told you we would be doing. The investors that understand that will stay with us. Actually, they will take the opportunity of the shares on sale to buy more. If we can buy more, we have the authorization. But what’s my priority, Carlos? My priority is to pay down debt—not to pay a dividend. When we get to the point to say, yeah, that’s good; that’s the level that I feel is sustainable going forward, and there is no inflation; and the Fed is no longer crazy, isn’t trying to destroy the economy; they are not trying to generate unemployment—because that's what they are doing—then we can do whatever we need to keep growing toward returning capital to shareholders. But don’t forget that we have bought a lot of stock so far, and that’s returning money to shareholders.
Carlos De Alba, Analyst
Alright, excellent. Thank you very much, Lourenco.
Lourenco Goncalves, CEO
Thanks, Carlos.
Operator, Conference Facilitator
Our next question is from Timna Tanners with Wolfe Research. Please proceed with your question.
Timna Tanners, Analyst
Hey, good morning. I really like Lourenco's point about how all new mills add carbon emissions. That's excellent. I wanted to ask a follow-up on the volume side, if I could. Looking ahead, we’ve seen a mix of philosophies out there. Some mills are adding capacity and running it; some are cutting capacity and shedding. Cliffs obviously benefits—as you point out—from running more volumes. You have Cleveland Bear running, you have automotive improving, but yet your steel production is still below year-ago levels. I’m just wondering how we think into next year on the mix of your potential volume and how that can continue to cut your average cost. Thanks.
Lourenco Goncalves, CEO
Thanks for the question. Look, we will continue to maximize the utilization of our assets. We are not going to take equipment down to implement discipline in the market if others are completely undisciplined. If others feel that their business model is based on destroying the marketplace just because they can put the scrap price wherever they want, they might be right, but we don’t agree with that approach. We run our assets to minimize our costs. As long as we can make money, we will run. That is a good balance because we can generate cash that way. Don’t count on me to take capacity out to make the lives of others better. While that happened in Q2 and part of Q3 due to repairs at Cleveland Works, when Cleveland Works was done, we came back. Remember, Cleveland Works is the biggest producer of advanced high-strength steel for automotive—not exposed users. That’s why we fixed that. We have significant confidence that automotive will pick up, and orders coming to Cleveland Works will start to pile up. We are seeing that as we speak. Others cannot do that, which is why our capacity can come back, particularly since it is serving markets we believe in that may be the only exciting spots in 2023.
Timna Tanners, Analyst
Got it. Is it reasonable to assume that continued progress in automotive recovery can result in Cliffs producing over 4 million tons again per quarter? Will that mix still sway toward automotive, or are you also going to be shipping into some of those other businesses? We’ve seen a bit of mix deterioration in the fourth quarter. How do you see that going forward?
Lourenco Goncalves, CEO
I already explained that mix deterioration. Automotive is the main reason we are back to producing $4 million a quarter, and it will be that going forward. So that’s automotive.
Celso Goncalves, CFO
No, I'll just clarify. You said $4 million; it's actually 4 million tons.
Lourenco Goncalves, CEO
Sorry—old man.
Timna Tanners, Analyst
Thank you.
Operator, Conference Facilitator
Ladies and gentlemen, there are no further questions at this time. This concludes today's presentation. You may disconnect your lines at this time. Thank you for your participation.