Good morning, ladies and gentlemen, and welcome to the GrafTech third quarter 2022 earnings conference call and webcast. At this time, all lines are in a listen-only mode. Following the presentation, we will conduct a question-and-answer session. If at any time during this call you need assistance, please press star zero for the operator. This call is being recorded on Friday, November 4, 2022. I would now like to turn the conference over to Mike Dillon, Vice President, Investor Relations and Corporate Communications. Please go ahead.
Good morning and welcome to GrafTech International's third quarter 2022 earnings call. On with me today are Marcel Kessler, Chief Executive Officer, Jeremy Halford, Chief Operating Officer, and Timothy Flanagan, Chief Financial Officer. Marcel will begin with comments related to our operations in Monterrey, Mexico. Jeremy will then discuss safety, sales, and operational matters. Tim will review our quarterly results and other financial details.
Marcel will then close with comments on our outlook. We will then open the call to questions. Turning to our next slide. As a reminder, some of the matters discussed on this call may include forward-looking statements regarding, among other things, performance, trends, and strategies. These statements are based on current expectations and are subject to risks and uncertainties. Factors that could cause actual results to differ materially from those indicated by forward-looking statements are shown here.
We will also discuss certain non-GAAP financial measures, and these slides include the relevant non-GAAP reconciliations. You can find these slides in the Investor Relations section of our website at www.graftech.com. A replay of the call will also be available on our website. I'll now turn the call over to Marcel.
Good morning, everyone. Thank you for joining GrafTech's third quarter earnings call. Before we dive into GrafTech's third quarter performance, I would like to begin with a detailed discussion about our operations in Monterrey, Mexico. First, I want to thank the entire GrafTech team, and in particular, all our employees in Monterrey for their efforts to address the situation and the continued focus on moving our business ahead.
I would also like to thank our customers for their ongoing support and understanding. In a nutshell, here is the update on the current status. First, Monterrey's manufacturing operations remain suspended, and we are pursuing all possible avenues to get the site reopened. At this point, we don't know when operations will resume. However, we remain confident in our ability to ultimately resolve this situation.
Second, Monterrey is 30% of our total annual production capacity and currently the only site that produces the pin stock utilized for all our electrodes. We are working to restart our facility in St. Marys, Pennsylvania, as well as pursuing other mitigation strategies to produce 100% of our pin needs when fully implemented.
Third, unless Monterrey reopens, our business performance will be significantly impacted for the first two quarters of 2023, with a reduction in sales volume of 50% or more before recovering in the back half of the year. Fourth, we expect to be able to meet our LTA commitments in 2023. Fifth, we have ample liquidity to see us through this challenge. Sixth, while the situation with Monterrey is very unfortunate, we remain optimistic about the longer-term outlook for GrafTech.
We have sustainable competitive advantages, including substantial vertical integration into petroleum needle coke, longer-term demand tailwinds, and a talented and experienced team. We will emerge stronger from this short-term challenge. Let me provide more detail on each of these six points. Our facility in Monterrey has been operating since 1959, has over 550 employees, and represents approximately 60,000 metric tons or 30% of our total annual electrode production capacity.
Monterrey's operations can produce a broad portfolio of products, including various sizes of graphite electrodes and pins. As we have previously reported, on September fifteenth, inspectors from the environmental authorities for the State of Nuevo León, Mexico, visited our facility in Monterrey. At the conclusion of this visit, the inspectors issued a temporary suspension notice. Other than to allow for safe wind down of all operations, the suspension notice was effective immediately.
In early October, we obtained clarification that certain non-production activities, including the movement of inventory, were permitted to continue. Apart from these permitted activities, operations have been halted since that time. The findings of the inspectors focused on procedural errors related to certain operating licenses and permits. I believe that it's important to point out that at no time during or after the inspection has it been alleged by the relevant authorities that our operations exceeded any existing emission standards.
In the past several years, we have invested over $10 million upgrading our Monterrey site to continuously improve our environmental performance. Also, we have previously initiated our voluntary participation in Mexico's Federal Clean Industry Certification Program. These efforts are part of our commitment to the community that we believe GrafTech has demonstrated in its long history in this area.
We strongly disagree with the conclusion to suspend our operations, and we believe this measure is in no way commensurate with the findings of the state inspectors. Further, we do not believe a suspension notice should legally be applied to this situation. While we are complying with the suspension notice, we are vigorously defending our rights to resume operations.
To that end, we are pursuing all available legal remedies, as well as engaging in dialogue with the respective state and local authorities involved in these matters. As I mentioned in my introduction, Monterrey is currently the only site that produces the pin stock needed for all our electrodes. Each electrode requires one pin to be utilized by our customers. We are actively pursuing multiple alternatives and mitigation strategies as it relates to internal production and external sourcing of pin stock. These include accelerating a potential restart of our
St. Marys, Pennsylvania facility. As many of you know, our St. Marys site was previously a full-scope electrode and pin production facility. Production at St. Marys was rationalized at the time of lower demand in the electrode industry. Over the last few years, we resumed operation of certain functions at St. Marys.
We are now actively pursuing approvals for operating permits to restart the facility for pin production. With these permits and an incremental investment of about $8 million, St. Marys will be able to resume operations, supplying 100% of the pins for GrafTech electrodes. We expect that any Mexico mitigation activities, including this potential restart of St. Marys, will take the first half of 2023 to be fully implemented. However, until our Monterrey operations are resumed or our St. Mary s facility is operational or other mitigation activities are successfully implemented, our ability to fulfill customer orders will be significantly impacted, particularly as we get into the next year.
The impact will be less significant for the fourth quarter as existing pin stock inventory is supporting our ability to fulfill most customer needs in the near term. For next year, if Monterrey remains suspended, sales volume will be reduced by 50% or more in the first half of 2023 compared to the first half of 2022, but will recover after that. We expect to be able to meet our LTA commitments throughout 2023. As we move into the second half of 2023, assuming our mitigation activities related to pin production are fully implemented and depending on market conditions, we anticipate that sales volume levels will recover.
With over $130 million in cash on hand as of today, we have ample liquidity to see us through all reasonable scenarios. Also, there has been no impact on our ability to borrow under our existing facility, on our borrowing costs, or on our borrowing needs. While we are deeply disappointed with the current situation and the uncertainty that it has caused, we believe that ultimately, reason and the rule of law will prevail and our Monterrey facility will resume operations.
As I said at the start, looking forward, we remain optimistic about the longer-term outlook for our business. We have a great team and sustainable competitive advantages. We will be able to leverage these competitive advantages to capitalize on long-term industry tailwinds generated by the steel industry's efforts to decarbonize. I will provide further comments on our outlook at the end of our prepared remarks. Let me first turn the call over to Jeremy now, who will be followed by Tim, as they provide commentary on our third quarter performance.
Thank you, Marcel, and good morning, everyone. I'll start my comments with a brief update on health and safety excellence, which is a core value at GrafTech as people are our most important asset. While our overall performance in this area continues to place us in the top quartile of operators in the broader manufacturing industry, our year-to-date reportable incident rate does not meet our high standards.
We will continue to emphasize the need for further improvement in this area as safety must be fundamental to everything we do. We remain steadfast in working toward our goal of zero injuries. Let me now turn to Slide 5 for an update on steel industry trends as context for our third quarter results. During the third quarter, we saw a further softening of key performance indicators for the steel industry.
In the third quarter of 2022, global steel production excluding China was 198 million tons, representing a 9% decline compared to the same period in the prior year. Global capacity utilization rates declined to 64%, commensurate with the lower production. These third quarter data points represent the lowest such production and utilization levels in the past eight quarters for the global steel industry.
We continue to see diverging steel industry trends in different geographic regions. This includes weakness in Europe as macroeconomic conditions further deteriorate, in large part due to the ongoing conflict between Ukraine and Russia. Inversely, U.S. trends remain comparatively healthier and more stable, although utilization rates have softened somewhat in the most recent periods. Turning to our third quarter performance, starting on Slide 6.
Our third quarter production volume was approximately 38,000 metric tons, representing a 5% year-over-year decline and a 14% sequential decline from the second quarter. During the third quarter, we executed our planned annual maintenance work at our two European facilities, which drove the sequential decline. The suspension of our Monterrey operations had only a modest impact on our production volume for the third quarter.
We sold approximately 36,000 metric tons of graphite electrodes in the quarter, which is an 18% decline from the third quarter of 2021. Along with softening electrode demand driven by the current macroeconomic conditions, the suspension of our Monterrey operations contributed to the year-over-year decline in sales volume.
Specifically, approximately 4,000 metric tons of predominantly non-LTA customer orders that were scheduled to ship from our Monterrey location at the end of the third quarter were delayed to the facility suspension that began in September. Third quarter shipments included 23,000 metric tons sold under our LTAs at a weighted average realized price of $9,400 per metric ton and 13,000 metric tons of non-LTA sales at a weighted average realized price of $6,000 per metric ton.
This non-LTA pricing represented an increase of more than 30% compared to the third quarter of 2021 and was in line with the first half of 2022, consistent with the expectations we provided on our most recent earnings call. Net sales in the third quarter decreased 13% compared to the third quarter of 2021.
This reflected the lower sales volume and a shift in mix from LTA to non-LTA business, partially offset by the higher non-LTA pricing. FX also had a slight unfavorable impact on our net sales performance during the quarter, reflecting the strengthened U.S. dollar versus the euro and Japanese yen, as a portion of our sales are denominated in these and other foreign currencies.
However, the FX top line headwind was more than offset on the bottom line by a benefit to COGS related to euro-denominated spending in our European operations. As we move through the fourth quarter, we expect our weighted average non-LTA pricing to remain comparable to the year-to-date level of approximately $6,000 per metric ton. However, we anticipate a further sequential decline in our sales volume for the fourth quarter, reflecting softness in the graphite electrode demand due to current market dynamics we have discussed.
In addition, the suspension of our Monterrey operations will constrain our electrode and pin production capabilities, impacting our ability to fulfill certain customer orders. As referenced in our press release this morning, we expect this constraint will have an impact on our fourth quarter sales volume in the range of 10-12,000 metric tons. Factoring all of this in, we anticipate our total graphite electrode sales volume for the fourth quarter will be in the range of 25-28,000 metric tons. Let me now turn it over to Tim to cover the rest of our financial details.
Thanks, Jeremy. Net income totaled $93 million in the third quarter, or $0.36 earnings per share. Adjusted EBITDA was $129 million, a decrease of 25% compared to the third quarter of 2021, reflecting the lower sales volume and higher year-over-year costs. Adjusted EBITDA margin was 42% in the third quarter of 2022. Let me expand briefly on costs.
We continue to be impacted by global inflationary pressures, most notably for certain raw materials, energy, and freight. For the third quarter, we experienced a year-over-year increase of approximately 24% in recognized cost per metric ton, excluding depreciation and amortization. Although this represented a 5% sequential increase compared to the second quarter of 2022, this was below our previous estimate of a 7% increase. As we look ahead, we expect sequential cost inflation persists at a similar 5% rate in the fourth quarter on a cost per metric ton basis as higher priced inventory is sold during the quarter.
This also factors in the absorption of certain fixed costs related to our operations in Monterrey. For 2023, if Monterrey were to remain suspended, we anticipate further significant cost increases for at least the first half of the year, primarily reflecting cost to execute the previously discussed mitigation strategy related to producing pin stock, as well as incremental absorption of certain fixed costs due to the anticipated decline in 2023 sales volume. We continue to focus on prudently managing our operating and discretionary spending as we navigate the near term challenges in the operating environment. Turning to cash flow.
In the third quarter, we generated $68 million of cash from operations and $52 million of Adjusted Free Cash Flow. Both measures decreased compared to the third quarter of 2021, reflecting higher working capital and lower net income. The year-over-year increase in cash used for working capital reflected a timing-related decline in accounts payable and an increase in inventory driven primarily by higher costs. Turning to Slide 8.
During the third quarter, we opted to retain our Free Cash Flow and did not make a voluntary prepayment on our term loan. This was done to support the financial flexibility as we continue to navigate near-term challenges, including the suspension of our Monterrey operations. Our gross debt to Adjusted EBITDA ratio was 1.5x as of September 30, as compared to 1.6x at the end of 2021.
On a net debt basis, we ended the third quarter at a ratio of 1.3x . During the quarter, our total liquidity increased to approximately $435 million, consisting of $109 million of cash on hand and $326 million available under our revolving credit facility. As of today, our total liquidity has further increased now and is now over $450 million. As Marcel previously indicated, as we look forward, we have ample liquidity between cash on hand and the availability under our existing credit facility to navigate this challenging situation. Now turning to Slide 9. Maintaining a prudent, disciplined capital allocation strategy remains a long-term priority.
This includes reducing debt to further strengthen our balance sheet and support our strategic flexibility, while also returning capital to our stockholders and investing in our business. While we elected not to pay down our debt or repurchase stock in the third quarter, a significant portion of our cash flow generation has been utilized for these purposes on a year-to-date basis. In the first half of the year, we reduced our term loan balance by $110 million, and we repurchased $60 million of our common stock.
Combined, these activities account for nearly three-quarters of our Free Cash Flow generation through the first nine months of the year. In addition, we continue to expect our 2022 capital expenditures to be in the range of $70 million-$80 million. Although the composition of our spend has somewhat changed to reflect our current priorities.
This includes an acceleration of investments to support the restart of St. Marys, as Marcel previously discussed. We will remain prudent in managing our CapEx spend, prioritizing those projects with the highest return on investment. Now et me turn it back to Marcel for his perspective on the outlook.
Thank you, Tim. As we have indicated, the current environment for the steel industry remains in flux. Global steel prices continue to retreat from recent highs, and global steel production, excluding China, has declined 5% year-to-date compared to 2021. As Jeremy indicated, we continue to see diverging steel industry trends in different geographical regions, but indicators for nearly all regions have softened since our last earnings call.
As a result, while we remain bullish on graphite electrode demand over the long term, the outlook for 2023 is more cautious. The near-term outlook is further challenged by the cost pressures that Tim spoke to, which we expect to peak for our business during 2023. In addition to the current suspension of our Monterrey operations, the ongoing shift in mix from LTA to non-LTA business creates another near-term headwind.
While these challenges are clearly significant, we remain confident in our ability to overcome the near-term headwinds and are optimistic about the longer-term outlook for our business. We are pursuing all avenues and remain confident in our ability to achieve a resumption of our Monterrey operations, and we are aggressively working toward multiple mitigation strategies at the same time. Given that the Monterrey suspension is, at least in part, a legal matter, we won't be able to provide much more information during the Q&A beyond what I laid out in my opening comments.
However, we hope to be able to provide more detail and clarity on the situation as soon as possible. As we progress, we will continue to align our operating and capital expenditures with the current environment. We remain committed to maintaining a strong balance sheet and have ample liquidity to see us through the near-term challenges. Longer term, we continue to expect the steel industry's efforts to decarbonize will drive a continued shift to electric arc furnace steelmaking, supporting long-term demand growth for graphite electrodes.
A recent announcement of planned EAF capacity additions by steel producers globally, excluding China, could result in an annual incremental graphite electrode demand of over 200,000 metric tons by 2030. The actions we are taking to invest in our product and service capabilities will optimally position us to benefit from that demand growth. Our vertical integration into petroleum needle coke production through our Seadrift facility is a critical differentiator from our competitors and foundational for our ability to deliver high-quality graphite electrodes. In closing, when I first spoke to you a quarter ago, I shared the reasons I was excited to join GrafTech.
Its industry-leading position, a distinct set of capabilities and competitive advantages, and a talented and dedicated team that is committed to serving our customers. All of this is still in place today. In fact, the resolve I have seen in our employees over the past couple of months makes me proud to be part of the GrafTech team. I am confident in our ability to deliver shareholder value over the long term. That concludes our prepared remarks. We will now open the call for questions.
Thank you. Ladies and gentlemen, we will now begin the question-and-answer session. Should you have a question, please press star followed by the one on your touchtone phone. You will hear a three-tone prompt acknowledging your request. If you are using a speakerphone, please lift the handset before pressing any keys. First question comes from David Gagliano at BMO Capital Markets. Please go ahead.
Hi. Thanks for taking my questions. I just had a few clarification questions. First of all, on the PIN situation, every graphite electrode needs a PIN, and the commentary was volumes will be down 50% if things don't change in Monterrey. I'm assuming that the PINs are being purchased from a third party. Is that correct?
As I indicated in my prepared remarks, the impact for Q4 will be modest because we do have quite a bit of existing pin inventory. Beyond that, we are actually exploring various mitigation strategies. I talked about the restart of St. Marys. We are also looking at producing pins at one of our European facilities, and we are looking to procure third-party pin stock.
Thank you for that. Now, what needs to happen for volumes to only be down 50% in the first half of those options? If that makes any sense. I'm trying to figure out how much of that is already, you know, capable of being produced versus how much do you have to actually figure out where you're gonna get the pins for to produce it?
Jerry, you wanna take that one?
Sure. Yeah. Thanks, Marcel, and thanks for the question, David. The substantial majority of the pins that are required to achieve what we're talking about are already in inventory in one form or another. This is not something that we are going to be dependent on third parties or some other source for achieving the level of achievement that Marcel talked about. We have a substantial amount of inventory. We have kept a substantial amount of inventory all the way along of pins and pin stock, and we will be processing that through the other facilities in order to achieve what Marcel was talking about.
Just on the restart of St. Marys, just for PIN production. I have a few follow-ups here. First of all, if for whatever reason St. Marys doesn't restart permits, or whatever, and I don't know how much of an issue that is, what would happen the second half volumes of 2023? That's one of the questions. The other question, you know, there was commentary that volume should improve in the second half.
Is that on the assumption that St. Marys restarts, and that's why volume should improve in the second half of 2023? The third question regarding St. Marys, at least from my seat, is, you know, why not just restart everything? What's the difference in terms of capital costs and permitting, and restarting UHP graphite electrode production at St. Marys as well?
Let me tackle the first two, and then we'll get back to the third question. With regards to the second half, we feel confident that a combination of our mitigation strategies will be in place that will lead to production and sales volume recovery. It will be the restart of St. Marys and/or the starting of PIN production at one of our European facilities and/or the securing of sufficient third-party PINs. It is not solely dependent on the St. Marys restart. Then I would also like to reiterate our confidence that we think we will believe that Monterrey will reopen.
Okay. Regarding restarting all of St. Marys?
With regards to restarting all of St. Marys, that's clearly something we are investigating. It will require a different set of permits that would likely take longer and will also require additional incremental spending. I think we are clearly on track to go there as well, but we probably won't be able to see that come to implementation before 2024.
Okay. Just switching gears to the costs. I have no idea what a PIN costs in the public domain or in the whatever domain PINs are traded. My question just generally speaking, we got the 5% per unit cost increase for the fourth quarter of 2022 quarter-over-quarter. You know, in the first half of 2023, if Monterrey stays shut, given all the fixed cost absorption and things like that, what's a reasonable range for expectations there for unit cost increases in the first half of 2023, say, for example, versus 4Q 2022?
Yeah. Dave, you know, just on the cost side, right? You know, we continue to work through the mitigating strategies as Marcel says, and obviously we'll have to continue to work through the economics of each of those, because they do vary by strategy. I'm not gonna provide any more guidance at this point in time on what we think the 2023 costs look like.
I think the other thing to take into consideration is that fixed cost absorption, right? With sales volume down, you know, fixed costs at our existing operations, you know, being spread over that volume, that'll have an impact as well beyond the 5%, you know, that we're talking about kind of on a normalized inflationary run rate, that we look like.
I think, you know, just talking about costs for a second more broadly, you know, we're seeing inflation into the fourth quarter. Certain areas we'll probably see some inflation into 2023. On the flip side, we are starting to see some moderation in some of the key areas of our business, whether it's the underlying Brent price for decant oil. I think we're starting to see favorability on freight rates. The routes that are important to us are starting to show some downward trends, which we would expect to continue, as well as longer term pitch pricing in some of the raw materials we've talked about in the past.
Okay, I'll turn it over to somebody else. Thanks.
Thank you. Next question comes from Arun Viswanathan at RBC Capital Markets. Please go ahead.
Great. Thanks for taking my question. I guess the first set of questions is just around some of the market developments. You know, you know, spot prices now have kind of hovered around the $6,000 per ton range. Where is needle coke? And I guess, how do you see the spot price evolving from here? You know, steel prices have also kind of continued to modestly move lower or you know, consistently move lower. Yeah, how should we think about kind of the price evolution in the electrode and needle coke markets from here? Thanks.
Yeah, we've Thanks, Arun. We've really seen needle coke prices, you know, really be pretty resilient. We've seen, you know, tracking the import statistics, we've seen continued transactions somewhere in the high 2,000s. You know, I think we had put a high end of the range around 2,900 last time we spoke. We're still in that range, maybe a very small amount of moderation, but still, you know, in that $2,700-$2,800 a ton.
As we look forward, you know, as you know, we expect to see continued acceleration for demand in needle coke driven by, you know, on the one hand, you know, more graphite electrode demand from the growth in EAF steel making. As we've talked about a couple of times, rapid growth of needle coke demand for use in the electric vehicle industry, where graphite's the key material used in lithium-ion battery anodes.
Okay. Thanks. It sounds like, you know, needle coke should continue to move modestly higher, because of strong demand. Okay. How does that translate to the electrode side? I mean, should we kind of just keep in mind that three to one rule of thumb or, is it unlikely that electrodes would be as resilient because maybe there's some excess supply? How should we think about how electrode prices should trend?
Yeah. Arun, I think, you know, as you look forward, I think those rules of thumb probably hold true, you know, longer term. As needle coke prices trend upwards, you know, we would see an upward demand or upward push on electrode pricing as well. I think in the short term, I think you have a bit of a dislocation because of, call it the global uncertainty that's in the markets right now, particularly in Europe, where, you know, those rules of thumb don't always hold true in the very near term. You may have a little bit of short-term dislocation, but I think over the long term, you know, upward trends in needle coke pricing will drive electrode pricing higher.
Okay. Then, maybe you could just help us understand, or get your perspective on contracting. You know, unfortunately, the Monterrey facility is not running full out, so your volumes are gonna be down in the first half. Maybe that limits the, you know, kind of commercial opportunities that you can put forward to your customers. Is that true? Are you kind of now operating more at a, you know, kind of, shorter timeframe, maybe one to three months of visibility? How are you thinking about, you know, setting up the next couple periods, of the order book? Is there other options for you in front of you?
Yeah, thanks. You know, it's an important question, Arun. You know, one of the things that I wanna make clear is that, you know, while we need to consider the near term supply constraints related to the Monterrey situation, none of this changes our commercial strategy. We continue to believe that we are unique in the market, in our ability, to offer a variety of different contracting terms to our customers.
That's supported by, our vertical integration, and that's a key differentiator, our ability to provide that certainty to our customers. While in the very near term, we're dealing with the Monterrey situation, we have absolute confidence in our ability to resolve this current environment we're in, and it's not changing our commercial strategy at all.
Okay. You know, lastly, just there are some, you know, you've called out weakness in Europe now for a couple quarters, and it sounds like it has continued to remain weak and potentially even worsen in Q3 and Q4. What is it gonna take for that market to improve? And is that, you know, one of the main things you guys are watching or are some other regions more important?
And just curious if you know, if this does continue, how you think about your own footprint, just given that you do have you know, a lot of production over there and you know, are there options to again you know, start up some of your other facilities a little bit quicker or shift production there? You know, what's your outlook for Europe and when this kind of it starts to improve?
With regards to the outlook in Europe and how that will be resolved, I think much hinges on the conflict in Ukraine. It creates so much uncertainty for the European economy overall and for energy prices in Western Europe in particular, right? I think that the key resolution point would be an easing or resolution of the conflict in Ukraine, and obviously we are not able to make any predictions around that.
With regards to our operating footprint, I think in the short term, we are obviously dependent on our European manufacturing sites, until we have been able to restart St. Marys first for pin production, and then in the medium term, hopefully for electrode production as well. Now we do take some solace in the fact that, our electrode factories in Europe are some of the most efficient and especially energy efficient ones out there.
Thanks.
Okay. Thanks, Arun.
Thank you. Next question comes from Alex Hacking at Citi Research. Please go ahead.
Hi. Good morning. Thanks for all the color on Monterrey. That was quite helpful. Let me ask Dave's cost question maybe a slightly different way. Roughly what percentage of your overall cost structure today is fixed versus variable? Thanks.
Yeah. Thanks, Alex. Yeah. Consider it roughly a third, if you think about it in broad strokes, is the way I would think about that. Now, obviously, we do have the opportunity over extended periods of time to adjust that fixed cost structure, right? But that's the way I would think about it, kind of from a broad brush perspective.
Okay, thanks. That's very helpful. On the Seadrift needle coke side, like, you know, if my math is correct and you're selling, you know, 50% electrodes, in theory you would have excess needle coke. Do you plan to sell that into the marketplace?
It's something that we are considering. Yes. Short answer, but we can't give you any specific estimates around that at this point.
Okay, sure. Just another one on Seadrift, if I may. If I remember correctly, the decant oil hedges kind of roll off around the end of this year, I think. Is that correct, and what's the incremental cost impact as we move to spot pricing next year? Thanks.
Yeah. The hedges did, you know, the hedge effect stopped, you know, in the midpoint of this current year, and we'll see the P&L effect roll through the first two quarters of next year. You're probably looking at, you know, somewhere about $100 a ton, give or take, on the hedge benefit that will be gone after the second quarter of next year.
Okay, thanks. A couple more. I apologize for peppering you with questions. On the electrode market, you know, if you're down to 50%, that's, you know, 80,000-ton annual rate of electrodes that's gone from this market, right? It's 800,000-ton-ish market, ex-China, if my memory is correct. I mean, are your customers expressing concern about their ability to source electrodes in this scenario? Is the electrode market potentially tightening up because of this? Thank you.
It's an excellent question. Now, given the weakness, especially in Europe, but also more broadly around the world within the steel markets that we've spoken to, I think that we don't really see any short-term tightness. In addition, given the slowdown that we have seen in the industry, the inventories at many of our customers are actually up significantly, so, which gives them quite a bit of buffer. I don't think there's unlikely to be a shortage in the market in the first half of 2023. Jeremy, anything you would add to that?
Yeah. No, I think you hit the key points, right. The, you know, we see a reasonable amount of inventory being held by our customers given the softness that they've been experiencing and that will bridge through any tightness that we would be creating in the near term.
Okay, thanks. All these answers are very helpful. I appreciate that. Just final one. I think the answer here is no, but are there any covenants on any of your debt tied to, you know, EBITDA or anything like that? Thank you.
Yeah. Just going back and kind of reiterating, you know, what Marcel said in the opening commentary. You know, no impact on our ability to borrow, as it exists today or cost of borrowing. We're in good shape from a liquidity perspective at this point in time.
There's no covenants or anything like that, right? Just to be clear.
I mean, we have customary covenants and we've laid those out in the 10-Q. We have a screening covenant on our revolver that isn't in jeopardy at this point in time.
Okay, thanks. I'll turn it over. Thank you very much.
Thank you. Next question comes from Curt Woodworth at Credit Suisse. Please go ahead.
Thanks. Good morning, everyone. You know, with respect to the Monterrey process, I realize maybe there's limitations in what you can say. Just in terms of, like, the legal precedents for issues like this or, you know, a timeline of things to sort out this issue, is there any more color you can say, and is it the type of thing where depending on the outcome of the case, you know, you would just have to resolve an issue, pay a fine and restart? Or if you could just walk through maybe some of the more procedural dynamics just to help us understand a little bit around timing and how we should think about it.
Yeah. Kurt, I don't think we are able to provide a lot more detail on the legal path, but I think it's important pointing out that I think our priority focus here is to resolve this through discussions with the Mexican authorities and regulators and jointly develop an agreed upon plan for reopening, which will hopefully be, we'll hopefully be able to do that in the near term, right? I think any legal path that we are pursuing in parallel will likely take longer. I think that's all I can say. The priority is active engagement with the authorities, and we are doing that. There are ongoing active conversations on a regular basis to make sure that we can agree on a plan to reopen.
Understood. With respect to your energy position, I think my understanding is about 15% of COGS last year, with most of that, I think two-thirds power, and I believe you enter into fixed price annual power contracts, so you're relatively hedged for the year. Can you give us any sense of, you know, have you entered into forward power price agreements for next year? Are you gonna be more exposed to spot? Just given where the energy curves are today, can you provide any color on what the potential year-on-year impact on your energy cost of goods sold would be for next year?
Yeah. Thanks, Kurt. Yeah. Your recap of what we've said in the past is spot on in terms of about 15% of our total cost and two-thirds of that's power versus natural gas. We do move into next year, and I think we previously commented that we are less fixed as we head into next year than previously. Where we sit today, we're about 50% fixed on our power needs in our Pamplona and Calais facilities and about 25% fixed on our natural gas needs heading into next year. We continue to work through opportunities to further lock in some of those power prices.
I think more broadly, as we look at that European power market, you know, we saw prices peak back in August and you know have come down significantly here over the last call it 60 days or so, and we're probably sitting around $120 MWh now. It's an improvement from where we were. Certainly there's still a long way to go in Europe with respect to power prices. We continue to manage it. We continue to work with our vendors and third parties to try to lock up as much of that as we can.
Can you just give us any perspective on dollar, you know, magnitude of dollar cost increase given where the spot price is today? Just to help us calibrate our models. If not now-
Yeah. I mean, I guess what I would offer, without getting into specifics of projecting out next year's costs, I mean, what we've locked in is at a rate commensurate with what we have this year.
Okay. All right, great. Thanks very much.
Thank you, Curt.
Thank you. The next question comes from Matthew Vittorioso at Jefferies. Please go ahead.
Yeah, good morning. Thanks for taking my call. Just thinking about cash flow for 2023. Obviously, we've all got to do some work on our models for 2023 EBITDA, given some of the moving parts on the cost side. Just thinking about capital spending, you talked about being able to potentially flex that. Wanted to see what you thought you could bring CapEx down to in 2023.
Along those lines, are there costs associated with restarting Monterrey if you got the go-ahead sometime in the first half of 2023 to restart Monterrey? Is there costs to take that out of some sort of cold idle? Or, you know, how do we think about bringing that facility back online from a capital perspective?
Yeah, thanks. Maybe I'll take the first half of that, which was your question about bringing Monterrey back from a cold idle to fully restart it, then I'll hand it over to Tim to talk about the balance of it. The quick answer is that no, there shouldn't be a disproportionate amount of cost associated with bringing it out of its current idle mode. You know, we have assets that were behaving the way that we expected them to, and you know, we would look to restart them exactly as they were. There's no extended warm-up period or anything like that, as you might see in other large capital asset businesses. I wouldn't anticipate any substantial cost increases associated with that.
Yeah, maybe I would just add more broadly on capital, right? You know, we're saying this year we're gonna spend $70 million-$80 million, and we've talked about kind of what makes up that in the past. You know, I think on a basis, our sustaining capital or maintenance capital is probably in that $50 million-$60 million range. Certainly we have the ability, kind of within that number, right, to flex that down further, to the extent that we need to do that. But I think it's important and we'll continue to make investments in kind of our key projects as we move forward beyond what Jeremy just talked about in St. Marys.
You know, in particular, we've got some projects in Pamplona that will significantly reduce our natural gas consumption and lower our overall cost input, as we move forward. Both of those projects are ongoing now and will continue into next year. It's a balance of what we need to spend money on just to keep the plants running in an efficient and safe manner, as well as those that generate a big ROI and balancing cash needs as well.
Thanks. That's helpful. I guess you know just big picture on the capital allocation going forward you did highlight that debt reduction will remain a priority. Clearly given the volatility we're gonna see in earnings over the coming 12 months that makes a lot of sense I would think. Share buybacks maybe are on the shelf for at least the time being but on the debt reduction side you know at times your bonds have traded into the mid-70s. You know wondering if that might be an avenue to pursue debt reduction you know buying back bonds at a discount. Is that something you would consider?
Yeah, I mean, I think when we broadly think about capital allocation, we look at what is best for the organization and more broadly our shareholders at large. Certainly, if there's an opportunity to take debt out at a discount, you know, you look at that, but you weigh the cost-benefit of pulling forward near-term maturity. Yeah, I think, you know, what's important is that commitment we have to our shareholders and stockholders for a disciplined approach.
You know, you said it, we're gonna continue to focus on the balance sheet. I think, frankly, the work we've done over the last two years gives us the confidence to maneuver and work our way through, you know, the challenges that we're facing right now. That's why we've done what we've done in the past. You know, right now I don't think there's any plans to change that strategy on a longer term basis.
Do you guys have maybe just a big picture target for what? You know, you're saying debt reduction is a priority. You know, steel in general is a volatile industry to participate in. Like, how do you think about the right amount of debt for this enterprise over the long run?
Yeah, I mean, again, I think we've been pretty consistent in the past when we've said, you know, our leverage target is no more than 2x-2.5x. Right now our current leverage is 1.5x on a gross basis or 1.3x on a net basis. We feel like we're in a good spot. You know, we kind of stick with that target. Longer term, we think that allows us to kind of work through any cycles, you know, that the steel industry has and position it as well with a strong balance sheet going forward.
Great. Maybe just one more quick one. On the cash flow front for 2023, again, lots of moving parts. I understand it's hard to pin things down. As we think about volumes coming off meaningfully and just the business not necessarily operating under its normal course, any working capital implications from that, from these disruptions and, you know, one way or the other, either positively or negatively impacting cash flow? Anything that jumps out at you?
Yeah, you know, I don't wanna comment on 2023 at this point in time. I think we've given some kind of directional indicators as the way we think 2023 is shaping up, you know, absent the restart of Monterrey. But certainly we think, you know, in the first half of the year, when volumes are down and then they pick up in the back half of the year, you know, that'll have an impact on working capital. If we look out to the fourth quarter, right? We've talked about the volume decrease that we're expecting in the fourth quarter. We're gonna be carrying some additional inventory in the back half or in the fourth quarter. You know, I would say working capital is relatively flat as we head through fourth quarter.
All right. Thanks for your time.
Thank you, Matt.
Thank you. This concludes our question- and- answer session. I will now turn the call back over to Mr. Kessler for closing comments.
Thank you, operator. I would like to thank everyone on this call for your interest in GrafTech, and we look forward to speaking with you the next quarter. Have a great weekend, everyone.
Ladies and gentlemen, this concludes your call for today. We thank you for participating, and we ask that you please disconnect your