Fair Value Measurements

9 Months Ended

Sep. 30, 2012

Text Block [Abstract]

Fair Value Measurements

Fair Value Measurements

Certain financial instruments are reported at fair value on the condensed consolidated balance sheets. Under fair value measurement accounting guidance, fair value is defined as the amount that would be received from the sale of an asset or paid for the transfer of a liability in an orderly transaction between market participants, i.e., an exit price. To estimate an exit price, a three-level hierarchy is used. The fair value hierarchy prioritizes the inputs, which refer broadly to assumptions market participants would use in pricing an asset or a liability, into three levels. Level 1 inputs are unadjusted quoted prices in active markets for identical assets and liabilities and have the highest priority. Level 2 inputs are inputs other than quoted prices within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the financial asset or liability and have the lowest priority. Chesapeake uses a market valuation approach based on available inputs and the following methods and assumptions to measure the fair values of its assets and liabilities, which may or may not be observable in the market.

Recurring Fair Value Measurement

Other Current Assets. Current assets related to forfeited 401(k) employee contributions are invested in traded securities.

Investments. The fair value of Chesapeake’s investment in Gastar Exploration Ltd. (NYSE Amex: GST) and Clean Energy Fuels Corporation (NASDAQ:CLNE) common stock is based on a quoted market price.

Other Long-Term Assets and Liabilities. Assets and liabilities related to Chesapeake's deferred compensation plan are included in other long-term assets and other long-term liabilities, respectively. The fair values of these assets and liabilities are determined using quoted market prices, as the plan consists of exchange-traded mutual funds and company common stock.

Derivatives. The fair value of our derivatives is based on third-party pricing models which utilize inputs that are either readily available in the public market, such as natural gas and oil forward curves and discount rates, or can be corroborated from active markets or broker quotes. These values are then compared to the values given by our counterparties for reasonableness. Since natural gas, oil, NGL, interest rate and cross currency swaps do not include optionality and therefore generally have no unobservable inputs, they are classified as Level 2. All other derivatives have some level of unobservable input, such as volatility curves, and are therefore classified as Level 3. Derivatives are also subject to the risk that either party to the contract will be unable to meet their obligations. We factor non-performance risk into the valuation of our derivatives using current published credit default swap rates. To date, this has not had a material impact on the values of our derivatives.

Debt. The fair value of certain of our long-term debt is based on the face amount of that debt along with the value of related designated fair value interest rate swaps. We currently do not have any debt recorded at fair value since we have no open fair value hedges.

The following table provides fair value measurement information for financial assets (liabilities) measured at fair value on a recurring basis as of September 30, 2012:

	Quoted Prices in Active Markets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total Fair Value
				($ in millions)
Financial Assets (Liabilities):
Other current assets	$	6		$	—		$	—		$	6
Investments	24			—			—			24
Other long-term assets	87			—			—			87
Other long-term liabilities	(83		)	—			—			(83		)
Derivatives:
Commodity assets	—			112			32			144
Commodity liabilities	—			(73		)	(1,105		)	(1,178		)
Interest rate liabilities	—			(39		)	(2		)	(41		)
Foreign currency liabilities	—			(37		)	—			(37		)
Total derivatives	—			(37		)	(1,075		)	(1,112		)
Total	$	34		$	(37	)	$	(1,075	)	$	(1,078	)

The following table provides fair value measurement information for financial assets (liabilities) measured at fair value on a recurring basis as of December 31, 2011:

	Quoted Prices in Active Markets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total Fair Value
				($ in millions)
Financial Assets (Liabilities):
Investments	$	34		$	—		$	—		$	34
Other long-term assets	61			—			—			61
Other long-term liabilities	(62		)	—			—			(62		)
Derivatives:
Commodity assets	—			46			9			55
Commodity liabilities	—			(31		)	(1,663		)	(1,694		)
Interest rate liabilities	—			(42		)	—			(42		)
Foreign currency liabilities	—			(38		)	—			(38		)
Total derivatives	—			(65		)	(1,654		)	(1,719		)
Total	$	33		$	(65	)	$	(1,654	)	$	(1,686	)

A summary of the changes in Chesapeake’s financial assets (liabilities) classified as Level 3 measurements during the Current Period and the Prior Period is presented below.

	Derivatives
	Commodity			Interest Rate			Foreign Currency			Debt
	($ in millions)
Beginning Balance as of January 1, 2012	$	(1,654	)	$	—		$	—		$	—
Total gains (losses) (realized/unrealized):
Included in earnings(a)	525			4			—			—
Total purchases, issuances, sales and settlements:
Sales	—			(6		)	—			—
Settlements	56			—			—			—
Ending Balance as of September 30, 2012	$	(1,073	)	$	(2	)	$	—		$	—
Beginning Balance as of January 1, 2011	$	(1,954	)	$	(69	)	$	(43	)	$	(1,371	)
Total gains (losses) (realized/unrealized):
Included in earnings(a)	256			21			—			—
Total purchases, issuances, sales and settlements:
Sales	—			(6		)	—			—
Settlements	146			—			—			—
Transfers in and out of Level 3(b)	—			54			43			1,371
Ending Balance as of September 30, 2011	$	(1,552	)	$	—		$	—		$	—

(a)	Natural Gas, Oil				Interest
	and NGL Sales				Expense
	2012		2011		2012			2011
	($ in millions)
Total gains (losses) included in earnings for the period	$	525	$	256	$	4		$	21
Change in unrealized gains (losses) relating to assets still held at reporting date	$	370	$	133	$	(2	)	$	—

(b) The values related to interest rate and cross currency swaps were transferred from Level 3 to Level 2 as a result of our ability to use data readily available in the public market to corroborate our estimated fair values.

Qualitative Disclosures about Unobservable Inputs for Level 3 Fair Value Measurements

The significant unobservable inputs for Level 3 derivative contracts include unpublished forward prices of natural gas, oil and NGL, unpublished forward interest rate curves, market volatility and credit risk of counterparties. Changes in these inputs will impact the fair value measurement of our derivative contracts, e.g. an increase (decrease) in the forward prices and volatility of natural gas, oil and NGL prices will decrease (increase) the fair value of natural gas, oil and NGL derivatives; an increase (decrease) in forward rates and volatility of interest rates will decrease (increase) the fair value of interest rate derivatives; and adverse changes to our counterparties’ creditworthiness will decrease the fair value of our derivatives.

Quantitative Disclosures about Unobservable Inputs for Level 3 Fair Value Measurements

Instrument Type	Unobservable Input	Range	Weighted Average			Fair Value September 30, 2012
						($ in millions)
Oil Trades(a)	Oil price volatility curve	14.79% - 32.61%	22.44		%	$	(805	)
Natural Gas Trades(a)	Natural gas price volatility curve	21.61% - 41.21%	23.51		%	$	(251	)
Natural Gas Basis Swaps(b)	Physical pricing point forward curves	($1.87) - $0.05	$	(0.21	)	$	(17	)
Interest Rate Swaptions:(a)	Forward interest rate curve	0.30% - 2.94%	1.46		%	$	(2	)
	Interest rate volatility	43.14% - 43.35%	43.25		%

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(a) Fair value is based on an estimate derived from option models.

(b) Fair value is based on an estimate of discounted cash flows.

Nonrecurring Fair Value Measurements

Fair value measurements were applied with respect to our non-financial assets, measured on a non-recurring basis, to determine impairments. These assets consist primarily of land, a building, drilling rigs and drill pipe. We have either received a bid from a third party or used a third party to assess the fair value of these assets. Since the inputs used are not observable in the market, these assets are classified as Level 3 in the fair value hierarchy. See Note 11 for additional discussion.

Fair Value of Other Financial Instruments

The following disclosure of the estimated fair value of financial instruments is made in accordance with accounting guidance for financial instruments. The carrying values of financial instruments comprising cash and cash equivalents, restricted cash, accounts payable and accounts receivable approximate fair values due to the short-term maturities of these instruments. We estimate the fair value of our exchange-traded debt using quoted market prices (Level 1). The fair value of all other debt, which consists of our credit facilities and our term loans, is estimated using our credit default swap rate (Level 2). Fair value is compared to the carrying value, excluding the impact of interest rate derivatives, in the table below.

	September 30, 2012				December 31, 2011
	Carrying     Amount		Estimated     Fair Value		Carrying     Amount		Estimated     Fair Value
			($ in millions)
Short-term debt (Level 1)	$	463	$	481	$	—	$	—
Long-term debt (Level 1)	$	9,727	$	10,299	$	8,849	$	9,709
Long-term debt (Level 2)	$	6,007	$	5,801	$	1,749	$	1,690