XML 74 R17.htm IDEA: XBRL DOCUMENT v2.4.1.9
Derivative and Hedging Activities (Note)
 3 Months Ended
Mar. 31, 2015
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative and Hedging Activities Disclosure [Text Block]
Derivative and Hedging Activities
Chesapeake uses commodity derivative instruments to secure attractive pricing and margins on its share of expected production, to reduce its exposure to fluctuations in future commodity prices and to protect its expected operating cash flow against significant market movements or volatility. Chesapeake also uses derivative instruments to mitigate a portion of its exposure to interest rate and foreign currency exchange rate fluctuations. All of our derivative instruments are net settled based on the difference between the fixed-price payment and the floating-price payment, resulting in a net amount due to or from the counterparty.
Oil and Natural Gas Derivatives
As of March 31, 2015 and December 31, 2014, our oil and natural gas derivative instruments consisted of the following types of instruments:
•
Swaps: Chesapeake receives a fixed price and pays a floating market price to the counterparty for the hedged commodity.
•
Collars: These instruments contain a fixed floor price (put) and ceiling price (call). If the market price exceeds the call strike price or falls below the put strike price, Chesapeake receives the fixed price and pays the market price. If the market price is between the put and the call strike prices, no payments are due from either party. Three-way collars include an additional put option in exchange for a more favorable strike price on the call option. This eliminates the counterparty’s downside exposure below the second put option strike price.
•
Options: Chesapeake sells, and occasionally buys, call options in exchange for a premium. At the time of settlement, if the market price exceeds the fixed price of the call option, Chesapeake pays the counterparty the excess on sold call options, and Chesapeake receives the excess on bought call options. If the market price settles below the fixed price of the call option, no payment is due from either party.
•
Basis Protection Swaps: These instruments are arrangements that guarantee a fixed price differential to NYMEX from a specified delivery point. Chesapeake receives the fixed price differential and pays the floating market price differential to the counterparty for the hedged commodity.
The estimated fair values of our oil and natural gas derivative instrument assets (liabilities) as of March 31, 2015 and December 31, 2014 are provided below. 
 
 
March 31, 2015
 
December 31, 2014
 
 
Volume
 
Fair Value
 
Volume
 
Fair Value
 
 
 
 
($ in millions)  
 
 
 
($ in millions)  
Oil (mmbbl):
 
 
 
 
 
 
 
 
Fixed-price swaps
 
8.4

 
$
363

 
12.5

 
$
471

Three-way collars
 
3.3

 
32

 
4.4

 
40

Call options
 
34.3

 
(30
)
 
35.8

 
(89
)
Total oil
 
46.0

 
$
365

 
52.7

 
$
422

 
 
 
 
 
 
 
 
 
Natural gas (tbtu):
 
 
 
 
 
 
 
 
Fixed-price swaps
 
195

 
$
212

 
275

 
$
281

Three-way collars
 
106

 
77

 
207

 
165

Call options
 
193

 
(148
)
 
193

 
(170
)
Basis protection swaps
 
56

 
(6
)
 
60

 
23

Total natural gas
 
550

 
$
135

 
735

 
$
299

Total estimated fair value
 
 
 
$
500

 
 
 
$
721


 We have terminated certain commodity derivative contracts that were previously designated as cash flow hedges for which the hedged production is still expected to occur. See further discussion below under Effect of Derivative Instruments – Accumulated Other Comprehensive Income (Loss).
Interest Rate Derivatives
As of March 31, 2015 and December 31, 2014, our interest rate derivative instruments consisted of swaps. We enter into fixed-to-floating interest rate swaps (we receive a fixed interest rate and pay a floating market rate) to mitigate our exposure to changes in the fair value of our senior notes. We enter into floating-to-fixed interest rate swaps (we receive a floating market rate and pay a fixed interest rate) to manage our interest rate exposure related to our bank credit facility borrowings.
The notional amount of our interest rate derivatives, associated with our long-term debt, as of March 31, 2015 and December 31, 2014, was $400 million and $850 million, respectively. The estimated fair value of our interest rate derivative liabilities, as of March 31, 2015 and December 31, 2014, was $3 million and $17 million, respectively. 
We have terminated certain fair value hedges related to senior notes. Gains and losses related to these terminated hedges will be amortized as an adjustment to interest expense over the remaining term of the related senior notes. Over the next six years, we will recognize $9 million in net gains related to these transactions.
Foreign Currency Derivatives
We are party to cross currency swaps to mitigate our exposure to foreign currency exchange rate fluctuations that may result from the €344 million principal amount of our euro-denominated senior notes. The terms of the cross currency swaps were based on the dollar/euro exchange rate on the issuance date of $1.3325 to €1.00. Under the terms of the cross currency swaps we currently hold, on each semi-annual interest payment date, the counterparties pay us €11 million and we pay the counterparties $17 million, which yields an annual dollar-equivalent interest rate of 7.491%. Upon maturity of the notes, the counterparties will pay us €344 million and we will pay the counterparties $459 million. The swaps are designated as cash flow hedges and, because they are entirely effective in having eliminated any potential variability in our expected cash flows related to changes in foreign exchange rates, changes in their fair value do not impact earnings. The fair values of the cross currency swaps are recorded on the condensed consolidated balance sheet as liabilities of $103 million and $53 million as of March 31, 2015 and December 31, 2014, respectively. The euro-denominated debt in long-term debt has been adjusted to $369 million as of March 31, 2015, using an exchange rate of $1.0731 to €1.00.
Effect of Derivative Instruments – Condensed Consolidated Balance Sheets
The following table presents the fair value and location of each classification of derivative instrument included in the condensed consolidated balance sheets as of March 31, 2015 and December 31, 2014 on a gross basis and after same-counterparty netting: 
Balance Sheet Classification
 
Gross
Fair Value
 
Amounts Netted
in Condensed Consolidated
Balance Sheet
 
Net Fair Value Presented
in Condensed Consolidated
Balance Sheet
 
 
($ in millions)
As of March 31, 2015
 
 
 
 
 
 
Commodity Contracts:
 
 
 
 
 
 
Short-term derivative asset
 
$
688

 
$
(76
)
 
$
612

Short-term derivative liability
 
(99
)
 
76

 
(23
)
Long-term derivative liability
 
(88
)
 
—

 
(88
)
Total commodity contracts
 
501

 
—

 
501

 
 
 
 
 
 
 
Interest Rate Contracts:
 
 
 
 
 
 
Short-term derivative liability
 
(3
)
 
—

 
(3
)
Total interest rate contracts
 
(3
)
 
—

 
(3
)
 
 
 
 
 
 
 
Foreign Currency Contracts:(a)
 
 
 
 
 
 
Long-term derivative liability
 
(103
)
 
—

 
(103
)
Total foreign currency contracts
 
(103
)
 
—

 
(103
)
 
 
 
 
 
 
 
Total derivatives
 
$
395

 
$
—

 
$
395

 
 
 
 
 
 
 
As of December 31, 2014
 
 
 
 
 
 
Commodity Contracts:
 
 
 
 
 
 
Short-term derivative asset
 
$
974

 
$
(95
)
 
$
879

Long-term derivative asset
 
16

 
(10
)
 
6

Short-term derivative liability
 
(105
)
 
95

 
(10
)
Long-term derivative liability
 
(163
)
 
10

 
(153
)
Total commodity contracts
 
722

 
—

 
722

 
 
 
 
 
 
 
Interest Rate Contracts:
 
 
 
 
 
 
Short-term derivative liability
 
(5
)
 
—

 
(5
)
Long-term derivative liability
 
(12
)
 
—

 
(12
)
Total interest rate contracts
 
(17
)
 
—

 
(17
)
 
 
 
 
 
 
 
Foreign Currency Contracts:(a)
 
 
 
 
 
 
Long-term derivative liability
 
(53
)
 
—

 
(53
)
Total foreign currency contracts
 
(53
)
 
—

 
(53
)
 
 
 
 
 
 
 
Total derivatives
 
$
652

 
$
—

 
$
652

____________________________________________
(a)
Designated as cash flow hedging instruments.
As of March 31, 2015 and December 31, 2014, we did not have any cash collateral balances for these derivatives.
Effect of Derivative Instruments – Condensed Consolidated Statements of Operations
The components of oil, natural gas and NGL sales for the Current Quarter and the Prior Quarter are presented below. 
 
 
Three Months Ended
March 31,
 
 
2015
 
2014
 
 
($ in millions)
Oil, natural gas and NGL sales
 
$
924

 
$
2,148

Gains (losses) on undesignated oil and natural gas derivatives
 
178

 
(365
)
Losses on terminated cash flow hedges
 
(17
)
 
(17
)
Total oil, natural gas and NGL sales
 
$
1,085

 
$
1,766

The components of interest expense for the Current Quarter and the Prior Quarter are presented below. 
 
 
Three Months Ended
March 31,
 
 
2015
 
2014
 
 
($ in millions)
Interest expense on senior notes
 
$
171

 
$
180

Interest expense on term loans
 
—

 
29

Amortization of loan discount, issuance costs and other
 
11

 
19

Interest expense on credit facilities
 
3

 
8

Gains on terminated fair value hedges
 
(1
)
 
(1
)
Gains on undesignated interest rate derivatives
 
(10
)
 
(18
)
Capitalized interest
 
(123
)
 
(178
)
Total interest expense
 
$
51

 
$
39


Effect of Derivative Instruments – Accumulated Other Comprehensive Income (Loss)
A reconciliation of the changes in accumulated other comprehensive income (loss) in our condensed consolidated statements of stockholders’ equity related to our cash flow hedges is presented below. 
 
 
Three Months Ended March 31,
 
 
2015
 
2014
 
 
Before 
Tax  
 
After 
Tax  
 
Before 
Tax  
 
After 
Tax  
 
 
($ in millions)
Balance, beginning of period
 
$
(231
)
 
$
(143
)
 
$
(269
)
 
$
(167
)
Net change in fair value
 
(2
)
 
(1
)
 
4

 
3

Losses reclassified to income
 
17

 
10

 
18

 
11

Balance, end of period
 
$
(216
)
 
$
(134
)
 
$
(247
)
 
$
(153
)
Approximately $126 million of the $134 million of accumulated other comprehensive loss as of March 31, 2015 represented the net deferred loss associated with commodity derivative contracts that were previously designated as cash flow hedges for which the hedged production is still expected to occur. Deferred gain or loss amounts will be recognized in earnings in the month in which the originally forecasted hedged production occurs. As of March 31, 2015, we expect to transfer approximately $19 million of net loss included in accumulated other comprehensive income to net income (loss) during the next 12 months. The remaining amounts will be transferred by December 31, 2022.
Credit Risk Considerations
Over-the-counter traded derivative instruments expose us to our counterparties’ credit risk. To mitigate this risk, we enter into derivative contracts only with counterparties that are rated investment grade and deemed by management to be competent and competitive market makers, and we attempt to limit our exposure to non-performance by any single counterparty. As of March 31, 2015, our oil, natural gas and interest rate derivative instruments were spread among 16 counterparties.
Hedging Facility
As of March 31, 2015, our secured commodity hedging facility with 17 counterparties provided approximately 1.031 bboe of hedging capacity for oil, natural gas and NGL price derivatives and 1.031 bboe for basis derivatives with an aggregate mark-to-market capacity of $16.5 billion. The facility is secured by proved reserves, the value of which must cover the fair value of the transactions outstanding under the facility by at least 1.65 times at semi-annual collateral redetermination dates and 1.30 times in between those dates, and guarantees by certain subsidiaries that also guarantee our revolving credit facility and indentures. Chesapeake has significant flexibility with regard to releases and/or substitutions of pledged reserves, provided that certain requirements are met including maintaining specified collateral coverage ratios as well as maintaining credit ratings with either of the designated rating agencies at or above current levels. The counterparties’ obligations under the facility must be secured by cash or short-term U.S. treasury instruments to the extent that any mark-to-market amounts they owe Chesapeake exceed defined thresholds. As of March 31, 2015, we had hedged under the facility 128 mmboe of our future production with price derivatives and 9 mmboe with basis derivatives.
In April 2015, we also began entering into bilateral hedging agreements with the intention of replacing and terminating the respective counterparties’ positions in the secured hedging facility. As of May 5, 2015, we had entered into bilateral arrangements that reduced the aggregate mark-to-market capacity under the secured hedging facility from $16.5 billion to $10 billion.
Fair Value
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 oil and natural gas forward curves and discount rates, or can be corroborated from active markets or broker quotes. These values are compared to the values given by our counterparties for reasonableness. Since oil, natural gas, 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 a contract will be unable to meet its 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.
The following table provides information for financial assets (liabilities) measured at fair value on a recurring basis as of March 31, 2015 and December 31, 2014: 
 
 
Quoted
Prices in
Active
Markets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2) 
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
Fair Value
 
 
 
 
($ in millions)
 
 
As of March 31, 2015
 
 
 
 
 
 
 
 
Derivative Assets (Liabilities):
 
 
 
 
 
 
 
 
Commodity assets
 
$
—

 
$
579

 
$
109

 
$
688

Commodity liabilities
 
—

 
(9
)
 
(178
)
 
(187
)
Interest rate liabilities
 
—

 
(3
)
 
—

 
(3
)
Foreign currency liabilities
 
—


(103
)
 
—

 
(103
)
Total derivatives
 
$
—

 
$
464

 
$
(69
)
 
$
395

 
 
 
 
 
 
 
 
 
As of December 31, 2014
 
 
 
 
 
 
 
 
Derivative Assets (Liabilities):
 
 
 
 
 
 
 
 
Commodity assets
 
$
—

 
$
785

 
$
205

 
$
990

Commodity liabilities
 
—

 
(9
)
 
(259
)
 
(268
)
Interest rate liabilities
 
—

 
(17
)
 
—

 
(17
)
Foreign currency liabilities
 
—

 
(53
)
 
—

 
(53
)
Total derivatives
 
$
—

 
$
706

 
$
(54
)
 
$
652


A summary of the changes in the fair values of Chesapeake’s financial assets (liabilities) classified as Level 3 during the Current Quarter and the Prior Quarter is presented below. 
 
 
Commodity
 
 
Derivatives
 
 
($ in millions)
Beginning balance as of January 1, 2015
 
$
(54
)
Total gains (losses) (realized/unrealized):
 
 
Included in earnings(a)
 
78

Total purchases, issuances, sales and settlements:
 
 
Settlements
 
(93
)
Ending balance as of March 31, 2015
 
$
(69
)
 
 
 
Beginning balance as of January 1, 2014
 
$
(478
)
Total gains (losses) (realized/unrealized):
 
 
Included in earnings(a)
 
(80
)
Total purchases, issuances, sales and settlements:
 
 
Settlements
 
55

Transfers(b)
 
(4
)
Ending balance as of March 31, 2014
 
$
(507
)
___________________________________________
(a)
 
Oil, Natural Gas and
NGL Sales
 
 
 
2015
 
2014
 
 
($ in millions)
Total gains (losses) included in earnings for the period
 
$
78

 
$
(80
)
Change in unrealized gains (losses) related to assets still held at reporting date
 
$
74

 
$
(57
)
(b)
The values related to basis swaps were transferred from Level 3 to Level 2 as a result of our ability to begin using data readily available in the public market to corroborate our estimated fair values.
Qualitative and Quantitative Disclosures about Unobservable Inputs for Level 3 Fair Value Measurements
The significant unobservable inputs for Level 3 derivative contracts include unpublished forward prices of oil and natural gas, market volatility and credit risk of counterparties. Changes in these inputs impact the fair value measurement of our derivative contracts. For example, an increase or decrease in the forward prices and volatility of oil and natural gas prices decreases or increases the fair value of oil and natural gas derivatives and adverse changes to our counterparties’ creditworthiness decreases the fair value of our derivatives. The following table presents quantitative information about Level 3 inputs used in the fair value measurement of our commodity derivative contracts at fair value as of March 31, 2015:
Instrument
Type
 
Unobservable
Input
 
Range
 
Weighted
Average
 
Fair Value
March 31, 2015(a)
 
 
 
 
 
 
 
 
($ in millions)
Oil trades
 
Oil price volatility curves
 
20.48% – 37.72%
 
29.46%
 
$
2

Natural gas trades
 
Natural gas price volatility
curves
 
18.96% – 53.74%
 
29.73%
 
$
(71
)
___________________________________________
(a)
Fair value is based on an estimate derived from option models.