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Derivative and Hedging Activities (Note)
 6 Months Ended
Jun. 30, 2016
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative and Hedging Activities Disclosure
Derivative and Hedging Activities
Chesapeake uses 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 foreign currency exchange rate fluctuations. All of our commodity 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, Natural Gas and NGL Derivatives
As of June 30, 2016 and December 31, 2015, our oil, natural gas and NGL 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. In exchange for higher fixed prices on certain of our swap trades, we granted options that allow the counterparty to double the notional amount.
•
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.
•
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.
•
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, natural gas and NGL derivative instrument assets (liabilities) as of June 30, 2016 and December 31, 2015 are provided below. 
 
 
June 30, 2016
 
December 31, 2015
 
 
Volume
 
Fair Value
 
Volume
 
Fair Value
 
 
 
 
($ in millions)  
 
 
 
($ in millions)  
Oil (mmbbl):
 
 
 
 
 
 
 
 
Fixed-price swaps
 
19.8

 
$
(78
)
 
13.5

 
$
144

Call options
 
12.3

 
(6
)
 
19.2

 
(7
)
Total oil
 
32.1

 
(84
)
 
32.7

 
137

 
 
 
 
 
 
 
 
 
Natural gas (tbtu):
 
 
 
 
 
 
 
 
Fixed-price swaps
 
577

 
(130
)
 
500

 
229

Collars
 
38

 
(4
)
 
—

 
—

Call options
 
205

 
(56
)
 
295

 
(99
)
Basis protection swaps
 
44

 
(8
)
 
57

 
—

Total natural gas
 
864

 
(198
)
 
852

 
130

 
 
 
 
 
 
 
 
 
NGL (mmgal):
 
 
 
 
 
 
 
 
Fixed-price swaps
 
144

 
(10
)
 
—

 
—

 
 
 
 
 
 
 
 
 
Total estimated fair value
 
 
 
$
(292
)
 
 
 
$
267


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 June 30, 2016 and December 31, 2015, there were no interest rate derivatives outstanding.
We have terminated fair value hedges related to certain of our 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 four years, we will recognize $6 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. In December 2015, we exchanged in privately negotiated transactions and subsequently retired €42 million in aggregate principal amount of 6.25% Euro-denominated Senior Notes due 2017, and we simultaneously unwound the cross currency swaps for the same principal amount at a cost of $8 million. As a result, we realized a loss of $8 million in 2015 which was included in losses on purchases or exchanges of debt. Under the terms of the remaining cross currency swaps, on each semi-annual interest payment date, the counterparties pay us €9 million and we pay the counterparties $15 million, which yields an annual dollar-equivalent interest rate of 7.491%. Upon maturity of the notes, the counterparties will pay us €302 million and we will pay the counterparties $403 million. 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. 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 sheets as liabilities of $64 million and $52 million as of June 30, 2016 and December 31, 2015, respectively. The euro-denominated debt in long-term debt has been adjusted to $337 million as of June 30, 2016, using an exchange rate of $1.1106 to €1.00.
Supply Contract Derivatives

From time to time and in the normal course of business, our marketing subsidiary enters into supply contracts under which we commit to deliver a predetermined quantity of natural gas to certain counterparties in an attempt to earn attractive margins. Under certain contracts, we receive a sales price that is based on the price of a product other than natural gas, thereby creating an embedded derivative requiring bifurcation. In one of these supply contracts, we are committed to supply a minimum of 90 bbtu per day of natural gas through March 2025. The bifurcated derivative is measured at fair value on a quarterly basis and resulted in an unrealized loss of $37 million in the Current Quarter and $17 million in the Current Period, respectively. Both settlements and mark-to-market gains (losses) are included in marketing, gathering and compression revenues in our condensed consolidated statements of operations.
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 June 30, 2016 and December 31, 2015 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 June 30, 2016
 
 
 
 
 
 
Commodity Contracts:
 
 
 
 
 
 
Short-term derivative asset
 
$
27

 
$
(27
)
 
$
—

Short-term derivative liability
 
(278
)
 
27

 
(251
)
Long-term derivative liability
 
(41
)
 
—

 
(41
)
Total commodity contracts
 
(292
)
 
—

 
(292
)
Foreign Currency Contracts:(a)
 
 
 
 
 
 
Short-term derivative liability
 
(64
)
 
—

 
(64
)
Total foreign currency contracts
 
(64
)
 
—

 
(64
)
Supply Contracts:
 
 
 
 
 
 
Short-term derivative asset
 
30

 
—

 
30

Long-term derivative asset
 
250

 
—

 
250

Total supply contracts
 
280

 
—

 
280

Total derivatives
 
$
(76
)
 
$
—

 
$
(76
)
 
 
 
 
 
 
 
As of December 31, 2015
 
 
 
 
 
 
Commodity Contracts:
 
 
 
 
 
 
Short-term derivative asset
 
$
381

 
$
(66
)
 
$
315

Short-term derivative liability
 
(106
)
 
66

 
(40
)
Long-term derivative liability
 
(8
)
 
—

 
(8
)
Total commodity contracts
 
267

 
—

 
267

Foreign Currency Contracts:(a)
 
 
 
 
 
 
Long-term derivative liability
 
(52
)
 
—

 
(52
)
Total foreign currency contracts
 
(52
)
 
—

 
(52
)
Supply Contracts:
 
 
 
 
 
 
Short-term derivative asset
 
51

 
—

 
51

Long-term derivative asset
 
246

 
—

 
246

Total supply contracts
 
297

 
—

 
297

Total derivatives
 
$
512

 
$
—

 
$
512

____________________________________________
(a)
Designated as cash flow hedging instruments.
As of June 30, 2016 and December 31, 2015, 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 revenues for the Current Quarter, the Prior Quarter, the Current Period and the Prior Period are presented below. 
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
($ in millions)
Oil, natural gas and NGL revenues
 
$
884

 
$
1,264

 
$
1,696

 
$
2,646

Gains (losses) on undesignated oil, natural gas
and NGL derivatives
 
(438
)
 
(43
)
 
(246
)
 
135

Losses on terminated cash flow hedges
 
(6
)
 
(5
)
 
(17
)
 
(22
)
Total oil, natural gas and NGL revenues
 
$
440

 
$
1,216

 
$
1,433

 
$
2,759

The components of marketing, gathering and compression revenues for the Current Quarter, the Prior Quarter, the Current Period and the Prior Period are presented below.    
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
($ in millions)
Marketing, gathering and compression revenues
 
$
1,219

 
$
2,085

 
$
2,159

 
$
3,760

Gains (losses) on undesignated supply contract derivatives
 
(37
)
 
220

 
(17
)
 
220

Total marketing, gathering and compression revenues
 
$
1,182

 
$
2,305

 
$
2,142

 
$
3,980

The components of interest expense for the Current Quarter, the Prior Quarter, the Current Period and the Prior Period are presented below. 
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2016
 
2015
 
2016
 
2015
 
 
($ in millions)
Interest expense on senior notes
 
$
107

 
$
171

 
$
222

 
$
342

Amortization of loan discount, issuance costs and other
 
7

 
12

 
18

 
23

Interest expense on credit facilities
 
12

 
3

 
17

 
6

Gains on terminated fair value hedges
 
(1
)
 
(1
)
 
(1
)
 
(2
)
Gains on undesignated interest rate derivatives
 
—

 
—

 
—

 
(10
)
Capitalized interest
 
(63
)
 
(114
)
 
(132
)
 
(237
)
Total interest expense
 
$
62

 
$
71

 
$
124

 
$
122


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 June 30,
 
 
2016
 
2015
 
 
Before 
Tax  
 
After 
Tax  
 
Before 
Tax  
 
After 
Tax  
 
 
($ in millions)
Balance, beginning of period
 
$
(156
)
 
$
(99
)
 
$
(216
)
 
$
(134
)
Net change in fair value
 
(13
)
 
(15
)
 
—

 
—

Losses reclassified to income
 
6

 
10

 
5

 
3

Balance, end of period
 
$
(163
)
 
$
(104
)
 
$
(211
)
 
$
(131
)
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30,
 
 
2016
 
2015
 
 
Before 
Tax  
 
After 
Tax  
 
Before 
Tax  
 
After 
Tax  
 
 
($ in millions)
Balance, beginning of period
 
$
(160
)
 
$
(99
)
 
$
(231
)
 
$
(143
)
Net change in fair value
 
(20
)
 
(19
)
 
(2
)
 
(1
)
Losses reclassified to income
 
17

 
14

 
22

 
13

Balance, end of period
 
$
(163
)
 
$
(104
)
 
$
(211
)
 
$
(131
)

Approximately $99 million of the $104 million of accumulated other comprehensive loss as of June 30, 2016 represents 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 June 30, 2016, we expect to transfer approximately $20 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
Our 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 June 30, 2016, our oil, natural gas, NGL, foreign currency and supply contract derivative instruments were spread among 15 counterparties.
Hedging Arrangements
In 2015, we began entering into bilateral hedging agreements. The counterparties’ and our obligations under certain of the bilateral hedging agreements must be secured by cash or letters of credit to the extent that any mark-to-market amounts owed to us or by us exceed defined thresholds.
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, natural gas and NGL 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, 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 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 June 30, 2016 and December 31, 2015: 
 
 
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 June 30, 2016
 
 
 
 
 
 
 
 
Derivative Assets (Liabilities):
 
 
 
 
 
 
 
 
Commodity assets
 
$
—

 
$
27

 
$
—

 
$
27

Commodity liabilities
 
—

 
(248
)
 
(71
)
 
(319
)
Foreign currency liabilities
 
—


(64
)
 
—

 
(64
)
Supply contract assets
 
—

 
—

 
280

 
280

Total derivatives
 
$
—

 
$
(285
)
 
$
209

 
$
(76
)
 
 
 
 
 
 
 
 
 
As of December 31, 2015
 
 
 
 
 
 
 
 
Derivative Assets (Liabilities):
 
 
 
 
 
 
 
 
Commodity assets
 
$
—

 
$
372

 
$
9

 
$
381

Commodity liabilities
 
—

 
(14
)
 
(100
)
 
(114
)
Foreign currency liabilities
 
—

 
(52
)
 
—

 
(52
)
Supply contract assets
 
—

 
—

 
297

 
297

Total derivatives
 
$
—

 
$
306

 
$
206

 
$
512



A summary of the changes in the fair values of Chesapeake’s financial assets (liabilities) classified as Level 3 during the Current Period and the Prior Period is presented below. 
 
 
Commodity
Derivatives
 
Supply
Contracts
 
 
($ in millions)
Beginning balance as of December 31, 2015
 
$
(91
)
 
$
297

Total gains (losses) (unrealized):
 
 
 
 
Included in earnings(a)
 
(8
)
 
13

Total purchases, issuances, sales and settlements:
 
 
 
 
Settlements
 
28

 
(30
)
Ending balance as of June 30, 2016
 
$
(71
)
 
$
280

 
 
 
 
 
Beginning balance as of December 31, 2014
 
$
(54
)
 
$
1

Total gains (losses) (unrealized):
 
 
 
 
Included in earnings(a)
 
80

 
220

Total purchases, issuances, sales and settlements:
 
 
 
 
Settlements
 
(108
)
 
—

Ending balance as of June 30, 2015
 
$
(82
)
 
$
221

___________________________________________
(a)
 
Oil, Natural Gas
and NGL
Sales
 
Marketing, Gathering and Compression Revenue
 
 
 
2016
 
2015
 
2016
 
2015
 
 
($ in millions)
Total gains (losses) included in earnings for the period
 
$
(8
)
 
$
80

 
$
(17
)
 
$
220

Change in unrealized gains (losses) related to assets still held at reporting date
 
$
(20
)
 
$
69

 
$
(17
)
 
$
220

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 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 June 30, 2016:
Instrument
Type
 
Unobservable
Input
 
Range
 
Weighted
Average
 
Fair Value
June 30, 2016
 
 
 
 
 
 
 
 
($ in millions)
Oil trades(a)
 
Oil price volatility curves
 
21.20% – 33.68%
 
29.04%
 
$
(6
)
Supply contracts(b)
 
Oil price volatility curves
 
19.94% – 37.25%
 
24.41%
 
$
280

Natural gas trades(a)
 
Natural gas price volatility
curves
 
19.97% – 53.48%
 
32.20%
 
$
(65
)
___________________________________________
(a)
Fair value is based on an estimate derived from option models.
(b)
Fair value is based on an estimate derived from industry standard methodologies which consider historical relationships among various commodities, modeled market prices, time value and volatility factors.