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Derivative and Hedging Activities (Notes)
 9 Months Ended
Sep. 30, 2017
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative and Hedging Activities Disclosure
Derivative and Hedging Activities
Chesapeake uses derivative instruments to reduce its exposure to fluctuations in future commodity prices and to protect its expected operating cash flow against significant market movements or volatility. 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. None of our derivative instruments were designated for hedge accounting as of September 30, 2017 and December 31, 2016.
Oil, Natural Gas and NGL Derivatives
As of September 30, 2017 and December 31, 2016, 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 may sell call options and call swaptions.
•
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.
•
Call Swaptions: Chesapeake sells call swaptions to counterparties that allow the counterparty, on a specific date, to extend an existing fixed-price swap for a certain period of time.
•
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 the sale by Chesapeake of 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.
•
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 September 30, 2017 and December 31, 2016 are provided below. 
 
 
September 30, 2017
 
December 31, 2016
 
 
Volume
 
Fair Value
 
Volume
 
Fair Value
 
 
 
 
($ in millions)  
 
 
 
($ in millions)  
Oil (mmbbl):
 
 
 
 
 
 
 
 
Fixed-price swaps
 
18

 
$
(17
)
 
23

 
$
(140
)
Three Way Collars
 
2

 
(2
)
 
—

 
—

Call options
 
1

 
—

 
5

 
(1
)
Call swaptions
 
2

 
(7
)
 
—

 
—

Basis protection swaps
 
3

 
(1
)
 
—

 
—

Total oil
 
26

 
(27
)
 
28

 
(141
)
Natural gas (tbtu):
 
 
 
 
 
 
 
 
Fixed-price swaps
 
696

 
38

 
719

 
(349
)
Collars
 
71

 
8

 
60

 
(9
)
Call options
 
121

 
(7
)
 
114

 
—

Basis protection swaps
 
26

 
(1
)
 
31

 
(5
)
Total natural gas
 
914

 
38

 
924

 
(363
)
NGL (mmgal):
 
 
 
 
 
 
 
 
Fixed-price swaps
 
15

 
(2
)
 
53

 
—

Total estimated fair value
 
 
 
$
9

 
 
 
$
(504
)

We have terminated certain commodity derivative contracts that were previously designated as cash flow hedges for which the original contract months are yet to occur. See further discussion below under Effect of Derivative Instruments – Accumulated Other Comprehensive Income (Loss).
Interest Rate Derivatives
As of September 30, 2017 and December 31, 2016, 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 three years, we will recognize $2 million in net gains related to these transactions.
Foreign Currency Derivatives
During the Current Period, both our 6.25% Euro-denominated Senior Notes due 2017 and cross currency swaps for the same principal amount matured. Upon maturity of the notes, the counterparties paid us €246 million and we paid the counterparties $327 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 were designated as cash flow hedges and, because they were 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 did not impact earnings. The fair values of the cross currency swaps were recorded on the condensed consolidated balance sheet as a liability of $73 million as of December 31, 2016.
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 the Prior Quarter, we sold a long-term natural gas supply contract to a third party for cash proceeds of $146 million, which is included in marketing, gathering and compression revenues as a realized gain. We reversed the cumulative unrealized gains, resulting in an unrealized loss of $280 million in the Prior Quarter and $297 million in Prior Period, respectively.
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 September 30, 2017 and December 31, 2016 on a gross basis and after same-counterparty netting: 
Balance Sheet Classification
 
Gross
Fair Value
 
Amounts Netted
in the
Condensed
Consolidated
Balance Sheets
 
Net Fair Value
Presented in the
Condensed
Consolidated
Balance Sheet
 
 
($ in millions)
As of September 30, 2017
 
 
 
 
 
 
Commodity Contracts:
 
 
 
 
 
 
Short-term derivative asset
 
$
57

 
$
(29
)
 
$
28

Short-term derivative liability
 
(37
)
 
29

 
(8
)
Long-term derivative asset
 
1

 
(1
)
 
—

Long-term derivative liability
 
(11
)
 
—

 
(11
)
Total commodity contracts
 
10

 
(1
)
 
9

Total derivatives
 
$
10

 
$
(1
)
 
$
9

 
 
 
 
 
 
 
As of December 31, 2016
 
 
 
 
 
 
Commodity Contracts:
 
 
 
 
 
 
Short-term derivative asset
 
$
1

 
$
(1
)
 
$
—

Short-term derivative liability
 
(490
)
 
1

 
(489
)
Long-term derivative liability
 
(15
)
 
—

 
(15
)
Total commodity contracts
 
(504
)
 
—

 
(504
)
Foreign Currency Contracts:(a)
 
 
 
 
 
 
Short-term derivative liability
 
(73
)
 
—

 
(73
)
Total foreign currency contracts
 
(73
)
 
—

 
(73
)
Total derivatives
 
$
(577
)
 
$
—

 
$
(577
)
____________________________________________
(a)
Designated as cash flow hedging instruments.
As of September 30, 2017 and December 31, 2016, 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
September 30,
 
Nine Months Ended
September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
($ in millions)
Oil, natural gas and NGL revenues
 
$
1,049

 
$
1,048

 
$
3,275

 
$
2,744

Gains (losses) on undesignated oil, natural gas
and NGL derivatives
 
(62
)
 
136

 
477

 
(110
)
Losses on terminated cash flow hedges
 
(8
)
 
(7
)
 
(25
)
 
(24
)
Total oil, natural gas and NGL revenues
 
$
979

 
$
1,177

 
$
3,727

 
$
2,610

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
September 30,
 
Nine Months Ended
September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
($ in millions)
Marketing, gathering and compression revenues
 
$
964

 
$
1,379

 
$
3,250

 
$
3,538

Losses on undesignated supply contract derivatives
 
—

 
(280
)
 
—

 
(297
)
Total marketing, gathering and compression revenues
 
$
964

 
$
1,099

 
$
3,250

 
$
3,241

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
September 30,
 
Nine Months Ended
September 30,
 
 
2017
 
2016
 
2017
 
2016
 
 
($ in millions)
Interest expense on senior notes
 
$
135

 
$
141

 
$
407

 
$
446

Interest expense on term loan
 
34

 
14

 
98

 
14

Amortization of loan discount, issuance costs and other
 
13

 
9

 
28

 
27

Amortization of premium associated with troubled debt restructuring
 
(29
)
 
(41
)
 
(112
)
 
(124
)
Interest expense on revolving credit facility
 
11

 
10

 
28

 
27

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

 
—

 
1

 
—

Capitalized interest
 
(49
)
 
(59
)
 
(147
)
 
(191
)
Total interest expense
 
$
114

 
$
73

 
$
302

 
$
197


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 September 30,
 
 
2017
 
2016
 
 
Before 
Tax  
 
After 
Tax  
 
Before 
Tax  
 
After 
Tax  
 
 
($ in millions)
Balance, beginning of period
 
$
(132
)
 
$
(75
)
 
$
(163
)
 
$
(104
)
Net change in fair value
 
—

 
—

 
(4
)
 
(4
)
Losses reclassified to income
 
8

 
8

 
7

 
7

Balance, end of period
 
$
(124
)
 
$
(67
)
 
$
(160
)
 
$
(101
)
 
 
 
 
 
 
 
 
 
 
 
Nine Months Ended September 30,
 
 
2017
 
2016
 
 
Before 
Tax  
 
After 
Tax  
 
Before 
Tax  
 
After 
Tax  
 
 
($ in millions)
Balance, beginning of period
 
$
(153
)
 
$
(96
)
 
$
(160
)
 
$
(99
)
Net change in fair value
 
4

 
4

 
(23
)
 
(23
)
Losses reclassified to income
 
25

 
25

 
23

 
21

Balance, end of period
 
$
(124
)
 
$
(67
)
 
$
(160
)
 
$
(101
)

The accumulated other comprehensive loss, as of September 30, 2017, represents the net deferred loss associated with commodity derivative contracts that were previously designated as cash flow hedges for which the original contract months are yet to occur. Remaining deferred gain or loss amounts will be recognized in earnings in the month for which the original contract months are to occur. As of September 30, 2017, 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
Our derivative instruments expose us to our counterparties’ credit risk. To mitigate this risk, we enter into derivative contracts only with counterparties that are highly rated or deemed by the Company to have acceptable credit strength 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 September 30, 2017, our oil, natural gas and NGL derivative instruments were spread among 10 counterparties.
Hedging Arrangements
Certain of our hedging arrangements are with counterparties that are also lenders (or affiliates of lenders) under our revolving credit facility. The contracts entered into with these counterparties are secured by the same collateral that secures our revolving credit facility, which allows us to reduce any letters of credit posted as security with those counterparties. In addition, we enter into bilateral hedging agreements with other counterparties. The counterparties’ and our obligations under 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 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 September 30, 2017 and December 31, 2016: 
 
 
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 September 30, 2017
 
 
 
 
 
 
 
 
Derivative Assets (Liabilities):
 
 
 
 
 
 
 
 
Commodity assets
 
$
—

 
$
55

 
$
2

 
$
57

Commodity liabilities
 
—

 
(38
)
 
(10
)
 
(48
)
Total derivatives
 
$
—

 
$
17

 
$
(8
)
 
$
9

 
 
 
 
 
 
 
 
 
As of December 31, 2016
 
 
 
 
 
 
 
 
Derivative Assets (Liabilities):
 
 
 
 
 
 
 
 
Commodity assets
 
$
—

 
$
1

 
$
—

 
$
1

Commodity liabilities
 
—

 
(495
)
 
(10
)
 
(505
)
Foreign currency liabilities
 
—

 
(73
)
 
—

 
(73
)
Total derivatives
 
$
—

 
$
(567
)
 
$
(10
)
 
$
(577
)


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)
Balance, as of January 1, 2017
 
$
(10
)
 
$
—

Total gains (losses) (realized/unrealized):
 
 
 
 
Included in earnings(a)
 
1

 
—

Total purchases, issuances, sales and settlements:
 
 
 
 
Settlements
 
1

 
—

Balance, as of September 30, 2017
 
$
(8
)
 
$
—

 
 
 
 
 
Balance, as of January 1, 2016
 
$
(91
)
 
$
297

Total gains (losses) (realized/unrealized):
 
 
 
 
Included in earnings(a)
 
12

 
(118
)
Total purchases, issuances, sales and settlements:
 
 
 
 
Settlements
 
49

 
(33
)
Sales
 
—

 
(146
)
Balance, as of September 30, 2016
 
$
(30
)
 
$
—

___________________________________________
(a)
 
 
Oil, Natural Gas
and NGL
Sales
 
Marketing, Gathering
and Compression
Revenue
 
 
 
 
 
2017
 
2016
 
2017
 
2016
 
 
 
($ in millions)
 
Total gains (losses) included in earnings for the period
 
$
1

 
$
12

 
$
—

 
$
(118
)
 
Change in unrealized gains (losses) related to assets still held at reporting date
 
$
(7
)
 
$
(1
)
 
$
—

 
$
—

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, which is based on an estimate derived from option models. 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 September 30, 2017:
Instrument
Type
 
Unobservable
Input
 
Range
 
Weighted
Average
 
Fair Value
September 30, 2017
 
 
 
 
 
 
 
 
($ in millions)
Oil trades
 
Oil price volatility curves
 
15.30% – 26.67%
 
23.43%
 
$
(9
)
Natural gas trades
 
Natural gas price volatility
curves
 
19.58% – 63.01%
 
38.24%
 
$
1