Exhibit 99.1
SCHEDULE “A”
CHESAPEAKE’S OUTLOOK AS OF NOVEMBER 3, 2008
Quarter Ending December 31, 2008 and Years Ending December 31, 2009 and 2010.
We have adopted a policy of periodically providing guidance on certain factors that affect our future financial performance. As of November 3, 2008, we are using the following key assumptions in our projections for the fourth quarter of 2008 and the full years 2009 and 2010.
The sole change from our October 30, 2008 Outlook is the correction of our estimated 2009 operating cash flow to reflect changes in our hedging positions. The primary changes from our October 14, 2008 Outlook are in italicized bold and are explained as follows:
1) | Natural gas production assumption for the quarter ending 12/31/08 has been reduced to reflect anticipated voluntary curtailments due to low wellhead price realizations; |
2) | Projected effects of changes in our hedging positions have been updated; |
3) | Our NYMEX natural gas and oil price assumptions for realized hedging effects and estimating future operating cash flow have been reduced for the quarter ending 12/31/08; and |
4) | Certain cost and cash income tax assumptions have been updated. |
Quarter Ending 12/31/2008 | Year Ending 12/31/2009 | Year Ending 12/31/2010 | |||
Estimated Production(a) | |||||
Natural gas – bcf | 188 – 192 | 893 – 913 | 1,032 – 1,072 | ||
Oil – mbbls | 2,825 | 12,000 | 13,000 | ||
Natural gas equivalent – bcfe | 205 – 209 | 965 – 985 | 1,110 –1,150 | ||
Daily natural gas equivalent midpoint – mmcfe | 2,250 | 2,670 | 3,095 | ||
Year-over-year production increase | 1.4% | 16.8% | 15.9% | ||
NYMEX Prices (b) (for calculation of realized hedging effects only): | |||||
Natural gas - $/mcf | $7.00 | $8.00 | $8.00 | ||
Oil - $/bbl | $60.00 | $80.00 | $80.00 | ||
Estimated Realized Hedging Effects (based on assumed NYMEX prices above): | |||||
Natural gas - $/mcf | $1.96 | $0.70 | $0.82 | ||
Oil - $/bbl | $5.48 | $1.32 | $4.79 | ||
Estimated Differentials to NYMEX Prices: | |||||
Natural gas - $/mcf | 10 – 14% | 10 – 14% | 10 – 14% | ||
Oil - $/bbl | 5 – 7% | 5 – 7% | 5 – 7% | ||
Operating Costs per Mcfe of Projected Production: | |||||
Production expense | $1.00 – 1.15 | $1.10 – 1.20 | $1.15 – 1.25 | ||
Production taxes (~ 5% of O&G revenues) (c) | $0.30 – 0.35 | $0.35 – 0.40 | $0.35 – 0.40 | ||
General and administrative(d) | $0.33 – 0.37 | $0.33 – 0.37 | $0.33 – 0.37 | ||
Stock-based compensation (non-cash) | $0.10 – 0.13 | $0.10 – 0.12 | $0.10 – 0.12 | ||
DD&A of natural gas and oil assets | $2.25 – 2.30 | $2.20 – 2.30 | $2.15 – 2.25 | ||
Depreciation of other assets | $0.20 – 0.25 | $0.20 – 0.24 | $0.20 – 0.24 | ||
Interest expense(e) | $0.30 – 0.35 | $0.40 – 0.45 | $0.35 – 0.40 | ||
Other Income per Mcfe: | |||||
Natural gas and oil marketing income | $0.09 – 0.11 | $0.09 – 0.11 | $0.09 – 0.11 | ||
Service operations income | $0.04 – 0.06 | $0.04 – 0.06 | $0.04 – 0.06 | ||
Book Tax Rate | 38.5% | 38.5% | 38.5% | ||
Cash Income Taxes – in millions | $550 – 650 | $200 – 300 | $200 – 300 | ||
Equivalent Shares Outstanding – in millions: | |||||
Basic | 560 – 565 | 565 - 570 | 575 - 580 | ||
Diluted | 580 – 585 | 585 - 590 | 595 - 600 |
Cash Flow Projections – in millions | Quarter Ending 12/31/2008 | Year Ending 12/31/2009 | Year Ending 12/31/2010 | ||
Net inflows: | |||||
Operating cash flow before changes in assets and liabilities(f)(g) | $1,250 – 1,375 | $5,350 –5,700 | $6,250 – 6,750 | ||
Leasehold and producing property transactions: | |||||
Sale of leasehold and producing properties(a) | $2,100 – 2,500 | $1,250 – 2,000 | $1,250 – 2,000 | ||
Sale of producing properties via VPP’s(a) | $400 – 500 | $1,000 – 1,250 | $1,000 – 1,250 | ||
Acquisition of leasehold and producing properties | ($750 - $1,000) | ($1,250 - $1,750) | ($1,000 - $1,500) | ||
Net leasehold and producing property transactions | $1,750 – 2,000 | $1,000 – 1,500 | $1,250 – 1,750 | ||
Debt and equity offerings | – | – | – | ||
Midstream financings | $1,050 – 1,275 | $500 – 700 | $500 – 700 | ||
Proceeds from investments and other | – | $500– 750 | $150 – 250 | ||
Total Cash Inflows | $4,050 – 4,650 | $7,350 – 8,650 | $8,150 – 9,450 | ||
Net outflows: | |||||
Drilling | $1,200 – 1,300 | $4,250 – 4,750 | $4,750 – 5,250 | ||
Geophysical costs | $75 | $225 – 275 | $225 – 275 | ||
Midstream infrastructure and compression | $300 – 325 | $1,000 – 1,200 | $900 – 1,000 | ||
Other PP&E | $50 – 75 | $250 – 300 | $250 – 300 | ||
Dividends, senior notes redemption, capitalized interest, etc. | $150 – 200 | $575 – 600 | $575 – 600 | ||
Cash income taxes | $550 – 650 | $200 – 300 | $200 – 300 | ||
Total Cash Outflows | $2,325 – 2,625 | $6,500 – 7,425 | $6,900 – 7,725 | ||
Net Cash Change | $1,725 – 2,025 | $850 – 1,225 | $1,250 – 1,725 | ||
(a) | The 2008 fourth quarter production and cash flow forecasts reflect anticipated sales by the company of: 1) producing properties for approximately $450 million in a volumetric production payment (VPP); and 2) producing properties in South Texas and undeveloped leasehold in the Marcellus Shale and other areas for approximately $2.3 billion. The 2009 and 2010 production and cash flow forecasts reflect anticipated sales by the company of: 1) producing properties for approximately $1.1 billion in each year in VPP transactions; and 2) undeveloped leasehold or other producing properties for approximately $1.6 billion in each year. |
(b) | NYMEX natural gas prices have been updated for actual contract prices through October 2008. |
(c) | Severance tax per mcfe is based on NYMEX prices of $60.00 per bbl of oil and $6.50 to $7.50 per mcf of natural gas during the 2008 fourth quarter; $80.00 per bbl of oil and $7.50 to $8.50 per mcf of natural gas during 2009; and $80.00 per bbl of oil and $7.50 to $8.50 per mcf of natural gas during 2010. |
(d) | Excludes expenses associated with noncash stock compensation. |
(e) | Does not include gains or losses on interest rate derivatives (SFAS 133). |
(f) | A non-GAAP financial measure. We are unable to provide a reconciliation to projected cash provided by operating activities, the most comparable GAAP measure, because of uncertainties associated with projecting future changes in assets and liabilities. |
(g) | Assumes NYMEX natural gas prices of $6.50 to $7.50 per mcf and NYMEX oil prices of $60.00 per bbl in the 2008 fourth quarter and NYMEX natural gas prices of $7.00 to $8.00 per mcf and NYMEX oil prices of $80.00 per bbl in 2009 and 2010. |
Commodity Hedging Activities
The company utilizes hedging strategies to hedge the price of a portion of its future natural gas and oil production. These strategies include:
(i) | For swap instruments, Chesapeake receives a fixed price and pays a floating market price to the counterparty. The fixed-price payment and the floating-price payment are netted, resulting in a net amount due to or from the counterparty. |
(ii) | Basis protection swaps are arrangements that guarantee a price differential for oil or natural gas from a specified delivery point. For Mid-Continent basis protection swaps, which have negative differentials to NYMEX, Chesapeake receives a payment from the counterparty if the price differential is greater than the stated terms of the contract and pays the counterparty if the price differential is less than the stated terms of the contract. For Appalachian basis protection swaps, which have positive differentials to NYMEX, Chesapeake receives a payment from the counterparty if the price differential is less than the stated terms of the contract and pays the counterparty if the price differential is greater than the stated terms of the contract. |
(iii) | For knockout swaps, Chesapeake receives a fixed price and pays a floating market price. The fixed price received by Chesapeake includes a premium in exchange for the possibility to reduce the counterparty’s exposure to zero, in any given month, if the floating market price is lower than certain predetermined knockout prices. |
(iv) | For cap-swaps, Chesapeake receives a fixed price and pays a floating market price. The fixed price received by Chesapeake includes a premium in exchange for a "cap" limiting the counterparty's exposure. In other words, there is no limit to Chesapeake's exposure but there is a limit to the downside exposure of the counterparty |
(v) | For written call options, Chesapeake receives a premium from the counterparty in exchange for the sale of a call option. If the market price exceeds the fixed price of the call option, Chesapeake pays the counterparty such excess. If the market price settles below the fixed price of the call option, no payment is due from Chesapeake. |
(vi) | Collars 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 call and the put strike price, no payments are due from either party. |
(vii) | A three-way collar contract consists of a standard collar contract plus a written put option with a strike price below the floor price of the collar. In addition to the settlement of the collar, the put option requires Chesapeake to make a payment to the counterparty equal to the difference between the put option price and the settlement price if the settlement price for any settlement period is below the put option strike price. |
Commodity markets are volatile, and as a result, Chesapeake’s hedging activity is dynamic. As market conditions warrant, the company may elect to settle a hedging transaction prior to its scheduled maturity date and lock in the gain or loss on the transaction.
Chesapeake enters into natural gas and oil derivative transactions in order to mitigate a portion of its exposure to adverse market changes in natural gas and oil prices. Accordingly, associated gains or losses from the derivative transactions are reflected as adjustments to natural gas and oil sales. All realized gains and losses from natural gas and oil derivatives are included in natural gas and oil sales in the month of related production. Pursuant to SFAS 133, certain derivatives do not qualify for designation as cash flow hedges. Changes in the fair value of these nonqualifying derivatives that occur prior to their maturity (i.e., because of temporary fluctuations in value) are reported currently in the consolidated statement of operations as unrealized gains (losses) within natural gas and oil sales.
Following provisions of SFAS 133, changes in the fair value of derivative instruments designated as cash flow hedges, to the extent effective in offsetting cash flows attributable to hedged risk, are recorded in other comprehensive income until the hedged item is recognized in earnings. Any change in fair value resulting from ineffectiveness is recognized currently in natural gas and oil sales.
Excluding the swaps assumed in connection with the acquisition of CNR which are described below, the company currently has the following open natural gas swaps in place and also has the following gains (losses) from lifted natural gas swaps:
Open Swaps in Bcf’s | Avg. NYMEX Strike Price of Open Swaps | Assuming Natural Gas Production in Bcf’s of: | Open Swap Positions as a % of Estimated Total Natural Gas Production | Total Gains (Losses) from Lifted Swaps ($ millions) | Total Lifted Gain (Loss) per Mcf of Estimated Total Natural Gas Production | |
Q4 2008 | 108.2 | $9.27 | 190 | 57% | $85.2 | $0.45 |
Total 2009(1) | 327.7 | $9.43 | 903 | 36% | ($36.7) | ($0.04) |
Total 2010(1) | 422.6 | $9.58 | 1,052 | 40% | $33.9 | $0.03 |
(1) | Certain hedging arrangements include knockout swaps with provisions limiting the counterparty’s exposure below $6.50 covering 9 bcf in 2008 and prices ranging from $5.65 to $7.25 covering 150 bcf in 2009 and $5.45 to $7.40 covering 321 bcf in 2010. |
The company currently has the following open natural gas collars in place:
Open Collars in Bcf’s | Avg. NYMEX Floor Price | Avg. NYMEX Ceiling Price | Assuming Natural Gas Production in Bcf’s of: | Open Collars as a % of Estimated Total Natural Gas Production | |
Q4 2008 | 26.6 | $7.75 | $9.32 | 190 | 14% |
Total 2009(1) | 267.5 | $7.21 | $9.27 | 903 | 30% |
Total 2010(1) | 25.6 | $7.71 | $11.46 | 1,052 | 2% |
(1) | Certain collar arrangements include three-way collars that include written put options with strike prices ranging from $5.00 to $6.00 covering 105 bcf in 2009 and at $6.00 covering 4 bcf in 2010. |
The company currently has the following natural gas written call options in place:
Call Options in Bcf’s | Avg. NYMEX Call Price | Avg. Premium per mcf | Assuming Natural Gas Production in Bcf’s of: | Call Options as a % of Estimated Total Natural Gas Production | |
Q4 2008 | 32.2 | $10.37 | $0.74 | 190 | 17% |
Total 2009 | 216.2 | $11.40 | $0.63 | 903 | 24% |
Total 2010 | 231.8 | $10.77 | $0.72 | 1,052 | 22% |
The company has the following natural gas basis protection swaps in place:
Mid-Continent | Appalachia | ||||||
Volume in Bcf’s | NYMEX less*: | Volume in Bcf’s | NYMEX plus*: | ||||
Q4 2008 | 32.1 | $0.45 | 5.8 | $0.33 | |||
2009 | 77.1 | 0.35 | 16.9 | 0.28 | |||
2010 | — | — | 10.2 | 0.26 | |||
2011 | 45.1 | 0.64 | 12.1 | 0.25 | |||
2012 | 43.2 | 0.48 | — | — | |||
Totals | 197.5 | $0.46 | 45.0 | $0.27 | |||
* weighted average
We assumed certain liabilities related to open derivative positions in connection with the CNR acquisition in November 2005. In accordance with SFAS 141, these derivative positions were recorded at fair value in the purchase price allocation as a liability of $592 million ($76 million as of September 30, 2008). The recognition of the derivative liability and other assumed liabilities resulted in an increase in the total purchase price which was allocated to the assets acquired. Because of this accounting treatment, only cash settlements for changes in fair value subsequent to the acquisition date for the derivative positions assumed result in adjustments to our natural gas and oil revenues upon settlement. For example, if the fair value of the derivative positions assumed does not change, then upon the sale of the underlying production and corresponding settlement of the derivative positions, cash would be paid to the counterparties and there would be no adjustment to natural gas and oil revenues related to the derivative positions. If, however, the actual sales price is different from the price assumed in the original fair value calculation, the difference would be reflected as either a decrease or increase in natural gas and oil revenues, depending upon whether the sales price was higher or lower, respectively, than the prices assumed in the original fair value calculation. For accounting purposes, the net effect of these acquired hedges is that we hedged the production volumes listed below at their fair values on the date of our acquisition of CNR.
Pursuant to SFAS 149 “Amendment of SFAS 133 on Derivative Instruments and Hedging Activities,” the assumed CNR derivative instruments are deemed to contain a significant financing element and all cash flows associated with these positions are reported as financing activity in the statement of cash flows.
The following details the CNR derivatives (natural gas swaps) we have assumed:
Open Swaps in Bcf’s | Avg. NYMEX Strike Price Of Open Swaps (per Mcf) | Avg. Fair Value Upon Acquisition of Open Swaps (per Mcf) | Initial Liability Acquired (per Mcf) | Assuming Natural Gas Production in Bcf’s of: | Open Swap Positions as a % of Estimated Total Natural Gas Production | |
Q4 2008 | 9.7 | $4.66 | $7.84 | ($3.17) | 190 | 5% |
Total 2009 | 18.3 | $5.18 | $7.28 | ($2.10) | 903 | 2% |
Note: Not shown above are collars covering 3.7 bcf of production in 2009 at an average floor and ceiling of $4.50 and $6.00.
The company also has the following crude oil swaps in place:
Open Swaps in mbbls | Avg. NYMEX Strike Price | Assuming Oil Production in mbbls of: | Open Swap Positions as a % of Estimated Total Oil Production | Total Gains (Losses) from Lifted Swaps ($ millions) | Total Lifted Gain (Loss) per bbl of Estimated Total Oil Production | |
Q4 2008(1) | 1,214 | $78.09 | 2,825 | 43% | ($2.3) | ($0.81) |
Total 2009(1) | 5,728 | $81.19 | 12,000 | 48% | $38.5 | $3.21 |
Total 2010(1) | 4,745 | $90.25 | 13,000 | 37% | — | — |
(1) | Certain hedging arrangements include cap-swaps and knockout swaps with provisions limiting the counterparty’s exposure below prices ranging from $45.00 to $60.00 covering 982 mbbls in 2008, from $50.00 to $60.00 covering 6,038 mbbls in 2009 and $60.00 covering 4,745 mbbls in 2010. |
Note: Not shown above are written call options covering 768 mbbls of production in 2008 at a weighted average price of $85.86 for a weighted average premium of $4.05, 5,110 mbbls of production in 2009 at a weighed average price of $133.93 for a weighted average premium of $3.90 and 5,110 mbbls of production in 2010 at a weighed average price of $140.00 for a weighted average premium of $4.46.
SCHEDULE “B”
CHESAPEAKE’S PREVIOUS OUTLOOK AS OF OCTOBER 14, 2008
(PROVIDED FOR REFERENCE ONLY)
NOW SUPERSEDED BY OUTLOOK AS OF NOVEMBER 3, 2008
Quarter Ending December 31, 2008 and Years Ending December 31, 2009 and 2010.
We have adopted a policy of periodically providing guidance on certain factors that affect our future financial performance. As of October 14, 2008, we are using the following key assumptions in our projections for the fourth quarter of 2008 and the full years 2009 and 2010.
The primary changes from our September 22, 2008 Outlook are in italicized bold and are explained as follows:
1) | Projected effects of changes in our hedging positions have been updated; |
2) | Certain cost assumptions and budgeted capital expenditure assumptions have been updated; |
3) | Our NYMEX oil price assumption for realized hedging effects and estimating future operating cash flow has been reduced; and |
4) | Shares outstanding have been updated to remove the effects of certain contingent convertible senior notes that are not presently convertible at the current stock price level. |
Quarter Ending 12/31/2008 | Year Ending 12/31/2009 | Year Ending 12/31/2010 | |||
Estimated Production(a) | |||||
Natural gas – bcf | 197 – 201 | 893 – 913 | 1,032 – 1,072 | ||
Oil – mbbls | 2,825 | 12,000 | 13,000 | ||
Natural gas equivalent – bcfe | 214 – 218 | 965 – 985 | 1,110 –1,150 | ||
Daily natural gas equivalent midpoint – mmcfe | 2,350 | 2,670 | 3,095 | ||
Year-over-year production increase | 5.9% | 15.6% | 15.9% | ||
NYMEX Prices (b) (for calculation of realized hedging effects only): | |||||
Natural gas - $/mcf | $7.82 | $8.00 | $8.00 | ||
Oil - $/bbl | $80.00 | $80.00 | $80.00 | ||
Estimated Realized Hedging Effects (based on assumed NYMEX prices above): | |||||
Natural gas - $/mcf | $1.48 | $1.04 | $0.82 | ||
Oil - $/bbl | ($2.82) | $2.42 | $4.79 | ||
Estimated Differentials to NYMEX Prices: | |||||
Natural gas - $/mcf | 10 – 14% | 10 – 14% | 10 – 14% | ||
Oil - $/bbl | 5 – 7% | 5 – 7% | 5 – 7% | ||
Operating Costs per Mcfe of Projected Production: | |||||
Production expense | $1.00 – 1.10 | $1.10 – 1.20 | $1.15 – 1.25 | ||
Production taxes (~ 5% of O&G revenues) (c) | $0.35 – 0.40 | $0.35 – 0.40 | $0.35 – 0.40 | ||
General and administrative(d) | $0.33 – 0.37 | $0.33 – 0.37 | $0.33 – 0.37 | ||
Stock-based compensation (non-cash) | $0.10 – 0.12 | $0.10 – 0.12 | $0.10 – 0.12 | ||
DD&A of natural gas and oil assets | $2.30 – 2.35 | $2.20 – 2.30 | $2.15 – 2.25 | ||
Depreciation of other assets | $0.20 – 0.24 | $0.20 – 0.24 | $0.20 – 0.24 | ||
Interest expense(e) | $0.30 – 0.35 | $0.40 – 0.45 | $0.35 – 0.40 | ||
Other Income per Mcfe: | |||||
Natural gas and oil marketing income | $0.09 – 0.11 | $0.09 – 0.11 | $0.09 – 0.11 | ||
Service operations income | $0.04 – 0.06 | $0.04 – 0.06 | $0.04 – 0.06 | ||
Book Tax Rate | 38.5% | 38.5% | 38.5% | ||
Cash Income Taxes – in millions | $350 - 450 | $200 – 300 | $200 – 300 | ||
Equivalent Shares Outstanding – in millions: | |||||
Basic | 560 – 565 | 565 - 570 | 575 - 580 | ||
Diluted | 580 – 585 | 585 - 590 | 595 - 600 |
Cash Flow Projections – in millions | Quarter Ending 12/31/2008 | Year Ending 12/31/2009 | Year Ending 12/31/2010 | ||
Net inflows: | |||||
Operating cash flow before changes in assets and liabilities(f)(g) | $1,375 – 1,425 | $5,800 – 6,000 | $6,250 – 6,750 | ||
Leasehold and producing property transactions: | |||||
Sale of leasehold and producing properties(a) | $2,100 – 2,500 | $1,250 – 2,000 | $1,250 – 2,000 | ||
Sale of producing properties via VPP’s(a) | $400 – 500 | $1,000 – 1,250 | $1,000 – 1,250 | ||
Acquisition of leasehold and producing properties | ($750 - $1,000) | ($1,250 - $1,750) | ($1,000 - $1,500) | ||
Net leasehold and producing property transactions | $1,750 – 2,000 | $1,000 – 1,500 | $1,250 – 1,750 | ||
Debt and equity offerings | – | – | – | ||
Midstream financings | $1,050 – 1,275 | $500 – 700 | $500 – 700 | ||
Proceeds from investments and other | – | $500– 750 | $150 – 250 | ||
Total Cash Inflows | $4,175 – 4,700 | $7,800 – 8,950 | $8,150 – 9,450 | ||
Net outflows: | |||||
Drilling | $1,200 – 1,300 | $4,250 – 4,750 | $4,750 – 5,250 | ||
Geophysical costs | $75 | $225 – 275 | $225 – 275 | ||
Midstream infrastructure and compression | $300 – 325 | $1,000 – 1,200 | $900 – 1,000 | ||
Other PP&E | $50 – 75 | $250 – 300 | $250 – 300 | ||
Dividends, senior notes redemption, capitalized interest, etc. | $150 – 200 | $575 – 600 | $575 – 600 | ||
Cash income taxes | $350 – 450 | $200 – 300 | $200 – 300 | ||
Total Cash Outflows | $2,125 – 2,425 | $6,500 – 7,425 | $6,900 – 7,725 | ||
Net Cash Change | $2,050 – 2,275 | $1,300 –1,525 | $1,250 – 1,725 | ||
(a) | The 2008 fourth quarter production and cash flow forecasts reflect anticipated sales by the company of: 1) producing properties for approximately $450 million in a volumetric production payment (VPP); and 2) producing properties in South Texas and undeveloped leasehold in the Marcellus Shale and other areas for approximately $2.3 billion. The 2009 and 2010 production and cash flow forecasts reflect anticipated sales by the company of: 1) producing properties for approximately $1.1 billion in each year in VPP transactions; and 2) undeveloped leasehold or other producing properties for approximately $1.6 billion in each year. |
(b) | NYMEX natural gas prices have been updated for actual contract prices through October 2008. |
(c) | Severance tax per mcfe is based on NYMEX prices of $80.00 per bbl of oil and $7.50 to $8.50 per mcf of natural gas during Q4 2008; $80.00 per bbl of oil and $7.50 to $8.50 per mcf of natural gas during 2009; and $80.00 per bbl of oil and $7.50 to $8.50 per mcf of natural gas during 2010. |
(d) | Excludes expenses associated with noncash stock compensation. |
(e) | Does not include gains or losses on interest rate derivatives (SFAS 133). |
(f) | A non-GAAP financial measure. We are unable to provide a reconciliation to projected cash provided by operating activities, the most comparable GAAP measure, because of uncertainties associated with projecting future changes in assets and liabilities. |
(g) | Assumes NYMEX natural gas of $7.00 to $8.00 per mcf and NYMEX oil prices of $80.00 per bbl. |
Commodity Hedging Activities
The company utilizes hedging strategies to hedge the price of a portion of its future natural gas and oil production.
These strategies include:
(i) | For swap instruments, Chesapeake receives a fixed price and pays a floating market price to the counterparty. The fixed-price payment and the floating-price payment are netted, resulting in a net amount due to or from the counterparty. |
(ii) | Basis protection swaps are arrangements that guarantee a price differential for oil or natural gas from a specified delivery point. For Mid-Continent basis protection swaps, which have negative differentials to NYMEX, Chesapeake receives a payment from the counterparty if the price differential is greater than the stated terms of the contract and pays the counterparty if the price differential is less than the stated terms of the contract. For Appalachian basis protection swaps, which have positive differentials to NYMEX, Chesapeake receives a payment from the counterparty if the price differential is less than the stated terms of the contract and pays the counterparty if the price differential is greater than the stated terms of the contract. |
(iii) | For knockout swaps, Chesapeake receives a fixed price and pays a floating market price. The fixed price received by Chesapeake includes a premium in exchange for the possibility to reduce the counterparty’s exposure to zero, in any given month, if the floating market price is lower than certain predetermined knockout prices. |
(iv) | For cap-swaps, Chesapeake receives a fixed price and pays a floating market price. The fixed price received by Chesapeake includes a premium in exchange for a "cap" limiting the counterparty's exposure. In other words, there is no limit to Chesapeake's exposure but there is a limit to the downside exposure of the counterparty |
(v) | For written call options, Chesapeake receives a premium from the counterparty in exchange for the sale of a call option. If the market price exceeds the fixed price of the call option, Chesapeake pays the counterparty such excess. If the market price settles below the fixed price of the call option, no payment is due from Chesapeake. |
(vi) | Collars 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 call and the put strike price, no payments are due from either party. |
(vii) | A three-way collar contract consists of a standard collar contract plus a written put option with a strike price below the floor price of the collar. In addition to the settlement of the collar, the put option requires Chesapeake to make a payment to the counterparty equal to the difference between the put option price and the settlement price if the settlement price for any settlement period is below the put option strike price. |
Commodity markets are volatile, and as a result, Chesapeake’s hedging activity is dynamic. As market conditions warrant, the company may elect to settle a hedging transaction prior to its scheduled maturity date and lock in the gain or loss on the transaction.
Chesapeake enters into natural gas and oil derivative transactions in order to mitigate a portion of its exposure to adverse market changes in natural gas and oil prices. Accordingly, associated gains or losses from the derivative transactions are reflected as adjustments to natural gas and oil sales. All realized gains and losses from natural gas and oil derivatives are included in natural gas and oil sales in the month of related production. Pursuant to SFAS 133, certain derivatives do not qualify for designation as cash flow hedges. Changes in the fair value of these nonqualifying derivatives that occur prior to their maturity (i.e., because of temporary fluctuations in value) are reported currently in the consolidated statement of operations as unrealized gains (losses) within natural gas and oil sales.
Following provisions of SFAS 133, changes in the fair value of derivative instruments designated as cash flow hedges, to the extent effective in offsetting cash flows attributable to hedged risk, are recorded in other comprehensive income until the hedged item is recognized in earnings. Any change in fair value resulting from ineffectiveness is recognized currently in natural gas and oil sales.
Excluding the swaps assumed in connection with the acquisition of CNR which are described below, the company currently has the following open natural gas swaps in place and also has the following gains (losses) from lifted natural gas swaps:
Open Swaps in Bcf’s | Avg. NYMEX Strike Price of Open Swaps | Assuming Natural Gas Production in Bcf’s of: | Open Swap Positions as a % of Estimated Total Natural Gas Production | Total Gains (Losses) from Lifted Swaps ($ millions) | Total Lifted Gain (Loss) per Mcf of Estimated Total Natural Gas Production | |
Q4 2008 | 110.6 | $9.30 | 199 | 56% | $79.70 | $0.40 |
Total 2009(1) | 533.0 | $9.46 | 903 | 59% | ($36.70) | ($0.04) |
Total 2010(1) | 422.6 | $9.58 | 1,052 | 40% | $33.90 | $0.03 |
(1) | Certain hedging arrangements include knockout swaps with provisions limiting the counterparty’s exposure below prices ranging from $5.45 to $6.50 covering 35 bcf in 2008, $5.45 to $7.25 covering 356 bcf in 2009 and $5.45 to $7.40 covering 318 bcf in 2010. |
The company currently has the following open natural gas collars in place:
Open Collars in Bcf’s | Avg. NYMEX Floor Price | Avg. NYMEX Ceiling Price | Assuming Natural Gas P roduction in Bcf’s of: | Open Collars as a % of Estimated Total Natural Gas Production | |
Q4 2008 | 26.6 | $7.75 | $9.32 | 199 | 13% |
Total 2009(1) | 63.9 | $8.05 | $11.18 | 903 | 7% |
Total 2010(1) | 25.6 | $7.71 | $11.46 | 1,052 | 2% |
(1) | Certain collar arrangements include three-way collars that include written put options with strike prices ranging from $5.50 to $6.00 covering 38 bcf in 2009 and at $6.00 covering 4 bcf in 2010. |
The company currently has the following natural gas written call options in place:
Call Options in Bcf’s | Avg. NYMEX Call Price | Avg. Premium per mcf | Assuming Natural Gas Production in Bcf’s of: | Call Options as a % of Estimated Total Natural Gas Production | |
Q4 2008 | 34.0 | $10.39 | $0.70 | 199 | 17% |
Total 2009 | 225.5 | $11.37 | $0.61 | 903 | 25% |
Total 2010 | 231.8 | $10.77 | $0.72 | 1,052 | 22% |
The company has the following natural gas basis protection swaps in place:
Mid-Continent | Appalachia | ||||||
Volume in Bcf’s | NYMEX less*: | Volume in Bcf’s | NYMEX plus*: | ||||
Q4 2008 | 32.1 | $0.45 | 5.8 | $0.33 | |||
2009 | 77.1 | 0.35 | 16.9 | 0.28 | |||
2010 | — | — | 10.2 | 0.26 | |||
2011 | 45.1 | 0.64 | 12.1 | 0.25 | |||
2012 | 43.2 | 0.48 | — | — | |||
Totals | 197.5 | $0.46 | 45.0 | $0.27 | |||
* weighted average
We assumed certain liabilities related to open derivative positions in connection with the CNR acquisition in November 2005. In accordance with SFAS 141, these derivative positions were recorded at fair value in the purchase price allocation as a liability of $592 million ($102 million as of June 30, 2008). The recognition of the derivative liability and other assumed liabilities resulted in an increase in the total purchase price which was allocated to the assets acquired. Because of this accounting treatment, only cash settlements for changes in fair value subsequent to the acquisition date for the derivative positions assumed result in adjustments to our natural gas and oil revenues upon settlement. For example, if the fair value of the derivative positions assumed does not change, then upon the sale of the underlying production and corresponding settlement of the derivative positions, cash would be paid to the counterparties and there would be no adjustment to natural gas and oil revenues related to the derivative positions. If, however, the actual sales price is different from the price assumed in the original fair value calculation, the difference would be reflected as either a decrease or increase in natural gas and oil revenues, depending upon whether the sales price was higher or lower, respectively, than the prices assumed in the original fair value calculation. For accounting purposes, the net effect of these acquired hedges is that we hedged the production volumes listed below at their fair values on the date of our acquisition of CNR.
Pursuant to SFAS 149 “Amendment of SFAS 133 on Derivative Instruments and Hedging Activities,” the assumed CNR derivative instruments are deemed to contain a significant financing element and all cash flows associated with these positions are reported as financing activity in the statement of cash flows.
The following details the CNR derivatives (natural gas swaps) we have assumed:
Open Swaps in Bcf’s | Avg. NYMEX Strike Price Of Open Swaps (per Mcf) | Avg. Fair Value Upon Acquisition of Open Swaps (per Mcf) | Initial Liability Acquired (per Mcf) | Assuming Natural Gas Production in Bcf’s of: | Open Swap Positions as a % of Estimated Total Natural Gas Production | |
Q4 2008 | 9.7 | $4.66 | $7.84 | ($3.17) | 199 | 5% |
Total 2009 | 18.3 | $5.18 | $7.28 | ($2.10) | 903 | 2% |
Note: Not shown above are collars covering 3.7 bcf of production in 2009 at an average floor and ceiling of $4.50 and $6.00.
The company also has the following crude oil swaps in place:
Open Swaps in mbbls | Avg. NYMEX Strike Price | Assuming Oil Production in mbbls of: | Open Swap Positions as a % of Estimated Total Oil Production | Total Losses from Lifted Swaps ($ millions) | Total Lifted Losses per bbl of Estimated Total Oil Production | |
Q4 2008(1) | 1,702 | $77.57 | 2,825 | 60% | ($4.7) | ($1.68) |
Total 2009(1) | 8,364 | $82.38 | 12,000 | 70% | ($0.6) | ($0.05) |
Total 2010(1) | 4,745 | $90.25 | 13,000 | 37% | — | — |
(1) | Certain hedging arrangements include cap-swaps and knockout swaps with provisions limiting the counterparty’s exposure below prices ranging from $45.00 to $60.00 covering 1,104 mbbls in 2008, from $52.50 to $60.00 covering 7,848 mbbls in 2009 and $60.00 covering 4,745 mbbls in 2010. |
Note: Not shown above are written call options covering 890 mbbls of production in 2008 at a weighted average price of $86.43 for a weighted average premium of $3.63, 3,285 mbbls of production in 2009 at a weighed average price of $122.22 for a weighted average premium of $6.07 and 3,285 mbbls of production in 2010 at a weighed average price of $131.67 for a weighted average premium of $6.94.