Item 5. Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Item 6. Selected Financial Data
Item 7. Management's Discussion and Analysis of Financial Condition and Results of Operations
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
Item 8. Financial Statements and Supplementary Data
Item 9. Changes in and Disagreements with Accountants on Accounting and Financial Disclosure
Item 9A. Controls and Procedures
Item 9B. Other Information
Part III
Item 10. Directors, Executive Officers and Corporate Governance
Item 11. Executive Compensation
Item 12. Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters
Item 13. Certain Relationships and Related Transactions and Director Independence
Item 14. Principal Accountant Fees and Services
Part IV
Item 15. Exhibits and Financial Statement Schedules
Item 16. Form 10-K Summary
Exhibits
EX-3.1.1
ex311cec_restatedcoi02-26x.htm
EX-10.3.2
ex1032deferredcompensation.htm
EX-10.10
ex10102019-01x01employment.htm
EX-10.11
ex10112019-01x01formofexec.htm
EX-21
chk-ex_21x20181231x10k.htm
EX-23.1
chk-ex_231x20181231x10k.htm
EX-23.2
chk-ex_232x20181231x10k.htm
EX-31.1
chk-ex_311x20181231x10k.htm
EX-31.2
chk-ex_312x20181231x10k.htm
EX-32.1
chk-ex_321x20181231x10k.htm
EX-32.2
chk-ex_322x20181231x10k.htm
EX-99
ex99schlumbergerye2018.htm
Chesapeake Energy Earnings 2018-12-31
CHK 10K Annual Report
Balance Sheet
Income Statement
Cash Flow
10-K 1 chk-20181231_10k.htm 10-K Document
UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
[X] ANNUAL REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Fiscal Year Ended December 31, 2018
[ ] TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the transition period from to
Commission File No. 1-13726
CHESAPEAKE ENERGY CORPORATION
(Exact name of registrant as specified in its charter)
Oklahoma
73-1395733
(State or other jurisdiction of incorporation or organization)
(I.R.S. Employer Identification No.)
6100 North Western Avenue, Oklahoma City, Oklahoma
73118
(Address of principal executive offices)
(Zip Code)
(405) 848-8000
(Registrant’s telephone number, including area code)
Securities Registered Pursuant to Section 12(b) of the Act:
Title of Each Class
Name of Each Exchange on Which Registered
Common Stock, par value $0.01
New York Stock Exchange
Floating Rate Senior Notes due 2019
New York Stock Exchange
6.625% Senior Notes due 2020
New York Stock Exchange
6.875% Senior Notes due 2020
New York Stock Exchange
6.125% Senior Notes due 2021
New York Stock Exchange
5.375% Senior Notes due 2021
New York Stock Exchange
4.875% Senior Notes due 2022
New York Stock Exchange
5.75% Senior Notes due 2023
New York Stock Exchange
4.5% Cumulative Convertible Preferred Stock
New York Stock Exchange
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark if the registrant is a well-known seasoned issuer, as defined in Rule 405 of the Securities Act. YES [X] NO [ ]
Indicate by check mark if the registrant is not required to file reports pursuant to Section 13 or Section 15(d) of the Exchange Act. YES [ ] NO [X]
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES [X] NO [ ]
Indicate by check mark whether the registrant has submitted electronically every Interactive Data File required to be submitted pursuant to Rule 405 of Regulation S-T (§ 232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit such files). YES [X] NO [ ]
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant's knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K. [X]
Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and “emerging growth company” in Rule 12b-2 of the Exchange Act.
Smaller Reporting Company [ ] Emerging Growth Company [ ]
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). YES [ ] NO [X]
The aggregate market value of our common stock held by non-affiliates on June 29, 2018, was approximately $4.7 billion. As of February 12, 2019, there were 1,631,724,765 shares of our $0.01 par value common stock outstanding.
__________________________________________
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the 2018 Annual Meeting of Shareholders are incorporated by reference in Part III.
The terms defined in this section are used throughout this report.
Bbl. One stock tank barrel, or 42 U.S. gallons liquid volume, used herein in reference to crude oil or other liquid hydrocarbons.
Bboe. One billion barrels of oil equivalent.
Bcf. One billion cubic feet of natural gas.
Bcfe. One billion cubic feet of natural gas equivalent.
Btu. British thermal unit, which is the heat required to raise the temperature of a one-pound mass of water from 58.5 to 59.5 degrees Fahrenheit.
Boe. Barrel of oil equivalent. Natural gas proved reserves and production are converted to boe at 14.73 psia and 60 degrees. Boe is based on six mcf of natural gas to one bbl of oil or one bbl of NGL. This ratio reflects an energy content equivalency and not a price or revenue equivalency. Despite holding this ratio constant at six mcf to one bbl, prices have historically often been higher or substantially higher for oil than natural gas on an energy equivalent basis, although there have been periods in which they have been lower or substantially lower.
Completion. The process of treating a drilled well followed by the installation of permanent equipment for the production of oil, natural gas or natural gas liquids, or in the case of a dry well, the reporting to the appropriate authority that the well has been abandoned.
Developed Acreage. The number of acres which are allocated or assignable to producing wells or wells capable of production.
Dry Well. A well found to be incapable of producing either oil or natural gas in sufficient quantities to justify completion as an oil or natural gas well.
Exploratory Well. A well drilled to find a new field or to find a new reservoir in a field previously found to be productive of oil or natural gas in another reservoir.
Formation. A succession of sedimentary beds that were deposited under the same general geologic conditions.
Full Cost. The full cost method of accounting, as governed by SEC Regulation S-X 4-10(c), consists of capitalizing all costs associated with property acquisition, exploration and development activities into a full cost pool. The full cost pool is tested for impairment quarterly using the “ceiling test” described in Regulation S-X 4-10(c). Additionally, any internal costs that can be directly identified with acquisition, exploration and development activities are included. Any costs related to production, general corporate overhead or similar activities are not included.
GAAP. Generally Accepted Accounting Principles in the United States.
Gross Acres or Gross Wells. The total acres or wells, as the case may be, in which a working interest is owned.
Mboe. One thousand barrels of oil equivalent.
Mcf. One thousand cubic feet.
Mmbbl. One million barrels of crude oil or other liquid hydrocarbons.
Mmboe. One million barrels of oil equivalent.
Mmbtu. One million btus.
Mmcf. One million cubic feet.
Natural Gas Liquids (NGL). Hydrocarbons in natural gas that are separated from the gas as liquids through the process of absorption, condensation, adsorption or other methods in gas processing or cycling plants. Natural gas liquids primarily include ethane, propane, butane, isobutene, pentane, hexane and natural gasoline.
Net Acres or Net Wells. The sum of the fractional working interests owned in gross acres or gross wells.
Play. A term applied to a portion of the exploration and production cycle following the identification by geologists and geophysicists of areas with potential oil, natural gas and NGL reserves.
Present Value of Estimated Future Net Revenues or PV-10 (non-GAAP). When used with respect to oil, natural gas and NGL reserves, present value of estimated future net revenues, or PV-10, means the estimated future gross revenue to be generated from the production of proved reserves, net of estimated production and future development costs, using prices calculated as the average oil and natural gas price during the preceding 12-month period prior to the end of the current reporting period, (determined as the unweighted arithmetic average of prices on the first day of each month within the 12-month period) and costs in effect at the determination date (unless such costs are subject to change pursuant to contractual provisions), without giving effect to non-property related expenses such as general and administrative expenses, debt service and future income tax expense or to depreciation, depletion and amortization, discounted using an annual discount rate of 10%.
Price Differential. The difference in the price of oil, natural gas or NGL received at the sales point and the NYMEX price.
Productive Well. A well that is not a dry well. Productive wells include producing wells and wells that are mechanically capable of production.
Proved Developed Reserves. Proved reserves that can be expected to be recovered through existing wells with existing equipment and operating methods or in which the cost of the required equipment is relatively minor compared to the cost of a new well.
Proved Properties. Properties with proved reserves.
Proved Reserves. As used in this report, proved reserves has the meaning given to such term in Rule 4-10(a)(22) of Regulation S-X, which states in part proved oil and natural gas reserves are those quantities of oil and natural gas, which, by analysis of geoscience and engineering data, can be estimated with reasonable certainty to be economically producible – from a given date forward, from known reservoirs, and under existing economic conditions, operating methods, and government regulations – prior to the time at which contracts providing the right to operate expire, unless evidence indicates that renewal is reasonably certain, regardless of whether deterministic or probabilistic methods are used for the estimation.
Proved Undeveloped Reserves (PUDs). Proved reserves that are expected to be recovered from new wells on undrilled acreage, or from existing wells where a relatively major expenditure is required. Reserves on undrilled acreage are limited to those directly offsetting development spacing areas that are reasonably certain of production when drilled, unless evidence using reliable technology exists that establishes reasonable certainty of economic producibility at greater distances.
Realized and Unrealized Gains and Losses on Oil, Natural Gas and NGL Derivatives. Realized gains and losses include the following items:(i) settlements and accruals for settlements of non-designated derivatives related to current period notional production revenues, (ii) prior period settlements for option premiums and for early-terminated derivatives originally scheduled to settle against current period notional production revenues, and (iii) gains and losses related to de-designated cash flow hedges originally designated to settle against current period notional production revenues. Unrealized gains and losses include the change in fair value of open derivatives scheduled to settle against future period notional production revenues (including current period settlements for option premiums and early-terminated derivatives) offset by amounts reclassified as realized gains and losses during the period. Although we no longer designate our derivatives as cash flow hedges for accounting purposes, we believe these definitions are useful to management and investors in determining the effectiveness of our price risk management program.
Realized and Unrealized Gains and Losses on Interest Rate Derivatives. Realized gains and losses include interest rate derivative settlements related to current period interest and the effect of gains and losses on early-terminated trades. Settlements of early-terminated trades are reflected in realized gains and losses over the original life of the hedged item. Unrealized gains and losses include changes in the fair value of open interest rate derivatives offset by amounts reclassified to realized gains and losses during the period.
Reservoir. A porous and permeable underground formation containing a natural accumulation of producible oil and/or natural gas that is confined by impermeable rock or water barriers and is individual and separate from other reservoirs.
Royalty Interest. An interest in an oil and natural gas property entitling the owner to a share of oil, natural gas or NGL production free of costs of production.
Seismic. An exploration method of sending energy waves or sound waves into the earth and recording the wave reflections to indicate the type, size, shape and depth of subsurface rock formations.
Shale. Fine-grained sedimentary rock composed mostly of consolidated clay or mud. Shale is the most frequently occurring sedimentary rock.
SEC. The United States Securities and Exchange Commission.
Standardized Measure. The discounted future net cash flows relating to proved reserves based on the means of the estimated future gross revenue to be generated from the production of proved reserves, net of estimated production and future development costs, using prices calculated as the average oil and natural gas price during the preceding 12-month period prior to the end of the current reporting period (determined as the unweighted arithmetic average of prices on the first day of each month within the 12-month period). The standardized measure differs from the PV-10 measure only because the former includes the effects of estimated future income tax expenses.
Undeveloped Acreage. Acreage on which wells have not been drilled or completed to a point that would permit the production of economic quantities of oil and natural gas regardless of whether the acreage contains proved reserves.
Unproved Properties. Properties with no proved reserves.
Volumetric Production Payment (VPP). As we use the term, a volumetric production payment represents a limited-term overriding royalty interest in oil and natural gas reserves that: (i) entitles the purchaser to receive scheduled production volumes over a period of time from specific lease interests; (ii) is free and clear of all associated future production costs and capital expenditures; (iii) is nonrecourse to the seller (i.e., the purchaser's only recourse is to the reserves acquired); (iv) transfers title of the reserves to the purchaser; and (v) allows the seller to retain the remaining reserves, if any, after the scheduled production volumes have been delivered.
WildHorse. WildHorse Resource Development Corporation. Immediately following the completion of our acquisition of WildHorse (the “First Merger”), WildHorse merged with and into Brazos Valley Longhorn, L.L.C., a newly formed Delaware limited liability company and wholly owned subsidiary of Chesapeake, which, together with the First Merger, we refer to as the “WildHorse Merger.” For ease of reference, we use the term “WildHorse” to refer to WildHorse Resource Development Corporation prior to the acquisition and Brazos Valley Longhorn, L.L.C. or “Brazos Valley Longhorn” after the acquisition, as applicable.
Working Interest. The operating interest which gives the owner the right to drill, produce and conduct operating activities on the property and a share of production.
This report includes “forward-looking statements” within the meaning of Section 27A of the Securities Act of 1933 and Section 21E of the Securities Exchange Act of 1934 (the “Exchange Act”). Forward-looking statements include our current expectations or forecasts of future events. In this context, forward-looking statements often address our expected future business and financial performance and financial condition, and often contain words such as "expect," “could,” “may,” "anticipate," "intend," "plan," “ability,” "believe," "seek," "see," "will," "would," “estimate,” “forecast,” "target," “guidance,” “outlook,” “opportunity” or “strategy.”
Although we believe the expectations and forecasts reflected in our forward-looking statements are reasonable, they are inherently subject to numerous risks and uncertainties, most of which are difficult to predict and many of which are beyond our control. No assurance can be given that such forward-looking statements will be correct or achieved or that the assumptions are accurate or will not change over time. Particular uncertainties that could cause our actual results to be materially different than those expressed in our forward-looking statements include:
•
the volatility of oil, natural gas and NGL prices;
•
uncertainties inherent in estimating quantities of oil, natural gas and NGL reserves and projecting future rates of production and the amount and timing of development expenditures;
•
our ability to replace reserves and sustain production;
•
drilling and operating risks and resulting liabilities;
•
our ability to generate profits or achieve targeted results in drilling and well operations;
•
the limitations our level of indebtedness may have on our financial flexibility;
•
our inability to access the capital markets on favorable terms;
•
the availability of cash flows from operations and other funds to finance reserve replacement costs or satisfy our debt obligations;
•
adverse developments or losses from pending or future litigation and regulatory proceedings, including royalty claims;
•
effects of environmental protection laws and regulation on our business;
effects of acquisitions and dispositions, including our acquisition of WildHorse and our ability to realize related synergies;
•
effects of purchase price adjustments and indemnity obligations; and
•
other factors that are described under Risk Factors in Item 1A of this Form 10-K.
We caution you not to place undue reliance on the forward-looking statements contained in this report, which speak only as of the filing date, and we undertake no obligation to update this information. We urge you to carefully review and consider the disclosures in this report and our other filings with the SEC that attempt to advise interested parties of the risks and factors that may affect our business.
Unless the context otherwise requires, references to “Chesapeake”, the “Company”, “us”, “we” and “our” in this report are to Chesapeake Energy Corporation together with its subsidiaries. Our principal executive offices are located at 6100 North Western Avenue, Oklahoma City, Oklahoma 73118, and our main telephone number at that location is (405) 848-8000.
Our Business
We are an independent exploration and production company engaged in the acquisition, exploration and development of properties to produce oil, natural gas and NGL from underground reservoirs. We own a large and geographically diverse portfolio of onshore U.S. unconventional liquids and natural gas assets, including interests in approximately 13,200 oil and natural gas wells. We have leading positions in the liquids-rich resource plays of the Eagle Ford Shale in South Texas, the stacked pay in the Powder River Basin in Wyoming and the Anadarko Basin in northwestern Oklahoma. Our natural gas resource plays are the Marcellus Shale in the northern Appalachian Basin in Pennsylvania and the Haynesville/Bossier Shales in northwestern Louisiana.
In October 2018, we sold our interests in the Utica Shale operating area located in Ohio for approximately $1.9 billion to Encino Acquisition Partners (“Encino”), a private oil and gas company headquartered in Houston, Texas. We used the net proceeds to reduce debt.
In February 2019, we acquired WildHorse Resource Development Corporation, an oil and gas company with operations in the Eagle Ford Shale and Austin Chalk formations in southeast Texas, for approximately 717.3 million shares of our common stock and $381 million in cash, and the assumption of WildHorse’s debt of $1.4 billion as of the acquisition date of February 1, 2019. The acquisition of WildHorse expands our oil growth platform and accelerates our progress toward our strategic and financial goals of enhancing our margins, achieving sustainable free cash flow generation, and reducing our net debt to EBITDA ratio. In conjunction with the acquisition under terms of the merger agreement, David W. Hayes, partner for NGP Energy Capital Management, L.L.C. (“NGP”), has joined our board and another designee of NGP is expected to be appointed to fill the next vacancy on our board.
Because the acquisition of WildHorse occurred after December 31, 2018, Chesapeake’s consolidated financial statements and the notes thereto do not include or take into account the closing of the acquisition and its effects.
Information About Us
We make available, free of charge on our website at chk.com, our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and any amendments to those reports as soon as reasonably practicable after we electronically file such material with, or furnish it to, the SEC. From time to time, we also post announcements, updates, events, investor information and presentations on our website in addition to copies of all recent news releases. Documents and information on our website are not incorporated by reference herein.
The SEC maintains a website at www.sec.gov that contains reports, proxy and information statements, and other information regarding issuers, including Chesapeake, that file electronically with the SEC.
Business Strategy
Our strategy is to create shareholder value through the development of our significant resource plays. Our substantial inventory of hydrocarbon resources, including our undeveloped acreage position in each of our key basins, provides a strong foundation to create future value. Concentrated blocks of undeveloped acreage give us the opportunity to apply what we believe are best in class well spacing analysis, completion techniques and lateral lengths to maximize capital efficiency. We have greatly improved our capital and operating efficiency metrics over the last several years and today have what we believe is a leading cost structure in each of our major resource plays. We believe our cost structure provides a significant competitive advantage in the current commodity price environment and it is our strategy to continue to seek capital and operating efficiencies to grow this advantage.
We continue to focus on reducing debt, increasing cash provided by operating activities, improving margins through financial discipline and operating efficiencies and improving environmental and safety performance. To accomplish these goals, we intend to allocate our capital expenditures to projects we believe offer the highest return
regardless of the commodity price environment, to deploy leading drilling and completion technology throughout our portfolio, and to take advantage of acquisition and divestiture opportunities to strengthen our cost structure and our portfolio. Increasing our margins means not only increasing our absolute level of cash flow from operations, but also increasing our cash flow from operations generated per barrel of oil equivalent production. We continue to seek opportunities to reduce cash costs (production, gathering, processing and transportation, general and administrative and interest expenses) through operational efficiencies, including but not limited to improving our production volumes from existing wells.
We believe that our dedication to financial discipline, the flexibility and efficiency of our capital program and cost structure and our continued focus on safety and environmental stewardship will provide opportunities to create value for us and our shareholders.
Operating Areas
We focus our exploration, development, acquisition and production efforts in the six geographic operating areas described below.
Marcellus - Northern Appalachian Basin in Pennsylvania.
Brazos Valley - Southeast Texas assets acquired in our WildHorse acquisition on February 1, 2019.
Powder River Basin - Stacked pay in Wyoming.
Mid-Continent - Anadarko Basin in northwestern Oklahoma.
Well Data
As of December 31, 2018, we held an interest in approximately 13,200 gross (5,600 net) productive wells, including 10,200 properties in which we held a working interest and 3,000 properties in which we held an overriding or royalty interest. Of the 10,200 properties in which we had a working interest, we operated 7,200 wells, 6,800 gross (3,800 net), of which were classified as productive natural gas wells and 3,400 gross (1,800 net) were classified as productive oil wells. During 2018, we drilled or participated in 351 gross (238 net) wells as operator and participated in another 26 gross (1 net) wells completed by other operators. We operate approximately 97% of our current daily production volumes.
Drilling Activity
The following table sets forth the wells we drilled or participated in during the periods indicated. In the table, "gross" refers to the total wells in which we had a working interest and "net" refers to gross wells multiplied by our working interest:
The following table shows the wells we drilled or participated in by operating area:
2018
2017
2016
Gross Wells
Net Wells
Gross Wells
Net Wells
Gross Wells
Net Wells
Marcellus
52
23
43
21
19
9
Haynesville
30
21
37
34
41
34
Eagle Ford
162
98
180
106
199
116
Powder River Basin
41
34
25
21
1
1
Mid-Continent
52
32
114
58
135
62
Utica
40
31
69
56
34
17
Other
—
—
—
—
6
—
Total
377
239
468
296
435
239
As of December 31, 2018, we had 149 gross (82 net) wells in the process of being drilled or completed.
Production, Sales Prices, Production and Gathering, Processing and Transportation Expenses
The following table sets forth information regarding our net production volumes, average sales price received for our production, average sales price of our production combined with our realized gains or losses on derivatives and production and gathering, processing and transportation expenses per boe for the periods indicated:
Years Ended December 31,
2018
2017
2016
Net Production:
Oil (mmbbl)
33
33
33
Natural gas (bcf)
832
878
1,049
NGL (mmbbl)
19
21
24
Oil equivalent (mmboe)
190
200
233
Average Sales Price of Production:
Oil ($ per bbl)
$
67.25
$
51.03
$
40.65
Natural gas ($ per mcf)
$
2.99
$
2.76
$
2.05
NGL ($ per bbl)
$
26.50
$
23.18
$
14.76
Oil equivalent ($ per boe)
$
27.27
$
22.88
$
16.63
Average Sales Price (including realized gains (losses) on derivatives):
Oil ($ per bbl)
$
57.42
$
53.19
$
43.58
Natural gas ($ per mcf)
$
3.00
$
2.75
$
2.20
NGL ($ per bbl)
$
25.84
$
22.98
$
14.43
Oil equivalent ($ per boe)
$
25.56
$
23.17
$
17.66
Expenses ($ per boe):
Oil, natural gas and NGL production
$
2.84
$
2.81
$
3.05
Oil, natural gas and NGL gathering, processing and transportation
The tables below set forth information as of December 31, 2018, with respect to our estimated proved reserves, the associated estimated future net revenue, the present value of estimated future net revenue (“PV-10”) and the standardized measure of discounted future net cash flows (“standardized measure”). None of the estimated future net revenue, PV-10 nor the standardized measure are intended to represent the current market value of the estimated oil, natural gas and NGL reserves we own. All of our estimated reserves are located within the United States.
December 31, 2018
Oil
Natural Gas
NGL
Total
(mmbbl)
(bcf)
(mmbbl)
(mmboe)
Proved developed
127.6
3,314
67.9
748
Proved undeveloped
87.9
3,463
35.4
700
Total proved(a)
215.5
6,777
103.3
1,448
Proved
Developed
Proved
Undeveloped
Total
Proved
($ in millions)
Estimated future net revenue(b)
$
10,214
$
7,120
$
17,334
Present value of estimated future net revenue (PV-10)(b)
$
6,177
$
3,350
$
9,527
Standardized measure(b)
$
9,495
___________________________________________
(a)
Marcellus, Haynesville and Eagle Ford accounted for approximately 40%, 27%, and 22%, respectively, of our estimated proved reserves by volume as of December 31, 2018.
(b)
Estimated future net revenue represents the estimated future revenue to be generated from the production of proved reserves, net of estimated production and future development costs, using prices and costs under existing economic conditions as of December 31, 2018, and assuming commodity prices as set forth below. For the purpose of determining prices used in our reserve reports, we used the unweighted arithmetic average of the prices on the first day of each month within the 12-month period ended December 31, 2018. The prices used in our PV-10 measure were $65.56 of oil and $3.10 of natural gas, before basis differential adjustments. These prices should not be interpreted as a prediction of future prices, nor do they reflect the value of our commodity derivative instruments in place as of December 31, 2018. The amounts shown do not give effect to non-property-related expenses, such as corporate general and administrative expenses and debt service, or to depreciation, depletion and amortization. The present value of estimated future net revenue typically differs from the standardized measure because the former does not include the effects of estimated future income tax expense of $32 million as of December 31, 2018.
Management uses PV-10, which is calculated without deducting estimated future income tax expenses, as a measure of the value of the Company's current proved reserves and to compare relative values among peer companies. We also understand that securities analysts and rating agencies use this measure in similar ways. While estimated future net revenue and the present value thereof are based on prices, costs and discount factors which may be consistent from company to company, the standardized measure of discounted future net cash flows is dependent on the unique tax situation of each individual company. PV-10 should not be considered in isolation or as a substitute for the standardized measure of discounted future net cash flows or any other measure of a company's financial or operating performance presented in accordance with GAAP.
A reconciliation of the standardized measure of discounted future net cash flows to PV-10 is presented above. Neither PV-10 nor the standardized measure of discounted future net cash flows purport to represent the fair value of our proved oil and gas reserves.
As of December 31, 2018, our proved reserve estimates included 700 mmboe of reserves classified as proved undeveloped, compared to 796 mmboe as of December 31, 2017. Presented below is a summary of changes in our proved undeveloped reserves (PUDs) for 2018:
Total
(mmboe)
Proved undeveloped reserves, beginning of period
796
Extensions and discoveries
236
Revisions of previous estimates
(27
)
Developed
(115
)
Sale of reserves-in-place
(190
)
Proved undeveloped reserves, end of period
700
As of December 31, 2018, all PUDs were planned to be developed within five years. In 2018, we invested approximately $807 million to convert 115 mmboe of PUDs to proved developed reserves. In 2019, we estimate that we will invest approximately $1.2 billion for PUD conversion. We added 236 mmboe of proved undeveloped reserves through extensions and discoveries primarily as a result of longer planned lateral lengths and additional allocated capital in our five-year development plan. We sold 190 mmboe of proved undeveloped reserves primarily in the divestiture of Utica Shale assets. We recorded a downward revision of 27 mmboe from previous estimates due to ongoing portfolio evaluation including longer lateral and spacing adjustments.
The future net revenue attributable to our estimated PUDs was $7.1 billion and the present value was $3.3 billion as of December 31, 2018. These values were calculated assuming that we will expend approximately $3.6 billion to develop these reserves ($1.2 billion in 2019, $984 million in 2020, $901 million in 2021, $337 million in 2022 and $166 million in 2023). The amount and timing of these expenditures will depend on a number of factors, including actual drilling results, service costs, commodity prices and the availability of capital. Our developmental drilling schedules are subject to revision and reprioritization throughout the year resulting from unknowable factors such as unexpected developmental drilling results, title issues and infrastructure availability or constraints.
Of our 748 mmboe of proved developed reserves as of December 31, 2018, approximately 20 mmboe, or 3%, were non-producing.
Our ownership interest used for calculating proved reserves and the associated estimated future net revenue assumes maximum participation by other parties to our farm-out and participation agreements.
Our estimated proved reserves and the standardized measure of discounted future net cash flows of the proved reserves as of December 31, 2018, 2017 and 2016, along with the changes in quantities and standardized measure of the reserves for each of the three years then ended, are shown in Supplemental Disclosures About Oil, Natural Gas and NGL Producing Activities included in Item 8 of Part II of this report. No estimates of proved reserves comparable to those included herein have been included in reports to any federal agency other than the SEC.
There are numerous uncertainties inherent in estimating quantities of proved reserves and in projecting future rates of production and timing of development expenditures, including many factors beyond our control. The reserve data represents only estimates. Reserve engineering is a subjective process of estimating underground accumulations of oil and natural gas that cannot be measured exactly, and the accuracy of any reserve estimate is a function of the quality of available data and of engineering and geological interpretation and judgment. As a result, estimates made by different engineers often vary. In addition, results of drilling, testing and production subsequent to the date of an estimate may justify revision of these estimates, and these revisions may be material. Accordingly, reserve estimates often differ from the actual quantities of oil, natural gas and NGL that are ultimately recovered. Furthermore, the estimated future net revenue from proved reserves and the associated present value are based upon certain assumptions, including prices, future production levels and costs that may not prove correct. Future prices and costs may be materially higher or lower than the prices and costs as of the date of any estimate. See Supplemental Disclosures About Oil, Natural Gas and NGL Producing Activities included in Item 8 of Part II of this report for further discussion of our reserve quantities.
Our Corporate Reserves Department prepared approximately 20% by volume, and approximately 18% by value, of our estimated proved reserves disclosed in this report. Those estimates were based upon the best available production, engineering and geologic data.
Our Director – Corporate Reserves, is the technical person primarily responsible for overseeing the preparation of our reserve estimates and for coordinating any reserves work conducted by a third-party engineering firm. Her qualifications include the following:
•
Over 15 years of practical experience in the oil and gas industry, with 12 years in reservoir engineering;
•
Bachelor of Science degree in Geology and Environmental Sciences;
•
Master’s Degree in Petroleum and Natural Gas Engineering;
•
Executive MBA; and
•
Member in good standing of the Society of Petroleum Engineers.
We ensure that the key members of our Corporate Reserves Department have appropriate technical qualifications to oversee the preparation of reserves estimates. Each of our Corporate Reserves Engineers has significant engineering experience in reserve estimation. Our engineering technicians have a minimum of a four-year degree in mathematics, economics, finance or other technical/business/science field. We maintain a continuous education program for our engineers and technicians on new technologies and industry advancements as well as refresher training on basic skills and analytical techniques.
We maintain internal controls such as the following to ensure the reliability of reserves estimations:
•
We follow comprehensive SEC-compliant internal policies to estimate and report proved reserves. Reserve estimates are made by experienced reservoir engineers or under their direct supervision. All material changes are reviewed and approved by Corporate Reserves Engineers.
•
The Corporate Reserves Department reviews our proved reserves at the close of each quarter.
•
Each quarter, Reservoir Managers, the Director – Corporate Reserves, the Vice Presidents of our business units, the Vice President of Corporate and Strategic Planning and the Executive Vice President – Exploration and Production review all significant reserves changes and all new proved undeveloped reserves additions.
•
The Corporate Reserves Department reports independently of our operations.
•
The five-year PUD development plan is reviewed and approved annually by the Director – Corporate Reserves and the Vice President of Corporate and Strategic Planning.
We engaged Software Integrated Solutions, Division of Schlumberger Technology Corporation, a third-party engineering firm, to prepare approximately 80% by volume, and approximately 82% by value, of our estimated proved reserves as of December 31, 2018. A copy of the report issued by the engineering firm is filed with this report as Exhibit 99.1. The qualifications of the technical person at the firm primarily responsible for overseeing the preparation of our reserve estimates are set forth below.
•
over 30 years of practical experience in the estimation and evaluation of reserves;
•
registered professional geologist license in the Commonwealth of Pennsylvania;
•
member in good standing of the Society of Petroleum Engineers and the Society of Petroleum Evaluation Engineers; and
•
Bachelor of Science degree in Geological Sciences.
Costs Incurred in Oil and Natural Gas Property Acquisition, Exploration and Development
The following table sets forth historical costs incurred in oil and natural gas property acquisition, exploration and development activities during the periods indicated:
Years Ended December 31,
2018
2017
2016
($ in millions)
Acquisition of Properties:
Proved properties
$
80
$
23
$
403
Unproved properties
216
271
403
Exploratory costs
132
21
52
Development costs
2,009
2,146
1,312
Costs incurred(a)
$
2,437
$
2,461
$
2,170
___________________________________________
(a)
Includes capitalized interest and asset retirement obligations as follows:
Capitalized interest
$
162
$
194
$
242
Asset retirement obligations(b)
$
8
$
(34
)
$
(57
)
(b)
Activity in 2017 and 2016 primarily reflects revisions as the result of decreased plugging and abandonment costs in certain of our operating areas.
A summary of our exploration and development, acquisition and divestiture activities in 2018 by operating area is as follows:
Gross Wells Drilled
Net Wells Drilled
Exploration and Development
Acquisition of Unproved Properties
Acquisition of Proved Properties
Sales of Unproved Properties
Sales of
Proved
Properties(a)
Total(b)
($ in millions)
Marcellus
52
23
$
170
$
5
$
1
$
(2
)
$
—
$
174
Haynesville
30
21
346
6
—
(5
)
(8
)
339
Eagle Ford
162
98
696
14
—
(2
)
—
708
Powder River Basin
41
34
395
73
—
(28
)
—
440
Mid-Continent
52
32
201
19
1
(123
)
(262
)
(164
)
Utica
40
31
301
90
77
(325
)
(2,039
)
(1,896
)
Other
—
—
32
9
1
—
(6
)
36
Total
377
239
$
2,141
$
216
$
80
$
(485
)
$
(2,315
)
$
(363
)
___________________________________________
(a)
Includes asset retirement disposal of $28 million related to divestitures.
(b)
Includes capitalized internal costs of $121 million and capitalized interest of $162 million.
The following table sets forth our gross and net developed and undeveloped oil and natural gas leasehold and fee mineral acreage as of December 31, 2018. Gross acres are the total number of acres in which we own a working interest. Net acres refer to gross acres multiplied by our fractional working interest. Acreage numbers do not include our unexercised options to acquire additional acreage.
Developed Leasehold
Undeveloped Leasehold
Fee Minerals
Total
Gross
Acres
Net
Acres
Gross
Acres
Net
Acres
Gross
Acres
Net
Acres
Gross
Acres
Net
Acres
(in thousands)
Marcellus
541
347
265
177
16
16
822
540
Haynesville
302
270
99
67
—
—
401
337
Eagle Ford
308
183
77
52
—
—
385
235
Powder River Basin
73
58
244
189
1
1
318
248
Mid-Continent
926
602
200
132
38
34
1,164
768
Other(a)
184
146
1,066
983
435
431
1,685
1,560
Total
2,334
1,606
1,951
1,600
490
482
4,775
3,688
___________________________________________
(a)
Includes 1.3 million net acres retained in the 2016 fourth quarter divestiture of our Devonian Shale assets, in which we retained all rights below the base of the Kope formation.
Most of our leases have a three- to five-year primary term, and we manage lease expirations to ensure that we do not experience unintended material expirations. Our leasehold management efforts include scheduling our drilling to establish production in paying quantities in order to hold leases by production, timely exercising our contractual rights to pay delay rentals to extend the terms of leases we value, planning noncore divestitures to high-grade our lease inventory and letting some leases expire that are no longer part of our development plans. The following table sets forth the expiration periods of gross and net undeveloped leasehold acres as of December 31, 2018:
Acres Expiring
Gross
Acres
Net
Acres
(in thousands)
Years Ending December 31:
2019
108
87
2020
49
44
2021
37
27
After 2021
53
51
Held-by-production(a)
1,704
1,391
Total
1,951
1,600
___________________________________________
(a)
Held-by-production acres will remain in force as production continues on the subject leases.
The principal function of our marketing operations is to provide oil, natural gas and NGL marketing services, including commodity price structuring, securing and negotiating of gathering, hauling, processing and transportation services, contract administration and nomination services for us and other interest owners in Chesapeake-operated wells. The marketing operations also provide other services for our exploration and production activities, including services to enhance the value of oil and natural gas production by aggregating volumes sold to various intermediary markets, end markets and pipelines. This aggregation allows us to attract larger, more creditworthy customers that in turn assist in maximizing the prices received. In addition, we periodically enter into a variety of oil, natural gas and NGL purchase and sale contracts with third parties for various commercial purposes, including credit risk mitigation and satisfaction of our pipeline delivery commitments.
Generally, our oil production is sold under market-sensitive short-term or spot price contracts. Natural gas and NGL production is sold to purchasers under percentage-of-proceeds contracts, percentage-of-index contracts or spot price contracts. Under the terms of our percentage-of-proceeds contracts, we receive a percentage of the resale price received from the ultimate purchaser. Under our percentage-of-index contracts, the price we receive is tied to published indices.
We have entered into long-term gathering, processing, and transportation contracts with various parties that require us to deliver fixed, determinable quantities of production over specified periods of time. Certain of our contracts require us to make payments for any shortfalls in delivering or transporting minimum volumes under these commitments. See Note 4 of the notes to our consolidated financial statements included in Item 8 of this report for further discussion of commitments.
Major Customers
Sales to Valero Energy Corporation constituted approximately 10% of our total revenues (before the effects of hedging) for the year ended December 31, 2018. No other purchasers accounted for more than 10% of our total revenues for 2018. Sales to Royal Dutch Shell PLC constituted approximately 10% of our total revenues (before the effects of hedging) for the year ended December 31, 2017. Sales to BP PLC constituted approximately 10% of our total revenues (before the effects of hedging) for the year ended December 31, 2016.
Competition
We compete with both major integrated and other independent oil and natural gas companies in all aspects of our business to explore, develop and operate our properties and market our production. Some of our competitors may have larger financial and other resources than us. Competitive conditions may be affected by future legislation and regulations as the United States develops new energy and climate-related policies. In addition, some of our competitors may have a competitive advantage when responding to factors that affect demand for oil and natural gas production, such as changing prices, domestic and foreign political conditions, weather conditions, the price and availability of alternative fuels, the proximity and capacity of natural gas pipelines and other transportation facilities and overall economic conditions. We also face indirect competition from alternative energy sources, including wind, solar and electric power. We believe that our technological expertise, combined with our exploration, land, drilling and production capabilities and the experience of our management team, enables us to compete effectively.
Public Policy and Government Regulation
All of our operations are conducted onshore in the United States. Our industry is subject to a wide range of regulations, laws, rules, taxes, fees and other policy implementation actions that have been pervasive and are under constant review for amendment or expansion. Numerous government agencies have issued extensive regulations which are binding on our industry, some of which carry substantial penalties for failure to comply. These laws and regulations increase the cost of doing business and consequently affect profitability. Additionally, currently unforeseen environmental incidents may occur or past non-compliance with environmental laws or regulations may be discovered. We actively monitor regulatory developments applicable to our industry in order to anticipate, design and implement required compliance activities and systems. The following are significant areas of government control and regulation affecting our operations.
Exploration and Production, Environmental, Health and Safety, and Occupational Laws and Regulations
Our operations are subject to federal, tribal, state, and local laws and regulations. These laws and regulations relate to matters that include, but are not limited to, the following:
•
reporting of workplace injuries and illnesses;
•
industrial hygiene monitoring;
•
worker protection and workplace safety;
•
approval or permits to drill and to conduct operations;
•
provision of financial assurances (such as bonds) covering drilling and well operations;
•
calculation and disbursement of royalty payments and production taxes;
•
seismic operations and data;
•
location, drilling, cementing and casing of wells;
•
well design and construction of pad and equipment;
•
construction and operations activities in sensitive areas, such as wetlands, coastal regions or areas that contain endangered or threatened species, their habitats, or sites of cultural significance;
•
method of completing wells;
•
hydraulic fracturing;
•
water withdrawal;
•
well production and operations, including processing and gathering systems;
•
emergency response, contingency plans and spill prevention plans;
•
air emissions and fluid discharges;
•
climate change;
•
use, transportation, storage and disposal of fluids and materials incidental to oil and gas operations;
•
surface usage, maintenance, monitoring and the restoration of properties associated with well pads, pipelines, impoundments and access roads;
•
plugging and abandoning of wells; and
•
transportation of production.
Failure to comply with these laws and regulations can lead to the imposition of remedial liabilities, fines, or criminal penalties or to injunctions limiting our operations in affected areas. Moreover, multiple environmental laws provide for citizen suits which allow environmental organizations to act in the place of the government and sue operators for alleged violations of environmental law. We consider the costs of environmental protection and of safety and health compliance to be necessary, manageable parts of our business. We have been able to plan for and comply with environmental, safety and health laws and regulations without materially altering our operating strategy or incurring significant unreimbursed expenditures. However, based on regulatory trends and increasingly stringent laws, our capital expenditures and operating expenses related to compliance with the protection of the environment, safety and health have increased over the years and may continue to increase. We cannot predict with any reasonable degree of certainty our future exposure concerning such matters. See the Risk Factors described in Item 1A of this report for further discussion of governmental regulation and ongoing regulatory changes, including with respect to environmental matters,
Our operations are also subject to conservation regulations, including the regulation of the size of drilling and spacing units or proration units, the number of wells that may be drilled in a unit, the rate of production allowable from oil and gas wells, and the unitization or pooling of oil and gas properties. In the United States, some states allow the forced pooling or integration of tracts to facilitate exploration. Other states rely on voluntary pooling of lands and leases which may make it more difficult to develop oil and gas properties. In addition, federal and state conservation laws generally limit the venting or flaring of natural gas, and state conservation laws impose certain requirements regarding the ratable purchase of production. These regulations limit the amounts of oil and gas we can produce from our wells and the number of wells or the locations at which we can drill.
Regulatory proposals in some states and local communities have been initiated to require or make more stringent the permitting and compliance requirements for hydraulic fracturing operations. Federal and state agencies have continued to assess the potential impacts of hydraulic fracturing, which could spur further action toward federal, state and/or local legislation and regulation. Further restrictions of hydraulic fracturing could reduce the amount of oil, natural gas and NGL that we are ultimately able to produce in commercial quantities from our properties.
Certain of our U.S. natural gas and oil leases are granted or approved by the federal government and administered by the Bureau of Land Management (BLM) or Bureau of Indian Affairs (BIA) of the Department of the Interior. Such leases require compliance with detailed federal regulations and orders that regulate, among other matters, drilling and operations on lands covered by these leases and calculation and disbursement of royalty payments to the federal government, tribes or tribal members. The federal government has been particularly active in recent years in evaluating and, in some cases, promulgating new rules and regulations regarding competitive lease bidding, venting and flaring, oil and gas measurement and royalty payment obligations for production from federal lands. In addition, permitting activities on federal lands are subject to frequent delays.
Delays in obtaining permits or an inability to obtain new permits or permit renewals could inhibit our ability to execute our drilling and production plans. Failure to comply with applicable regulations or permit requirements could result in revocation of our permits, inability to obtain new permits and the imposition of fines and penalties.
Title to Properties
Our title to properties is subject to royalty, overriding royalty, carried, net profits, working and other similar interests and contractual arrangements customary in the oil and natural gas industry, to liens for current taxes not yet due and to other encumbrances. As is customary in the industry in the case of undeveloped properties, only cursory investigation of record title is made at the time of acquisition. Drilling title opinions are usually prepared before commencement of drilling operations. We believe we have satisfactory title to substantially all of our active properties in accordance with standards generally accepted in the oil and natural gas industry. Nevertheless, we are involved in title disputes from time to time that may result in litigation.
Operating Hazards and Insurance
The oil and natural gas business involves a variety of operating risks, including the risk of fire, explosions, blow-outs, pipe failure, abnormally pressured formations and environmental hazards such as oil spills, natural gas leaks, ruptures or discharges of toxic gases. If any of these should occur, we could incur legal defense costs and could suffer substantial losses due to injury or loss of life, severe damage to or destruction of property, natural resources and equipment, pollution or other environmental damage, clean-up responsibilities, regulatory investigation and penalties, and suspension of operations. Our horizontal and deep drilling activities involve greater risk of mechanical problems than vertical and shallow drilling operations.
We maintain a control of well insurance policy with a $50 million single well limit and a $100 million multiple wells limit that insures against certain sudden and accidental risks associated with drilling, completing and operating our wells. This insurance may not be adequate to cover all losses or exposure to liability. We also carry a $250 million comprehensive general liability umbrella insurance policy. In addition, we maintain a $75 million pollution liability insurance policy providing coverage for gradual pollution related risks and in excess of the general liability policy for sudden and accidental pollution risks. We provide workers' compensation insurance coverage to employees in all states in which we operate. While we believe these policies are customary in the industry, they do not provide complete coverage against all operating risks, and policy limits scale to our working interest percentage in certain situations. In addition, our insurance does not cover penalties or fines that may be assessed by a governmental authority. A loss not fully covered by insurance could have a material adverse effect on our financial position, results of operations and cash flows. Our insurance coverage may not be sufficient to cover every claim made against us or may not be commercially available for purchase in the future.
Facilities
We own an office complex in Oklahoma City and we own or lease various field offices in cities or towns in the areas where we conduct our operations.
Robert D. Lawler, President, Chief Executive Officer and Director
Robert D. (“Doug”) Lawler, 52, has served as President and Chief Executive Officer since June 2013. Prior to joining Chesapeake, Mr. Lawler served in multiple engineering and leadership positions at Anadarko Petroleum Corporation. His positions at Anadarko included Senior Vice President, International and Deepwater Operations and member of Anadarko’s Executive Committee from July 2012 to May 2013; Vice President, International Operations from December 2011 to July 2012; Vice President, Operations for the Southern and Appalachia Region from March 2009 to July 2012; and Vice President, Corporate Planning from August 2008 to March 2009. Mr. Lawler began his career with Kerr-McGee Corporation in 1988 and joined Anadarko following its acquisition of Kerr-McGee in 2006.
Domenic J. Dell'Osso, Jr., Executive Vice President and Chief Financial Officer
Domenic J. (“Nick”) Dell'Osso, Jr., 42, has served as Executive Vice President and Chief Financial Officer since November 2010. Mr. Dell'Osso served as our Vice President – Finance and Chief Financial Officer of our wholly owned midstream subsidiary, Chesapeake Midstream Development, L.P., from August 2008 to November 2010.
Frank J. Patterson, Executive Vice President – Exploration and Production
Frank J. Patterson, 60, has served as Executive Vice President - Exploration and Production since August 2016. Previously, he served as Executive Vice President – Exploration and Northern Division since April 2016 and as Executive Vice President – Exploration, Technology & Land since May 2015. Before joining Chesapeake, Mr. Patterson served in various roles at Anadarko from 2006 to 2015, most recently as Senior Vice President – International Exploration. Prior to that he was Vice President – Deepwater Exploration at Kerr-McGee and Manager – Geology at Sun E&P/Oryx Energy.
M. Jason Pigott, Executive Vice President – Operations and Technical Services
M. Jason Pigott, 45, has served as Executive Vice President – Operations and Technical Services since August 2016. Previously, he served as Executive Vice President – Operations, Southern Division since January 2015 and Senior Vice President – Operations, Southern Division since August 2013. Before joining Chesapeake, Mr. Pigott served in various positions at Anadarko and focused on all aspects of developing unconventional resources. His positions at Anadarko included General Manager Eagle Ford from June to August 2013; General Manager East Texas and North Louisiana from October 2010 to June 2013; Southern & Appalachia Planning Manager from October 2009 to October 2010; Reservoir Engineering Manager East Texas and North Louisiana from July to October 2009; and Reservoir Engineering Manager Bossier from 2007 to July 2009.
James R. Webb, Executive Vice President – General Counsel and Corporate Secretary
James R. Webb, 51, has served as Executive Vice President – General Counsel and Corporate Secretary since January 2014. Previously, he served as Senior Vice President – Legal and General Counsel since October 2012 and as Corporate Secretary since August 2013. Mr. Webb first joined Chesapeake in May 2012 on a contract basis as Chief Legal Counsel. Prior to joining Chesapeake, Mr. Webb was an attorney with the law firm of McAfee & Taft from 1995 to October 2012.
William M. Buergler – Senior Vice President and Chief Accounting Officer
William Buergler, 46, has served as Senior Vice President and Chief Accounting Officer since August 2017. Previously, he served as Vice President - Tax since July 2014. Before joining Chesapeake, he worked for Ernst & Young LLP, where he served as a Partner since 2009.
Employees
We had approximately 2,350 employees as of December 31, 2018.
ITEM 1A.
Risk Factors
There are numerous factors that affect our business and operating results, many of which are beyond our control. The following is a description of significant factors that might cause our future results to differ materially from those currently expected. The risks described below are not the only risks facing our company. Additional risks and uncertainties not presently known to us or that we currently deem immaterial may also affect our business operations. If any of these risks actually occur, our business, financial position, operating results, cash flows, reserves and/or our ability to pay our debts and other liabilities could suffer, the trading price and liquidity of our securities could decline and you may lose all or part of your investment in our securities.
Oil, natural gas and NGL prices fluctuate widely, and lower prices for an extended period of time are likely to have a material adverse effect on our business.
Our revenues, operating results, profitability, liquidity and ability to grow depend primarily upon the prices we receive for the oil, natural gas and NGL we sell. We incur substantial expenditures to replace reserves, sustain production and fund our business plans. Low oil, natural gas and NGL prices can negatively affect the amount of cash available for capital expenditures, debt service and debt repayment and our ability to borrow money or raise additional capital and, as a result, could have a material adverse effect on our financial condition, results of operations, cash flows and reserves. In addition, periods of low oil and natural gas prices may result in ceiling test write-downs of our oil and natural gas properties.
Historically, the markets for oil, natural gas and NGL have been volatile, and they are likely to continue to be volatile. For example, during the period from January 1, 2014 to December 31, 2018, NYMEX WTI oil prices ranged from a high of $107.26 per bbl to a low of $26.21 per bbl and NYMEX Henry Hub natural gas prices ranged from a high of $6.15 per MMBtu to a low of $1.64 per MMBtu. As of February 22, 2019, the NYMEX WTI oil price was $57.08 per bbl and the NYMEX Henry Hub natural gas price was $2.72 per MMBtu.
Wide fluctuations in oil, natural gas and NGL prices may result from factors that are beyond our control, including:
•
domestic and worldwide supplies of oil, natural gas and NGL, including U.S. inventories of oil and natural gas reserves;
•
weather conditions;
•
changes in the level of consumer and industrial demand;
•
the price and availability of alternative fuels;
•
technological advances affecting energy consumption;
•
the effectiveness of worldwide conservation measures;
•
the availability, proximity and capacity of pipelines, other transportation facilities and processing facilities;
•
the level and effect of trading in commodity futures markets, including by commodity price speculators and others;
•
U.S. exports of oil, natural gas, liquefied natural gas and NGL;
•
the price and level of foreign imports;
•
the nature and extent of domestic and foreign governmental regulations and taxes;
•
the ability of the members of the Organization of Petroleum Exporting Countries to agree to and maintain oil price and production controls;
•
political instability or armed conflict in oil and natural gas producing regions;
•
acts of terrorism; and
•
domestic and global economic conditions.
These factors and the volatility of the energy markets make it extremely difficult to predict future oil, natural gas and NGL price movements with any certainty. As of February 22, 2019, including January and February derivative contracts that have settled, approximately 63% of our forecasted oil, natural gas and NGL production revenue was hedged, including 56% and 81% of our forecasted 2019 oil and natural gas production (including WildHorse production from February 1, 2019) at average prices of $57.12 per barrel and $2.85 per mcf, respectively. Even with oil, natural gas and NGL derivatives currently in place to mitigate price risks associated with a portion of our 2019 cash flows, we have substantial exposure to oil, natural gas and NGL prices in 2020 and beyond. In addition, a prolonged extension of lower prices could reduce the quantities of reserves that we may economically produce.
We have a significant amount of indebtedness. Our leverage and debt service obligations may adversely affect our financial condition, results of operations and business prospects, and we may have difficulty paying our debts as they become due.
As of December 31, 2018, we had approximately $8.2 billion in principal amount of debt outstanding (including $381 million of current maturities and $419 million drawn under our senior secured revolving credit facility). As of December 31, 2018, we had approximately $107 million of letters of credit issued and borrowing capacity of approximately $2.5 billion under our $3.0 billion senior secured revolving credit facility (the “Chesapeake revolving credit facility”). In addition, on February 1, 2019, we acquired $1.4 billion principal amount of debt upon the closing of the WildHorse Merger (including $675 million drawn under the WildHorse senior secured revolving credit facility (the “WildHorse revolving credit facility”)). We had approximately $47 million of letters of credit issued and borrowing capacity of approximately $578 million under the $1.3 billion WildHorse revolving credit facility. See Note 3 of the notes to our consolidated financial statements included in Item 8 of this report for further discussion of our debt obligations, including debt maturities for the next five years and thereafter.
The level of and terms and conditions governing our debt:
•
require us to dedicate a substantial portion of our cash flow from operations to service our existing debt obligations and could limit our flexibility in planning for or reacting to changes in our business and the industry in which we operate;
•
increase our vulnerability to the cyclical nature of our business, economic downturns or other adverse developments in our business;
•
could limit our ability to access capital markets, refinance our existing indebtedness, raise capital on favorable terms, or obtain additional financing for working capital, capital expenditures, acquisitions, debt service requirements, execution of our business strategy, or for other purposes;
•
expose us to the risk of increased interest rates as certain of our borrowings, including borrowings under the Chesapeake revolving credit facility and the WildHorse revolving credit facility, bear interest at floating rates;
•
place restrictions on our ability to obtain additional financing, make investments, lease equipment, sell assets and engage in business combinations;
•
place us at a competitive disadvantage relative to competitors with lower levels of indebtedness in relation to their overall size, or those that have less restrictive terms governing their indebtedness, thereby enabling competitors to take advantage of opportunities that our indebtedness may prevent us from pursuing;
•
limit management’s discretion in operating our business; and
•
increase our cost of borrowing.
Any of the above listed factors could have a material adverse effect on our business, financial condition, cash flows and results of operations.
Our ability to pay our expenses and fund our working capital needs and debt obligations will depend on our future performance, which will be affected by financial, business, economic, regulatory and other factors. We will not be able to control many of these factors, such as commodity prices, other economic conditions and governmental regulation. We have drawn on our credit facilities for liquidity, and the borrowing bases under our $3.0 billion Chesapeake credit facility and our $1.3 billion WildHorse revolving credit facility are subject to redeterminations in the second quarter of 2019. If our borrowing bases under our revolving credit facilities decrease as a result of lower prices of oil, natural gas or NGL, operating difficulties, declines in reserves or for any other reason, we may have limited ability to obtain the capital necessary to sustain our operations and growth at current levels. To the extent that the value of the collateral pledged under either or both of our credit facilities declines as a result of lower oil and natural gas prices, asset dispositions or otherwise, we may be required to pledge additional collateral in order to maintain the current availability of the commitments thereunder, and we cannot assure you that we will be able to maintain a sufficiently high valuation to maintain the current commitments. In addition, we cannot be certain that our cash flow will be sufficient to allow us to pay the principal and interest on our debt and meet our other obligations. If we are unable to service our indebtedness and other obligations, we may be required to restructure or refinance all or part of our existing debt, sell assets, reduce capital expenditures, borrow more money or raise equity, some or all of which may not be available to us on terms acceptable to us, if at all, or such alternative strategies may yield insufficient funds to make required payments on our indebtedness. In addition, our ability to comply with the financial and other restrictive covenants in our indebtedness could be affected by our future performance and events or circumstances beyond our control. Failure to comply with these covenants would result in an event of default under such indebtedness, the potential acceleration of our obligation
to repay outstanding debt and the potential foreclosure on the collateral securing such debt, and could cause a cross-default under our other outstanding indebtedness. Any of the above risks could materially adversely affect our business, financial condition, cash flows and results of operations.
We have significant capital needs, and our ability to access the capital and credit markets to raise capital on favorable terms is limited by our debt level and industry conditions.
Disruptions in the capital and credit markets, in particular with respect to the energy sector, could limit our ability to access these markets or may significantly increase our cost to borrow. Low commodity prices have caused and may continue to cause lenders to increase the interest rates under our credit facilities, enact tighter lending standards, refuse to refinance existing debt around maturity on favorable terms or at all and may reduce or cease to provide funding to borrowers. If we are unable to access the capital and credit markets on favorable terms, it could have a material adverse effect on our business, financial condition, results of operations, cash flows and liquidity and our ability to repay or refinance our debt. Additionally, challenges in the economy have led and could further lead to reductions in the demand for oil and gas, or further reductions in the prices of oil and gas, or both, which could have a negative impact on our financial position, results of operations and cash flows.
If we are unable to generate enough cash flow from operations to service our indebtedness or are unable to use future borrowings to refinance our indebtedness or fund other capital needs, we may have to undertake alternative financing plans, which may have onerous terms or may be unavailable.
Our earnings and cash flow could vary significantly from year to year due to the volatility of hydrocarbon commodity prices. As a result, the amount of debt that we can manage in some periods may not be appropriate for us in other periods. Additionally, our future cash flow may be insufficient to meet our debt obligations and commitments. A range of economic, competitive, business and industry factors will affect our future financial performance and, as a result, our ability to generate cash flow from operations and service our debt. Factors that may cause us to generate cash flow that is insufficient to meet our debt obligations include the events and risks related to our business, many of which are beyond our control. Any cash flow insufficiency would have a material adverse impact on our business, financial condition, results of operations, cash flows and liquidity and our ability to repay or refinance our debt.
If we do not generate sufficient cash flow from operations to service our outstanding indebtedness, or if future borrowings are not available to us in an amount sufficient to enable us to pay or refinance our indebtedness, we may be required to undertake various alternative financing plans, which may include:
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refinancing or restructuring all or a portion of our debt;
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seeking alternative financing or additional capital investment;
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selling strategic assets;
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reducing or delaying capital investments; or
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revising or delaying our strategic plans.
We cannot assure you that we would be able to implement any of the above alternative financing plans, if necessary, on commercially reasonable terms or at all. If we are unable to generate sufficient cash flow to satisfy our debt obligations or to obtain alternative financing, our business, financial condition, results of operations, cash flows and liquidity could be materially and adversely affected. Any failure to make scheduled payments of interest and principal on our outstanding indebtedness would likely result in a reduction of our credit rating, which could significantly harm our ability to incur additional indebtedness on acceptable terms. Further, if for any reason we are unable to meet our debt service and repayment obligations, we would be in default under the terms of the agreements governing our debt, which would allow our creditors under those agreements to declare all outstanding indebtedness thereunder to be due and payable (which would in turn trigger cross-acceleration or cross-default rights between the relevant agreements), the lenders under our credit facilities could terminate their commitments to extend credit, and the lenders could foreclose against our assets securing their borrowings and we could be forced into bankruptcy or liquidation. In addition, the lenders under our credit facilities could compel us to apply our available cash to repay our borrowings. If the amounts outstanding under the credit facilities or any of our other significant indebtedness were to be accelerated, we cannot assure you that our assets would be sufficient to repay in full the amounts owed to the lenders or to our other debt holders.
Our variable rate indebtedness subjects us to interest rate risk, which could cause our debt service obligations to increase.
Borrowings under our revolving credit facilities and floating rate senior notes due 2019 bear interest at variable rates and expose us to interest rate risk. As of December 31, 2018, we had $799 million of variable rate indebtedness outstanding. If interest rates increase and we are unable to hedge our interest rate risk on acceptable terms, our debt service obligations on the variable rate indebtedness would increase even though the amount borrowed remained the same.
Restrictive covenants in certain of our debt agreements could limit our growth and our ability to finance our operations, fund our capital needs, respond to changing conditions and engage in other business activities that may be in our best interests.
Our debt agreements impose operating and financial restrictions on us. These restrictions limit our ability and that of our restricted subsidiaries to, among other things:
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incur additional indebtedness;
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make investments or loans;
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create liens;
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consummate mergers and similar fundamental changes;
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make restricted payments;
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make investments in unrestricted subsidiaries;
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enter into transactions with affiliates; and
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use the proceeds of asset sales.
We may be prevented from taking advantage of business opportunities that arise because of the limitations imposed on us by the restrictive covenants under certain of our debt agreements. The restrictions contained in the covenants could:
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limit our ability to plan for, or react to, market conditions, to meet capital needs or otherwise to restrict our activities or business plan; and
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adversely affect our ability to finance our operations, enter into acquisitions or divestitures to engage in other business activities that would be in our interest.
Also, our credit facilities require us to maintain compliance with specified financial ratios and satisfy certain financial condition tests. Declines in oil, NGL and natural gas prices, or a prolonged period of low oil, NGL and natural gas prices and other events, some of which are beyond our control, could eventually result in our failing to meet one or more of the financial covenants under our credit facilities, which could require us to refinance or amend such obligations resulting in the payment of consent fees or higher interest rates, or require us to raise additional capital at an inopportune time or on terms not favorable to us.
The WildHorse revolving credit facility and the WildHorse Indenture constrain the ability of WildHorse and its subsidiaries to make distributions or otherwise provide funds to, or guarantee the obligations of, Chesapeake and its other subsidiaries. The provisions of the WildHorse revolving credit facility and the WildHorse Indenture require that all transactions between WildHorse and its subsidiaries, on the one hand, and Chesapeake and its other subsidiaries, on the other hand, be on an arm's-length basis.
A breach of any of these covenants or our inability to comply with the required financial ratios or financial condition tests could result in a default under our credit facilities that, if not cured or waived, could result in acceleration of all indebtedness outstanding thereunder and cross-default rights under our other debt. In addition, in the event of an event of default under one of the credit facilities, the affected lenders could foreclose on the collateral securing such credit facility and require repayment of all borrowings outstanding thereunder. If the amounts outstanding under the credit facilities or any of our other indebtedness were to be accelerated, our assets may not be sufficient to repay in full the amounts owed to the lenders or to our other debt holders.
Our credit rating could negatively impact our availability and cost of capital and could require us to post more collateral under certain commercial arrangements.
Some of our counterparties have requested or required us to post collateral as financial assurance of our performance under certain contractual arrangements, such as gathering, transportation, processing and hedging agreements. These collateral requirements depend, in part, on our credit ratings. As of February 22, 2019, we have received requests and posted approximately $162 million of collateral related to certain of our marketing and other contracts. We may be requested or required by other counterparties to post additional collateral in an aggregate amount of approximately $355 million, which may be in the form of additional letters of credit, cash or other acceptable collateral. Any downgrade to our credit ratings could impact the posting of collateral consisting of cash or letters of credit, which would reduce availability under our credit facilities, and negatively impact our liquidity.
Declines in commodity prices could result in write downs of the carrying value of our oil and natural gas properties.
Under the full cost method of accounting for costs related to our oil and natural gas properties, we are required to write down the carrying value of our oil and natural gas assets if capitalized costs exceed the present value of future net revenues of our proved reserves, which is based on the average of commodity prices on the first day of the month over the trailing 12-month period. Such write-downs could be material. As of December 31, 2018, the present value of estimated future net revenue of our proved reserves, discounted at an annual rate of 10%, was $9.5 billion, which exceeds the carrying value of our oil and natural gas properties. See Impairment of Oil and Natural Gas Properties included in Item 7 of this report for further information.
Significant capital expenditures are required to replace our reserves and conduct our business.
Our exploration, development and acquisition activities require substantial capital expenditures. We intend to fund our capital expenditures through cash flows from operations, and to the extent that is not sufficient, borrowings under our revolving credit facilities. Our ability to generate operating cash flow is subject to a number of risks and variables, such as the level of production from existing wells, prices of oil, natural gas and NGL, our success in developing and producing new reserves and the other risk factors discussed herein. Our forecasted 2019 capital expenditures, inclusive of Brazos Valley and capitalized interest, are $2.3 - $2.5 billion compared to our 2018 capital spending level of $2.4 billion. Management continues to review operational plans for 2019 and beyond, which could result in changes to projected capital expenditures and projected revenues from sales of oil, natural gas and NGL. If we are unable to fund our capital expenditures as planned, we could experience a curtailment of our exploration and development activity, a loss of properties and a decline in our oil, natural gas and NGL reserves.
If we are not able to replace reserves, we may not be able to sustain production.
Our future success depends largely upon our ability to find, develop or acquire additional oil and natural gas reserves that are economically recoverable. Unless we replace the reserves we produce through successful development, exploration or acquisition activities, our proved reserves and production will decline over time. Thus, our future oil and natural gas reserves and production, and therefore our cash flow and income, are highly dependent on our success in efficiently developing our current reserves and economically finding or acquiring additional recoverable reserves.
The actual quantities of and future net revenues from our proved reserves may be less than our estimates.
The estimates of our proved reserves and the estimated future net revenues from our proved reserves included in this report are based upon various assumptions, including assumptions required by the SEC relating to oil, natural gas and NGL prices, drilling and operating expenses, capital expenditures, taxes and availability of funds. The process of estimating oil, natural gas and NGL reserves is complex and involves significant decisions and assumptions associated with geological, geophysical, engineering and economic data for each well. Therefore, these estimates are subject to future revisions.
Actual future production, oil, natural gas and NGL prices, revenues, taxes, development expenditures, operating expenses and quantities of recoverable oil, natural gas and NGL reserves most likely will vary from these estimates. Such variations may be significant and could materially affect the estimated quantities and present value of our proved reserves. In addition, we may adjust estimates of proved reserves to reflect production history, results of exploration and development drilling, prevailing oil and natural gas prices and other factors, many of which are beyond our control.
As of December 31, 2018, approximately 48% of our estimated proved reserves (by volume) were undeveloped. These reserve estimates reflect our plans to make significant capital expenditures to convert our PUDs into proved developed reserves, including approximately $3.6 billion during the next five years ending in 2023. You should be aware that the estimated development costs may not equal our actual costs, development may not occur as scheduled and results may not be as estimated. If we choose not to develop our PUDs, or if we are not otherwise able to successfully develop them, we will be required to remove them from our reported proved reserves. In addition, under the SEC's reserve reporting rules, because PUDs generally may be booked only if they relate to wells scheduled to be drilled within five years of the date of booking, we may be required to remove any PUDs that are not developed within this five-year time frame.
You should not assume that the present values included in this report represent the current market value of our estimated reserves. In accordance with SEC requirements, the estimates of our present values are based on prices and costs as of the date of the estimates. The price on the date of estimate is calculated as the average oil and natural gas price during the 12 months ending in the current reporting period, determined as the unweighted arithmetic average of prices on the first day of each month within the 12-month period. The December 31, 2018 present value is based on a $65.56 per bbl of oil price and a $3.10 per mcf of natural gas price, before considering basis differential adjustments. Actual future prices and costs may be materially higher or lower than the prices and costs as of the date of an estimate.
The timing of both the production and the expenses from the development and production of oil and natural gas properties will affect both the timing of future net cash flows from our proved reserves and their present value. Any changes in demand for oil and natural gas, governmental regulations or taxation will also affect the future net cash flows from our production. In addition, the 10% discount factor that is required by the SEC to be used in calculating discounted future net cash flows for reporting purposes is not necessarily the most appropriate discount factor. Interest rates in effect from time to time and the risks associated with our business or the oil and gas industry in general will affect the appropriateness of the 10% discount factor.
Our development and exploratory drilling efforts and our well operations may not be profitable or achieve our targeted returns.
We have a substantial inventory of undeveloped properties. Development and exploratory drilling and production activities are subject to many risks, including the risk that commercially productive reservoirs will not be discovered. We have acquired undeveloped properties that we believe will enhance our growth potential and increase our earnings over time. However, we cannot assure you that all prospects will be economically viable or that we will not abandon our initial investments. Additionally, there can be no assurance that undeveloped properties acquired by us will be profitably developed, that new wells drilled by us in prospects that we pursue will be productive, or that we will recover all or any portion of our investment in such undeveloped properties or wells.
Drilling for oil and natural gas may involve unprofitable efforts, not only from dry wells but also from wells that are productive but do not produce sufficient commercial quantities to cover the drilling, operating and other costs. The cost of drilling, completing and operating a well is often uncertain, and many factors can adversely affect the economics of a well or property. Drilling and completion operations may be curtailed, delayed or canceled as a result of unexpected drilling conditions, title problems, equipment failures or accidents, shortages of midstream transportation, equipment or personnel, environmental issues, state or local bans or moratoriums on hydraulic fracturing and produced water disposal, and a decline in commodity prices, among others. The profitability of wells, particularly in certain of the areas in which we operate, will be reduced or eliminated if commodity prices decline. In addition, wells that are profitable may not meet our internal return targets, which are dependent upon the current and future market prices for oil, natural gas and NGL, costs associated with producing oil, natural gas and NGL and our ability to add reserves at an acceptable cost. All costs of development and exploratory drilling activities are capitalized under the full cost method, even if the activities do not result in commercially productive discoveries, which may result in a future impairment of our oil and natural gas properties if commodity prices decrease.
We rely to a significant extent on seismic data and other technologies in evaluating undeveloped properties and in conducting our exploration activities. The seismic data and other technologies we use do not allow us to know conclusively, prior to acquisition of undeveloped properties, or drilling a well, whether oil or natural gas is present or may be produced economically. If we incur significant expense in acquiring or developing properties that do not produce as expected or at profitable levels, it could have a material adverse effect on our results of operations and financial condition.
Certain of our undeveloped properties are subject to leases that will expire over the next several years unless production is established on units containing the acreage or the leases are renewed.
Leases on oil and natural gas properties typically have a term of three to five years, after which they expire unless, prior to expiration, a well is drilled and production of hydrocarbons in paying quantities is established. If our leases on our undeveloped properties expire and we are unable to renew the leases, we will lose our right to develop the related properties. Although we seek to actively manage our undeveloped properties, our drilling plans for these areas are subject to change based upon various factors, including drilling results, oil and natural gas prices, the availability and cost of capital, drilling and production costs, availability of drilling services and equipment, gathering system and pipeline transportation constraints and regulatory approvals. Low commodity prices may cause us to delay our drilling plans and, as a result, lose our right to develop the related properties.
Our commodity price risk management activities may limit the benefit we would receive from increases in commodity prices, may require us to provide collateral for derivative liabilities and involve risk that our counterparties may be unable to satisfy their obligations to us.
In order to manage our exposure to price volatility, we enter into oil, natural gas and NGL price derivative contracts. Our oil, natural gas and NGL derivative arrangements may limit the benefit we would receive from increases in commodity prices. The fair value of our oil, natural gas and NGL derivative instruments can fluctuate significantly between periods. Our decision to mitigate cash flow volatility through derivative arrangements, if any, is based in part on our view of current and future market conditions and our desire to stabilize cash flows necessary for the development of our proved reserves. We may choose not to enter into derivatives if the pricing environment for certain time periods is not deemed to be favorable. Additionally, we may choose to liquidate existing derivative positions prior to the expiration of their contractual maturities to monetize gain positions for the purpose of funding our capital program.
Most of our oil, natural gas and NGL derivative contracts are with counterparties under bi-lateral hedging arrangements. Under a majority of our arrangements, the collateral provided for our obligations is secured by the same hydrocarbon interests that secure the Chesapeake revolving credit facility or the WildHorse revolving credit facility, as the case may be. Under other arrangements, our obligations under the bi-lateral hedging arrangements 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. Under certain circumstances, the cash collateral value posted could fall below the coverage designated, and we would be required to post additional cash or letter of credit collateral under our hedging arrangements. Our counterparties’ obligations under the arrangements must be secured by cash or letters of credit to the extent that any mark-to-market amounts owed to us exceed defined thresholds. Collateral requirements are dependent to a large extent on oil and natural gas prices.
Oil, natural gas and NGL derivative transactions expose us to the risk that our counterparties, which are generally financial institutions, may be unable to satisfy their obligations to us. During periods of declining commodity prices, the value of our commodity derivative asset positions increase, which increases our counterparty exposure. Although the counterparties to our hedging arrangements are required to secure their obligations to us under certain scenarios, if any of our counterparties were to default on its obligations to us under the derivative contracts or seek bankruptcy protection, it could have an adverse effect on our ability to fund our planned activities and could result in a larger percentage of our future cash flows being exposed to commodity price changes.
The ultimate outcome of pending legal and governmental proceedings is uncertain, and there are significant costs associated with these matters.
We are defending against claims by royalty owners alleging, among other things, that we used below-market prices, made improper deductions, used improper measurement techniques, entered into arrangements with affiliates that resulted in underpayment of royalties in connection with the production and sales of natural gas and NGL and similar theories. Numerous cases are pending. The resolution of disputes regarding past payments could cause our future obligations to royalty owners to increase and would negatively impact our future results of operations.
In addition, there are ongoing governmental regulatory investigations and inquiries into various matters such as our royalty practices. The outcome of any pending or future litigation or governmental regulatory matter is uncertain and may adversely affect our results of operations. In addition, we have incurred substantial legal expenses in the past three years, and such expenses may continue to be significant in the future. Further, attention to these matters by members of our senior management has been required, reducing the time they have available to devote to managing our business.
We may continue to incur cash and noncash charges that would negatively impact our future results of operations and liquidity.
While executing our strategic priorities to reduce financial leverage and complexity and to lower our capital expenditures in the face of lower commodity prices, we have incurred certain cash charges, including contract termination charges, restructuring and other termination costs, financing extinguishment costs and charges for unused natural gas transportation and gathering capacity. As we continue to focus on our strategic priorities, we may incur additional cash and noncash charges in 2019 and in future years. If incurred, these charges could materially adversely impact our future results of operations and liquidity.
Oil and natural gas operations are uncertain and involve substantial costs and risks.
Our oil and natural gas operating activities are subject to numerous costs and risks, including the risk that we will not encounter commercially productive oil or gas reservoirs. Drilling for oil, gas and NGLs can be unprofitable, not only from dry holes, but from productive wells that do not return a profit because of insufficient revenue from production or high costs. Substantial costs are required to locate, acquire and develop oil and gas properties, and we are often uncertain as to the amount and timing of those costs. Our cost of drilling, completing, equipping and operating wells is often uncertain before drilling commences. Declines in commodity prices and overruns in budgeted expenditures are common risks that can make a particular project uneconomic or less economic than forecasted. While both exploratory and developmental drilling activities involve these risks, exploratory drilling involves greater risks of dry holes or failure to find commercial quantities of hydrocarbons. For the 3% of our daily production volumes from properties which we did not serve as operator as of December 31, 2018, we are dependent on the operator for operational and regulatory compliance. In addition, our oil and gas properties can become damaged, our operations may be curtailed, delayed or canceled and the costs of such operations may increase as a result of a variety of factors, including, but not limited to:
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unexpected drilling conditions, pressure conditions or irregularities in reservoir formations;
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equipment failures or accidents;
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fires, explosions, blowouts, cratering or loss of well control, as well as the mishandling or underground migration of fluids and chemicals;
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adverse weather conditions and natural disasters, such as tornadoes, earthquakes, hurricanes and extreme temperatures;
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issues with title or in receiving governmental permits or approvals;
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restricted takeaway capacity for our production, including due to inadequate midstream infrastructure or constrained downstream markets;
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environmental hazards or liabilities;
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restrictions in access to, or disposal of, water used or produced in drilling and completion operations;
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shortages or delays in the availability of services or delivery of equipment; and
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unexpected or unforeseen changes in regulatory policy, and political or public opinions.
The occurrence of one or more of these factors could result in a partial or total loss of our investment in a particular property, as well as significant liabilities. While we may maintain insurance against some, but not all, of the risks described above, our insurance may not be adequate to cover casualty losses or liabilities, and our insurance does not cover penalties or fines that may be assessed by a governmental authority. For certain risks, such as political risk, business interruption, war, terrorism and piracy, we have limited or no insurance coverage. Also, in the future we may not be able to obtain insurance at premium levels that justify its purchase. The occurrence of a significant event against which we are not fully insured may expose us to liabilities.
We are subject to extensive governmental regulation and ongoing regulatory changes, which could adversely impact our business.
Our operations are subject to extensive federal, state, tribal, local and other laws, rules and regulations, including with respect to environmental matters, worker health and safety, wildlife conservation, the gathering and transportation of oil, gas and NGLs, conservation policies, reporting obligations, royalty payments, unclaimed property and the imposition of taxes. Such regulations include requirements for permits to drill and to conduct other operations and for provision of financial assurances (such as bonds) covering drilling, completion and well operations. If permits are not issued, or if unfavorable restrictions or conditions are imposed on our drilling or completion activities, we may not be
able to conduct our operations as planned. In addition, we may be required to make large, sometimes unexpected, expenditures to comply with applicable governmental laws, rules, regulations, permits or orders.
In addition, changes in public policy have affected, and in the future could further affect, our operations. Regulatory changes could, among other things, restrict production levels, impose price controls, alter environmental protection requirements and increase taxes, royalties and other amounts payable to the government. Our operating and compliance costs could increase further if existing laws and regulations are revised or reinterpreted or if new laws and regulations become applicable to our operations. We do not expect that any of these laws and regulations will affect our operations materially differently than they would affect other companies with similar operations, size and financial strength. Although we are unable to predict changes to existing laws and regulations, such changes could significantly impact our profitability, financial condition and liquidity. As is discussed below this is particularly true of changes related to pipeline safety, seismic activity, hydraulic fracturing, climate change and endangered species designations.
Pipeline Safety. The pipeline assets in which we own interests are subject to stringent and complex regulations related to pipeline safety and integrity management. The Pipeline and Hazardous Materials Safety Administration (PHMSA) has established a series of rules that require pipeline operators to develop and implement integrity management programs for gas, NGL and condensate transmission pipelines as well as certain low stress pipelines and gathering lines transporting hazardous liquids, such as oil, that, in the event of a failure, could affect “high consequence areas.” Additional action by PHMSA with respect to pipeline integrity management requirements may occur in the future. For example, in 2016 PHMSA proposed new rules for gas pipelines that extend pipeline safety programs beyond high consequence areas to newly proposed “moderate consequence areas or rural areas” and would also impose more rigorous testing and reporting requirements on such pipelines. Elements of a final rulemaking, commonly referred to as the “Gas Mega Rule,” continues to be deliberated by PHMSA’s Gas Pipeline Advisory Committee (GPAC). To date, no final regulatory action has been taken. More recently, in January 2017, PHMSA finalized regulations for hazardous liquid pipelines that significantly extend and expand the reach of certain PHMSA integrity management requirements (i.e., periodic assessments, leak detection and repairs), regardless of the pipeline’s proximity to a high consequence area. The final rule also imposes new reporting requirements for certain unregulated pipelines, including all hazardous liquid gathering lines. Per direction provided via a “Regulatory Freeze” Memo published on January 20, 2017 by the Trump Administration, this final regulatory action was withdrawn and continues to be evaluated by executive leadership. In July 2018, PHMSA issued an advance notice of proposed rulemaking seeking comment on the class location requirements for natural gas transmission pipelines, and particularly the actions operators must take when class locations change due to population growth or building construction near the pipeline. At this time, we cannot predict the cost of these requirements or other potential new or amended regulations, but they could be significant. Moreover, violations of pipeline safety regulations can result in the imposition of significant penalties.
Seismic Activity. Earthquakes in some of our operating areas and elsewhere have prompted concerns about seismic activity and possible relationships with the energy industry. For example, the Oklahoma Corporation Commission (OCC) issued guidance to operators in the SCOOP and STACK areas for management of certain seismic activity that may be related to hydraulic fracturing activities. Legislative and regulatory initiatives intended to address these concerns may result in additional levels of regulation or other requirements that could lead to operational delays, increase our operating and compliance costs or otherwise adversely affect our operations. In addition, we are currently defending against certain third- party lawsuits and could be subject to additional claims, seeking damages or other remedies as a result of alleged induced seismic activity in our areas of operation.
Hydraulic Fracturing. Several states have adopted or are considering adopting regulations that could impose more stringent permitting, public disclosure and/or well construction requirements on hydraulic fracturing operations. Three states (New York, Maryland and Vermont) have banned the use of high-volume hydraulic fracturing. In addition to state laws, some local municipalities have adopted or are considering adopting land use restrictions, such as city ordinances, that may restrict or prohibit the performance of well drilling in general and/or hydraulic fracturing in particular. There have also been certain governmental reviews that focus on deep shale and other formation completion and production practices, including hydraulic fracturing. Governments may continue to study hydraulic fracturing. We cannot predict the outcome of future studies, but based on the results of these studies to date, federal and state legislatures and agencies may seek to further regulate or even ban hydraulic fracturing activities. In addition, if existing laws and regulations with regard to hydraulic fracturing are revised or reinterpreted or if new laws and regulations become applicable to our operations through judicial or administrative actions, our business, financial condition, results of operations and cash flows could be adversely affected. For example, a decision by a Pennsylvania state court in 2018, if upheld, could change the established common law rule of capture and apply liability to oil and gas companies for trespass when hydraulic fracturing results in the production of oil and gas from adjoining property, which may impose burdens on hydraulic fracturing in Pennsylvania that may be material.
We cannot predict whether additional federal, state or local laws or regulations applicable to hydraulic fracturing will be enacted in the future and, if so, what actions any such laws or regulations would require or prohibit. If additional levels of regulation or permitting requirements were imposed on hydraulic fracturing operations, our business and operations could be subject to delays, increased operating and compliance costs and potential bans. Additional regulation could also lead to greater opposition to hydraulic fracturing, including litigation.
Climate Change. Continuing political and social attention to the issue of climate change has resulted in legislative, regulatory and other initiatives to reduce greenhouse gas emissions, such as carbon dioxide and methane. Policy makers at both the U.S. federal and state levels have introduced legislation and proposed new regulations designed to quantify and limit the emission of greenhouse gases through inventories, limitations and/or taxes on greenhouse gas emissions. EPA and BLM have issued regulations for the control of methane emissions, which also include leak detection and repair requirements, for the oil and gas industry; however, following the change in presidential administrations, both agencies took actions to rescind or revise the rules. In September 2018, BLM issued a final rule that rescinded certain requirements of its venting and flaring rule. Similarly, in October 2018, EPA published a proposed rule that amends certain requirements of its methane rule. The EPA rule remains in effect. Nevertheless, several states where we operate have imposed venting and flaring limitations designed to reduce methane emissions from oil and gas exploration and production activities. Legislative and state initiatives to date have generally focused on the development of cap and trade and/or carbon tax programs. Cap and trade programs offer greenhouse gas emission allowances that are gradually reduced over time. A cap and trade program could impose direct costs on us through the purchase of allowances and could impose indirect costs by incentivizing consumers to shift away from fossil fuels. A carbon tax could directly increase our costs of operation and similarly incentivize consumers to shift away from fossil fuels.
In addition, activists concerned about the potential effects of climate change have directed their attention at sources of funding for fossil-fuel energy companies, which has resulted in certain financial institutions, funds and other sources of capital restricting or eliminating their investment in oil and natural gas activities. Ultimately, this could make it more difficult to secure funding for exploration and production activities.
These various legislative, regulatory and other activities addressing greenhouse gas emissions could adversely affect our business, including by imposing reporting obligations on, or limiting emissions of greenhouse gases from, our equipment and operations, which could require us to incur costs to reduce emissions of greenhouse gases associated with our operations. Limitations on greenhouse gas emissions could also adversely affect demand for oil and gas, which could lower the value of our reserves and have a material adverse effect on our profitability, financial condition and liquidity. Furthermore, increasing attention to climate change risks has resulted in increased likelihood of governmental investigations and private litigation, which could increase our costs or otherwise adversely affect our business.
Endangered Species. The Endangered Species Act (ESA) prohibits the taking of endangered or threatened species or their habitats. While some of our assets and lease acreage may be located in areas that are designated as habitats for endangered or threatened species, we believe that we are in material compliance with the ESA. However, the designation of previously unidentified endangered or threatened species in areas where we intend to conduct construction activity or the imposition of seasonal restrictions on our construction or operational activities could materially limit or delay our plans.
Our ability to produce oil, natural gas and NGL economically and in commercial quantities could be impaired if we are unable to acquire adequate supplies of water for our operations or are unable to dispose of or recycle the water we use economically and in an environmentally safe manner.
For water sourcing, Chesapeake first seeks to use non-potable water supplies for our operational needs. In certain areas, there may be insufficient local aquifer capacity to provide a source of water for drilling activities. Water must then be obtained from other sources and transported to the drilling site. An inability to secure sufficient amounts of water or to dispose of or recycle the water used in our operations could adversely impact our operations in certain areas. The imposition of new environmental regulations could further restrict our ability to conduct operations such as hydraulic fracturing by restricting the disposal of things such as produced water and drilling fluids
Environmental matters and related costs can be significant.
As an owner, lessee or operator of oil and gas properties, we are subject to various federal, state, tribal and local laws and regulations relating to discharge of materials into, and protection of, the environment. These laws and regulations may, among other things, impose liability on us for the cost of remediating pollution that results from our
operations. Environmental laws may impose strict, joint and several liability, and the failure to comply with environmental laws and regulations can result in the imposition of administrative, civil and/or criminal fines and penalties, as well as injunctions limiting operations in affected areas. Any future costs associated with these matters are uncertain and will be governed by several factors, including future changes to regulatory requirements. Changes in or additions to public policy regarding the protection of the environment could have a significant impact on our operations and profitability.
The taxation of independent producers is subject to change, and changes in tax law could increase our cost of doing business.
We are subject to taxation by various taxing authorities at the federal, state and local levels where we do business. New legislation increasing our tax burden could be enacted by any of these governmental authorities. Recently, legislative changes imposing additional taxes or increases to existing taxes were considered in Louisiana, Oklahoma, Pennsylvania and Wyoming. It is possible that any of these states could enact new tax legislation making it more costly for us to explore for oil and natural gas resources.
The oil and gas exploration and production industry is very competitive, and some of our competitors have greater financial and other resources than we do.
We face competition in every aspect of our business, including, but not limited to, buying and selling reserves and leases, obtaining goods and services needed to operate our business and marketing oil, natural gas or NGL. Competitors include multinational oil companies, independent production companies and individual producers and operators. Some of our competitors have greater financial and other resources than we do and, due to our debt levels and other factors, may have greater access to the capital and credit markets. As a result, these competitors may be able to address these competitive factors more effectively or weather industry downturns more easily than we can. We also face indirect competition from alternative energy sources, including wind, solar and electric power.
Our performance depends largely on the talents and efforts of highly skilled individuals and on our ability to attract new employees and to retain and motivate our existing employees. Competition in our industry for qualified employees is intense. If we are unsuccessful in attracting and retaining skilled employees and managerial talent, our ability to compete effectively may be diminished. We also compete for the equipment required to explore, develop and operate properties. Typically, during times of rising commodity prices, drilling and operating costs will also increase. During these periods, there is often a shortage of drilling rigs and other oilfield equipment and services, which could adversely affect our ability to execute our development plans on a timely basis and within budget.
Risks related to potential acquisitions or dispositions may adversely affect our business.
From time to time, we evaluate acquisitions and dispositions of assets, businesses and other investments. These transactions may not result in the anticipated benefits or efficiencies. In addition, acquisitions may be financed by borrowings, requiring us to incur more debt, or by the issuance of our common stock. Any such acquisition or disposition involves risks and we cannot assure you that:
•
any acquisition would be successfully integrated into our operations and internal controls;
•
the due diligence conducted prior to an acquisition would uncover situations that could result in financial or legal exposure, such as title defects and potential environmental and other liabilities;
•
post-closing purchase price adjustments will be realized in our favor;
•
our assumptions about, among other things, reserves, estimated production, revenues, capital expenditures, operating, operating expenses and costs would be accurate;
•
any investment, acquisition, disposition or integration would not divert management resources from the operation of our business; and
•
any investment, acquisition, or disposition or integration would not have a material adverse effect on our financial condition, results of operations, cash flows or reserves.
If any of these risks materialize, the benefits of such acquisition or disposition may not be fully realized, if at all, and our financial condition, results of operations, cash flows and reserves could be negatively impacted.
A deterioration in general economic, business or industry conditions would have a material adverse effect on our results of operations, liquidity and financial condition.
Historically, concerns about global economic growth have had a significant impact on global financial markets and commodity prices. If the economic climate in the United States or abroad deteriorates, worldwide demand for
petroleum products could diminish, which could impact the price at which we can sell our production, affect the ability of our vendors, suppliers and customers to continue operations and materially adversely impact our results of operations, liquidity and financial condition.
Terrorist activities could materially and adversely affect our business and results of operations.
Terrorist attacks and the threat of terrorist attacks, whether domestic or foreign attacks, as well as military or other actions taken in response to these acts, could cause instability in the global financial and energy markets. Continued hostilities in the Middle East and the occurrence or threat of terrorist attacks in the United States or other countries could adversely affect the global economy in unpredictable ways, including the disruption of energy supplies and markets, increased volatility in commodity prices, or the possibility that the infrastructure on which we rely could be a direct target or an indirect casualty of an act of terrorism, and, in turn, could materially and adversely affect our business and results of operations.
Negative public perception regarding us and/or our industry could have an adverse effect on our operations.
Negative public perception regarding us and/or our industry resulting from, among other things, concerns raised by advocacy groups about hydraulic fracturing, waste disposal, oil spills, seismic activity, climate change, explosions of natural gas transmission lines and the development and operation of pipelines and other midstream facilities may lead to increased regulatory scrutiny, which may, in turn, lead to new state and federal safety and environmental laws, regulations, guidelines and enforcement interpretations. Additionally, environmental groups, landowners, local groups and other advocates may oppose our operations through organized protests, attempts to block or sabotage our operations or those of our midstream transportation providers, intervene in regulatory or administrative proceedings involving our assets or those of our midstream transportation providers, or file lawsuits or other actions designed to prevent, disrupt or delay the development or operation of our assets and business or those of our midstream transportation providers. These actions may cause operational delays or restrictions, increased operating costs, additional regulatory burdens and increased risk of litigation. Moreover, governmental authorities exercise considerable discretion in the timing and scope of permit issuance and the public may engage in the permitting process, including through intervention in the courts. Negative public perception could cause the permits we require to conduct our operations to be withheld, delayed or burdened by requirements that restrict our ability to profitably conduct our business.
Recently, activists concerned about the potential effects of climate change have directed their attention towards sources of funding for fossil-fuel energy companies, which has resulted in certain financial institutions, funds and other sources of capital restricting or eliminating their investment in energy-related activities. Ultimately, this could make it more difficult to secure funding for exploration and production activities.
Our operations may be adversely affected by pipeline, trucking and gathering system capacity constraints and may be subject to interruptions that could adversely affect our cash flow.
In certain resource plays, the capacity of gathering and transportation systems is insufficient to accommodate potential production from existing and new wells. We rely heavily on third parties to meet our oil, natural gas and NGL gathering needs. Capital constraints could limit the construction of new pipelines and gathering systems and the providing or expansion of trucking services by third parties. Until this new capacity is available, we may experience delays in producing and selling our oil, natural gas and NGL. In such event, we might have to shut in our wells awaiting a pipeline connection or capacity and/or sell oil, natural gas or NGL production at significantly lower prices than those quoted on NYMEX or than we currently project, which would adversely affect our results of operations.
A portion of our oil, natural gas and NGL production in any region may be interrupted, or shut in, from time to time for numerous reasons, including weather conditions, accidents, loss of pipeline or gathering system access, field labor issues or strikes, or we might voluntarily curtail production in response to market conditions. If a substantial amount of our production is interrupted at the same time, it could materially adversely affect our cash flow.
Cyber-attacks targeting systems and infrastructure used by the oil and gas industry and related regulations may adversely impact our operations and, if we are unable to obtain and maintain adequate protection for our data, our business may be harmed.
Our business has become increasingly dependent on digital technologies to conduct certain exploration, development and production activities. We depend on digital technology to estimate quantities of oil, natural gas and NGL reserves, process and record financial and operating data, analyze seismic and drilling information, and communicate with our customers, employees and third-party partners. We have been the subject of cyber-attacks on
our internal systems and through those of third parties, but these incidents did not have a material adverse impact on our results of operations. Nevertheless, unauthorized access to our seismic data, reserves information, customer or employee data or other proprietary or commercially sensitive information could lead to data corruption, communication interruption, or other disruptions in our exploration or production operations or planned business transactions, any of which could have a material adverse impact on our results of operations. If our information technology systems cease to function properly or our cybersecurity is breached, we could suffer disruptions to our normal operations, which may include drilling, completion, production and corporate functions. A cyber-attack involving our information systems and related infrastructure, or that of our business associates, could result in supply chain disruptions that delay or prevent the transportation and marketing of our production, non-compliance leading to regulatory fines or penalties, loss or disclosure of, or damage to, our or any of our customer’s or supplier’s data or confidential information that could harm our business by damaging our reputation, subjecting us to potential financial or legal liability, and requiring us to incur significant costs, including costs to repair or restore our systems and data or to take other remedial steps.
Further, as cyber-attacks continue to evolve, we may be required to expend significant additional resources to continue to modify or enhance our protective measures or to investigate and remediate any vulnerabilities to cyber-attacks. In addition, new laws and regulations governing data privacy and the unauthorized disclosure of confidential information pose increasingly complex compliance challenges and potentially elevate costs, and any failure to comply with these laws and regulations could result in significant penalties and legal liability.
An interruption in operations at our headquarters could adversely affect our business.
Our headquarters are located in Oklahoma City, Oklahoma, an area that experiences severe weather events, including tornadoes and earthquakes. Our information systems and administrative and management processes are primarily provided to our various drilling projects and producing wells throughout the United States from this location, which could be disrupted if a catastrophic event, such as a tornado, power outage or act of terror, destroyed or severely damaged our headquarters. Any such catastrophic event could harm our ability to conduct normal operations and could adversely affect our business.
We do not anticipate paying dividends on our common stock in the near future.
In July 2015, our Board of Directors determined to eliminate quarterly cash dividends on our common stock. We do not intend to resume paying cash dividends on our common stock in the foreseeable future. We currently intend to retain any earnings for the future operation and development of our business, including exploration, development and acquisition activities or to retire outstanding debt and/or preferred stock. Any future dividend payments will require approval by the Board of Directors. In addition, dividends may be restricted by the terms of our debt agreements. Additionally, our Board of Directors may determine to suspend dividend payments on our preferred stock in the future. If we fail to pay dividends on our preferred stock with respect to six or more quarterly periods (whether or not consecutive), the holders of our preferred stock, voting as a single class, will be entitled at the next regular or special meeting of shareholders to elect two additional directors of the Company. We had previously failed to pay dividends on our outstanding preferred stock with respect to four quarterly periods during the fiscal year ended December 31, 2016, before resuming payment, in arrears, in the first quarter of 2017.
Certain anti-takeover and other provisions may affect your rights as a shareholder.
Our certificate of incorporation authorizes our Board of Directors to set the terms of and issue preferred stock without shareholder approval. Our Board of Directors could use the preferred stock as a means to delay, defer or prevent a takeover attempt that a shareholder might consider to be in our best interest. In addition, our revolving credit facilities, preferred stock and certain of our notes contain terms that may restrict our ability to enter into change of control transactions, including requirements to repay borrowings under our revolving credit facilities and to offer to repurchase such notes on a change in control. These provisions, along with specified provisions of the Oklahoma General Corporation Act and our certificate of incorporation and bylaws, may discourage or impede transactions involving actual or potential changes in our control, including transactions that otherwise could involve payment of a premium over prevailing market prices to holders of our common stock.
Risks Associated with Acquisition of WildHorse
The WildHorse Merger may not be accretive, and may be dilutive, to our earnings per share, which may negatively affect the market price of shares on our common stock.
In connection with the completion of the WildHorse Merger, we issued approximately 717.3 million shares of our common stock. The issuance of these new shares of our common stock could have the effect of depressing the market
price of shares of our common stock, through dilution of earnings per share or otherwise. Any dilution of, or delay of any accretion to, our earnings per share could cause the price of shares of our common stock to decline or increase at a reduced rate.
The market price of shares of our common stock may decline in the future as a result of the sale of shares of our common stock held by former WildHorse stockholders or current stockholders.
Former WildHorse stockholders may, following 60- and 180-day lock-up periods for certain primary former WildHorse stockholders following the closing date of the WildHorse Merger, seek to sell the shares of our common stock delivered to them following the consummation of the WildHorse Merger. Other shareholders may also seek to sell shares of our common stock held by them following, or in anticipation of, completion of the WildHorse Merger. In addition, we have granted certain stockholders of WildHorse registration rights with respect to the shares of our common stock they receive in the WildHorse Merger. These sales (or the perception that these sales may occur), coupled with the increase in the outstanding number of shares of our common stock, may affect the market for, and the market price of, our common stock in an adverse manner.
We may fail to realize all of the anticipated benefits of the WildHorse Merger.
The success of the WildHorse Merger will depend, in part, on our ability to realize the anticipated benefits and cost savings from combining our and WildHorse’s businesses, including operational and other synergies that we believe the combined company will achieve. We expect that the WildHorse Merger will provide substantial cost savings with $200 million to $280 million in projected average annual savings, totaling $1 billion to $1.5 billion by 2023, due to operational and capital efficiencies as a result of Chesapeake’s significant expertise with unconventional assets and technical and operational excellence. The anticipated benefits and cost savings of the WildHorse Merger may not be realized fully or at all, may take longer to realize than expected or could have other adverse effects that we do not currently foresee. Some of the assumptions that we have made, such as the achievement of operational cost savings, may not be realized. The integration process may, for us and WildHorse, result in the loss of key employees, the disruption of ongoing businesses or inconsistencies in standards, controls, procedures and policies. There could be potential unknown liabilities and unforeseen expenses associated with the WildHorse Merger that were not discovered in the course of performing due diligence. The integration will require significant time and focus from management following the acquisition.
We will incur substantial transaction fees and costs in connection with the WildHorse Merger.
We expect to incur a number of non-recurring transaction-related costs associated with completing the WildHorse Merger. These fees and costs may be substantial. Non-recurring transaction costs include, but are not limited to, fees paid to legal, financial and accounting advisors, filing fees and printing costs.
The issuance of our common stock to shareholders of WildHorse as well as other stock transactions could lead to a limitation on the utilization of our loss carryforwards to reduce future taxable income.
Our ability to utilize U.S. net operating loss carryforwards (NOL) to reduce future taxable income and federal income tax is subject to various limitations under Section 382 of the Internal Revenue Code of 1986, as amended (the “Code”). The utilization of such carryforwards may be limited under Section 382 of the Code upon the occurrence of ownership changes resulting from issuances of our stock or the sale or exchange of our stock by certain shareholders if, as a result, there is a cumulative change of more than 50% in the beneficial ownership of our stock during any three-year period. For this purpose, “stock” includes certain preferred stock. In the event of such an ownership change, Section 382 of the Code imposes an annual limitation on the amount of our loss carryforwards that can be used to offset taxable income. The limitation is generally equal to the product of (a) the fair market value of our equity multiplied by (b) the long-term tax-exempt rate in effect for the month in which an ownership change occurs. If we are in a net unrealized built-in gain position at the time of an ownership change, then the limitation is increased if there are recognized built-in gains during any post-change year, but only to the extent of any net unrealized built-in gains inherent in the assets sold. If we are in a net unrealized built-in loss position at the time of an ownership change, then the limitation may apply to tax attributes other than just loss carryforwards, such as depreciable basis of tangible equipment. Some states impose similar limitations on tax attribute utilization upon experiencing an ownership change. We do not believe we have a limitation on the ability to utilize our U.S. loss carryforwards and other tax attributes under Section 382 of the Code as of December 31, 2018. We further believe that the WildHorse Merger did not result in an ownership change based on information currently available. However, issuances, sales and/or exchanges of our stock (including, potentially, relatively small transactions and transactions beyond our control) occurring after December 31, 2018, taken together with prior transactions with respect to our stock and the WildHorse Merger, could trigger an ownership change
under Section 382 of the Code and therefore a limitation on our ability to utilize our U.S. loss carryforwards and other tax attributes. Any such limitation could cause some loss carryforwards to expire before we would be able to utilize them to reduce taxable income in future periods, possibly resulting in a substantial income tax expense or write down of our tax assets or both.
ITEM 1B.
Unresolved Staff Comments
Not applicable.
ITEM 2.
Properties
Information regarding our properties is included in Item 1 and in the Supplementary Information included in Item 8 of Part II of this report.
We are involved in a number of litigation and regulatory proceedings including those described below. Many of these proceedings are in early stages, and many of them seek or may seek damages and penalties, the amount of which is currently indeterminate. See Note 4 of the notes to our consolidated financial statements included in Item 8 of Part II of this report for information regarding our estimation and provision for potential losses related to litigation and regulatory proceedings.
Business Operations. We are involved in various lawsuits and disputes incidental to our business operations, including commercial disputes, personal injury claims, royalty claims, property damage claims and contract actions.
Regarding royalty claims, we and other natural gas producers have been named in various lawsuits alleging royalty underpayments. The lawsuits against us allege, among other things, that we used below-market prices, made improper deductions, utilized improper measurement techniques, entered into arrangements with affiliates that resulted in underpayment of royalties in connection with the production and sale of natural gas and NGL, or similar theories. These lawsuits include cases filed by individual royalty owners and putative class actions, some of which seek to certify a statewide class. The lawsuits seek compensatory, consequential, treble, and punitive damages, restitution and disgorgement of profits, declaratory and injunctive relief regarding our royalty payment practices, pre-and post-judgment interest, and attorney’s fees and costs. Plaintiffs have varying royalty provisions in their respective leases, oil and gas law varies from state to state, and royalty owners and producers differ in their interpretation of the legal effect of lease provisions governing royalty calculations. We have resolved a number of these claims through negotiated settlements of past and future royalty obligations and have prevailed in various other lawsuits. We are currently defending numerous lawsuits seeking damages with respect to underpayment of royalties in multiple states where we have operated, including the matters set forth below.
On December 9, 2015, the Commonwealth of Pennsylvania, by the Office of Attorney General, filed a lawsuit in the Bradford County Court of Common Pleas related to royalty underpayment and lease acquisition and accounting practices with respect to properties in Pennsylvania. The lawsuit, which primarily relates to the Marcellus Shale and Utica Shale, alleges that we violated the Pennsylvania Unfair Trade Practices and Consumer Protection Law (UTPCPL) by making improper deductions and entering into arrangements with affiliates that resulted in underpayment of royalties. The lawsuit includes other UTPCPL claims and antitrust claims, including that a joint exploration agreement to which we are a party established unlawful market allocation for the acquisition of leases. The lawsuit seeks statutory restitution, civil penalties and costs, as well as a temporary injunction from exploration and drilling activities in Pennsylvania until restitution, penalties and costs have been paid, and a permanent injunction from further violations of the UTPCPL.
Putative statewide class actions in Pennsylvania and Ohio and purported class arbitrations in Pennsylvania have been filed on behalf of royalty owners asserting various claims for damages related to alleged underpayment of royalties as a result of our divestiture of substantially all of our midstream business and most of our gathering assets in 2012 and 2013. These cases include claims for violation of and conspiracy to violate the federal Racketeer Influenced and Corrupt Organizations Act and for an unlawful market allocation agreement for mineral rights, intentional interference with contractual relations, and violations of antitrust laws related to purported markets for gas mineral rights, operating rights and gas gathering sources. These lawsuits seek in aggregate compensatory, consequential, treble, and punitive damages, restitution and disgorgement of profits, declaratory and injunctive relief regarding our royalty payment practices, pre-and post-judgment interest, and attorney’s fees and costs. On December 20, 2017 and August 9, 2018, we reached tentative settlements to resolve substantially all Pennsylvania civil royalty cases for a total of approximately $35 million.
We also previously disclosed defending lawsuits alleging various violations of the Sherman Antitrust Act and state antitrust laws. In 2016, putative class action lawsuits were filed in the U.S. District Court for the Western District of Oklahoma and in Oklahoma state courts, and an individual lawsuit was filed in the U.S. District Court of Kansas, in each case against us and other defendants. The lawsuits generally allege that, since 2007 and continuing through April 2013, the defendants conspired to rig bids and depress the market for the purchases of oil and natural gas leasehold interests and properties in the Anadarko Basin containing producing oil and natural gas wells. The lawsuits seek damages, attorney’s fees, costs and interest, as well as enjoinment from adopting practices or plans that would restrain competition in a similar manner as alleged in the lawsuits. On April 12, 2018, we reached a tentative settlement to resolve substantially all Oklahoma civil class action antitrust cases for an insignificant amount. The final fairness hearing is set for April 25, 2019.
On July 28, 2017, OOGC America LLC (OOGC) filed a demand for arbitration with the American Arbitration Association against Chesapeake Exploration, L.L.C., our wholly owned subsidiary, in connection with OOGC’s purchase of certain oil and gas leases and other assets pursuant to a Purchase and Sale Agreement entered into on October 10, 2010. In connection with the sale, we also entered into a Development Agreement with OOGC, dated November 15, 2010 (the “Development Agreement”), which governs each of our rights and obligations with respect to the sale, including the transportation and marketing of oil and gas. OOGC’s breach of contract, breach of agency and fiduciary duties and other claims generally alleged, among other things, that we subjected OOGC to excessive rates for gathering and other services provided for under the Development Agreement and interfered with OOGC’s right to audit the documents that supported those rates. On November 13, 2018, a unanimous panel denied every claim asserted by OOGC other than OOGC being entitled to a declaration clarifying its audit rights.
On July 24, 2018, Healthcare of Ontario Pension Plan (HOOPP) filed a demand for arbitration with the American Arbitration Association regarding HOOPP’s purchase of our interest in Chaparral Energy, Inc. stock for $215 million on January 5, 2014. HOOPP claims that we engaged in material misrepresentations and fraud, and that we violated the Exchange Act and Oklahoma Uniform Securities Act. HOOPP seeks either rescission or $215 million in monetary damages, and in either case, interest, attorney’s fees, disgorgement and punitive damages. We intend to vigorously defend these claims.
In February 2019, a putative class action lawsuit in the District Court of Dallas County, Texas was filed against FTS International, Inc. (“FTSI”), certain investment banks, FTSI’s directors including certain of our officers and certain shareholders of FTSI including us. The lawsuit alleges various violations of Sections 11 (with respect to certain of our officers in their capacities as directors of FTSI) and 15 (with respect to such officers and us) of the Securities Act of 1933 in connection with public disclosure made during the initial public offering of FTSI. The suit seeks damages in excess of $1,000,000 and attorneys’ fees and other expenses. We intend to vigorously defend these claims.
Environmental Proceedings
Our subsidiary Chesapeake Appalachia, LLC (CALLC) is engaged in discussions with the EPA, the U.S. Army Corps of Engineers and the Pennsylvania Department of Environmental Protection (PADEP) regarding potential violations of the permitting requirements of the federal Clean Water Act (CWA), the Pennsylvania Clean Streams Law and the Pennsylvania Dam Safety and Encroachments Act in connection with the placement of dredge and fill material during construction of certain sites in Pennsylvania. CALLC identified the potential violations in connection with an internal review of its facilities siting and construction processes and voluntarily reported them to the regulatory agencies. Resolution of the matter may result in monetary sanctions of more than $100,000.
We are also in discussions with PADEP regarding gas migration in the vicinity of certain of our wells in Bradford County, Pennsylvania. We believe we are close to identifying agreed-upon steps to resolve PADEP’s concerns regarding the issue.
On December 27, 2016, we received a Finding of Violation from the EPA alleging violations of the CAA at a number of locations in Ohio. We have exchanged information with the EPA and are engaged in discussions aimed at resolving the allegations. Resolution of the matter may result in monetary sanctions of more than $100,000. We received another Finding of Violation from EPA on December 20, 2018 alleging violations of the CAA and violations of the Ohio State Implementation Plan at a number of our Ohio facilities. We have begun discussions with EPA aimed at resolving the allegations. Resolution of this matter may result in monetary sanctions of more than $100,000.
We are named as a defendant in numerous lawsuits in Oklahoma alleging that we and other companies have engaged in activities that have caused earthquakes. These lawsuits seek compensation for injury to real and personal property, diminution of property value, economic losses due to business interruption, interference with the use and enjoyment of property, annoyance and inconvenience, personal injury and emotional distress. In addition, they seek the reimbursement of insurance premiums and the award of punitive damages, attorneys’ fees, costs, expenses and interest.
Market for Registrant's Common Equity, Related Stockholder Matters and Issuer Purchases of Equity Securities
Common Stock
Our common stock trades on the New York Stock Exchange under the symbol "CHK".
Shareholders
As of February 12, 2019, there were approximately 2,000 holders of record of our common stock and approximately 307,000 beneficial owners.
Dividends
We ceased paying dividends on our common stock in the 2015 third quarter and do not intend to resume paying cash dividends on our common stock in the foreseeable future. Our revolving credit facility and the certificates of designation for our preferred stock contain restrictions on our ability to declare and pay cash dividends on our common or preferred stock if an event of default has occurred. The certificates of designation for our preferred stock prohibit payment of cash dividends on our common stock unless we have declared and paid (or set apart for payment) full accumulated dividends on the preferred stock. After suspending the payment of dividends on our outstanding convertible preferred stock during fiscal year 2016, we reinstated the payment of dividends on each series of our outstanding convertible preferred stock beginning with the dividends payable in the 2017 first quarter and paid all dividends in arrears.
Unregistered Sales of Equity Securities and Use of Proceeds
The following table presents information about repurchases of our common stock during the quarter ended December 31, 2018:
Period
Total
Number
of Shares
Purchased(a)
Average
Price
Paid
Per Share(a)
Total Number
of Shares
Purchased as
Part of
Publicly
Announced
Plans or
Programs
Maximum
Approximate
Dollar Value
of Shares
That May Yet
Be Purchased
Under
the Plans
or Programs(b)
($ in millions)
October 1, 2018 through October 31, 2018
10,989
$
4.60
—
$
1,000
November 1, 2018 through November 30, 2018
—
$
—
—
$
1,000
December 1, 2018 through December 31, 2018
—
$
—
—
$
1,000
Total
10,989
$
—
—
___________________________________________
(a)
Includes shares of common stock purchased on behalf of our deferred compensation plan.
(b)
In December 2014, our Board of Directors authorized the repurchase of up to $1 billion of our common stock from time to time. The repurchase program does not have an expiration date. As of December 31, 2018, there have been no repurchases under the program.
The following table sets forth selected consolidated financial data of Chesapeake as of and for the years ended December 31, 2018, 2017, 2016, 2015 and 2014. The data are derived from our audited consolidated financial statements. The table below should be read in conjunction with Management's Discussion and Analysis of Financial Condition and Results of Operations and our consolidated financial statements, including the notes thereto, appearing in Items 7 and 8, respectively, of this report.
Years Ended December 31,
2018
2017
2016
2015
2014
($ in millions, except per share data)
STATEMENT OF OPERATIONS DATA:
Total revenues
$
10,231
$
9,496
$
7,872
$
12,764
$
23,125
Net income (loss) available to common stockholders(a)
$
775
$
813
$
(4,915
)
$
(14,738
)
$
1,273
EARNINGS (LOSS) PER COMMON SHARE:
Basic
$
0.85
$
0.90
$
(6.43
)
$
(22.26
)
$
1.93
Diluted
$
0.85
$
0.90
$
(6.43
)
$
(22.26
)
$
1.87
CASH DIVIDEND DECLARED PER COMMON SHARE
$
—
$
—
$
—
$
0.0875
$
0.35
BALANCE SHEET DATA (AT END OF PERIOD):
Total assets
$
10,947
$
12,425
$
13,028
$
17,314
$
40,655
Long-term debt, net of current maturities
$
7,341
$
9,921
$
9,938
$
10,311
$
11,058
Total equity (deficit)
$
467
$
(372
)
$
(1,203
)
$
2,397
$
18,205
___________________________________________
(a)
Includes $2.564 billion and $18.238 billion of full cost ceiling test write-downs on our oil and natural gas properties for the years ended December 31, 2016 and 2015, respectively. In 2018, 2017 and 2014, we did not have any ceiling test impairments on our oil and natural gas properties.
Management’s Discussion and Analysis of Financial Condition and Results of Operations
Overview
The following discussion and analysis presents management’s perspective of our business, financial condition and overall performance. This information is intended to provide investors with an understanding of our past performance, current financial condition and outlook for the future and should be read in conjunction with “Item 8. Financial Statements and Supplementary Data” of this report.
The transformation of Chesapeake over the past five years has been significant and our progress accelerated in 2018 and early 2019. We believe our recent accomplishments and achievements have made our company stronger. Highlights include the following:
•
acquired WildHorse, an oil and gas company with operations in the Eagle Ford Shale and Austin Chalk formations in southeast Texas, for approximately 717.3 million shares of our common stock and $381 million in cash, and the assumption of WildHorse’s debt of $1.4 billion as of February 1, 2019. We anticipate the acquisition to materially increase our oil production and enhance our oil production mix as well as significantly reduce costs due to operational synergies that we believe the combined company will achieve. We expect that the WildHorse Merger will provide substantial cost savings with $200 million to $280 million in projected average annual savings, totaling $1 billion to $1.5 billion by 2023, due to operational and capital efficiencies as a result of Chesapeake’s significant expertise with unconventional assets and technical and operational excellence;
•
sold our interests in the Utica Shale operating area located in Ohio for approximately $1.9 billion, and used the proceeds to reduce outstanding debt by approximately $1.8 billion, including our senior secured second lien notes;
•
retired our secured term loan due 2021 and significantly extended our debt maturity profile by issuing at par $850 million of 7.00% Senior Notes due 2024 and $400 million of 7.50% Senior Notes due 2026 for net proceeds of $1.2 billion, reducing our annual cash interest by approximately $30 million based on interest rates at the time of retirement;
•
continued to simplify our balance sheet, by repurchasing the CHK Utica, L.L.C. investors’ overriding royalty interests (ORRI) for $199 million;
•
improved liquidity by amending and restating our Chesapeake revolving credit facility, extending its maturity date by approximately four years;
•
improved cash flow from operations by $1.3 billion;
•
improved our cost structure by reducing our production, general and administrative, and gathering, processing and transportation expenses by $78 million, or 3%; and
•
generated approximately $528 million in proceeds from the disposition of certain non-core assets and other property sales in addition to the sale of our Utica Shale properties.
Looking forward into 2019, we are confident in our ability to drive further competitive performance through the quality of our investments and our capital and operating discipline. We have secured a strong hedge position for oil and natural gas that provides stability and certainty in our cash generating capability should commodity prices experience volatility.
In 2019, our focus remains concentrated on four strategic priorities:
•
reduce total leverage to achieve long term net debt/EBITDA of 2x;
•
increase net cash provided by operating activities to fund capital expenditures;
•
improve margins through financial discipline and operating efficiencies; and
•
maintain industry leading environmental and safety performance.
Business and Industry Outlook
Over the past decade, the landscape of energy production has changed dramatically in the United States. Domestic energy production capabilities have increased the nation’s supply of both crude oil and natural gas, primarily driven by advances in technology, horizontal drilling and hydraulic fracture stimulation techniques. As a result of this increase
in domestic supply of crude oil and natural gas, commodity prices for these products are meaningfully lower than they were a decade ago, and may remain volatile for the foreseeable future.
We have undergone a mutli-year effort to reduce our cost structure significantly and improve the profitability of our upstream portfolio. We have sold our non-upstream businesses, assets in under-performing basins and reduced our operating and general and administrative costs such that we are currently experiencing higher profitability than compared to periods when commodity prices were much higher. The improvements in our cost structure give us a strategic advantage as a low cost developer of unconventional oil and gas assets in the U.S. We recently used this strategic advantage to successfully acquire Wildhorse, a single asset, oil-focused company with an attractive acreage position of high-margin, undrilled locations. Our strategy going forward will be to leverage our advantages to drive shareholder value by growing cash flow through the development of our extensive portfolio of drilling opportunities. We intend to maintain capital discipline as we target cash flow growth rates that can be sustainable with internally generated resources.
Liquidity and Capital Resources
Liquidity Overview
Our ability to grow, make capital expenditures and service our debt depends primarily upon the prices we receive for the oil, natural gas and NGL we sell. Substantial expenditures are required to replace reserves, sustain production and fund our business plans. Historically, oil and natural gas prices have been volatile, and may be subject to wide fluctuations in the future. A decline in oil, natural gas and NGL prices could negatively affect the amount of cash we generate and have available for capital expenditures and debt service and could have a material impact on our financial position, results of operations, cash flows and on the quantities of reserves that we can economically produce or provide as collateral to our credit facility lenders. Other risks and uncertainties that could affect our liquidity include, but are not limited to, counterparty credit risk for our receivables, access to capital markets, regulatory risks and our ability to meet financial covenants in our financing agreements.
Based on our cash balance, forecasted cash flows from operating activities and availability under our revolving credit facilities, we expect to be able to fund our planned capital expenditures, meet our debt service requirements and fund our other commitments and obligations for the next 12 months.
As of December 31, 2018, we had a cash balance of $4 million compared to $5 million as of December 31, 2017, and a net working capital deficit of $1.230 billion as of December 31, 2018, compared to a net working capital deficit of $831 million as of December 31, 2017. As of December 31, 2018, our working capital deficit includes $381 million of debt due in the next 12 months. Our total principal debt as of December 31, 2018 was $8.168 billion compared to $9.981 billion as of December 31, 2017. As of December 31, 2018, we had $2.474 billion of borrowing capacity available under the Chesapeake revolving credit facility, with outstanding borrowings of $419 million and $107 million utilized for various letters of credit. As of the WildHorse acquisition date of February 1, 2019, we had $578 million of borrowing capacity available under the WildHorse revolving credit facility, with outstanding borrowings of $675 million and $47 million utilized as a letter of credit. See Note 3 of the notes to our consolidated financial statements included in Item 8 of this report for further discussion of our debt obligations, including principal and carrying amounts of our notes.
Although we have taken measures to mitigate liquidity concerns over the next 12 months, as outlined above in Overview, there can be no assurance that these measures will be sufficient for periods beyond the next 12 months. If needed, we may seek to access the capital markets or otherwise refinance a portion of our outstanding indebtedness to improve our liquidity. We closely monitor the amounts and timing of our sources and uses of funds, particularly as they affect our ability to maintain compliance with the financial covenants of our revolving credit facilities. Furthermore, our ability to generate operating cash flow in the current commodity price environment, sell assets, access capital markets or take any other action to improve our liquidity and manage our debt is subject to the risks discussed above and the other risks and uncertainties that exist in our industry, some of which we may not be able to anticipate at this time or control.
Our results of operations and cash flows are impacted by changes in market prices for oil, natural gas and NGL. To mitigate a portion of the exposure to adverse market changes, we have entered into various derivative instruments. Our oil, natural gas and NGL derivative activities, when combined with our sales of oil, natural gas and NGL, allow us to predict with greater certainty the total revenue we will receive.
We utilize various oil, natural gas and NGL derivative instruments to protect a portion of our cash flow against downside risk. As of February 22, 2019, including January and February derivative contracts that have settled, approximately 63% of our forecasted oil, natural gas and NGL production revenue was hedged, including 56% and 81% of our forecasted 2019 oil and natural gas production (including WildHorse production from February 1, 2019) at average prices of $57.12 per barrel and $2.85 per mcf, respectively.
Oil Derivatives(a)
Year
Type of Derivative Instrument
Notional Volume
Average NYMEX Price
(mmbbls)
2019
Swaps
17
$57.16
2019
Two-way collars
6
$58.00/$67.75
2019
Basis protection swaps
7
$6.01
2019
Puts
2
$53.83
2020
Swaps
7
$58.28
2020
Two-way collars
2
$65.00/$83.25
Natural Gas Derivatives(a)
Year
Type of Derivative Instrument
Notional Volume
Average NYMEX Price
(bcf)
2019
Swaps
453
$2.87
2019
Two-way collars
55
$2.75/$3.02
2019
Three-way collars
88
$2.50/$2.80/$3.10
2019
Calls
22
$12.00
2019
Basis protection swaps
50
($0.56)
2020
Swaps
217
$2.75
2020
Call swaptions
106
$2.77
2020
Calls
22
$12.00
___________________________________________
(a)
Includes amounts settled in January and February 2019.
See Note 13 of the notes to our consolidated financial statements included in Item 8 of this report for further discussion of derivatives and hedging activities.
Debt
We decreased our total principal amount of debt outstanding by approximately $1.8 billion in 2018. We accomplished this primarily by using the net proceeds from the sale of our Utica interests and other assets. We currently plan to use cash flow from operations and availability under our credit facilities to fund our capital expenditures for 2019. We are seeking to reduce cash costs (production, gathering, processing and transportation, general and administrative and interest expenses), improve our production volumes from existing wells, and achieve additional operating and capital efficiencies with a focus on growing our oil volumes.
In 2018, we issued at par $850 million of 7.00% Senior Notes due 2024 (the “2024 notes”) and $400 million of 7.50% Senior Notes due 2026 (the “2026 notes” and, together with the 2024 notes, the “senior notes”) pursuant to a public offering for net proceeds of approximately $1.236 billion. We may redeem some or all of the 2024 notes at any time prior to April 1, 2021 and some or all of the 2026 notes at any time prior to October 1, 2021, in each case at a price equal to 100% of the principal amount of the notes to be redeemed plus a “make-whole” premium.
We used the net proceeds from the senior notes, together with cash on hand and borrowings under the Chesapeake revolving credit facility, to repay in full $1.233 billion of borrowings under our secured term loan due 2021 for $1.285 billion, which included a $52 million make-whole premium. We recorded a loss of approximately $65 million associated with the repayment of the term loan, including the make-whole premium and the write-off of $13 million of associated deferred charges. Also in 2018, we used the proceeds from the sale of our Utica assets in Ohio to redeem all of the $1.416 billion aggregate principal amount outstanding of our 8.00% Senior Secured Second Lien Notes due 2022 which included a $60 million make-whole premium. We recorded a gain of approximately $331 million associated with the redemption, including the realization of the remaining $391 million difference in principal and book value due to troubled debt restructuring accounting in 2015, offset by the make-whole premium of $60 million.
We may continue to use a combination of cash, borrowings and issuances of our common stock or other securities to retire our outstanding debt, including any debt assumed in connection with the completion with the WildHorse acquisition, through privately negotiated transactions, open market repurchases, redemptions, tender offers or otherwise, but we are under no obligation to do so. We expect to generate additional liquidity with proceeds from future sales of assets that do not fit our strategic priorities.
Chesapeake Revolving Credit Facility
The Chesapeake revolving credit facility is currently subject to a $3.0 billion borrowing base that matures in September 2023. As of December 31, 2018, we had $2.474 billion of borrowing capacity available under the Chesapeake revolving credit facility. Our next borrowing base redetermination is scheduled for the second quarter of 2019. As of December 31, 2018, we had outstanding borrowings of $419 million under the Chesapeake revolving credit facility and had used $107 million of the Chesapeake revolving credit facility for various letters of credit. Borrowings under the facility bear interest at a variable rate. Under the Chesapeake revolving credit facility, we borrowed $11.697 billion and repaid $12.059 billion in 2018, we borrowed $7.771 billion and repaid $6.990 billion in 2017 and we borrowed and repaid $5.146 billion in 2016. See Note 3 of the notes to our consolidated financial statements included in Item 8 of this report for further discussion of the terms of the Chesapeake revolving credit facility. As of December 31, 2018, we were in compliance with all applicable financial covenants under the credit agreement. Our leverage ratio was approximately 3.31 to 1.00. Our secured leverage ratio and fixed charge coverage ratio were not in effect for the quarter ended December 31, 2018, due to the Utica Shale divestiture taking place during the quarter. Both ratios, in addition to the leverage ratio, will be in effect for the quarter ending March 31, 2019.
WildHorse Revolving Credit Facility
In connection with the acquisition of WildHorse, our subsidiary Brazos Valley Longhorn became the borrower under the WildHorse revolving credit facility. The WildHorse revolving credit facility has a maximum credit amount of $2.0 billion, with current aggregate elected commitments of $1.3 billion and a current borrowing base of $1.3 billion. The WildHorse revolving credit facility matures in December 2021. The borrowing base under the WildHorse revolving credit facility is subject to redetermination, on at least a semi-annual basis, primarily on estimated proved reserves. The next scheduled redetermination is in the second quarter of 2019. As of the WildHorse acquisition date of February 1, 2019, we had $578 million of borrowing capacity available under the WildHorse revolving credit facility, with outstanding borrowings of $675 million and $47 million utilized as a letter of credit. The WildHorse revolving credit facility is guaranteed by certain of Brazos Valley Longhorn’s subsidiaries (the “BVL Guarantors”) and is required to be secured by substantially all of the assets of Brazos Valley Longhorn and BVL Guarantors, including mortgages on not less than 85% of the proved reserves of their oil and gas properties.
The obligations under the WildHorse revolving credit facility are the senior secured obligations of Brazos Valley Longhorn and the BVL Guarantors. The obligations under the WildHorse revolving credit facility will not be obligations of Chesapeake or any of its subsidiaries other than Brazos Valley Longhorn and the BVL Guarantors. The obligations under the WildHorse revolving credit facility will rank equally in right of payment with all other senior secured indebtedness of Brazos Valley Longhorn and the other BVL Guarantors, and will be effectively senior to Brazos Valley Longhorn’s and the BVL Guarantors’ senior unsecured indebtedness, including their obligations under the WildHorse senior notes, to the extent of the value of the collateral securing the WildHorse revolving credit facility.
The Wildhorse revolving credit facility is used for the liquidity and expenses of Brazos Valley Longhorn and its subsidiaries and not Chesapeake or any of its subsidiaries other than Brazos Valley Longhorn, Brazos Valley Longhorn Finance Corp. (“BVL Finance Corp.”) and the other BVL Guarantors. Revolving loans under the WildHorse revolving credit facility bear interest at the alternate base rate, Eurodollar rate or LIBOR market index rate at Brazos Valley Longhorn’s election, plus an applicable margin (ranging from 0.50%-1.50% per annum for alternate base rate loans, 1.50%-2.50% per annum for Eurodollar loans and 1.50%-2.50% per annum for LIBOR market index rate loans), depending on Brazos Valley Longhorn’s total commitment usage. The unused portion of the total commitments are subject to a commitment fee that varies from 0.375% to 0.500%, depending on Brazos Valley Longhorn’s total commitment usage. The terms of the WildHorse revolving credit facility include covenants limiting, among other things, the ability of Brazos Valley Longhorn and its Restricted Subsidiaries (as defined under the WildHorse revolving credit facility) to incur additional indebtedness, make investments or loans, incur liens, consummate mergers or similar fundamental changes, make restricted payments, including dividends to Chesapeake, and enter into transactions with affiliates, including Chesapeake and its other subsidiaries. The WildHorse revolving credit facility also contains financial covenants that require Brazos Valley Longhorn to maintain (i)(x) if there are no loans outstanding thereunder, a ratio of net debt to EBITDAX (as defined under the WildHorse revolving credit facility) of not more than 4.00 to 1.00 as of the last day of each fiscal quarter or (y) if there are such loans outstanding, a ratio of total debt to EBITDAX of not more than 4.00 to 1.00 as of the last day of each fiscal quarter and (ii) a ratio of current assets (including availability under the WildHorse revolving credit facility) to current liabilities of not less than 1.00 to 1.00 as of the last day of each fiscal quarter. As of December 31, 2018, WildHorse was in compliance with all applicable financial covenants under the credit agreement. WildHorse’s ratio of net debt to EBITDAX was 1.81 to 1.00 and our ratio of current assets was 4.30 to 1.00 as of December 31, 2018.
The WildHorse revolving credit facility includes events of default relating to customary matters, including, among other things, nonpayment of principal, interest or other amounts; violation of covenants; incorrectness of representations and warranties in any material respect; defaults with respect to indebtedness in an aggregate principal amount of $25.0 million or more; bankruptcy; judgments involving liability of $15.0 million or more that are not paid; change of control; and ERISA events. Many events of default are subject to customary notice and cure periods.
WildHorse Senior Notes
As a result of the completion of the acquisition of WildHorse, Brazos Valley Longhorn assumed the obligations under WildHorse’s $700 million aggregate principal amount of 6.875% Senior Notes due 2025 (the “WildHorse senior notes”) and BVL Finance Corp., a wholly owned subsidiary of Brazos Valley Longhorn, became a co-issuer of the WildHorse senior notes.
The WildHorse senior notes are the senior unsecured obligations of Brazos Valley Longhorn, BVL Finance Corp. and the other BVL Guarantors. The WildHorse senior notes will not be obligations of Chesapeake or any of its subsidiaries other than Brazos Valley Longhorn, BVL Finance Corp. and the other BVL Guarantors. The WildHorse senior notes will rank equally in right of payment with all other senior unsecured indebtedness of Brazos Valley Longhorn, BVL Finance Corp. and the other BVL Guarantors, and will be effectively subordinated to Brazos Valley Longhorn’s, BVL Finance Corp.’s and the other BVL Guarantors’ senior secured indebtedness, including their obligations under the WildHorse revolving credit facility, to the extent of the value of the collateral securing such indebtedness.
The indenture (the “WildHorse indenture”) governing the WildHorse senior notes contains customary reporting covenants (including furnishing quarterly and annual reports to the holders of the WildHorse senior notes) and restrictive covenants that, among other things, restrict the ability of Brazos Valley Longhorn and its subsidiaries to: (i) pay dividends on, purchase or redeem Brazos Valley Longhorn’s equity interests or purchase or redeem subordinated debt; (ii) make certain investments; (iii) incur or guarantee additional indebtedness or issue certain types of equity securities; (iv) create or incur certain secured debt; (v) sell assets; (vi) consolidate, merge or transfer all or substantially all of Brazos Valley Longhorn’s assets; (vii) enter into agreements that restrict distributions or other payments from Brazos Valley Longhorn’s restricted subsidiaries to Brazos Valley Longhorn; (viii) engage in transactions with affiliates, including Chesapeake and its other subsidiaries; and (ix) create unrestricted subsidiaries. These covenants are subject to a number of important qualifications and limitations. In addition, most of the covenants will be terminated before the WildHorse senior notes mature if at any time no default or event of default exists under the WildHorse indenture and the WildHorse senior notes receive an investment grade rating from both of two specified ratings agencies. The WildHorse indenture also contains customary events of default.
If the WildHorse senior notes are downgraded within 90 days after the consummation of the acquisition of WildHorse (which constitutes a “Change of Control” under the WildHorse indenture), the WildHorse indenture requires Brazos Valley Longhorn (or a third party, in certain circumstances) to make an offer to repurchase the WildHorse senior notes at 101% of their principal amount, plus accrued and unpaid interest, within 30 days of such downgrade. If any holder of WildHorse senior notes accepts such offer, Brazos Valley Longhorn may (subject to the terms and conditions thereof) fund the purchase price with loans under the WildHorse revolving credit facility or Chesapeake may elect to draw under the Chesapeake revolving credit facility, use cash on hand, issue debt securities or use other sources of liquidity to fund such repurchase. If Brazos Valley Longhorn and Chesapeake are not required to make such offer or not all holders of WildHorse senior notes accept such an offer, Chesapeake may seek to amend, engage in liability management transactions with respect to, or redeem or refinance, the WildHorse senior notes at any time.
The WildHorse revolving credit facility and the WildHorse Indenture constrain the ability of WildHorse and its subsidiaries to make distributions or otherwise provide funds to, or guarantee the obligations of, Chesapeake and its other subsidiaries. The provisions of the WildHorse revolving credit facility and the WildHorse Indenture require that all transactions between WildHorse and its subsidiaries, on the one hand, and Chesapeake and its other subsidiaries, on the other hand, be on an arm's-length basis
Contractual Obligations and Off-Balance Sheet Arrangements
From time to time, we enter into arrangements and transactions that can give rise to contractual obligations and off-balance sheet commitments. The table below summarizes our contractual cash obligations for both recorded obligations and certain off-balance sheet arrangements and commitments as of December 31, 2018:
Payments Due By Period
Total
2019
2020-2021
2022-2023
2024 and Beyond
($ in millions)
Long-term debt:(a)
Principal(b)
$
8,168
$
381
$
1,479
$
1,208
$
5,100
Interest
3,058
523
942
793
800
Capital lease obligation(c)
30
10
20
—
—
Operating lease obligations(d)
4
3
1
—
—
Operating commitments(e)
5,786
837
1,467
1,051
2,431
Unrecognized tax benefits(f)
53
—
—
53
—
Standby letters of credit
107
107
—
—
—
Other
18
4
8
6
—
Total contractual cash obligations(g)
$
17,224
$
1,865
$
3,917
$
3,111
$
8,331
___________________________________________
(a)
We assumed $1.4 billion of debt with the completion of the WildHorse acquisition on February 1, 2019 that is not included in the table above.
(b)
See Note 3 of the notes to our consolidated financial statements included in Item 8 of this report for a description of our long-term debt.
(c)
See Note 6 of the notes to our consolidated financial statements included in Item 8 of this report for a description of our capital lease obligation.
(d)
See Note 4 of the notes to our consolidated financial statements included in Item 8 of this report for a description of our operating lease obligations.
(e)
See Note 4 of the notes to our consolidated financial statements included in Item 8 of this report for a description of our gathering, processing and transportation agreements and service contract commitments.
(f)
See Note 8 of the notes to our consolidated financial statements included in Item 8 of this report for a discussion of unrecognized tax benefits.
(g) This table does not include derivative liabilities or the estimated discounted liability for future dismantlement, abandonment and restoration costs of oil and natural gas properties. See Notes 13 and 21, respectively, of the
notes to our consolidated financial statements included in Item 8 of this report for more information on our derivatives and asset retirement obligations. This table also does not include our costs to produce reserves attributable to non-expense-bearing royalty and other interests in our properties, including VPPs, which are discussed in Note 14 of the notes to our consolidated financial statements included in Item 8 of this report.
Capital Expenditures
Our 2019 capital expenditures program is expected to generate greater capital efficiency than the 2018 program as we focus on expanding our margins through disciplined investing in the highest-return projects. We have significant control and flexibility over the timing and execution of our development plan, enabling us to reduce our capital spending as needed. Our forecasted 2019 capital expenditures, inclusive of Brazos Valley and capitalized interest, are $2.3 – $2.5 billion compared to our 2018 capital spending level of $2.4 billion. Management continues to review operational plans for 2019 and beyond, which could result in changes to projected capital expenditures and projected revenues from sales of oil, natural gas and NGL.
Credit Risk
Derivative instruments that enable us to manage our exposure to oil, natural gas and NGL prices expose us to credit risk from our counterparties. To mitigate this risk, we enter into oil, natural gas and NGL derivative contracts only with counterparties that we deem to have acceptable credit strength and are 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 December 31, 2018, our oil, natural gas and NGL derivative instruments were spread among 11 counterparties. Additionally, the counterparties under these arrangements are required to secure their obligations in excess of defined thresholds.
Our accounts receivable are primarily from purchasers of oil, natural gas and NGL ($976 million as of December 31, 2018) and exploration and production companies that own interests in properties we operate ($211 million as of December 31, 2018). This industry concentration has the potential to impact our overall exposure to credit risk, either positively or negatively, in that our customers and joint working interest owners may be similarly affected by changes in economic, industry or other conditions. We generally require letters of credit or parent guarantees for receivables from parties deemed to have sub-standard credit, unless the credit risk can otherwise be mitigated. During 2018, 2017 and 2016, we recognized $6 million, $9 million and $10 million, respectively, of bad debt expense related to potentially uncollectible receivables.
Some of our counterparties have requested or required us to post collateral as financial assurance of our performance under certain contractual arrangements, such as gathering, processing, transportation and hedging agreements. As of February 22, 2019, we have received requests and posted approximately $162 million of collateral related to certain of our marketing and other contracts. We may be requested or required by other counterparties to post additional collateral in an aggregate amount of approximately $355 million, which may be in the form of additional letters of credit, cash or other acceptable collateral. However, we have substantial long-term business relationships with each of these counterparties, and we may be able to mitigate any collateral requests through ongoing business arrangements and by offsetting amounts that the counterparty owes us. Any posting of collateral consisting of cash or letters of credit reduces availability under our revolving credit facility and negatively impacts our liquidity.
The following table presents the sources of our cash and cash equivalents for the years ended December 31, 2018, 2017 and 2016. See Note 14 of the notes to our consolidated financial statements included in Item 8 of this report for further discussion of divestitures of oil and natural gas assets.
Years Ended December 31,
2018
2017
2016
($ in millions)
Cash provided by (used in) operating activities
$
2,000
$
745
$
(204
)
Proceeds from issuances of debt, net
1,236
1,585
3,686
Proceeds from revolving credit facility borrowings, net
—
781
—
Proceeds from divestitures of proved and unproved properties, net
2,231
1,249
1,406
Proceeds from sales of other property and equipment, net
147
55
131
Proceeds from sales of investments
74
—
—
Total sources of cash and cash equivalents
$
5,688
$
4,415
$
5,019
Cash Flow from Operating Activities
Cash provided by operating activities was $2.000 billion in 2018 compared to cash provided by operating activities of $745 million in 2017 and cash used in operating activities of $204 million in 2016. The increase in 2018 is primarily the result of higher prices for the oil, natural gas and NGL we sold. The increase in 2017 is primarily the result of higher prices for the oil, natural gas and NGL we sold and decreases in certain of our operating expenses, partially offset by lower volumes of oil, natural gas and NGL sold, the payment related to the litigation involving the early redemption of our 6.775% Senior Notes due 2019 and payments for terminations of transportation contracts. Changes in cash flow from operations are largely due to the same factors that affect our net income, excluding various non-cash items, such as depreciation, depletion and amortization, certain impairments, gains or losses on sales of fixed assets, deferred income taxes and mark-to-market changes in our derivative instruments. See further discussion below under Results of Operations.
Debt issuances
The following table reflects the proceeds received from issuances of debt in 2018, 2017 and 2016. See Note 3 of the notes to our consolidated financial statements included in Item 8 of this report for further discussion.
Years Ended December 31,
2018
2017
2016
Principal Amount
of Debt
Issued
Net
Proceeds
Principal Amount
of Debt
Issued
Net
Proceeds
Principal Amount
of Debt
Issued
Net Proceeds
($ in millions)
Senior notes
$
1,250
$
1,236
$
1,600
$
1,585
$
1,000
$
975
Convertible senior notes
—
—
—
—
1,250
1,235
Term loans
—
—
—
—
1,500
1,476
Total
$
1,250
$
1,236
$
1,600
$
1,585
$
3,750
$
3,686
Divestitures of Proved and Unproved Properties
During 2018, we divested $2.231 billion of proved and unproved properties including $1.868 billion for all of our Utica Shale properties in Ohio. During 2017 and 2016, we divested certain non-core assets for approximately $1.249 billion and $1.406 billion, respectively. Proceeds from these transactions were used to repay debt and fund our development program. See Note 14 of the notes to our consolidated financial statements included in Item 8 of this report for further discussion.