Chesapeake Energy Corporation — FY 2009 Form 10-K
Entity and period: The supplied filing is for Chesapeake Energy Corporation, not Expand Energy Corp. It covers the fiscal year ended December 31, 2009, and was signed March 1, 2010. It reports full-year results; quarterly figures are included, but this is not a standalone fourth-quarter filing.
Business context
Chesapeake described itself as the second-largest U.S. natural gas producer, with operations focused on onshore U.S. shale and other oil and gas plays. At year-end it held interests in about 44,100 producing wells and reported 2.4 bcfe per day of production, 93% natural gas. Its strategy emphasized organic drilling, monetizing selected acreage and production through joint ventures and asset sales, and reducing debt. The company also planned to expand into unconventional oil and liquids-rich plays.
Financial and operating performance
| Metric | FY 2009 | FY 2008 |
|---|---|---|
| Total revenue | $7.702 billion | $11.629 billion |
| Natural gas and oil sales, including derivative effects | $5.049 billion | $7.858 billion |
| Operating income (loss) | $(8.945) billion | $1.457 billion |
| Net income (loss) attributable to Chesapeake | $(5.830) billion | $604 million |
| Diluted earnings (loss) per share | $(9.57) | $0.93 |
| Cash provided by operating activities | $4.356 billion | $5.357 billion |
| Cash used in investing activities | $5.462 billion | $9.965 billion |
| Cash and cash equivalents at year-end | $307 million | $1.749 billion |
| Long-term debt, net of current maturities | $12.295 billion | $13.175 billion |
- Production increased 7% to 905.5 bcfe, including 834.8 bcf of natural gas and 11.8 million barrels of oil. Average sales price excluding unrealized derivative effects was $6.22 per mcfe, versus $8.38 in 2008; excluding derivative gains and losses, the reported average was $3.63 per mcfe.
- Realized natural gas and oil derivative gains were $2.346 billion in 2009, compared with an $8 million net loss in 2008. Unrealized derivative losses were $588 million in 2009. Derivatives materially affected reported sales and earnings.
- The company recorded $11.130 billion of impairment charges on natural gas and oil properties and other assets, including an approximately $6.9 billion after-tax write-down of oil and gas properties. It also recorded $162 million of investment impairment and $34 million of restructuring costs. The large impairment drove the reported operating and net losses.
- At year-end, current assets were $2.446 billion and current liabilities were $2.688 billion. The filing reported $12.3 billion of long-term debt on the balance sheet; contractual debt principal was $13.147 billion. Revolver borrowings were $1.936 billion at year-end. The company said its net indebtedness was 49% of book capitalization and acknowledged that it lacked an investment-grade credit rating.
- Operating cash flow declined by $1.001 billion year over year, primarily due to lower commodity prices. Investing outflows fell substantially, reflecting reduced acquisition and drilling activity, asset monetizations, and joint-venture drilling carries. Cash declined by $1.442 billion during the year.
- Proved reserves rose 18% to 14.254 tcfe; reserve replacement was reported at 343%. Approximately 42% of proved reserves were undeveloped. The year-end standardized measure of discounted future net cash flows was $8.203 billion, down from $11.833 billion, using SEC-prescribed prices and assumptions—not a market valuation.
Material changes and transactions
- Revenue fell about 34% from 2008, principally because of lower realized commodity prices, partly offset by higher production. Oil and gas sales excluding unrealized derivative effects fell by $1.424 billion, as price declines more than offset production growth.
- Chesapeake reported downward reserve revisions of 1.397 tcfe, including 952 bcfe attributable to lower gas prices under the new 12-month-average SEC pricing rule. The company cautioned that 2009 reserve estimates are not directly comparable with prior-year estimates because of revised SEC rules.
- Joint ventures with PXP, BP and Statoil generated substantial upfront proceeds and drilling carries. Together with the January 2010 Total Barnett transaction, the filing described up to $4.8 billion in cash proceeds and $5.9 billion in drilling carries across four shale ventures; about $3.4 billion of carries remained at the stated dates. Chesapeake retained majority interests in the properties.
- In September 2009, GIP acquired 50% of Chesapeake Midstream Partners for $588 million. The venture was consolidated at year-end; Chesapeake expected to deconsolidate it and use equity-method accounting starting January 2010.
- Chesapeake issued $1.425 billion of 9.5% senior notes in February 2009 and used net proceeds to repay revolver debt. It also exchanged $364 million principal amount of convertible notes for common shares. Common shares issued increased to about 649 million at year-end from 608 million.
Outlook, risks and unusual items
- Management projected 2010 production of 975–995 bcfe, an 8%–10% increase over 2009, and expected to direct about 75% of drilling capital to the Big 6 shale plays. It planned to increase oil and liquids production, particularly in the Granite Wash and Eagle Ford.
- The filing presents different 2010 spending measures: an approximately $3.3 billion budget for drilling, property transactions, seismic and other property/equipment, and a separate $4.1–$4.4 billion drilling-capital budget net of carries. These figures have different stated scopes and should not be treated as directly comparable without checking the detailed budget definitions.
- Management said it expected to fund its 2010 plan from operating cash flow under current assumptions, while noting that weaker prices, economic conditions, or capital-market access could require additional monetizations or spending cuts. Its stated balance-sheet objective was to reduce long-term debt per proved mcfe from $0.84 at year-end 2009 to below $0.60 by year-end 2011.
- As of February 17, 2010, hedges covered approximately 60% of expected 2010 production at an average $8.16 per mcfe. Hedges can limit upside, create collateral needs, and expose the company to counterparty and production-volume risks.
- Key business risks include volatile gas prices, high leverage and borrowing-base or covenant constraints, further impairment charges, the capital and execution required to develop PUD reserves, lease expirations, drilling and environmental hazards, hydraulic-fracturing or greenhouse-gas regulation, and pipeline or gathering capacity limits. The company also identified potential liquidity reliance on asset sales and joint-venture partners’ ability to fund drilling carries.
- Pending matters included a securities class action over the July 2008 share offering and other shareholder litigation. The filing said potential liabilities could not be estimated; a derivative case was dismissed in February 2010 with leave for plaintiffs to amend. The filing also disclosed CEO participation in the Founder Well Participation Program and a $75 million well-cost incentive award, with a five-year clawback provision.
- Price and reserve assumptions are especially consequential: the SEC reserve calculation used $3.87 per mcf of gas and $61.14 per barrel of oil. The filing estimated that a $0.10 per mcf gas-price change would alter proved-reserve present value by about $500 million.
Investor verification priorities
- Reconcile the 2010 capital-budget figures by scope, timing, and treatment of drilling carries and property transactions.
- Review debt maturities, revolver availability, covenant headroom, borrowing-base exposure, ratings, and the company’s progress toward its debt-reduction target.
- Assess the sensitivity of cash flow, impairment risk, reserve volumes, and PUD development economics to commodity prices and the new SEC reserve rules.
- Verify realized hedge coverage and prices, potential collateral requirements, counterparty exposure, and the distinction between realized and unrealized derivative effects.
- Track joint-venture carry funding, asset monetization proceeds, the midstream IPO and accounting transition, and whether planned production growth is achieved within budget.
- Monitor litigation, environmental and regulatory developments, lease expirations, and material changes in pipeline capacity or access.
PricewaterhouseCoopers issued an unqualified audit opinion on the consolidated financial statements and concluded that internal control over financial reporting was effective as of December 31, 2009.