Chesapeake Energy Corporation — 2018 Form 10-K
Entity and period: The supplied filing is Chesapeake Energy Corporation’s annual report for the fiscal year ended December 31, 2018, filed February 27, 2019. It is not a filing for “EXPAND ENERGY Corp.” The quarterly figures below are unaudited.
Business context and reporting period
Chesapeake was a U.S. onshore oil and gas exploration and production company, with operations including the Marcellus, Haynesville, Eagle Ford, Powder River Basin and Mid-Continent. It reported approximately 190 million boe of 2018 production, down from 200 million boe in 2017. In October 2018, it sold its Ohio Utica properties; the February 2019 WildHorse acquisition occurred after year-end and is not included in 2018 results.
Key financial metrics
| Metric | 2018 | 2017 |
|---|---|---|
| Total revenue | $10.231 billion | $9.496 billion |
| Net income attributable to Chesapeake | $873 million | $949 million |
| Net income available to common shareholders | $775 million; $0.85 per diluted share | $813 million; $0.90 per diluted share |
| Cash from operating activities | $2.000 billion | $745 million |
| Capital spending on oil and gas properties | $2.246 billion | $2.471 billion |
| Principal debt outstanding at year-end | $8.168 billion | $9.981 billion |
| Cash at year-end | $4 million | $5 million |
| Net working capital | Deficit of $1.230 billion | Deficit of $831 million |
| Total equity | $467 million | Deficit of $372 million |
Oil, natural gas and NGL sales were $5.189 billion, up 13%; marketing revenue was $5.076 billion, with marketing expenses of $5.158 billion and a gross margin deficit of $82 million. Average realized production price, including realized derivative gains and losses, was $25.56 per boe, compared with $23.17 in 2017. Production and gathering, processing and transportation costs were $2.84 and $7.35 per boe, respectively. Total interest expense was $487 million, up from $426 million.
Year-end borrowing capacity under Chesapeake’s revolving credit facility was approximately $2.474 billion, after $419 million of borrowings and $107 million of letters of credit. The company reported compliance with applicable covenants at December 31, 2018. This liquidity position coexisted with very low cash and a substantial working-capital deficit.
Material changes versus the prior comparable period
- Revenue rose about 8%, while net income attributable to Chesapeake declined about 8% and production volume fell about 5%. Higher commodity prices more than offset the effect of lower volumes on sales.
- Operating cash flow increased to $2.0 billion from $745 million, primarily due to higher prices. Capital spending exceeded operating cash flow by approximately $246 million before considering asset sales and other investing flows.
- Debt principal declined approximately $1.8 billion, primarily using proceeds from asset dispositions, including the Utica sale. Chesapeake also refinanced debt, issuing $1.25 billion of 2024 and 2026 notes and repaying its secured term loan.
- The Utica disposition generated $1.868 billion net proceeds but resulted in a $578 million accounting loss. The company sold 559 million boe of proved reserves during 2018, while extensions and discoveries added 270 million boe; year-end proved reserves were 1.448 billion boe versus 1.912 billion boe in 2017.
- 2018 included $139 million of investment gains and $263 million of gains on debt purchases or exchanges, as well as a $38 million workforce-reduction charge. No oil and gas ceiling-test impairment was recorded in 2018; 2017 also had none.
- Fourth-quarter 2018 revenue was $3.069 billion and net income available to common shareholders was $486 million, or $0.53 per share. The quarter included $513 million of net income attributable to Chesapeake.
Outlook, management commentary, risks and unusual items
- Management forecast 2019 capital expenditures of $2.3–$2.5 billion, inclusive of Brazos Valley and capitalized interest, compared with approximately $2.4 billion of 2018 capital spending. It expected to fund the program with operating cash flow and revolving-credit availability, while retaining flexibility to adjust spending.
- Management’s stated priorities were to reduce leverage toward a long-term net-debt-to-EBITDA ratio of 2x, fund capital expenditures with operating cash flow, improve margins through operating efficiencies, and maintain environmental and safety performance.
- As of February 22, 2019, including certain settled contracts, management reported hedging approximately 63% of forecast 2019 oil, gas and NGL production revenue; 56% of forecast oil and 81% of forecast natural gas production were hedged at average prices of $57.12 per barrel and $2.85 per Mcf, respectively. Derivatives reduce downside exposure but can also limit gains if prices rise.
- WildHorse was acquired on February 1, 2019 for approximately 717.3 million Chesapeake shares, $381 million cash and assumption of $1.4 billion of debt. Management projected average annual savings of $200–$280 million and cumulative savings of $1–$1.5 billion by 2023; these were forward-looking estimates, not 2018 realized results. The acquisition added substantial share dilution and debt.
- Key risks include commodity-price volatility, high leverage and debt-service needs, borrowing-base redeterminations, covenant compliance, access to capital, reserve and development-estimate uncertainty, and substantial gathering and transportation commitments. Environmental and regulatory exposure includes hydraulic fracturing, water, methane emissions and induced-seismicity matters.
- Legal contingencies include royalty-underpayment claims and regulatory matters. The filing describes a $35 million tentative settlement covering substantially all Pennsylvania civil royalty cases; other potential losses were not clearly quantifiable. The company also disclosed an arbitration claim seeking $215 million, along with environmental proceedings and Oklahoma earthquake litigation.
- Common-stock dividends had been suspended since 2015 and were not expected to resume in the foreseeable future. Preferred dividends continued; $92 million was paid in 2018.
Important facts for investors to verify
- Reconcile reported earnings with significant nonrecurring and noncash items, particularly the Utica sale loss, debt-extinguishment gains, investment gains and derivative mark-to-market effects.
- Assess whether operating cash flow can sustainably cover the planned capital program, debt service and commitments without continued asset sales or additional borrowing.
- Review debt maturities, 2019 borrowing-base redeterminations, covenant requirements, collateral calls and the effect of WildHorse’s assumed debt and separate credit arrangements.
- Test the assumptions behind WildHorse’s projected synergies, integration plan, share dilution and the combined company’s leverage and cash-flow outlook.
- Evaluate reserve additions, downward revisions, the large proved-undeveloped-reserve program and its estimated $3.6 billion development cost; reserve values use prescribed prices and are not market-value estimates.
- Monitor unresolved royalty, environmental and seismic claims, as well as gathering and transportation obligations totaling approximately $5.8 billion undiscounted in the filing’s commitment disclosures.