Chesapeake Energy 1999 Annual Report Download - page 66

The exercise of certain stock options results in state and federal incometax benefits to the Company related to
the difference between the market price of the common stock at the date of disposition and the option price. During
fiscal 1997, $4,808,000 was recorded as an adjustment to additional paid-in capital and deferred income taxes with
respect to such tax benefits. During 1999, 1998 and the Transition Period, the Company did not recognize any such
tax benefits.
10. Financial Instruments and Hedging Activities
The Company has only limited involvement with derivative financial instruments, as defined in Statement of
Financial Accounting Standards No. 119 "Disclosure About Derivative Financial Instruments and Fair Value of
Financial Instruments", and does not use them for trading purposes. The Company's primary objective is to hedge a
portion of its exposure to price volatility from producing crude oil and natural gas. These arrangements may expose
the Company to credit risk from its counterparties and to basis risk. The Company does not expect that the
counterparties will fail to meet their obligations given their high credit ratings.
Hedging Activities
Periodically the Company utilizes hedging strategies to hedge the price of a portion of its future oil and gas
production. These strategies include:
swap arrangements that establish an index-related price above which the Company pays the
counterparty and below which the Company is paid by the counterparty,
the purchase of index-related puts that provide for a "floor" price below which the counterparty pays
the Company the amount by which the price of the commodity is below the contracted floor,
the sale of index-related calls that provide for a "ceiling" price above which the Company pays the
counterparty the amount by which the price of the commodity is above the contracted ceiling, and
basis protection swaps, which are arrangements that guarantee the price differential of oil or gas from a
specified delivery point or points.
Results from commodity hedging transactions are reflected in oil and gas sales to the extent related to the
Company's oil and gas production. The Company only enters into commodity hedging transactions related to the
Company's oil and gas production volumes or CEMI's physical purchase or sale commitments. Gains or losses on
crude oil and natural gas hedging transactions are recognized as price adjustments in the months of related
production.
As of December 31, 1999, the Company had the following open natural gas swap arrangements designed to
hedge a portion of the Company's domestic gas production for periods after December 1999:
NYMEX-Index
Volume Strike Price
Months (MMBtu (per MMBtu)
April 2000 600,000 $ 2.50
May 2000 620,000 2.50
June 2000 600,000 2.50
July 2000 620,000 2.50
August 2000 620,000 2.50
September2000 600,000 2.50
October 2000 620,000 2.50
If the swap arrangements listed above had been settled on December 31, 1999, the Company would have incurred
a gain of $0.5 million.
As of December 31, 1999, the Company had no open oil swap arrangements.
The Company has also closed transactions designed to hedge a portion of the Company's domestic oil and
natural gas production. The net unrecognized losses resulting from these transactions, $3.9 million as of December
31, 1999, will be recognized as price adjustments in the months of related production. These hedging gains and
losses are set forth below ($ in thousands):
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