Chesapeake Energy 2012 Annual Report Download - page 101

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
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Risks and Uncertainties
Our business strategy is to continue growing our reserves and production and transitioning from an asset base
primarily focused on natural gas to an asset base more balanced between natural gas and liquids production. This is
a capital-intensive strategy, and we made capital expenditures in 2012 that exceeded our cash flow from operations,
filling the gap with borrowings and proceeds from sales of assets that we determined were non-core or did not fit our
long-term plans. See Note 11 for a description of our 2012 asset sales. We project that our capital expenditures will
continue to exceed our operating cash flow in 2013, although by a significantly smaller amount. Our 2013 capital
expenditure budget is approximately 50% less than our 2012 capital expenditures, and as operator of a substantial
portion of our natural gas and oil properties under development, we have significant control and flexibility over the
development plan and the associated timing, enabling us to expeditiously reduce at least a portion of our capital
spending if needed. To add certainty to future estimated cash flows by mitigating our downside exposure to lower
commodity prices, we currently have downside hedge protection on approximately 50% of our 2013 estimated natural
gas production at a price of $3.62 per mcf and 85% of our 2013 estimated oil production at a price of $95.45 per bbl,
allowing us to reduce the effect of price volatility on our cash flows and earnings before interest, taxes, depreciation,
depletion and amortization (EBITDA). Based on these and other factors, we believe we have adequate borrowing
capacity through our current credit arrangements, together with anticipated proceeds from transactions subject to
binding agreements to sell non-core assets, to make up the difference between our budgeted capital expenditures and
cash flow from operations in 2013.
As part of our asset sales planning and capital expenditure budgeting process, we closely monitor the resulting
effects on 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 corporate revolving bank credit facility. While asset sales enhance our
ability to reduce debt, sales of producing natural gas and oil properties may adversely affect the amount of cash flow
and EBITDA we generate and reduce the amount and value of collateral available to secure our obligations, both of
which can be exacerbated by low prices received for our production. In September 2012, we obtained an amendment
to our revolving bank credit facility agreement that relaxed the required indebtedness to EBITDA ratio for the quarter
ended September 30, 2012 and the four subsequent quarters. We would have been unable to meet the required ratio
as of September 30, 2012 without this amendment primarily because the closing of certain asset sales transactions
occurred in the fourth quarter and not in September as we had anticipated. As a result, without the amendment, we
would have been unable to reduce our indebtedness sufficiently as of September 30, 2012 to maintain our covenant
compliance. Failure to maintain compliance with the covenants of our revolving bank credit facility could result in the
acceleration of outstanding indebtedness under the facility and lead to cross defaults under our senior note and
contingent convertible senior note indentures, hedge facility, equipment master lease arrangements and term loan.
See Note 3 for further discussion of our debt instruments, including the terms of the credit facility amendment. Based
on reductions in our budgeted capital expenditures, expected commodity prices (including the prices for our currently
hedged production), our forecasted drilling and production, projected levels of indebtedness and binding purchase and
sale agreements for certain future asset sales, we expect we will be in compliance with the financial maintenance
covenants of our corporate revolving bank credit facility through 2013. We believe the assumptions underlying our
budget for this period are reasonable and that we have adequate flexibility, including the ability to adjust discretionary
capital expenditures, to adapt to potential negative developments if needed to maintain covenant compliance.
Natural gas prices reached 10-year lows in 2012, and although our strategic focus on increasing liquids production
is progressing and we have hedges in place covering approximately 50% of our projected 2013 natural gas production,
we continue to have significant exposure to natural gas prices. Approximately 70% and 83% of our estimated proved
reserves volumes as of December 31, 2012 and December 31, 2011, respectively, were natural gas, and natural gas
represented approximately 80% and 84% of our natural gas, oil and NGL sales volumes for 2012 and 2011, respectively.
In 2012, we reduced our estimate of proved reserves by 3.1 tcfe, or 17%, primarily due to the impact of downward
natural gas price revisions. Natural gas prices used in estimating proved reserves at December 31, 2012 and 2011
decreased by 33% from $4.12 per mcf to $2.76 per mcf, causing the loss of significant proved undeveloped reserves
for which future development is uneconomic. As a result of lower estimated reserves, in the 2012 third quarter, we
were required to impair the carrying value of our natural gas and oil properties, and we could have additional impairments
in the future. See Natural Gas and Oil Properties below for further discussion of our impairment of the carrying value
of our natural gas and oil properties in 2012.