Chesapeake Energy 2012 Annual Report Download - page 69

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31, 2012 pursuant to SEC reporting requirements, was estimated to be approximately $954 million in total and $182
million for the next twelve months on an undiscounted basis and approximately $760 million and $173 million,
respectively, on a discounted basis using an annual discount rate of 10%. Our commitment to bear the costs on any
future production of VPP volumes is not reflected as a liability on our balance sheet. The costs that will apply in the
future will depend on the actual production volumes as well as the production costs and taxes in effect during the
periods in which such production actually occurs, which could differ materially from our current and historical costs,
and production may not occur at the times or in the quantities projected, or at all. We have committed to purchase
natural gas and liquids associated with our VPP transactions. Production purchased under these arrangements is
based on market prices at the time of production, and the purchased natural gas and liquids are resold at market prices.
See Notes 4, 11 and 13 of the notes to our consolidated financial statements included in Item 8 of this report for
further discussion of commitments, VPPs and VIEs, respectively.
Hedging Activities
Natural Gas, Oil and NGL Derivatives
Our results of operations and cash flows are impacted by changes in market prices for natural gas, oil and NGL.
To mitigate a portion of the exposure to adverse market changes, we have entered into various derivative instruments.
Executive management is involved in all risk management activities and the Board of Directors reviews the Company's
hedging program at its quarterly board meetings. We believe we have sufficient internal controls to prevent unauthorized
hedging. As of December 31, 2012, our natural gas and oil derivative instruments consisted of swaps, options, swaptions
and basis protection swaps. Item 7A. Quantitative and Qualitative Disclosures About Market Risk contains a description
of each of these instruments and realized and unrealized gains and losses on natural gas, oil and NGL derivatives
during 2012, 2011 and 2010. Although derivatives often fail to achieve 100% effectiveness for accounting purposes,
we believe our derivative instruments continue to be highly effective in achieving our risk management objectives.
Hedging allows us to predict with greater certainty the effective prices we will receive for our hedged production.
We closely monitor the fair value of our derivative contracts and may elect to settle a contract prior to its scheduled
maturity date in order to lock in a gain or minimize loss. Commodity markets are volatile and Chesapeake's hedging
activities are dynamic.
Mark-to-market positions under commodity derivative contracts fluctuate with commodity prices. As described
under Hedging Facility in Item 7A, our secured multi-counterparty hedging facility allows us to minimize the potential
liquidity impact of significant mark-to-market fluctuations in the value of such derivatives by pledging our proved
reserves.
The estimated fair values of our natural gas, oil and NGL derivative contracts as of December 31, 2012 and 2011
are provided below. See Item 7A. Quantitative and Qualitative Disclosures About Market Risk for additional information
concerning the fair value of our natural gas, oil and NGL derivative instruments.
December 31,
2012 2011
($ in millions)
Derivative assets (liabilities):
Fixed-price natural gas swaps ...................................................................................... $ 24 $ —
Natural gas call options ................................................................................................ (240) (284)
Natural gas basis protection swaps .............................................................................. (15) (42)
Fixed-price oil swaps .................................................................................................... 68 15
Oil call options .............................................................................................................. (748) (1,282)
Oil call swaptions ......................................................................................................... (13) (53)
Fixed-price oil knockout swaps .................................................................................... — 7
Estimated fair value ................................................................................................. $ (924) $ (1,639)
Changes in the fair value of natural gas and oil derivative instruments designated as cash flow hedges, to the
extent effective in offsetting cash flows attributable to the hedged commodities, and locked-in gains and losses of
settled designated derivative contracts are recorded in accumulated other comprehensive income and are transferred
to earnings in the month of related production. These unrealized gains (losses), net of related tax effects, totaled ($179)
million, ($162) million and ($156) million as of December 31, 2012, 2011 and 2010, respectively. Based upon the market