Chesapeake Energy 2013 Annual Report Download - page 115

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
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investors contributed $1.25 billion in cash to CHK Utica in exchange for (i) 1.25 million preferred shares, and (ii) our
obligation to deliver a 3% ORRI in 1,500 net wells to be drilled on certain of our Utica Shale leasehold. Subject to
customary minority interest protections afforded the investors by the terms of the CHK Utica limited liability company
agreement (the CHK Utica LLC Agreement), as the holder of all the common shares and the sole managing member
of CHK Utica, we maintain voting and managerial control of CHK Utica and therefore include it in our consolidated
financial statements. Of the $1.25 billion of investment proceeds, we allocated $300 million to the ORRI obligation and
$950 million to the preferred shares based on estimates of fair values. The remaining ORRI obligation is included in
other current and long-term liabilities and the preferred shares are included in noncontrolling interests on our
consolidated balance sheets. Pursuant to the CHK Utica LLC Agreement, CHK Utica is required to retain a cash balance
equal to the next two quarters of preferred dividend payments. The amounts reserved for paying such dividends,
approximately $37 million and $44 million as of December 31, 2013 and 2012, respectively, were reflected as restricted
cash on our consolidated balance sheets. In addition, pursuant to the CHK Utica LLC Agreement, with respect to any
divestiture proceeds as defined by the agreement, CHK Utica is required to separately account for, and dedicate all
of such divestiture proceeds to either (i) capital expenditures made by CHK Utica in connection with its assets or (ii)
the redemption of CHK Utica preferred shares. As of December 31, 2012, $155 million of proceeds received from such
divestitures was recorded as restricted cash in other long-term assets on our consolidated balance sheet. In 2013, we
used all of the proceeds for CHK Utica capital expenditures.
Dividends on the preferred shares are payable on a quarterly basis at a rate of 7% per annum based on $1,000
per share. This dividend rate is subject to increase in limited circumstances in the event that, and only for so long as,
any dividend amount is not paid in full for any quarter. As the managing member of CHK Utica, we may, at our sole
discretion and election at any time after December 31, 2013, distribute certain excess cash of CHK Utica, as determined
in accordance with the CHK Utica LLC Agreement. Any such optional distribution of excess cash is allocated 70% to
the preferred shares (which is applied toward redemption of the preferred shares) and 30% to the common shares.
We may also, at our sole discretion and election, in accordance with the CHK Utica LLC Agreement, cause CHK Utica
to redeem the CHK Utica preferred shares for cash, in whole or in part. The preferred shares may be redeemed at a
valuation equal to the greater of a 10% internal rate of return or a return on investment of 1.4x, in each case inclusive
of dividends paid at the rate of 7% per annum and optional distributions made through the applicable redemption date.
In the event that redemption does not occur on or prior to October 31, 2018, the optional redemption valuation will
increase to provide the investors the greater of a 17.5% internal rate of return or a return on investment of 2.0x. The
preferred shares can be redeemed on a pro-rata basis in accordance with the then-applicable redemption valuation
formula. As of December 31, 2013 and 2012, the redemption price and the liquidation preference were each
approximately $1,252 and $1,322, respectively, per preferred share.
We have committed to drill and complete, for the benefit of CHK Utica in the area of mutual interest, a minimum
of 50 net wells per year from 2012 through 2016, up to a minimum cumulative total of 250 net wells. CHK Utica is
responsible for all capital and operating costs of the wells drilled for the benefit of the entity. If we fail to meet the then-
current drilling commitment in any year, we must pay CHK Utica $5 million for each well we are short of such drilling
commitment. CHK Utica also receives its proportionate share of the benefit of the drilling carry associated with our
joint venture with Total in the Utica Shale. See Note 12 for further discussion of the joint venture. Under the development
agreement, approximately 111 and 61 qualified net wells were added in 2013 and 2012, respectively. Through
December 31, 2013, we had met the drilling commitments associated with the CHK Utica transaction.
The CHK Utica investors’ right to receive, proportionately, a 3% ORRI in the first 1,500 net wells drilled on our
Utica Shale leasehold is subject to an increase to 4% on net wells earned in any year following a year in which we do
not meet our net well commitment under the ORRI obligation, which runs from 2012 through 2023. However, in no
event would we deliver to investors more than a total ORRI of 3% in 1,500 net wells. If at any time we hold fewer net
acres than would enable us to drill all then-remaining net wells on 150-acre spacing, the investors have the right to
require us to repurchase their right to receive ORRIs in the remaining net wells at the then-current fair market value
of such remaining ORRIs. We retain the right to repurchase the investors’ right to receive ORRIs in the remaining net
wells at the then-current fair market value of such remaining ORRIs once we have drilled a minimum of 1,300 net wells.
The obligation to deliver future ORRIs has been recorded as a liability which will be settled through the future conveyance
of the underlying ORRIs to the investors on a net-well basis, at which time the associated liability will be reversed and
the sale of the ORRIs reflected as an adjustment to the capitalized cost of our natural gas and oil properties. Under
the ORRI obligation, we delivered an ORRI in approximately 149 new net wells in 2013 and 28 net wells in 2012.
Because we did not meet our ORRI commitment in 2012, the ORRI increased to 4% for wells earned in 2013, and the
ultimate number of wells in which we must assign an interest will be reduced accordingly. Through December 31, 2013,
we were on target to meet the ORRI conveyance commitments associated with the CHK Utica transaction.