Chesapeake Energy 2013 Annual Report Download - page 67

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are also recognized currently in earnings. See Derivative Activities above and Item 7A. Quantitative and Qualitative
Disclosures About Market Risk for additional information regarding our derivative activities.
One of the primary factors that can have an impact on our results of operations is the method used to value our
derivatives. We have established the fair value of our derivative instruments utilizing established index prices, volatility
curves and discount factors. These estimates are compared to counterparty valuations for reasonableness. Derivative
transactions are also subject to the risk that counterparties will be unable to meet their obligations. Such non-
performance risk is considered in the valuation of our derivative instruments, but to date has not had a material impact
on the values of our derivatives. The values we report in our financial statements are as of a point in time and
subsequently change as these estimates are revised to reflect actual results, changes in market conditions and other
factors. Additionally, in accordance with accounting guidance for derivatives and hedging, to the extent that a legal
right of set-off exists, we net the value of our derivative instruments with the same counterparty in the accompanying
consolidated balance sheets.
Another factor that can impact our results of operations each period is our ability to estimate the level of correlation
between future changes in the fair value of the derivative instruments and the transactions being hedged, both at
inception and on an ongoing basis. This correlation is complicated since energy commodity prices, the primary risk
we hedge, have quality and location differences that can be difficult to hedge effectively. The factors underlying our
estimates of fair value and our assessment of correlation of our derivative instruments are impacted by actual results
and changes in conditions that affect these factors, many of which are beyond our control.
Due to the volatility of natural gas, oil and NGL prices and, to a lesser extent, interest rates and foreign exchange
rates, the Company's financial condition and results of operations can be significantly impacted by changes in the
market value of our derivative instruments. As of December 31, 2013, 2012 and 2011, the fair value of our derivatives
were liabilities of $649 million, $979 million and $1.719 billion, respectively.
Income Taxes. As part of the process of preparing the consolidated financial statements, we are required to
estimate the federal and state income taxes in each of the jurisdictions in which Chesapeake operates. This process
involves estimating the actual current tax exposure together with assessing temporary differences resulting from
differing treatment of items, such as derivative instruments, depreciation, depletion and amortization, and certain
accrued liabilities for tax and accounting purposes. These differences and our net operating loss carryforwards result
in deferred tax assets and liabilities, which are included in our consolidated balance sheets. We must then assess,
using all available positive and negative evidence, the likelihood that the deferred tax assets will be recovered from
future taxable income. If we believe that recovery is not likely, we must establish a valuation allowance. Generally, to
the extent Chesapeake establishes a valuation allowance or increases or decreases this allowance in a period, we
must include an expense or reduction of expense within the tax provision in the consolidated statement of operations.
Under accounting guidance for income taxes, an enterprise must use judgment in considering the relative impact
of negative and positive evidence. The weight given to the potential effect of negative and positive evidence should
be commensurate with the extent to which it can be objectively verified. The more negative evidence that exists (i) the
more positive evidence is necessary and (ii) the more difficult it is to support a conclusion that a valuation allowance
is not needed for some portion or all of the deferred tax asset. Among the more significant types of evidence that we
consider are:
• taxable income projections in future years;
• whether the carryforward period is so brief that it would limit realization of the tax benefit;
• future sales and operating cost projections that will produce more than enough taxable income to realize the
deferred tax asset based on existing sales prices and cost structures; and
• our earnings history exclusive of the loss that created the future deductible amount coupled with evidence
indicating that the loss is an aberration rather than a continuing condition.
If (i) natural gas and oil prices were to decrease significantly below present levels (and if such decreases were
considered other than temporary), (ii) exploration, drilling and operating costs were to increase significantly beyond
current levels, or (iii) we were confronted with any other significantly negative evidence pertaining to our ability to
realize our net operating loss carryforwards prior to their expiration, we may be required to provide a valuation allowance
against our deferred tax assets. As of December 31, 2013 and 2012, we had deferred tax assets of $1.621 billion and
$1.726 billion, respectively, upon which we had a valuation allowance of $148 million and $160 million, respectively,
for certain state net operating losses that we have concluded are not more likely than not to be utilized prior to expiration.