UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-K
| x | Annual Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
For the Fiscal Year Ended December 31, 2004
| ¨ | Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934 |
Commission File No. 1-13726
Chesapeake Energy Corporation
(Exact Name of Registrant as Specified in Its Charter)
| Oklahoma | 73-1395733 | |
| (State or other jurisdiction of incorporation or organization) |
(I.R.S. Employer Identification No.) | |
| 6100 North Western Avenue Oklahoma City, Oklahoma |
73118 | |
| (Address of principal executive offices) | (Zip Code) | |
(405) 848-8000
Registrant’s telephone number, including area code
Securities registered pursuant to Section 12(b) of the Act:
| Title of Each Class |
Name of Each Exchange on Which Registered | |
| Common Stock, par value $.01 |
New York Stock Exchange | |
| 8.375% Senior Notes due 2008 |
New York Stock Exchange | |
| 8.125% Senior Notes due 2011 |
New York Stock Exchange | |
| 9.0% Senior Notes due 2012 |
New York Stock Exchange | |
| 7.5% Senior Notes due 2013 |
New York Stock Exchange | |
| 7.0% Senior Notes due 2014 |
New York Stock Exchange | |
| 7.5% Senior Notes due 2014 |
New York Stock Exchange | |
| 7.75% Senior Notes due 2015 |
New York Stock Exchange | |
| 6.875% Senior Notes due 2016 |
New York Stock Exchange | |
| 6.0% Cumulative Convertible Preferred Stock |
New York Stock Exchange | |
| 5.0% Cumulative Convertible Preferred Stock |
New York Stock Exchange |
Securities registered pursuant to Section 12(g) of the Act:
None
Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. YES x NO ¨
Indicate by check mark if disclosure of delinquent filers pursuant to Item 405 of Regulation S-K is not contained herein, and will not be contained, to the best of registrant’s knowledge, in definitive proxy or information statements incorporated by reference in Part III of this Form 10-K or any amendment to this Form 10-K x
Indicate by check mark whether the registrant is an accelerated filer (as defined in Exchange Act Rule 12b-2). YES x NO ¨
The aggregate market value of our common stock held by non-affiliates on June 30, 2004 was $3,229,393,436. At March 2, 2005, there were 314,122,017 shares of common stock issued and outstanding.
DOCUMENTS INCORPORATED BY REFERENCE
Portions of the proxy statement for the 2005 Annual Meeting of Shareholders are incorporated by reference in Part III.
PART I
ITEM 1. Business
General
We are one of the four largest independent producers of natural gas in the U.S. and own interests in approximately 20,000 producing oil and gas wells. Our proved oil and natural gas reserves as of December 31, 2004 were approximately 4.9 tcfe. At December 31, 2004, approximately 89% of our proved reserves (by volume) were natural gas, and approximately 70% of our proved oil and natural gas reserves were located in our primary operating area-the Mid-Continent region of the United States, which includes Oklahoma, western Arkansas, southwestern Kansas and the Texas Panhandle. In addition, we are building significant secondary operating areas in the South Texas and Texas Gulf Coast region, the Permian Basin of western Texas and eastern New Mexico and in the Ark-La-Tex area of central and eastern Texas and northern Louisiana.
From January 1, 1998 through December 31, 2004, we have been one of the most active consolidators of onshore U.S. natural gas assets, having purchased approximately 3.8 tcfe of proved reserves at a total cost of approximately $4.5 billion (excluding $851 million of unproved properties as well as $558 million of deferred taxes in connection with certain corporate acquisitions).
During 2004, we remained active in the acquisitions market. Acquisition expenditures totaled $2.0 billion in 2004 (excluding $464 million of deferred taxes in connection with certain corporate acquisitions). Through our completed 2004 acquisitions, we acquired an internally estimated 1,137 bcfe of proved oil and natural gas reserves at a cost of $1.36 per mcfe (excluding $0.41 per mcfe of deferred taxes in connection with certain corporate acquisitions).
During 2004, we drilled 561 (425 net) operated wells and participated in another 890 (121 net) wells operated by other companies. The company’s success rate was 96% for both operated and non-operated wells. Through our exploration and development operations, we added approximately 962 bcfe of proved oil and gas reserves. As of December 31, 2004, our proved developed producing reserves were 66% of our total proved reserves. In 2004, we invested $299.8 million in leasehold (exclusive of leases acquired through acquisitions) and 3-D seismic data.
Our principal executive offices are located at 6100 North Western Avenue, Oklahoma City, Oklahoma 73118 and our main telephone number at that location is (405) 848-8000. We make available free of charge on our website at www.chkenergy.com our annual reports on Form 10-K, quarterly reports on Form 10-Q, current reports on Form 8-K, and amendments to those reports as soon as reasonably practicable after we electronically file such material with, or furnish it to, the Securities and Exchange Commission. References to “us”, “we” and “our” in this report refer to Chesapeake Energy Corporation together with its subsidiaries.
Recent Developments
On January 28, 2005, we amended and restated our revolving bank credit facility, increasing the borrowing base to $1.25 billion and extending the maturity to January 2010.
On February 1, 2005, we acquired Mid-Continent and Ark-La-Tex natural gas and oil assets through the purchase of the stock of BRG Petroleum Corporation and the acquisition of various other partnership interests for cash consideration of approximately $325 million, of which $16.3 million was paid in 2004.
Business Strategy
Since the company’s inception in 1989, our goal has been to create value for our investors by building one of the largest onshore natural gas resource bases in the United States. For the past seven years, our strategy to
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accomplish this goal has been to build the dominant operating position in the Mid-Continent region, the third largest gas supply region in the U.S. In building this industry-leading position in the Mid-Continent, we have integrated an aggressive and technologically advanced drilling program with an active property consolidation program focused on small to medium-sized corporate and property acquisitions of up to $600 million. We are now building significant secondary operating areas in the South Texas and Texas Gulf Coast region, Permian Basin and Ark-La-Tex area. We believe significant elements of our successful Mid-Continent strategy can be transferred to these areas.
Key elements of this business strategy are further explained below:
| • | Make High-Quality Acquisitions. Our acquisition program is focused on small to medium-sized acquisitions of natural gas properties that offer high-quality, long-lived production and significant development and higher potential deep drilling opportunities. From January 1, 1998 through December 31, 2004, we have acquired $4.5 billion of such proved properties (largely through 48 separate transactions of greater than $10 million each) at an estimated average cost of $1.18 per mcfe of proved reserves (excluding $0.15 per mcfe of deferred taxes in connection with certain corporate acquisitions). The vast majority of these acquisitions either increased our ownership in existing wells or fields or added additional drilling locations in the Mid-Continent, and more recently in our secondary operating areas. Because our operating areas contain many small companies seeking liquidity opportunities and larger companies seeking to divest non-core assets, we expect to continue to find additional attractive acquisition opportunities in the future. |
| • | Grow through the Drillbit. One of our most distinctive characteristics is our ability to increase reserves and production through the drillbit. We are currently utilizing 68 operated drilling rigs and 62 non-operated drilling rigs to conduct what we believe is the most active drilling program in the United States. We focus on both finding significant new natural gas reserves and developing existing proved reserves, principally at deeper depths than the industry average. For the past seven years, we have been aggressively investing in the leasehold, 3-D seismic information and human capital to be able to take advantage of the favorable drilling economics that exist in our industry today. While U.S. natural gas production has been declining during the past few years, we are one of the few mid- to large-cap companies that have been able to increase production, as we have successfully done for the past 15 years and 14 consecutive quarters. In the Mid-Continent, our drilling program remains the most active in the region and is supported by our ownership of the region’s largest leasehold and 3-D seismic inventories. Across our operating areas, we seek a balanced approach to drilling, with approximately one-third of our expenditures focused on targets located at depths shallower than 10,000 feet, one-third on medium depth drilling between 10,000 – 15,000 feet and one-third targeting deeper objectives below 15,000 feet. |
| • | Build Regional Scale. We believe one of the keys to success in the natural gas exploration industry is to build significant operating scale in a limited number of operating areas. Achieving such scale provides many benefits, the most important of which are higher per unit revenues, lower per unit operating costs, greater rates of drilling success, higher returns from more easily integrated acquisitions and higher returns on drilling investments. We first began pursuing this focused strategy in the Mid-Continent in 1997 and we are now the largest natural gas producer, the most active driller and the most active acquirer of leasehold and producing properties in the Mid-Continent. We believe this region, which trails only the Gulf Coast and Rocky Mountain basins in current U.S. gas production, has many attractive characteristics. These characteristics include long-lived natural gas properties with predictable decline curves; multi-pay geological targets that decrease drilling risk and have resulted in a drilling success rate of 92% over the past fifteen years; favorable basis differentials to benchmark commodity prices; generally lower service costs than in more competitive or more remote basins; and a favorable regulatory environment with virtually no federal land ownership. We believe our secondary operating areas possess many of these same favorable characteristics. |
| • | Focus on Low Costs. By minimizing lease operating costs and general and administrative expenses through focused activities and increased scale, we have been able to deliver attractive financial returns |
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| through all phases of the commodity price cycle. We believe our low cost structure is the result of our management’s effective cost-control programs, a high-quality asset base and the extensive and competitive services, gas processing and transportation infrastructures that exist in our key operating areas. We believe our acquisitions in 2004 will help maintain our low per unit operating and administrative costs because of our large existing scale of operations and the reimbursements we will receive from third parties in the approximately 2,800 wells on which we have assumed operations during 2004. As of December 31, 2004, we operated approximately 8,800 wells, or approximately 81% of our current daily production. |
| • | Improve Our Balance Sheet. We made significant progress in improving our balance sheet over the past six years. From December 31, 1998 through December 31, 2004, we have increased our shareholders’ equity by $3.4 billion through a combination of earnings and common and preferred equity issuances. During 2004, we issued $650.0 million of common equity and $313.3 million of preferred equity (4.125% convertible preferred stock) and our net income was $515.2 million. We also completed an exchange of our 6.0% convertible preferred stock (liquidation preference of $224.8 million) for 24.0 million shares of common stock and forced the conversion of all of our 6.75% convertible preferred stock (liquidation preference of $149.9 million) into 19.5 million shares of common stock. As of December 31, 2004, our debt as a percentage of total capitalization (total capitalization is the sum of debt and stockholders’ equity) was 49%, compared to 137% as of December 31, 1998. Additionally, through debt repurchases and exchanges completed in 2004, we have extended the average maturity of our long-term debt to over nine years and have lowered our average interest rate to 7.3%. We plan to continue improving our balance sheet in years ahead. |
Based on our view that natural gas will be in a tight supply/high demand relationship in the U.S. during at least the next five years because of flat to declining supply and growing demand for this clean-burning, domestically-produced fuel, we believe our focused natural gas acquisition, exploitation and exploration strategy should provide substantial value-creating growth opportunities in the years ahead. Our goal is to increase our overall production by 10% to 20% per year, with growth at an annual rate of 10% generated organically through the drillbit and the remaining growth generated through future acquisitions. We have reached or exceeded this overall production goal in 10 of our 12 years as a public company.
Company Strengths
We believe the following six characteristics distinguish our past performance and differentiate our future growth potential from other independent natural gas producers:
| • | High-Quality Asset Base. Our producing properties are characterized by long-lived reserves, established production profiles and an emphasis on natural gas. Based upon current production and reserve estimates, our proved reserves-to-production ratio, or reserve life, is approximately 12 years. In each of our operating areas, our properties are concentrated in locations that enable us to establish substantial economies of scale in drilling and production operations and facilitate the application of more effective reservoir management practices. We intend to continue building our asset base in each of our operating areas through a balance of acquisitions, exploitation and exploration. We operate properties accounting for approximately 81% of our current daily production volumes. This large percentage of operated properties provides us with a high degree of operating flexibility and cost control. |
| • | Low-Cost Producer. Our high-quality asset base, the work ethic of our employees, our “hands-on” management style and our location in Oklahoma City have enabled us to achieve a low operating and administrative cost structure. During the year ended December 31, 2004, our operating costs per unit of production were $0.95 per mcfe, which consisted of general and administrative expenses of $0.10 per mcfe (including non-cash stock-based compensation of $0.01 per mcfe), production expenses of $0.56 per mcfe and production taxes of $0.29 per mcfe. We believe this is one of the lowest cost structures among publicly traded mid- to large-cap independent oil and natural gas producers. |
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| • | Successful Acquisition Program. Our experienced asset acquisition team focuses on enhancing and expanding our existing assets in each of our operating areas. These areas are characterized by long-lived natural gas reserves, low lifting costs, multiple geological targets, favorable basis differentials to benchmark commodity prices, well-developed oil and gas transportation infrastructures and considerable potential for further consolidation of assets. Since 1998, we have completed $4.5 billion in acquisitions of proved properties at an average cost of $1.18 per mcfe of proved reserves (excluding $0.15 per mcfe of deferred taxes in connection with certain corporate acquisitions). We believe we are well-positioned to continue making attractive small and medium-sized acquisitions as a result of our extensive track record of identifying, completing and integrating multiple successful acquisitions, our large operating scale and our knowledge and expertise in the regions in which we operate. |
| • | Large Inventory of Drilling Projects. During the 15 years since our inception, we believe we have been among the five most active drillers of new wells in the United States. Presently, we are the most active driller in the United States (with 68 operated and 62 non-operated rigs drilling) and the most active driller in the Mid-Continent (with 40 of our 68 operated rigs). Through this high level of activity over the years, we have developed an industry-leading expertise in drilling deep vertical and horizontal wells in search of large natural gas accumulations in challenging reservoir conditions. We pursue deep drilling targets because of our view that most undiscovered gas reserves in the U.S. will be found at depths below 15,000 feet. In addition, we believe that our large 3-D seismic inventory, much of which is proprietary to us, provides us with significant advantages over our competitors, which largely prefer to drill shallower development wells. As a result of our aggressive leasehold acquisition and seismic acquisition strategies, we have been able to accumulate an onshore leasehold position of approximately 3.3 million net acres and have acquired rights to over 9.9 million acres of 3-D seismic data to help evaluate our expansive acreage inventory. On this very large acreage position, our technical teams have identified over 7,000 exploratory and developmental drill sites, representing a backlog of more than seven years of future drilling opportunities. |
| • | Hedging Program. We have used and intend to continue using hedging programs to reduce the risks inherent in producing oil and natural gas, commodities that are frequently characterized by significant price volatility. We believe this price volatility is likely to continue and may even increase in the years ahead, but that we can use this volatility to our benefit by taking advantage of prices when they reach levels that management believes lock in unusually high rates of return on our invested capital. Between January 1, 2001 and December 31, 2004, we have increased our oil and gas revenues by $29 million from net realized gains through our successful hedging programs. We currently have gas hedges in place covering 51% of our anticipated gas production for 2005 and 11% of our anticipated gas production for 2006 at average NYMEX prices of $6.27 and $6.38 per mcf, respectively. In addition, we have 34% of our projected oil production hedged for 2005 at an average NYMEX price of $41.02 per barrel of oil. |
| • | Entrepreneurial Management. Our management team formed the company in 1989 with an initial capitalization of $50,000. Since then, our current management team has guided the company through various operational and industry challenges and extremes of oil and gas prices to create one of the four largest independent producers of natural gas in the U.S. with an enterprise value of approximately $10.1 billion (based on a common stock price of $20 per share). Our co-founders, Aubrey K. McClendon and Tom L. Ward, have been business partners in the oil and gas industry for 22 years and beneficially own, as of March 2, 2005, approximately 17.3 million and 18.8 million of our common shares, respectively. |
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Drilling Activity
The following table sets forth the wells we drilled during the periods indicated. In the table, “gross” refers to the total wells in which we had a working interest and “net” refers to gross wells multiplied by our working interest.
| 2004 |
2003 |
2002 |
||||||||||||||||||||||||||||
| Gross |
Percent |
Net |
Percent |
Gross |
Percent |
Net |
Percent |
Gross |
Percent |
Net |
Percent |
|||||||||||||||||||
| Development: |
||||||||||||||||||||||||||||||
| Productive |
1,239 | 97 | % | 462.5 | 98 | % | 958 | 96 | % | 401.0 | 97 | % | 617 | 95 | % | 237.7 | 95 | % | ||||||||||||
| Non-productive |
34 | 3 | 9.2 | 2 | 37 | 4 | 11.2 | 3 | 34 | 5 | 11.5 | 5 | ||||||||||||||||||
| Total |
1,273 | 100 | % | 471.7 | 100 | % | 995 | 100 | % | 412.2 | 100 | % | 651 | 100 | % | 249.2 | 100 | % | ||||||||||||
| Exploratory: |
||||||||||||||||||||||||||||||
| Productive |
164 | 92 | % | 67.6 | 91 | % | 76 | 86 | % | 35.9 | 83 | % | 47 | 82 | % | 24.6 | 82 | % | ||||||||||||
| Non-productive |
14 | 8 | 7.0 | 9 | 12 | 14 | 7.5 | 17 | 10 | 18 | 5.4 | 18 | ||||||||||||||||||
| Total |
178 | 100 | % | 74.6 | 100 | % | 88 | 100 | % | 43.4 | 100 | % | 57 | 100 | % | 30.0 | 100 | % | ||||||||||||
The following table shows the wells we drilled by area:
| 2004 |
2003 |
2002 | ||||||||||
| Gross Wells |
Net Wells |
Gross Wells |
Net Wells |
Gross Wells |
Net Wells | |||||||
| Mid-Continent |
1,195 | 417 | 984 | 403 | 673 | 263 | ||||||
| South Texas and Texas Gulf Coast |
67 | 38 | 55 | 25 | 19 | 9 | ||||||
| Permian Basin |
107 | 55 | 44 | 28 | 13 | 6 | ||||||
| Ark-La-Tex |
82 | 36 | — | — | — | — | ||||||
| Other |
— | — | — | — | 3 | 1 | ||||||
| Total |
1,451 | 546 | 1,083 | 456 | 708 | 279 | ||||||
At December 31, 2004, we had 114 (50 net) wells in process. We own 10 rigs which are dedicated to drilling wells operated by Chesapeake and 12 additional rigs are under construction or on order. Our drilling business is conducted through our wholly owned subsidiary, Nomac Drilling Corporation.
Well Data
At December 31, 2004, we had interests in approximately 19,800 (8,058 net) producing wells, including properties in which we held an overriding royalty interest, of which 2,900 (1,222 net) were classified as primarily oil producing wells and 16,900 (6,836 net) were classified as primarily gas producing wells. Chesapeake operates approximately 8,800 of its 19,800 producing wells. During 2004, we drilled 561 (425 net) wells and participated in another 890 (121 net) wells operated by other companies. We operate approximately 81% of our current daily production volumes.
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Production, Sales, Prices and Expenses
The following table sets forth information regarding the production volumes, oil and gas sales, average sales prices received and expenses for the periods indicated:
| 2004 |
2003 |
2002 |
||||||||||
| Net Production: |
||||||||||||
| Oil (mbbl) |
6,764 | 4,665 | 3,466 | |||||||||
| Gas (mmcf) |
322,009 | 240,366 | 160,682 | |||||||||
| Gas equivalent (mmcfe) |
362,593 | 268,356 | 181,478 | |||||||||
| Oil and Gas Sales ($ in thousands): |
||||||||||||
| Oil sales |
$ | 260,915 | $ | 132,630 | $ | 88,495 | ||||||
| Oil derivatives – realized gains (losses) |
(69,267 | ) | (12,058 | ) | (1,092 | ) | ||||||
| Oil derivatives – unrealized gains (losses) |
3,454 | (9,440 | ) | (7,369 | ) | |||||||
| Total oil sales |
$ | 195,102 | $ | 111,132 | $ | 80,034 | ||||||
| Gas sales |
$ | 1,789,275 | $ | 1,171,050 | $ | 470,913 | ||||||
| Gas derivatives – realized gains (losses) |
(85,634 | ) | (5,331 | ) | 97,138 | |||||||
| Gas derivatives – unrealized gains (losses) |
37,433 | 19,971 | (79,898 | ) | ||||||||
| Total gas sales |
$ | 1,741,074 | $ | 1,185,690 | $ | 488,153 | ||||||
| Total oil and gas sales |
$ | 1,936,176 | $ | 1,296,822 | $ | 568,187 | ||||||
| Average Sales Price |
||||||||||||
| Oil ($ per bbl) |
$ | 38.57 | $ | 28.43 | $ | 25.53 | ||||||
| Gas ($ per mcf) |
$ | 5.56 | $ | 4.87 | $ | 2.93 | ||||||
| Gas equivalent ($ per mcfe) |
$ | 5.65 | $ | 4.86 | $ | 3.08 | ||||||
| Average Sales Price |
||||||||||||
| Oil ($ per bbl) |
$ | 28.33 | $ | 25.85 | $ | 25.22 | ||||||
| Gas ($ per mcf) |
$ | 5.29 | $ | 4.85 | $ | 3.54 | ||||||
| Gas equivalent ($ per mcfe) |
$ | 5.23 | $ | 4.79 | $ | 3.61 | ||||||
| Expenses ($ per mcfe): |
||||||||||||
| Production expenses |
$ | 0.56 | $ | 0.51 | $ | 0.54 | ||||||
| Production taxes |
$ | 0.29 | $ | 0.29 | $ | 0.17 | ||||||
| General and administrative expenses: |
||||||||||||
| General and administrative expenses (excluding stock-based compensation) |
$ | 0.09 | $ | 0.09 | $ | 0.10 | ||||||
| Stock-based compensation |
$ | 0.01 | $ | 0.00 | $ | 0.00 | ||||||
| Oil and gas depreciation, depletion and amortization |
$ | 1.61 | $ | 1.38 | $ | 1.22 | ||||||
| Depreciation and amortization of other assets |
$ | 0.08 | $ | 0.06 | $ | 0.08 | ||||||
| Interest expense(a) |
$ | 0.45 | $ | 0.55 | $ | 0.61 | ||||||
| (a) | Includes the effects of realized gains or (losses) from hedging, but does not include the effects of unrealized gains or (losses) from hedging. |
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Proved Reserves
The following table sets forth our estimated proved reserves and the present value of the proved reserves (based on our weighted average wellhead prices at December 31, 2004 of $39.91 per barrel of oil and $5.65 per mcf of gas). These weighted average wellhead prices were based on the cash spot prices for oil and natural gas at December 31, 2004.
| Oil (mbbl) |
Gas (mmcf) |
Gas Equivalent (mmcfe) |
Percent of Proved Reserves |
Present Value ($ in thousands) |
|||||||||
| Mid-Continent |
46,726 | 3,157,081 | 3,437,439 | 70 | % | $ | 7,112,733 | ||||||
| South Texas and Texas Gul | |||||||||||||