Chesapeake Energy Corp. is no stranger to big financing deals.
In recent years, the company has increasingly turned to a finance structure known as a Volumetric Production Payment, or VPP. Chesapeake has raised $6.4 billion since 2007 using the finance instrument that provides the company with a cash payment up front in exchange for a percentage of the oil or natural gas produced in a specific set of wells over a specific amount of time.
Some observers have compared VPPs to futures contracts, which are more common.
“VPPs are a pretty widespread instrument in the industry,” said Bruce Bullock, director of the Maguire Energy Institute at Southern Methodist University in Dallas. “Chesapeake is not at all unusual for a natural gas producer to use that investment. It's actually safer than debt for the lender, and it's quicker and easier than trying to do a share offering because it's secured by an asset. It's an actually much more efficient way to raise money.”
Bullock said the use of VPPs makes sense for Chesapeake, which for years has used hedges and forward sales contracts to minimize the risk of falling commodity prices.
The futures market for natural gas has all but dried up in recent months as natural gas prices fell below $2 per thousand cubic feet. Even with the low sales prices, Chesapeake has locked in relatively strong prices with its VPPs, averaging $4.65 per thousand cubic feet equivalent for the 10 contracts it has signed since 2007.
Chesapeake pointed out that the average sales cost is 300 percent of its finding and development costs. The price also is 87 percent higher than Friday's closing price for natural gas at $2.50 per thousand cubic feet.
Chesapeake's most recent VPP, signed in April, carried a price per thousand cubic feet of $4.68.
While some observers have praised Chesapeake for its use of VPPs, others have a much lower view of the strategy.
Maclyn Clouse, professor of finance at the University of Denver's Daniels College of Business, went as far as to call the accounting practices “dishonest.”
“Those liabilities don't show up on the statements,” Clouse said. “They're just treated as an asset sale, as though they sold the whole thing. But in fact, they sold the production, not the whole well.”
Chesapeake said the details of the VPP sales are included in its quarterly and annual earnings reports.
“Nobody who follows us and is an analyst has any mystery,” Chesapeake spokesman Michael Kehs said. “We publicize quite vividly our VPPs. We've had enormous success with those. We also do all the appropriate accounting to factor in the costs associated with carrying out those VPPs.”
Clouse and Argus Research analyst Philip Weiss have said Chesapeake should count the proceeds from the VPPs as unearned revenue — a liability on the company's balance sheet — until the fuel is delivered.
Clouse compared the transaction to consumers who pay their cable bill a month in advance. The cable company treats that payment as a liability until the cable service is deli
In his April 20 Argus report, Weise said he does not consider Chesapeake's VPPs when calculating its
“In our view, VPPs are similar to loans. The only difference is that
Bullock, however, said Chesapeake is accounting for the VPPs properly.
“I have always thought of it as a non-operating asset, somewhat like a royalty payment system,” he said. “Because you have sold in effect a portion of that well to somebody else, then you don't book it as part of your operating earnings. Therefore, that portion of the production is not considered an operating asset on your balance sheet either.”
The Wall Street Journal reported last week that Chesapeake's 10 existing VPPs will cost the company $1.4 billion over the next decade in costs associated with the wells included in the plan.
The Journal said Chesapeake had not publicly disclosed the full cost, but research firm Bernstein Research on Friday defended the Oklahoma City company.
“We do not believe these quoted amounts were ‘previously unreported,' and, in fact, we already include an estimate of the costs in our models,” the Bernstein report stated. “These costs are already reflected in (Chesapeake's) guidance.”
Because the $1.4 billion cost is included in the company's income and cash flow estimates, counting it as a liability “is double-counting in our view,” the statement continued.
PAUL MONIES, B