This excerpt taken from the CHK DEF 14A filed Apr 30, 2009.
date have proven to be the most volatile in the history of our industry, fluctuating from $6.19 to begin 2008 and climbing to a high of $13.57 in July 2008 before falling to a 2008 low of $5.29 and then further to below $3.60 in 2009 (as of the filing of this proxy statement).
In addition to yielding a poor approximation of actual reserve value, we believe that the use of a single-day price has arbitrary effects on our financial statements, particularly as a result of our utilization of the full-cost method of accounting for natural gas and oil reserves. Under the full-cost method of accounting, we are required to calculate a ceiling test at the end of each quarter based on commodity prices as of the end of the applicable quarterly period. This ceiling test can result in the write-down of our assets as a result of the volatility of commodity prices in situations where there is no substantive decline in the future value of the natural gas and oil properties. Although the SEC has adopted new rules that provide for an average price based on the prior 12-month period for use in valuing our natural gas and oil reserves on December 31, 2009 and thereafter, the volatility in any given year, as we have seen in 2008 and 2009, may still generate reserve values and ceiling test write-downs which we believe are not indicative of the true future value of our reserves or the efforts of our executive officers. As discussed below, linking compensation to a variable that the executive cannot influence may incentivize our executives to take risks that are counter to the Companys long-term interests.
Under current accounting rules, the fair value of hedging contracts to be settled in future periods may require the recording of unrealized losses in the Companys financial statements when, in reality, the ultimate value of the hedging contracts is not known with certainty until the contract matures. Such unrealized financial statement losses are not relevant indicators of poor performance or execution of the Companys hedging strategy. For example, the fair value of our natural gas and oil hedges was a negative $6.229 billion as of June 30, 3008 and a positive $1.305 billion as of December 31, 2008.
Additionally, should the actual price received for production be higher than the price at which the production is hedged for any particular production month, the Company will realize a hedging loss. These hedging losses, should they occur, may not diminish the success of our hedging program nor are they relevant indicators of the execution of the program. In fact, a hedging program that locks-in attractive margins and provides consistency and stability in budgeting for our natural gas and oil revenue may be considered a successful business strategy while generating realized hedging losses month after month.
When setting executive compensation levels, our Compensation Committee analyzes our executive officers effectiveness in managing the organizations operations and financial results in light of the volatility associated with natural gas and oil prices, as described above. This analysis involves a subjective consideration of each executive with respect to the three factors listed above using a comprehensive approach and not giving more weight to any one factor over another.