Edgar Filing: CHESAPEAKE ENERGY CORP

Form 10-Q

UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

[X] Quarterly Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the quarterly period ended June 30, 2009

[ ] Transition Report pursuant to Section 13 or 15(d) of the Securities Exchange Act of 1934

For the transition period from to

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		73118
		Oklahoma City, Oklahoma		(Zip Code)
		(Address of principal executive offices)

(405) 848-8000

Registrant’s telephone number, including area code

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 whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes [X] No [ ]

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer”, “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act.


Large accelerated filer [X]				Accelerated filer [ ]

Non-accelerated filer [ ] (Do not check if a smaller reporting company)				Smaller reporting company [ ]

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes [ ] No [X]

As of August 6, 2009, there were 641,652,116 shares of our $0.01 par value common stock outstanding.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

INDEX TO FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2009

PART I.

Financial Information


		Page

Item 1.	Condensed Consolidated Financial Statements (Unaudited):

	Condensed Consolidated Balance Sheets as of June 30, 2009 and December 31, 2008	1
	Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2009 and 2008	3
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2009 and 2008	4
	Condensed Consolidated Statements of Stockholders’ Equity for the Six Months Ended June 30, 2009 and 2008	6
	Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2009 and 2008	7

	Notes to Condensed Consolidated Financial Statements	8

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	40

Item 3.	Quantitative and Qualitative Disclosures About Market Risk	58

Item 4.	Controls and Procedures	66

PART II.
Other Information

Item 1.	Legal Proceedings	67

Item 1A.	Risk Factors	67

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	68

Item 3.	Defaults Upon Senior Securities	68

Item 4.	Submission of Matters to a Vote of Security Holders	68

Item 5.	Other Information	69

Item 6.	Exhibits	70

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)


	June 30, 2009			December 31, 2008
				(Adjusted)
	($ in millions)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	554		$	1,749
Accounts receivable		1,122			1,324
Short-term derivative instruments		1,133			1,082
Other		139			137

Total Current Assets		2,948			4,292

PROPERTY AND EQUIPMENT:
Natural gas and oil properties, at cost based on full-cost accounting:
Evaluated natural gas and oil properties		33,886			28,965
Unevaluated properties		9,465			11,379
Less: accumulated depreciation, depletion and amortization of natural gas and oil properties		(22,199	)		(11,866	)

Total natural gas and oil properties, at cost based on full-cost accounting		21,152			28,478

Other property and equipment:
Natural gas gathering systems and treating plants		3,256			2,717
Buildings and land		1,618			1,513
Drilling rigs and equipment		556			430
Natural gas compressors		248			184
Other		522			482
Less: accumulated depreciation and amortization of other property and equipment		(616	)		(496	)

Total Other Property and Equipment		5,584			4,830

Total Property and Equipment		26,736			33,308

OTHER ASSETS:
Investments		394			444
Long-term derivative instruments		88			261
Other assets		303			288

Total Other Assets		785			993

TOTAL ASSETS	$	30,469		$	38,593

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS – (Continued)

(Unaudited)


	June 30, 2009			December 31, 2008
				(Adjusted)
	($ in millions)
LIABILITIES AND STOCKHOLDERS’ EQUITY
CURRENT LIABILITIES:
Accounts payable	$	971		$	1,611
Short-term derivative instruments		28			66
Accrued liabilities		983			880
Deferred income taxes		401			358
Income taxes payable		—			108
Revenues and royalties due others		371			431
Accrued interest		220			167

Total Current Liabilities		2,974			3,621

LONG-TERM LIABILITIES:
Long-term debt, net		13,568			13,175
Deferred income tax liabilities		906			4,200
Asset retirement obligations		279			269
Long-term derivative instruments		322			111
Other liabilities		418			200

Total Long-Term Liabilities		15,493			17,955

CONTINGENCIES AND COMMITMENTS (Note 3)
STOCKHOLDERS’ EQUITY:
Preferred Stock, $0.01 par value, 20,000,000 shares authorized:
4.50% cumulative convertible preferred stock, 2,558,900 shares issued and outstanding as of June 30, 2009 and December 31, 2008, entitled in liquidation to $256 million		256			256
5.00% cumulative convertible preferred stock (series 2005B), 2,095,615 shares issued and outstanding as of June 30, 2009 and December 31, 2008, entitled in liquidation to $209 million		209			209
5.00% cumulative convertible preferred stock (series 2005), 5,000 shares issued and outstanding as of June 30, 2009 and December 31, 2008, entitled in liquidation to $1 million		1			1
6.25% mandatory convertible preferred stock, 0 shares and 143,768 shares issued and outstanding as of June 30, 2009 and December 31, 2008, respectively, entitled in liquidation to $0 and $36 million		—			36
4.125% cumulative convertible preferred stock, 0 and 3,033 shares issued and outstanding as of June 30, 2009 and December 31, 2008, respectively, entitled in liquidation to $0 and $3 million		—			3
Common Stock, $0.01 par value, 1,000,000,000 shares and 750,000,000 shares authorized, 630,251,782 and 607,953,437 shares issued at June 30, 2009 and December 31, 2008, respectively		6			6
Paid-in capital		12,032			11,680
Retained earnings (deficit)		(929	)		4,569
Accumulated other comprehensive income (loss), net of tax of ($267) million and ($163) million, respectively		438			267
Less: treasury stock, at cost; 718,800 and 657,276 common shares as of June 30, 2009 and December 31, 2008, respectively		(11	)		(10	)

Total Stockholders’ Equity		12,002			17,017

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	30,469		$	38,593

The accompanying notes are an integral part of these condensed consolidated financial statements.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS

(Unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2009			2008			2009			2008
				(Adjusted)						(Adjusted)
	($ in millions except per share data)
REVENUES:
Natural gas and oil sales	$	1,097		$	(1,594	)	$	2,494		$	(821	)
Natural gas and oil marketing sales		532			1,099			1,084			1,895
Service operations revenue		44			40			90			82

Total Revenues		1,673			(455	)		3,668			1,156

OPERATING COSTS:
Production expenses		213			219			451			419
Production taxes		24			88			46			163
General and administrative expenses		74			101			164			180
Natural gas and oil marketing expenses		500			1,075			1,023			1,849
Service operations expense		46			32			87			67
Natural gas and oil depreciation, depletion and amortization		295			523			742			1,038
Depreciation and amortization of other assets		58			40			115			76
Impairment of natural gas and oil properties and other assets		5			—			9,635			—
Restructuring costs		34			—			34			—

Total Operating Costs		1,249			2,078			12,297			3,792

INCOME (LOSS) FROM OPERATIONS		424			(2,533	)		(8,629	)		(2,636	)

OTHER INCOME (EXPENSE):
Other income (expense)		(2	)		(1	)		5			(11	)
Interest expense		(22	)		(54	)		(8	)		(153	)
Impairment of investments		(10	)		—			(162	)		—
Loss on exchanges of Chesapeake debt		(2	)		—			(2	)		—

Total Other Income (Expense)		(36	)		(55	)		(167	)		(164	)

INCOME (LOSS) BEFORE INCOME TAXES		388			(2,588	)		(8,796	)		(2,800	)
INCOME TAX EXPENSE (BENEFIT):
Current income taxes		1			3			1			3
Deferred income taxes		144			(999	)		(3,299	)		(1,081	)

Total Income Tax Expense (Benefit)		145			(996	)		(3,298	)		(1,078	)

NET INCOME (LOSS)		243			(1,592	)		(5,498	)		(1,722	)
PREFERRED STOCK DIVIDENDS		(6	)		(9	)		(12	)		(21	)

LOSS ON CONVERSION/EXCHANGE OF PREFERRED STOCK		—			(42	)		—			(42	)

NET INCOME (LOSS) AVAILABLE TO COMMON SHAREHOLDERS	$	237		$	(1,643	)	$	(5,510	)	$	(1,785	)


EARNINGS (LOSS) PER COMMON SHARE:
Basic	$	0.39		$	(3.16	)	$	(9.18	)	$	(3.52	)
Assuming dilution	$	0.39		$	(3.16	)	$	(9.18	)	$	(3.52	)

CASH DIVIDEND DECLARED PER COMMON SHARE	$	0.075		$	0.075		$	0.15		$	0.1425

WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING (in millions):
Basic		603			521			600			507
Assuming dilution		610			521			600			507

The accompanying notes are an integral part of these condensed consolidated financial statements.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS

(Unaudited)


	Six Months Ended June 30,
	2009			2008
				(Adjusted)
	($ in millions)
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME (LOSS)	$	(5,498	)	$	(1,722	)
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO CASH PROVIDED BY OPERATING ACTIVITIES:
Depreciation, depletion and amortization		857			1,119
Deferred income taxes		(3,299	)		(1,081	)
Impairments		9,792			—
Unrealized (gains) losses on derivatives		29			4,538
Realized (gains) losses on financing derivatives		(35	)		32
Stock-based compensation		68			61
Interest expense on contingent convertible notes		40			33
Restructuring costs		29			—
Loss from equity investments		8			—
Loss on exchanges of Chesapeake debt		2			—
Other		12			20
Change in assets and liabilities		(7	)		(202	)

Cash provided by operating activities		1,998			2,798


CASH FLOWS FROM INVESTING ACTIVITIES:
Exploration and development of natural gas and oil properties		(2,092	)		(2,935	)
Acquisitions of natural gas and oil companies, proved and unproved properties and leasehold, net of cash acquired		(412	)		(2,815	)
Interest capitalized on unproved properties		(314	)		(244	)
Proceeds from sale of volumetric production payments		41			616
Divestitures of proved and unproved properties and leasehold		187			247
Additions to other property and equipment		(980	)		(1,229	)
Proceeds from (additions to) investments		2			(81	)
Proceeds from sale of drilling rigs and equipment		—			34
Proceeds from sale of compressors		68			51
Deposits made for acquisitions		(9	)		(19	)
Deposits received for divestitures		8			—
Proceeds from sale of other assets		36			2

Cash used in investing activities		(3,465	)		(6,373	)


CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from credit facility borrowings		3,363			6,758
Payments on credit facility borrowings		(4,166	)		(6,195	)
Proceeds from issuance of senior notes, net of offering costs		1,346			2,136
Proceeds from issuance of common stock, net of offering costs		—			1,011
Cash paid for common stock dividends		(89	)		(66	)
Cash paid for preferred stock dividends		(12	)		(22	)
Derivative settlements		9			(93	)
Net increase (decrease) in outstanding payments in excess of cash balance		(350	)		47
Proceeds from mortgage of building		54			—
Proceeds from sale/leaseback of surface land		145			—
Excess tax benefit from stock-based compensation		—			21
Other		(28	)		(23	)

Cash provided by financing activities		272			3,574

Net decrease in cash and cash equivalents		(1,195	)		(1	)
Cash and cash equivalents, beginning of period		1,749			1

Cash and cash equivalents, end of period	$	554		$	—

The accompanying notes are an integral part of these condensed consolidated financial statements.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS – (Continued)

(Unaudited)


	Six Months Ended June 30,
	2009		2008
			(Adjusted)
	($ in millions)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION OF CASH PAYMENTS FOR:
Interest, net of $314 million and $244 million of capitalized interest, respectively	$	2	$	96
Income taxes, net of refunds received	$	176	$	5

SUPPLEMENTAL SCHEDULE OF NON-CASH INVESTING AND FINANCING ACTIVITIES:

As of June 30, 2009 and 2008, dividends payable on our common and preferred stock were $51 million and $48 million, respectively.

For the six months ended June 30, 2009 and 2008, natural gas and oil properties were adjusted by a nominal amount and $12 million, respectively, for net income tax liabilities related to acquisitions.

For the six months ended June 30, 2009 and 2008, natural gas and oil properties were adjusted by ($65) million and $33 million, respectively, as a result of an increase (decrease) in accrued exploration and development costs.

For the six months ended June 30, 2009 and 2008, other property and equipment were adjusted by ($12) million and $17 million, respectively, as a result of an increase (decrease) in accrued costs.

We recorded non-cash asset additions (reductions) to natural gas and oil properties of ($2) million and $6 million for the six months ended June 30, 2009 and 2008, respectively, for asset retirement obligations.

On March 31, 2009, we converted all of our outstanding 4.125% Cumulative Convertible Preferred Stock (3,033 shares) into 182,887 shares of common stock.

On June 15, 2009, we converted all of our outstanding 6.25% Mandatory Convertible Preferred Stock (143,768 shares) into 1,239,538 shares of common stock.

In June 2009, we privately exchanged approximately $85 million in aggregate principal amount of our 2.25% Contingent Convertible Senior Notes due 2038 for an aggregate of 2,530,650 shares of our common stock.

For the six months ended June 30, 2009, we issued 15,823,838 shares of common stock, valued at $269 million, for the purchase of proved and unproved properties and leasehold pursuant to an acquisition shelf registration statement.

For the six months ended June 30, 2008, holders of our 5.0% (Series 2005B) Cumulative Convertible Preferred Stock exchanged 2,718,500 shares for 7,780,703 shares of common stock in privately negotiated exchanges.

The accompanying notes are an integral part of these condensed consolidated financial statements.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited)


	Six Months Ended June 30,
	2009			2008
				(Adjusted)
	($ in millions)
PREFERRED STOCK:
Balance, beginning of period	$	505		$	960
Exchange of common stock for 143,768 and 0 shares of 6.25% preferred stock		(36	)		—
Exchange of common stock for 3,033 and 0 shares of 4.125% preferred stock		(3	)		—
Exchange of common stock for 0 and 2,718,500 shares of 5.00% preferred stock (series 2005B)		—			(272	)

Balance, end of period		466			688


COMMON STOCK:
Balance, beginning of period		6			5
Issuance of 15,823,838 and 0 shares of common stock for the purchase of proved and unproved properties and leasehold		—			—
Issuance of 0 and 23,000,000 shares of common stock		—			—
Exchange of 2,530,650 and 0 shares of common stock for convertible notes		—			—
Exchange of 1,422,425 and 7,780,883 shares of common stock for preferred stock		—			—

Balance, end of period		6			5


PAID-IN CAPITAL:
Balance, beginning of period		11,680			7,532
Issuance of 15,823,838 shares and 0 shares of common stock for the purchase of proved and unproved properties and leasehold		254			—
Issuance of 0 and 23,000,000 shares of common stock		—			1,052
Issuance of 2.25% contingent convertible senior notes due 2038		—			345
Exchange of 2,530,650 and 0 shares of common stock for convertible notes		54			—
Exchange of 1,422,425 and 7,780,883 shares of common stock for preferred stock		39			272
Stock-based compensation		119			82
Exercise of stock options		1			7
Offering expenses		—			(53	)
Dividends on common stock		(91	)		—
Dividends on preferred stock		(12	)		—
Tax benefit (reduction in tax benefit) from exercise of stock options and restricted stock		(12	)		21

Balance, end of period		12,032			9,258


RETAINED EARNINGS (DEFICIT):
Balance, beginning of period		4,569			4,145
Net income (loss)		(5,498	)		(1,722	)
Dividends on common stock		—			(73	)
Dividends on preferred stock		—			(10	)

Balance, end of period		(929	)		2,340


ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS):
Balance, beginning of period		267			(11	)
Hedging activity		110			(1,191	)
Investment activity		61			28

Balance, end of period		438			(1,174	)


TREASURY STOCK – COMMON:
Balance, beginning of period		(10	)		(6	)
Purchase of 64,242 and 0 shares for company benefit plans		(1	)		—
Release of 2,718 and 1,098 shares for company benefit plans		—			—

Balance, end of period		(11	)		(6	)


TOTAL STOCKHOLDERS’ EQUITY	$	12,002		$	11,111

The accompanying notes are an integral part of these condensed consolidated financial statements.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME (LOSS)

(Unaudited)


	Three Months Ended June 30,						Six Months Ended June 30,
	2009			2008			2009			2008
				(Adjusted)						(Adjusted)
	($ in millions)

Net income (loss)	$	243		$	(1,592	)	$	(5,498	)	$	(1,722	)
Other comprehensive income (loss), net of income tax:
Change in fair value of derivative instruments, net of income taxes of $37 million, ($530) million, $333 million and ($833) million		63			(865	)		547			(1,357	)
Reclassification of (gain) loss on settled contracts, net of income taxes of ($120) million, $103 million, ($232) million, and $52 million		(197	)		167			(381	)		85
Ineffective portion of derivatives qualifying for cash flow hedge accounting, net of income taxes of ($13) million, $24 million, ($34) million and $49 million		(22	)		39			(56	)		80
Unrealized (gain) loss on investments, net of income taxes of $7 million, $16 million, $11 million and $17 million		12			27			18			28
Reclassification of loss on investments, net of income taxes of $0, $0, $26 million and $0		—			—			43			—

Comprehensive income (loss)	$	99		$	(2,224	)	$	(5,327	)	$	(2,886	)

The accompanying notes are an integral part of these condensed consolidated financial statements.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

(Unaudited)

1.	Basis of Presentation and Summary of Significant Accounting Policies

Principles of Consolidation

The accompanying unaudited condensed consolidated financial statements of Chesapeake Energy Corporation and its subsidiaries have been prepared in accordance with the instructions to Form 10-Q as prescribed by the Securities and Exchange Commission (SEC). Chesapeake’s annual report on Form 10-K for the year ended December 31, 2008 (“2008 Form 10-K”) includes certain definitions and a summary of significant accounting policies and should be read in conjunction with this Form 10-Q. The accompanying consolidated financial statements should be read in conjunction with the consolidated financial statements and the notes thereto for the year ended December 31, 2008 contained in our Current Report on Form 8-K dated June 25, 2009. All material adjustments (consisting solely of normal recurring adjustments) which, in the opinion of management, are necessary for a fair statement of the results for the interim periods have been reflected. The results for the three and six months ended June 30, 2009 are not necessarily indicative of the results to be expected for the full year. This Form 10-Q relates to the three and six months ended June 30, 2009 (the “Current Quarter” and the “Current Period”, respectively) and the three and six months ended June 30, 2008 (the “Prior Quarter” and the “Prior Period”, respectively). Any material subsequent events have been considered for disclosure through August 10, 2009, the filing date of this Form 10-Q.

Change in Accounting Principle

On January 1, 2009, we adopted and applied retrospectively Financial Accounting Standards Board (FASB) Staff Position No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion. As a result, our prior year condensed consolidated financial statements have been retrospectively adjusted. See Note 6 for additional information on the application of this accounting principle.

Oil and Natural Gas Properties – Ceiling Test

We review the carrying value of our natural gas and oil properties under the full-cost accounting rules of the SEC on a quarterly basis. This quarterly review is referred to as a ceiling test. Under the ceiling test, capitalized costs, less accumulated amortization and related deferred income taxes, may not exceed an amount equal to the sum of the present value of estimated future net revenues (including the impact of cash flow hedges) less estimated future expenditures to be incurred in developing and producing the proved reserves, less any related income tax effects. Any excess of the net book value, less deferred income taxes, is written off as an expense. As of June 30, 2009, the present value of our proved reserves was $11.076 billion which exceeded our net capitalized cost and no impairment was necessary.

In calculating future net revenues, prices and costs used are those as of the end of the appropriate quarterly period except where different prices are fixed and determinable from applicable contracts for the remaining term of those contracts, including the effects of derivatives qualifying as cash flow hedges. Our qualifying cash flow hedges as of June 30, 2009, which consisted of swaps and collars, covered 253 bcfe, 74 bcfe and 11 bcfe in 2009, 2010 and 2011, respectively. Our natural gas and oil hedging activities are discussed in Note 2 of these condensed consolidated financial statements. Based on spot prices for natural gas and oil of $3.89 per mcf and $70.00 per barrel, respectively, as of June 30, 2009, these cash flow hedges increased the full-cost ceiling by $1.219 billion, thereby reducing any potential ceiling test write-down by the same amount. Had the effects of our cash flow hedges not been considered in calculating the ceiling limitation, the impairment as of June 30, 2009 would have been approximately $115 million, net of tax.

Critical Accounting Policies

We consider accounting policies related to hedging, natural gas and oil properties, income taxes and business combinations to be critical policies. These policies are summarized in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2008 Form 10-K.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

2.	Financial Instruments and Hedging Activities

Natural Gas and Oil Derivatives

Our results of operations and operating cash flows are impacted by changes in market prices for natural gas and oil. To mitigate a portion of the exposure to adverse market changes, we have entered into various derivative instruments. These instruments allow us to predict with greater certainty the effective natural gas and oil prices to be received for our hedged production. Although derivatives often fail to achieve 100% effectiveness for accounting purposes, we believe our derivative instruments continue to be highly effective in achieving the risk management objectives for which they were intended. As of June 30, 2009, our natural gas and oil derivative instruments were comprised of the following:

•

For swap instruments, Chesapeake receives a fixed price for the hedged commodity and pays a floating market price to the counterparty.

•

Collars contain a fixed floor price (put) and ceiling price (call). If the market price exceeds the call strike price or falls below the put strike price, Chesapeake receives the fixed price and pays the market price. If the market price is between the call and the put strike price, no payments are due from either party. On occasion, we sell an additional put option with the collar and receive a premium to make a three-way collar. This eliminates the counterparty’s downside exposure below the second put option.

•

For knockout swaps, Chesapeake receives a fixed price and pays a floating market price. The fixed price received by Chesapeake includes a premium in exchange for the possibility to reduce the counterparty’s exposure to zero, in any given month, if the floating market price is lower than certain pre-determined knockout prices.

•

For cap-swaps, Chesapeake receives a fixed price and pays a floating market price. The fixed price received by Chesapeake includes a premium in exchange for a “cap” limiting the counterparty’s exposure. In other words, there is no limit to Chesapeake’s exposure but there is a limit to the downside exposure of the counterparty.

•

For call options, Chesapeake receives a premium from the counterparty in exchange for the sale of a call option. If the market price exceeds the fixed price of the call option, Chesapeake pays the counterparty such excess. If the market price settles below the fixed price of the call option, no payment is due from Chesapeake.

•

For put options, Chesapeake receives a premium from the counterparty in exchange for the sale of a put option. If the market price falls below the fixed price of the put option, Chesapeake pays the counterparty such shortfall. If the market price settles above the fixed price of the put option, no payment is due from Chesapeake.

•

Basis protection swaps are arrangements that guarantee a price differential to NYMEX for natural gas or oil from a specified delivery point. For non-Appalachian Basin basis protection swaps, which typically have negative differentials to NYMEX, Chesapeake receives a payment from the counterparty if the price differential is greater than the stated terms of the contract and pays the counterparty if the price differential is less than the stated terms of the contract. For Appalachian Basin basis protection swaps, which typically have positive differentials to NYMEX, Chesapeake receives a payment from the counterparty if the price differential is less than the stated terms of the contract and pays the counterparty if the price differential is greater than the stated terms of the contract.

All of our derivative instruments are net settled based on the difference between the fixed-price payment and the floating-price payment, resulting in a net amount due to or from the counterparty.

Chesapeake enters into counter-swaps from time to time for the purpose of locking-in the value of a swap. Under the counter-swap, Chesapeake receives a floating price for the hedged commodity and pays a fixed price to the counterparty. The counter-swap is 100% effective in locking-in the value of a swap since subsequent changes in the market value of the swap are entirely offset by subsequent changes in the market value of the counter-swap. We refer to this locked-in value as a locked swap. Generally, at the time Chesapeake enters into a counter-swap, Chesapeake removes the original swap’s designation as a cash flow hedge and classifies the original swap as a non-qualifying hedge under SFAS 133. The reason for this new designation is that collectively the swap and the counter-swap no longer hedge the exposure to variability in expected future cash flows. Instead, the swap and counter-swap effectively lock-in a specific gain or loss that will be unaffected by subsequent variability in natural

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

gas and oil prices. Any locked-in gain or loss is recorded in accumulated other comprehensive income and reclassified to natural gas and oil sales in the month of related production.

Gains or losses from certain derivative transactions are reflected as adjustments to natural gas and oil sales on the condensed consolidated statements of operations. Realized gains (losses) are included in natural gas and oil sales in the month of related production. Pursuant to SFAS 133, certain derivatives do not qualify for designation as cash flow hedges. Changes in the fair value of these non-qualifying derivatives that occur prior to their maturity (i.e., temporary fluctuations in value) are reported currently in the condensed consolidated statements of operations as unrealized gains (losses) within natural gas and oil sales. Following provisions of SFAS 133, changes in the fair value of derivative instruments designated as cash flow hedges, to the extent they are effective in offsetting cash flows attributable to the hedged risk, are recorded in accumulated other comprehensive income until the hedged item is recognized in earnings. Any change in fair value resulting from ineffectiveness is currently recognized in natural gas and oil sales as unrealized gains (losses). The components of natural gas and oil sales for the Current Quarter, the Prior Quarter, the Current Period and the Prior Period are presented below.


	Three Months Ended June 30,						Six Months Ended June 30,

	2009			2008			2009			2008
	($ in millions)
Natural gas and oil sales	$	717		$	2,233		$	1,495		$	3,925
Realized gains (losses) on natural gas and oil derivatives		597			(423	)		1,115			(208	)
Unrealized gains (losses) on non-qualifying natural gas and oil derivatives		(253	)		(3,340	)		(206	)		(4,409	)
Unrealized gains (losses) on ineffectiveness of cash flow hedges		36			(64	)		90			(129	)

Total natural gas and oil sales	$	1,097		$	(1,594	)	$	2,494		$	(821	)

The estimated fair values of our natural gas and oil derivative instruments as of June 30, 2009 and December 31, 2008 are provided below. The associated carrying values of these instruments are equal to the estimated fair values.


	June 30, 2009			December 31, 2008
	($ in millions)
Derivative assets (liabilities)^(a):
Fixed-price natural gas swaps	$	733		$	863
Fixed-price natural gas collars		492			402
Fixed-price natural gas knockout swaps		47			141
Natural gas call options		(157	)		(178	)
Natural gas put options		(59	)		(39	)
Natural gas basis protection swaps		(54	)		93
Fixed-price oil swaps		1			31
Fixed-price oil knockout swaps		66			19
Fixed-price oil cap-swaps		—			3
Oil call options		(71	)		(35	)
Fixed-price oil collars		—			5

Estimated fair value	$	998		$	1,305

(a)	After adjusting for $488 million and $736 million of unrealized premiums, the value to be realized for these derivatives as of June 30, 2009 and December 31, 2008 was $1.486 billion and $2.041 billion, respectively.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

The volume hedged under natural gas and oil derivative instruments as of June 30, 2009 and December 31, 2008 is summarized below.


	June 30, 2009		December 31, 2008
Natural Gas and Oil Volume Hedged:
Natural Gas (bbtu)

Fixed-price natural gas swaps	354,291		466,800
Fixed-price natural gas collars	260,110		457,715
Fixed-price natural gas knockout swaps	98,670		532,660
Natural gas call options	595,525		551,555
Natural gas put options	91,400		73,000
Natural gas basis protection swaps	210,822		219,487

Total natural gas volume	1,610,818		2,301,217

Oil (mbbls)

Fixed-price oil swaps	(460	)	(310	)
Fixed-price oil knockout swaps	9,148		12,248
Fixed-price oil cap-swaps	—		362
Oil call options	14,996		19,355
Fixed-price oil collars	—		730

Total oil volume	23,684		32,385

To mitigate our exposure to the fluctuation in prices of diesel fuel, we have entered into diesel swaps from July 2009 to March 2010 for a total of 29,025,000 gallons with an average fixed price of $1.58 per gallon. The fair value of these swaps as of June 30, 2009 was an asset of $10 million.

We have six secured hedging facilities, each of which permits us to enter into cash-settled natural gas and oil commodity transactions, valued by the counterparty, for up to a stated maximum value. Outstanding transactions under each facility are collateralized by certain of our natural gas and oil properties that do not secure any of our other obligations. The value of reserve collateral pledged to each facility is required to be at least 1.3 or 1.5 times the fair value of transactions outstanding under each facility. In addition, we may pledge collateral from our revolving bank credit facility, from time to time, to these facilities to meet any additional collateral coverage requirements. The hedging facilities are subject to a per annum exposure fee, which is assessed quarterly based on the average of the daily negative fair value amounts of the hedges, if any, during the quarter. The hedging facilities contain the standard representations and default provisions that are typical of such agreements. The agreements also contain various restrictive provisions which govern the aggregate natural gas and oil production volumes that we are permitted to hedge under all of our agreements at any one time. The fair value of outstanding transactions, per annum exposure fees and the scheduled maturity dates are shown below.


	Secured Hedging Facilities^(a)
	#1			#2			#3			#4			#5			#6
	($ in millions)
Fair value of outstanding transactions, as of June 30, 2009	$	130		$	370		$	22		$	(1	)	$	77		$	84
Per annum exposure fee		1	%		1	%		0.8	%		0.8	%		0.8	%		0.8	%
Scheduled maturity date		2010			2013			2020			2012			2012			2012

(a)	Chesapeake Exploration, L.L.C. is the named party to the facilities numbered 1 – 3 and Chesapeake Energy Corporation is the named party to the facilities numbered 4 – 6.

On June 11, 2009, we entered into a multi-counterparty secured hedging facility with 13 hedge counterparties, one of which is a new counterparty to the company. These 13 hedge counterparties have committed to provide approximately 3.9 tcfe of trading capacity under the terms of the facility. Each of the six counterparties to our existing secured hedging facilities is a party to this new facility. The facility allows us to enter into cash-settled natural gas and oil price and basis hedges with the hedge counterparties. Our obligations under the new facility will be secured by natural gas and oil proved reserves, the value of which must cover the fair value of the transactions outstanding under the facility by at least 1.65 times, and guarantees by our subsidiaries that also guarantee our revolving bank credit facility and indentures. The hedge counterparties’ obligations under the facility will be secured by cash or short-term U.S. Treasury instruments to the extent that any mark-to-market amounts they owe to Chesapeake exceed defined thresholds. The maximum volume-based trading capacity under the facility is governed by the expected production of the pledged reserve collateral and volume-based trading limits are applied separately to price and basis hedges. In addition, there are volume-based sub-limits for natural gas and oil hedges. Chesapeake has significant flexibility with regard to releases and/or substitutions of pledged reserves, provided that

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

certain collateral coverage and other requirements are met. The facility does not have a maturity date. Counterparties to the agreement have the right to cease trading with the company on a prospective basis as long as obligations associated with any existing trades in the facility continue to be satisfied in accordance with the terms of the agreement.

All existing trades with the hedge counterparties are expected to be novated into the multi-counterparty facility along with any collateral currently pledged under the existing secured hedge facilities. Trades novated into the multi-counterparty facility from the existing secured hedge facilities will continue to be subject to pre-existing exposure fees, if any, but we are not required to pay an exposure fee for any new trades in the multi-counterparty facility. The new multi-counterparty facility will consolidate and replace our six secured hedging facilities described above. As of July 31, 2009, no trades had been transacted or novated or collateral pledged under the multi-counterparty facility.

Interest Rate Derivatives

We use interest rate derivatives to mitigate our exposure to volatility in interest rates related to our senior notes and credit facility. For interest rate derivative instruments designated as fair value hedges (in accordance with SFAS 133), changes in fair value are recorded on the condensed consolidated balance sheets as assets (liabilities), and the debt’s carrying value amount is adjusted by the change in the fair value of the debt subsequent to the initiation of the derivative. Changes in the fair value of non-qualifying derivatives that occur prior to their maturity (i.e., temporary fluctuations in value) are reported currently in the condensed consolidated statements of operations as unrealized gains (losses) within interest expense.

Gains or losses from certain derivative transactions are reflected as adjustments to interest expense on the condensed consolidated statements of operations. Realized gains (losses) included in interest expense were $5 million, $4 million, $12 million and $4 million in the Current Quarter, the Prior Quarter, the Current Period and the Prior Period, respectively. Unrealized gains (losses) included in interest expense were $42 million, $14 million, $87 million and $1 million in the Current Quarter, the Prior Quarter, the Current Period and the Prior Period, respectively.

As of June 30, 2009, the following interest rate derivatives were outstanding:


	Notional Amount ($ in millions)		Weighted Average Fixed Rate	Weighted Average Floating Rate^(b)	Fair Value Hedge	Net Premiums ($ in millions)			Fair Value ($ in millions)
Fixed to Floating Interest Rate:
Swaps
April 2009 – December 2018	$	1,750	7.78%	1 –6 mL plus 492 bp	Yes	$	—		$	(62	)
April 2008 – November 2020	$	1,000	8.09%	1 –6 mL plus 485 bp	No	$	(1	)	$	(16	)
Call Options
August 2009 – November 2009	$	500	6.69%	1 –6 mL plus 263 bp	No	$	—		$	(14	)

Floating to Fixed Interest Rate:
Swaps
August 2007 – July 2012	$	1,375	4.20%	1 - 6 mL	No	$	—		$	(32	)
Collars^(a)
August 2007 – August 2010	$	250	4.52%	6 mL	No	$	—		$	(9	)
Swaption
August 2009	$	500	2.56%	1 mL	No	$	4		$	(11	)

						$	3		$	(144	)

(a)	The collars have ceiling and floor fixed interest rates of 5.37% and 4.52%, respectively.

(b)	Month LIBOR has been abbreviated “mL” and basis points has been abbreviated “bp”.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

In the Current Period, we closed interest rate derivatives for gains totaling $30 million, of which $18 million was recognized in interest expense. The remaining $12 million was from interest rate derivatives designated as fair value hedges and the settlement amounts received will be amortized as a reduction to interest expense over the remaining term of the related senior notes ranging from four to eleven years.

Foreign Currency Derivatives

On December 6, 2006, we issued €600 million of 6.25% Euro-denominated Senior Notes due 2017. Concurrent with the issuance of the euro-denominated senior notes, we entered into a cross currency swap to mitigate our exposure to fluctuations in the euro relative to the dollar over the term of the notes. Under the terms of the cross currency swap, on each semi-annual interest payment date, the counterparties pay Chesapeake €19 million and Chesapeake pays the counterparties $30 million, which yields an annual dollar-equivalent interest rate of 7.491%. Upon maturity of the notes, the counterparties will pay Chesapeake €600 million and Chesapeake will pay the counterparties $800 million. The terms of the cross currency swap were based on the dollar/euro exchange rate on the issuance date of $1.3325 to €1.00. Through the cross currency swap, we have eliminated any potential variability in Chesapeake’s expected cash flows related to changes in foreign exchange rates and therefore the swap qualifies as a cash flow hedge under SFAS 133. The fair value of the cross currency swap is recorded on the condensed consolidated balance sheet as an asset of $7 million at June 30, 2009. The euro-denominated debt in notes payable has been adjusted to $841 million at June 30, 2009 using an exchange rate of $1.4020 to €1.00 with an offsetting entry to other comprehensive income of $34 million related to future interest expense.

Disclosures About Derivative Instruments and Hedging Activities

In accordance with FASB Interpretation No. 39, to the extent that a legal right of set-off exists, Chesapeake nets the value of its derivative arrangements with the same counterparty in the accompanying condensed consolidated balance sheets. Pursuant to SFAS 161, the following table sets forth the fair value of each classification of derivative instrument as of June 30, 2009 on a gross basis:


	June 30, 2009

	Balance Sheet Location	Fair Value
		($ in millions)
ASSET DERIVATIVES:
Derivatives designated as hedging instruments under SFAS 133:
Foreign exchange contracts	Long-term derivative instruments	$	7
Commodity contracts	Short-term derivative instruments		797
Commodity contracts	Long-term derivative instruments		84

Total			888


Derivatives not designated as hedging instruments under SFAS 133:
Interest rate contracts	Long-term derivative instruments		5
Commodity contracts	Short-term derivative instruments		454
Commodity contracts	Long-term derivative instruments		82

Total			541


LIABILITY DERIVATIVES:
Derivatives designated as hedging instruments under SFAS 133:
Interest rate contracts	Long-term derivative instruments		62
Commodity contracts	Short-term derivative instruments		3

Total			65


Derivatives not designated as hedging instruments under SFAS 133:
Interest rate contracts	Short-term derivative instruments		26
Interest rate contracts	Long-term derivative instruments		61
Commodity contracts	Short-term derivative instruments		117
Commodity contracts	Long-term derivative instruments		289

Total			493


Total derivative instruments		$	871

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

A consolidated summary of the effect of derivative instruments on the condensed consolidated statement of operations for the three and six months ended June 30, 2009 is provided below, separating fair value, cash flow and non-qualifying hedges (as defined by SFAS 133).

The following table presents the gain (loss) recognized in net income (loss) for instruments designated as fair value hedges:


		Three Months Ended June 30, 2009		Six Months Ended June 30, 2009
Fair Value Derivatives	Location of Gain (Loss)	($ in millions)
Interest rate contracts	Interest expense^(a)	$	10	$	18

(a)	Interest expense on the hedged items for the Current Quarter and the Current Period was $20 million and $33 million, respectively, which is included in interest expense on the condensed consolidated statement of operations.

The following table presents the pre-tax gain (loss) recognized in, and reclassified from, accumulated other comprehensive income (AOCI) and recognized in net income (loss), including any hedge ineffectiveness, for derivative instruments classified as cash flow hedges ($ in millions):


Cash Flow Derivatives	Gain (Loss) Recognized in AOCI (Effective Portion)		Location of Gain (Loss) Reclassified from AOCI (Effective Portion)	Gain (Loss) Reclassified from AOCI (Effective Portion)		Location of Gain (Loss) Recognized (Ineffective Portion)	Gain (Loss) Recognized (Ineffective Portion) ^(a)

Three Months Ended June 30, 2009
Commodity contracts	$	30	Natural gas and oil sales	$	317	Natural gas and oil sales	$	36
Foreign exchange contracts		35	Other income		—	Other income		—

Total	$	65		$	317		$	36


Six Months Ended June 30, 2009
Commodity contracts	$	712	Natural gas and oil sales	$	613	Natural gas and oil sales	$	90
Foreign exchange contracts		78	Other income		—	Other income		—

Total	$	790		$	613		$	90

(a)	The amount of gain (loss) recognized in net income (loss) represents the ineffective portion of all our cash flow derivatives.

Based upon the market prices at June 30, 2009, we expect to transfer approximately $461 million (net of income taxes) of the gain included in the balance in accumulated other comprehensive income to net income (loss) during the next 12 months in the related month of production. All transactions hedged as of June 30, 2009 are expected to mature by December 31, 2022.

The following table presents the gain (loss) recognized in net income (loss) for derivatives not designated under SFAS 133:


		Three Months Ended June 30, 2009		Six Months Ended June 30, 2009
Non-SFAS 133 Derivatives	Location of Gain (Loss)	($ in millions)
Commodity contracts	Natural gas and oil sales	$	27	$	296
Interest rate contracts	Interest expense		37		81

	Total	$	64	$	377

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Concentration of Credit Risk

A significant portion of our liquidity is concentrated in derivative instruments that enable us to hedge a portion of our exposure to natural gas and oil price and interest rate volatility. These arrangements expose us to credit risk from our counterparties. To mitigate this risk, we enter into derivative contracts only with investment-grade rated counterparties deemed by management to be competent and competitive market makers, and we attempt to limit our exposure to non-performance by any single counterparty. On June 30, 2009, our commodity and interest rate derivative instruments were spread among 14 counterparties. Additionally, our multi-counterparty secured hedging facility described above requires our counterparties to secure their natural gas and oil hedging obligations in excess of defined thresholds. We expect to use the facility for all of our commodity hedging.

Other financial instruments which potentially subject us to concentrations of credit risk consist principally of investments in equity instruments and accounts receivable. Our accounts receivable are primarily from purchasers of natural gas and oil and exploration and production companies which own interests in properties we operate. This industry concentration has the potential to impact our overall exposure to credit risk, either positively or negatively, in that our customers may be similarly affected by changes in economic, industry or other conditions. We monitor the creditworthiness of all our counterparties. We generally require letters of credit for receivables from customers which are judged to have sub-standard credit, unless the credit risk can otherwise be mitigated. During the Current Quarter and the Current Period, we recognized $5 million and $13 million, respectively, of bad debt expense related to potentially uncollectible receivables.

3.	Contingencies and Commitments

Litigation

On February 25, 2009, a putative class action was filed in the U.S. District Court for the Southern District of New York against the company and certain of its officers and directors along with certain underwriters of the company’s July 2008 common stock offering. The complaint alleges that the registration statement for the offering contained material misstatements and omissions and seeks damages under Sections 11, 12 and 15 of the Securities Act of 1933 of an unspecified amount and rescission. A derivative action was also filed in the District Court of Oklahoma County, Oklahoma on March 10, 2009 against the company’s directors and certain of its officers alleging breaches of fiduciary duties relating to the disclosure matters alleged in the securities case.

On March 26, 2009, a shareholder filed a petition in the District Court of Oklahoma County, Oklahoma seeking to compel inspection of company books and records relating to compensation of the company’s CEO. Chesapeake opposed the petition and a hearing is scheduled for August 20, 2009.

Three derivative actions were filed in the District Court of Oklahoma County, Oklahoma on April 28, May 7, and May 20, 2009 against the company’s directors alleging breaches of fiduciary duties relating to compensation of the company’s CEO and alleged insider trading, among other things, and seeking unspecified damages, equitable relief and disgorgement. These three derivative actions were consolidated and a Consolidated Derivative Shareholder Petition was filed on June 23, 2009. Chesapeake is named as a nominal defendant.

It is inherently difficult to predict the outcome of litigation, and we are currently unable to estimate the amount of any potential liabilities associated with the foregoing cases, which are all in preliminary stages.

Chesapeake is also involved in various other lawsuits and disputes incidental to its business operations, including commercial disputes, personal injury claims, claims for underpayment of royalties, property damage claims and contract actions. With regard to the latter, several mineral or leasehold owners have filed lawsuits against us seeking specific performance to require us to acquire their oil and natural gas interests and pay acreage bonus payments, damages based on breach of contract and/or, in certain cases, punitive damages based on alleged fraud. The company has satisfactorily resolved several of the suits but some remain pending. The remaining leasehold acquisition cases are in various stages of discovery. The company believes that it has substantial defenses to the claims made in all these cases.

The company records an associated liability when a loss is probable and the amount is reasonably estimable. Although the outcome of litigation cannot be predicted with certainty, management is of the opinion that no pending or threatened lawsuit or dispute incidental to its business operations is likely to have a material adverse effect on the

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

company’s consolidated financial position, results of operations or cash flows. The final resolution of such matters could exceed amounts accrued, however, and actual results could differ materially from management’s estimates.

Employment Agreements with Officers

Chesapeake has employment agreements with its chief executive officer, chief operating officer, chief financial officer and other executive officers, which provide for annual base salaries, various benefits and eligibility for bonus compensation. The agreement with the chief executive officer expires on December 31, 2013 unless extended. The agreement contains a cap on cash salary and bonus compensation for the next five years at 2008 levels. The term of the agreement is automatically extended for one additional year on each December 31 unless the company provides 30 days notice of non-extension. In the event of termination of employment without cause, the chief executive officer’s base compensation (defined as base salary plus bonus compensation received during the preceding 12 months) and benefits would continue during the remaining term of the agreement. The chief executive officer is entitled to receive a payment in the amount of three times his base compensation upon the happening of certain events following a change of control. The agreement further provides that any stock-based awards held by the chief executive officer and deferred compensation will immediately become 100% vested upon termination of employment without cause, incapacity, death or retirement at or after age 55. The agreement also provides for a one-time $75 million well cost incentive award with a five-year clawback. The well cost incentive award was fully applied against Mr. McClendon’s obligations under the Founder Well Participation Program as of March 31, 2009. The agreements with the chief operating officer, chief financial officer and other executive officers expire on September 30, 2009. These agreements provide for the continuation of salary for one year in the event of termination of employment without cause or death and, in the event of a change of control, a payment in the amount of two times the executive officer’s base compensation. These executive officers are entitled to continue to receive compensation and benefits for 180 days following termination of employment as a result of incapacity. Any stock-based awards held by such executive officers will immediately become 100% vested upon termination of employment without cause, a change of control, death or retirement at or after age 55.

Environmental Risk

Due to the nature of the natural gas and oil business, Chesapeake and its subsidiaries are exposed to possible environmental risks. Chesapeake has implemented various policies and procedures to avoid environmental contamination and risks from environmental contamination. Chesapeake conducts periodic reviews, on a company-wide basis, to identify changes in our environmental risk profile. These reviews evaluate whether there is a contingent liability, its amount, and the likelihood that the liability will be incurred. The amount of any potential liability is determined by considering, among other matters, incremental direct costs of any likely remediation and the proportionate cost of employees who are expected to devote a significant amount of time directly to any possible remediation effort. We manage our exposure to environmental liabilities on properties to be acquired by identifying existing problems and assessing the potential liability. Depending on the extent of an identified environmental problem, Chesapeake may exclude a property from the acquisition, require the seller to remediate the property to our satisfaction, or agree to assume liability for the remediation of the property. Chesapeake has historically not experienced any significant environmental liability, and is not aware of any potential material environmental issues or claims at June 30, 2009.

Rig Leases

In a series of transactions in 2006, 2007 and 2008, our drilling subsidiaries sold 83 drilling rigs and related equipment for $677 million and entered into a master lease agreement under which we agreed to lease the rigs from the buyer for initial terms of seven to ten years for lease payments of approximately $95 million annually. The lease obligations are guaranteed by Chesapeake and its other material restricted subsidiaries. These transactions were recorded as sales and operating leasebacks and any related gain or loss is being amortized to service operations expense over the lease term. Under the rig leases, we can exercise an early purchase option after six or seven years or on the expiration of the lease term for a purchase price equal to the then fair market value of the rigs. Additionally, we have the option to renew the rig lease for a negotiated renewal term at a periodic lease payment equal to the fair market rental value of the rigs as determined at the time of renewal. Commitments related to rig lease payments are not recorded in the accompanying condensed consolidated balance sheets. As of June 30, 2009, the minimum aggregate future rig lease payments were approximately $574 million. As of June 30, 2009, Chesapeake’s drilling subsidiaries had committed to acquire seven rigs by the end of 2009 and had incurred costs of $47 million as of that date. The total remaining cost of the rigs is estimated to be approximately $52 million. Our intent is to sell and lease back those rigs as they are delivered if acceptable leasing arrangements are available to us.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Compressor Leases

In a series of transactions in 2007, 2008 and 2009, our compression subsidiary sold a significant portion of its compressor fleet, consisting of 1,685 compressors, for $372 million and entered into a master lease agreement. The term of the agreement varies by buyer ranging from seven to ten years for aggregate lease payments of approximately $46 million annually. The lease obligations are guaranteed by Chesapeake and its other material restricted subsidiaries. These transactions were recorded as sales and operating leasebacks and any related gain or loss is being amortized to natural gas and oil marketing expenses over the lease term. Under the leases, we can exercise an early purchase option after five to nine years or we can purchase the compressors at expiration of the lease for the fair market value at the time. In addition, we have the option to renew the lease for negotiated new terms at the expiration of the lease. Commitments related to compressor lease payments are not recorded in the accompanying condensed consolidated balance sheets. As of June 30, 2009, the minimum aggregate future compressor lease payments were approximately $362 million. As of June 30, 2009, 339 new compressors were on order for approximately $129 million and our intent is to sell and lease back those compressors as they are delivered if acceptable leasing arrangements are available to us.

Surface Land Leases

In the Current Quarter, we sold 113 surface land sites in the Barnett Shale area in and around Fort Worth, Texas for approximately $145 million and entered into a 40-year master lease agreement under which we agreed to lease the sites for approximately $15 million to $27 million annually. These lease transactions were recorded as a financing lease and the cash received was recorded with an offsetting long-term liability on the condensed consolidated balance sheet. As of June 30, 2009, the minimum aggregate future surface land site payments were approximately $866 million. Chesapeake has the option to repurchase up to a specified number of sites at any time during the term of the lease.

Transportation Contracts

Chesapeake has various firm pipeline transportation service agreements with expiration dates ranging from 2009 to 2099. These commitments are not recorded in the accompanying condensed consolidated balance sheets. Under the terms of these contracts, we are obligated to pay demand charges as set forth in the transporter’s Federal Energy Regulatory Commission (FERC) gas tariff. In exchange, the company receives rights to flow natural gas production through pipelines located in highly competitive markets. The aggregate amounts of such required demand payments as of June 30, 2009, excluding demand charges for pipeline projects that are currently seeking regulatory approval, were as follows ($ in millions):


2009	$	110
2010		224
2011		196
2012		185
2013		168
After 2013		891

Total	$	1,774

Drilling Contracts

Currently, Chesapeake has contracts with various drilling contractors to lease approximately 22 rigs with terms of one to three years. These commitments are not recorded in the accompanying condensed consolidated balance sheets. As of June 30, 2009, the aggregate drilling rig commitment was approximately $200 million.

Natural Gas and Oil Purchase Obligations

Our midstream segment regularly commits to purchase natural gas from other owners in our properties and such commitments typically are short term in nature. We have also committed to purchasers of our volumetric production payment transactions (VPPs) that we will purchase natural gas and oil associated with the VPPs. Our VPP purchase commitments are based on market prices at the time of production and extend over 11 to 15 year terms. As of June 30, 2009, we were obligated to purchase 420 bcfe under the terms of the VPPs. We resell the natural gas and oil we purchase at market prices.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Other Commitments

We own a 49% interest in Mountain Drilling Company, a company that specializes in hydraulic drilling rigs which are designed for drilling in urban areas. Due to a meaningful decline in the overall activity in the drilling market and poor operating performance of Mountain Drilling Company, we determined that an impairment had occurred and we fully impaired our investment at March 31, 2009. Chesapeake has an agreement to lend Mountain Drilling Company up to $19 million through December 31, 2009. At June 30, 2009, Mountain Drilling owed Chesapeake $19 million under this agreement.

We invested in Ventura Refining and Transmission LLC in early 2007 in an effort to improve the market for our oil and condensate production in western Oklahoma. Due to worsening economic conditions, the lack of third party credit available to Ventura and poor operating performance in the second half of 2008, management determined that an impairment had occurred and we wrote off our investment at December 31, 2008. During the Current Period, we paid an additional $13 million to fund various costs associated with Ventura’s operations. These payments were expensed as incurred.

4.	Net Income Per Share

Statement of Financial Accounting Standards No. 128, Earnings Per Share, requires presentation of “basic” and “diluted” earnings per share, as defined, on the face of the statements of operations for all entities with complex capital structures. SFAS 128 requires a reconciliation of the numerator and denominator of the basic and diluted EPS computations. The following securities were not included in the calculation of diluted earnings per share, as the effect was antidilutive:


	Shares	Net Income Adjustments
	(in millions)	($ in millions)
Three Months Ended June 30, 2009:
Common stock equivalent of our preferred stock outstanding:
5.00% (series 2005B) cumulative convertible preferred stock	5	$	3
4.50% cumulative convertible preferred stock	6	$	3

A reconciliation for the Current Quarter is as follows:


	Income (Numerator)		Shares (Denominator)	Per Share Amount
	(in millions, except per share data)
Three Months Ended June 30, 2009:
Basic EPS:
Income available to common shareholders	$	237	603	$	0.39

Effect of Dilutive Securities
Assumed conversion as of the beginning of the period of preferred shares outstanding during the period:
Common shares assumed issued for 5.00% (Series 2005) cumulative convertible preferred stock		—	—
Assumed conversion as of the beginning of the period of preferred shares outstanding prior to conversion:
Common stock equivalent of preferred stock outstanding prior to conversion of 6.25% mandatory convertible preferred stock		—	1
Employee stock options		—	1
Restricted stock		—	5


Diluted EPS income available to common shareholders and assumed conversions	$	237	610	$	0.39

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

For the Current Period, Prior Quarter and Prior Period, there was no difference between basic weighted average shares outstanding, which are used in computing basic EPS, and diluted weighted average shares, which are used in computing EPS assuming dilution. As a result, diluted shares do not include the effect of the following:


	Shares	Net Income Adjustments
	(in millions)	($ in millions)
Six Months Ended June 30, 2009:
Employee stock options	1	$	—
Restricted stock	4	$	—
Common stock equivalent of our preferred stock outstanding:
5.00% (series 2005) cumulative convertible preferred stock	—	$	—
5.00% (series 2005B) cumulative convertible preferred stock	5	$	5
4.50% cumulative convertible preferred stock	6	$	6
Common stock equivalent of our preferred stock outstanding prior to conversion:
4.125% cumulative convertible preferred stock	—	$	—
6.25% mandatory convertible preferred stock	1	$	1

Three Months Ended June 30, 2008:
Employee stock options	2	$	—
Restricted stock	8	$	—
2.75% contingent convertible senior notes due 2035	3	$	3
Common stock equivalent of our preferred stock outstanding:
4.125% cumulative convertible preferred stock	—	$	—
5.00% (series 2005) cumulative convertible preferred stock	—	$	—
5.00% (series 2005B) cumulative convertible preferred stock	8	$	4
4.50% cumulative convertible preferred stock	8	$	4
6.25% mandatory convertible preferred stock	1	$	1
Common stock equivalent of our preferred stock outstanding prior to conversion:
5.00% (series 2005B) cumulative convertible preferred stock	3	$	43
4.125% cumulative convertible preferred stock	—	$	—

Six Months Ended June 30, 2008:
Employee stock options	2	$	—
Restricted stock	7	$	—
2.75% contingent convertible senior notes due 2035	3	$	3
Common stock equivalent of our preferred stock outstanding:
4.125% cumulative convertible preferred stock	—	$	—
5.00% (series 2005) cumulative convertible preferred stock	—	$	—
5.00% (series 2005B) cumulative convertible preferred stock	8	$	8
4.50% cumulative convertible preferred stock	8	$	8
6.25% mandatory convertible preferred stock	1	$	1
Common stock equivalent of our preferred stock outstanding prior to conversion:
5.00% (series 2005B) cumulative convertible preferred stock	5	$	47
4.125% cumulative convertible preferred stock	—	$	—

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

5.	Stockholders’ Equity, Restricted Stock and Stock Options

Common Stock

The following is a summary of the changes in our common shares issued for the six months ended June 30, 2009 and 2008:


	2009	2008
	(in thousands)
Shares issued at January 1	607,953	511,648
Stock option exercises	157	1,213
Restricted stock issuances (net of forfeitures)	2,365	2,136
Convertible note exchanges	2,531	—
Preferred stock conversions/exchanges	1,422	7,781
Common stock issued for the purchase of proved and unproved properties and leasehold	15,824	—
Common stock issuance	—	23,000

Shares issued at June 30	630,252	545,778

In the Current Period, we issued 15,823,838 shares of common stock, valued at $269 million, for the purchase of proved and unproved properties and leasehold pursuant to an acquisition shelf registration statement.

Preferred Shares

The following is a summary of the changes in our preferred shares outstanding for the six months ended June 30, 2009 and 2008:


	4.125%		5.00% (2005)	4.50%	5.00% (2005B)		6.25%
	(in thousands)
Shares outstanding at January 1, 2009	3		5	2,559	2,096		144
Conversion/exchange of preferred for common stock	(3	)	—	—	—		(144	)

Shares outstanding at June 30, 2009	—		5	2,559	2,096		—


Shares outstanding at January 1, 2008	3		5	3,450	5,750		144
Conversion/exchange of preferred for common stock	—		—	—	(2,718	)	—

Shares outstanding at June 30, 2008	3		5	3,450	3,032		144

On March 31, 2009, we converted all of our outstanding 4.125% Cumulative Convertible Preferred Stock (3,033 shares) into 182,887 shares of common stock pursuant to the company’s mandatory conversion rights.

On June 15, 2009, we converted all of our outstanding 6.25% Mandatory Convertible Preferred Stock (143,768 shares) into 1,239,538 shares of common stock pursuant to the company’s mandatory conversion rights.

Dividends

Dividends declared on our common stock and preferred stock are reflected as adjustments to retained earnings to the extent a surplus of retained earnings will exist after giving effect to the dividends. To the extent retained earnings are insufficient to fund the distributions, such payments constitute a return of contributed capital rather than earnings and are accounted for as a reduction to paid-in capital.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Stock-Based Compensation

Chesapeake’s stock-based compensation programs consist of restricted stock and stock options issued to employees and non-employee directors. To the extent compensation cost relates to employees directly involved in natural gas and oil exploration and development activities, such amounts are capitalized to natural gas and oil properties. Amounts not capitalized are recognized as general and administrative expenses, production expenses, natural gas and oil marketing expenses or service operations expense. We recorded the following stock-based compensation during the Current Quarter, the Prior Quarter, the Current Period and the Prior Period:


	Three Months Ended June 30,				Six Months Ended June 30,
	2009		2008		2009		2008
	($ in millions)
Natural gas and oil properties	$	29	$	26	$	58	$	51
General and administrative expenses		19		21		39		40
Production expenses		9		7		17		14
Natural gas and oil marketing expenses		4		2		8		4
Service operations expense		2		1		4		3

Total	$	63	$	57	$	126	$	112

Restricted Stock. Chesapeake regularly issues shares of restricted common stock to employees and to non-employee directors. The fair value of the awards issued is determined based on the fair market value of the shares on the date of grant. This value is amortized over the vesting period, which is generally four or five years from the date of grant for employees and three years for non-employee directors.

A summary of the changes in unvested shares of restricted stock during the Current Period is presented below:


	Number of Unvested Restricted Shares		Weighted-Average Grant-Date Fair Value
	(in thousands)
Unvested shares as of January 1, 2009	21,622		$	38.85
Granted	4,039		$	17.47
Vested	(2,751	)	$	32.85
Forfeited	(708	)	$	35.75

Unvested shares as of June 30, 2009	22,202		$	35.80

The aggregate intrinsic value of restricted stock vested during the Current Period was approximately $50 million based on the stock price at the time of vesting.

As of June 30, 2009, there was $565 million of total unrecognized compensation cost related to unvested restricted stock. The cost is expected to be recognized over a weighted average period of 2.44 years.

The vesting of certain restricted stock grants results in state and federal income tax benefits related to the difference between the market price of the common stock at the date of vesting and the date of grant. During the Current Quarter and the Current Period we recognized a reduction in tax benefits related to restricted stock of $5 million and $13 million, respectively. During the Prior Quarter and the Prior Period we recognized excess tax benefits related to restricted stock of $3 million and $9 million, respectively. The reduction in tax benefits and the excess tax benefits were recorded as adjustments to additional paid-in capital and deferred income taxes.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Stock Options. Prior to 2006, we granted stock options under several stock compensation plans. Outstanding options expire ten years from the date of grant and all are currently fully vested.

The following table provides information related to stock option activity during the Current Period:


	Number of Shares Underlying Options		Weighted Average Exercise Price Per Share		Weighted Average Contract Life in Years	Aggregate Intrinsic Value^(a) ($ in millions)
	(in thousands)
Outstanding at January 1, 2009	2,802		$	8.13	3.59	$	23
Exercised	(157	)	$	7.68		$	2
Expired	—		$	—

Outstanding at June 30, 2009	2,645		$	8.15	3.10	$	31


Exercisable at June 30, 2009	2,645		$	8.15	3.10	$	31

(a)	The intrinsic value of a stock option is the amount by which the current market value or the market value upon exercise of the underlying stock exceeds the exercise price of the option.

During the Current Quarter, the Prior Quarter, the Current Period and the Prior Period, we recognized excess tax benefits related to stock options of a nominal amount, $7 million, a nominal amount and $12 million, respectively, which were recorded as adjustments to additional paid-in capital and deferred income taxes.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

6.	Senior Notes and Revolving Bank Credit Facilities

Our total debt consisted of the following:


	June 30, 2009			December 31, 2008
				(Adjusted)
	($ in millions)
7.5% Senior Notes due 2013	$	364		$	364
7.625% Senior Notes due 2013		500			500
7.0% Senior Notes due 2014		300			300
7.5% Senior Notes due 2014		300			300
6.375% Senior Notes due 2015		600			600
9.5% Senior Notes due 2015		1,425			—
6.625% Senior Notes due 2016		600			600
6.875% Senior Notes due 2016		670			670
6.25% Euro-denominated Senior Notes due 2017^(a)		841			835
6.5% Senior Notes due 2017		1,100			1,100
6.25% Senior Notes due 2018		600			600
7.25% Senior Notes due 2018		800			800
6.875% Senior Notes due 2020		500			500
2.75% Contingent Convertible Senior Notes due 2035^(b)		451			451
2.5% Contingent Convertible Senior Notes due 2037^(b)		1,378			1,378
2.25% Contingent Convertible Senior Notes due 2038^(b)		1,041			1,126
Revolving bank credit facility		2,834			3,474
Midstream revolving bank credit facility		297			460
Discount on senior notes^(c)		(1,072	)		(1,094	)
Interest rate derivatives^(d)		39			211

Total notes payable and long-term debt	$	13,568		$	13,175

(a)	The principal amount shown is based on the dollar/euro exchange rate of $1.4020 to €1.00 and $1.3919 to €1.00 as of June 30, 2009 and December 31, 2008, respectively. See Note 2 for information on our related cross currency swap.

(b)

The holders of our contingent convertible senior notes may require us to repurchase, in cash, all or a portion of their notes at 100% of the principal amount of the notes on any of four dates that are five, ten, fifteen and twenty years before the maturity date. The notes are convertible, at the holder’s option, prior to maturity under certain circumstances into cash and, if applicable, shares of our common stock using a net share settlement process. One such triggering circumstance is when the price of our common stock exceeds a threshold amount during a specified period in a fiscal quarter. Convertibility based on common stock price is measured quarter by quarter. In the second quarter of 2009, the price of our common stock was below the threshold level for each series of the contingent convertible senior notes during the specified period and, as a result, the holders do not have the option to convert their notes into cash and common stock in the third quarter of 2009 under this provision. The notes are also convertible, at the holder’s option, during specified five-day periods if the trading price of the notes is below certain levels determined by reference to the trading price of our common stock. In general, upon conversion of a contingent convertible senior note, the holder will receive cash equal to the principal amount of the note and common stock for the note’s conversion value in excess of such principal amount. We will pay contingent interest on the convertible senior notes after they have been outstanding at least ten years, under certain conditions. We may redeem the convertible senior notes once they have been outstanding for ten years at a redemption price of 100% of the principal amount of the notes, payable in cash. The optional repurchase dates, the common stock price conversion threshold amounts and the ending date of the first six-month period contingent interest may be payable for the contingent convertible senior notes are as follows:


Contingent Convertible Senior Notes	Repurchase Dates	Common Stock Price Conversion Thresholds		Contingent Interest First Payable (if applicable)
2.75% due 2035	November 15, 2015, 2020, 2025, 2030	$	48.81	May 14, 2016
2.5% due 2037	May 15, 2017, 2022, 2027, 2032	$	64.36	November 14, 2017
2.25% due 2038	December 15, 2018, 2023, 2028, 2033	$	107.36	June 14, 2019

(c)

Discount at December 31, 2008 is adjusted for the retrospective application of FSP APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion. Discount at June 30, 2009 and December 31, 2008 included $936 million and $1.009 billion, respectively, associated with the equity component of our contingent convertible senior notes.

(d)	See Note 2 for discussion related to these instruments.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

No scheduled principal payments are required under our senior notes until 2013 when $864 million is due.

Our outstanding senior notes are unsecured senior obligations of Chesapeake that rank equally in right of payment with all of our existing and future senior indebtedness and rank senior in right of payment to all of our future subordinated indebtedness. We may redeem the senior notes, other than the contingent convertible senior notes, at any time at specified make-whole or redemption prices. Senior notes issued before July 2005 are governed by indentures containing covenants that limit our ability and our restricted subsidiaries’ ability to incur additional indebtedness; pay dividends on our capital stock or redeem, repurchase or retire our capital stock or subordinated indebtedness; make investments and other restricted payments; incur liens; enter into sale/leaseback transactions; create restrictions on the payment of dividends or other amounts to us from our restricted subsidiaries; engage in transactions with affiliates; sell assets; and consolidate, merge or transfer assets. Senior notes issued after June 2005 are governed by indentures containing covenants that limit our ability and our subsidiaries’ ability to incur certain secured indebtedness; enter into sale/leaseback transactions; and consolidate, merge or transfer assets.

Chesapeake Energy Corporation is a holding company and owns no operating assets and has no significant operations independent of its subsidiaries. As of September 30, 2008, our obligations under our outstanding senior notes and contingent convertible notes were fully and unconditionally guaranteed, jointly and severally, by all of our wholly-owned restricted subsidiaries, other than minor subsidiaries, on a senior unsecured basis. In October 2008, we restructured our non-Appalachian midstream operations. As a result, beginning in the fourth quarter of 2008, our wholly-owned midstream subsidiaries having significant assets and operations do not guarantee our outstanding senior notes.

On January 1, 2009, we adopted and applied retrospectively FASB Staff Position No. APB 14-1, Accounting for Convertible Debt Instruments That May Be Settled in Cash upon Conversion (Including Partial Cash Settlement) (FSP APB 14-1). We have three debt issuances affected by this change: our 2.75% Contingent Convertible Senior Notes due 2035, our 2.5% Contingent Convertible Senior Notes due 2037 and our 2.25% Contingent Convertible Senior Notes due 2038. FSP APB 14-1 requires us to account for the liability and equity components of our convertible debt instruments separately and to reflect interest expense at the interest rate of similar nonconvertible debt at the time of issuance (6.86%, 8.0% and 8.0%, respectively). Additionally, debt issuance costs are required to be allocated in proportion to the liability and equity components and accounted for as debt issuance costs and equity issuance costs, respectively. The allocation to the equity component of the convertible notes was $845 million (net of tax) at December 31, 2008. The accretion of the resulting discount on the debt is recognized as a part of interest expense, thereby increasing the amount of interest expense required to be recognized with respect to such instruments. Given the increase in our overall effective interest rate after adoption of FSP APB 14-1, we also capitalized additional interest which largely offset the increase in interest expense.

The following table summarizes the effect of the change in accounting principle related to our contingent convertible notes on the condensed consolidated balance sheet:


	December 31, 2008
	Previously Reported		Adjustment			Adjusted
	($ in millions)

Unevaluated properties	$	11,216	$	163		$	11,379
Other long-term assets	$	1,007	$	(14	)	$	993

Long-term debt, net	$	14,184	$	(1,009	)	$	13,175
Deferred income tax liability	$	3,763	$	437		$	4,200
Paid-in-capital	$	10,835	$	845		$	11,680
Retained earnings	$	4,694	$	(125	)	$	4,569

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

The following table summarizes the effect of the change in accounting principle related to our contingent convertible notes on the condensed consolidated statement of operations ($ in millions, except per share data):


	Previously Reported			Adjustment			Adjusted
Three Months Ended June 30, 2008:
Depreciation and amortization of other assets	$	40		$	—		$	40
Interest expense	$	63		$	(9	)	$	54
Income tax expense (benefit)	$	(1,000	)	$	4		$	(996	)
Net income (loss)	$	(1,597	)	$	5		$	(1,592	)

Weighted average common and common equivalent shares outstanding – assuming dilution (in millions)		521			—			521

Earnings (loss) per common share:
Basic	$	(3.17	)	$	0.01		$	(3.16	)
Diluted	$	(3.17	)	$	0.01		$	(3.16	)

	Previously Reported			Adjustment			Adjusted
Six Months Ended June 30, 2008:
Depreciation and amortization of other assets	$	77		$	(1	)	$	76
Interest expense	$	163		$	(10	)	$	153
Income tax expense (benefit)	$	(1,082	)	$	4		$	(1,078	)
Net income (loss)	$	(1,729	)	$	7		$	(1,722	)

Weighted average common and common equivalent shares outstanding – assuming dilution (in millions)		507			—			507

Earnings (loss) per common share:
Basic	$	(3.54	)	$	0.02		$	(3.52	)
Diluted	$	(3.54	)	$	0.02		$	(3.52	)

The following table summarizes the effect of the change in accounting principle related to our contingent convertible notes on the condensed consolidated statement of cash flows for the six months ended June 30, 2008 ($ in millions):

	Previously Reported			Adjustment			Adjusted
Six Months Ended June 30, 2008:
Cash flows provided by operating activities	$	2,754		$	44		$	2,798
Cash flows used in investing activities	$	(6,329	)	$	(44	)	$	(6,373	)
Cash flows provided by financing activities	$	3,574		$	—		$	3,574

We have a $3.5 billion syndicated revolving bank credit facility which matures in November 2012. As of June 30, 2009, we had $2.834 billion in outstanding borrowings under this facility and utilized approximately $10 million of the facility for various letters of credit.

Borrowings under the facility are secured by certain producing natural gas and oil properties and bear interest at our option at either (i) the greater of the reference rate of Union Bank, N.A. or the federal funds effective rate plus 0.50%, both of which are subject to a margin that varies from 0.00% to 0.75% per annum according to our senior unsecured long-term debt ratings, or (ii) the London Interbank Offered Rate (LIBOR), plus a margin that varies from 1.50% to 2.25% per annum according to our senior unsecured long-term debt ratings. The collateral value and borrowing base are determined periodically. The unused portion of the facility is subject to a commitment fee of 0.50%. Interest is payable quarterly or, if LIBOR applies, it may be payable at more frequent intervals.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

The credit facility agreement contains various covenants and restrictive provisions which limit our ability to incur additional indebtedness, make investments or loans and create liens. The credit facility agreement requires us to maintain an indebtedness to total capitalization ratio (as defined) not to exceed 0.70 to 1 and an indebtedness to EBITDA ratio (as defined) not to exceed 3.75 to 1. As defined by the credit facility agreement, our indebtedness to total capitalization ratio was 0.43 to 1 and our indebtedness to EBITDA ratio was 3.47 to 1 at June 30, 2009. If we should fail to perform our obligations under these and other covenants, the revolving credit commitment could be terminated and any outstanding borrowings under the facility could be declared immediately due and payable. Such acceleration, if involving a principal amount of $10 million ($50 million in the case of our senior notes issued after 2004), would constitute an event of default under our senior note indentures, which could in turn result in the acceleration of a significant portion of our senior note indebtedness. The credit facility agreement also has cross default provisions that apply to other indebtedness of Chesapeake and its restricted subsidiaries with an outstanding principal amount in excess of $75 million.

Two of our subsidiaries, Chesapeake Exploration, L.L.C. and Chesapeake Appalachia, L.L.C., are the borrowers under our revolving bank credit facility. The facility is fully and unconditionally guaranteed, on a joint and several basis, by Chesapeake and all of our other wholly-owned restricted subsidiaries.

We also have a $460 million syndicated revolving bank credit facility for our midstream operations, organized under an unrestricted subsidiary, Chesapeake Midstream Partners, L.P. (CMP) and its operating subsidiary, Chesapeake Midstream Operating, L.L.C. (CMO). CMO is the borrower under the facility, which matures in October 2013 and may be expanded up to $750 million at CMO’s option, subject to additional bank participation. CMO is utilizing the facility to fund capital expenditures associated with building additional natural gas gathering and other systems associated with our drilling program and for general corporate purposes related to our midstream operations. As of June 30, 2009, we had $297 million in outstanding borrowings under the midstream credit facility.

Borrowings under the midstream credit facility are secured by all of the assets of the midstream companies organized under CMP and bear interest at our option at either (i) the greater of the reference rate of Wells Fargo Bank, National Association, the federal funds effective rate plus 0.50%, and the one-month LIBOR plus 1.50%, all of which would be subject to a margin that varies from 0.75% to 1.50% per annum according to the most recent indebtedness to EBITDA ratio (as defined) or (ii) the LIBOR plus a margin that varies from 1.75% to 2.50% per annum according to the most recent indebtedness to EBITDA ratio (as defined). The unused portion of the facility is subject to a commitment fee that varies from 0.30% to 0.45% per annum according the most recent indebtedness to EBITDA ratio (as defined). Interest is payable quarterly or, if LIBOR applies, it may be paid at more frequent intervals.

The midstream credit facility agreement contains various covenants and restrictive provisions which limit the ability of CMP and its subsidiaries to incur additional indebtedness, make investments or loans and create liens. The credit facility agreement requires maintenance of an indebtedness to EBITDA ratio (as defined) not to exceed 3.50 to 1, and an EBITDA (as defined) to interest expense coverage ratio of not less than 2.50 to 1. As defined by the credit facility agreement, our indebtedness to EBITDA ratio was 1.35 to 1 and our EBITDA to interest expense coverage ratio was 12.84 to 1 at June 30, 2009. If CMP or its subsidiaries should fail to perform their obligations under these and other covenants, the revolving credit commitment could be terminated and any outstanding borrowings under the midstream facility could be declared immediately due and payable. The midstream credit facility agreement also has cross default provisions that apply to other indebtedness CMP and its subsidiaries may have with an outstanding principal amount in excess of $15 million.

Our revolving bank credit facility and the midstream credit facility do not contain material adverse change or adequate assurance covenants. Although the applicable interest rates in our revolving bank credit facility fluctuate slightly based on our long-term senior unsecured credit ratings, neither of our credit facilities contains provisions which would trigger an acceleration of amounts due under the facilities or a requirement to post additional collateral in the event of a downgrade of our credit ratings.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

7.	Segment Information

In accordance with Statement of Financial Accounting Standards No. 131, Disclosures about Segments of an Enterprise and Related Information, we have two reportable operating segments. Our exploration and production operational segment and natural gas and oil midstream segment are managed separately because of the nature of their products and services. The exploration and production segment is responsible for finding and producing natural gas and oil. The midstream segment is responsible for gathering, processing, compressing, transporting and selling natural gas and oil primarily from Chesapeake-operated wells. We also have drilling rig and trucking operations which are responsible for providing drilling rigs primarily used on Chesapeake-operated wells and trucking services utilized in the transportation of drilling rigs on both Chesapeake-operated wells and wells operated by third parties.

Management evaluates the performance of our segments based upon income (loss) before income taxes. Revenues from the midstream segment’s sale of natural gas and oil related to Chesapeake’s ownership interests are reflected as exploration and production revenues. Such amounts totaled $622 million, $1.787 billion, $1.293 billion and $3.076 billion for the Current Quarter, the Prior Quarter, the Current Period and the Prior Period. The following table presents selected financial information for Chesapeake’s operating segments. Our drilling rig and trucking service operations are presented in “Other Operations”.


	Exploration and Production			Midstream			Other Operations			Intercompany Eliminations			Consolidated Total
	($ in millions)
Three Months Ended June 30, 2009:
Revenues	$	1,097		$	1,154		$	115		$	(693	)	$	1,673
Intersegment revenues		—			(622	)		(71	)		693			—

Total revenues	$	1,097		$	532		$	44		$	—		$	1,673


Income (loss) before income taxes	$	408		$	11		$	(14	)	$	(17	)	$	388


Three Months Ended June 30, 2008 (Adjusted):
Revenues	$	(1,594	)	$	2,886		$	154		$	(1,901	)	$	(455	)
Intersegment revenues		—			(1,787	)		(114	)		1,901			—

Total revenues	$	(1,594	)	$	1,099		$	40		$	—		$	(455	)


Income (loss) before income taxes	$	(2,605	)	$	15		$	27		$	(25	)	$	(2,588	)


Six Months Ended June 30, 2009:
Revenues	$	2,494		$	2,377		$	269		$	(1,472	)	$	3,668
Intersegment revenues		—			(1,293	)		(179	)		1,472			—

Total revenues	$	2,494		$	1,084		$	90		$	—		$	3,668


Income (loss) before income taxes	$	(8,785	)	$	29		$	(34	)	$	(6	)	$	(8,796	)


Six Months Ended June 30, 2008 (Adjusted):
Revenues	$	(821	)	$	4,971		$	303		$	(3,297	)	$	1,156
Intersegment revenues		—			(3,076	)		(221	)		3,297			—

Total revenues	$	(821	)	$	1,895		$	82		$	—		$	1,156


Income (loss) before income taxes	$	(2,831	)	$	30		$	47		$	(46	)	$	(2,800	)


As of June 30, 2009:
Total assets	$	26,258		$	6,052		$	800		$	(2,641	)	$	30,469

As of December 31, 2008 (Adjusted):
Total assets	$	35,192		$	3,416		$	688		$	(703	)	$	38,593

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

8.	Restructuring

In the Current Period, we reorganized our Charleston, West Virginia-based Eastern Division from a regional corporate headquarters to a regional field office consistent with the business model the company uses elsewhere in the country. As a result, we consolidated the management of our Eastern Division land, legal, accounting, information technology, geoscience and engineering departments into our corporate offices in Oklahoma City. The costs of the reorganization include termination benefits, consolidating or closing facilities and relocating employees. In addition, we had certain other workforce reductions that resulted in termination benefits. We expect all costs associated with our reorganization to be paid by year-end 2009.

A summary of Chesapeake’s restructuring charges is presented below ($ in millions):


	Restructuring Costs Through June 30, 2009		Restructuring Costs To Be Incurred		Total Restructuring Costs
Restructuring Costs:
Termination and relocation costs	$	6	$	16	$	22
Acceleration of restricted stock awards		9		—		9
Other associated costs		3		—		3

Total Restructuring Costs	$	18	$	16	$	34

9.	Investments

At June 30, 2009, investments accounted for under the equity method totaled $379 million and investments accounted for under the cost method totaled $15 million. Following is a summary of our investments:


			Carrying Value
	Approximate % Owned	Accounting Method	June 30, 2009		December 31, 2008
			($ in millions)
Frac Tech Services, Ltd.^(a)	20%	Equity	$	217	$	223
Chaparral Energy, Inc.^(b)(c)	32%	Equity		126		152
DHS Drilling Company^(b)	47%	Equity		—		19
Sierra Mid-Con, L.P.	50%	Equity		14		12
Gastar Exploration Ltd.^(b)	17%	Cost		14		11
Mountain Drilling Company^(b)	49%	Equity		—		9
Other	—	Cost/Equity		23		18

			$	394	$	444

(a)

The carrying value of our investment in Frac Tech is in excess of our underlying equity in net assets by approximately $155 million as of June 30, 2009. This excess amount is attributed to certain intangibles associated with the specialty services provided by Frac Tech and is being amortized over the estimated life of the intangibles.

(b)

Our investees have been impacted by the dramatic slowing of the worldwide economy and the tightening of the credit markets in the fourth quarter of 2008 and into 2009. The economic weakness has resulted in significantly reduced oil and natural gas prices leading to a meaningful decline in the overall level of activity in the markets served by our investees. Associated with the weakness in performance of certain of the investees, as well as an evaluation of their financial condition and near-term prospects, we recognized during the Current Period that an other than temporary impairment had occurred on March 31, 2009 on the following investments: Chaparral Energy of $51 million, DHS Drilling Company of $19 million, Gastar Exploration Ltd. of $70 million and Mountain Drilling Company of $9 million. We will continue to monitor the performance of our investments and it is reasonably possible that we may experience additional impairments, although we do not believe that our exposure to future charges would be material to our condensed consolidated results of operations.

(c)

The carrying value of our investment in Chaparral is in excess of our underlying equity in net assets by approximately $53 million as of June 30, 2009. This excess is attributed to the natural gas and oil reserves held by Chaparral and is being amortized over the estimated life of these reserves based on a unit of production rate.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

10.

Fair Value Measurements

Effective January 1, 2008, we adopted Statement of Financial Accounting Standards No. 157, Fair Value Measurements for our financial assets and liabilities measured on a recurring basis. Our nonfinancial assets and liabilities became subject to the statement effective January 1, 2009. This statement establishes a framework for measuring fair value of assets and liabilities and expands disclosures about fair value measurements.

SFAS 157 defines fair value as the amount that would be received from the sale of an asset or paid for the transfer of a liability in an orderly transaction between market participants, i.e., an exit price. To estimate an exit price, a three-level hierarchy is used. The fair value hierarchy prioritizes the inputs, which refer broadly to assumptions market participants would use in pricing an asset or a liability, into three levels. Level 1 inputs are unadjusted quoted prices in active markets for identical assets and liabilities and have the highest priority. Level 2 inputs are inputs other than quoted prices within Level 1 that are observable for the asset or liability, either directly or indirectly. Level 3 inputs are unobservable inputs for the financial asset or liability and have the lowest priority. Chesapeake uses appropriate valuation techniques based on available inputs, including counterparty quotes, to measure the fair values of its assets and liabilities. Counterparty quotes are generally assessed as a Level 3 input.

The following table provides fair value measurement information for financial assets (liabilities) measured at fair value on a recurring basis as of June 30, 2009:


	Quoted Prices in Active Markets (Level 1)			Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)			Total Fair Value
	($ in millions)
Financial Assets (Liabilities):
Cash equivalents	$	506		$	—	$	—		$	506
Derivatives, net	$	—		$	743	$	128		$	871
Investments	$	14		$	—	$	—		$	14
Other long-term assets	$	23		$	—	$	—		$	23
Long-term debt	$	—		$	—	$	(2,529	)	$	(2,529	)
Other long-term liabilities	$	(23	)	$	—	$	—		$	(23	)

The following methods and assumptions were used to estimate the fair values of the assets and liabilities in the table above.

Level 1 Fair Value Measurements

Cash Equivalents. The fair value of cash equivalents is based on quoted market prices.

Investments. The fair value of Chesapeake’s investment in Gastar Exploration Ltd. common stock is based on a quoted market price.

Other Long-Term Assets and Liabilities. The fair value of other long-term assets and liabilities, consisting of obligations under our Deferred Compensation Plan, is based on quoted market prices.

Level 2 Fair Value Measurements

Derivatives. The fair values of our natural gas, oil and diesel swaps are measured internally using established index prices and other sources. These values are based upon, among other things, futures prices and time to maturity. 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.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Level 3 Fair Value Measurements

Derivatives. The fair value of our derivative instruments, excluding natural gas and diesel swaps, have been established utilizing established index prices, volatility curves, discount factors and options pricing models. These estimates are compared to our counterparty values 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.

Debt. The fair value of certain of our long-term debt is based on the face amount of that debt along with the value of the related interest rate swaps. The interest rate swap values are based on estimates provided by our respective counterparties and reviewed internally for reasonableness using future interest rate curves and time to maturity.

A summary of the changes in Chesapeake’s assets (liabilities) classified as Level 3 measurements during the Current Period is presented below:


	Derivatives			Debt			Total
	($ in millions)
Balance of Level 3 as of January 1, 2009	$	292		$	(1,470	)	$	(1,178	)
Total gains (losses) (realized/unrealized):
Included in earnings^(a)		416			(59	)		357
Included in other comprehensive income (loss)		170			—			170
Purchases, issuances and settlements		(750	)		(1,000	)^(b)		(1,750	)
Transfers in and out of Level 3		—			—			—

Balance of Level 3 as of June 30, 2009	$	128		$	(2,529	)	$	(2,401	)


(a)		Natural Gas and Oil Sales			Interest Expense
		($ in millions)
	Total gains (losses) related to derivatives included in earnings for the period	$	311		$	105
	Change in unrealized gains (losses) relating to assets still held at reporting date	$	(148	)	$	92

(b)	Amount represents additional debt now recorded at fair value as a result of new interest rate swaps entered into in the Current Period.

Fair Value of Other Financial Instruments

The following disclosure of the estimated fair value of financial instruments is made in accordance with the requirements of Statement of Financial Accounting Standards No. 107, Disclosures About Fair Value of Financial Instruments. We have determined the estimated fair values by using available market information and valuation methodologies. Considerable judgment is required in interpreting market data to develop the estimates of fair value. The use of different market assumptions or valuation methodologies may have a material effect on the estimated fair value amounts.

The carrying values of financial instruments comprising current assets and current liabilities approximate fair values due to the short-term maturities of these instruments. We estimate the fair value of our long-term debt and our convertible preferred stock primarily using quoted market prices. Our carrying amounts for such debt, excluding the impact of interest rate derivatives, at June 30, 2009 and December 31, 2008 were $13.5 billion and $13.0 billion, respectively, compared to approximate fair values of $11.8 billion and $10.5 billion, respectively. The carrying amounts for our convertible preferred stock as of June 30, 2009 and December 31, 2008 were $466 million and $505 million, respectively, compared to approximate fair values of $319 million and $294 million, respectively.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

11.

Condensed Consolidating Financial Information

Chesapeake Energy Corporation is a holding company and owns no operating assets and has no significant operations independent of its subsidiaries. As of September 30, 2008, our obligations under our outstanding senior notes and contingent convertible notes listed in Note 6 were fully and unconditionally guaranteed, jointly and severally, by all of our wholly-owned subsidiaries, other than minor subsidiaries, on a senior unsecured basis. Since October 2008, following the restructuring of our non-Appalachian midstream operations, certain of our wholly-owned subsidiaries having significant assets and operations have not guaranteed our outstanding notes. The midstream revolving credit facility referred to in Note 6 contains a covenant restricting Chesapeake Midstream Partners, L.P., the parent of our midstream subsidiaries, from paying dividends or distributions or making loans to Chesapeake.

Set forth below are condensed consolidating financial statements for Chesapeake Energy Corporation (the “parent”) on a stand-alone, unconsolidated basis, and its combined guarantor and combined non-guarantor subsidiaries as of June 30, 2009 and December 31, 2008 and for the three and six months ended June 30, 2009 and 2008. The financial information may not necessarily be indicative of results of operations, cash flows or financial position had the subsidiaries operated as independent entities.

CONDENSED CONSOLIDATING BALANCE SHEET

AS OF JUNE 30, 2009

($ in millions)


	Parent			Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminations			Consolidated
CURRENT ASSETS:
Cash and cash equivalents	$	—		$	554	$	—	$	—		$	554
Other current assets		9			2,247		175		(37	)		2,394

Total Current Assets		9			2,801		175		(37	)		2,948

PROPERTY AND EQUIPMENT:
Total natural gas and oil properties, at cost based on full-cost accounting, net		—			21,147		5		—			21,152
Other property and equipment, net		—			2,717		2,867		—			5,584

Total Property and Equipment		—			23,864		2,872		—			26,736


Other assets		157			616		12		—			785
Investments in subsidiaries and intercompany advance		4,449			265		—		(4,714	)		—

TOTAL ASSETS	$	4,615		$	27,546	$	3,059	$	(4,751	)	$	30,469


CURRENT LIABILITIES:
Current liabilities	$	321		$	2,509	$	183	$	(39	)	$	2,974
Intercompany payable (receivable) from parent		(18,760	)		16,475		2,184		101			—

Total Current Liabilities		(18,439	)		18,984		2,367		62			2,974


Long-term debt, net		10,436			2,835		297		—			13,568
Deferred income tax liability		564			320		121		(99	)		906
Other liabilities		52			958		9		—			1,019

Total Long-Term Liabilities		11,052			4,113		427		(99	)		15,493


Total Stockholders’ Equity		12,002			4,449		265		(4,714	)		12,002

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	4,615		$	27,546	$	3,059	$	(4,751	)	$	30,469

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

CONDENSED CONSOLIDATING BALANCE SHEET

AS OF DECEMBER 31, 2008

(Adjusted)

($ in millions)


	Parent			Guarantor Subsidiaries		Non-Guarantor Subsidiaries		Eliminations			Consolidated
CURRENT ASSETS:
Cash and cash equivalents	$	—		$	1,749	$	—	$	—		$	1,749
Other current assets		13			2,392		169		(31	)		2,543

Total Current Assets		13			4,141		169		(31	)		4,292

PROPERTY AND EQUIPMENT:
Total natural gas and oil properties, at cost based on full-cost accounting, net		—			28,474		4		—			28,478
Other property and equipment, net		—			2,481		2,349		—			4,830

Total Property and Equipment		—			30,955		2,353		—			33,308


Other assets		140			838		15		—			993
Investments in subsidiaries and intercompany advance		8,452			143		—		(8,595	)		—

TOTAL ASSETS	$	8,605		$	36,077	$	2,537	$	(8,626	)	$	38,593


CURRENT LIABILITIES:
Current liabilities	$	257		$	3,324	$	131	$	(91	)	$	3,621
Intercompany payable (receivable) from parent		(18,274	)		16,636		1,578		60			—

Total Current Liabilities		(18,017	)		19,960		1,709		(31	)		3,621


Long-term debt, net		9,241			3,474		460		—			13,175
Deferred income tax liability		438			3,543		219		—			4,200
Other liabilities		(74	)		648		6		—			580

Total Long-Term Liabilities		9,605			7,665		685		—			17,955


Total Stockholders’ Equity		17,017			8,452		143		(8,595	)		17,017

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	8,605		$	36,077	$	2,537	$	(8,626	)	$	38,593

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

($ in millions)


	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Three Months Ended June 30, 2009:
REVENUES:
Natural gas and oil sales	$	—		$	1,097		$	—		$	—		$	1,097
Natural gas and oil marketing sales		—			467			118			(53	)		532
Service operations revenue		—			44			—			—			44

Total Revenues		—			1,608			118			(53	)		1,673

OPERATING COSTS:
Production expenses		—			213			—			—			213
Production taxes		—			24			—			—			24
General and administrative expenses		—			68			6			—			74
Natural gas and oil marketing expenses		—			450			46			4			500
Service operations expense		—			46			—			—			46
Natural gas and oil depreciation, depletion and amortization		—			295			—			—			295
Depreciation and amortization of other assets		—			36			22			—			58
Impairment of natural gas and oil properties and other assets		—			(4	)		9			—			5
Restructuring costs		—			34			—			—			34

Total Operating Costs		—			1,162			83			4			1,249

INCOME (LOSS) FROM OPERATIONS		—			446			35			(57	)		424

OTHER INCOME (EXPENSE):
Other income (expense)		175			(1	)		(1	)		(175	)		(2	)
Interest expense		(159	)		(36	)		(2	)		175			(22	)
Impairment of investments		—			(10	)		—			—			(10	)
Loss on exchanges of Chesapeake debt		(2	)		—			—			—			(2	)
Equity in net earnings of subsidiary		235			(16	)		—			(219	)		—

Total Other Income (Expense)		249			(63	)		(3	)		(219	)		(36	)

INCOME (LOSS) BEFORE INCOME TAXES		249			383			32			(276	)		388
INCOME TAX EXPENSE (BENEFIT)		6			150			12			(23	)		145

NET INCOME (LOSS)	$	243		$	233		$	20		$	(253	)	$	243

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

(Adjusted)

($ in millions)


	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries		Eliminations			Consolidated
Three Months Ended June 30, 2008:
REVENUES:
Natural gas and oil sales	$	—		$	(1,594	)	$	—	$	—		$	(1,594	)
Natural gas and oil marketing sales		—			1,058			78		(37	)		1,099
Service operations revenue		—			40			—		—			40

Total Revenues		—			(496	)		78		(37	)		(455	)

OPERATING COSTS:
Production expenses		—			219			—		—			219
Production taxes		—			88			—		—			88
General and administrative expenses		—			98			3		—			101
Natural gas and oil marketing expenses		—			1,046			33		(4	)		1,075
Service operations expense		—			32			—		—			32
Natural gas and oil depreciation, depletion and amortization		—			523			—		—			523
Depreciation and amortization of other assets		—			32			11		(3	)		40

Total Operating Costs		—			2,038			47		(7	)		2,078

INCOME (LOSS) FROM OPERATIONS		—			(2,534	)		31		(30	)		(2,533	)

OTHER INCOME (EXPENSE):
Other income (expense)		175			(1	)		—		(175	)		(1	)
Interest expense		(167	)		(62	)		—		175			(54	)
Equity in net earnings of subsidiary		(1,597	)		1			—		1,596			—

Total Other Income (Expense)		(1,589	)		(62	)		—		1,596			(55	)

INCOME (LOSS) BEFORE INCOME TAXES		(1,589	)		(2,596	)		31		1,566			(2,588	)
INCOME TAX EXPENSE (BENEFIT)		3			(1,000	)		12		(11	)		(996	)

NET INCOME (LOSS)	$	(1,592	)	$	(1,596	)	$	19	$	1,577		$	(1,592	)

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

($ in millions)


	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
Six Months Ended June 30, 2009:
REVENUES:
Natural gas and oil sales	$	—		$	2,494		$	—		$	—		$	2,494
Natural gas and oil marketing sales		—			956			228			(100	)		1,084
Service operations revenue		—			90			—			—			90

Total Revenues		—			3,540			228			(100	)		3,668

OPERATING COSTS:
Production expenses		—			452			(1	)		—			451
Production taxes		—			46			—			—			46
General and administrative expenses		—			153			11			—			164
Natural gas and oil marketing expenses		—			919			94			10			1,023
Service operations expense		—			87			—			—			87
Natural gas and oil depreciation, depletion and amortization		—			742			—			—			742
Depreciation and amortization of other assets		(1	)		74			41			1			115
Impairment of natural gas and oil properties and other assets		—			9,621			14			—			9,635
Restructuring costs		—			34			—			—			34

Total Operating Costs		(1	)		12,128			159			11			12,297

INCOME (LOSS) FROM OPERATIONS		1			(8,588	)		69			(111	)		(8,629	)

OTHER INCOME (EXPENSE):
Other income (expense)		337			3			2			(337	)		5
Interest expense		(286	)		(54	)		(5	)		337			(8	)
Impairment of investments		—			(162	)		—			—			(162	)
Gain (loss) on debt exchanges or repurchases		(2	)		—			—			—			(2	)
Equity in net earnings of subsidiary		(5,529	)		(28	)		—			5,557			—

Total Other Income (Expense)		(5,480	)		(241	)		(3	)		5,557			(167	)

INCOME (LOSS) BEFORE INCOME TAXES		(5,479	)		(8,829	)		66			5,446			(8,796	)
INCOME TAX EXPENSE (BENEFIT)		19			(3,300	)		25			(42	)		(3,298	)

NET INCOME (LOSS)	$	(5,498	)	$	(5,529	)	$	41		$	5,488		$	(5,498	)

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

(Adjusted)

($ in millions)


	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries		Eliminations			Consolidated
Six Months Ended June 30, 2008:
REVENUES:
Natural gas and oil sales	$	—		$	(821	)	$	—	$	—		$	(821	)
Natural gas and oil marketing sales		—			1,816			147		(68	)		1,895
Service operations revenue		—			82			—		—			82

Total Revenues		—			1,077			147		(68	)		1,156

OPERATING COSTS:
Production expenses		—			419			—		—			419
Production taxes		—			163			—		—			163
General and administrative expenses		—			174			6		—			180
Natural gas and oil marketing expenses		—			1,793			63		(7	)		1,849
Service operations expense		—			67			—		—			67
Natural gas and oil depreciation, depletion and amortization		—			1,038			—		—			1,038
Depreciation and amortization of other assets		1			62			19		(6	)		76

Total Operating Costs		1			3,716			88		(13	)		3,792

INCOME (LOSS) FROM OPERATIONS		(1	)		(2,639	)		59		(55	)		(2,636	)

OTHER INCOME (EXPENSE):
Other income (expense)		339			(11	)		—		(339	)		(11	)
Interest expense		(266	)		(226	)		—		339			(153	)
Equity in net earnings of subsidiary		(1,766	)		2			—		1,764			—

Total Other Income (Expense)		(1,693	)		(235	)		—		1,764			(164	)

INCOME (LOSS) BEFORE INCOME TAXES		(1,694	)		(2,874	)		59		1,709			(2,800	)
INCOME TAX EXPENSE (BENEFIT)		28			(1,106	)		23		(23	)		(1,078	)

NET INCOME (LOSS)	$	(1,722	)	$	(1,768	)	$	36	$	1,732		$	(1,722	)

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

CONDENSED CONSOLIDATING STATEMENTS OF CASH FLOWS

($ in millions)


	Parent		Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations		Consolidated
Six Months Ended June 30, 2009:
CASH FLOWS FROM OPERATING ACTIVITIES	$	—	$	1,854		$	144		$	—	$	1,998
CASH FLOWS FROM INVESTING ACTIVITIES:
Additions to natural gas and oil properties		—		(2,825	)		7			—		(2,818	)
Divestitures of proved and unproved natural gas and oil properties		—		228			—			—		228
Additions to other property and equipment		—		(793	)		(187	)		—		(980	)
Other investing activities		—		97			8			—		105

Cash used in investing activities		—		(3,293	)		(172	)		—		(3,465	)

CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from credit facility borrowings		—		2,825			538			—		3,363
Payments on credit facility borrowings		—		(3,466	)		(700	)		—		(4,166	)
Proceeds from issuance of senior notes, net of offering costs		1,346		—			—			—		1,346
Other financ

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