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, 2010

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

(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 [ ] 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 3, 2010, there were 654,329,768 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, 2010


PART I.
Financial Information
		Page
Item 1.	Condensed Consolidated Financial Statements (Unaudited):
	Condensed Consolidated Balance Sheets as of June 30, 2010 and December 31, 2009	1
	Condensed Consolidated Statements of Operations for the Three and Six Months Ended June 30, 2010 and 2009	3
	Condensed Consolidated Statements of Cash Flows for the Six Months Ended June 30, 2010 and 2009	4
	Condensed Consolidated Statements of Equity for the Six Months Ended June 30, 2010 and 2009	6
	Condensed Consolidated Statements of Comprehensive Income (Loss) for the Three and Six Months Ended June 30, 2010 and 2009	7
	Notes to Condensed Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	42
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	62
Item 4.	Controls and Procedures	69

PART II.
Other Information

Item 1.	Legal Proceedings	70
Item 1A.	Risk Factors	70
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	70
Item 3.	Defaults Upon Senior Securities	70
Item 4.	(Removed and Reserved)	70
Item 5.	Other Information	70
Item 6.	Exhibits	71

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)


	June 30, 2010			December 31, 2009
	($ in millions)
ASSETS
CURRENT ASSETS:
Cash and cash equivalents	$	601		$	307
Accounts receivable		1,359			1,325
Short-term derivative instruments		965			692
Deferred income tax asset		—			24
Other		93			98

Total Current Assets		3,018			2,446


PROPERTY AND EQUIPMENT:
Natural gas and oil properties, at cost based on full-cost accounting:
Evaluated natural gas and oil properties		36,576			35,007
Unevaluated properties		11,678			10,005
Less: accumulated depreciation, depletion and amortization of natural gas and oil properties		(24,858	)		(24,220	)

Total natural gas and oil properties, at cost based on full-cost accounting		23,396			20,792

Other property and equipment:
Natural gas gathering systems and treating plants		1,699			3,516
Buildings and land		1,711			1,673
Drilling rigs and equipment		752			687
Natural gas compressors		273			325
Other		607			550
Less: accumulated depreciation and amortization of other property and equipment		(608	)		(833	)

Total other property and equipment		4,434			5,918

Total Property and Equipment		27,830			26,710


OTHER ASSETS:
Investments		1,047			404
Long-term derivative instruments		10			60
Other assets		264			294

Total Other Assets		1,321			758


TOTAL ASSETS	$	32,169		$	29,914

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

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS – (Continued)

(Unaudited)


	June 30, 2010			December 31, 2009
	($ in millions)
LIABILITIES AND EQUITY
CURRENT LIABILITIES:
Accounts payable	$	1,564		$	957
Short-term derivative instruments		17			27
Accrued liabilities		970			920
Deferred income taxes		337			—
Income taxes payable		4			1
Revenues and royalties due others		575			565
Accrued interest		188			218

Total Current Liabilities		3,655			2,688


LONG-TERM LIABILITIES:
Long-term debt, net		10,501			12,295
Deferred income tax liabilities		1,546			1,059
Long-term derivative instruments		972			787
Asset retirement obligations		285			282
Revenues and royalties due others		82			73
Other liabilities		313			389

Total Long-Term Liabilities		13,699			14,885


CONTINGENCIES AND COMMITMENTS (Note 3)
EQUITY:
Chesapeake stockholders’ equity:
Preferred stock, $0.01 par value, 20,000,000 shares authorized:
5.75% cumulative convertible non-voting preferred stock, 1,500,000 and 0 shares issued and outstanding as of June 30, 2010 and December 31, 2009, respectively, entitled in liquidation to $1.5 billion and $0		1,500			—
5.75% cumulative convertible non-voting preferred stock (series A), 1,100,000 and 0 shares issued and outstanding as of June 30, 2010 and December 31, 2009, respectively, entitled in liquidation to $1.1 billion and $0		1,100			—
4.50% cumulative convertible preferred stock, 2,558,900 shares issued and outstanding as of June 30, 2010 and December 31, 2009, 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, 2010 and December 31, 2009, entitled in liquidation to $209 million		209			209
5.00% cumulative convertible preferred stock (series 2005), 0 and 5,000 shares issued and outstanding as of June 30, 2010 and December 31, 2009, entitled in liquidation to $0 and $1 million		—			1
Common stock, $0.01 par value, 1,000,000,000 shares authorized, 651,996,688 and 648,549,165 shares issued at June 30, 2010 and December 31, 2009, respectively		7			6
Paid-in capital		12,096			12,146
Retained earnings (deficit)		(410	)		(1,261	)
Accumulated other comprehensive income, net of tax of ($45) million and ($62) million, respectively		75			102
Less: treasury stock, at cost; 993,966 and 877,205 common shares as of June 30, 2010 and December 31, 2009, respectively		(18	)		(15	)

Total Chesapeake Stockholders’ Equity		14,815			11,444

Noncontrolling interest		—			897

Total Equity		14,815			12,341


TOTAL LIABILITIES AND EQUITY	$	32,169		$	29,914

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,
	2010			2009			2010			2009
	($ in millions, except per share data)
REVENUES:
Natural gas and oil sales	$	1,161		$	1,097		$	3,059		$	2,494
Marketing, gathering and compression sales		793			532			1,637			1,084
Service operations revenue		58			44			114			90

Total Revenues		2,012			1,673			4,810			3,668


OPERATING COSTS:
Production expenses		213			213			421			451
Production taxes		37			24			85			46
General and administrative expenses		106			74			215			164
Marketing, gathering and compression expenses		763			500			1,578			1,023
Service operations expense		53			46			102			87
Natural gas and oil depreciation, depletion and amortization		340			295			647			742
Depreciation and amortization of other assets		53			58			103			115
Impairment of natural gas and oil properties and other assets		—			5			—			9,635
Restructuring costs		—			34			—			34

Total Operating Costs		1,565			1,249			3,151			12,297

INCOME (LOSS) FROM OPERATIONS		447			424			1,659			(8,629	)


OTHER INCOME (EXPENSE):
Interest (expense) income		16			(22	)		(9	)		(8	)
Loss on redemptions or exchanges of Chesapeake debt		(69	)		(2	)		(71	)		(2	)
Impairment of investments		—			(10	)		—			(162	)
Other income (expense)		20			(2	)		35			5

Total Other Income (Expense)		(33	)		(36	)		(45	)		(167	)


INCOME (LOSS) BEFORE INCOME TAXES		414			388			1,614			(8,796	)


INCOME TAX EXPENSE (BENEFIT):
Current income taxes		5			1			5			1
Deferred income taxes		154			144			616			(3,299	)

Total Income Tax Expense (Benefit)		159			145			621			(3,298	)


NET INCOME (LOSS)		255			243			993			(5,498	)


Net (income) loss attributable to noncontrolling interest		—			—			—			—

NET INCOME (LOSS) ATTRIBUTABLE TO CHESAPEAKE		255			243			993			(5,498	)
Preferred stock dividends		(20	)		(6	)		(25	)		(12	)

NET INCOME (LOSS) AVAILABLE TO CHESAPEAKE COMMON STOCKHOLDERS	$	235		$	237		$	968		$	(5,510	)


EARNINGS (LOSS) PER COMMON SHARE:
Basic	$	0.37		$	0.39		$	1.54		$	(9.18	)
Diluted	$	0.37		$	0.39		$	1.49		$	(9.18	)

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

WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING (in millions):
Basic		631			603			630			600
Diluted		635			610			665			600

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,
	2010			2009
	($ in millions)
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME (LOSS) ATTRIBUTABLE TO CHESAPEAKE	$	993		$	(5,498	)
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO CASH PROVIDED BY OPERATING ACTIVITIES:
Depreciation, depletion and amortization		750			857
Deferred income tax expense (benefit)		616			(3,299	)
Unrealized losses on derivatives		5			29
Realized gains on financing derivatives		(271	)		(35	)
Stock-based compensation		67			68
Accretion of discount on contingent convertible notes		38			40
Loss on equity investments		35			8
Loss on redemptions or exchanges of Chesapeake debt		39			2
Impairment of natural gas and oil properties and other assets		—			9,630
Impairment of investments		—			162
Restructuring costs		—			29
Other		22			12
Change in assets and liabilities		684			(7	)

Cash provided by operating activities		2,978			1,998


CASH FLOWS FROM INVESTING ACTIVITIES:
Exploration and development of natural gas and oil properties		(2,331	)		(2,108	)
Acquisitions of natural gas and oil proved and unproved properties		(2,855	)		(710	)
Additions to other property and equipment		(679	)		(980	)
Proceeds from divestitures of proved and unproved properties		1,431			187
Proceeds from sales of volumetric production payments		502			41
Proceeds from sale of other assets		306			104
Proceeds from (additions to) investments		(109	)		2
Other		3			(1	)

Cash used in investing activities		(3,732	)		(3,465	)


CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from credit facilities borrowings		7,044			3,363
Payments on credit facilities borrowings		(7,415	)		(4,166	)
Proceeds from issuance of preferred stock, net of offering costs		2,562			—
Proceeds from issuance of senior notes, net of offering costs		—			1,346
Cash paid to redeem Chesapeake debt		(1,334	)		—
Cash paid for common stock dividends		(95	)		(89	)
Cash paid for preferred stock dividends		(11	)		(12	)
Realized gains on financing derivatives		271			9
Proceeds from sale/leaseback of real estate surface assets		—			145
Proceeds from mortgage of building		—			54
Net increase (decrease) in outstanding payments in excess of cash balance		47			(350	)
Other		(21	)		(28	)

Cash provided by financing activities		1,048			272

Net increase (decrease) in cash and cash equivalents		294			(1,195	)
Cash and cash equivalents, beginning of period		307			1,749

Cash and cash equivalents, end of period	$	601		$	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)



SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION OF CASH PAYMENTS FOR:
Interest, net of capitalized interest	$	57		$	2
Income taxes, net of refunds received	$	(291	)	$	176

SUPPLEMENTAL SCHEDULE OF SIGNIFICANT NON-CASH INVESTING AND FINANCING ACTIVITIES:

As of June 30, 2010 and 2009, dividends payable on our common and preferred stock were $90 million and $51 million, respectively.

For the six months ended June 30, 2010 and 2009, natural gas and oil properties were adjusted by $64 million and ($65) million, respectively, as a result of an increase (decrease) in accrued exploration and development costs.

For the six months ended June 30, 2010 and 2009, other property and equipment were adjusted by $2 million and ($12) 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 ($3) million and ($2) million for the six months ended June 30, 2010 and 2009, respectively, for asset retirement obligations.

During the six months ended June 30, 2010, holders of our 2.25% Contingent Convertible Senior Notes due 2038 exchanged approximately $11 million in aggregate principal amount for an aggregate of 298,500 shares of our common stock in privately negotiated exchanges.

On May 3, 2010, we converted all 5,000 shares of our outstanding 5.00% Cumulative Convertible Preferred Stock (Series 2005) into 20,774 shares of common stock pursuant to the company’s mandatory conversion rights.

During 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 pursuant to an acquisition shelf registration statement.

During the six months ended June 30, 2009, holders of our 2.25% Contingent Convertible Senior Notes due 2038 exchanged approximately $85 million in aggregate principal amount for an aggregate of 2,530,650 shares of our common stock in privately negotiated exchanges.

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

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

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

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF EQUITY

(Unaudited)


	Six Months Ended June 30,
	2010			2009
	($ in millions)
PREFERRED STOCK:
Balance, beginning of period	$	466		$	505
Issuance of 1,500,000 and 0 shares of 5.75% preferred stock		1,500			—
Issuance of 1,100,000 and 0 shares of 5.75% preferred stock (series A)		1,100			—
Exchange of 5,000 and 0 shares of 5.00% preferred stock (series 2005) for common stock		(1	)		—
Exchange of 0 and 143,768 shares of 6.25% preferred stock for common stock		—			(36	)
Exchange of 0 and 3,033 shares of 4.125% preferred stock for common stock		—			(3	)

Balance, end of period		3,065			466


COMMON STOCK:
Balance, beginning of period		6			6
Issuance of 0 and 15,823,838 shares of common stock for the purchase of proved and unproved properties		—			—
Exchange of convertible notes for 298,500 and 2,530,650 shares of common stock		—			—
Exchange of preferred stock for 20,774 and 1,422,425 shares of common stock		—			—
Stock-based compensation		1			—

Balance, end of period		7			6


PAID-IN CAPITAL:
Balance, beginning of period		12,146			11,680
Issuance of 0 and 15,823,838 shares of common stock for the purchase of proved and unproved properties		—			254
Exchange of convertible notes for 298,500 and 2,530,650 shares of common stock		8			54
Exchange of 5,000 and 146,801 shares of preferred stock for common stock		1			39
Stock-based compensation		116			119
Exercise of stock options		2			1
Offering expenses		(38	)		—
Dividends on common stock		(95	)		(91	)
Dividends on preferred stock		(44	)		(12	)
Tax benefit (reduction in tax benefit) from exercise of stock-based compensation		—			(12	)

Balance, end of period		12,096			12,032


RETAINED EARNINGS (DEFICIT):
Balance, beginning of period		(1,261	)		4,569
Net income (loss)		993			(5,498	)
Cumulative effect of accounting change, net of income taxes of $89 million		(142	)		—

Balance, end of period		(410	)		(929	)


ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS):
Balance, beginning of period		102			267
Hedging activity		(19	)		110
Investment activity		(8	)		61

Balance, end of period		75			438


TREASURY STOCK – COMMON:
Balance, beginning of period		(15	)		(10	)
Purchase of 123,579 and 64,242 shares for company benefit plans		(3	)		(1	)
Release of 6,818 and 2,718 shares for company benefit plans		—			—

Balance, end of period		(18	)		(11	)


TOTAL CHESAPEAKE STOCKHOLDERS’ EQUITY		14,815			12,002


NONCONTROLLING INTEREST:
Balance, beginning of period		897			—
Deconsolidation of investment in CMP		(897	)		—

Balance, end of period		—			—


TOTAL EQUITY	$	14,815		$	12,002

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,
	2010			2009			2010			2009
	($ in millions)
Net income (loss)	$	255		$	243		$	993		$	(5,498	)
Other comprehensive income (loss), net of income tax:
Change in fair value of derivative instruments, net of income taxes of ($38) million, $37 million, $114 million and $333 million		(62	)		63			187			547
Reclassification of gain on settled contracts, net of income taxes of ($82) million, ($120) million, ($135) million and ($232) million		(134	)		(197	)		(221	)		(381	)
Ineffective portion of derivatives qualifying for cash flow hedge accounting, net of income taxes of $7 million, ($13) million, $9 million and ($34) million		11			(22	)		15			(56	)
Unrealized (gain) loss on marketable securities, net of income taxes of ($3) million, $7 million, ($5) million and $11 million		(5	)		12			(8	)		18
Reclassification of loss on investments, net of income taxes of $0, $0, $0 and $26 million		—			—			—			43

Comprehensive income (loss)		65			99			966			(5,327	)

(Income) loss attributable to noncontrolling interest		—			—			—			—

Comprehensive income (loss) available to Chesapeake	$	65		$	99		$	966		$	(5,327	)

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, 2009 (“2009 Form 10-K”) includes certain definitions and a summary of significant accounting policies and should be read in conjunction with this Form 10-Q. 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, 2010 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, 2010 (the “Current Quarter” and the “Current Period”, respectively) and the three and six months ended June 30, 2009 (the “Prior Quarter” and the “Prior Period”, respectively).

Cumulative Effect of Accounting Change

Beginning January 1, 2010, in accordance with new authoritative guidance for variable interest entities, we no longer consolidate our midstream joint venture, Chesapeake Midstream Partners, L.L.C. Because we share control 50/50 with our joint venture partner, Global Infrastructure Partners, our investment in the joint venture is now accounted for under the equity method (See Note 9). Adoption of this new guidance resulted in an after-tax cumulative effect charge to retained earnings of $142 million, which is reflected in our condensed consolidated statement of equity for the Current Period. This charge reflects the difference between the carrying value of our initial investment in the joint venture, which was recorded at carryover basis as an entity under common control, and the fair value of our equity in the joint venture as of the formation date.

Critical Accounting Policies

We consider accounting policies related to hedging, natural gas and oil properties and income taxes to be critical policies. These policies are summarized in Management’s Discussion and Analysis of Financial Condition and Results of Operations in our 2009 Form 10-K.

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 our risk management objectives. As of June 30, 2010 and December 31, 2009, our natural gas and oil derivative instruments were comprised of the following types of instruments:

•

Swaps: Chesapeake receives a fixed price and pays a floating market price to the counterparty for the hedged commodity.

•

Collars: These instruments 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 put and the call strike price, no payments are due from either party. Three-way collars include an additional put option in exchange for a more favorable strike price on the collar. This eliminates the counterparty’s downside exposure below the second put option.

•

Call options: Chesapeake sells call options in exchange for a premium from the counterparty. At the time of settlement, if the market price exceeds the fixed price of the call option, Chesapeake pays the counterparty such excess and if the market price settles below the fixed price of the call option, no payment is due from either party.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

•

Put options: Chesapeake receives a premium from the counterparty in exchange for the sale of a put option. At the time of settlement, if the market price falls below the fixed price of the put option, Chesapeake pays the counterparty such shortfall, and if the market price settles above the fixed price of the put option, no payment is due from either party.

•

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.

•

Basis protection swaps: These instruments are arrangements that guarantee a price differential to NYMEX for natural gas 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.

The estimated fair values of our natural gas and oil derivative instruments as of June 30, 2010 and December 31, 2009 are provided below. The associated carrying values of these instruments are equal to the estimated fair values.


	June 30, 2010					December 31, 2009
	Volume		Fair Value			Volume		Fair Value
Natural gas (bbtu):			($ in millions)					($ in millions)
Fixed-price swaps	565,288		$	1,150		492,053		$	662
Fixed-price collars	14,660			39		74,240			92
Call options	1,244,630			(548	)	996,750			(541	)
Put options	(65,940	)		(52	)	(69,620	)		(50	)
Fixed-price knockout swaps	28,530			12		38,370			17
Basis protection swaps	120,663			(48	)	125,469			(50	)

Total natural gas	1,907,831			553		1,657,262			130


Oil (mbbl):
Fixed-price swaps	9,148			(5	)	5,475			3
Call options	38,912			(451	)	14,975			(144	)
Fixed-price knockout swaps	4,219			50		6,572			32

Total oil	52,279			(406	)	27,022			(109	)


Total estimated fair value			$	147				$	21

Pursuant to accounting guidance for derivatives and hedging, certain derivatives qualify for designation as cash flow hedges. Following this guidance, 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 as the physical transactions being hedged occur. Any change in fair value resulting from ineffectiveness is currently recognized in natural gas and oil sales as unrealized gains (losses). 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 natural gas and oil sales. Realized gains (losses) are included in natural gas and oil sales in the month of related production.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

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,
	2010			2009			2010			2009
	($ in millions)
Natural gas and oil sales	$	984		$	717		$	2,169		$	1,495
Realized gains (losses) on natural gas and oil derivatives		573			597			972			1,115
Unrealized gains (losses) on non-qualifying natural gas and oil derivatives		(378	)		(253	)		(58	)		(206	)
Unrealized gains (losses) on ineffectiveness of cash flow hedges		(18	)		36			(24	)		90

Total natural gas and oil sales	$	1,161		$	1,097		$	3,059		$	2,494

Based upon the market prices at June 30, 2010, we expect to transfer approximately $196 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, 2010 are expected to mature by December 31, 2022.

We have a multi-counterparty hedge facility with 13 counterparties that have committed to provide approximately 5.6 tcfe of trading capacity and an aggregate mark-to-market capacity of $15.0 billion under the terms of the facility. As of June 30, 2010, we had hedged a total of 2.1 tcfe under the facility. The multi-counterparty facility allows us to enter into cash-settled natural gas and oil price and basis hedges with the counterparties. Our obligations under the multi-counterparty facility are 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 certain subsidiaries that also guarantee our corporate revolving bank credit facility and indentures. The counterparties’ obligations under the facility must 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 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.

Interest Rate Derivatives

To mitigate our exposure to volatility in interest rates related to our senior notes and bank credit facilities, we enter into interest rate derivatives. As of June 30, 2010 and December 31, 2009, our interest rate derivative instruments were comprised of the following types of instruments:

•

Swaps: Chesapeake enters into fixed-to-floating interest rate swaps (we receive a fixed interest rate and pay a floating market rate) to mitigate our exposure to changes in the fair value of our senior notes. We enter into floating-to-fixed interest rate swaps (we receive a floating market rate and pay a fixed interest rate) to manage our interest rate exposure related to our bank credit facilities borrowings.

•

Collars: These instruments contain a fixed floor rate (floor) and a ceiling rate (cap). If the floating rate is above the cap, we have a net receivable from the counterparty and if the floating rate is below the floor, we have a net payable to the counterparty. If the floating rate is between the floor and the cap, there is no payment due from either party. Collars are used to manage our interest rate exposure related to our bank credit facilities borrowings.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

•

Call options: Occasionally we sell call options for a premium when we think it is more likely that the option will expire unexercised. The option allows the counterparty to terminate an open swap on a specific date.

•

Swaptions: Occasionally we sell an option to a counterparty for a premium which allows the counterparty to enter into a swap with us on a specific date.

The notional amount of debt hedged and the estimated fair value of our interest rate derivatives outstanding as of June 30, 2010 and December 31, 2009 are provided below.


	June 30, 2010					December 31, 2009
	Notional Amount		Fair Value			Notional Amount		Fair Value
	($ in millions)
Interest rate:
Swaps	$	2,125	$	(27	)	$	2,925	$	(113	)
Collars		250		(1	)		250		(6	)
Call options		250		(14	)		250		(2	)
Swaptions		400		(1	)		500		(11	)

Totals	$	3,025	$	(43	)	$	3,925	$	(132	)

For interest rate derivative instruments designated as fair value hedges, the fair values of the hedges are recorded on the condensed consolidated balance sheets as assets or liabilities, with corresponding offsetting adjustments to the debt’s carrying value. Changes in the fair value of non-qualifying derivatives that occur prior to their maturity (i.e., temporary fluctuations in value) are currently reported in the condensed consolidated statements of operations as unrealized (gains) losses within interest expense.

Realized gains or losses from interest rate derivative transactions are reflected as adjustments to interest expense in the condensed consolidated statements of operations. The components of interest expense 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,
	2010			2009			2010			2009
	($ in millions)

Interest expense on senior notes	$	(190	)	$	(196	)	$	(383	)	$	(378	)
Interest expense on credit facilities		(12	)		(17	)		(24	)		(29	)
Capitalized interest		179			152			340			314
Realized gains (losses) on interest rate derivatives		2			5			4			12
Unrealized gains (losses) on interest rate derivatives		49			42			77			87
Amortization of loan discount and other		(12	)		(8	)		(23	)		(14	)

Total interest (expense) income	$	16		$	(22	)	$	(9	)	$	(8	)

Our qualifying interest rate swaps are considered 100% effective and therefore no ineffectiveness was recorded for the periods presented above.

Gains and losses related to terminated qualifying interest rate derivative transactions will be amortized as an adjustment to interest expense over the remaining term of the related senior notes. Over the next ten years, we will be recognizing $92 million in gains related to such transactions.

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.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

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. The fair value of the cross currency swap is recorded on the condensed consolidated balance sheet as a liability of $118 million at June 30, 2010. The euro-denominated debt in notes payable has been adjusted to $738 million at June 30, 2010 using an exchange rate of $1.2291 to €1.00.

Additional Disclosures Regarding Derivative Instruments and Hedging Activities

In accordance with accounting guidance for derivatives and hedging, 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. Derivative instruments reflected as current in the condensed consolidated balance sheet represent the estimated fair value of derivatives scheduled to settle over the next twelve months based on market prices/rates as of the balance sheet date. The derivative settlement amounts are not due until the month in which the related underlying hedged transaction occurs. Cash settlements of our derivative arrangements are generally classified as operating cash flows unless the derivative contains a significant financing element at contract inception, in which case, all cash settlements are classified as financing cash flows in the accompanying condensed consolidated statements of cash flows.

The following table sets forth the fair value of each classification of derivative instrument as of June 30, 2010 and December 31, 2009, on a gross basis without regard to same-counterparty netting:


		Fair Value
	Balance Sheet Location	June 30, 2010			December 31, 2009
		($ in millions)
ASSET DERIVATIVES:
Derivatives designated as hedging instruments:
Commodity contracts	Short-term derivative instruments	$	454		$	417
Commodity contracts	Long-term derivative instruments		57			36
Foreign currency contracts	Long-term derivative instruments		—			43

Total			511			496


Derivatives not designated as hedging instruments:
Commodity contracts	Short-term derivative instruments		568			318
Commodity contracts	Long-term derivative instruments		200			66
Interest rate contracts	Long-term derivative instruments		18			—

Total			786			384


LIABILITY DERIVATIVES:
Derivatives designated as hedging instruments:
Commodity contracts	Short-term derivative instruments		—			(1	)
Interest rate contracts	Long-term derivative instruments		—			(11	)
Foreign currency contracts	Long-term derivative instruments		(118	)		—

Total			(118	)		(12	)


Derivatives not designated as hedging instruments:
Commodity contracts	Short-term derivative instruments		(57	)		(42	)
Commodity contracts	Long-term derivative instruments		(1,075	)		(768	)
Interest rate contracts	Short-term derivative instruments		(17	)		(27	)
Interest rate contracts	Long-term derivative instruments		(44	)		(94	)

Total			(1,193	)		(931	)


Total derivative instruments		$	(14	)	$	(63	)

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 statements of operations for the Current Quarter, the Prior Quarter, the Current Period and the Prior Period is provided below, separating fair value, cash flow and non-qualifying derivatives.

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


		Three Months Ended June 30,				Six Months Ended June 30,
Fair Value Derivatives	Location of Gain (Loss)	2010		2009		2010		2009

Interest rate contracts	Interest expense^(a)	$	5	$	10	$	13	$	18

(a)	Interest expense on items hedged during the Current Quarter, the Prior Quarter, the Current Period and the Prior Period was $5 million, $20 million, $15 million and $33 million, respectively, which is included in interest expense on the condensed consolidated statements 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 designated as cash flow derivatives ($ in millions):


		Three Months Ended June 30,					Six Months Ended June 30,
Cash Flow Derivatives	Location of Gain (Loss)	2010			2009		2010			2009

Gain (Loss) Recognized in AOCI (Effective Portion)
Commodity contracts	AOCI	$	(41	)	$	30	$	364		$	712
Foreign exchange contracts	AOCI		(41	)		35		(39	)		78

		$	(82	)	$	65	$	325		$	790

Gain (Loss) Reclassified from AOCI (Effective Portion)
Commodity contracts	Natural gas and oil sales	$	216		$	317	$	356		$	613

		$	216		$	317	$	356		$	613

Gain (Loss) Recognized (Ineffective Portion and Amount Excluded from Effectiveness Testing)^(a)
Commodity contracts	Natural gas and oil sales	$	18		$	36	$	48		$	90

		$	18		$	36	$	48		$	90

(a)

In the Current Quarter, the Prior Quarter, the Current Period and the Prior Period, the amount of gain (loss) recognized in net income (loss) represents ($18) million, $36 million, ($24) million and $90 million related to the ineffective portion of our cash flow derivatives and $36 million, $0, $72 million and $0, respectively, related to the amount excluded from the assessment of hedge effectiveness.

The following table presents the gain (loss) recognized in net income (loss) for instruments not qualifying as cash flow or fair value derivatives ($ in millions):


		Three Months Ended June 30,					Six Months Ended June 30,
Non-Qualifying Derivatives	Location of Gain (Loss)	2010			2009		2010		2009

Commodity contracts	Natural gas and oil sales	$	(57	)	$	27	$	486	$	296
Interest rate contracts	Interest expense		46			37		68		81

	Total	$	(11	)	$	64	$	554	$	377

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Concentration of Credit Risk

A significant portion of our credit risk is concentrated in derivative instruments that enable us to hedge a portion of our exposure to natural gas and oil prices, interest rate volatility and exchange rate exposure. 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, 2010, our derivative instruments were spread among 14 counterparties. Additionally, our multi-counterparty secured hedging facility described previously includes 13 of our counterparties which are required to secure their natural gas and oil hedging obligations in excess of defined thresholds. We use this 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, the Prior Quarter, the Current Period and the Prior Period we recognized $0, $5 million, $0 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. Following the appointment of a lead plaintiff and counsel, the plaintiff filed an amended complaint on September 11, 2009 alleging that the registration statement for the offering contained material misstatements and omissions and seeking damages under Sections 11, 12 and 15 of the Securities Act of 1933 of an unspecified amount and rescission. The action was transferred to the U.S. District Court for the Western District of Oklahoma on October 13, 2009. The company has filed a motion to dismiss which has been fully briefed. 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. The derivative action is stayed pending resolution of the motion to dismiss in the class action.

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. On August 20, 2009, the court denied the inspection demand, dismissed the petition and entered judgment in favor of Chesapeake. The shareholder is appealing the court’s ruling in the Court of Civil Appeals of the State of Oklahoma.

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. Chesapeake has filed a motion to dismiss which was heard on February 1, 2010. On February 28, 2010, the court ordered that plaintiffs’ claims be dismissed and granted plaintiffs leave to file an amended petition within 90 days. Plaintiffs chose not to amend and on April 9, 2010, at plaintiffs’ request, the court entered an order certifying that the February 28, 2010 dismissal was a final, appealable order. Plaintiffs are appealing the dismissal. By the order of the Oklahoma Supreme Court dated June 16, 2010, the appeal was assigned to the Court of Civil Appeals.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

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, various 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 most of the suits but a few remain pending. In one case, following trial, plaintiffs have requested reconsideration of the judgment entered in favor of Chesapeake on June 11, 2010. 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 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 has an initial term of five years which commenced in 2008 and is automatically extended for one additional year on each December 31 unless the company provides 30 days notice of non-extension. The agreement contains a cap on annual cash salary and bonus compensation at 2008 levels through 2013. 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, or in the event of his incapacity, death or retirement at or after age 55. The agreements with the chief operating officer, chief financial officer and other executive officers expire on September 30, 2012. The agreements with our COO, CFO and other executive vice presidents contain a cap on annual cash salary for the three-year term of the agreement. In addition, annual cash bonuses will not exceed the sum of the individual EVP’s cash bonus compensation for (a) the last half of 2008 and (b) the first half of 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 receive a lump sum payment equal to 26 weeks of cash salary 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. The agreements also provide for a 2008 incentive award payable in four equal annual installments, the first of which was paid on September 30, 2009. The payment of each installment of the award is subject to the individual’s continued employment on the date of payment, except that the unpaid installments of the award would be accelerated and paid in a lump sum in the event of a change of control or a termination of employment without cause, a voluntary termination by the executive due to a material breach of contract by the company, or termination due to incapacity or death.

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.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

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, 2010.

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 $93 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, 2010, the minimum aggregate undiscounted future rig lease payments were approximately $476 million.

Compressor Leases

Through various transactions since 2007 our compression subsidiary sold 2,189 compressors, a significant portion of its compressor fleet, for $497 million and entered into a master lease agreement. The term of the agreement varies by buyer ranging from four to ten years for aggregate lease payments of approximately $73 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 marketing, gathering and compression expenses over the lease term. Under the leases, we can exercise an early purchase option 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, 2010, the minimum aggregate undiscounted future compressor lease payments were approximately $434 million.

Transportation Contracts

Chesapeake has various firm pipeline transportation service agreements with expiration dates ranging from 2010 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 undiscounted amounts of such required demand payments as of June 30, 2010 were as follows ($ in millions):


2010	$	147
2011		350
2012		377
2013		362
2014		343
2015 – 2099		2,478

Total	$	4,057

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Drilling Contracts

Currently, Chesapeake has contracts with various drilling contractors to lease approximately 41 rigs with terms of six months to three years. These commitments are not recorded in the accompanying condensed consolidated balance sheets. As of June 30, 2010, the aggregate undiscounted drilling rig commitment was approximately $238 million.

Natural Gas and Oil Purchase Obligations

Our marketing 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 purchase any natural gas and oil associated with certain volumetric production payment transactions. The purchase commitments are based on market prices at the time of production, and the purchased natural gas and oil is resold.

Minimum Volume Commitments

At June 30, 2010, we were a party to a gas gathering agreement with Chesapeake Midstream Partners, L.L.C. (see Note 9) pursuant to which we committed to deliver specified minimum volumes of natural gas from our Barnett Shale production annually through December 31, 2018 and for the six-month period ending June 30, 2019. Effective August 3, 2010, a subsidiary of Chesapeake Midstream Partners L.P. (see Note 14) became our counterparty to this agreement. At the end of the term or annually, Chesapeake will be invoiced for any shortfalls in such volume commitments at the rate specified in the agreement. Volume commitments remaining as of June 30, 2010 are as follows:


		Bcf
2010		198
2011		313
2012		325
2013		338
2014		351
After 2014		1,686

Total		3,211

In addition, Chesapeake has entered into commitments to deliver 630 bcf from July 2010 through September 2021 to third-party midstream companies.

Net Acreage Maintenance Commitments

Under the terms of our joint development agreements with our joint venture partners Statoil and Total, we are required to extend, renew or replace certain expiring joint leasehold, at our cost, to ensure that the net acreage is maintained in certain designated areas.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

4.	Net Income Per Share

Accounting guidance for earnings per share (EPS) requires presentation of “basic” and “diluted” earnings per share on the face of the statements of operations for all entities with complex capital structures as well as a reconciliation of the numerator and denominator of the basic and diluted EPS computations.

For the Current Period, no securities were antidilutive in the calculation of diluted EPS. The following securities and associated adjustments to net income comprised of dividends and losses on conversions/exchanges were not included in the calculation of diluted EPS for the Current Quarter, the Prior Quarter and the Prior Period, as the effect was antidilutive.


	Shares	Net Income Adjustments
	(in millions)	($ in millions)

Three Months Ended June 30, 2010:

Common stock equivalent of our preferred stock outstanding:
5.75% cumulative convertible preferred stock	16	$	6
5.75% cumulative convertible preferred stock (series A)	19	$	8
5.00% cumulative convertible preferred stock (series 2005B)	5	$	3
4.50% cumulative convertible preferred stock	6	$	3

Three Months Ended June 30, 2009:

Common stock equivalent of our preferred stock outstanding:
5.00% cumulative convertible preferred stock (series 2005B)	5	$	3
4.50% cumulative convertible preferred stock	6	$	3

Six Months Ended June 30, 2009:
Outstanding stock options	1	$	—
Unvested restricted stock	4	$	—

Common stock equivalent of our preferred stock outstanding:
4.50% cumulative convertible preferred stock	6	$	6
5.00% cumulative convertible preferred stock (series 2005B)	5	$	5
Common stock equivalent of our preferred stock outstanding prior to conversion:
6.25% mandatory convertible preferred stock	1	$	1

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

A reconciliation of basic EPS and diluted EPS for the Current Quarter, the Prior Quarter and the Current Period is as follows:


	Income (Numerator)		Weighted Average Shares (Denominator)	Per Share Amount
	(in millions, except per share data)
Three Months Ended June 30, 2010:
Basic EPS	$	235	631	$	0.37

Effect of Dilutive Securities:
Employee stock options		—	1
Restricted stock		—	3


Diluted EPS	$	235	635	$	0.37


Three Months Ended June 30, 2009:
Basic EPS	$	237	603	$	0.39

Effect of Dilutive Securities:
Assumed conversion as of the beginning of the period of preferred shares outstanding prior to conversion:
Common shares assumed issued for 6.25% cumulative convertible preferred stock		—	1
Employee stock options		—	1
Restricted stock		—	5


Diluted EPS	$	237	610	$	0.39


Six Months Ended June 30, 2010:
Basic EPS	$	968	630	$	1.54

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 5.75% cumulative convertible preferred stock		6	8
Common shares assumed issued for 5.75% cumulative convertible preferred stock (series A)		8	10
Common shares assumed issued for 5.00% cumulative convertible preferred stock (series 2005B)		5	6
Common shares assumed issued for 4.50% cumulative convertible preferred stock		6	6
Employee stock options		—	1
Restricted stock		—	4


Diluted EPS	$	993	665	$	1.49

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, 2010 and 2009:


	2010	2009
	(in thousands)

Shares issued at January 1	648,549	607,953
Stock option exercises	316	157
Restricted stock issuances (net of forfeitures)	2,812	2,365
Convertible note exchanges	299	2,531
Preferred stock conversions/exchanges	21	1,422
Common stock issued for the purchase of proved and unproved properties	—	15,824

Shares issued at June 30	651,997	630,252

In the Current Period, we privately exchanged approximately $11 million in aggregate principal amount of our 2.25% Contingent Convertible Senior Notes due 2038 for an aggregate of 298,500 shares of our common stock valued at approximately $9 million. Through these transactions, we were able to retire this debt for common stock valued at approximately 80% of the face value of the notes. In connection with accounting guidance for debt with conversion and other options, we are required to account for the liability and equity components of our convertible debt instruments separately. Of the $11 million principal amount of convertible notes exchanged in the Current Quarter, $7 million was allocated to the debt component and the remaining $4 million was allocated to the equity conversion feature and was recorded as an adjustment to paid-in-capital. The difference between the debt component and value of the common stock exchanged in these transactions resulted in the $2 million loss, (including a nominal amount of deferred charges associated with the exchanges).

In the Prior Period, 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 valued at approximately $53 million. Through these transactions, we were able to retire this debt for common stock valued at approximately 63% of the face value of the notes. Of the $85 million principal amount of convertible notes exchanged in the Prior Period, $52 million was allocated to the debt component and the remaining $33 million was allocated to the equity conversion feature and was recorded as an adjustment to paid-in-capital. The difference between the debt component and value of the common stock exchanged in these transactions resulted in the $2 million loss, (including $1 million of deferred charges associated with the exchanges that were written off).

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

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Preferred Shares

The following is a summary of the changes in our preferred shares outstanding for the six months ended June 30, 2010 and 2009:


	5.75%	5.75%(A)	4.50%	5.00% (2005B)	5.00% (2005)		6.25%		4.125%
	($ in thousands)
Shares outstanding at January 1, 2010	—	—	2,559	2,096	5		—		—
Preferred stock issuances	1,500	1,100	—	—	—		—		—
Conversion of preferred into common stock	—	—	—	—	(5	)	—		—

Shares outstanding at June 30, 2010	1,500	1,100	2,559	2,096	—		—		—

Shares outstanding at January 1, 2009	—	—	2,559	2,096	5		144		3
Conversion of preferred into common stock	—	—	—	—	—		(144	)	(3	)

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

On May 17, 2010, we issued 600,000 shares of 5.75% Cumulative Convertible Non-Voting Preferred Stock, par value $0.01 per share and liquidation preference $1,000 per share, in a private placement for net proceeds of approximately $594 million. We issued an additional 900,000 shares of 5.75% Cumulative Convertible Non-Voting Preferred Stock on June 18, 2010, upon the exercise of the purchasers’ option to place the additional shares, for net proceeds of approximately $877 million.

On May 17, 2010, we issued 1,100,000 shares of 5.75% Cumulative Convertible Non-Voting Preferred Stock (Series A), par value $0.01 per share and liquidation preference $1,000 per share, in a private placement for net proceeds of approximately $1.091 billion.

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

On March 31, 2009, we converted all 3,033 shares of our outstanding 4.125% Cumulative Convertible Preferred Stock into 182,887 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, marketing, gathering and compression 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,
	2010		2009		2010		2009
	($ in millions)

Natural gas and oil properties	$	28	$	29	$	66	$	58
General and administrative expenses		21		19		42		39
Production expenses		9		9		18		17
Marketing, gathering and compression expenses		4		4		9		8
Service operations expense		2		2		4		4

Total	$	64	$	63	$	139	$	126

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, 2010	19,225		$ 31.89
Granted	4,354		$ 27.74
Vested	(2,719	)	$ 28.32
Forfeited	(550	)	$ 31.79

Unvested shares as of June 30, 2010	20,310		$ 31.48

The aggregate intrinsic value of restricted stock vested during the Current Period was approximately $70 million based on the stock price at the time of vesting.

As of June 30, 2010, there was $408 million of total unrecognized compensation cost related to unvested restricted stock. The cost is expected to be recognized over a weighted average period of 2.25 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, the Prior Quarter, the Current Period and the Prior Period, we recognized a reduction in tax benefits related to restricted stock of $1 million, $5 million, $1 million and $12 million, respectively, which were recorded as adjustments to additional paid-in capital and deferred income taxes.

Stock Options. We granted stock options prior to 2006 under several stock compensation plans. Outstanding options expire ten years from the date of grant and vested over a four-year period. All stock options outstanding are fully vested and exercisable.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

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 thousands)				($ in millions)

Outstanding at January 1, 2010	2,283		$ 8.36	2.75	$ 40
Exercised	(316	)	$ 6.10
Expired	—		$ —

Outstanding at June 30, 2010	1,967		$ 8.72	2.44	$ 24


Exercisable at June 30, 2010	1,967		$ 8.72	2.44	$ 24

(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 Period, we recognized excess tax benefits related to stock options of $1 million, which was recorded as an adjustment to additional paid-in capital and deferred income taxes. Nominal amounts of excess tax benefits related to stock options were recorded as adjustments to additional paid-in capital and deferred income taxes in the Current Quarter, the Prior Quarter and the Prior Period.

Debt

Our total debt consisted of the following at June 30, 2010 and December 31, 2009:


	June 30, 2010			December 31, 2009
	($ in millions)

7.5% senior notes due 2013	$	—		$	364
7.625% senior notes due 2013		500			500
7.0% senior notes due 2014^(a)		300			300
7.5% senior notes due 2014		—			300
6.375% senior notes due 2015^(b)		600			600
9.5% senior notes due 2015		1,425			1,425
6.625% senior notes due 2016^(a)		600			600
6.875% senior notes due 2016		—			670
6.25% Euro-denominated senior notes due 2017^(c)		738			860
6.5% senior notes due 2017		1,100			1,100
6.25% senior notes due 2018^(a)		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^(d)		451			451
2.5% contingent convertible senior notes due 2037^(d)		1,378			1,378
2.25% contingent convertible senior notes due 2038^(d)		752			763
Corporate revolving bank credit facility		1,371			1,892
Midstream revolving bank credit facility		150			—
Midstream joint venture revolving bank credit facility^(e)		—			44
Discount on senior notes^(f)		(832	)		(921	)
Interest rate derivatives^(g)		68			69

Total notes payable and long-term debt	$	10,501		$	12,295

(a)	Subsequent to June 30, 2010, we commenced a tender offer for these notes. See Note 14 for further discussion.

(b)	These notes were called for redemption on June 21, 2010 and redeemed on July 22, 2010 utilizing funds from our corporate revolving credit facility.

(c)	The principal amount shown is based on the dollar/euro exchange rate of $1.2291 to €1.00 and $1.4332 to €1.00 as of June 30, 2010 and December 31, 2009, respectively. See Note 2 for information on our related foreign currency derivatives.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

(d)

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 2010, 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 2010 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	$	48.71	May 14, 2016
2.5% due 2037	May 15, 2017, 2022, 2027, 2032	$	64.26	November 14, 2017
2.25% due 2038	December 15, 2018, 2023, 2028, 2033	$	107.36	June 14, 2019

(e)	Effective January 1, 2010, our midstream joint venture was no longer consolidated in accordance with the new authoritative guidance. See Note 1 for further details.

(f)	Included in this discount is $751 million at June 30, 2010 and $794 million at December 31, 2009 associated with the equity component of our contingent convertible senior notes.

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

Senior Notes

Our senior notes are unsecured senior obligations of Chesapeake and rank equally in right of payment with all of our other existing and future senior indebtedness and rank senior in right of payment to all of our future subordinated indebtedness. Chesapeake is a holding company and owns no operating assets and has no significant operations independent of its subsidiaries. Our senior note obligations are guaranteed by certain of our wholly owned subsidiaries. See Note 12 for condensed consolidating financial information regarding our guarantor and non-guarantor subsidiaries. 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.

We are required 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. These rates for 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 are 6.86%, 8.0% and 8.0%, respectively.

On June 21, 2010, we redeemed in whole for an aggregate redemption price of approximately $1.366 billion, plus accrued interest, approximately $364 million in principal amount of our outstanding 7.50% Senior Notes due 2013, $300 million in principal amount of our 7.50% Senior Notes due 2014 and approximately $670 million in principal amount of our 6.875% Senior Notes due 2016. Associated with the redemptions, we recognized a loss of $69 million in the Current Period.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

On June 21, 2010, we called for redemption in whole for a redemption price of approximately $619 million, plus accrued interest, $600 million in principal amount of our 6.375% Senior Notes due 2015. This redemption occurred on July 22, 2010.

During the Current Period, holders of our 2.25% Contingent Convertible Senior Notes due 2038 exchanged approximately $11 million in aggregate principal amount for an aggregate of 298,500 shares of our common stock in privately negotiated exchanges. Associated with these exchanges, we recognized a loss of $2 million in the Current Period.

No scheduled principal payments are required under our senior notes until 2013 when $500 million is due.

Bank Credit Facilities

We utilize two bank credit facilities, described below, as sources of liquidity.


	Corporate Credit Facility^(a)	Midstream Credit Facility^(b)
	($ in millions)

Borrowing capacity	$ 3,500	$ 250

Maturity date	November 2012	September 2012

Facility structure	Senior secured revolving	Senior secured revolving

Amount outstanding as of June 30, 2010	$ 1,371	$ 150

Letters of credit outstanding as of June 30, 2010	$ 14	$ —

(a)	Borrowers are Chesapeake Exploration, L.L.C. and Chesapeake Appalachia, L.L.C.

(b)	Borrower is Chesapeake Midstream Operating, L.L.C., a wholly owned subsidiary of Chesapeake Midstream Development, L.P. Certain terms of the credit agreement for this facility were amended on August 2, 2010. See Note 14.

Our credit facilities do not contain material adverse change or adequate assurance covenants. Although the applicable interest rates under our corporate credit facility fluctuate slightly based on our long-term senior unsecured credit ratings, none of our credit facilities contain 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.

Corporate Credit Facility

Our $3.5 billion syndicated revolving bank credit facility is used for general corporate purposes. Borrowings under the facility are secured by natural gas and oil proved reserves 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.

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. It was amended during the Current Quarter to, among other things, bring in additional lenders to replace Lehman Brothers’ unfunded commitment. The credit facility agreement requires us to maintain an indebtedness (excluding discount on senior notes) 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

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

indebtedness to total capitalization ratio was 0.35 to 1 and our indebtedness to EBITDA ratio was 2.64 to 1 at June 30, 2010. 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.

The facility is fully and unconditionally guaranteed, on a joint and several basis, by Chesapeake and all of our other wholly owned restricted subsidiaries.

Midstream Credit Facility

Our $250 million midstream syndicated revolving bank credit facility is used to fund capital expenditures to build natural gas gathering and other systems for our drilling program and for general corporate purposes associated with our midstream operations. Borrowings under the midstream credit facility are secured by all of the assets of the wholly owned subsidiaries (the restricted subsidiaries) of Chesapeake Midstream Development, L.P. (CMD), itself a wholly owned subsidiary of Chesapeake, 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 1.00%, all of which are subject to a margin that varies from 2.00% to 2.75% per annum according to the most recent indebtedness to EBITDA ratio (as defined) or (ii) the LIBOR plus a margin that varies from 3.00% to 3.75% 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 of 0.50% per annum according to the most recent indebtedness to EBITDA ratio (as defined). Interest is payable quarterly or, if LIBOR applies, it may be payable at more frequent intervals.

The midstream credit facility agreement contains various covenants and restrictive provisions which limit the ability of CMD and its restricted 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 3.00 to 1. As defined by the credit facility agreement, our indebtedness to EBITDA ratio was 1.03 to 1 and our EBITDA to interest expense coverage ratio was 19.77 to 1 at June 30, 2010. If CMD or its restricted 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 facility could be declared immediately due and payable. The midstream credit facility agreement also has cross default provisions that apply to other indebtedness CMD and its restricted subsidiaries may have with an outstanding principal amount in excess of $15 million.

Other Financings

In 2009, we financed 113 real estate surface assets in the Barnett Shale area 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. This lease transaction was recorded as a financing lease and the cash received was recorded with an offsetting long-term liability on the condensed consolidated balance sheet. Chesapeake exercised its option to repurchase two of the assets in the Current Period. As of June 30, 2010, 111 assets were leased and the minimum aggregate undiscounted future lease payments were approximately $836 million.

In 2009, we financed our regional Barnett Shale headquarters building in Fort Worth, Texas for net proceeds of approximately $54 million with a five-year term loan which has a floating rate of prime plus 275 basis points. At our option, we may prepay in full without penalty beginning in year four. The payment obligation is guaranteed by Chesapeake.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

7.	Segment Information

In accordance with accounting guidance for 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 marketing, gathering and compression of 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. Our drilling rig and trucking service operations are presented in “Other Operations” in the table below.

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 $926 million, $622 million, $1.933 billion and $1.293 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.


	Exploration and Production			Midstream			Other Operations			Intercompany Eliminations			Consolidated Total
	($ in millions)
Three Months Ended June 30, 2010:
Revenues	$	1,161		$	1,719		$	181		$	(1,049	)	$	2,012
Intersegment revenues		—			(926	)		(123	)		1,049			—

Total revenues	$	1,161		$	793		$	58		$	—		$	2,012

Income (loss) before income taxes	$	403		$	23		$	(14	)	$	2		$	414


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


Six Months Ended June 30, 2010:
Revenues	$	3,059		$	3,570		$	351		$	(2,170	)	$	4,810
Intersegment revenues		—			(1,933	)		(237	)		2,170			—

Total revenues	$	3,059		$	1,637		$	114		$	—		$	4,810

Income (loss) before income taxes	$	1,579		$	55		$	(25	)	$	5		$	1,614


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	)


As of June 30, 2010:
Total assets	$	28,963		$	3,180		$	703		$	(677	)	$	32,169

As of December 31, 2009:
Total assets	$	25,637		$	4,323		$	660		$	(706	)	$	29,914

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

8.	Divestitures

Joint Ventures

In January 2010, Chesapeake and Total E&P USA, Inc., a wholly owned subsidiary of Total S.A. (NYSE: TOT, FP: FP) (Total), closed a $2.25 billion Barnett Shale joint venture transaction, whereby Total acquired a 25% interest in our upstream Barnett Shale assets. Total paid us approximately $800 million in cash at closing and will pay an additional $1.45 billion over time by funding 60% of our share of future drilling and completion expenditures. We expect this drilling carry to be fully utilized by year-end 2012.

During the Current Period, as part of our joint venture agreements with Statoil and Plains Exploration & Production Company, we sold an interest in additional leasehold in the Marcellus and Haynesville shale plays for approximately $320 million.

For accounting purposes, cash proceeds from these transactions were reflected as a reduction of natural gas and oil properties with no gain or loss recognized.

During the Current Period, we received the benefit of approximately $534 million in drilling carries associated with the Barnett ($299 million) and Marcellus ($235 million) joint ventures. In the Prior Period, we received the benefit of approximately $580 million in drilling carries associated with the Fayetteville ($337 million), the Haynesville ($204 million) and the Marcellus ($39 million) joint ventures.

Volumetric Production Payment

On February 5, 2010, we sold certain Chesapeake-operated long-lived producing assets in East Texas and the Texas Gulf Coast in our sixth volumetric production payment (VPP) transaction for net proceeds of approximately $180 million, or $3.95 per mcfe.

On June 14, 2010, we sold certain Chesapeake-operated long-lived producing assets in the Permian Basin in our seventh VPP transaction for proceeds of approximately $335 million, or $8.73 per mcfe.

For accounting purposes, cash proceeds from these transactions were reflected as a reduction of natural gas and oil properties with no gain or loss recognized and our proved reserves were reduced accordingly.

Other Divestitures

In the Current Quarter, we sold producing properties and gathering systems in Virginia and in the Permian Basin for proceeds of approximately $330 million.

9.	Investments

At June 30, 2010, investments accounted for under the equity method totaled $1.021 billion and investments accounted for under the cost method totaled $26 million. Following is a summary of our investments:


			Carrying Value
	Approximate % Owned	Accounting Method	June 30, 2010		December 31, 2009
			($ in millions)
Chesapeake Midstream Partners, L.L.C.	50%	Equity	$	559	$	—
Private oilfield services company	25%	Equity		333		239
Chaparral Energy, Inc.	21%	Equity		103		103
Gastar Exploration Ltd.	14%	Cost		24		32
Other	—	Cost/Equity		28		30

			$	1,047	$	404

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Chesapeake Midstream Partners, L.L.C. On September 30, 2009, we formed a joint venture with Global Infrastructure Partners (GIP), a New York-based private equity fund, to own and operate natural gas midstream assets. As part of the transaction, Chesapeake contributed certain natural gas gathering and processing assets to a new joint venture entity, Chesapeake Midstream Partners, L.L.C. (CMP), and GIP purchased a 50% interest in CMP. The assets we contributed to the joint venture were substantially all of our midstream assets in the Barnett Shale and also the majority of our non-shale midstream assets in the Arkoma, Anadarko, Delaware and Permian Basins. During the fourth quarter of 2009, CMP was consolidated within our financial statements. Effective January 1, 2010, in accordance with new authoritative guidance for variable interest entities, we no longer consolidate our midstream joint venture. Because we share control 50/50 with GIP, our midstream joint venture is now accounted for under the equity method. Adoption of this new guidance resulted in an after-tax cumulative effect charge to retained earnings of $142 million, which is reflected in our condensed consolidated statement of equity for the six months ended June 30, 2010. This charge reflects the difference between the carrying value of our initial investment in the joint venture, which was recorded at carryover basis as an entity under common control, and the fair value of our equity in the joint venture as of the formation date. In May 2010, we received a $75 million cash distribution from the joint venture. The carrying value of our investment in the joint venture is less than our underlying equity in net assets by approximately $286 million as of June 30, 2010. This difference is being accreted over 20 years.

Private oilfield services company. The carrying value of our investment in a private oilfield services company is in excess of our underlying equity in net assets by approximately $157 million as of June 30, 2010. This excess amount is attributed to certain intangibles associated with the specialty services provided by the private oilfield services company and is being amortized over the estimated life of the intangibles.

Chaparral Energy, Inc. The carrying value of our investment in Chaparral is in excess of our underlying equity in net assets by approximately $38 million as of June 30, 2010. 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.

10.

Restructuring

In the Prior Period, we restructured 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. A summary of Chesapeake’s restructuring cost is presented below ($ in millions):


	Six Months Ended June 30, 2009
Termination and relocation costs	$	22
Acceleration of restricted stock awards		9
Other associated costs		3

Total Restructuring Costs	$	34

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

11.

Fair Value Measurements

Certain financial instruments are reported at fair value on the condensed consolidated balance sheets. Under fair value measurement accounting guidance, fair value is defined 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 a market valuation approach based on available inputs, which may or may not be observable in the market, to measure the fair values of its assets and liabilities.

The following table provides fair value measurement information for financial assets (liabilities) measured at fair value on a recurring basis as of June 30, 2010 ($ in millions):


	Quoted Prices in Active Markets (Level 1)			Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)			Total Fair Value
Financial Assets (Liabilities):
Cash equivalents	$	601		$	—	$	—		$	601
Investments		24			—		—			24
Other long-term assets		36			—		—			36
Long-term debt		—			—		(738	)		(738	)
Other long-term liabilities		(36	)		—		—			(36	)

Derivatives:
Commodity assets		—			1,177		102			1,279
Commodity liabilities		—			—		(1,132	)		(1,132	)
Interest rate assets		—			—		18			18
Interest rate liabilities		—			—		(61	)		(61	)
Foreign currency liabilities		—			—		(118	)		(118	)

Total derivatives		—			1,177		(1,191	)		(14	)


Total	$	625		$	1,177	$	(1,929	)	$	(127	)

The following table provides fair value measurement information for financial assets (liabilities) measured at fair value on a recurring basis as of December 31, 2009 ($ in millions):


	Quoted Prices in Active Markets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total Fair Value
Financial Assets (Liabilities):
Cash equivalents	$	307		$	—		$	—		$	307
Investments		32			—			—			32
Other long-term assets		34			—			—			34
Long-term debt		—			—			(1,398	)		(1,398	)
Other long-term liabilities		(34	)		—			—			(34	)
Derivatives:
Commodity assets		—			693			143			836
Commodity liabilities		—			(1	)		(809	)		(810	)
Interest rate liabilities		—			—			(132	)		(132	)
Foreign currency assets		—			—			43			43

Total derivatives		—			692			(755	)		(63	)


Total	$	339		$	692		$	(2,153	)		$ (1,122	)

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

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

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.

Derivatives. The fair values of our commodity derivatives are based on a third-party pricing model which utilizes inputs that are either readily available in the public market, such as natural gas and oil forward curves and discount rates, or can be corroborated from active markets or broker quotes. These values are then compared to the values given by our counterparties for reasonableness. Since the commodity swaps do not have options and therefore no unobservable inputs, they are classified as Level 2. All other commodity derivatives have some level of unobservable input, such as volatility curves, and are therefore classified as Level 3. For interest rate and foreign currency derivatives, we use the fair value estimates provided by our respective counterparties, which are classified as Level 3 inputs. These values are reviewed internally for reasonableness using future interest rate curves and time to maturity. Derivatives are also subject to the risk that counterparties will be unable to meet their obligations. We factor in the non-performance risk in the valuation of our derivatives using current published credit default swaps rates. To date this 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.

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


	Derivatives
	Commodity			Interest Rate			Foreign Currency			Debt
Balance of Level 3 as of January 1, 2010	$	(666	)	$	(132	)	$	43		$	(1,398	)
Total gains (losses) (realized/unrealized):
Included in earnings (realized)^(a)		214			(5	)		—			—
Included in earnings or change in net assets (unrealized)^(a)		(453	)		88			(122	)		110
Included in other comprehensive income (loss)		(10	)		—			(39	)		—
Purchases, issuances and settlements		(115	)		6			—			550	^(b)
Transfers in and out of Level 3		—			—			—			—

Balance of Level 3 as of June 30, 2010	$	(1,030	)	$	(43	)	$	(118	)	$	(738	)


Balance of Level 3 as of January 1, 2009	$	431		$	(63	)	$	(76	)	$	(1,470	)
Total gains (losses) (realized/unrealized):
Included in earnings (realized)^(a)		459			12			—			—
Included in earnings or change in net assets (unrealized)^(a)		(148	)		87			6			(59	)
Included in other comprehensive income (loss)		93			—			77			—
Purchases, issuances and settlements		(571	)		(179	)		—			(1,000	)^(b)
Transfers in and out of Level 3		—			—			—			—

Balance of Level 3 as of June 30, 2009	$	264		$	(143	)	$	7		$	(2,529	)

(a)	Amounts related to commodity derivatives are included in Natural Gas and Oil Sales, and amounts related to interest rate and foreign currency derivatives and debt are included in Interest Expense.

(b)	Amount represents a(n) (increase)/decrease in debt recorded at fair value as a result of new or terminated interest rate swaps.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Fair Value of Other Financial Instruments

The following disclosure of the estimated fair value of financial instruments is made in accordance with accounting guidance for 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. Fair value is compared to the carrying value, excluding the impact of interest rate derivatives, in the table below.


	June 30, 2010				December 31, 2009
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
	($ in millions)

Long-term debt	$	10,433	$	10,853	$	12,226	$	12,824
Convertible preferred stock	$	3,065	$	2,980	$	466	$	401

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

12.

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. Our obligations under our outstanding senior notes and contingent convertible notes listed in Note 6 are fully and unconditionally guaranteed, jointly and severally, by certain of our wholly owned subsidiaries on a senior unsecured basis. Our midstream subsidiary, CMD, is not a guarantor and is subject to covenants in the midstream revolving credit facility referred to in Note 6 that restricts it 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, 2010 and December 31, 2009 and for the three and six months ended June 30, 2010 and 2009. 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, 2010

($ in millions)


	Parent			Guarantor Subsidiaries		Non-Guarantor Subsidiaries			Eliminations			Consolidated
CURRENT ASSETS:
Cash and cash equivalents	$	—		$	601	$	—		$	—		$	601
Other		3			2,311		193			(90	)		2,417

Total Current Assets		3			2,912		193			(90	)		3,018


PROPERTY AND EQUIPMENT:
Natural gas and oil properties, at cost based on full-cost accounting		—			23,173		223			—			23,396
Other property and equipment, net		—			2,973		1,461			—			4,434

Total Property and Equipment		—			26,146		1,684			—			27,830


Other assets		158			599		564			—			1,321
Investments in subsidiaries and intercompany advance		694			64		—			(758	)		—

TOTAL ASSETS	$	855		$	29,721	$	2,441		$	(848	)	$	32,169


CURRENT LIABILITIES:
Current liabilities	$	353		$	3,279	$	113		$	(90	)	$	3,655
Intercompany payable (receivable) from parent		(23,744	)		21,498		2,145			101			—

Total Current Liabilities		(23,391	)		24,777		2,258			11			3,655


LONG-TERM LIABILITIES:
Long-term debt, net		8,980			1,371		150			—			10,501
Deferred income tax liabilities		428			1,250		(31	)		(101	)		1,546
Other liabilities		23			1,629		—			—			1,652

Total Long-Term Liabilities		9,431			4,250		119			(101	)		13,699


EQUITY:
Chesapeake stockholders’ equity		14,815			694		64			(758	)		14,815
Noncontrolling interest		—			—		—			—			—

Total Equity		14,815			694		64			(758	)		14,815

TOTAL LIABILITIES AND EQUITY	$	855		$	29,721	$	2,441		$	(848	)	$	32,169

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

CONDENSED CONSOLIDATING BALANCE SHEET

AS OF DECEMBER 31, 2009

($ in millions)


	Parent			Guarantor Subsidiaries		Non- Guarantor Subsidiaries		Eliminations			Consolidated
CURRENT ASSETS:
Cash and cash equivalents	$	—		$	293	$	14	$	—		$	307
Other		27			2,031		166		(85	)		2,139

Total Current Assets		27			2,324		180		(85	)		2,446


PROPERTY AND EQUIPMENT:
Natural gas and oil properties, at cost based on full-cost accounting		—			20,788		4		—			20,792
Other property and equipment, net		—			2,903		3,015		—			5,918

Total Property and Equipment		—			23,691		3,019		—			26,710


Other assets		197			540		21		—			758
Investments in subsidiaries and intercompany advance		3,029			222		—		(3,251	)		—

TOTAL ASSETS	$	3,253		$	26,777	$	3,220	$	(3,336	)	$	29,914


CURRENT LIABILITIES:
Current liabilities	$	277		$	2,261	$	235	$	(85	)	$	2,688
Intercompany payable (receivable) from parent		(19,388	)		17,508		1,793		87			—

Total Current Liabilities		(19,111	)		19,769		2,028		2			2,688


LONG-TERM LIABILITIES:
Long-term debt, net		10,359			1,892		44		—			12,295
Deferred income tax liabilities		393			727		26		(87	)		1,059
Other liabilities		168			1,360		3		—			1,531

Total Long-Term Liabilities		10,920			3,979		73		(87	)		14,885


EQUITY:
Chesapeake stockholders’ equity		11,444			3,029		222		(3,251	)		11,444
Noncontrolling interest		—			—		897		—			897

Total Equity		11,444			3,029		1,119		(3,251	)		12,341


TOTAL LIABILITIES AND EQUITY	$	3,253		$	26,777	$	3,220	$	(3,336	)	$	29,914

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

THREE MONTHS ENDED JUNE 30, 2010

($ in millions)


	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
REVENUES:
Natural gas and oil sales	$	—		$	1,161		$	—		$	—		$	1,161
Marketing, gathering and compression sales		—			768			62			(37	)		793
Service operations revenue		—			58			—			—			58

Total Revenues		—			1,987			62			(37	)		2,012


OPERATING COSTS:
Production expenses		—			213			—			—			213
Production taxes		—			37			—			—			37
General and administrative expenses		—			99			7			—			106
Marketing, gathering and compression expenses		—			751			32			(20	)		763
Service operations expense		—			53			—			—			53
Natural gas and oil depreciation, depletion and amortization		—			340			—			—			340
Depreciation and amortization of other assets		—			41			12			—			53

Total Operating Costs		—			1,534			51			(20	)		1,565


INCOME (LOSS) FROM OPERATIONS		—			453			11			(17	)		447


OTHER INCOME (EXPENSE):
Interest (expense) income		(140	)		(33	)		(1	)		190			16
Loss on redemptions or exchanges of Chesapeake debt		(69	)		—			—			—			(69	)
Other income (expense)		190			7			13			(190	)		20
Equity in net earnings of subsidiary		267			14			—			(281	)		—

Total Other Income (Expense)		248			(12	)		12			(281	)		(33	)

INCOME (LOSS) BEFORE INCOME TAXES		248			441			23			(298	)		414
INCOME TAX EXPENSE (BENEFIT)		(7	)		164			9			(7	)		159

NET INCOME (LOSS)		255			277			14			(291	)		255
Net income (loss)attributable to noncontrolling interest		—			—			—			—			—

NET INCOME (LOSS) ATTRIBUTABLE TO CHESAPEAKE	$	255		$	277		$	14		$	(291	)	$	255

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

THREE MONTHS ENDED JUNE 30, 2009

($ in millions)


	Parent			Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
REVENUES:
Natural gas and oil sales	$	—		$	1,097		$	—		$	—		$	1,097
Marketing, gathering and compression 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
Marketing, gathering and compression 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):
Interest (expense) income		(159	)		(36	)		(2	)		175			(22	)
Impairment of investments		—			(10	)		—			—			(10	)
Loss on redemptions or exchanges of Chesapeake debt		(2	)		—			—			—			(2	)
Other income (expense)		175			(1	)		(1	)		(175	)		(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
Net income (loss) attributable to noncontrolling interest		—			—			—			—			—

NET INCOME (LOSS) ATTRIBUTABLE TO CHESAPEAKE	$	243		$	233		$	20		$	(253	)	$	243

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

SIX MONTHS ENDED JUNE 30, 2010

($ in millions)


	Parent				Guarantor Subsidiaries			Non-Guarantor Subsidiaries			Eliminations			Consolidated
REVENUES:
Natural gas and oil sales	$	—			$	3,059		$	—		$	—		$	3,059
Marketing, gathering and compression sales		—				1,581			110			(54	)		1,637
Service operations revenue		—				114			—			—			114

Total Revenues		—				4,754			110			(54	)		4,810


OPERATING COSTS:
Production expenses		—				421			—			—			421
Production taxes		—				85			—			—			85
General and administrative expenses		—				202			13			—			215
Marketing, gathering and compression expenses		—				1,544			54			(20	)		1,578
Service operations expense		—				102			—			—			102
Natural gas and oil depreciation, depletion and amortization		—				647			—			—			647
Depreciation and amortization of other assets		—				81			22			—			103

Total Operating Costs		—				3,082			89			(20	)		3,151


INCOME (LOSS) FROM OPERATIONS		—				1,672			21			(34	)		1,659


OTHER INCOME (EXPENSE):
Interest (expense) income		(298	)			(92	)		(2	)		383			(9	)
Loss on redemptions or exchanges of Chesapeake debt		(71	)			—			—			—			(71	)
Other income (expense)		383				—			35			(383	)		35
Equity in net earnings of subsidiary		984				33			—			(1,017	)		—

Total Other Income (Expense)		998				(59	)		33			(1,017	)		(45	)

INCOME (LOSS) BEFORE INCOME TAXES		998				1,613			54			(1,051	)		1,614
INCOME TAX EXPENSE (BENEFIT)		5				608			21			(13	)		621

NET INCOME (LOSS)		993		<

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