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 September 30, 2011

[ ] 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 November 2, 2011, there were 659,266,080 shares of our common stock, $0.01 par value, outstanding.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

INDEX TO FORM 10-Q FOR THE QUARTER ENDED SEPTEMBER 30, 2011


PART I.
Financial Information
		Page
Item 1.	Condensed Consolidated Financial Statements (Unaudited):

	Condensed Consolidated Balance Sheets as of September 30, 2011 and December 31, 2010		1

	Condensed Consolidated Statements of Operations for the Three and Nine Months Ended September 30, 2011 and 2010		2

	Condensed Consolidated Statements of Comprehensive Income for the Three and Nine Months Ended September 30, 2011 and 2010		3

	Condensed Consolidated Statements of Cash Flows for the Nine Months Ended September 30, 2011 and 2010		4

	Condensed Consolidated Statements of Stockholders’ Equity for the Nine Months Ended September 30, 2011 and 2010		6

	Notes to Condensed Consolidated Financial Statements		7

Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations		49

Item 3.	Quantitative and Qualitative Disclosures About Market Risk		73

Item 4.	Controls and Procedures		81

PART II.
Other Information

Item 1.	Legal Proceedings		82

Item 1A.	Risk Factors		83

Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds		84

Item 3.	Defaults Upon Senior Securities		84

Item 4.	(Removed and Reserved)		84

Item 5.	Other Information		84

Item 6.	Exhibits		85

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)


	September 30, 2011			December 31, 2010
	($ in millions)
CURRENT ASSETS:
Cash and cash equivalents	$	111		$	102
Accounts receivable		2,737			1,974
Short-term derivative instruments		5			947
Deferred income tax asset		474			139
Other current assets		143			104

Total Current Assets		3,470			3,266

PROPERTY AND EQUIPMENT:
Natural gas and oil properties, at cost based on full-cost accounting:
Evaluated natural gas and oil properties		39,955			38,952
Unevaluated properties		16,421			14,469
Natural gas gathering systems and treating plants		1,836			1,545
Other property and equipment		4,531			3,726

Total Property and Equipment, at Cost		62,743			58,692

Less: accumulated depreciation, depletion and amortization		(27,605	)		(26,314	)

Total Property and Equipment, Net		35,138			32,378

OTHER ASSETS:
Investments		1,166			1,208
Other long-term assets		348			327

Total Other Assets		1,514			1,535

TOTAL ASSETS	$	40,122		$	37,179


CURRENT LIABILITIES:
Accounts payable	$	2,844		$	2,069
Short-term derivative instruments		136			15
Accrued interest		106			191
Other current liabilities		3,109			2,215

Total Current Liabilities		6,195			4,490

LONG-TERM LIABILITIES:
Long-term debt, net		11,789			12,640
Deferred income tax liabilities		3,524			2,384
Long-term derivative instruments		1,502			1,693
Asset retirement obligations		313			301
Other long-term liabilities		501			407

Total Long-Term Liabilities		17,629			17,425

CONTINGENCIES AND COMMITMENTS (Note 3)
STOCKHOLDERS’ EQUITY:
Preferred Stock, $0.01 par value, 20,000,000 shares authorized: 7,251,515 and 7,254,515 shares outstanding		3,062			3,065
Common stock, $0.01 par value, 1,000,000,000 shares authorized, 660,852,092 and 655,251,275 shares issued		7			7
Paid-in capital		12,128			12,194
Retained earnings		1,234			190
Accumulated other comprehensive income (loss), net of tax of $65 million and $102 million		(106	)		(168	)
Less: treasury stock, at cost; 1,338,448 and 1,221,299 common shares		(27	)		(24	)

Total Stockholders’ Equity		16,298			15,264

TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	40,122		$	37,179

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 September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
	($ in millions, except per share data)
REVENUES:
Natural gas and oil sales	$	2,402		$	1,639		$	4,688		$	4,698
Marketing, gathering and compression sales		1,422			883			3,844			2,520
Oilfield services revenue		153			59			376			173

Total Revenues		3,977			2,581			8,908			7,391


OPERATING COSTS:
Production expenses		282			231			782			652
Production taxes		50			34			140			119
General and administrative expenses		151			125			410			340
Marketing, gathering and compression expenses		1,392			851			3,744			2,429
Oilfield services expense		118			52			287			154
Natural gas and oil depreciation, depletion and amortization		423			378			1,147			1,025
Depreciation and amortization of other assets		75			56			206			159
Losses on sales of other property and equipment		3			17			3			17
Other impairments		—			20			4			20

Total Operating Costs		2,494			1,764			6,723			4,915


INCOME FROM OPERATIONS		1,483			817			2,185			2,476


OTHER INCOME (EXPENSE):
Interest expense		(4	)		(3	)		(37	)		(12	)
Earnings on investments		28			151			100			190
Losses on purchases or exchanges of debt		—			(59	)		(176	)		(130	)
Impairment of investments		—			(16	)		—			(16	)
Other income		4			17			9			12

Total Other Income (Expense)		28			90			(104	)		44


INCOME BEFORE INCOME TAXES		1,511			907			2,081			2,520


INCOME TAX EXPENSE (BENEFIT):
Current income taxes		(1	)		(1	)		11			4
Deferred income taxes		590			350			801			966

Total Income Tax Expense		589			349			812			970


NET INCOME		922			558			1,269			1,550

Preferred stock dividends		(43	)		(43	)		(128	)		(68	)

NET INCOME AVAILABLE TO COMMON STOCKHOLDERS	$	879		$	515		$	1,141		$	1,482


EARNINGS PER COMMON SHARE:
Basic	$	1.38		$	0.81		$	1.79		$	2.35
Diluted	$	1.23		$	0.75		$	1.69		$	2.24

CASH DIVIDEND DECLARED PER COMMON SHARE	$	0.0875		$	0.075		$	0.25		$	0.225

WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING (in millions):
Basic		638			632			636			631
Diluted		753			744			752			692

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

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME

(Unaudited)


	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
	($ in millions)

Net income	$	922		$	558		$	1,269		$	1,550
Other comprehensive income, net of income tax:
Change in fair value of derivative instruments, net of income taxes of $44 million, $39 million, $133 million and $153 million		72			65			218			251
Reclassification of gain on settled contracts, net of income taxes of ($49) million, ($68) million, ($88) million and ($203) million		(80	)		(112	)		(144	)		(333	)
Ineffective portion of derivatives qualifying for cash flow hedge accounting, net of income taxes of $2 million, ($2) million, ($5) million and $8 million		3			(3	)		(8	)		12
Unrealized gain (loss) on marketable securities, net of income taxes of ($1) million, $1 million, ($2) million and ($4) million		(1	)		1			(4	)		(7	)

Comprehensive income	$	916		$	509		$	1,331		$	1,473

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)


	Nine Months Ended September 30,
	2011			2010
	($ in millions)
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME	$	1,269		$	1,550
ADJUSTMENTS TO RECONCILE NET INCOME TO CASH PROVIDED BY OPERATING ACTIVITIES:
Depreciation, depletion and amortization		1,353			1,184
Deferred income tax expense		801			966
Unrealized (gains) losses on derivatives		456			(45	)
Stock-based compensation		119			111
Accretion of discount on contingent convertible notes		—			58
Gains on investments		(19	)		(120	)
Losses on purchases or exchanges of debt		5			29
Losses on sales of other property and equipment		3			17
Impairment of investments		—			16
Other impairments		4			20
Other		7			12
Changes in assets and liabilities		(274	)		173

Cash provided by operating activities		3,724			3,971


CASH FLOWS FROM INVESTING ACTIVITIES:
Drilling and completion costs on proved and unproved properties		(5,345	)		(3,718	)
Acquisitions of proved and unproved properties		(3,773	)		(4,217	)
Proceeds from divestitures of proved and unproved properties		6,357			3,107
Additions to other property and equipment		(1,416	)		(968	)
Proceeds from sales of other assets		682			328
Proceeds from (additions to) investments		126			(113	)
Deposits on acquisitions		—			(95	)
Acquisition of drilling company		(339	)		—
Other		(7	)		11

Cash used in investing activities		(3,715	)		(5,665	)


CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from credit facilities borrowings		11,914			10,458
Payments on credit facilities borrowings		(12,057	)		(9,863	)
Proceeds from issuance of senior notes, net of offering costs		977			1,967
Proceeds from issuance of preferred stock, net of offering costs		—			2,562
Cash paid to purchase debt		(2,015	)		(3,434	)
Cash paid for common stock dividends		(151	)		(142	)
Cash paid for preferred stock dividends		(128	)		(49	)
Cash received on financing derivatives		1,085			436
Net increase in outstanding payments in excess of cash balance		489			116
Other		(114	)		(55	)

Cash provided by financing activities		—			1,996

Net increase in cash and cash equivalents		9			302
Cash and cash equivalents, beginning of period		102			307

Cash and cash equivalents, end of period	$	111		$	609

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)


	Nine Months Ended September 30,
	2011			2010
	($ in millions)
SUPPLEMENTAL DISCLOSURE OF CASH FLOW INFORMATION OF NET CASH PAYMENTS (REFUNDS) FOR:

Interest, net of capitalized interest	$	18		$	103
Income taxes, net of refunds received	$	(25	)	$	(291	)

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

As of September 30, 2011 and 2010, dividends payable on our common and preferred stock were $99 million and $90 million, respectively.

For the nine months ended September 30, 2011 and 2010, natural gas and oil properties were adjusted by $148 million and $116 million, respectively, as a result of an increase in accrued costs.

For the nine months ended September 30, 2011 and 2010, other property and equipment were adjusted by $90 million and ($6) million, respectively, as a result of an increase (decrease) in accrued costs.

As of September 30, 2011 and 2010, we had recorded $173 million and $317 million, respectively, as a result of various accrued liabilities related to the purchase of proved and unproved properties and other assets.

During the nine months ended September 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 September 30, 2011, 3,000 shares of our outstanding 5.75% Cumulative Convertible Non-Voting Preferred Stock were converted into 111,111 shares of common stock pursuant to the holder’s conversion rights.

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.

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

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY

(Unaudited)


	Nine Months Ended September 30,
	2011			2010
	($ in millions)
PREFERRED STOCK:
Balance, beginning of period	$	3,065		$	466
Issuance of 0 and 1,500,000 shares of 5.75% preferred stock		—			1,500
Issuance of 0 and 1,100,000 shares of 5.75% preferred stock (series A)		—			1,100
Exchange of 3,000 and 5,000 shares of preferred stock for common stock		(3	)		(1	)

Balance, end of period		3,062			3,065


COMMON STOCK:
Balance, beginning of period		7			6
Exchange of convertible notes for 0 and 298,500 shares of common stock		—			—
Exchange of preferred stock for 111,111 and 20,774 shares of common stock		—			—
Stock-based compensation		—			1

Balance, end of period		7			7


PAID-IN CAPITAL:
Balance, beginning of period		12,194			12,146
Stock-based compensation		120			172
Purchase of contingent convertible notes		(123	)		—
Exchange of convertible notes for 0 and 298,500 shares of common stock		—			8
Exchange of 3,000 and 5,000 shares of preferred stock for common stock		3			1
Exercise of stock options		2			2
Offering expenses		—			(39	)
Reduction in tax benefit from stock-based compensation		(5	)		(13	)
Dividends on common stock		(48	)		(95	)
Dividends on preferred stock		(15	)		(44	)

Balance, end of period		12,128			12,138


RETAINED EARNINGS (DEFICIT):
Balance, beginning of period		190			(1,261	)
Net income		1,269			1,550
Cumulative effect of accounting change, net of income taxes of $89 million		—			(142	)
Dividends on common stock		(112	)		(47	)
Dividends on preferred stock		(113	)		(43	)

Balance, end of period		1,234			57


ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS):
Balance, beginning of period		(168	)		102
Hedging activity		66			(70	)
Investment activity		(4	)		(7	)

Balance, end of period		(106	)		25


TREASURY STOCK – COMMON:
Balance, beginning of period		(24	)		(15	)
Purchase of 191,153 and 179,140 shares for company benefit plans		(5	)		(4	)
Release of 74,004 and 6,963 shares for company benefit plans		2			—

Balance, end of period		(27	)		(19	)


NONCONTROLLING INTEREST:
Balance, beginning of period		—			897
Deconsolidation of investment in Chesapeake Midstream Partners		—			(897	)

Balance, end of period		—			—


TOTAL STOCKHOLDERS’ EQUITY	$	16,298		$	15,273

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 (“Chesapeake” or the “company”) 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, 2010 (2010 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 accompanying condensed consolidated financial statements of Chesapeake include the accounts of our direct and indirect wholly owned subsidiaries. All significant intercompany accounts and transactions have been eliminated. The results for the three and nine months ended September 30, 2011 are not necessarily indicative of the results to be expected for the full year. This Form 10-Q relates to the three and nine months ended September 30, 2011 (the “Current Quarter” and the “Current Period”, respectively) and the three and nine months ended September 30, 2010 (the “Prior Quarter” and the “Prior Period”, respectively).

Cumulative Effect of Accounting Change

Effective January 1, 2010, in accordance with new authoritative guidance for variable interest entities, we ceased consolidating our 50/50 midstream joint venture with Global Infrastructure Partners within our financial statements and began to account for the joint venture 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 Prior 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 2010 Form 10-K.

2.	Derivative and Hedging Activities

Natural Gas and Oil Derivatives

Our results of operations and 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 September 30, 2011 and December 31, 2010, our natural gas and oil derivative instruments consisted 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.

•

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 a certain pre-determined knockout price.

•

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 September 30, 2011 and December 31, 2010 are provided below. The associated carrying values of these instruments are equal to the estimated fair values.


	September 30, 2011						December 31, 2010
	Volume			Fair Value			Volume			Fair Value
				($ in millions)						($ in millions)
Natural gas (bbtu):
Fixed-price swaps		—		$	—			1,035,134		$	1,307
Call options		1,499,285			(554	)		1,477,742			(701	)
Put options		(16,560	)		(27	)		(51,220	)		(59	)
Basis protection swaps		98,885			(44	)		173,691			(55	)

Total natural gas		1,581,610			(625	)		2,635,347			492


Oil (mbbl):
Fixed-price swaps		2,808			11			4,385			(31	)
Call options		89,243			(946	)		64,226			(1,129	)
Fixed-price knockout swaps		1,008			20			1,827			19

Total oil		93,059			(915	)		70,438			(1,141	)


Total estimated fair value				$	(1,540	)				$	(649	)

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. 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 within natural gas and oil sales.

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 September 30,					Nine Months Ended September 30,
	2011			2010		2011		2010
	($ in millions)
Natural gas and oil sales	$	1,427		$	1,074	$	3,892	$	3,243
Gains (losses) on natural gas and oil derivatives		980			560		783		1,475
Gains (losses) on ineffectiveness of cash flow hedges		(5	)		5		13		(20	)

Total natural gas and oil sales	$	2,402		$	1,639	$	4,688	$	4,698

Based upon the market prices at September 30, 2011, we expect to transfer approximately $87 million (net of income taxes) of gain included in accumulated other comprehensive income to net income (loss) during the next 12 months in the related month of production. All derivatives as of September 30, 2011 are expected to mature by December 31, 2022.

We have a multi-counterparty secured hedging facility with 18 counterparties that have committed to provide approximately 6.5 tcfe of hedging capacity for commodity price derivatives and 6.5 tcfe for basis derivatives with an aggregate mark-to-market capacity of $17.5 billion under the terms of the facility. As of September 30, 2011, we had hedged under the facility 2.0 tcfe of our future production with price derivatives and 0.1 tcfe with basis derivatives. The multi-counterparty facility allows us to enter into cash-settled natural gas, oil and natural gas liquids price and basis hedges with the counterparties. Our obligations under the multi-counterparty facility are secured by 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 hedging capacity under the facility is governed by the expected production of the pledged reserve collateral, and volume-based hedging limits are applied separately to price and basis hedges. In addition, there are volume-based sub-limits for natural gas, oil and natural gas liquids 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 entering into hedges with the company on a prospective basis as long as obligations associated with any existing transactions in the facility continue to be satisfied in accordance with the terms of the agreement.

To mitigate our exposure to the fluctuation in prices of diesel fuel, which is used in our exploration and development activities, we have entered into diesel swaps from October 2011 to December 2012 for a total of 60 million gallons with an average fixed price of $2.99 per gallon. Chesapeake pays the fixed price and receives a floating price. The fair value of these swaps as of September 30, 2011 was a liability of $16 million.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Interest Rate Derivatives

To mitigate a portion of our exposure to volatility in interest rates related to our senior notes and bank credit facilities, we enter into interest rate derivatives. As of September 30, 2011 and December 31, 2010, our interest rate derivative instruments consisted 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.

•

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 a pre-determined 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 pre-determined 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 September 30, 2011 and December 31, 2010 are provided below.


	September 30, 2011					December 31, 2010
	Notional Amount		Fair Value			Notional Amount		Fair Value
	($ in millions)
Interest rate:
Swaps	$	1,050	$	(46	)	$	1,900	$	(54	)
Call options		—		—			250		(2	)
Swaptions		300		—			500		(13	)

Total	$	1,350	$	(46	)	$	2,650	$	(69	)

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. Our qualifying interest rate swaps are considered 100% effective and therefore no ineffectiveness was recorded for the periods presented below. Changes in the fair value of non-qualifying interest rate derivatives that occur prior to their maturity (i.e., temporary fluctuations in value) are currently reported in the condensed consolidated statements of operations within interest expense.

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 September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
	($ in millions)
Interest expense on senior notes	$	152		$	167		$	494		$	550
Interest expense on credit facilities		18			18			49			42
(Gains) losses on interest rate derivatives		—			—			19			(81	)
Amortization of loan discount and other		8			3			30			26
Capitalized interest		(174	)		(185	)		(555	)		(525	)

Total interest expense	$	4		$	3		$	37		$	12

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

We have terminated certain fair value hedges related to senior notes. Gains and losses related to these terminated hedges will be amortized as an adjustment to interest expense over the remaining term of the related senior notes. Over the next nine years, we will recognize $30 million in gains related to such transactions.

Foreign Currency Derivatives

In December 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 cross currency swaps to mitigate our exposure to fluctuations in the euro relative to the dollar over the term of the notes. In May 2011, we purchased and subsequently retired €256 million in aggregate principal amount of these senior notes following a tender offer, and we simultaneously unwound the cross currency swaps for the same principal amount. As a result, we reclassified a loss of $38 million from accumulated other comprehensive income to the condensed consolidated statement of operations, $20 million of which related to the unwound notional amount and was included in losses on purchases or exchanges of debt, and $18 million of which related to future interest associated with the unwound principal and was included in interest expense. Under the terms of the remaining cross currency swaps, on each semi-annual interest payment date, the counterparties pay Chesapeake €11 million and Chesapeake pays the counterparties $17 million, which yields an annual dollar-equivalent interest rate of 7.491%. Upon maturity of the notes, the counterparties will pay Chesapeake €344 million and Chesapeake will pay the counterparties $459 million. The terms of the cross currency swaps were based on the dollar/euro exchange rate on the issuance date of $1.3325 to €1.00. Through the cross currency swaps, we have eliminated any potential variability in Chesapeake’s expected cash flows related to changes in foreign exchange rates and therefore the swaps qualify as cash flow hedges. The fair values of the cross currency swaps are recorded on the condensed consolidated balance sheet as a liability of $31 million at September 30, 2011. The euro-denominated debt in long-term debt has been adjusted to $463 million at September 30, 2011 using an exchange rate of $1.3449 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 sheets represent the estimated fair value of derivatives scheduled to settle over the next twelve months based on market prices/rates as of the respective balance sheet dates. The derivative settlement amounts are not due until the month in which the related underlying hedged transaction occurs. Cash settlements of our derivative instruments are generally classified as operating cash flows unless the derivative contains a significant financing element at contract inception, in which case these cash settlements are classified as financing cash flows in the accompanying condensed consolidated statements of cash flows.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

The following table presents the fair value and location of each classification of derivative instrument as disclosed in the condensed consolidated balance sheets as of September 30, 2011 and December 31, 2010 on a gross basis without regard to same-counterparty netting:


		Fair Value
	Balance Sheet Location	September 30, 2011			December 31, 2010
		($ in millions)
Asset Derivatives:
Derivatives designated as hedging instruments:
Commodity contracts	Short-term derivative instruments	$	—		$	307
Commodity contracts	Long-term derivative instruments		—			12

Total			—			319


Derivatives not designated as hedging instruments:
Commodity contracts	Short-term derivative instruments		73			921
Commodity contracts	Long-term derivative instruments		36			229

Total			109			1,150


Liability Derivatives:
Derivatives designated as hedging instruments:
Commodity contracts	Short-term derivative instruments		—			(59	)
Interest rate contracts	Long-term derivative instruments		—			(25	)
Foreign currency contracts	Long-term derivative instruments		(31	)		(43	)

Total			(31	)		(127	)


Derivatives not designated as hedging instruments:
Commodity contracts	Short-term derivative instruments		(204	)		(222	)
Commodity contracts	Long-term derivative instruments		(1,461	)		(1,837	)
Interest rate contracts	Short-term derivative instruments		—			(15	)
Interest rate contracts	Long-term derivative instruments		(46	)		(29	)

Total			(1,711	)		(2,103	)


Total derivative instruments		$	(1,633	)	$	(761	)

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.

Fair Value Hedges

The following table presents the gain (loss) recognized in the condensed consolidated statements of operations for instruments designated as fair value derivatives:

	$000		$000		$000		$000		$000
		Three Months Ended September 30,				Nine Months Ended September 30,
Fair Value Derivatives	Location of Gain (Loss)	2011		2010		2011		2010
		($ in millions)

Interest rate contracts	Interest expense^(a)	$	3	$	3	$	14	$	16

(a)	Interest expense on items hedged during the Current Quarter, the Prior Quarter, the Current Period and the Prior Period was $2 million, $0, $23 million and $15 million, respectively, which is included in interest expense on the condensed consolidated statements of operations.

Cash Flow Hedges

The following table presents the pre-tax gain (loss) recognized in, and reclassified from, accumulated other comprehensive income (AOCI) related to instruments designated as cash flow derivatives:


		Three Months Ended September 30,						Nine Months Ended September 30,
Cash Flow Derivatives	Location of Gain (Loss)	2011			2010			2011			2010
		($ in millions)
Gain (Loss) Recognized in AOCI (Effective Portion)
Commodity contracts	AOCI	$	122		$	94		$	372		$	458
Foreign currency contracts	AOCI		(1	)		5			(34	)		(34	)

		$	121		$	99		$	338		$	424


Gain (Loss) Reclassified from AOCI (Effective Portion)
Commodity contracts	Natural gas and oil sales	$	129		$	179		$	270		$	535
Foreign currency contracts	Interest expense		—			—			(18	)		—
Foreign currency contracts	Loss on purchase of debt		—			—			(20	)		—

		$	129		$	179		$	232		$	535


Gain (Loss) Recognized in Income
Commodity contracts
Ineffective portion	Natural gas and oil sales	$	(5	)	$	5		$	13		$	(20	)
Amount initially excluded from effectiveness testing	Natural gas and oil sales		—			(3	)		22			(75	)

		$	(5	)	$	2		$	35		$	(95	)

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Non-Qualifying Derivatives

The following table presents the gain (loss) recognized in the condensed consolidated statements of operations for instruments not qualifying as cash flow or fair value derivatives:


		Three Months Ended September 30,						Nine Months Ended September 30,
Derivative Contracts	Location of Gain (Loss)	2011			2010			2011			2010
		($ in millions)

Commodity contracts	Natural gas and oil sales	$	851		$	384		$	491		$	1,015
Interest rate contracts	Interest expense		(3	)		(3	)		(14	)		65

	Total	$	848		$	381		$	477		$	1,080

Credit Risk

Derivative instruments that enable us to hedge a portion of our exposure to natural gas and oil prices and interest rate volatility 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 September 30, 2011, our commodity and interest rate derivative instruments were spread among 12 counterparties. Additionally, our multi-counterparty secured hedging facility described above includes 11 of our counterparties which are required to secure their natural gas and oil derivative obligations in excess of defined thresholds. We use this facility for all of our natural gas, oil and natural gas liquids derivatives.

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. On September 2, 2010, the court denied the defendants’ motion to dismiss, and on August 1, 2011, the plaintiffs filed a motion for class certification. Discovery in the case is proceeding. We are currently unable to assess the probability of loss or estimate a range of potential loss associated with the case. A derivative action was also filed in the District Court of Oklahoma County, Oklahoma on March 10, 2009 against certain current and former directors and officers of the company asserting breaches of fiduciary duties relating to alleged material omissions in the registration statement for the July 2008 offering. The derivative action is stayed pursuant to stipulation. A second derivative action relating to the July 2008 offering was filed against certain current and former directors and officers of the company in the U.S. District Court for the Western District of Oklahoma on September 6, 2011. This action also asserts breaches of fiduciary duties with respect to alleged material omissions in the offering registration statement. Chesapeake is named as a nominal defendant in both derivative actions.

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, among other things, breaches of fiduciary duties relating to the 2008 compensation of the company’s CEO 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’s motion to dismiss was granted on February 26, 2010, and the Oklahoma Court of Civil Appeals affirmed the dismissal on August 26, 2011. The plaintiffs filed a petition

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

for writ of certiorari with the Oklahoma Supreme Court on September 13, 2011. On November 1, 2011, the company entered into a Stipulation and Agreement of Settlement (the “Stipulation”) setting forth the terms of a proposed settlement between the parties in this derivative action, as well as in an inspection demand case requesting books and records relating to the company’s December 2008 employment agreement with its CEO. The inspection demand case, currently on appeal at the Oklahoma Court of Civil Appeals, was filed initially on March 26, 2009 in the District Court of Oklahoma County, Oklahoma, and the plaintiff’s petition for writ of mandate to compel inspection was denied on September 2, 2009. On November 1, 2011, the District Court of Oklahoma County, Oklahoma entered an order preliminarily approving settlement of the two cases in accordance with the Stipulation filed November 1, 2011. The settlement, if approved by the court, will not have a material effect on the company’s consolidated financial position, results of operations or cash flows, and the litigation will be dismissed with prejudice against all defendants. The order also approved distribution of a notice of settlement to Chesapeake shareholders and set a hearing date to consider final approval of the settlement for January 30, 2012. The appeals of both the consolidated derivative case and the inspection demand case have been stayed pending court approval of the settlement.

On September 6 and 8, 2011, in separate derivative actions filed in the U.S. District Court for the Western District of Oklahoma against certain of the company’s current and former directors, two shareholders have alleged that the company’s directors have waived the demand requirement for derivative actions or wrongfully refused their demands that the board take certain actions related to executive compensation and, as a result, each of these shareholders asserts he is entitled to seek relief on behalf of the company.

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 natural gas and oil 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 successfully defended a number of these cases in various courts, has settled others and believes that it has substantial defenses to the claims made in those pending at the trial court and on appeal.

The company records an associated liability when a loss is probable and the amount is reasonably estimable. Based on management’s current assessment, we are of the opinion that no pending or threatened lawsuit or dispute incidental to the company’s business operations is likely to have a material adverse effect on its 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.

Environmental Risk

Due to the nature of the natural gas and oil business, Chesapeake and its subsidiaries are exposed to environmental risks. Chesapeake has implemented various policies and procedures to reduce and mitigate such environmental risks. Chesapeake conducts periodic reviews, on a company-wide basis, to identify changes in our environmental risk profile. These reviews evaluate whether there is a contingent liability, its amount, and the likelihood that the liability will be incurred. The amount of any potential liability is determined by considering, among other matters, incremental direct costs of any likely remediation. 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 September 30, 2011. There is, however, an enforcement action pending against us related to compliance with Clean Water Act permitting requirements in West Virginia, and the Pennsylvania Department of Environmental Protection has issued compliance orders with respect to alleged violations of the Pennsylvania Clean Streams Law related to the construction of a well pad and erosion and sediment control associated with another pad site. The Pennsylvania Department of Environmental Protection has also issued a notice of violation alleging violations of the state’s Oil and Gas Act, Clean Streams Law and Solid Waste Management Act relating to a well control incident. While we

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

anticipate these actions will result in monetary sanctions, we do not expect that they will have a material adverse effect on the company’s consolidated financial position, results of operations or cash flows.

Rig Leases

In a series of transactions since 2006, our drilling subsidiaries have sold 93 drilling rigs (net of one repurchased rig) and related equipment for $802 million and entered into master lease agreements under which we agreed to lease the rigs from the buyer for initial terms of five to ten years. The lease obligations are guaranteed by Chesapeake and certain of its subsidiaries. These transactions were recorded as sales and operating leasebacks and any related gain or loss is amortized to oilfield services expense over the lease term. Under the leases, we can exercise an early purchase option or we can purchase the rigs at the expiration of the lease for the fair market value at the time. In addition, in most cases we have the option to renew the lease for negotiated new terms at the expiration of the lease. Commitments related to rig lease payments are not recorded in the accompanying condensed consolidated balance sheets. As of September 30, 2011, the minimum aggregate undiscounted future rig lease payments were approximately $481 million.

Compressor Leases

Through various transactions since 2007, our compression subsidiary has sold 2,542 compressors (net of six repurchased units), a significant portion of its compressor fleet, for $635 million and entered into a master lease agreement. The term of the agreement varies by buyer ranging from four to ten years. The lease obligations are guaranteed by Chesapeake and certain of its subsidiaries. These transactions were recorded as sales and operating leasebacks and any related gain or loss is 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 the expiration of the lease for the fair market value at the time. In addition, in most cases 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 September 30, 2011, the minimum aggregate undiscounted future compressor lease payments were approximately $496 million.

Gathering, Processing and Transportation Agreements

We have contractual commitments with midstream service companies and pipeline carriers for future gathering, processing and transportation of natural gas and liquids to move certain of our production to market. Working interest owners who are selling with us under our marketing agreements will reimburse us for some of these costs. While we expect to have sufficient production to fully utilize the committed capacity, we can pursue a release of any unused capacity to others, thus potentially reducing our future commitment. Commitments related to gathering, processing and transportation agreements are not recorded in the accompanying condensed consolidated balance sheets.

The aggregate undiscounted commitments under our gathering, processing and transportation agreements, excluding any reimbursement from working interest owners, are presented below.


	September 30, 2011
	($ in millions)

2011		$	233
2012			1,026
2013			1,170
2014			1,168
2015			1,213
2016 - 2099			6,878

Total		$	11,688

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Drilling Contracts

Chesapeake has contracts with various drilling contractors to lease approximately 64 rigs with terms ranging from four months to three years. These commitments are not recorded in the accompanying condensed consolidated balance sheets. As of September 30, 2011, the aggregate undiscounted minimum future drilling rig commitment was approximately $494 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.

Net Acreage Maintenance Commitments

Under the terms of our joint venture agreements with certain of our partners (Statoil, Total and CNOOC), 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 for certain designated time periods.

Other Obligations

In April 2011, we entered into a master frac services agreement with Frac Tech Services, LLC, under which we agreed to a structured fee for the exclusive use of a portion of Frac Tech’s pressure pumping fleets through December 31, 2014.

In July 2011, we agreed to invest $150 million in newly issued convertible promissory notes of Clean Energy Fuels Corp. (Nasdaq:CLNE), based in Seal Beach, California. The investment is being made in three equal $50 million promissory notes, the first of which was issued on July 11, 2011, with the remaining notes scheduled to be issued in June 2012 and June 2013. The notes bear interest at the annual rate of 7.5%, payable quarterly, and are convertible at our option into shares of Clean Energy’s common stock at a 22.5% conversion premium, resulting in a conversion price of $15.80 per share. See Note 9 for further discussion of this investment.

In July 2011, we agreed to invest $155 million in preferred equity securities of Sundrop Fuels, Inc., a privately held cellulosic biofuels company based in Louisville, Colorado. The first $35 million tranche of our investment was funded on July 11, 2011 and the remaining tranches of preferred equity investment will be scheduled around certain funding and operational milestones that are expected to be reached over the next two years. See Note 9 for further discussion of this investment.

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 Quarter, the Prior Quarter, the Current Period and the Prior Period, all outstanding securities that were convertible into common stock were included in the calculation of diluted EPS.

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


		Income (Numerator)		Weighted Average Shares (Denominator)		Per Share Amount
		(in millions, except per share data)
Three Months Ended September 30, 2011:
Basic EPS	$		879		638	$	1.38


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			21		56
Common shares assumed issued for 5.75% cumulative convertible preferred stock (series A)			16		39
Common shares assumed issued for 5.00% cumulative convertible preferred stock (series 2005B)			3		5
Common shares assumed issued for 4.50% cumulative convertible preferred stock			3		6
Unvested restricted stock			—		8
Outstanding stock options			—		1


Diluted EPS	$		922		753	$	1.23


Three Months Ended September 30, 2010:
Basic EPS	$		515		632	$	0.81


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			21		56
Common shares assumed issued for 5.75% cumulative convertible preferred stock (series A)			16		40
Common shares assumed issued for 5.00% cumulative convertible preferred stock (series 2005B)			3		5
Common shares assumed issued for 4.50% cumulative convertible preferred stock			3		6
Unvested restricted stock			—		4
Outstanding stock options			—		1


Diluted EPS	$		558		744	$	0.75

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)


		Income (Numerator)		Weighted Average Shares (Denominator)		Per Share Amount
		(in millions, except per share data)
Nine Months Ended September 30, 2011:
Basic EPS	$		1,141		636	$	1.79


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			64		56
Common shares assumed issued for 5.75% cumulative convertible preferred stock (series A)			47		39
Common shares assumed issued for 5.00% cumulative convertible preferred stock (series 2005B)			8		5
Common shares assumed issued for 4.50% cumulative convertible preferred stock			9		6
Unvested restricted stock			—		9
Outstanding stock options			—		1


Diluted EPS	$		1,269		752	$	1.69


Nine Months Ended September 30, 2010:
Basic EPS	$		1,482		631	$	2.35


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			28		24
Common shares assumed issued for 5.75% cumulative convertible preferred stock (series A)			23		20
Common shares assumed issued for 5.00% cumulative convertible preferred stock (series 2005B)			8		5
Common shares assumed issued for 4.50% cumulative convertible preferred stock			9		6
Unvested restricted stock			—		5
Outstanding stock options			—		1


Diluted EPS	$		1,550		692	$	2.24

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 nine months ended September 30, 2011 and 2010:


	2011		2010
	(in thousands)

Shares issued at January 1		655,251		648,549
Restricted stock issuances (net of forfeitures)		5,096		6,108
Stock option exercises		394		354
Convertible note exchanges		—		299
Preferred stock conversions/exchanges		111		21

Shares issued at September 30		660,852		655,331

In the Prior 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. The difference between the allocated debt value of the notes that were exchanged and the fair value of the common stock issued resulted in a $2 million loss (including a nominal amount of deferred charges associated with the exchanges).

Preferred Stock

The following reflects our preferred shares outstanding for the nine months ended September 30, 2011 and 2010:


	5.75%			5.75% (A)		4.50%		5.00% (2005B)		5.00% (2005)
	(in thousands)

Shares outstanding at January 1, 2011		1,500			1,100		2,559		2,096		—
Conversion of preferred into common stock		(3	)		—		—		—		—

Shares outstanding at September 30, 2011		1,497			1,100		2,559		2,096		—


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 September 30, 2010		1,500			1,100		2,559		2,096		—

In the Current Period, 3,000 shares of our outstanding 5.75% Cumulative Convertible Non-Voting Preferred Stock were converted into 111,111 shares of common stock pursuant to the holder’s conversion rights.

In the Prior Period, 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.

In the Prior Period, 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.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

In the Prior Period, 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.

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.

Dividends on our outstanding preferred stock are payable quarterly. We may pay dividends on our 5.00% Cumulative Convertible Preferred Stock (Series 2005B) and our 4.50% Cumulative Convertible Preferred Stock in cash, common stock or a combination thereof, at our option. Dividends on both series of our 5.75% Cumulative Convertible Non-Voting Preferred Stock are payable only in cash.

Stock-Based Compensation

Chesapeake’s stock-based compensation program consists of restricted stock, and prior to 2006 stock options, issued to employees and non-employee directors. We recognize in our financial statements the cost of employee services received in exchange for awards of equity instruments based on the fair value of the equity instruments at the date of the grant. To the extent compensation cost relates to employees directly involved in natural gas and oil acquisition, exploration and development activities, such amounts are capitalized to natural gas and oil properties. Amounts not capitalized to natural gas and oil properties are recognized as general and administrative expenses, production expenses, marketing, gathering and compression expenses or oilfield services 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 September 30,				Nine Months Ended September 30,
	2011		2010		2011		2010
	($ in millions)

Natural gas and oil properties	$	30	$	30	$	90	$	95
General and administrative expenses		24		21		71		63
Production expenses		8		9		26		27
Marketing, gathering and compression expenses		5		5		14		13
Oilfield services expense		3		2		8		7

Total	$	70	$	67	$	209	$	205

Restricted Stock. Chesapeake began issuing shares of restricted common stock to employees in January 2004 and to non-employee directors in July 2005. 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.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

A summary of the changes in unvested shares of restricted stock for the nine months ended September 30, 2011 is presented below.


	Number of Unvested Restricted Shares			Weighted Average Grant-Date Fair Value
	(in thousands)

Unvested shares as of January 1, 2011		21,375		$ 28.68
Granted		9,321		$ 28.44
Vested		(10,033	)	$ 31.88
Forfeited		(749	)	$ 27.37

Unvested shares as of September 30, 2011		19,914		$ 27.01

The aggregate intrinsic value of restricted stock vested during the Current Period was approximately $289 million based on the stock price at the time of vesting.

As of September 30, 2011, there was $397 million of total unrecognized compensation cost related to unvested restricted stock. The cost is expected to be recognized over a weighted average period of approximately three years.

The vesting of certain restricted stock grants could result 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 reductions in tax benefits related to restricted stock of $7 million, $14 million, $8 million and $15 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 of our outstanding stock options are fully vested and exercisable.

The following table provides information related to stock option activity for the nine months ended September 30, 2011:


	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, 2011		1,808			$	8.90		2.03		$	31
Exercised		(483	)		$	6.88

Outstanding and exercisable at September 30, 2011		1,325			$	9.64		1.53		$	21

(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.

There is no remaining unrecognized compensation cost related to unvested stock options.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

During the Current Quarter, the Prior Quarter, the Current Period and the Prior Period, we recognized excess tax benefits related to stock options of a nominal amount, $1 million, $3 million and $2 million, respectively, which were recorded as adjustments to additional paid-in capital and deferred income taxes.

Debt

Our long-term debt consisted of the following at September 30, 2011 and December 31, 2010:


	September 30, 2011			December 31, 2010
	($ in millions)

7.625% senior notes due 2013	$	464		$	500
9.5% senior notes due 2015		1,265			1,425
6.25% euro-denominated senior notes due 2017^(a)		463			796
6.5% senior notes due 2017		660			1,100
6.875% senior notes due 2018		474			600
7.25% senior notes due 2018		669			800
6.625% senior notes due 2020		1,300			1,400
6.875% senior notes due 2020		500			500
6.125% senior notes due 2021		1,000			—
2.75% contingent convertible senior notes due 2035^(b)		396			451
2.5% contingent convertible senior notes due 2037^(b)		1,168			1,378
2.25% contingent convertible senior notes due 2038^(b)		346			752
Corporate revolving bank credit facility		3,236			3,612
Midstream revolving bank credit facility		327			94
Discount on senior notes^(c)		(509	)		(777	)
Interest rate derivatives^(d)		30			9

Total long-term debt	$	11,789		$	12,640

(a)	The principal amount shown is based on the exchange rate of $1.3449 to €1.00 and $1.3269 to €1.00 as of September 30, 2011 and December 31, 2010, respectively. See Note 2 for information on our related foreign currency derivatives.

(b)

The holders of our contingent convertible senior notes may require us to repurchase, in cash, all or a portion of their notes at 100% of the principal amount of the notes on any of four dates that are five, ten, fifteen and twenty years before the maturity date. The notes are convertible, at the holder’s option, prior to maturity under certain circumstances into cash and, if applicable, shares of our common stock using a net share settlement process. One such triggering circumstance is when the price of our common stock exceeds a threshold amount during a specified period in a fiscal quarter. Convertibility based on common stock price is measured quarter by quarter. In the third quarter of 2011, 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 fourth quarter of 2011 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 in which contingent interest may be payable for the contingent convertible senior notes are as follows:

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

	Repurchase Dates	Repurchase Dates	Repurchase Dates
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	$ 48.62	May 14, 2016
2.5% due 2037	May 15, 2017, 2022, 2027, 2032	$ 64.16	November 14, 2017
2.25% due 2038	December 15, 2018, 2023, 2028, 2033	$ 107.36	June 14, 2019

(c)	Included in this discount is $460 million at September 30, 2011 and $711 million at December 31, 2010 associated with the equity component of our contingent convertible senior notes. This discount is based on an effective yield method.

(d)	See Note 2 for further 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, excluding Chesapeake Midstream Development, L.P. (CMD) and its subsidiaries and, beginning in the 2011 fourth quarter, Chesapeake Oilfield Services, L.L.C. and its subsidiaries (see Note 13 for this subsequent event). See Note 11 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. Our senior notes 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.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

In May 2011, we completed and settled tender offers to purchase the following senior notes and contingent convertible senior notes in order to reduce the amount of our outstanding indebtedness. We funded the purchase of the notes with a portion of the net proceeds we received from the sale of our Fayetteville Shale assets which is described in Note 8.


	Principal Amount Purchased
	($ in millions)

7.625% senior notes due 2013	$	36
9.5% senior notes due 2015		160
6.25% euro-denominated senior notes due 2017^(a)		380
6.5% senior notes due 2017		440
6.875% senior notes due 2018		126
7.25% senior notes due 2018		131
6.625% senior notes due 2020		100

Total senior notes		1,373


2.75% contingent convertible senior notes due 2035		55
2.5% contingent convertible senior notes due 2037		210
2.25% contingent convertible senior notes due 2038		266

Total contingent convertible senior notes		531


Total	$	1,904

(a)

We purchased €256 million in aggregate principal amount of our euro-denominated senior notes which had a value of $380 million based on the exchange rate of $1.4821 to €1.00. Simultaneously with our purchase of the euro-denominated senior notes, we unwound cross currency swaps for the same principal amount. See Note 2 for additional information.

We paid $2.058 billion in cash for the tender offers described above and recorded associated losses of approximately $174 million. The losses included $154 million in cash premiums, $20 million of deferred charges, $160 million of note discounts and $2 million of interest rate hedging losses, offset by $162 million of the equity component of the contingent convertible notes.

During the Current Period, we repurchased $140 million in aggregate principal amount of our 2.25% Contingent Convertible Senior Notes due 2038 for approximately $128 million. Associated with these repurchases, we recognized a loss of $2 million in the Current Period.

During the Current Period, we issued $1.0 billion principal amount of 6.125% Senior Notes due 2021 in a registered public offering. We used the net proceeds of $977 million from the offering to repay indebtedness outstanding under our corporate revolving bank credit facility.

During the Prior Period, 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 Prior Period.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

During the Prior Period, we redeemed in whole for a redemption price of approximately $619 million, plus accrued interest, all $600 million in principal amount of our 6.375% Senior Notes due 2015. Associated with the redemption, we recognized a loss of $19 million in the Prior Period.

During the Prior Period, we filed a shelf registration statement on Form S-3 with the SEC for the offering from time to time of debt securities.

During the Prior Period, we completed a public offering of $2.0 billion aggregate principal amount of senior notes for net proceeds of approximately $1.967 billion. The offering consisted of $600 million of 6.875% Senior Notes due 2018 and $1.4 billion of 6.625% Senior Notes due 2020. Both series were priced at par.

During the Prior Period, we completed tender offers to purchase for cash $245 million of 7.00% Senior Notes due 2014, $567 million of 6.625% Senior Notes due 2016 and $582 million of 6.25% Senior Notes due 2018. Following the completion of these tender offers, we redeemed the remaining $55 million of 7.00% Senior Notes due 2014, $33 million of 6.625% Senior Notes due 2016 and $18 million of 6.25% Senior Notes due 2018 based on the redemption provisions in the indentures. Associated with the tender offers and redemptions, we recognized a loss of $40 million in the Prior Period.

During the Prior 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 Prior Period.

No scheduled principal payments are required under our senior notes until 2013 when $464 million is due.

Bank Credit Facilities

As of September 30, 2011, we utilized two revolving bank credit facilities, described below, as sources of liquidity.

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

Facility structure	Senior secured revolving	Senior secured revolving
Maturity date	December 2015	June 2016
Borrowing capacity	$ 4,000	$ 600^(c)
Amount outstanding as of September 30, 2011	$ 3,236	$ 327
Letters of credit outstanding as of September 30, 2011	$ 60	$ —

(a)	Borrower is Chesapeake Exploration, L.L.C.

(b)	Borrower is Chesapeake Midstream Operating, L.L.C.

(c)	The decrease in operating income following the sale of our Haynesville Springridge gathering system in December 2010 and the sale of our Fayetteville gathering system in March 2011 caused the borrowing capacity under the facility to be limited to $440 million as of September 30, 2011.

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, neither of our credit facilities contains provisions which would trigger an acceleration of amounts due under the facilities or a requirement to post additional collateral in the event of a downgrade of our credit ratings.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Corporate Credit Facility

Our $4.0 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 0.50% to 1.25% per annum according to our senior unsecured long-term debt ratings, or (ii) the Eurodollar rate, which is based on 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% per annum. 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 and require us to maintain an indebtedness to total capitalization ratio and an indebtedness to EBITDA ratio, in each case as defined in the agreement. We were in compliance with all covenants under the agreement at September 30, 2011. 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 $50 million or more, 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 $125 million.

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

Midstream Credit Facility

Our $600 million midstream syndicated revolving bank credit facility is used to fund capital expenditures to build natural gas gathering and other systems in support of 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 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 1.00% to 1.75% per annum or (ii) the Eurodollar rate, which is based on the LIBOR plus a margin that varies from 2.00% to 2.75% per annum. The unused portion of the facility is subject to a commitment fee that varies from 0.375% to 0.50% per annum. Both margins and commitment fees are determined according to the most recent leverage ratio described below. 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 agreement requires maintenance of a leverage ratio based on the ratio of indebtedness to EBITDA and an interest coverage ratio based on the ratio of EBITDA to interest expense, in each case as defined in the agreement. The leverage ratio increases during any three-quarter period, beginning in the quarter in which CMD makes a material disposition of assets to our master limited partnership midstream affiliate, Chesapeake Midstream Partners, L.P. We were in compliance with all covenants under the agreement at September 30, 2011. 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 from time to time with an outstanding principal amount in excess of $15 million.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

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 2010 and one of the assets in 2011. As of September 30, 2011, we had 110 assets remaining and the obligation is recorded in other long-term liabilities on our condensed consolidated balance sheets.

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. This obligation is recorded in other long-term liabilities on our condensed consolidated balance sheets.

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 operating segment and natural gas and oil marketing, gathering and compression operating segment are managed separately because of the nature of their products and services. The exploration and production operating segment is responsible for finding and producing natural gas and oil. The marketing, gathering and compression operating segment is responsible for marketing, gathering and compression of natural gas and oil primarily from Chesapeake-operated wells. We also have contract drilling, oilfield trucking, oilfield rental and other oilfield service operations which are responsible for providing services for both Chesapeake-operated wells and wells operated by third parties. Our contract drilling, oilfield trucking, oilfield rental and other oilfield service operations are included in “Other Operations” in the following table:

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Management evaluates the performance of our segments based upon income (loss) before income taxes. Revenues from the sale of natural gas and oil related to Chesapeake’s ownership interests by the marketing, gathering and compression operating segment are reflected as exploration and production revenues. Such amounts totaled $1.324 billion, $1.045 billion, $3.739 billion and $2.978 billion for the Current Quarter, the Prior Quarter, the Current Period and the Prior Period, respectively. The following table presents selected financial information for Chesapeake’s operating segments.

		Intercompany		Intercompany			Intercompany			Intercompany			Intercompany
	Exploration and Production		Marketing, Gathering and Compression			Other Operations			Intercompany Eliminations			Consolidated Total
	($ in millions)
Three Months Ended September 30, 2011:
Revenues	$	2,402	$	2,746		$	343		$	(1,514	)	$	3,977
Intersegment revenues		—		(1,324	)		(190	)		1,514			—

Total revenues	$	2,402	$	1,422		$	153		$	—		$	3,977


Income before income taxes	$	1,496	$	79		$	23		$	(87	)	$	1,511


Three Months Ended September 30, 2010:
Revenues	$	1,639	$	1,928		$	187		$	(1,173	)	$	2,581
Intersegment revenues		—		(1,045	)		(128	)		1,173			—

Total revenues	$	1,639	$	883		$	59		$	—		$	2,581


Income (loss) before income taxes	$	822	$	96		$	(7	)	$	(4	)	$	907


Nine Months Ended September 30, 2011:
Revenues	$	4,688	$	7,583		$	866		$	(4,229	)	$	8,908
Intersegment revenues		—		(3,739	)		(490	)		4,229			—

Total revenues	$	4,688	$	3,844		$	376		$	—		$	8,908


Income before income taxes	$	2,007	$	239		$	66		$	(231	)	$	2,081


Nine Months Ended September 30, 2010:
Revenues	$	4,698	$	5,498		$	538		$	(3,343	)	$	7,391
Intersegment revenues		—		(2,978	)		(365	)		3,343			—

Total revenues	$	4,698	$	2,520		$	173		$	—		$	7,391


Income (loss) before income taxes	$	2,401	$	152		$	(32	)	$	(1	)	$	2,520


As of September 30 2011:
Total assets	$	35,991	$	3,885		$	1,604		$	(1,358	)	$	40,122

As of December 31, 2010:
Total assets	$	33,560	$	3,458		$	854		$	(693	)	$	37,179

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

8.	Acquisitions and Divestitures

Acquisition of Bronco Drilling

In June 2011, we acquired Bronco Drilling Company, Inc. (Nasdaq/GS:BRNC) for an aggregate purchase price of approximately $339 million, or $11.00 per share of Bronco common stock. The acquisition was accounted for as a business combination which, among other things, requires assets acquired and liabilities assumed to be measured at their acquisition date fair values. Pro forma financial information is not presented as it would not be materially different from the information presented in the condensed consolidated statement of income.

The following table summarizes the assets acquired and liabilities assumed:


	As of June 6, 2011
	($ in millions)

Current assets		$	46
Drilling rigs and equipment			287
Goodwill			42
Intangible assets			10
Other			12

Total assets acquired			397

Current liabilities			33
Long-term liabilities			1
Deferred income taxes			24

Total liabilities assumed			58


Net assets acquired		$	339

The acquisition date fair value of the consideration transferred was $339 million in cash. We received carryover tax basis in Bronco’s assets and liabilities because the acquisition was not a taxable transaction under the Internal Revenue Code. Based upon the purchase price allocation, a step-up in basis related to the assets acquired from Bronco resulted in a net deferred tax liability of approximately $24 million. We recorded goodwill of $42 million, which represents the amount of the consideration transferred in excess of the fair values assigned to the individual assets acquired and liabilities assumed. Goodwill is primarily attributable to operational and cost synergies expected to be realized from the acquisition by integrating Bronco’s drilling rigs and assembled workforce. Goodwill was assigned to drilling rig operations which is discussed in Note 7. Goodwill recorded in the acquisition is not subject to amortization but will be tested annually for impairment. None of the goodwill is deductible for tax purposes. The drilling rigs and equipment we acquired from Bronco are now owned by Nomac Drilling, L.L.C., our drilling subsidiary.

Fayetteville Shale Asset Sale

On March 31, 2011, we sold all of our Fayetteville Shale assets in central Arkansas to BHP Billiton Petroleum, a wholly owned subsidiary of BHP Billiton Limited (NYSE:BHP;ASX:BHP), for net proceeds of approximately $4.65 billion in cash. The properties sold consisted of approximately 487,000 net acres of leasehold, net production at closing of approximately 415 million cubic feet of natural gas equivalent per day and midstream assets consisting of approximately 420 miles of pipeline. As part of the transaction, Chesapeake agreed to provide technical and business services for up to one year for BHP Billiton’s Fayetteville properties for an agreed-upon fee. Under full cost accounting rules, we accounted for the sale of our Fayetteville Shale natural gas and oil properties as an adjustment to capitalized costs, with no recognition of gain or loss.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Joint Ventures

As of September 30, 2011, we had entered into six significant joint ventures pursuant to which we sold a portion of our leasehold, producing properties and other assets located in six different resource plays and received cash of $6.5 billion and commitments for future drilling and completion cost sharing of $7.7 billion. These transactions have allowed us to recover much or all of our initial leasehold investments and reduce our ongoing capital costs in these plays. For accounting purposes, initial cash proceeds from these joint venture transactions were reflected as a reduction of natural gas and oil properties with no gain or loss recognized. The transactions are detailed below.


Primary Play	Joint Venture Partner^(a)	Joint Venture Date	Interest Acquired	Cash Proceeds Received at Closing		Total Drilling Carries		Drilling Carries Remaining^(b⁾
				($ in millions)

Niobrara	CNOOC	February 2011	33.3%	$	570	$	697	$	607
Eagle Ford & Pearsall	CNOOC	November 2010	33.3%		1,120		1,080		467
Barnett	TOT	January 2010	25.0%		800		1,450		471	^(c)
Marcellus	STO	November 2008	32.5%		1,250		2,125		564
Fayetteville	BP	September 2008	25.0%		1,100		800		—
Haynesville & Bossier	PXP	July 2008	20.0%		1,650		1,508		—

				$	6,490	$	7,660	$	2,109

(a)	Joint venture partners include CNOOC Limited (CNOOC), Total S.A. (TOT), Statoil (STO), BP America (BP) and Plains Exploration & Production Company (PXP).

(b)	As of September 30, 2011.

(c)	On October 24, 2011, Total accelerated the payment of its remaining joint venture carry in exchange for an approximate 9% reduction to the total amount of drilling carry obligation due to us. See Note 13 for this subsequent event.

During the Current Period and the Prior Period, our drilling and completion costs included the benefit of approximately $1.868 billion and $745 million, respectively, in drilling and completion carries paid by our joint venture partners, CNOOC, Total and Statoil.

During the Current Period and the Prior Period, as part of our joint venture agreements with CNOOC, Total, Statoil and Plains Exploration & Production Company, we sold interests in additional leasehold in the Niobrara, Eagle Ford and Pearsall, Barnett, Marcellus and Haynesville and Bossier shale plays to our joint venture partners for approximately $474 million and $395 million, respectively.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

Volumetric Production Payments

From time to time, we have monetized certain of our producing assets which are located in more mature producing regions through the sale of volumetric production payments (VPPs). A VPP is a limited-term overriding royalty interest in natural gas and oil reserves that (i) entitles the purchaser to receive scheduled production volumes over a period of time from specific lease interests; (ii) is free and clear of all associated future production costs and capital expenditures; (iii) is nonrecourse to the seller (i.e., the purchaser’s only recourse is to the reserves acquired); (iv) transfers title of the reserves to the purchaser; and (v) allows the seller to retain the remaining reserves, if any, after the scheduled production volumes have been delivered. We retain drilling rights on the properties below currently producing intervals and outside of producing well bores. We also retain all production beyond the specified volumes sold in the transaction.

We have completed the following VPP transactions since 2007:


					Proved Reserves				Original
Date of VPP	Location	Proceeds			(at time of sale)		$ / mcfe		Term
		($ in millions)			(bcfe)				(years)

May 2011	Mid-Continent		$	853		177		$ 4.82		10

September 2010	Barnett Shale			1,150		390		$ 2.93		5

June 2010	Permian Basin			335		38		$ 8.73		10

February 2010	East Texas and the Texas Gulf Coast			180		46		$ 3.95		10

August 2009	South Texas			370		68		$ 5.46		7.5

December 2008	Anadarko and Arkoma Basins			412		98		$ 4.19		8

August 2008	Anadarko Basin			600		93		$ 6.38		11

May 2008	Texas, Oklahoma and Kansas			622		94		$ 6.53		11

December 2007	Kentucky and West Virginia			1,100		208		$ 5.29		15

			$	5,622		1,212		$ 4.64

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.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

9.	Investments

At September 30, 2011 and December 31, 2010, we had the following investments:


			Carrying Value
	Approximate	Accounting	September 30,		December 30
	% Owned	Method	2011		2010
			($ in millions)

Chesapeake Midstream Partners, L.P.	42%	Equity	$	696	$	695
FTS International, LLC	30%^(a)	Equity		202		311
Chaparral Energy, Inc.	20%	Equity		130		133
Clean Energy Fuels Corp.	—	Cost		50		—
Sundrop Fuels, Inc.	25%	Equity		35		—
Gastar Exploration Ltd.	10%	Cost		20		29
Other	—	Cost/Equity		33		40

			$	1,166	$	1,208

(a)	Formerly Frac Tech International, LLC. Prior to the recapitalization described below, we owned approximately 26% of Frac Tech Holdings, LLC.

Chesapeake Midstream Partners, L.P. 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, and GIP purchased a 50% interest in, a new joint venture entity. 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.

On August 3, 2010, Chesapeake Midstream Partners, L.P. (NYSE:CHKM) completed an initial public offering of 24,437,500 common units representing limited partner interests (including 3,187,500 common units issued pursuant to the exercise of the underwriters’ over-allotment option on August 3, 2010) and received gross offering proceeds of approximately $513 million at an initial offering price of $21.00 per unit less approximately $38 million for underwriting discounts and commissions, structuring fees and offering expenses. As of September 30, 2011, common units owned by public security holders represented 17.7% of all outstanding limited partner interests, and Chesapeake and GIP held 42.3% and 40.0%, respectively, of all outstanding limited partner interests. The limited partners, collectively, have a 98.0% interest in CHKM and the general partner, which is owned and controlled 50/50 by Chesapeake and GIP, has a 2.0% interest in CHKM.

During the Current Period, we recorded positive equity method adjustments of $55 million for our share of CHKM’s income, received cash distributions of $63 million from CHKM and recorded accretion adjustments of $9 million related to our share of equity in excess of cost. The carrying value of our investment in CHKM is less than our underlying equity in net assets by approximately $229 million as of September 30, 2011. This difference is being accreted over 20 years.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

FTS International, LLC. FTS International, LLC (FTS), based in Fort Worth, Texas, is the privately held parent company of Frac Tech Services, LLC, which provides pressure pumping and well stimulation to oil and gas companies. On May 6, 2011, there was a change in controlling ownership of FTS’s predecessor, Frac Tech Holdings, L.L.C., which resulted in a recapitalization that increased our equity ownership from 26% to 30%. We also entered into a master frac services agreement that obligates us to use certain services of FTS through 2014. Based on the valuation of the net assets performed by FTS in conjunction with the change in controlling ownership, the carrying value of our investment in FTS is less than our underlying equity in FTS’s net assets by approximately $870 million as of September 30, 2011. We allocated this difference to the tangible and intangible assets of FTS and will accrete the portion attributable to the non-goodwill assets over their estimated lives of nine years.

In the Current Period, we recorded positive equity method adjustments of $104 million for our share of FTS’s income, received cash distributions of $224 million from FTS and recorded accretion adjustments of $11 million.

Clean Energy Fuels Corp. On July 11, 2011, we agreed to invest $150 million in newly issued convertible promissory notes of Clean Energy Fuels Corp. (Nasdaq:CLNE), based in Seal Beach, California. The investment is being made in three equal $50 million promissory notes, the first of which was issued on July 11, 2011, with the remaining notes scheduled to be issued in June 2012 and June 2013. The notes bear interest at the annual rate of 7.5%, payable quarterly, and are convertible at our option into shares of Clean Energy’s common stock at a 22.5% conversion premium, resulting in a conversion price of $15.80 per share. Under certain circumstances following the second anniversary of the issuance of a note, Clean Energy can force conversion of the debt. The entire principal balance of each note is due and payable seven years following issuance. Clean Energy will use our $150 million investment to accelerate its build-out of LNG fueling infrastructure for heavy-duty trucks at truck stops across interstate highways in the U.S.

Sundrop Fuels, Inc. On July 11, 2011, we agreed to invest $155 million in preferred equity securities of Sundrop Fuels, Inc., a privately held cellulosic biofuels company based in Louisville, Colorado. The investment over the next two years will fund construction of a nonfood biomass-based “green gasoline” plant, capable of annually producing more than 40 million gallons of gasoline from natural gas and waste cellulosic material. The investment is intended to accelerate the development of an affordable, stable, room-temperature, natural gas-based fuel for immediate use in automobiles, diesel engine vehicles and aircraft. The first $35 million tranche of our investment was funded on July 11, 2011 and the remaining tranches of preferred equity investment will be scheduled around certain funding and operational milestones that are expected to be reached over the next two years. The full investment will represent 50% of Sundrop Fuels’ equity on a fully diluted basis.

Chaparral Energy, Inc. Chaparral Energy, Inc., based in Oklahoma City, Oklahoma, is a private independent oil and natural gas company engaged in the production, acquisition and exploitation of oil and natural gas properties. The carrying value of our investment in Chaparral is in excess of our underlying equity in net assets by approximately $55 million as of September 30, 2011. 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. In the Current Period, we recorded a $1 million charge related to our share of Chaparral’s net loss and depreciation adjustments of $2 million related to the excess of our cost over our proportionate share of Chaparral’s book equity.

Gastar Exploration Ltd. Gastar Exploration Ltd. (NYSE Amex:GST), based in Houston, Texas, is an independent energy company engaged in the exploration, development and production of natural gas and oil in the U.S. During the Current Period, the common stock price of Gastar decreased from $4.30 per share to $3.00 per share. Our investment in Gastar had a historical cost basis of $89 million as of September 30, 2011.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

10.

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 and the following methods and assumptions to measure the fair values of its assets and liabilities, which may or may not be observable in the market.

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, interest rate swaps and cross currency swaps are based on third-party pricing models which utilize 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 commodity, interest rate and cross currency swaps do not include optionality and therefore have no unobservable inputs, they are classified as Level 2. All other derivatives have some level of unobservable input, such as volatility curves, and are therefore classified as Level 3. For interest rate options and swaptions, we use the fair value estimates provided by our respective counterparties. 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 non-performance risk into the valuation of our derivatives using current published credit default swap 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 related qualifying interest rate swaps.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

The following table provides fair value measurement information for financial assets (liabilities) measured at fair value on a recurring basis as of September 30, 2011:


	Quoted Prices in Active Markets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total Fair Value




	($ in millions)
Financial Assets (Liabilities):
Cash equivalents	$	111		$	—		$	—		$	111
Investments		20			—			—			20
Other long-term assets		61			—			—			61
Other long-term liabilities		(55	)		—			—			(55	)

Derivatives:
Commodity assets		—			11			98			109
Commodity liabilities		—			(15	)		(1,650	)		(1,665	)
Interest rate liabilities		—			(46	)		—			(46	)
Foreign currency liabilities		—			(31	)		—			(31	)

Total derivatives		—			(81	)		(1,552	)		(1,633	)


Total	$	137		$	(81	)	$	(1,552	)	$	(1,496	)

The following table provides fair value measurement information for financial assets (liabilities) measured at fair value on a recurring basis as of December 31, 2010:


	Quoted Prices in Active Markets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total Fair Value




	($ in millions)
Financial Assets (Liabilities):
Cash equivalents	$	102		$	—		$	—		$	102
Investments		29			—			—			29
Other long-term assets		52			—			—			52
Long-term debt		—			—			(1,371	)		(1,371	)
Other long-term liabilities		(52	)		—			—			(52	)

Derivatives:
Commodity assets		—			1,364			105			1,469
Commodity liabilities		—			(59	)		(2,059	)		(2,118	)
Interest rate liabilities		—			—			(69	)		(69	)
Foreign currency liabilities		—			—			(43	)		(43	)

Total derivatives		—			1,305			(2,066	)		(761	)


Total	$	131		$	1,305		$	(3,437	)	$	(2,001	)

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

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.


	Derivatives									Debt
	Commodity			Interest Rate			Foreign Currency
	Commodity			Interest Rate			Foreign Currency
	($ in millions)

Beginning Balance as of January 1, 2011	$	(1,954	)	$	(69	)	$	(43	)	$	(1,371	)
Total gains (losses):
Included in earnings (realized)^(a)		(50	)		—			—			—
Included in earnings or change in net assets (unrealized)^(a)		306			21			—			—
Included in other comprehensive income (loss)		—			—			—			—
Total purchases, issuances, sales and settlements:
Sales		—			(6	)		—			—
Settlements		146			—			—			—
Transfers in and out of Level 3⁽^b ⁾		—			54			43			1,371

Ending Balance as of September 30, 2011	$	(1,552	)	$	—		$	—		$	—


Beginning Balance as of January 1, 2010	$	(666	)	$	(132	)	$	43		$	(1,398	)
Total gains (losses):
Included in earnings (realized)^(a)		305			(6	)		—			—
Included in earnings or change in net assets (unrealized)^(a)		(669	)		85			(44	)		32
Included in other comprehensive income (loss)		(18	)		—			(34	)		—
Total purchases, issuances, sales and settlements:
Issuances		—			—			—			(700	)⁽^c⁾
Sales		—			(6	)		—			—
Settlements		(142	)		20			—			1,250	⁽^c⁾
Transfers in and out of Level 3		—			—			—			—

Ending Balance as of September 30, 2010	$	(1,190	)	$	(39	)	$	(35	)	$	(816	)

(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)	The values related to interest rate and cross currency swaps were transferred from Level 3 to Level 2 as a result of our ability to use data readily available in the public market to corroborate our estimated fair values.

(c)	Amount represents an increase or 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.


	September 30, 2011				December 31, 2010
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
	($ in millions)

Long-term debt	$	11,759	$	12,527	$	12,631	$	13,272
Convertible preferred stock	$	3,062	$	3,340	$	3,065	$	3,019

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

11.

Condensed Consolidating Financial Information

Chesapeake Energy Corporation is a holding company and owns no operating assets and has no significant operations independent of its subsidiaries. Our obligations under our outstanding senior notes and contingent convertible senior 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 bank credit facility referred to in Note 6 that restrict it from paying dividends or distributions or making loans to Chesapeake. Beginning in the 2011 fourth quarter, Chesapeake Oilfield Services, L.L.C. and its subsidiaries will no longer be guarantors under our outstanding senior notes and contingent convertible senior notes. See Note 13 for this subsequent event.

Set forth below are condensed consolidating financial statements for Chesapeake Energy Corporation (parent) on a stand-alone, unconsolidated basis, and its combined guarantor and combined non-guarantor subsidiaries as of September 30, 2011 and December 31, 2010 and for the three and nine months ended September 30, 2011 and 2010. 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 SEPTEMBER 30, 2011

($ in millions)


	Parent			Guarantor Subsidiaries		Non- Guarantor Subsidiaries		Eliminations			Consolidated



CURRENT ASSETS:
Cash and cash equivalents	$	—		$	88	$	23	$	—		$	111
Other		1			3,194		182		(18	)		3,359

Total Current Assets		1			3,282		205		(18	)		3,470

PROPERTY AND EQUIPMENT:
Natural gas and oil properties, at cost based on full-cost accounting, net		—			29,644		4		—			29,648
Other property and equipment, net		—			3,858		1,632		—			5,490

Total Property and Equipment, Net		—			33,502		1,636		—			35,138


Other assets		166			900		787		(339	)		1,514
Investments in subsidiaries and intercompany advances		2,371			293		—		(2,664	)		—

TOTAL ASSETS	$	2,538		$	37,977	$	2,628	$	(3,021	)	$	40,122


CURRENT LIABILITIES:
Current liabilities	$	216		$	5,704	$	294	$	(19	)	$	6,195
Intercompany payable to (receivable) from parent		(22,574	)		21,331		1,205		38			—

Total Current Liabilities		(22,358	)		27,035		1,499		19			6,195


LONG-TERM LIABILITIES:
Long-term debt, net		8,226			3,236		327		—			11,789
Deferred income tax liabilities		341			3,065		156		(38	)		3,524
Other liabilities		31			2,270		353		(338	)		2,316

Total Long-Term Liabilities		8,598			8,571		836		(376	)		17,629


STOCKHOLDERS’ EQUITY:

Total Stockholders’ Equity		16,298			2,371		293		(2,664	)		16,298


TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	2,538		$	37,977	$	2,628	$	(3,021	)	$	40,122

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

CONDENSED CONSOLIDATING BALANCE SHEET

AS OF DECEMBER 31, 2010

($ in millions)


	Parent			Guarantor Subsidiaries		Non- Guarantor Subsidiaries		Eliminations			Consolidated

CURRENT ASSETS:
Cash and cash equivalents	$	—		$	2	$	100	$	—		$	102
Other		7			3,065		123		(31	)		3,164

Total Current Assets		7			3,067		223		(31	)		3,266

PROPERTY AND EQUIPMENT:
Natural gas and oil properties, at cost based on full-cost accounting, net		—			27,822		4		—			27,826
Other property and equipment, net		—			3,246		1,306		—			4,552

Total Property and Equipment, Net		—			31,068		1,310		—			32,378


Other assets		166			669		700		—			1,535
Investments in subsidiaries and intercompany advances		1,217			269		—		(1,486	)		—

TOTAL ASSETS	$	1,390		$	35,073	$	2,233	$	(1,517	)	$	37,179


CURRENT LIABILITIES:
Current liabilities	$	302		$	4,082	$	137	$	(31	)	$	4,490
Intercompany payable to (receivable) from parent		(23,664	)		21,955		1,596		113			—

Total Current Liabilities		(23,362	)		26,037		1,733		82			4,490


LONG-TERM LIABILITIES:
Long-term debt, net		8,934			3,612		94		—			12,640
Deferred income tax liabilities		482			1,885		130		(113	)		2,384
Other liabilities		72			2,322		7		—			2,401

Total Long-Term Liabilities		9,488			7,819		231		(113	)		17,425


STOCKHOLDERS’ EQUITY:

Total Stockholders’ Equity		15,264			1,217		269		(1,486	)		15,264


TOTAL LIABILITIES AND STOCKHOLDERS’ EQUITY	$	1,390		$	35,073	$	2,233	$	(1,517	)	$	37,179

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(Unaudited)

CONDENSED CONSOLIDATING STATEMENT OF OPERATIONS

THREE MONTHS ENDED SEPTEMBER 30, 2011

($ in millions)


	Parent			Guarantor Subsidiaries			Non- Guarantor Subsidiaries			Eliminations			Consolidated

REVENUES:
Natural gas and oil sales	$	—		$	2,402		$	—		$	—		$	2,402
Marketing, gathering and compression sales		—			1,393			55			(26	)		1,422
Oilfield services revenue		—			129			24			—			153

Total Revenues		—			3,924			79			(26	)		3,977

OPERATING COSTS:
Production expenses		—			282			—			—			282
Production taxes		—			50			—			—			50
General and administrative expenses		—			143			8			—			151
Marketing, gathering and compression expenses		—			1,377			30			(15	)		1,392
Oilfield services expense		—			94			24			—			118
Natural gas and oil depreciation, depletion and amortization		—			423			—			—			423
Depreciation and amortization of other assets		—			59			16			—			75
Losses on sales of other property and equipment		—			1			2			—			3

Total Operating Costs		—			2,429			80			(15	)		2,494

INCOME (LOSS) FROM OPERATIONS		—			1,495			(1	)		(11	)		1,483

OTHER INCOME (EXPENSE):
Interest expense		(138	)		(17	)		(7	)		158			(4	)
Earnings on investments		—			4			24			—			28
Other income		152			9			1			(158	)		4
Equity in net earnings of subsidiary		914			4			—			(918	)		—

Total Other Income		928			—			18			(918	)		28

INCOME BEFORE INCOME TAXES		928			1,495			17			(929	)		1,511
INCOME TAX EXPENSE		6			581			6			(4	)		589

NET INCOME	$	922		$	914		$	11		$	(925	)	$	922

CHESAPEAKE ENERGY C