Edgar Filing: CHESAPEAKE ENERGY CORP

CHK-2013.03.31 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 March 31, 2013

[ ] 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 May 1, 2013, there were 666,461,015 shares of our $0.01 par value common stock outstanding.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

INDEX TO FORM 10-Q FOR THE QUARTER ENDED MARCH 31, 2013



	PART I.
Financial Information
		Page
Item 1.	Condensed Consolidated Financial Statements (Unaudited)
	Condensed Consolidated Balance Sheets as of March 31, 2013 and December 31, 2012	1
	Condensed Consolidated Statements of Operations for the Three Months Ended March 31, 2013 and 2012	3
	Condensed Consolidated Statements of Comprehensive Income for the Three Months Ended March 31, 2013 and 2012	4
	Condensed Consolidated Statements of Cash Flows for the Three Months Ended March 31, 2013 and 2012	5
	Condensed Consolidated Statements of Stockholders’ Equity for the Three Months Ended March 31, 2013 and 2012	7
	Notes to Condensed Consolidated Financial Statements	8
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	62
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	80
Item 4.	Controls and Procedures	87

	PART II.
Other Information

Item 1.	Legal Proceedings	88
Item 1A.	Risk Factors	88
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	88
Item 3.	Defaults Upon Senior Securities	88
Item 4.	Mine Safety Disclosures	88
Item 5.	Other Information	88
Item 6.	Exhibits	93

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS

(Unaudited)



	March 31, 2013			December 31, 2012
	($ in millions)
CURRENT ASSETS:
Cash and cash equivalents ($1 and $1 attributable to our VIE)	$	33		$	287
Restricted cash	81			111
Accounts receivable	2,382			2,245
Short-term derivative assets	5			58
Deferred income tax asset	216			90
Other current assets	156			153
Current assets held for sale	11			4
Total Current Assets	2,884			2,948
PROPERTY AND EQUIPMENT:
Natural gas and oil properties, at cost based on full cost accounting:
Evaluated natural gas and oil properties ($488 and $488 attributable to our VIE)	51,918			50,172
Unevaluated properties	14,626			14,755
Oilfield services equipment	2,261			2,130
Other property and equipment	3,797			3,778
Total Property and Equipment, at Cost	72,602			70,835
Less: accumulated depreciation, depletion and amortization (($109) and ($58) attributable to our VIEs)	(35,043		)	(34,302		)
Property and equipment held for sale, net	588			634
Total Property and Equipment, Net	38,147			37,167
LONG-TERM ASSETS:
Investments	711			728
Long-term derivative assets	2			2
Other long-term assets	737			766
TOTAL ASSETS	$	42,481		$	41,611

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

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED BALANCE SHEETS – (Continued)

(Unaudited)



	March 31, 2013			December 31, 2012
	($ in millions)
CURRENT LIABILITIES:
Accounts payable	$	1,909		$	1,710
Short-term derivative liabilities ($6 and $4 attributable to our VIEs)	424			105
Accrued interest	144			226
Current maturities of long-term debt, net	—			463
Other current liabilities ($23 and $21 attributable to our VIEs)	3,288			3,741
Current liabilities held for sale	20			21
Total Current Liabilities	5,785			6,266
LONG-TERM LIABILITIES:
Long-term debt, net	13,449			12,157
Deferred income tax liabilities	3,021			2,807
Long-term derivative liabilities ($3 and $3 attributable to our VIEs)	693			934
Asset retirement obligations	387			375
Other long-term liabilities	1,132			1,176
Total Long-Term Liabilities	18,682			17,449
CONTINGENCIES AND COMMITMENTS (Note 4)
EQUITY:
Chesapeake Stockholders’ Equity:
Preferred stock, $0.01 par value, 20,000,000 shares authorized:
7,251,515 shares outstanding	3,062			3,062
Common stock, $0.01 par value, 1,000,000,000 shares authorized:
669,274,935 and 666,467,664 shares issued	7			7
Paid-in capital	12,355			12,293
Retained earnings	495			437
Accumulated other comprehensive income (loss)	(170		)	(182		)
Less: treasury stock, at cost; 2,229,977 and 2,147,724 common shares	(49		)	(48		)
Total Chesapeake Stockholders’ Equity	15,700			15,569
Noncontrolling interests	2,314			2,327
Total Equity	18,014			17,896
TOTAL LIABILITIES AND EQUITY	$	42,481		$	41,611

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 March 31,
	2013			2012
	($ in millions except per share data)
REVENUES:
Natural gas, oil and NGL	$	1,453		$	1,068
Marketing, gathering and compression	1,781			1,216
Oilfield services	190			135
Total Revenues	3,424			2,419
OPERATING EXPENSES:
Natural gas, oil and NGL production	307			349
Production taxes	53			47
Marketing, gathering and compression	1,745			1,197
Oilfield services	155			96
General and administrative	110			136
Natural gas, oil and NGL depreciation, depletion and amortization	648			506
Depreciation and amortization of other assets	78			84
Net gains on sales of fixed assets	(49		)	(2		)
Impairments of fixed assets and other	27			—
Employee retirement and other termination benefits	133			—
Total Operating Expenses	3,207			2,413
INCOME FROM OPERATIONS	217			6
OTHER INCOME (EXPENSE):
Interest expense	(21		)	(12		)
Losses on investments	(27		)	(5		)
Impairment of investment	(10		)	—
Other income	6			6
Total Other Income (Expense)	(52		)	(11		)
INCOME (LOSS) BEFORE INCOME TAXES	165			(5		)
INCOME TAX EXPENSE (BENEFIT):
Current income taxes	1			—
Deferred income taxes	62			(2		)
Total Income Tax Expense (Benefit)	63			(2		)
NET INCOME (LOSS)	102			(3		)
Net income attributable to noncontrolling interests	(44		)	(25		)
NET INCOME (LOSS) ATTRIBUTABLE TO CHESAPEAKE	58			(28		)
Preferred stock dividends	(43		)	(43		)
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS	$	15		$	(71	)
EARNINGS (LOSS) PER COMMON SHARE:
Basic	$	0.02		$	(0.11	)
Diluted	$	0.02		$	(0.11	)
CASH DIVIDEND DECLARED PER COMMON SHARE	$	—		$	0.0875
WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING (in millions):
Basic	651			642
Diluted	651			642

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 March 31,
	2013			2012
	($ in millions)
NET INCOME (LOSS)	$	102		$	(3	)
Other comprehensive income (loss), net of income tax:
Unrealized gain (loss) on derivative instruments, net of income tax expense (benefit) of ($1) million and $2 million	(1		)	4
Reclassification of (gain) loss on settled derivative instruments, net of income tax expense (benefit) of $7 million and ($1) million	12			(2		)
Unrealized gain (loss) on investments, net of income tax expense (benefit) of ($3) million and $3 million	(5		)	5
Reclassification of impairment of investment, net of income tax expense (benefit) of $4 million and $0	6			—
Other comprehensive income	12			7
COMPREHENSIVE INCOME	114			4
COMPREHENSIVE INCOME ATTRIBUTABLE TO NONCONTROLLING INTERESTS	(44		)	(25		)
COMPREHENSIVE INCOME (LOSS) ATTRIBUTABLE TO CHESAPEAKE	$	70		$	(21	)

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)



	Three Months Ended March 31,
	2013			2012
	($ in millions)
CASH FLOWS FROM OPERATING ACTIVITIES:
NET INCOME (LOSS)	$	102		$	(3	)
ADJUSTMENTS TO RECONCILE NET INCOME (LOSS) TO CASH PROVIDED BY OPERATING ACTIVITIES:
Depreciation, depletion and amortization	726			590
Deferred income tax expense (benefit)	62			(2		)
Unrealized losses on derivatives	152			276
Stock-based compensation	32			32
Net gains on sales of fixed assets	(49		)	(2		)
Impairments of fixed assets and other	27			—
Losses on investments	29			33
Impairment of investment	10			—
Employee retirement and other termination benefits	105			—
Other	(20		)	(14		)
Changes in assets and liabilities	(252		)	(636		)
Cash provided by operating activities	924			274
CASH FLOWS FROM INVESTING ACTIVITIES:
Drilling and completion costs	(1,579		)	(2,574		)
Acquisitions of proved and unproved properties	(280		)	(1,135		)
Proceeds from divestitures of proved and unproved properties	190			821
Additions to other property and equipment	(330		)	(690		)
Proceeds from sales of other assets	201			48
Additions to investments	(3		)	(73		)
(Increase) decrease in restricted cash	55			(37		)
Other	1			(10		)
Cash used in investing activities	(1,745		)	(3,650		)
CASH FLOWS FROM FINANCING ACTIVITIES:
Proceeds from credit facilities borrowings	3,632			5,688
Payments on credit facilities borrowings	(2,811		)	(4,546		)
Proceeds from issuance of senior notes, net of discount and offering costs	—			1,263
Cash paid for prepayment of mortgage	(55		)	—
Cash paid for common stock dividends	(58		)	(56		)
Cash paid for preferred stock dividends	(43		)	(43		)
Cash paid on financing derivatives	(11		)	(9		)
Proceeds from sales of noncontrolling interests	—			1,044
Proceeds from other financings	—			225
Distributions to noncontrolling interest owners	(57		)	(39		)
Other	(30		)	(64		)
Cash provided by financing activities	567			3,463
Net increase (decrease) in cash and cash equivalents	(254		)	87
Cash and cash equivalents, beginning of period	287			351
Cash and cash equivalents, end of period	$	33		$	438

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

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS – (Continued)

(Unaudited)

Supplemental disclosures to the condensed consolidated statements of cash flows are presented below:



	Three Months Ended March 31,
	2013			2012
	($ in millions)
Supplemental disclosure of cash flow information of net cash payments (refunds) for:
Interest, net of capitalized interest	$	60		$	36
Income taxes, net of refunds received	$	—		$	—

Supplemental disclosure of significant non-cash investing and financing activities:
Change in accrued drilling and completion costs	$	(79	)	$	26
Change in accrued acquisition of proved and unproved property costs	$	(3	)	$	(2	)
Change in accrued costs for other property and equipment	$	11		$	24

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)



	Three Months Ended March 31,
	2013			2012
	($ in millions)
PREFERRED STOCK:
Balance, beginning and end of period	$	3,062		$	3,062
COMMON STOCK:
Balance, beginning and end of period	7			7
PAID-IN CAPITAL:
Balance, beginning of period	12,293			12,146
Stock-based compensation	70			33
Reduction in tax benefit from stock-based compensation	(10		)	(4		)
Exercise of stock options	2			1
Balance, end of period	12,355			12,176
RETAINED EARNINGS:
Balance, beginning of period	437			1,608
Net income (loss) attributable to Chesapeake	58			(28		)
Dividends on common stock	—			(56		)
Dividends on preferred stock	—			(43		)
Balance, end of period	495			1,481
ACCUMULATED OTHER COMPREHENSIVE INCOME (LOSS):
Balance, beginning of period	(182		)	(166		)
Hedging activity	11			2
Investment activity	1			5
Balance, end of period	(170		)	(159		)
TREASURY STOCK – COMMON:
Balance, beginning of period	(48		)	(33		)
Purchase of 160,145 and 142,655 shares for company benefit plans	(3		)	(3		)
Release of 77,892 and 12,834 shares from company benefit plans	2			—
Balance, end of period	(49		)	(36		)
TOTAL CHESAPEAKE STOCKHOLDERS’ EQUITY	15,700			16,531
NONCONTROLLING INTERESTS:
Balance, beginning of period	2,327			1,337
Sales of noncontrolling interests	—			1,040
Net income attributable to noncontrolling interests	44			25
Distributions to noncontrolling interest owners	(57		)	(39		)
Balance, end of period	2,314			2,363
TOTAL EQUITY	$	18,014		$	18,894

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). This Form 10-Q relates to the three months ended March 31, 2013 (the “Current Quarter”) and three months ended March 31, 2012 (the “Prior Quarter”). Chesapeake’s annual report on Form 10-K for the year ended December 31, 2012 (2012 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 presentation 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 and entities in which Chesapeake holds a controlling interest. All significant intercompany accounts and transactions have been eliminated. The results for the Current Quarter are not necessarily indicative of the results to be expected for the full year.

Critical Accounting Policies

We consider accounting policies related to variable interest entities, natural gas and oil properties, derivatives 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 2012 Form 10-K.

Risks and Uncertainties

Our business strategy is to continue growing our reserves and production while transitioning from an asset base primarily focused on natural gas to an asset base more balanced between natural gas and liquids production. This is a capital-intensive strategy, and we made capital expenditures in 2012 and the Current Quarter that exceeded our cash flow from operations, filling the gap with borrowings and proceeds from sales of assets that we determined were noncore or did not fit our long-term plans. We project that our capital expenditures will continue to exceed our operating cash flow in 2013, although by a significantly smaller amount. Our 2013 capital expenditure budget is approximately 50% less than our 2012 capital expenditures, and as operator of a substantial portion of our natural gas and oil properties under development, we have significant control and flexibility over the development plan and the associated timing, enabling us to expeditiously reduce at least a portion of our capital spending if needed. To add certainty to future estimated cash flows by mitigating our downside exposure to lower commodity prices, we currently have downside price protection, in the form of over-the-counter derivative contracts, on approximately 78% of our remaining 2013 estimated natural gas production at an average price of $3.72 per mcf and 88% of our remaining 2013 estimated oil production at an average price of $95.43 per bbl. Hedging allows us to reduce our exposure to price volatility on our cash flows and EBITDA (defined as earnings before interest, taxes, depreciation, depletion and amortization). Based on these and other factors, we believe we have adequate borrowing capacity through our current credit arrangements, together with anticipated proceeds from transactions subject to binding agreements to sell assets, to make up the difference between our budgeted capital expenditures and operating cash flow in 2013.

As part of our asset sales planning and capital expenditure budgeting process, we closely monitor the resulting effects on the amounts and timing of our sources and uses of funds, particularly as they affect our ability to maintain compliance with the financial covenants of our corporate revolving bank credit facility. While asset sales enhance our ability to reduce debt, sales of producing natural gas and oil properties may adversely affect the amount of cash flow and EBITDA we generate and reduce the amount and value of collateral available to secure our obligations, both of which can be exacerbated by low prices received for our production. In September 2012, we obtained an amendment to our corporate revolving bank credit facility agreement that relaxed the required indebtedness to EBITDA ratio for the quarter ended September 30, 2012 and the four subsequent quarters. Without the amendment, we would have been unable to reduce our indebtedness sufficiently as of September 30, 2012 to maintain our covenant compliance, primarily because the closing of certain asset sales transactions occurred in the fourth quarter and not in September as we had anticipated. Failure to maintain compliance with the covenants of our corporate revolving bank credit facility could result in the acceleration of outstanding indebtedness under the facility and lead to cross defaults under our senior note and contingent convertible senior note indentures, secured hedging facility, equipment master lease agreements, term loan and other agreements. See Note 3 for further discussion of our debt instruments, including the

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

terms of the credit facility amendment. Based on our budgeted capital expenditures, expected commodity prices (including the impact from our derivative contracts), our forecasted drilling and production, projected levels of indebtedness and binding purchase and sale agreements for certain future asset sales, we expect we will be in compliance with the financial maintenance covenants of our corporate revolving bank credit facility through the 2014 first quarter. We believe the assumptions underlying our budget for this period are reasonable and that we have adequate flexibility, including the ability to adjust discretionary capital expenditures, to adapt to potential negative developments if needed to maintain covenant compliance.

Natural gas prices reached 10-year lows in 2012, and although our strategic focus on increasing liquids production is progressing and we have derivatives providing downside price protection in place covering approximately 78% of our projected remaining 2013 natural gas production, we continue to have significant exposure to natural gas prices. Approximately 70% of our estimated proved reserves volumes as of December 31, 2012 were natural gas, and natural gas represented approximately 76% and 80% of our natural gas, oil and NGL sales volumes for the Current Quarter and the 2012 full year, respectively. In 2012, we reduced our estimate of proved reserves by 3.1 tcfe, or 17%, primarily due to the impact of downward natural gas price revisions. Natural gas prices used in estimating proved reserves at December 31, 2012, including the effect of price differential adjustments, decreased by 45% from $3.19 per mcf to $1.75 per mcf, causing the loss of significant proved undeveloped reserves for which future development is uneconomic. As a result of lower estimated reserves, in the 2012 third quarter, we were required to impair the carrying value of our natural gas and oil properties, and we could have additional impairments in the future.

We believe we have taken appropriate measures to mitigate the risks and uncertainties facing us in 2013. Nevertheless, our ability to generate operating cash flow and complete asset sales in order to manage debt is subject to all the risks and uncertainties that exist in our industry, some of which we may not be able to anticipate at this time. We do not have binding agreements for all of our planned asset sales, and our ability to consummate each of these transactions is subject to changes in market conditions and other factors beyond our control. If one or more of the transactions are not completed in the anticipated time frame, or at all, or for less proceeds than anticipated, our ability to fund budgeted capital expenditures and reduce our indebtedness could be adversely affected. Future impairments of the carrying value of our natural gas and oil properties, if any, will be dependent on many factors, including natural gas, oil and NGL prices, production rates, levels of reserves, the evaluation of costs excluded from amortization, the timing and impact of asset sales, future development costs and service costs.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

Assets and Liabilities Held for Sale

We are currently pursuing sales of the majority of our remaining natural gas gathering business which we expect to complete in the 2013 second quarter. The natural gas gathering business qualified as held for sale as of March 31, 2013 and December 31, 2012 and is reported under our marketing, gathering and compression operating segment. In addition, we are pursuing the sale, within the next 12 months, of various other property and equipment, including land and buildings primarily in the Fort Worth, Texas area. The land and buildings are reported under our other operating segment. Natural gas and oil properties that we intend to sell are not presented as held for sale pursuant to the rules governing full cost accounting for oil and gas properties. We are also continuing to review our portfolio of other noncore assets, including real estate and other holdings in Oklahoma City (other than our core campus), and we may determine to divest all or a portion of these assets in subsequent periods. A summary of the assets and liabilities held for sale on our condensed consolidated balance sheets as of March 31, 2013 and December 31, 2012 is detailed below.



	March 31, 2013		December 31, 2012
	($ in millions)
Accounts receivable	$	11	$	4
Current assets held for sale	$	11	$	4

Natural gas gathering systems and treating plants, net of accumulated depreciation	$	330	$	352
Oilfield services equipment, net of accumulated depreciation^(a)	—		27
Other property and equipment, net of accumulated depreciation	258		255
Property and equipment held for sale, net	$	588	$	634

Accounts payable	$	—	$	4
Accrued liabilities	20		17
Current liabilities held for sale	$	20	$	21

___________________________________________


(a)	In the Current Quarter, we sold eight rigs classified as assets held for sale as of December 31, 2012 for proceeds of approximately $27 million.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

Accumulated Other Comprehensive Income (Loss)

For the Current Quarter, changes in accumulated other comprehensive income (loss) by component, net of tax, are detailed below.



	Net Gains (Losses) on Cash Flow Hedges			Net Gains (Losses) on Investments			Total
	($ in millions)
Balance, December 31, 2012	$	(189	)	$	7		$	(182	)
Other comprehensive income before reclassifications	(1		)	(5		)	(6		)
Amounts reclassified from accumulated other comprehensive income	12			6			18
Net current period other comprehensive income	11			1			12
Balance, March 31, 2013	$	(178	)	$	8		$	(170	)

For the Current Quarter, amounts reclassified from accumulated other comprehensive income (loss), net of tax, into the condensed consolidated statement of operations are detailed below.



Details About Accumulated Other Comprehensive Income Components	Affected Line Item in the Statement Where Net Income is Presented	Amount Reclassified from Accumulated Other Comprehensive Income
		($ in millions)
Net losses on cash flow hedges:
Commodity contracts	Natural gas, oil and NGL revenues	$	12
Investments:
Impairment of investment	Impairment of investment	6
Total reclassifications for the period, net of tax		$	18

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)


2.	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 and the Prior Quarter, the contingent convertible senior notes did not have a dilutive effect and therefore were not included in the calculation of diluted EPS. See Note 3 for discussion of the contingent convertible senior notes.

For the Current Quarter and the Prior Quarter, the following shares of unvested restricted stock, outstanding stock options and cumulative convertible preferred stock and associated adjustments to net income, consisting of dividends on such shares, were not included in the calculation of diluted EPS, as the effect was antidilutive:



	Net Income Adjustments		Shares
	($ in millions)		(in millions)
Three Months Ended March 31, 2013:
Common stock equivalent of our preferred stock outstanding:
5.75% cumulative convertible preferred stock	$	22	56
5.75% cumulative convertible preferred stock (series A)	$	16	39
5.00% cumulative convertible preferred stock (series 2005B)	$	3	5
4.50% cumulative convertible preferred stock	$	3	6

Three Months Ended March 31, 2012:
Common stock equivalent of our preferred stock outstanding:
5.75% cumulative convertible preferred stock	$	22	55
5.75% cumulative convertible preferred stock (series A)	$	16	39
5.00% cumulative convertible preferred stock (series 2005B)	$	3	5
4.50% cumulative convertible preferred stock	$	3	6
Unvested restricted stock	$	—	4
Outstanding stock options	$	—	1

Basic weighted average shares outstanding, which is used in computing basic EPS, and diluted weighted average shares outstanding, which is used in computing diluted EPS, were 651 million shares in the Current Quarter and 642 million shares in the Prior Quarter, respectively. The basic and diluted earnings per common share were $0.02 in the Current Quarter and the basic and diluted loss per common share was $0.11 in the Prior Quarter.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)


3.	Debt

Our long-term debt consisted of the following as of March 31, 2013 and December 31, 2012:



	March 31, 2013			December 31, 2012
	($ in millions)
Term loan due 2017	$	2,000		$	2,000
7.625% senior notes due 2013^(a)	464			464
9.5% senior notes due 2015	1,265			1,265
6.25% euro-denominated senior notes due 2017^(b)	440			454
6.5% senior notes due 2017	660			660
6.875% senior notes due 2018^(a)	474			474
7.25% senior notes due 2018	669			669
6.625% senior notes due 2019^(c)	650			650
6.775% senior notes due 2019^(d)	1,300			1,300
6.625% senior notes due 2020	1,300			1,300
6.875% senior notes due 2020	500			500
6.125% senior notes due 2021	1,000			1,000
2.75% contingent convertible senior notes due 2035^(e)	396			396
2.5% contingent convertible senior notes due 2037^(e)	1,168			1,168
2.25% contingent convertible senior notes due 2038^(e)	347			347
Corporate revolving bank credit facility	832			—
Oilfield services revolving bank credit facility	408			418
Discount on senior notes and term loan^(f)	(441		)	(465		)
Interest rate derivatives^(g)	17			20
Total debt, net	13,449			12,620
Less current maturities of long-term debt, net^(a)	—			(463		)
Total long-term debt, net	$	13,449		$	12,157

___________________________________________


(a)	See Note 18 for further discussion of tender offers completed for a portion of these notes subsequent to March 31, 2013. We reclassified our 7.625% Senior Notes due 2013 from current liabilities to long-term debt as of March 31, 2013 as we refinanced these notes on a long-term basis subsequent to March 31, 2013. There is $1 million of discount associated with the 7.625% Senior Notes due 2013.


(b)	The principal amount shown is based on the exchange rate of $1.2816 to €1.00 and $1.3193 to €1.00 as of March 31, 2013 and December 31, 2012, respectively. See Note 7 for information on our related foreign currency derivatives.

(c)

Issuers are Chesapeake Oilfield Operating, L.L.C. (COO), an indirect wholly owned subsidiary of the Company, and Chesapeake Oilfield Finance, Inc. (COF), a wholly owned subsidiary of COO formed solely to facilitate the offering of the 6.625% Senior Notes due 2019. COF is nominally capitalized and has no operations or revenues. Chesapeake Energy Corporation is the issuer of all other senior notes and the contingent convertible senior notes.


(d)	In the Current Quarter, we issued notice to the trustee to redeem our 6.775% Senior Notes due 2019 at par. See Note 18 for further discussion.

(e)

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

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

specified period in a fiscal quarter. Convertibility based on common stock price is measured quarterly. In the first quarter of 2013, 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 second quarter of 2013 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. During the Current Quarter, the notes were not convertible under this provision. 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:



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	$	48.31	May 14, 2016
2.5% due 2037	May 15, 2017, 2022, 2027, 2032	$	63.93	November 14, 2017
2.25% due 2038	December 15, 2018, 2023, 2028, 2033	$	107.01	June 14, 2019

(f)

Discount as of March 31, 2013 and December 31, 2012 included $359 million and $376 million, respectively, associated with the equity component of our contingent convertible senior notes. This discount is amortized based on an effective yield method. Also included $37 million and $40 million of discount as of March 31, 2013 and December 31, 2012, respectively, associated with our November 2012 term loan.


(g)	See Note 7 for further discussion related to these instruments.

Term Loan

November 2012 Term Loan. In November 2012, we established an unsecured five-year term loan credit facility in an aggregate principal amount of $2.0 billion for net proceeds of $1.935 billion (November 2012 term loan). Our obligations under the facility rank equally with our outstanding senior notes and contingent convertible senior notes and are unconditionally guaranteed on a joint and several basis by our direct and indirect wholly owned subsidiaries that are subsidiary guarantors under the indentures for such notes. Amounts borrowed under the facility bear interest at our option, at either (i) the Eurodollar rate, which is based on the London Interbank Offered Rate (LIBOR), plus a margin of 4.50% or (ii) a base rate equal to the greater of (a) the Bank of America, N.A. prime rate, (b) the federal funds effective rate plus 0.50% per annum and (c) the Eurodollar rate that would be applicable to a Eurodollar loan with an interest period of one month plus 1% per annum, in each case, plus a margin of 3.50%. The Eurodollar rate is subject to a floor of 1.25% per annum, and the base rate is subject to a floor of 2.25% per annum. Interest is payable quarterly or, if the Eurodollar rate applies, it may be payable at more frequent intervals.

The November 2012 term loan matures on December 2, 2017 and may be voluntarily repaid at a make-whole price in the first year, may be voluntarily repaid in the second and third years at par plus a specified call premium and may be voluntarily repaid at any time thereafter at par. The term loan may also be refinanced or amended to extend the maturity date at our option, subject to lender approval.

The November 2012 term loan credit agreement contains negative covenants substantially similar to those contained in the Company’s corporate revolving bank credit facility, including covenants that limit our ability to incur indebtedness, grant liens, make investments, loans and restricted payments and enter into certain business combination transactions. Other covenants include additional restrictions regarding the incurrence of certain unsecured indebtedness, the incurrence of secured indebtedness, the disposition of assets and the prepayment of certain indebtedness. The term loan credit agreement does not contain financial maintenance covenants.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

We were in compliance with all covenants under the November 2012 term loan credit agreement as of March 31, 2013. If we should fail to perform our obligations under the agreement, the term loan could be terminated and any outstanding borrowings under the term loan credit agreement could be declared immediately due and payable. The term loan credit 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.

Chesapeake Senior Notes and Contingent Convertible Senior Notes

The Chesapeake senior notes and the contingent convertible senior notes are unsecured senior obligations of Chesapeake and rank equally in right of payment with all of our other existing and future senior unsecured 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. Chesapeake’s obligations under the senior notes and the contingent convertible senior notes are jointly and severally, fully and unconditionally guaranteed by certain of our direct and indirect wholly owned subsidiaries. Certain of our oilfield services subsidiaries and subsidiaries formed to invest in natural gas demand initiatives, subsidiaries with noncontrolling interests, subsidiaries qualified as variable interest entities, and certain de minimis subsidiaries are not guarantors. See Note 16 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 may limit our ability and our subsidiaries’ ability to incur certain secured indebtedness, enter into sale/leaseback transactions, and consolidate, merge or transfer assets. The indentures governing the contingent convertible senior notes do not have any financial or restricted payment covenants. The senior notes and contingent convertible senior notes indentures have cross default provisions that apply to other indebtedness the Company or any guarantor subsidiary may have from time to time with an outstanding principal amount of $50 million or $75 million, depending on the indenture.

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.

During the Prior Quarter, we issued $1.3 billion of 6.775% Senior Notes due 2019 in a registered public offering. We used the net proceeds of $1.263 billion from the offering to repay indebtedness outstanding under our corporate revolving bank credit facility. On March 15, 2013, we provided notice to the trustee of our election to redeem the notes at a redemption price equal to 100% of the principal amount of the notes plus accrued and unpaid interest on May 13, 2013. See Note 18 for further discussion of litigation related to the redemption of these notes.

The $464 million aggregate principal amount of our 7.625% senior notes, which is due in July 2013, was partially refinanced on a long-term basis subsequent to March 31, 2013 and the remaining balance will be repaid and/or retired upon maturity. No other scheduled principal payments are required on our senior notes until 2015. See Note 18 for further discussion of tender offers for certain series of our senior notes completed subsequent to March 31, 2013.

COO Senior Notes

In October 2011, our wholly owned subsidiaries, Chesapeake Oilfield Operating, L.L.C. (COO) and Chesapeake Oilfield Finance, Inc., issued $650 million principal amount of 6.625% Senior Notes due 2019 in a private placement. COO used the net proceeds of approximately $637 million from the placement to make a cash distribution to its direct parent, COS Holdings, L.L.C. (COS), to enable it to reduce indebtedness under an intercompany note with Chesapeake. Chesapeake then used the cash distribution to reduce indebtedness under its corporate revolving bank credit facility.

The COO senior notes are the unsecured senior obligations of COO and rank equally in right of payment with all of COO’s other existing and future senior unsecured indebtedness and rank senior in right of payment to all of its future subordinated indebtedness. The COO senior notes are jointly and severally, fully and unconditionally guaranteed by all of COO’s wholly owned subsidiaries, other than de minimis subsidiaries. The notes may be redeemed at any time at specified make-whole or redemption prices and, prior to November 15, 2014, up to 35% of the aggregate principal amount may be redeemed in connection with certain equity offerings. Holders of the COO notes have the right to require COO to repurchase their notes upon a change of control on the terms set forth in the indenture, and COO must offer to repurchase the notes upon certain asset sales. The COO senior notes are subject to covenants that may, among other things, limit the ability of COO and its subsidiaries to make restricted payments, incur

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

indebtedness, issue preferred stock, create liens, and consolidate, merge or transfer assets. The COO senior notes have cross default provisions that apply to other indebtedness COO or any of its guarantor subsidiaries may have from time to time with an outstanding principal amount of $50 million or more.

Under a registration rights agreement, we agreed to file a registration statement enabling holders of the COO senior notes to exchange the privately placed COO senior notes for publicly registered notes with substantially the same terms. We filed the registration statement on April 5, 2013. We are required to use our commercially reasonable best efforts to cause the registration statement to become effective as soon as practicable after filing and to consummate the exchange offer on the earliest practicable date after such date, but in no event later than 60 days after the date the registration statement has become effective.

Bank Credit Facilities

During the Current Quarter, we used two revolving bank credit facilities as sources of liquidity. In addition, in the Prior Quarter, we utilized a midstream credit facility. In June 2012, we paid off and terminated our midstream credit facility. Our remaining revolving bank credit facilities are described below.



	Corporate Credit Facility^(a)		Oilfield Services Credit Facility^(b)
	($ in millions)
Facility structure	Senior secured revolving		Senior secured revolving
Maturity date	December 2015		November 2016
Borrowing capacity	$	4,000	$	500
Amount outstanding as of March 31, 2013	$	832	$	408
Letters of credit outstanding as of March 31, 2013	$	31	$	—

___________________________________________


(a)	Co-borrowers are Chesapeake Exploration, L.L.C., Chesapeake Appalachia, L.L.C. and Chesapeake Louisiana, L.P.


(b)	Borrower is COO.

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, our credit facilities do not contain provisions which would trigger an acceleration of amounts due under the respective facilities or a requirement to post additional collateral in the event of a downgrade of our credit ratings.

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 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 LIBOR, plus a margin that varies from 1.50% to 2.25% per annum according to our senior unsecured long-term debt ratings. These margins may be increased pursuant to the terms of the credit facility amendment discussed below. 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.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

The credit facility agreement contains various covenants and restrictive provisions which limit our ability to incur additional indebtedness, make investments or loans and create liens 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. In September 2012, we entered into an amendment to the credit facility agreement, effective September 30, 2012. See Risks and Uncertainties in Note 1 for further discussion. The amendment, among other things, adjusts our required indebtedness to EBITDA ratio as set forth below through the earlier of (i) December 31, 2013 and (ii) the date on which we elect to reinstate the indebtedness to EBITDA ratio in effect prior to the amendment (in either case, the “Amendment Effective Period”). The amendment increased the maximum indebtedness to EBITDA ratio as of September 30, 2012 from 4.00 to 1.00 to 6.00 to 1.00 and revises the required ratio for the next four quarters as shown below. The ratio returns to 4.00 to 1.00 as of December 31, 2013 and thereafter.



Effective Date		Amended Indebtedness to EBITDA Ratio
December 31, 2012		5.00 to 1.00
March 31, 2013		4.75 to 1.00
June 30, 2013		4.50 to 1.00
September 30, 2013		4.25 to 1.00

The credit facility amendment increases the applicable margin by 0.25% for borrowings under the corporate credit facility on each day during the Amendment Effective Period when credit extensions exceed 50% of the borrowing capacity and requires us to pay a fee to each lender in an amount equal to 0.05% of its revolving commitment in the event that the Amendment Effective Period is in effect on June 30, 2013. Based on current commitment levels, this would result in an additional payment of $2 million. The amendment does not allow our collateral value securing the borrowings to be more than $75 million below the collateral value that was in effect as of September 30, 2012 during the Amendment Effective Period. We were in compliance with all covenants under the amended agreement as of March 31, 2013.

The facility is fully and unconditionally guaranteed, on a joint and several basis, by Chesapeake and certain of our wholly owned subsidiaries. If we should fail to perform our obligations under the agreement, 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 and contingent convertible senior note indentures, which could in turn result in the acceleration of a significant portion of such indebtedness. The credit facility agreement also has cross default provisions that apply to our secured hedging facility, equipment master lease agreements, term loan and other indebtedness of Chesapeake and its restricted subsidiaries with an outstanding principal amount in excess of $125 million. In addition, the facility contains a restriction on our ability to declare and pay cash dividends on our common or preferred stock if an event of default has occurred.

Oilfield Services Credit Facility. Our $500 million syndicated oilfield services revolving bank credit facility is used to fund capital expenditures and for general corporate purposes associated with our oilfield services operations. Borrowings under the oilfield services credit facility are secured by all of the assets of the wholly owned subsidiaries of COO, itself an indirect wholly owned subsidiary of Chesapeake. The facility has initial commitments of $500 million and may be expanded to $900 million at COO’s option, subject to additional bank participation. Borrowings under the credit facility are secured by all of the equity interests and assets of COO and its wholly owned subsidiaries (the restricted subsidiaries for this facility, which are unrestricted subsidiaries under Chesapeake’s senior notes, contingent convertible senior notes, term loan and corporate revolving bank credit facility), and bear interest at our option at either (i) the greater of the reference rate of Bank of America, N.A., the federal funds effective rate plus 0.50%, or 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 LIBOR plus a margin that varies from 2.00% to 2.75% per annum. The unused portion of the credit 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 oilfield services credit facility agreement contains various covenants and restrictive provisions which limit the ability of COO 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 lease adjusted indebtedness

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

to earnings before interest, taxes, depreciation, amortization and rent (EBITDAR), a senior secured leverage ratio based on the ratio of secured indebtedness to EBITDA and a fixed charge coverage ratio based on the ratio of EBITDAR to lease adjusted interest expense, in each case as defined in the agreement. COO was in compliance with all covenants under the agreement as of March 31, 2013. If COO or its restricted subsidiaries should fail to perform their obligations under the agreement, 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 COO senior note indenture, which could in turn result in the acceleration of the COO senior note indebtedness. The oilfield services credit facility agreement also has cross default provisions that apply to other indebtedness COO and its restricted subsidiaries may have from time to time with an outstanding principal amount in excess of $15 million.

Midstream Credit Facility. Prior to June 15, 2012, we utilized a $600 million syndicated senior secured revolving bank credit facility 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. With the sale of a substantial portion of our midstream business in the second half of 2012, on June 15, 2012, we paid off and terminated our midstream credit facility.


4.	Contingencies and Commitments

Contingencies

Litigation and Regulatory Proceedings

The Company is involved in a number of litigation and regulatory proceedings (including those described below). Many of these proceedings are in early stages, and many of them seek an indeterminate amount of damages. We estimate and provide for potential losses that may arise out of litigation and regulatory proceedings to the extent that such losses are probable and can be reasonably estimated. Significant judgment is required in making these estimates and our final liabilities may ultimately be materially different. Our total estimated liability in respect of litigation and regulatory proceedings is determined on a case-by-case basis and represents an estimate of probable losses after considering, among other factors, the progress of each case or proceeding, our experience and the experience of others in similar cases or proceedings, and the opinions and views of legal counsel. We account for legal defense costs in the period the costs are incurred.

July 2008 Common Stock Offering. 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 the court certified the class on March 30, 2012. Defendants moved for summary judgment on grounds of loss causation and materiality on December 16, 2011, and the motion was granted as to all claims as a matter of law on March 29, 2013.

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. On October 22, 2012, the court issued an order staying the derivative action until resolution of the federal class action. On May 3, 2013, the derivative action was dismissed pursuant to the parties’ joint stipulation of dismissal without prejudice. 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. On November 30, 2011, the Company filed a motion to dismiss the action, which was denied on September 28, 2012. Pursuant to court order, nominal defendant Chesapeake filed an answer on October 12, 2012. By stipulation between the parties, the individual defendants are not required to answer the complaint unless and until the plaintiff establishes standing to pursue claims derivatively.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

2008 CEO Compensation and Related Party Transaction. 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 former CEO, Aubrey K. McClendon, and seeking unspecified damages, equitable relief and disgorgement. These three derivative actions were consolidated and a Consolidated Derivative Shareholder Petition naming Chesapeake as a nominal defendant was filed on June 23, 2009. 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 for writ of certiorari with the Oklahoma Supreme Court on September 13, 2011. The appeal is currently stayed pending resolution of the settlement referenced in the following paragraph.

On January 30, 2012, the District Court of Oklahoma County, Oklahoma approved a settlement between the parties in the consolidated derivative action, as well as a case on appeal at the Oklahoma Court of Civil Appeals requesting inspection of Company books and records relating to the December 2008 employment agreement with Mr. McClendon. The principal terms of the settlement include the rescission of the sale of an antique map collection that occurred in December 2008 between Mr. McClendon and the Company, whereby Mr. McClendon will pay the Company approximately $12 million plus interest and the Company will reconvey the map collection to Mr. McClendon, and the adoption and/or implementation of a variety of corporate governance measures. The court awarded attorney fees and expenses to plaintiffs’ counsel in the amount of $3.75 million. Pursuant to the settlement, the consolidated derivative action and books and records action were dismissed with prejudice against all defendants. On February 29, 2012, certain shareholders filed a petition in error with the Oklahoma Supreme Court opposing the terms of the settlement. Their appeal was fully briefed as of October 24, 2012.

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 alleged that the Chesapeake Board wrongfully refused their demands to investigate purported breaches of fiduciary duties relating to Mr. McClendon’s 2008 compensation and, as a result, each of these shareholders asserts he is entitled to seek relief on behalf of the Company. These federal derivative actions were consolidated on December 23, 2011 and on March 14, 2012 were stayed until 30 days after the Supreme Court of Oklahoma resolves the appeal of the settlement of the consolidated derivative action and books and records action.

FWPP, Conflict of Interest and Other Matters. From April 19 to June 29, 2012, 13 substantially similar shareholder derivative actions were filed in the U.S. District Court for the Western District of Oklahoma against the Company and its directors alleging, among other things, violations of Section 14 of the Securities Exchange Act of 1934 and Rule 14a-9 promulgated thereunder for purported material misstatements in the Company’s 2009 and subsequent proxy statements related to Mr. McClendon’s participation in the Founder Well Participation Program (FWPP) and breaches of fiduciary duties, corporate waste, and unjust enrichment against the Board for failing to make proper disclosures in the proxy statements and failing to properly monitor Mr. McClendon’s personal use of assets acquired pursuant to the FWPP. As previously disclosed, in conjunction with Mr. McClendon’s employment agreement with the Company, the FWPP provides Mr. McClendon a contractual right through June 2014 to participate and invest as a working interest owner (with up to a 2.5% working interest) in new wells drilled on the Company’s leasehold. On July 13, 2012, these 13 shareholder actions were consolidated into a single case. On April 27, 2012, a shareholder derivative action was filed in the District Court of Oklahoma County, Oklahoma setting forth substantially similar claims to those alleged in the federal shareholder actions. The plaintiffs in both the federal consolidated derivative action and the state court derivative action stipulated to stay their cases pending a ruling on the motion to dismiss filed in the federal securities class action described in the following paragraph. On November 9, 2012, a shareholder derivative suit was filed in the District Court of Oklahoma County, Oklahoma asserting claims substantially similar to those of the stayed derivative cases, but also asserting that the shareholder had derivative standing because the Board had wrongfully refused his litigation demand made in August 2012. Chesapeake moved to dismiss for lack of derivative standing, and on April 18, 2013 the motion to dismiss was granted. On February 6, 2013, another shareholder derivative suit was filed in the District Court of Oklahoma County, Oklahoma asserting claims substantially similar to those of the stayed derivative cases and seeking a temporary restraining order barring the Company from providing Mr. McClendon severance compensation and benefits. The request for the restraining order was denied March 28, 2013. Chesapeake filed a motion to dismiss the case for the plaintiff's lack of derivative standing and briefing was completed on April 19, 2013.

A putative class action was filed in the U.S. District Court for the Western District of Oklahoma on April 26, 2012 against the Company and Mr. McClendon alleging violations of Sections 10(b) (and Rule 10b-5 promulgated thereunder) and 20(a) of the Securities Exchange Act of 1934. On July 20, 2012, the court appointed a lead plaintiff, which filed

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

an amended complaint on October 19, 2012 against the Company, Mr. McClendon and certain other officers. The amended complaint asserted claims under Sections 10(b) (and Rule 10b-5) and 20(a) of the Securities Exchange Act of 1934 based on alleged misrepresentations regarding the Company’s asset monetization strategy, including liabilities associated with its volumetric production payment (VPP) transactions, as well as Mr. McClendon’s personal loans and the Company’s internal controls. The action sought class certification, damages of an unspecified amount and attorneys’ fees and other costs. On December 6, 2012, the Company and other defendants filed a motion to dismiss the action. The Court granted the motion and dismissed the complaint with prejudice on April 10, 2013.

On June 19, July 17 and July 20, 2012, putative class actions were filed in the U.S. District Court for the Western District of Oklahoma against the Company, Chesapeake Energy Savings and Incentive Stock Bonus Plan (the Plan), and certain of the Company’s officers and directors alleging breaches of fiduciary duties under the Employee Retirement Income Security Act (ERISA). The actions are brought on behalf of participants and beneficiaries of the Plan, and allege that as fiduciaries of the Plan, defendants owed fiduciary duties, which they purportedly breached by, among other things, failing to manage and administer the Plan’s assets with appropriate skill and care, and engaging in activities that were in conflict with the best interest of the Plan. The plaintiffs seek class certification, damages of an unspecified amount, equitable relief, and attorneys’ fees and other costs. The three cases have been consolidated and a consolidated amended complaint was filed on February 21, 2013. The defendants filed a motion to dismiss on April 22, 2013. We are currently unable to assess the probability of loss or estimate a range of potential loss associated with this matter.

On May 2, 2012, Chesapeake and Mr. McClendon received notice from the U.S. Securities and Exchange Commission that its Fort Worth Regional Office had commenced an informal inquiry into, among other things, certain of the matters alleged in the foregoing lawsuits. On December 21, 2012, the SEC’s Fort Worth Regional Office advised Chesapeake that its inquiry is continuing as an investigation and it has issued subpoenas for information and testimony. The Company is providing information to the SEC in connection with this matter. The Company is also responding to related inquiries from other governmental and regulatory agencies and self-regulatory organizations.

Director and Officer Use of Company Aircraft. On May 8, 2012, a derivative action was filed in the District Court of Oklahoma County, Oklahoma against the Company’s directors alleging, among other things, breaches of fiduciary duties and corporate waste related to the Company’s officers and directors’ use of the Company’s fractionally owned corporate jets. Chesapeake was named a nominal defendant in the derivative action. On August 21, 2012, the District Court granted the Company’s motion to dismiss the case. On December 6, 2012, the plaintiff filed an amended petition in error with the Oklahoma Supreme Court, and on December 26, 2012 nominal defendant/appellee Chesapeake filed its response. The appeal is currently before the Oklahoma Court of Appeals by appointment of the Supreme Court.

Antitrust Investigations. On June 29, 2012, Chesapeake received a subpoena from the Antitrust Division, Midwest Field Office of the U.S. Department of Justice. The subpoena requires the Company to produce certain documents before a grand jury in the Western District of Michigan, which is conducting an investigation into possible violations of antitrust laws in connection with the purchase and lease of oil and gas rights. The Company has also received demands for documents and information from certain state governmental agencies in connection with other investigations relating to the Company’s purchase and lease of oil and gas rights. Chesapeake has been providing information in response to these investigations. Chesapeake’s Board of Directors commenced its own investigation of these allegations in June 2012 and in February 2013 announced its conclusion that the Company did not violate antitrust laws in connection with the acquisition of Michigan oil and gas rights in 2010.

Business Operations. Chesapeake is 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 contract actions, 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. Based on management’s current assessment, we are of the opinion that no pending or threatened lawsuit or dispute relating 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.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

Environmental Risk

The nature of the natural gas and oil business carries with it certain environmental risks for Chesapeake and its subsidiaries. Chesapeake has implemented various policies, procedures, training and auditing to reduce and mitigate such environmental risks. Chesapeake conducts periodic reviews, on a company-wide basis, to assess changes in our environmental risk profile. Environmental reserves are set for environmental liabilities for which economic losses are probable and reasonably estimable. We manage our exposure to environmental liabilities in acquisitions and divestitures by using an evaluation process that seeks to identify pre-existing contamination or compliance concerns and addressing the potential liability. Depending on the extent of an identified environmental concern, Chesapeake may, among other things, exclude a property from the transaction, require the seller to remediate the property to our satisfaction in an acquisition, or agree to assume liability for the remediation of the property.

There are presently pending against our subsidiary, Chesapeake Appalachia, L.L.C. (CALLC), orders for compliance first initiated in the 2010 fourth quarter by the U.S. Environmental Protection Agency (EPA) related to our compliance with Clean Water Act (CWA) permitting requirements in West Virginia. We have responded to all pending orders and are actively working with the EPA to resolve these and similar matters. For one site subject to an EPA order for compliance, CALLC pled guilty in 2012 to three misdemeanor counts of unauthorized discharge of dredged or fill materials into a water of the U.S. We have paid the applicable fine in full, our restoration of the site has been completed and approved by the government, and we believe that we are in compliance with the terms of probation.

The CWA provides authority for significant civil penalties for the placement of fill in a jurisdictional stream or wetland without a permit from the Army Corps of Engineers. CWA civil penalties can be as high as $37,500 per day, per violation. The CWA sets forth subjective criteria, including degree of fault and history of prior violations, that influence CWA penalty assessments, and the EPA may also seek to recover the economic benefit derived from non-compliance. While we expect that resolution of the EPA’s orders for compliance will include monetary sanctions exceeding $100,000, we believe the liability with respect to these matters will not have a material effect on the consolidated financial position, results of operations or cash flow of the Company.

Commitments

Rig Leases

In a series of transactions beginning in 2006, our drilling subsidiary sold 94 drilling rigs (of which 26 rigs have been repurchased) and related equipment 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 commitments are guaranteed by Chesapeake and certain of its subsidiaries. These transactions were recorded as sales and operating leasebacks and any related net gains are amortized to oilfield services expenses 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 a 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 March 31, 2013, the minimum aggregate undiscounted future rig lease payments were approximately $282 million.

Chesapeake has contracts with various drilling contractors to utilize approximately 18 rigs with terms ranging from one year to three years. These commitments are not recorded in the accompanying condensed consolidated balance sheets. As of March 31, 2013, the aggregate undiscounted minimum future payments under these drilling rig commitments were approximately $145 million.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

Compressor Leases

Through various transactions beginning in 2007, our compression subsidiary sold 2,558 compressors (of which 238 units have been repurchased), a significant portion of its compressor fleet, and entered into a master lease agreement under which we agreed to lease the compressors from the buyer for initial terms of four to ten years. The lease commitments are guaranteed by Chesapeake and certain of its subsidiaries. These transactions were recorded as sales and operating leasebacks, and any related net gains are 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 a 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 March 31, 2013, the minimum aggregate undiscounted future compressor lease payments were approximately $384 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 and royalty interest owners, where appropriate, will be responsible for their proportionate share of these costs. Commitments related to gathering, processing and transportation agreements are not recorded in the accompanying condensed consolidated balance sheets; however, they are reflected as adjustments to future natural gas, oil and NGL sales prices used in our proved reserves estimates.

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



	March 31, 2013
	($ in millions)
2013	$	1,215
2014	1,991
2015	1,810
2016	1,904
2017	1,931
2018 - 2099	9,381
Total	$	18,232

Drilling Commitments

In December 2011, as part of our Utica joint venture development agreement with Total S.A. (Total) (see Note 8), we committed to spud no less than 90 cumulative Utica wells by December 31, 2012, 270 cumulative wells by December 31, 2013 and 540 cumulative wells by December 31, 2014. We met our 2012 commitment and, through March 31, 2013, we had spud 217 cumulative Utica wells and are on target to meet our 2013 commitment. If we fail to meet the drilling commitment at any such year end for any reason other than a force majeure event, the drilling carry percentage used to determine our promoted well reimbursement will be reduced from 60% to 45% for a number of wells drilled in the following calendar year equal to the number of wells we were short the drilling commitment. As such, any reduction would only affect the timing of the receipt of the drilling carry but not the total drilling carry to be received.

We have also committed to drill wells in conjunction with our CHK Utica and CHK C-T financial transactions and in conjunction with the formation of the Chesapeake Granite Wash Trust. See Note 6 for discussion of these transactions and commitments.

Property and Equipment Purchase Commitments

Much of the oilfield services equipment we purchase requires long production lead times. As a result, we have outstanding orders and commitments for such equipment. As of March 31, 2013, we had $85 million of purchase obligations related to future capital expenditures for drilling rigs and related equipment and hydraulic fracturing equipment in 2013.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

Natural Gas and Liquids Purchase Commitments

We regularly commit to purchase natural gas and liquids from other owners in the properties we operate, including owners associated with our volumetric production payment (VPP) transactions. Production purchased under these arrangements is based on market prices at the time of production, and the purchased natural gas and liquids are resold at market prices. See Note 8 for further discussion of our VPP transactions.

Net Acreage Maintenance Commitments

Under the terms of our joint venture agreements with Statoil and Total (see Note 8), 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. To date, we have satisfied our replacement obligations under the Statoil agreement. We did not fully meet the initial net acreage maintenance commitment with Total under the terms of our Barnett Shale joint venture agreement as of the December 31, 2012 measurement date. As of December 31, 2012, we estimated a net acreage shortfall of approximately 13,000 net acres and anticipate making a cash payment of approximately $26 million to Total in the 2013 second quarter. The final resolution of such matters could exceed amounts accrued, however, and actual results could differ from management’s estimates.

Affiliate Commitments

Under the terms of our corporate revolving bank credit facility, certain of our subsidiaries, including our oilfield services companies, are not guarantors of the credit facility debt. Transactions under certain agreements between us and our non-guarantor subsidiaries could affect our EBITDA or indebtedness for purposes of our credit facility covenant calculations, but they would have no effect on the consolidated financial statements because the transactions would be eliminated through consolidation. See Note 3 for discussion of our covenant calculations.

In October 2011, we entered into a services agreement with our wholly owned subsidiary, COO, under which we guarantee the utilization of a portion of COO’s drilling rig and hydraulic fracturing fleets during the term of the agreement. Through October 2016, we are subject to monetary penalties if we do not operate a specific number of COO’s drilling rigs or utilize a specific number of its hydraulic fracturing fleets. No payments have been made pursuant to the services agreement. Any payments made in future periods will be eliminated in consolidation.

Other Commitments

In April 2011, we entered into a master frac service agreement with our equity affiliate, FTS International, Inc. (FTS), which expires on December 31, 2014. Pursuant to this agreement, we are committed to enter into a predetermined number of backstop contracts, providing at least a 10% gross margin to FTS, if utilization of FTS fleets falls below a certain level. To date, we have not entered into any backstop contracts and, since we use hydraulic fracturing services continuously, we do not anticipate any material payments under this commitment.

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 two of which were issued in July 2011 and July 2012, with the remaining note scheduled to be issued in June 2013. 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 Longmont, Colorado. As of March 31, 2013, we had funded $115 million of our commitment. The remaining tranches of preferred equity investment will be scheduled around certain funding and operational milestones that are expected to be reached by July 2013. See Note 9 for further discussion of this investment.

In December 2011, we sold Appalachia Midstream Services, L.L.C., a wholly owned subsidiary of our wholly owned subsidiary, Chesapeake Midstream Development, L.L.C. (CMD), to Chesapeake Midstream Partners, L.P. (now named Access Midstream Partners, L.P. (NYSE:ACMP)) for total consideration of $884 million. In addition, CMD committed to pay ACMP for any quarterly shortfall between the actual adjusted EBITDA from the assets sold and specified quarterly targets, which total $100 million in 2012 and $150 million in 2013. We recorded this guarantee at an estimated fair value of $27 million at the time of the sale. No payment was required for the Current Quarter or for 2012, and we recognized $1 million of gain in the Current Quarter associated with the release of the liability related to the quarterly target achieved. The remaining $18 million fair value is included in other current liabilities on our condensed consolidated balance sheet as of March 31, 2013. We will release this liability over the remainder of 2013. To the extent

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

CMD is required to make payments under the guarantee, we will record the differences between the liability and the associated payments in earnings.

As part of our normal course of business, we enter into various agreements providing, or otherwise arranging, financial or performance assurances to third parties on behalf of our wholly owned guarantor subsidiaries. These agreements may include future payment obligations or commitments regarding operational performance that effectively guarantee our subsidiaries’ future performance.

In connection with divestitures, our purchase and sale agreements generally provide indemnification to the counterparty for liabilities incurred as a result of a breach of a representation or warranty by the indemnifying party or in regards to perfecting title to property. These indemnifications generally have a discrete term and are intended to protect the parties against risks that are difficult to predict or cannot be quantified at the time of the consummation of a particular transaction.

Certain of our natural gas and oil properties are burdened by non-operating interests such as royalty and overriding royalty interests, including overriding royalty interests sold through our VPP transactions. As the holder of the working interest from which such interests have been created, we have the responsibility to bear the cost of developing and producing the reserves attributable to such interests. See Note 8 for further discussion of our VPP transactions.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)


5.	Other Liabilities

Other current liabilities as of March 31, 2013 and December 31, 2012 are detailed below.



	March 31, 2013		December 31, 2012
	($ in millions)
Revenues and royalties due others	$	1,275	$	1,337
Accrued natural gas, oil and NGL drilling and production costs	444		525
Joint interest prepayments received	594		749
Accrued payroll and benefits	128		224
Accrued dividends^(a)	—		101
Other	847		805
Total other current liabilities	$	3,288	$	3,741

____________________________________________

(a) On April 8, 2013, our Board of Directors declared dividends on our common and preferred shares outstanding. See Note 18 for further discussion.

Other long-term liabilities as of March 31, 2013 and December 31, 2012 are detailed below.



	March 31, 2013		December 31, 2012
	($ in millions)
CHK Utica ORRI conveyance obligation^(a)	$	269	$	275
CHK C-T ORRI conveyance obligation^(b)	160		164
Financing lease obligations^(c)	143		143
Mortgages payable^(d)	—		56
Other	560		538
Total other long-term liabilities	$	1,132	$	1,176

____________________________________________


(a)	$20 million and $18 million of the total $289 million and $293 million obligations are recorded in other current liabilities as of March 31, 2013 and December 31, 2012, respectively. See Note 6 for further discussion of the transaction.


(b)	$13 million and $14 million of the total $173 million and $178 million obligation is recorded in other current liabilities as of March 31, 2013 and December 31, 2012, respectively. See Note 6 for further discussion of the transaction.

(c)

In 2009, we financed 111 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 one of the assets in 2011.

(d)

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 had a floating interest rate of prime plus 275 basis points. In the Current Quarter, we prepaid the term loan in full without penalty. As of March 31, 2013, our Barnett Shale headquarters building was classified as property and equipment held for sale on our condensed consolidated balance sheet.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)


6.	Stockholders’ Equity, Stock-Based Compensation, Performance Share Units and Noncontrolling Interests

Common Stock

The following is a summary of the changes in our common shares issued for the three months ended March 31, 2013 and 2012:



	Three Months Ended March 31,
	2013	2012
	(in thousands)
Shares issued as of January 1	666,468	660,888
Restricted stock issuances (net of forfeitures)	2,631	3,184
Stock option exercises	176	109
Shares issued as of March 31	669,275	664,181

Preferred Stock

The following reflects our preferred shares outstanding for the three months ended March 31, 2013 and 2012:



	5.75%	5.75% (A)	4.5%	5.00% (2005B)
	(in thousands)
Shares outstanding as of January 1, 2013 and March 31, 2013	1,497	1,100	2,559	2,096

Shares outstanding as of January 1, 2012 and March 31, 2012	1,497	1,100	2,559	2,096

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.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

Stock-Based Compensation

Chesapeake’s stock-based compensation program consists of restricted stock and stock options issued to employees and restricted stock issued to 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. For employees, this value is amortized over the vesting period, which is generally four years from the date of grant. For directors, although the restricted stock grants vest over three years, this value is expensed immediately as there is a non-substantive service condition for vesting. To the extent compensation cost relates to employees directly involved in the acquisition of natural gas and oil leasehold and 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, natural gas, oil and NGL production expenses, marketing, gathering and compression expenses or oilfield services expenses. We recorded the following stock-based compensation during the Current Quarter and the Prior Quarter:



	Three Months Ended March 31,
	2013		2012
	($ in millions)
Natural gas and oil properties	$	21	$	20
General and administrative expenses	20		19
Natural gas, oil and NGL production expenses	6		6
Marketing, gathering and compression expenses	3		4
Oilfield services expenses	3		3
Total	$	53	$	52

Restricted Stock

Chesapeake began issuing shares of restricted common stock to employees in January 2004 and to non-employee directors in July 2005. A summary of the unvested shares of restricted stock and changes during the three months ended March 31, 2013 is presented below.



	Number of Unvested Restricted Shares		Weighted Average Grant-Date Fair Value
	(in thousands)
Unvested shares as of January 1, 2013	18,899		$	23.72
Granted	4,945		$	17.87
Vested	(4,740	)	$	23.66
Forfeited	(583	)	$	21.89
Unvested shares as of March 31, 2013	18,521		$	22.23

The aggregate intrinsic value of restricted stock that vested during the Current Quarter was approximately $85 million based on the stock price at the time of vesting.

As of March 31, 2013, there was $275 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 2.6 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 and the Prior Quarter, we recognized reductions in tax benefits related to restricted stock of $10 million, and $4 million, respectively, which were recorded as adjustments to additional paid-in capital and deferred income taxes.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

Stock Options

In the Current Quarter, we granted incentive-based and retention-based stock options to members of our senior management team. The incentive-based stock options will vest ratably over a three-year period and the retention-based stock options will vest one-third on each of the third, fourth and fifth anniversaries of the grant date. The stock option awards have an exercise price equal to the closing price of the Company’s common stock on the grant date. Historically, we had granted stock options prior to 2006 under several stock compensation plans and they vested over a four-year period. Outstanding options expire ten years from the date of grant.

The following table provides information related to stock option activity for the three months ended March 31, 2013:



	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, 2013	481		$	12.69	0.96	$	2
Granted	4,563		$	18.97
Exercised	(178	)	$	11.06
Outstanding at March 31, 2013	4,866		$	18.64	9.27	$	9

Exercisable at March 31, 2013	302		$	13.66	0.74	$	2

___________________________________________


(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.

As of March 31, 2013, there was $27 million of total unrecognized compensation cost related to stock options. The cost is expected to be recognized over a weighted average period of approximately 3.4 years.

During the Current Quarter and the Prior Quarter, we recognized excess tax benefits related to stock options of $0 and a nominal amount, respectively. All amounts were recorded as adjustments to additional paid-in capital and deferred income taxes.

Performance Share Units

In January 2012 and 2013, we granted performance share units (PSUs) to senior management under our Long Term Incentive Plan that include both an internal performance measure and an external market condition. The 2012 awards vest over one-, two- and three-year service periods, and the 2013 awards vest over a three-year service period. The internal performance measure is considered a performance condition with a fair value generally equal to the Company’s stock price. The external market condition is considered a market condition and generally requires Monte Carlo simulation to determine the fair value. The latter calculation for the 2012 awards is based on the absolute total shareholder return (TSR) of Chesapeake common stock and the relative TSR of Chesapeake common stock compared to the TSR of certain peers. The calculation for the 2013 awards is based on the relative TSR of Chesapeake common stock compared to the TSR of certain peers.

For PSUs granted in 2012, each of the TSR and operational payout components can range from 0% to 125%. For PSUs granted in 2013, the TSR component can range from 0% and 125% and each of the two operational components can range from 0% to 62.5%, in each case resulting in a total range of payout from 0% to 200%. The PSUs can only be settled in cash, so they are classified as a liability in our condensed consolidated financial statements and are measured at fair value as of the grant date, with such value re-measured at the end of each reporting period. Compensation expense is recognized over the vesting period with a corresponding adjustment to the liability.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

As of the respective grant dates, the fair value of the 1,271,240 PSUs issued in 2012 was $35 million and the fair value of the 1,426,235 PSUs issued in 2013 was $30 million. As of March 31, 2013, the fair value of the PSUs was $57 million. We have recorded $5 million of this value as a short-term liability for PSUs that will be settled in January 2014 and $36 million as a long-term liability representing the portion of the award that will be settled in January 2015 or thereafter. The remaining $16 million relates to PSUs for which the requisite service period has not been completed.

Noncontrolling Interests

Cleveland Tonkawa Financial Transaction. We formed CHK Cleveland Tonkawa, L.L.C. (CHK C-T) in March 2012 to continue development of a portion of our natural gas and oil assets in our Cleveland and Tonkawa plays. CHK C-T is an unrestricted subsidiary under our corporate credit facility agreement and is not a guarantor of, or otherwise liable for, any of our indebtedness or other liabilities, including indebtedness under our indentures. In exchange for all of the common shares of CHK C-T, we contributed to CHK C-T approximately 245,000 net acres of leasehold and the existing wells within an area of mutual interest in the Cleveland and Tonkawa plays covering Ellis and Roger Mills counties in western Oklahoma. In March 2012, in a private placement, third-party investors contributed $1.25 billion in cash to CHK C-T in exchange for (i) 1.25 million preferred shares, and (ii) our obligation to deliver a 3.75% overriding royalty interest (ORRI) in the existing wells and up to 1,000 new net wells to be drilled on certain of our Cleveland and Tonkawa play leasehold. Subject to customary minority interest protections afforded the investors by the terms of the CHK C-T limited liability company agreement (the CHK C-T LLC Agreement), as the holder of all the common shares and the sole managing member of CHK C-T, we maintain voting and managerial control of CHK C-T and therefore include it in our condensed consolidated financial statements. Of the $1.25 billion of investment proceeds, we allocated $225 million to the ORRI obligation and $1.025 billion to the preferred shares based on estimates of fair values. The remaining ORRI obligation is included in other current and long-term liabilities and the preferred shares are included in noncontrolling interests on our condensed consolidated balance sheets. Pursuant to the CHK C-T LLC Agreement, CHK C-T is currently required to retain an amount of cash (measured quarterly) equal to (i) the next two quarters of preferred dividend payments plus (ii) its projected operating funding shortfall for the next six months (projected operating funding shortfall requirement ends on December 31, 2013). The amount so retained, approximately $37 million as of March 31, 2013, is reflected as restricted cash on our condensed consolidated balance sheet.

Dividends on the preferred shares are payable on a quarterly basis at a rate of 6% per annum based on $1,000 per share. This dividend rate is subject to increase in limited circumstances in the event that, and only for so long as, any dividend amount is not paid in full for any quarter. As the managing member of CHK C-T, we may, at our sole discretion and election at any time after March 31, 2014, distribute certain excess cash of CHK C-T, as determined in accordance with the CHK C-T LLC Agreement. Any such optional distribution of excess cash is allocated 75% to the preferred shares (which is applied toward redemption of the preferred shares) and 25% to the common shares unless we have not met our drilling commitment at such time, in which case an optional distribution would be allocated 100% to the preferred shares (and applied toward redemption thereof). We may also, at our sole discretion and election, in accordance with the CHK C-T LLC Agreement, cause CHK C-T to redeem all or a portion of the CHK C-T preferred shares for cash. The preferred shares may be redeemed at a valuation equal to the greater of a 9% internal rate of return or a return on investment of 1.35x, in each case inclusive of dividends paid through redemption at the rate of 6% per annum and optional distributions made through the applicable redemption date. In the event that redemption does not occur on or prior to March 31, 2019, the optional redemption valuation will increase to provide a 15% internal rate of return to the investors. The preferred shares can be redeemed on a pro-rata basis in accordance with the then-applicable redemption valuation formula. As of March 31, 2013, the redemption price and the liquidation preference were each $1,290 per preferred share.

We have committed to drill, for the benefit of CHK C-T in the area of mutual interest, a minimum of 37.5 net wells per six-month period through 2013, inclusive of wells drilled in 2012, and 25 net wells per six-month period in 2014 through 2016, up to a minimum cumulative total of 300 net wells. If we fail to meet the then-current cumulative drilling commitment in any six-month period, any optional cash distributions would be distributed 100% to the investors. If we fail to meet the then-current cumulative drilling commitment in two consecutive six-month periods, the then-applicable internal rate of return to investors at redemption would increase by 3% per annum. In addition, if we fail to meet the then-current cumulative drilling commitment in four consecutive six-month periods, the then-applicable internal rate of return to investors at redemption would be increased by an additional 3% per annum. Any such increase in the internal rate of return would be effective only until the end of the first succeeding six-month period in which we have met our then-current cumulative drilling commitment. CHK C-T is responsible for all capital and operating costs of the wells drilled for the benefit of the entity. Under the development agreement, approximately 20 and 23 qualified net

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

wells were added in the Current Quarter and the Prior Quarter, respectively. Through March 31, 2013, we were on target to meet our 2013 drilling commitment associated with the CHK C-T transaction.

The CHK C-T investors’ right to receive, proportionately, a 3.75% ORRI in up to 1,000 new net wells and the contributed wells on our Cleveland and Tonkawa leasehold is subject to an increase to 5% on net wells drilled in any year following a year in which we do not meet our commitment to drill the wells subject to the ORRI obligation, which runs from 2012 through the first quarter of 2025. However, in no event would we deliver to investors more than a total ORRI of 3.75% in existing wells and 1,000 new net wells. If at any time we hold fewer net acres than would enable us to drill all then-remaining net wells on 160-acre spacing, the investors have the right to require us to repurchase their right to receive ORRIs in the remaining net wells at the then-current fair market value of such remaining ORRIs. We retain the right to repurchase the investors’ right to receive ORRIs in the remaining net wells at the then-current fair market value of such remaining ORRIs once we have drilled a minimum of 867 net wells. The obligation to deliver future ORRIs has been recorded as a liability which will be settled through the conveyance of the underlying ORRIs to the investors on a net-well basis, at which time the associated liability will be reversed and the sale of the ORRIs reflected as an adjustment to the capitalized cost of our natural gas and oil properties. Under the ORRI obligation, we delivered an ORRI in approximately 22 net wells in the Current Quarter and 17 net wells in the Prior Quarter. While operations began on April 1, 2012, all wells completed since January 1, 2012 are credited to the ORRI obligation of 1,000 new net wells. Through March 31, 2013, we have met all current commitments associated with the CHK C-T transaction.

As of March 31, 2013 and December 31, 2012, $1.015 billion was recorded as noncontrolling interests on our condensed consolidated balance sheets. In the Current Quarter and the Prior Quarter, income of $19 million and $0 was attributable to the noncontrolling interests of CHK C-T. No income was attributable to the noncontrolling interests of CHK C-T in the Prior Quarter as the operational effective date was April 1, 2012.

Utica Financial Transaction. We formed CHK Utica, L.L.C. (CHK Utica) in October 2011 to develop a portion of our Utica Shale natural gas and oil assets. CHK Utica is an unrestricted subsidiary under our corporate credit facility agreement and is not a guarantor of, or otherwise liable for, any of our indebtedness or other liabilities, including indebtedness under our indentures. In exchange for all of the common shares of CHK Utica, we contributed to CHK Utica approximately 700,000 net acres of leasehold and the existing wells within an area of mutual interest in the Utica Shale play covering 13 counties located primarily in eastern Ohio. During November and December 2011, in private placements, third-party investors contributed $1.25 billion in cash to CHK Utica in exchange for (i) 1.25 million preferred shares, and (ii) our obligation to deliver a 3% ORRI in 1,500 net wells to be drilled on certain of our Utica Shale leasehold. Subject to customary minority interest protections afforded the investors by the terms of the CHK Utica limited liability company agreement (the CHK Utica LLC Agreement), as the holder of all the common shares and the sole managing member of CHK Utica, we maintain voting and managerial control of CHK Utica and therefore include it in our condensed consolidated financial statements. Of the $1.25 billion of investment proceeds, we allocated $300 million to the ORRI obligation and $950 million to the preferred shares based on estimates of fair values. The remaining ORRI obligation is included in other current and long-term liabilities and the preferred shares are included in noncontrolling interests on our condensed consolidated balance sheets. Pursuant to the CHK Utica LLC Agreement, CHK Utica is required to retain a cash balance equal to the next two quarters of preferred dividend payments. The amount reserved for paying such dividends, approximately $44 million, is reflected as restricted cash on our condensed consolidated balance sheet as of March 31, 2013. In addition, pursuant to the CHK Utica LLC Agreement, with respect to any sales proceeds as defined by the agreement, CHK Utica is required to separately account for, and dedicate all of such sales proceeds to either (i) capital expenditures made by CHK Utica in connection with its assets or (ii) the redemption of CHK Utica preferred shares. As a result of the sale of noncore Utica Shale assets in the Current Quarter and 2012, the amount reserved for paying capital expenditures, approximately $130 million, is reflected as restricted cash in other long-term assets on our condensed consolidated balance sheet as of March 31, 2013.

Dividends on the preferred shares are payable on a quarterly basis at a rate of 7% per annum based on $1,000 per share. This dividend rate is subject to increase in limited circumstances in the event that, and only for so long as, any dividend amount is not paid in full for any quarter. If we fail to meet the then-current drilling commitment in any year, we must pay CHK Utica $5 million for each well we are short of such drilling commitment. As the managing member of CHK Utica, we may, at our sole discretion and election at any time after December 31, 2013, distribute certain excess cash of CHK Utica, as determined in accordance with the CHK Utica LLC Agreement. Any such optional distribution of excess cash is allocated 70% to the preferred shares (which is applied toward redemption of the preferred shares) and 30% to the common shares unless we have not met our drilling commitment during a liquidated damages

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

period, in which case an optional distribution would be allocated 100% to the preferred shares (and applied toward redemption thereof). We may also, at our sole discretion and election, in accordance with the CHK Utica LLC Agreement, cause CHK Utica to redeem the CHK Utica preferred shares for cash, in whole or in part. The preferred shares may be redeemed at a valuation equal to the greater of a 10% internal rate of return or a return on investment of 1.4x, in each case inclusive of dividends paid at the rate of 7% per annum and optional distributions made through the applicable redemption date. In the event that redemption does not occur on or prior to October 31, 2018, the optional redemption valuation will increase to provide the investors the greater of a 17.5% internal rate of return or a return on investment of 2.0x. The preferred shares can be redeemed on a pro-rata basis in accordance with the then-applicable redemption valuation formula. As of March 31, 2013, the redemption price and the liquidation preference were each approximately $1,305 per preferred share.

We have committed to drill, for the benefit of CHK Utica in the area of mutual interest, a minimum of 50 net wells per year from 2012 through 2016, up to a minimum cumulative total of 250 net wells. CHK Utica is responsible for all capital and operating costs of the wells drilled for the benefit of the entity. CHK Utica also receives its proportionate share of the benefit of the drilling carry associated with our joint venture with Total in the Utica Shale. See Note 8 for further discussion of the joint venture. Under the development agreement, approximately 27 and 12 qualified net wells were added in the Current Quarter and Prior Quarter, respectively. Through March 31, 2013, we were on target to meet our 2013 drilling commitment associated with the CHK Utica transaction.

The CHK Utica investors’ right to receive, proportionately, a 3% ORRI in the first 1,500 net wells drilled on our Utica Shale leasehold is subject to an increase to 4% on net wells drilled in any year following a year in which we do not meet our commitment to drill the wells subject to the ORRI obligation, which runs from 2012 through 2023. However, in no event would we deliver to investors more than a total ORRI of 3% in 1,500 net wells. If at any time we hold fewer net acres than would enable us to drill all then-remaining net wells on 150-acre spacing, the investors have the right to require us to repurchase their right to receive ORRIs in the remaining net wells at the then-current fair market value of such remaining ORRIs. We retain the right to repurchase the investors’ right to receive ORRIs in the remaining net wells at the then-current fair market value of such remaining ORRIs once we have drilled a minimum of 1,300 net wells. The obligation to deliver future ORRIs has been recorded as a liability which will be settled through the future conveyance of the underlying ORRIs to the investors on a net-well basis, at which time the associated liability will be reversed and the sale of the ORRIs reflected as an adjustment to the capitalized cost of our natural gas and oil properties. Under the ORRI obligation, we delivered an ORRI in approximately 11 new net wells in the Current Quarter. We did not meet our ORRI commitment in 2012. The ORRI increased to 4% for wells drilled or to be drilled in 2013, and the ultimate number of wells in which we must assign an interest will be reduced accordingly.

As of March 31, 2013 and December 31, 2012, $950 million was recorded as noncontrolling interests on our condensed consolidated balance sheets. For the Current Quarter and the Prior Quarter, income of approximately $22 million was attributable to the noncontrolling interests of CHK Utica. Subsequent to March 31, 2013, we purchased approximately 15% of the outstanding CHK Utica preferred shares from existing investors for $213 million. See Note 18 for further discussion of this transaction.

Chesapeake Granite Wash Trust. In November 2011, Chesapeake Granite Wash Trust (the Trust) sold 23,000,000 common units representing beneficial interests in the Trust at a price of $19.00 per common unit in its initial public offering. The common units are listed on the New York Stock Exchange and trade under the symbol “CHKR”. We own 12,062,500 common units and 11,687,500 subordinated units, which in the aggregate represent an approximate 51% beneficial interest in the Trust. The Trust has a total of 46,750,000 units outstanding.

In connection with the initial public offering of the Trust, we conveyed royalty interests to the Trust that entitle the Trust to receive (i) 90% of the proceeds (after deducting certain post-production expenses and any applicable taxes) that we receive from the production of hydrocarbons from 69 producing wells, and (ii) 50% of the proceeds (after deducting certain post-production expenses and any applicable taxes) in 118 development wells that have been or will be drilled on approximately 45,400 gross acres (29,000 net acres) in the Colony Granite Wash play in Washita County in the Anadarko Basin of western Oklahoma. Pursuant to the terms of a development agreement with the Trust, we are obligated to drill, or cause to be drilled, the development wells at our own expense prior to June 30, 2016, and the Trust will not be responsible for any costs related to the drilling of the development wells or any other operating or capital costs of the Trust properties. In addition, we granted to the Trust a lien on our remaining interests in the undeveloped properties that are subject to the development agreement in order to secure our drilling obligation to the Trust, although the maximum amount that may be recovered by the Trust under such lien could not exceed $263 million initially and is proportionately reduced as we fulfill our drilling obligation over time. As of March 31, 2013, we had drilled

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

or caused to be drilled approximately 64 development wells, as calculated under the development agreement, and the maximum amount recoverable under the drilling support lien was approximately $120 million.

The subordinated units we hold in the Trust are entitled to receive pro rata distributions from the Trust each quarter if and to the extent there is sufficient cash to provide a cash distribution on the common units that is not less than the applicable subordination threshold for such quarter. If there is not sufficient cash to fund such a distribution on all of the Trust units, the distribution to be made with respect to the subordinated units will be reduced or eliminated for such quarter in order to make a distribution, to the extent possible, of up to the subordination threshold amount on the common units. In exchange for agreeing to subordinate a portion of our Trust units, and in order to provide additional financial incentive to us to satisfy our drilling obligation and perform operations on the underlying properties in an efficient and cost-effective manner, Chesapeake is entitled to receive incentive distributions equal to 50% of the amount by which the cash available for distribution on the Trust units in any quarter exceeds the applicable incentive threshold for such quarter. The remaining 50% of cash available for distribution in excess of the applicable incentive threshold will be paid to Trust unitholders, including Chesapeake, on a pro rata basis. At the end of the fourth full calendar quarter following our satisfaction of our drilling obligation with respect to the development wells, the subordinated units will automatically convert into common units on a one-for-one basis and our right to receive incentive distributions will terminate. After such time, the common units will no longer have the protection of the subordination threshold, and all Trust unitholders will share in the Trust’s distributions on a pro rata basis.

On February 8, 2013, the Trust declared a cash distribution of $0.6700 per common unit and $0.3772 per subordinated unit for the three-month period ended December 31, 2012 and covering production for the period from September 1, 2012 to November 30, 2012. The distribution paid to third-party unitholders on March 1, 2013 was approximately $15 million.

On February 8, 2012, the Trust declared a cash distribution of $0.7277 per unit for the three-month period ended December 31, 2011 and covering production for the period from September 1, 2011 to November 30, 2011. The distribution paid to third-party unitholders on March 1, 2012 was approximately $17 million.

We have determined that the Trust constitutes a VIE and that Chesapeake is the primary beneficiary. As a result, the Trust is included in our condensed consolidated financial statements. As of March 31, 2013 and December 31, 2012, $344 million and $356 million, respectively, were recorded as noncontrolling interests on our condensed consolidated balance sheets. For the Current Quarter and the Prior Quarter, approximately $5 million and $3 million of income was attributable to the Trust’s noncontrolling interests in our condensed consolidated statements of operations. See Note 10 for further discussion of VIEs.

Wireless Seismic, Inc. We have a controlling 57% equity interest in Wireless Seismic, Inc. (Wireless), a privately owned company engaged in research, development and eventual production of wireless seismic systems and any related technology that deliver seismic information obtained from standard geophones in real time to laptop and desktop computers. As a result of our control, Wireless is included in our condensed consolidated financial statements as of the 2012 fourth quarter. As of March 31, 2013 and December 31, 2012, $3 million and $5 million, respectively, was recorded as noncontrolling interests on our condensed consolidated balance sheets. In the Current Quarter, $1 million of Wireless’ loss was attributable to noncontrolling interests of Wireless in our condensed consolidated statement of operations.

Big Star Crude Co., LLC. Oilfield Trucking Solutions, LLC, a wholly owned subsidiary of Chesapeake, entered into a joint venture to form Big Star Crude Co., LLC, which engages in commercial trucking. We have determined that Big Star is a VIE because our voting rights are disproportionate to our economic interests and the activities of the entity involve us and are conducted on our behalf. We have also determined that Chesapeake is the primary beneficiary, since it has the power to direct the activities of the VIE, has the obligation to absorb losses and has the right to receive benefits from the VIE. As a result, Big Star is included in our condensed consolidated financial statements as of the 2012 fourth quarter. As of March 31, 2013 and December 31, 2012, $1 million was recorded as noncontrolling interests on our condensed consolidated balance sheets. In the Current Quarter, a nominal amount of Big Star’s loss was attributable to noncontrolling interests of Big Star in our condensed consolidated statement of operations.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)


7.	Derivative and Hedging Activities

Natural Gas, Oil and NGL Derivatives

Our results of operations and cash flows are impacted by changes in market prices for natural gas, oil and NGL. To mitigate a portion of our exposure to adverse price changes, we have entered into various derivative instruments. These instruments allow us to predict with greater certainty the effective prices to be received for our production. We believe our derivative instruments continue to be highly effective in achieving our risk management objectives. As of March 31, 2013 and December 31, 2012, 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.

•

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


•	Swaptions: Chesapeake sells call swaptions to counterparties that allow them, on a specific date, to extend an existing fixed-price swap for a certain period of time.

•

Basis Protection Swaps: These instruments are arrangements that guarantee a price differential to NYMEX from a specified delivery point. Our natural gas basis protection swaps 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. Our oil basis protection swaps 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.

•

Collars: These instruments contain a fixed floor price (put) and ceiling price (call). If the market price exceeds the call strike price or falls below the put strike price, Chesapeake receives the fixed price and pays the market price. If the market price is between the put and the call strike price, no payments are due from either party. Three-way collars include an additional put option in exchange for a more favorable strike price on the collar. This eliminates the counterparty’s downside exposure below the second put option.

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 instrument assets (liabilities) as of March 31, 2013 and December 31, 2012 are provided below.



	March 31, 2013				December 31, 2012
	Volume	Fair Value			Volume	Fair Value
		($ in millions)				($ in millions)
Natural gas (tbtu):
Fixed-price swaps	586	$	(233	)	49	$	24
Call options	193	(233		)	193	(240		)
Basis protection swaps	101	(15		)	111	(15		)
Three-way collars	72	(15		)	—	—
Total natural gas	952	(496		)	353	(231		)
Oil (mmbbl):
Fixed-price swaps	43.8	(17		)	28.1	68
Call options	69.5	(514		)	73.8	(748		)
Call swaptions	5.3	(6		)	5.3	(13		)
Basis protection swaps	3.2	(2		)	5.5	—
Total oil	121.8	(539		)	112.7	(693		)
Total estimated fair value		$	(1,035	)		$	(924	)

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

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 and locked-in gains and losses of settled designated derivative contracts, are recorded in accumulated other comprehensive income until the hedged item is recognized in earnings. Any change in fair value resulting from ineffectiveness is recognized in natural gas, oil and NGL sales. Changes in the fair value of derivatives not designated as cash flow hedges that occur prior to their maturity (i.e., temporary fluctuations in value) are reported in the condensed consolidated statements of operations within natural gas, oil and NGL sales. As of March 31, 2013, we did not have any natural gas or oil derivatives that were designated as cash flow hedges. Therefore, changes in the fair value of these derivatives are reported in the condensed consolidated statement of operations. See further discussion below under Cash Flow Hedges.

The components of natural gas, oil and NGL sales for the Current Quarter and the Prior Quarter are presented below.



	Three Months Ended March 31,
	2013			2012
	($ in millions)
Natural gas, oil and NGL sales	$	1,595		$	1,221
Gains (losses) on natural gas, oil and NGL derivatives	(142		)	(153		)
Total natural gas, oil and NGL sales	$	1,453		$	1,068

Hedging Facility

We have a multi-counterparty secured hedging facility with 17 counterparties that have committed to provide approximately 6.4 tcfe of hedging capacity for natural gas, oil and NGL price derivatives and 6.4 tcfe for basis derivatives with an aggregate mark-to-market capacity of $17.25 billion under the terms of the facility. As of March 31, 2013, we had hedged under the facility 1.5 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 NGL price and basis derivatives 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 at semi-annual collateral dates and 1.30 times in between those dates, and guarantees by certain subsidiaries that also guarantee our corporate revolving bank credit facility, indentures, term loan and sale/leaseback agreements. The counterparties’ obligations under the facility must be secured by cash or short-term U.S. Treasury instruments to the extent that any mark-to-market amounts they owe to Chesapeake exceed defined thresholds. The maximum volume-based trading capacity under the facility is governed by the expected production of the pledged reserve collateral, and volume-based trading limits are applied separately to price and basis derivatives. In addition, there are volume-based sub-limits for natural gas, oil and NGL derivative instruments. Chesapeake has significant flexibility with regard to releases and/or substitutions of pledged reserves, provided that certain requirements are met including maintaining specified collateral coverage ratios as well as maintaining credit ratings with either of the designated rating agencies at or above current levels. The facility does not have a maturity date. Counterparties to the agreement have the right to cease entering into derivative instruments 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.

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 March 31, 2013 and December 31, 2012, 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.


•	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.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

The notional amount and the estimated fair value of our interest rate derivative liabilities as of March 31, 2013 and December 31, 2012 are provided below.



	March 31, 2013					December 31, 2012
	Notional Amount		Fair Value			Notional Amount		Fair Value
			($ in millions)
Interest rate:
Swaps	$	1,750	$	(37	)	$	1,050	$	(35	)
Swaptions	125		(2		)	—		—
Totals	$	1,875	$	(39	)	$	1,050	$	(35	)

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 and the Prior Quarter are presented below.



	Three Months Ended March 31,
	2013			2012
	($ in millions)
Interest expense on senior notes	$	186		$	174
Interest expense on credit facilities	12			21
Interest expense on term loans	29			—
(Gains) losses on interest rate derivatives	4			4
Amortization of loan discount, issuance costs and other	19			1
Capitalized interest	(229		)	(188		)
Total interest expense	$	21		$	12

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 eight years, we will recognize $18 million in net 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. 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 are designated as cash flow hedges. The fair values of the cross currency swaps are recorded on the condensed consolidated balance sheet as a liability of $36 million as of March 31, 2013. The euro-denominated debt in long-term debt has been adjusted to $440 million as of March 31, 2013 using an exchange rate of $1.2816 to €1.00.

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

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 hedged transaction occurs. Cash settlements of our derivative instruments are generally classified as operating cash flows unless the derivative is deemed to contain, for accounting purposes, 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.

The following table presents the fair value and location of each classification of derivative instrument disclosed in the condensed consolidated balance sheets as of March 31, 2013 and December 31, 2012 on a gross basis without regard to same-counterparty netting:



		Fair Value
	Balance Sheet Location	March 31, 2013			December 31, 2012
		($ in millions)
Asset Derivatives:
Not designated as hedging instruments:
Commodity contracts	Short-term derivative instruments	$	18		$	110
Commodity contracts	Long-term derivative instruments	22			5
Total		40			115

Liability Derivatives:
Designated as hedging instruments:
Foreign currency contracts	Long-term derivative instruments	(36		)	(20		)
Total		(36		)	(20		)

Not designated as hedging instruments:
Commodity contracts	Short-term derivative instruments	(435		)	(157		)
Commodity contracts	Long-term derivative instruments	(640		)	(882		)
Interest rate contracts	Short-term derivative instruments	(2		)	—
Interest rate contracts	Long-term derivative instruments	(37		)	(35		)
Total		(1,114		)	(1,074		)
Total derivative instruments		$	(1,110	)	$	(979	)

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

All of the Company’s derivative positions are subject to netting arrangements which provide for offsetting of asset and liability positions, as well as related cash collateral if applicable. Such netting arrangements generally do not have restrictions. Under such netting arrangements, the Company offsets the fair value of derivative instruments with cash collateral received or paid for those contracts executed with the same counterparty, which reduces the Company’s total assets and liabilities. As of March 31, 2013 and December 31, 2012, we did not have any cash collateral balances for these derivatives.

The following tables present the netting offsets of derivative assets and liabilities as of March 31, 2013 and December 31, 2012:



	March 31, 2013
	Derivative Assets						Derivative Liabilities
	Short-Term			Long-Term			Short-Term			Long-Term
	($ in millions)
Commodity Contracts:
Gross amounts of recognized assets (liabilities)	$	18		$	22		$	(435	)	$	(640	)
Gross amounts offset in the condensed consolidated statements of financial position	(13		)	(20		)	13			20
Net amounts of assets (liabilities) presented in the statements of financial position	5			2			(422		)	(620		)
Interest Rate Contracts:
Gross amounts of recognized assets (liabilities)	—			—			(2		)	(37		)
Gross amounts offset in the condensed consolidated statements of financial position	—			—			—			—
Net amounts of assets (liabilities) presented in the statements of financial position	—			—			(2		)	(37		)
Foreign Currency Contracts:
Gross amounts of recognized assets (liabilities)	—			—			—			(36		)
Gross amounts offset in the condensed consolidated statements of financial position	—			—			—			—
Net amounts of assets (liabilities) presented in the statements of financial position	—			—			—			(36		)

Total derivatives as reported	$	5		$	2		$	(424	)	$	(693	)

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)

(unaudited)

December 31,
2012

Derivative Assets

Derivative Liabilities

Short-Term

Long-Term

Short-Term

Long-Term

($ in millions)

Commodity Contracts: