Document



UNITED STATES
SECURITIES AND EXCHANGE COMMISSION
Washington, D.C. 20549
FORM 10-Q
[X]    QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934
For the Quarterly Period Ended June 30, 2018
[  ]    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 every Interactive Data File required to be submitted 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 such files). YES [X]     NO [ ]
 
 Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, a smaller reporting company or an emerging growth company. See the definitions of "large accelerated filer," "accelerated filer," "smaller reporting company" and “emerging growth company” in Rule 12b-2 of the Exchange Act.
 
Large Accelerated Filer [X] Accelerated Filer [ ] Non-accelerated Filer [ ]
Smaller Reporting Company [ ] Emerging Growth Company [ ]
 
If an emerging growth company, indicate by check mark if the registrant has elected not to use the extended transition period for complying with any new or revised financial accounting standards provided pursuant to Section 13(a) of the Exchange Act. [ ]
 
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 July 25, 2018, there were 912,274,017 shares of our $0.01 par value common stock outstanding.







CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
INDEX TO FORM 10-Q FOR THE QUARTER ENDED JUNE 30, 2018


 
PART I. FINANCIAL INFORMATION
Page
Item 1.
 
 
June 30, 2018 and December 31, 2017
 
for the Three and Six Months Ended June 30, 2018 and 2017
 
for the Three and Six Months Ended June 30, 2018 and 2017
 
for the Six Months Ended June 30, 2018 and 2017
 
for the Six Months Ended June 30, 2018 and 2017
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Item 2.
 
 
Item 3.
Item 4.
 
PART II. OTHER INFORMATION
 
 
Item 1.
Item 1A.
Item 2.
Item 3.
Item 4.
Item 5.
Item 6.
 
 
 
 


Table of Contents
PART I. FINANCIAL INFORMATION



ITEM 1.
Condensed Consolidated Financial Statements

CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS
(Unaudited)
 
 
June 30,
2018
 
December 31, 2017
 
 
($ in millions)
CURRENT ASSETS:
 
 
 
 
Cash and cash equivalents ($2 and $2 attributable to our VIE)
 
$
3

 
$
5

Accounts receivable, net
 
1,060

 
1,322

Short-term derivative assets
 

 
27

Other current assets
 
177

 
171

Total Current Assets
 
1,240

 
1,525

PROPERTY AND EQUIPMENT:
 
 
 
 
Oil and natural gas properties, at cost based on full cost accounting:
 
 
 
 
Proved oil and natural gas properties
($488 and $488 attributable to our VIE)
 
69,976

 
68,858

Unproved properties
 
3,226

 
3,484

Other property and equipment
 
1,822

 
1,986

Total Property and Equipment, at Cost
 
75,024

 
74,328

Less: accumulated depreciation, depletion and amortization
(($463) and ($461) attributable to our VIE)
 
(64,185
)
 
(63,664
)
Property and equipment held for sale, net
 
11

 
16

Total Property and Equipment, Net
 
10,850

 
10,680

LONG-TERM ASSETS:
 
 
 
 
Other long-term assets
 
251

 
220

TOTAL ASSETS
 
$
12,341

 
$
12,425

 
 
 
 
 

The accompanying notes are an integral part of these condensed consolidated financial statements.
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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED BALANCE SHEETS – (Continued)
(Unaudited)

 
 
June 30,
2018
 
December 31, 2017
 
 
($ in millions)
CURRENT LIABILITIES:
 
 
 
 
Accounts payable
 
$
742

 
$
654

Current maturities of long-term debt, net
 
432

 
52

Accrued interest
 
125

 
137

Short-term derivative liabilities
 
297

 
58

Other current liabilities ($2 and $3 attributable to our VIE)
 
1,277

 
1,455

Total Current Liabilities
 
2,873

 
2,356

LONG-TERM LIABILITIES:
 
 
 
 
Long-term debt, net
 
9,238

 
9,921

Long-term derivative liabilities
 
21

 
4

Asset retirement obligations, net of current portion
 
149

 
162

Other long-term liabilities
 
177

 
354

Total Long-Term Liabilities
 
9,585

 
10,441

CONTINGENCIES AND COMMITMENTS (Note 4)
 

 

EQUITY:
 
 
 
 
Chesapeake Stockholders’ Equity (Deficit):
 
 
 
 
Preferred stock, $0.01 par value, 20,000,000 shares authorized:
5,603,458 shares outstanding
 
1,671

 
1,671

Common stock, $0.01 par value, 2,000,000,000 shares authorized:
913,271,035 and 908,732,809 shares issued
 
9

 
9

Additional paid-in capital
 
14,408

 
14,437

Accumulated deficit
 
(16,257
)
 
(16,525
)
Accumulated other comprehensive loss
 
(40
)
 
(57
)
Less: treasury stock, at cost;
3,319,061 and 2,240,394 common shares
 
(31
)
 
(31
)
Total Chesapeake Stockholders’ Equity (Deficit)
 
(240
)
 
(496
)
Noncontrolling interests
 
123

 
124

Total Equity (Deficit)
 
(117
)
 
(372
)
TOTAL LIABILITIES AND EQUITY
 
$
12,341

 
$
12,425


The accompanying notes are an integral part of these condensed consolidated financial statements.
4

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF OPERATIONS
(Unaudited)


 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2018
 
2017
 
2018
 
2017
  
 
($ in millions except per share data)
REVENUES:
 
 
 
 
 
 
 
 
Oil, natural gas and NGL
 
$
982

 
$
1,279

 
$
2,225

 
$
2,748

Marketing
 
1,273

 
1,002

 
2,519

 
2,286

Total Revenues
 
2,255

 
2,281

 
4,744

 
5,034

OPERATING EXPENSES:
 
 
 
 
 
 
 
 
Oil, natural gas and NGL production
 
138

 
140

 
285

 
275

Oil, natural gas and NGL gathering, processing and transportation
 
340

 
357

 
696

 
712

Production taxes
 
26

 
21

 
57

 
43

Marketing
 
1,292

 
1,027

 
2,560

 
2,355

General and administrative
 
91

 
70

 
163

 
135

Restructuring and other termination costs
 

 

 
38

 

Provision for legal contingencies, net
 
4

 
17

 
9

 
15

Oil, natural gas and NGL depreciation, depletion and amortization
 
271

 
202

 
539

 
399

Depreciation and amortization of other assets
 
19

 
21

 
37

 
42

Impairments
 
46

 

 
46

 

Other operating (income) expense
 
(1
)
 
26

 
(1
)
 
417

Net (gains) losses on sales of fixed assets
 
(1
)
 
1

 
7

 
1

Total Operating Expenses
 
2,225

 
1,882

 
4,436

 
4,394

INCOME FROM OPERATIONS
 
30

 
399

 
308

 
640

OTHER INCOME (EXPENSE):
 
 
 
 
 
 
 
 
Interest expense
 
(117
)
 
(93
)
 
(240
)
 
(188
)
Gains on investments
 

 

 
139

 

Gains on purchases or exchanges of debt
 

 
191

 

 
184

Other income (expense)
 
62

 
(1
)
 
62

 
2

Total Other Income (Expense)
 
(55
)
 
97

 
(39
)
 
(2
)
INCOME (LOSS) BEFORE INCOME TAXES
 
(25
)
 
496

 
269

 
638

Income tax expense (benefit)
 
(9
)
 
1

 
(9
)
 
2

NET INCOME (LOSS)
 
(16
)
 
495

 
278

 
636

Net income attributable to noncontrolling interests
 
(1
)
 
(1
)
 
(2
)
 
(2
)
NET INCOME (LOSS) ATTRIBUTABLE TO CHESAPEAKE
 
(17
)
 
494

 
276

 
634

Preferred stock dividends
 
(23
)
 
(16
)
 
(46
)
 
(39
)
Loss on exchange of preferred stock
 

 

 

 
(41
)
Earnings allocated to participating securities
 

 
(8
)
 
(2
)
 
(7
)
NET INCOME (LOSS) AVAILABLE TO COMMON STOCKHOLDERS
 
$
(40
)
 
$
470

 
$
228

 
$
547

EARNINGS (LOSS) PER COMMON SHARE:
 
 
 
 
 
 
 
 
Basic
 
$
(0.04
)
 
$
0.52

 
$
0.25

 
$
0.60

Diluted
 
$
(0.04
)
 
$
0.47

 
$
0.25

 
$
0.59

WEIGHTED AVERAGE COMMON AND COMMON EQUIVALENT SHARES OUTSTANDING (in millions):
 
 
 
 
 
 
 
 
Basic
 
909

 
908

 
908

 
907

Diluted
 
909

 
1,114

 
908

 
1,053


The accompanying notes are an integral part of these condensed consolidated financial statements.
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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF COMPREHENSIVE INCOME
(Unaudited)



 
 
Three Months Ended June 30,
 
Six Months Ended
June 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
($ in millions)
NET INCOME (LOSS)
 
$
(16
)
 
$
495

 
$
278

 
$
636

OTHER COMPREHENSIVE INCOME, NET OF INCOME TAX:
 
 
 
 
 
 
 
 
Unrealized gains on derivative instruments(a)
 

 

 

 
4

Reclassification of losses on settled derivative instruments(a)
 
7

 
7

 
17

 
17

Other Comprehensive Income
 
7

 
7

 
17

 
21

COMPREHENSIVE INCOME (LOSS)
 
(9
)
 
502

 
295

 
657

COMPREHENSIVE INCOME ATTRIBUTABLE TO NONCONTROLLING INTERESTS
 
(1
)
 
(1
)
 
(2
)
 
(2
)
COMPREHENSIVE INCOME (LOSS) ATTRIBUTABLE TO CHESAPEAKE
 
$
(10
)
 
$
501

 
$
293

 
$
655

___________________________________________
(a)
Deferred tax activity incurred in other comprehensive income was offset by a valuation allowance.


The accompanying notes are an integral part of these condensed consolidated financial statements.
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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS
(Unaudited)

 
 
Six Months Ended
June 30,
 
 
2018
 
2017
 
 
($ in millions)
CASH FLOWS FROM OPERATING ACTIVITIES:
 
 
 
 
NET INCOME
 
$
278

 
$
636

ADJUSTMENTS TO RECONCILE NET INCOME TO CASH
PROVIDED BY (USED IN) OPERATING ACTIVITIES:
 
 
 
 
Depreciation, depletion and amortization
 
576

 
441

Derivative (gains) losses, net
 
368

 
(522
)
Cash payments on derivative settlements, net
 
(55
)
 
(66
)
Stock-based compensation
 
18

 
27

Net losses on sales of fixed assets
 
7

 
1

Impairments
 
46

 

Gains on investments
 
(139
)
 

Gains on purchases or exchanges of debt
 

 
(185
)
Other
 
(102
)
 
(43
)
Changes in assets and liabilities
 
94

 
(347
)
Net Cash Provided By (Used In) Operating Activities
 
1,091

 
(58
)
CASH FLOWS FROM INVESTING ACTIVITIES:
 
 
 
 
Drilling and completion costs
 
(979
)
 
(1,031
)
Acquisitions of proved and unproved properties
 
(191
)
 
(162
)
Proceeds from divestitures of proved and unproved properties
 
384

 
951

Additions to other property and equipment
 
(5
)
 
(7
)
Proceeds from sales of other property and equipment
 
74

 
26

Proceeds from sales of investments
 
74

 

Net Cash Used In Investing Activities
 
(643
)
 
(223
)
CASH FLOWS FROM FINANCING ACTIVITIES:
 
 
 
 
Proceeds from revolving credit facility borrowings
 
6,118

 
2,551

Payments on revolving credit facility borrowings
 
(6,393
)
 
(1,976
)
Proceeds from issuance of senior notes, net
 

 
742

Extinguishment of other financing
 
(122
)
 

Cash paid to purchase debt
 

 
(1,746
)
Cash paid for preferred stock dividends
 
(46
)
 
(137
)
Distributions to noncontrolling interest owners
 
(3
)
 
(5
)
Other
 
(4
)
 
(17
)
Net Cash Used In Financing Activities
 
(450
)
 
(588
)
Net decrease in cash and cash equivalents
 
(2
)
 
(869
)
Cash and cash equivalents, beginning of period
 
5

 
882

Cash and cash equivalents, end of period
 
$
3

 
$
13

 
 
 
 
 
 

The accompanying notes are an integral part of these condensed consolidated financial statements.
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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF CASH FLOWS – (Continued)
(Unaudited)

Supplemental disclosures to the consolidated statements of cash flows are presented below:
 
 
Six Months Ended
June 30,
 
 
2018
 
2017
 
 
($ in millions)
SUPPLEMENTAL CASH FLOW INFORMATION:
 
 
 
 
Interest paid, net of capitalized interest
 
$
276

 
$
217

Income taxes paid, net of refunds received
 
$
(7
)
 
$
(14
)
 
 
 
 
 
SUPPLEMENTAL DISCLOSURE OF SIGNIFICANT NON-CASH INVESTING AND FINANCING ACTIVITIES:
 
 
 
 
Change in accrued drilling and completion costs
 
$
109

 
$
87

Change in accrued acquisitions of proved and unproved properties
 
$
1

 
$
4

Change in divested proved and unproved properties
 
$
(21
)
 
$
16



The accompanying notes are an integral part of these condensed consolidated financial statements.
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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
CONDENSED CONSOLIDATED STATEMENTS OF STOCKHOLDERS’ EQUITY
(Unaudited)




 
 
Six Months Ended
June 30,
 
 
2018
 
2017
 
 
($ in millions)
PREFERRED STOCK:
 
 
 
 
Balance, beginning of period
 
$
1,671

 
$
1,771

Exchange/conversions of 0 and 236,048 shares of preferred stock for common stock
 

 
(100
)
Balance, end of period
 
1,671

 
1,671

COMMON STOCK:
 
 
 
 
Balance, beginning and end of period
 
9

 
9

ADDITIONAL PAID-IN CAPITAL:
 
 
 
 
Balance, beginning of period
 
14,437

 
14,486

Stock-based compensation
 
17

 
29

Exchange of preferred stock for 0 and 9,965,835 shares of common stock
 

 
100

Equity component of contingent convertible notes repurchased, net of tax
 

 
(20
)
Dividends on preferred stock
 
(46
)
 
(137
)
Balance, end of period
 
14,408

 
14,458

RETAINED EARNINGS (ACCUMULATED DEFICIT):
 
 
 
 
Balance, beginning of period
 
(16,525
)
 
(17,603
)
Net income attributable to Chesapeake
 
276

 
634

Cumulative effect of accounting change
 
(8
)
 

Balance, end of period
 
(16,257
)
 
(16,969
)
ACCUMULATED OTHER COMPREHENSIVE LOSS:
 
 
 
 
Balance, beginning of period
 
(57
)
 
(96
)
Hedging activity
 
17

 
21

Balance, end of period
 
(40
)
 
(75
)
TREASURY STOCK – COMMON:
 
 
 
 
Balance, beginning of period
 
(31
)
 
(27
)
Purchase of 1,468,524 and 1,189,813 shares for company benefit plans
 
(4
)
 
(6
)
Release of 389,857 and 73,990 shares from company benefit plans
 
4

 
1

Balance, end of period
 
(31
)
 
(32
)
TOTAL CHESAPEAKE STOCKHOLDERS’ EQUITY (DEFICIT)
 
(240
)
 
(938
)
NONCONTROLLING INTERESTS:
 
 
 
 
Balance, beginning of period
 
124

 
257

Net income attributable to noncontrolling interests
 
2

 
2

Distributions to noncontrolling interest owners
 
(3
)
 
(5
)
Balance, end of period
 
123

 
254

TOTAL EQUITY (DEFICIT)
 
$
(117
)
 
$
(684
)

The accompanying notes are an integral part of these condensed consolidated financial statements.
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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS
(Unaudited)


1.
Basis of Presentation
Basis of Presentation
The accompanying condensed consolidated financial statements of Chesapeake were prepared in accordance with accounting principles generally accepted in the United States of America (“GAAP”) and the rules and regulations of the SEC. Pursuant to such rules and regulations, certain disclosures have been condensed or omitted.
This Form 10-Q relates to the three and six months ended June 30, 2018 (the “Current Quarter” and the “Current Period”, respectively) and the three and six months ended June 30, 2017 (the “Prior Quarter” and the “Prior Period”, respectively). Our annual report on Form 10-K for the year ended December 31, 2017 (“2017 Form 10-K”) should be read in conjunction with this Form 10-Q. The accompanying condensed consolidated financial statements reflect all normal recurring adjustments which, in the opinion of management, are necessary for a fair statement of our condensed consolidated financial statements and accompanying notes and include the accounts of our direct and indirect wholly owned subsidiaries and entities in which we have a controlling financial interest. Intercompany accounts and balances have been eliminated.
Recently Issued Accounting Standards
The Financial Accounting Standards Board (FASB) issued Revenue from Contracts with Customers (Topic 606) superseding virtually all existing revenue recognition guidance. We adopted this new standard in the first quarter of 2018 using the modified retrospective approach. We applied the new standard to all contracts that were not completed as of January 1, 2018 and reflected the aggregate effect of all modifications in determining and allocating the transaction price. See Note 10 for further details regarding our adoption of Topic 606.
In February 2018, the FASB issued Accounting Standards Update (ASU) 2018-02, Reclassification of Certain Tax Effects from Accumulated Other Comprehensive Income. The new standard allows for stranded tax effects resulting from tax reform legislation known as the Tax Cuts and Jobs Act of 2017 (the “Tax Act”) previously recognized in accumulated other comprehensive income to be reclassified to retained earnings. For public business entities, the amendments are effective for annual periods, including interim periods within the annual periods, beginning after December 15, 2018. Early adoption is permitted in any interim or annual period, but we do not plan to early adopt. We are currently evaluating the impact of this standard on our consolidated financial statements and related disclosures.
In August 2017, the FASB issued ASU 2017-12, Derivatives and Hedging (Topic 815), which makes significant changes to the current hedge accounting guidance. The new standard eliminates the requirement to separately measure and report hedge ineffectiveness and generally requires the entire change in the fair value of a hedging instrument to be presented in the same income statement line as the hedged item. The new standard also eases certain documentation and assessment requirements and modifies the accounting for components excluded from the assessment of hedge effectiveness. The new standard update is effective for annual and interim periods beginning after December 15, 2018, including interim periods within those annual periods. Early adoption is permitted, but we do not plan to early adopt. We are currently evaluating the impact of this standard on our consolidated financial statements and related disclosures.

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

In February 2016, the FASB issued ASU 2016-02, Leases (Topic 842), which updated lease accounting guidance requiring lessees to recognize most leases, including operating leases, on the balance sheet as a right-of-use asset and lease liability for leases with terms in excess of 12 months. In January 2018, the FASB issued an update permitting an entity to elect an optional transition practical expedient to not evaluate land easements that existed or expired before the adoption of Topic 842 and were not previously accounted for as leases. Currently the guidance would be applied using a modified retrospective transition method, which requires applying the new guidance to leases that exist or are entered into after the beginning of the earliest period in the financial statements. However, the FASB recently issued Proposed ASU No. 2018-200, Leases (Topic 842), Targeted Improvements which would allow entities to apply the transition provisions of the new standard at its adoption date instead of at the earliest comparative period presented in the consolidated financial statements. The proposed ASU will allow entities to continue to apply the legacy guidance in Topic 840, including its disclosure requirements, in the comparative periods presented in the year the new leases standard is adopted. Entities that elect this option would still adopt the new leases standard using a modified retrospective transition method, but would recognize a cumulative-effect adjustment to the opening balance of retained earnings in the period of adoption rather than in the earliest period presented. Early adoption is permitted, but we do not plan to early adopt. The standard will not apply to our leases of mineral rights. Using the revised framework, we have completed our assessment of lease categories that we believe will be affected by the new standard. We are continuing to assess the accounting treatment for these leases and the resulting impacts to our consolidated financial statements and related disclosures.

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

2.
Earnings Per Share
Basic earnings per share (EPS) is calculated using the weighted average number of common shares outstanding during the period and includes the effect of any participating securities as appropriate. Participating securities consist of unvested restricted stock issued to our employees and non-employee directors that provide dividend rights.
Diluted EPS is calculated assuming the issuance of common shares for all potentially dilutive securities, provided the effect is not antidilutive. For all periods presented, our contingent convertible senior notes did not have a dilutive effect and, therefore, were excluded from the calculation of diluted EPS. See Note 3 for further discussion of our convertible senior notes and contingent convertible senior notes.
A reconciliation of basic EPS and diluted EPS is as follows:
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
(in millions, except per share data)
Net income (loss) available to common stockholders
 
$
(40
)
 
$
470

 
$
228

 
$
547

Effect of dilutive securities
 

 
59

 

 
72

Diluted income (loss) available to common stockholders
 
$
(40
)
 
$
529

 
$
228

 
$
619

 
 
 
 
 
 
 
 
 
Weighted average common and common equivalent shares outstanding - basic
 
909

 
908

 
908

 
907

Effect of dilutive securities
 

 
206

 

 
146

Weighted average common and common equivalent shares outstanding - diluted
 
909

 
1,114

 
908

 
1,053

 
 
 
 
 
 
 
 
 
Net income per share attributable to Chesapeake:
 
 
 
 
 
 
 
 
Basic
 
$
(0.04
)
 
$
0.52

 
$
0.25

 
$
0.60

Diluted
 
$
(0.04
)
 
$
0.47

 
$
0.25

 
$
0.59

 
 
 
 
 
 
 
 
 
Shares of common stock for the following securities were excluded from the calculation of diluted EPS as the effect was antidilutive:
 
 
 
 
 
 
 
 
Common stock equivalent of our preferred stock outstanding
 
60

 

 
60

 
60

Common stock equivalent of our convertible senior notes outstanding
 
146

 

 
146

 

Common stock equivalent of our preferred stock outstanding
prior to exchange
 

 

 

 
1

Participating securities
 
1

 
1

 
1

 
1



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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 June 30, 2018 and December 31, 2017:
 
June 30, 2018
 
December 31, 2017
 
Principal
Amount
 
Carrying
Amount
 
Principal
Amount
 
Carrying
Amount
 
($ in millions)
7.25% senior notes due 2018
$
44

 
$
44

 
$
44

 
$
44

Floating rate senior notes due 2019
380

 
380

 
380

 
380

6.625% senior notes due 2020
437

 
437

 
437

 
437

6.875% senior notes due 2020
227

 
227

 
227

 
227

6.125% senior notes due 2021
548

 
548

 
548

 
548

5.375% senior notes due 2021
267

 
267

 
267

 
267

4.875% senior notes due 2022
451

 
451

 
451

 
451

8.00% senior secured second lien notes due 2022
1,416

 
1,847

 
1,416

 
1,895

5.75% senior notes due 2023
338

 
338

 
338

 
338

8.00% senior notes due 2025
1,300

 
1,290

 
1,300

 
1,290

5.5% convertible senior notes due 2026(a)(b)
1,250

 
852

 
1,250

 
837

8.00% senior notes due 2027
1,300

 
1,298

 
1,300

 
1,298

2.25% contingent convertible senior notes due 2038(a)
9

 
8

 
9

 
8

Term loan due 2021
1,233

 
1,233

 
1,233

 
1,233

Revolving credit facility
506

 
506

 
781

 
781

Debt issuance costs

 
(57
)
 

 
(63
)
Interest rate derivatives

 
1

 

 
2

Total debt, net
9,706

 
9,670

 
9,981

 
9,973

Less current maturities of long-term debt, net(c)
(433
)
 
(432
)
 
(53
)
 
(52
)
Total long-term debt, net
$
9,273

 
$
9,238

 
$
9,928

 
$
9,921

___________________________________________
(a)
We are required to account for the liability and equity components of our convertible debt instruments separately and to reflect interest expense through the first demand repurchase date, as applicable, at the interest rate of similar nonconvertible debt at the time of issuance. The applicable rates for our 2.25% Contingent Convertible Senior Notes due 2038 and our 5.5% Convertible Senior Notes due 2026 are 8.0% and 11.5%, respectively.
(b)
Prior to maturity under certain circumstances and at the holder’s option, the notes are convertible. During the Current Quarter, the price of our common stock was below the threshold level for conversion and, as a result, the holders do not have the option to convert their notes in the third quarter of 2018.
(c)
As of June 30, 2018, current maturities of long-term debt, net includes our 7.25% Senior Notes due December 2018, our Floating Rate Senior Notes due April 2019, and due to the holders’ put option, our 2.25% Contingent Convertible Notes due December 2038.
Debt Retirements
In the Prior Period, we retired $1.604 billion principal amount of our outstanding senior notes, senior secured second lien notes and contingent convertible notes through purchases in the open market, tender offers or repayment upon maturity for $1.746 billion. For the open market repurchases and tender offers, we recorded aggregate net gains of approximately $191 million and $184 million in the Prior Quarter and the Prior Period, respectively.

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

Revolving Credit Facility
We have a senior secured revolving credit facility currently subject to a $3.8 billion borrowing base that matures in December 2019. As of June 30, 2018, we had outstanding borrowings of $506 million under the revolving credit facility and had used $183 million of the revolving credit facility for various letters of credit. Borrowings under the revolving credit facility bear interest at a variable rate. In the Current Quarter, we completed a scheduled borrowing base redetermination review and our lenders reaffirmed our $3.8 billion borrowing base. Our next scheduled borrowing base redetermination is scheduled for the fourth quarter of 2018.
Our revolving credit facility is subject to various financial and other covenants. The terms of the revolving credit facility include covenants limiting, among other things, our ability to incur additional indebtedness, make investments or loans, create liens, consummate mergers and similar fundamental changes, make restricted payments, make investments in unrestricted subsidiaries and enter into transactions with affiliates. As of June 30, 2018, we were in compliance with all applicable financial covenants under the credit agreement and we were able to borrow up to the full availability under the revolving credit facility.
Fair Value of Debt
We estimate the fair value of our senior notes based on the market value of our publicly traded debt as determined based on the yield of our senior notes (Level 1). The fair value of all other debt is based on a market approach using estimates provided by an independent investment financial data services firm (Level 2). Fair value is compared to the carrying value, excluding the impact of interest rate derivatives, in the table below:
 
 
June 30, 2018
 
December 31, 2017
 
 
Carrying
Amount
 
Estimated
Fair Value
 
Carrying
Amount
 
Estimated
Fair Value
 
 
 
 
($ in millions)
 
 
Short-term debt (Level 1)
 
$
432

 
$
432

 
$
52

 
$
53

Long-term debt (Level 1)
 
$
2,256

 
$
2,261

 
$
2,633

 
$
2,629

Long-term debt (Level 2)
 
$
6,982

 
$
7,215

 
$
7,286

 
$
7,301

4.
Contingencies and Commitments
There have been no material developments in previously reported legal or environmental contingencies or commitments other than the items discussed below. For a discussion of commitments and contingencies, see “Contingencies and Commitments,” Note 4 to the Consolidated Financial Statements in our 2017 Form 10-K.
Contingencies
Regulatory and Related Proceedings. We have previously disclosed receiving U.S. Postal Service and state subpoenas seeking information on our royalty payment practices. The U.S. Postal Service inquiry and all such outstanding state subpoenas have been resolved.
We have also previously disclosed defending lawsuits alleging various violations of the Sherman Antitrust Act and state antitrust laws. In 2016, putative class action lawsuits were filed in the U.S. District Court for the Western District of Oklahoma and in Oklahoma state courts, and an individual lawsuit was filed in the U.S. District Court of Kansas, in each case against us and other defendants. The lawsuits generally allege that, since 2007 and continuing through April 2013, the defendants conspired to rig bids and depress the market for the purchases of oil and natural gas leasehold interests and properties in the Anadarko Basin containing producing oil and natural gas wells. The lawsuits seek damages, attorney’s fees, costs and interest, as well as enjoinment from adopting practices or plans that would restrain competition in a similar manner as alleged in the lawsuits. On April 12, 2018, we reached a tentative settlement to resolve substantially all Oklahoma civil class action antitrust cases for an immaterial amount.
On July 28, 2017, OOGC America LLC (OOGC) filed a demand for arbitration with the American Arbitration Association against Chesapeake Exploration, L.L.C., our wholly owned subsidiary, in connection with OOGC’s purchase of certain oil and gas leases and other assets pursuant to a Purchase and Sale Agreement entered into on October 10, 2010. In connection with the sale, we also entered into a Development Agreement with OOGC, dated November 15, 2010 (the “Development Agreement”), which governs each of our rights and obligations with respect to the sale, including the transportation and marketing of oil and gas. OOGC’s breach of contract, breach of agency and fiduciary duties and other claims generally allege, among other things, that we subjected OOGC to excessive rates for gathering and other services provided for under the Development Agreement and interfered with OOGC’s right to audit the documents that supported those rates. OOGC seeks relief that may be material, including unspecified damages, attorneys’ fees, costs and expenses, disgorgement and various declaratory judgments.  We intend to vigorously defend these claims.
On July 24, 2018, Healthcare of Ontario Pension Plan (HOOPP) filed a demand for arbitration with the American Arbitration Association regarding HOOPP’s purchase of our interest in Chaparral Energy, Inc. stock for $215 million on January 5, 2014. HOOPP claims that the Company engaged in material misrepresentations and fraud, and that we violated the Exchange Act and Oklahoma Uniform Securities Act. HOOPP seeks either rescission or $215 million in monetary damages, and in either case, interest, attorney’s fees, disgorgement and punitive damages. We intend to vigorously defend these claims.
Commitments
Gathering, Processing and Transportation Agreements
We have contractual commitments with midstream service companies and pipeline carriers for future gathering, processing and transportation of oil, natural gas and NGL 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 as obligations in the accompanying consolidated balance sheets; however, they are reflected in our estimates of proved reserves.
The aggregate undiscounted commitments under our gathering, processing and transportation agreements, excluding any reimbursement from working interest and royalty interest owners, credits for third-party volumes or future costs under cost-of-service agreements, are presented below:
 
 
June 30,
2018
 
 
($ in millions)
2018
 
$
537

2019
 
1,047

2020
 
992

2021
 
900

2022
 
792

2023 – 2035
 
4,434

Total
 
$
8,702

In addition, we have entered into long-term agreements for certain natural gas gathering and related services within specified acreage dedication areas in exchange for cost-of-service based fees redetermined annually, or tiered fees based on volumes delivered relative to scheduled volumes. Future gathering fees may vary with the applicable agreement.

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

5.
Other Liabilities
Other current liabilities as of June 30, 2018 and December 31, 2017 are detailed below:
 
 
June 30,
2018
 
December 31,
2017
 
 
($ in millions)
Revenues and royalties due others
 
$
488

 
$
612

Accrued drilling and production costs
 
261

 
216

Joint interest prepayments received
 
81

 
74

Accrued compensation and benefits
 
156

 
214

Other accrued taxes
 
104

 
43

Other
 
187

 
296

Total other current liabilities
 
$
1,277

 
$
1,455

Other long-term liabilities as of June 30, 2018 and December 31, 2017 are detailed below:
 
 
June 30,
2018
 
December 31,
2017
 
 
($ in millions)
CHK Utica ORRI conveyance obligation(a)
 
$

 
$
156

Unrecognized tax benefits
 
81

 
101

Other
 
96

 
97

Total other long-term liabilities
 
$
177

 
$
354

____________________________________________
(a)
In the Current Quarter, we repurchased previously conveyed overriding royalty interests (ORRI) from the CHK Utica, L.L.C. investors and extinguished our obligation to convey future ORRIs to the CHK Utica, L.L.C. investors for combined consideration of $199 million. The total CHK Utica ORRI conveyance obligation extinguished in the Current Quarter was $183 million, of which, $30 million was recorded in current liabilities and $153 million was recorded in long-term liabilities. The fair value of the consideration allocated to the extinguishment of liability, $122 million, was less than the carrying amount of the conveyance obligation and resulted in a gain of $61 million recognized in other income on our condensed consolidated statement of operations. The fair value of the consideration allocated to the purchase of ORRIs on proved producing properties was $77 million and recorded in proved oil and natural gas properties in our condensed consolidated balance sheet.

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

6.
Income Taxes
We estimate our annual effective tax rate for continuing operations in recording our quarterly income tax provision (or benefit) for the various jurisdictions in which we operate. The tax effects of statutory rate changes, significant unusual or infrequent items, and certain changes in the assessment of the realizability of deferred tax assets are excluded from the determination of our estimated annual effective tax rate as such items are recognized as discrete items in the quarter in which they occur.
For the Current Quarter, our estimated annual effective tax rate remains nominal as a result of having a full valuation allowance against our net deferred tax asset. Based on our projected operating results for the subsequent 2018 quarters, we project remaining in a net deferred tax asset position as of December 31, 2018. Based on all available positive and negative evidence, including estimates of future taxable income, we believe it is more-likely-than-not that these deferred tax assets will not be realized. A significant piece of objectively verifiable negative evidence evaluated is the cumulative loss incurred over the rolling three-year period ending June 30, 2018. Such evidence limits our ability to consider various forms of subjective positive evidence, such as our projections for future growth and earnings. A valuation allowance was recorded against substantially all of our net deferred tax asset as of December 31, 2017 and against all of our net deferred tax asset as of June 30, 2018.
We are subject to U.S. federal income tax as well as income and capital taxes in various state jurisdictions in which we operate. We recorded a $9 million income tax benefit in the Current Quarter and the Current Period. This benefit was a result of discrete items consisting of a $13 million reduction to the liability for state unrecognized tax benefits due to the expiration of applicable statutes of limitations which was partially offset by eliminating a deferred tax asset for alternative minimum tax carryforwards in the amount of $3 million and recording additional state income tax expense of $1 million relating primarily to amended state income tax returns. A further reduction to the liability for state unrecognized tax benefits was also recorded against interest expense in the amount of $4 million.
On December 22, 2017, the President of the United States signed into law the Tax Act, which substantially revised numerous areas of U.S. federal income tax law, including reducing the tax rate for corporations from a maximum rate of 35% to a flat rate of 21% and eliminating the corporate alternative minimum tax (AMT). The various estimates included in determining our tax provision as of December 31, 2017 remain provisional through the six months ended June 30, 2018 and may be adjusted through subsequent events such as the filing of the 2017 consolidated federal income tax return and the issuance of additional guidance such as new Treasury Regulations. Moreover, we are still in the process of evaluating the full impact of the Tax Act both at the federal and state level.
7.
Share-Based Compensation
Our share-based compensation program consists of restricted stock, stock options, performance share units (PSUs) and cash restricted stock units (CRSUs) granted to employees and restricted stock granted to non-employee directors under our long term incentive plans. The restricted stock and stock options are equity-classified awards and the PSUs and CRSUs are liability-classified awards.
Equity-Classified Awards
Restricted Stock. We grant restricted stock units to employees and non-employee directors. A summary of the changes in unvested restricted stock during the Current Period is presented below:
 
 
Shares of
Unvested
Restricted Stock
 
Weighted Average
Grant Date
Fair Value
 
 
(in thousands)
 
 
Unvested restricted stock as of January 1, 2018
 
13,178

 
$
6.37

Granted
 
4,765

 
$
3.57

Vested
 
(5,207
)
 
$
7.73

Forfeited
 
(1,295
)
 
$
6.13

Unvested restricted stock as of June 30, 2018
 
11,441

 
$
4.61

The aggregate intrinsic value of restricted stock that vested during the Current Period was approximately $17 million based on the stock price at the time of vesting.

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

As of June 30, 2018, there was approximately $40 million of total unrecognized compensation expense related to unvested restricted stock. The expense is expected to be recognized over a weighted average period of approximately 2.20 years.
Stock Options. In the Current Period and the Prior Period, we granted members of management stock options that vest ratably over a three-year period. Each stock option award has an exercise price equal to the closing price of our common stock on the grant date. Outstanding options expire seven years to ten years from the date of grant.
We utilize the Black-Scholes option pricing model to measure the fair value of stock options. The expected life of an option is determined using the simplified method. Volatility assumptions are estimated based on an average of historical volatility of Chesapeake stock over the expected life of an option. The risk-free interest rate is based on the U.S. Treasury rate in effect at the time of the grant over the expected life of the option. The dividend yield is based on an annual dividend yield, taking into account our dividend policy, over the expected life of the option. We used the following weighted average assumptions to estimate the grant date fair value of the stock options granted in the Current Period:
Expected option life – years
 
6.0

Volatility
 
63.55
%
Risk-free interest rate
 
2.72
%
Dividend yield
 
%
The following table provides information related to stock option activity in the Current Period: 
 
 
Number of
Shares
Underlying  
Options
 
Weighted
Average
Exercise Price Per Share
 
Weighted  
Average
Contract Life in Years
 
Aggregate  
Intrinsic
Value(a)
 
 
(in thousands)
 
 
 
 
 
($ in millions)
Outstanding as of January 1, 2018
 
16,285

 
$
8.25

 
7.73
 
$
1

Granted
 
3,611

 
$
3.01

 
 
 
 
Exercised
 

 
$

 
 
 
$

Expired
 
(602
)
 
$
13.83

 
 
 
 
Forfeited
 
(995
)
 
$
5.45

 
 
 
 
Outstanding as of June 30, 2018
 
18,299

 
$
7.18

 
7.71
 
$
14

Exercisable as of June 30, 2018
 
8,250

 
$
10.73

 
6.34
 
$
3

___________________________________________
(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 June 30, 2018, there was $20 million of total unrecognized compensation expense related to stock options. The expense is expected to be recognized over a weighted average period of approximately 1.94 years.
Restricted Stock and Stock Option Compensation. We recognized the following compensation costs related to restricted stock and stock options for the Current Quarter, the Prior Quarter, the Current Period and the Prior Period:
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
($ in millions)
General and administrative expenses
 
$
8

 
$
12

 
$
15

 
$
20

Oil and natural gas properties
 
2

 
3

 
4

 
7

Oil, natural gas and NGL production expenses
 
1

 
4

 
3

 
7

Total restricted stock and stock option compensation
 
$
11

 
$
19

 
$
22

 
$
34


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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

Liability-Classified Awards
Performance Share Units. We granted PSUs to senior management that vest ratably over a three-year performance period and are settled in cash. The ultimate amount earned is based on achievement of performance metrics established by the Compensation Committee of the Board of Directors. Compensation expense associated with PSU awards is recognized over the service period based on the graded-vesting method. The value of the PSU awards at the end of each reporting period is dependent upon our estimates of the underlying performance measures.
For PSUs granted in 2017 and 2016, performance metrics include a total shareholder return (TSR) component, which can range from 0% to 100% and an operational performance component based on finding and development costs, which can range from 0% to 100%, resulting in a maximum payout of 200%. The payout percentage for the 2016 and 2017 PSU awards is capped at 100% if our absolute TSR is less than zero. The PSUs are settled in cash on the third anniversary of the awards. We utilized a Monte Carlo simulation for the TSR performance measure and the following assumptions to determine the grant date fair value of the 2017 and 2016 PSU awards.
Grant Date Assumptions
Assumption
 
2017 Awards
 
2016 Awards
Volatility
 
80.65
%
 
49.74
%
Risk-free interest rate
 
1.54
%
 
1.13
%
Dividend yield for value of awards
 
%
 
%
Reporting Period Assumptions
Assumption
 
2017 Awards
 
2016 Awards
Volatility
 
51.31
%
 
59.84
%
Risk-free interest rate
 
2.43
%
 
2.11
%
Dividend yield for value of awards
 
%
 
%
The PSUs are subsequently adjusted, based on adjustments to the above assumptions through the end of each subsequent reporting period, through the end of the performance period.
For PSUs granted in 2018, performance metrics include an operational performance component based on a ratio of cumulative earnings before interest expense, income taxes, and depreciation, depletion and amortization expense (EBITDA) to capital expenditures, for which payout can range from 0% to 200%. The vested PSUs are settled in cash on each of the three annual vesting dates. We used the closing price of our common stock on the grant date to determine the grant date fair value of the PSUs. The PSUs are subsequently adjusted, based on changes in our stock price through the end of each subsequent reporting period, through the end of the performance period.
Cash Restricted Stock Units. In the Current Period, we granted CRSUs to employees that vest straight-line over a three-year period and are settled in cash on each of the three annual vesting dates. The ultimate amount earned is based on the closing price of our common stock on each of the vesting dates. We used the closing price of our common stock on the grant date to determine the grant date fair value of the CRSUs. The CRSUs are subsequently adjusted, based on changes in our stock price through the end of each subsequent reporting period, through the end of each vesting period.

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

The following table presents a summary of our liability-classified awards:
 
 
 
 
Grant Date
Fair Value
 
June 30, 2018
 
 
Units
 
 
Fair Value
 
Vested Liability
 
 
 
 
($ in millions)
 
($ in millions)
2018 PSU Awards:
 
 
 
 
 
 
 
 
Payable 2019, 2020 and 2021
 
3,992,358

 
$
12

 
$
21

 
$

2017 PSU Awards:
 
 
 
 
 
 
 
 
Payable 2020
 
1,217,774

 
$
8

 
$
8

 
$
5

2016 PSU Awards:
 
 
 
 
 
 
 
 
Payable 2019
 
2,348,893

 
$
10

 
$
16

 
$
14

2018 CRSU Awards:
 
 
 
 
 
 
 
 
Payable 2019, 2020 and 2021
 
16,367,724

 
$
49

 
$
86

 
$


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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

8.
Derivative and Hedging Activities
We use derivative instruments to reduce our exposure to fluctuations in future commodity prices and to protect our expected operating cash flow against significant market movements or volatility. All of our oil, natural gas and NGL 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. None of our open oil, natural gas and NGL derivative instruments were designated for hedge accounting as of June 30, 2018 or December 31, 2017.
Oil, Natural Gas and NGL Derivatives
As of June 30, 2018 and December 31, 2017, our oil, natural gas and NGL derivative instruments consisted of the following types of instruments:
Swaps: We receive a fixed price and pay a floating market price to the counterparty for the hedged commodity. In exchange for higher fixed prices on certain of our swap trades, we may sell call options and call swaptions.
Options: We sell, and occasionally buy, call options in exchange for a premium. At the time of settlement, if the market price exceeds the fixed price of the call option, we pay the counterparty the excess on sold call options and we receive the 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.
Call Swaptions: We sell call swaptions to counterparties that allow the counterparty, on a specific date, to extend an existing fixed-price swap for a certain period of time.
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, we receive the fixed price and pay the market price. If the market price is between the put and the call strike prices, no payments are due from either party. Three-way collars include the sale by us of an additional put option in exchange for a more favorable strike price on the call option. This eliminates the counterparty’s downside exposure below the second put option strike price.
Basis Protection Swaps: These instruments are arrangements that guarantee a fixed price differential to NYMEX from a specified delivery point. We receive the fixed price differential and pay the floating market price differential to the counterparty for the hedged commodity.
The estimated fair values of our oil, natural gas and NGL derivative instrument assets (liabilities) as of June 30, 2018 and December 31, 2017 are provided below: 
 
 
June 30, 2018
 
December 31, 2017
 
 
Notional Volume
 
Fair Value
 
Notional Volume
 
Fair Value
 
 
 
 
($ in millions)  
 
 
 
($ in millions)  
Oil (mmbbl):
 
 
 
 
 
 
 
 
Fixed-price swaps
 
26

 
$
(271
)
 
21

 
$
(151
)
Three-way collars
 
1

 
(14
)
 
2

 
(10
)
Call swaptions
 
2

 
(32
)
 
2

 
(13
)
Basis protection swaps
 
11

 
6

 
11

 
(9
)
Total oil
 
40

 
(311
)
 
36

 
(183
)
Natural gas (bcf):
 
 
 
 
 
 
 
 
Fixed-price swaps
 
240

 
3

 
532

 
149

Three-way collars
 
87

 

 

 

Collars
 
24

 
2

 
47

 
11

Call options
 
77

 

 
110

 
(3
)
Basis protection swaps
 
45

 
(1
)
 
65

 
(7
)
Total natural gas
 
473

 
4

 
754

 
150

NGL (mmgal):
 
 
 
 
 
 
 
 
Fixed-price swaps
 
114

 
(11
)
 
33

 
(2
)
Total estimated fair value
 
 
 
$
(318
)
 
 
 
$
(35
)

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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

We have terminated certain commodity derivative contracts that were previously designated as cash flow hedges for which the original contract months are yet to occur. See further discussion below under Effect of Derivative Instruments – Accumulated Other Comprehensive Income (Loss).

Effect of Derivative Instruments – Condensed Consolidated Balance Sheets
The following table presents the fair value and location of each classification of derivative instrument included in the condensed consolidated balance sheets as of June 30, 2018 and December 31, 2017 on a gross basis and after same-counterparty netting:
Balance Sheet Classification
 
Gross
Fair Value
 
Amounts Netted
in the
Consolidated
Balance Sheets
 
Net Fair Value
Presented in the
Consolidated
Balance Sheet
 
 
($ in millions)
As of June 30, 2018
 
 
 
 
 
 
Commodity Contracts:
 
 
 
 
 
 
Short-term derivative asset
 
$
20

 
$
(20
)
 
$

Long-term derivative asset
 
7

 
(7
)
 

Short-term derivative liability
 
(317
)
 
20

 
(297
)
Long-term derivative liability
 
(28
)
 
7

 
(21
)
Total derivatives
 
$
(318
)
 
$

 
$
(318
)
 
 
 
 
 
 
 
As of December 31, 2017
 
 
 
 
 
 
Commodity Contracts:
 
 
 
 
 
 
Short-term derivative asset
 
$
157

 
$
(130
)
 
$
27

Short-term derivative liability
 
(188
)
 
130

 
(58
)
Long-term derivative liability
 
(4
)
 

 
(4
)
Total derivatives
 
$
(35
)
 
$

 
$
(35
)


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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

Effect of Derivative Instruments – Condensed Consolidated Statements of Operations
The components of oil, natural gas and NGL revenues for the Current Quarter, the Prior Quarter, the Current Period and the Prior Period are presented below:
 
 
Three Months Ended
June 30,
 
Six Months Ended
June 30,
 
 
2018
 
2017
 
2018
 
2017
 
 
($ in millions)
Oil, natural gas and NGL revenues
 
$
1,233

 
$
1,079

 
$
2,593

 
$
2,226

Gains (losses) on undesignated oil, natural gas
and NGL derivatives
 
(244
)
 
207

 
(351
)
 
539

Losses on terminated cash flow hedges
 
(7
)
 
(7
)
 
(17
)
 
(17
)
Total oil, natural gas and NGL revenues
 
$
982

 
$
1,279

 
$
2,225

 
$
2,748


Effect of Derivative Instruments – Accumulated Other Comprehensive Income (Loss)
A reconciliation of the changes in accumulated other comprehensive income (loss) in our consolidated statements of stockholders’ equity related to our cash flow hedges is presented below:
 
 
Three Months Ended June 30,
 
 
2018
 
2017
 
 
Before 
Tax  
 
After 
Tax  
 
Before 
Tax  
 
After 
Tax  
 
 
($ in millions)
Balance, beginning of period
 
$
(104
)
 
$
(47
)
 
$
(139
)
 
(82
)
Losses reclassified to income
 
7

 
7

 
7

 
7

Balance, end of period
 
$
(97
)
 
$
(40
)
 
(132
)
 
(75
)
 
 
 
 
 
 
 
 
 
 
 
Six Months Ended June 30,
 
 
2018
 
2017
 
 
Before 
Tax  
 
After 
Tax  
 
Before 
Tax  
 
After 
Tax  
 
 
($ in millions)
Balance, beginning of period
 
$
(114
)
 
$
(57
)
 
$
(153
)
 
$
(96
)
Net change in fair value
 

 

 
4

 
4

Losses reclassified to income
 
17

 
17

 
17

 
17

Balance, end of period
 
$
(97
)
 
$
(40
)
 
$
(132
)
 
$
(75
)
The accumulated other comprehensive loss as of June 30, 2018 represents the net deferred loss associated with commodity derivative contracts that were previously designated as cash flow hedges for which the original contract months are yet to occur. Remaining deferred gain or loss amounts will be recognized in earnings in the month for which the original contract months are to occur. As of June 30, 2018, we expect to transfer approximately $33 million of net loss included in accumulated other comprehensive income to net income (loss) during the next 12 months. The remaining amounts will be transferred by December 31, 2022.
Credit Risk Considerations
Our derivative instruments expose us to our counterparties’ credit risk. To mitigate this risk, we enter into derivative contracts only with counterparties that are highly rated or deemed by us to have acceptable credit strength and deemed by management to be competent and competitive market-makers, and we attempt to limit our exposure to non-performance by any single counterparty. As of June 30, 2018, our oil, natural gas and NGL derivative instruments were spread among 11 counterparties.

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NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

Hedging Arrangements
Certain of our hedging arrangements are with counterparties that are also lenders (or affiliates of lenders) under our revolving credit facility. The contracts entered into with these counterparties are secured by the same collateral that secures our revolving credit facility. In addition, we enter into bilateral hedging agreements with other counterparties. The counterparties’ and our obligations under the bilateral hedging agreements must be secured by cash or letters of credit to the extent that any mark-to-market amounts owed to us or by us exceed defined thresholds. As of June 30, 2018 and December 31, 2017, we did not have any cash collateral balances for our derivatives.
Fair Value
The fair value of our derivatives is based on third-party pricing models which utilize inputs that are either readily available in the public market, such as oil, natural gas and NGL forward curves and discount rates, or can be corroborated from active markets or broker quotes. These values are compared to the values given by our counterparties for reasonableness. Since oil, natural gas and NGL swaps do not include optionality and therefore generally have no unobservable inputs, they are classified as Level 2. All other derivatives have some level of unobservable input, such as volatility curves, and are therefore classified as Level 3. Derivatives are also subject to the risk that either party to a contract will be unable to meet its obligations. We factor non-performance risk into the valuation of our derivatives using current published credit default swap rates. To date, this has not had a material impact on the values of our derivatives.
The following table provides information for financial assets (liabilities) measured at fair value on a recurring basis as of June 30, 2018 and December 31, 2017: 
 
 
Quoted
Prices in
Active
Markets
(Level 1)
 
Significant
Other
Observable
Inputs
(Level 2) 
 
Significant
Unobservable
Inputs
(Level 3)
 
Total
Fair Value
 
 
 
 
($ in millions)
 
 
As of June 30, 2018
 
 
 
 
 
 
 
 
Derivative Assets (Liabilities):
 
 
 
 
 
 
 
 
Commodity assets
 
$

 
$
20

 
$
7

 
$
27

Commodity liabilities
 

 
(293
)
 
(52
)
 
(345
)
Total derivatives
 
$

 
$
(273
)
 
$
(45
)
 
$
(318
)
 
 
 
 
 
 
 
 
 
As of December 31, 2017
 
 
 
 
 
 
 
 
Derivative Assets (Liabilities):
 
 
 
 
 
 
 
 
Commodity assets
 
$

 
$

 
$
8

 
$
8

Commodity liabilities
 

 
(20
)
 
(23
)
 
(43
)
Total derivatives
 
$

 
$
(20
)
 
$
(15
)
 
$
(35
)


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CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

A summary of the changes in the fair values of our financial assets (liabilities) classified as Level 3 during the Current Period and the Prior Period is presented below: 
 
 
Commodity
Derivatives
 
 
($ in millions)
Balance, as of January 1, 2018
 
$
(15
)
Total gains (losses) (realized/unrealized):
 
 
Included in earnings(a)
 
(32
)
Total purchases, issuances, sales and settlements:
 
 
Settlements
 
2

Balance, as of June 30, 2018
 
$
(45
)
 
 
 
Balance, as of January 1, 2017
 
$
(10
)
Total gains (losses) (realized/unrealized):
 
 
Included in earnings(a)
 
19

Total purchases, issuances, sales and settlements:
 
 
Settlements
 
1

Balance, as of June 30, 2017
 
$
10

___________________________________________
(a)
 
 
Commodity Derivatives
 
 
 
 
 
2018
 
2017
 
 
 
($ in millions)
 
Total gains (losses) included in earnings for the period
 
$
(32
)
 
$
19

 
Change in unrealized gains (losses) related to assets
still held at reporting date
 
$
(30
)
 
$
12

Qualitative and Quantitative Disclosures about Unobservable Inputs for Level 3 Fair Value Measurements
The significant unobservable inputs for Level 3 derivative contracts include unpublished forward prices of natural gas, market volatility and credit risk of counterparties. Changes in these inputs impact the fair value measurement of our derivative contracts, which is based on an estimate derived from option models. For example, an increase or decrease in the forward prices and volatility of oil and natural gas prices decreases or increases the fair value of oil and natural gas derivatives, and adverse changes to our counterparties’ creditworthiness decreases the fair value of our derivatives. The following table presents quantitative information about Level 3 inputs used in the fair value measurement of our commodity derivative contracts at fair value as of June 30, 2018:
Instrument
Type
 
Unobservable
Input
 
Range
 
Weighted
Average
 
Fair Value
June 30, 2018
 
 
 
 
 
 
 
 
($ in millions)
Oil trades
 
Oil price volatility curves
 
17.16% – 30.26%
 
25.01%
 
$
(47
)
Natural gas trades
 
Natural gas price volatility curves
 
14.23% – 46.86%
 
18.30%
 
$
2



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TABLE OF CONTENTS
CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

9.
Oil and Natural Gas Property Transactions
Under full cost accounting rules, we accounted for the sales of oil and natural gas properties discussed below as adjustments to capitalized costs, with no recognition of gain or loss as the sales did not involve a significant change in proved reserves or significantly alter the relationship between costs and proved reserves.
In the Current Period, we sold portions of our acreage, producing properties and other related property and equipment in the Mid-Continent, including our Mississippian Lime assets, for approximately $491 million, subject to certain customary closing adjustments. Included in the sales were approximately 238,500 net acres and interests in approximately 3,200 wells. Also, in the Current Quarter and the Current Period, we received proceeds of approximately $5 million and $23 million, respectively, subject to customary closing adjustments, for the sale of other oil and natural gas properties covering various operating areas.
In the Prior Period, we sold portions of our acreage and producing properties in our Haynesville Shale operating area in northern Louisiana for approximately $915 million, subject to certain customary closing adjustments. Included in the sales were approximately 119,500 net acres and interests in 576 wells that were producing approximately 80 mmcf of gas per day at the time of closing. Also in the Prior Quarter and the Prior Period, we received proceeds of approximately $63 million and $83 million, respectively, net of post-closing adjustments, for the sale of other oil and natural gas properties covering various operating areas.
Volumetric Production Payments
A VPP is a limited-term overriding royalty interest in oil and natural gas reserves that (i) entitles the purchaser to receive scheduled production volumes over a period of time from specific lease interests; (ii) is free and clear of all associated future production costs and capital expenditures; (iii) is non-recourse to the seller (i.e., the purchaser’s only recourse is to the reserves acquired); (iv) transfers title of the reserves to the purchaser; and (v) allows the seller to retain all production beyond the specified volumes, if any, after the scheduled production volumes have been delivered. If contractually scheduled volumes exceed the actual volumes produced from the VPP wellbores that are attributable to the ORRI conveyed, either the shortfall will be made up from future production from these wellbores (or, at our option, from our retained interest in the wellbores) through an adjustment mechanism, or the initial term of the VPP will be extended until all scheduled volumes, to the extent produced, are delivered from the VPP wellbores to the VPP buyer. We retain drilling rights on the properties below currently producing intervals and outside of producing wellbores.
As the operator of the properties from which the VPP volumes have been sold, we bear the cost of producing the reserves attributable to these interests, which we include as a component of production expenses and production taxes in our consolidated statements of operations in the periods these costs are incurred. As with all non-expense-bearing royalty interests, volumes conveyed in a VPP transaction are excluded from our estimated proved reserves; however, the estimated production expenses and taxes associated with VPP volumes expected to be delivered in future periods are included as a reduction of the future net cash flows attributable to our proved reserves for purposes of determining our full cost ceiling test for impairment purposes and in determining our standardized measure. Our commitment to bear the costs on any future production of VPP volumes is not reflected as a liability on our balance sheet. Future costs will depend on the actual production volumes as well as the production costs and taxes in effect during the periods in which the production actually occurs, which could differ materially from our current and historical costs, and production may not occur at the times or in the quantities projected, or at all.
We have committed to purchase natural gas and liquids associated with our 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.
As of June 30, 2018, we had the following VPP outstanding:
 
 
 
 
 
 
 
 
Volume Sold
VPP #
 
Date of VPP        
 
Location
 
Proceeds
 
Oil
 
Natural Gas
 
NGL
 
Total
 
 
 
 
 
 
($ in millions)
 
(mmbbl)
 
 (bcf)
 
(mmbbl)
 
(bcfe)
9
 
May 2011
 
Mid-Continent
 
$
853

 
1.7

 
138

 
4.8

 
177


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TABLE OF CONTENTS
CHESAPEAKE ENERGY CORPORATION AND SUBSIDIARIES
NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS – (Continued)
(Unaudited)

The volumes remaining to be delivered on behalf of our VPP buyers as of June 30, 2018 were as follows:
 
 
 
 
Volume Remaining as of June 30, 2018
VPP #
 
Term Remaining
 
Oil
 
Natural Gas
 
NGL
 
Total<