Chesapeake Energy (CHK)

Sources and Uses of Funds

Cash flow from operations is a significant source of liquidity used to fund capital expenditures. Our joint venture drilling credits also provide an additional source of liquidity that have reduced and will continue to reduce our capital expenditures. Cash provided by operating activities was $1.261 billion in the Current Quarter compared to $1.515 billion in the Prior Quarter. The $254 million decrease in the Current Quarter was primarily due to lower natural gas and oil prices. Changes in cash flow from operations are largely due to the same factors that affect our net income, excluding non-cash items such as ceiling test write-downs, depreciation, depletion and amortization, deferred income taxes and unrealized gains and (losses) on derivatives. See the discussion below under Results of Operations.

Changes in market prices for natural gas and oil directly impact the level of our cash flow from operations. To mitigate the risk of declines in natural gas and oil prices and to provide more predictable future cash flow from operations, we currently have hedged through swaps and collars 82% of our expected remaining natural gas and oil production in 2009 and 24% of our expected natural gas and oil production in 2010 at average prices of $7.56 per mcfe and $9.45 per mcfe, respectively. Our natural gas and oil hedges as of March 31, 2009 are detailed in Item 3 of Part I of this report. Depending on changes in natural gas and oil futures markets and management’s view of underlying natural gas and oil supply and demand trends, we may increase or decrease our current hedging positions. As of March 31, 2009, we had a net natural gas and oil derivative asset of $1.481 billion.

Our $3.5 billion bank credit facility, our $460 million midstream credit facility and cash and cash equivalents are other sources of liquidity. At May 7, 2009, there was $1.268 billion of borrowing capacity available under the revolving bank credit facility and $220 million of borrowing capacity under the midstream credit facility. We use the facilities and cash on hand to fund daily operating activities and acquisitions as needed. We borrowed $1.575 billion and repaid $3.120 billion in the Current Quarter, and we borrowed $2.591 billion and repaid $1.377 billion in the Prior Quarter.

On February 2, 2009, we completed a public offering of $1.0 billion aggregate principal amount of senior notes due 2015, which have a stated coupon rate of 9.5% per annum. The senior notes were priced at 95.071% of par to yield 10.625%. On February 17, 2009, we completed an offering of an additional $425 million aggregate principal amount of the 9.5% Senior Notes due 2015. The additional senior notes were priced at 97.75% of par plus accrued interest from February 2 to February 17, 2009 to yield 10.0% per annum. Net proceeds of $1.346 billion from these two offerings were used to repay outstanding indebtedness under our revolving bank credit facility, which we may reborrow from time to time to fund drilling and leasehold acquisition initiatives and for general corporate purposes.

Our primary use of funds is for capital expenditures related to exploration, development and acquisition of natural gas and oil properties. We refer you to the table under Investing Activities below, which sets forth the components of our natural gas and oil investing activities and our other investing activities for the Current Quarter and the Prior Quarter. We retain a significant degree of control over the timing of our capital expenditures which permits us to defer or accelerate certain capital expenditures if necessary to address any potential liquidity issues. In addition, changes in drilling and field operating costs, drilling results that alter planned development schedules, acquisitions or other factors could cause us to revise our drilling program, which is largely discretionary.

We paid dividends on our common stock of $44 million and $33 million in the Current Quarter and the Prior Quarter, respectively. The board of directors increased the quarterly dividend on common stock from $0.0675 to $0.075 per share beginning with the dividend paid in July 2008. Dividends paid on our preferred stock decreased to $6 million in the Current Quarter from $12 million in the Prior Quarter as a result of conversions and exchanges of preferred stock into common stock during 2008 and 2009. We received $1 million and $4 million from the exercise of employee and director stock options in the Current Quarter and the Prior Quarter.

In the Current Quarter and Prior Quarter, we received $1 million and paid $33 million, respectively, to settle a portion of the derivative liabilities assumed in our November 2005 acquisition of Columbia Natural Resources, LLC.

37

Table of Contents

SFAS 123(R) requires tax benefits resulting from stock-based compensation deductions in excess of amounts reported for financial reporting purposes to be reported as cash flows from financing activities. In the Current Quarter and the Prior Quarter, we reported a tax benefit from stock-based compensation of $0 and $11 million, respectively.

Outstanding payments from certain disbursement accounts in excess of funded cash balances where no legal right of set-off exists decreased $287 million in the Current Quarter and increased $44 million in the Prior Quarter. All disbursements are funded on the day they are presented to our bank using available cash on hand or draws on our revolving bank credit facility.

Sources and Uses of Funds

Cash flow from operations is a significant source of liquidity used to fund operating expenses and capital expenditures. Cash provided by operating activities was $4.305 billion in the Current Period compared to $3.389 billion in the Prior Period. The $916 million increase in the Current Period was primarily due to higher natural gas and oil prices and higher volumes of natural gas and oil production. Changes in cash flow from operations are largely due to the same factors that affect our net income, excluding non-cash items such as depreciation, depletion and amortization, deferred income taxes and unrealized gains and (losses) on derivatives. See the discussion below under Results of Operations.

Changes in market prices for natural gas and oil directly impact the level of our cash flow from operations. While a decline in natural gas or oil prices would affect the amount of cash flow that would be generated from operations, we currently have hedged through swaps and collars 73% of our expected remaining natural gas and oil production in 2008 and 67% of our expected natural gas and oil production in 2009 at average prices of $9.09 and $8.65 per mcfe, respectively. Our natural gas and oil hedges as of September 30, 2008 are detailed in Item 3 of Part I of this report. Depending on changes in natural gas and oil futures markets and management’s view of underlying natural gas and oil supply and demand trends, we may increase or decrease our current hedging positions.

As of September 30, 2008, we had a net natural gas and oil derivative asset of $46 million. We satisfy commodity derivative liabilities from a portion of the proceeds of natural gas and oil production sold at market prices during the period of contract settlement (which will occur through 2022). We have arrangements with our hedging counterparties that allow us to minimize the potential liquidity impact of significant mark-to-market fluctuations in the value of our natural gas and oil hedges by making collateral allocations from our bank credit facility or directly pledging natural gas and oil properties, rather than posting cash or letters of credit with the counterparties.

Our $3.5 billion bank credit facility and cash and cash equivalents are other sources of liquidity. At November 6, 2008, there was no borrowing capacity available under the revolving bank credit facility; however, we had approximately $800 million of cash on hand and $378 million of borrowing capacity under the midstream credit facility. We use the facilities and cash on hand to fund daily operating activities and acquisitions as needed. We borrowed $12.831 billion and repaid $11.307 billion in the Current Period, and we borrowed $5.949 billion and repaid $4.177 billion in the Prior Period.

32

Table of Contents

On April 2, 2008, we issued 23 million shares of our common stock in a public offering at a price of $45.75 per share, and on July 15, 2008, we issued 28.75 million shares of common stock in a public offering at a price of $57.25 per share. On May 20, 2008 we completed public offerings of $800 million of our 7.25% Senior Notes due 2018 and $1.380 billion of our 2.25% Contingent Convertible Senior Notes due 2038. These four offerings resulted in aggregate net proceeds to us of approximately $4.734 billion, which we used to fund the redemption of our 7.75% Senior Notes due 2015 and to temporarily repay indebtedness outstanding under our revolving bank credit facility. The following table reflects the proceeds from sales of securities we issued in the Current Period and the Prior Period ($ in millions):

In May 2008, we sold a portion of our proved reserves in certain producing assets in Texas, Oklahoma and Kansas in a VPP transaction for proceeds of approximately $616 million, net of transaction costs. We completed another VPP transaction in August 2008, when we sold a portion of our proved reserves in certain producing assets in the Anadarko Basin of Oklahoma for proceeds of approximately $594 million, net of transaction costs.

Our primary use of funds is for capital expenditures related to exploration, development and acquisition of natural gas and oil properties. We refer you to the table under Investing Activities below, which sets forth the components of our natural gas and oil investing activities for the Current Period and the Prior Period. We retain a significant degree of control over the timing of our capital expenditures which permits us to defer or accelerate certain capital expenditures if necessary to address any potential liquidity issues. In addition, higher drilling and field operating costs, drilling results that alter planned development schedules, acquisitions or other factors could cause us to revise our drilling program, which is largely discretionary.

We paid dividends on our common stock of $106 million and $85 million in the Current Period and the Prior Period, respectively. The board of directors increased the quarterly dividend on common stock from $0.0675 to $0.075 per share beginning with the dividend paid in July 2008. Dividends paid on our preferred stock decreased to $29 million in the Current Period from $78 million in the Prior Period as a result of conversions and exchanges of preferred stock into common stock during the Current Period and 2007. We received $8 million from the exercise of employee and director stock options in both the Current Period and the Prior Period.

In the Current Period and Prior Period, we paid $146 million and $65 million, respectively, to settle a portion of the derivative liabilities assumed in our November 2005 acquisition of Columbia Natural Resources, LLC.

SFAS 123(R) requires tax benefits resulting from stock-based compensation deductions in excess of amounts reported for financial reporting purposes to be reported as cash flows from financing activities. In the Current Period and the Prior Period, we reported a tax benefit from stock-based compensation of $42 million and $13 million, respectively.

Outstanding payments from certain disbursement accounts in excess of funded cash balances where no legal right of set-off exists increased $210 million in the Current Period and decreased $54 million in the Prior Period. All disbursements are funded on the day they are presented to our bank using available cash on hand or draws on our revolving bank credit facility.

33

Table of Contents

Sources and Uses of Funds

Cash flow from operations is a significant source of liquidity used to fund operating expenses and capital expenditures. Cash provided by operating activities was $2.754 billion in the Current Period compared to $2.122 billion in the Prior Period. The $632 million increase in the Current Period was primarily due to higher natural gas and oil prices and higher volumes of natural gas and oil production. Changes in cash flow from operations are largely due to the same factors that affect our net income, excluding non-cash items such as depreciation, depletion and amortization, deferred income taxes and unrealized gains and (losses) on derivatives. See the discussion below under Results of Operations.

Changes in market prices for natural gas and oil directly impact the level of our cash flow from operations. While a decline in natural gas or oil prices would affect the amount of cash flow that would be generated from operations, we currently have natural gas and oil hedges in place covering 96% of our expected remaining natural gas production in 2008 and 99% of our expected remaining oil production in 2008, thereby minimizing the commodity price risk associated with almost all of our 2008 cash flow. Our natural gas and oil hedges as of June 30, 2008 are detailed in Item 3 of Part I of this report. Depending on changes in natural gas and oil futures markets and management’s view of underlying natural gas and oil supply and demand trends, we may increase or decrease our current hedging positions.

Extreme volatility in natural gas and oil prices in 2008 has created wide swings in the mark-to-market value of our natural gas and oil derivatives. As of June 30, 2008, we had a net natural gas and oil derivative liability of $6.551 billion as a result of significant increases in natural gas and oil prices since December 31, 2007. Of this amount, $3.367 billion was classified as a current liability and was largely responsible for our $4.1 billion working capital deficit at June 30, 2008. Subsequent to June 30, 2008, natural gas and oil prices have decreased significantly causing our natural gas and oil hedges to move in our favor. Should prices on September 30, 2008 be the same as current prices, we believe substantially all of the 2008 unrealized loss on natural gas and oil derivatives would be reversed and reported as an unrealized gain in the 2008 third quarter. We satisfy commodity derivative liabilities from a portion of the proceeds of natural gas and oil production sold at market prices during the period of contract settlement (which will occur through 2022). We have arrangements with our hedging counterparties that allow us to minimize the potential liquidity impact of significant mark-to-market fluctuations in the value of our natural gas and oil hedges by making collateral allocations from our bank credit facility or directly pledging natural gas and oil properties, rather than posting cash or letters of credit with the counterparties.

Our $3.5 billion bank credit facility is another source of liquidity. At August 8, 2008, there was $1.744 billion of borrowing capacity available under the revolving bank credit facility. We use the facility to fund daily operating activities and acquisitions as needed. We borrowed $6.758 billion and repaid $6.195 billion in the Current Period, and we borrowed $3.544 billion and repaid $2.624 billion in the Prior Period.

On April 2, 2008 we issued 23 million shares of our common stock in a public offering at a price of $45.75 per share, and on May 20, 2008 we completed public offerings of $800 million of our 7.25% Senior Notes due 2018 and $1.380 billion of our 2.25% Contingent Convertible Senior Notes due 2038. These three offerings resulted in aggregate net proceeds to us of approximately $3.147 billion, which we used to fund the redemption of our 7.75% Senior Notes due 2015 and to temporarily repay indebtedness outstanding under our revolving bank credit facility. The following table reflects the proceeds from sales of securities we issued in the Current Period and the Prior Period ($ in millions):

In May 2008, we sold a portion of our proved reserves in certain producing assets in Texas, Oklahoma and Kansas in a VPP transaction for proceeds of approximately $616 million, net of transaction costs.

28

Table of Contents

Our primary use of funds is for capital expenditures related to exploration, development and acquisition of natural gas and oil properties. We refer you to the table under Investing Activities below, which sets forth the components of our natural gas and oil investing activities for the Current Period and the Prior Period. We retain a significant degree of control over the timing of our capital expenditures which permits us to defer or accelerate certain capital expenditures if necessary to address any potential liquidity issues. In addition, higher drilling and field operating costs, drilling results that alter planned development schedules, acquisitions or other factors could cause us to revise our drilling program, which is largely discretionary.

We paid dividends on our common stock of $66 million and $54 million in the Current Period and the Prior Period, respectively. The board of directors increased the quarterly dividend on common stock from $0.0675 to $0.075 per share beginning with the dividend paid in July 2008. Dividends paid on our preferred stock decreased to $22 million in the Current Period from $52 million in the Prior Period as a result of conversions and exchanges of preferred stock into common stock during 2007 and the Current Period. We received $7 million and $6 million from the exercise of employee and director stock options in the Current Period and the Prior Period, respectively.

In the Current Period and Prior Period, we paid $93 million and $52 million, respectively, to settle a portion of the derivative liabilities assumed in our November 2005 acquisition of Columbia Natural Resources, LLC.

On January 1, 2006, we adopted SFAS 123(R), which requires tax benefits resulting from stock-based compensation deductions in excess of amounts reported for financial reporting purposes to be reported as cash flows from financing activities. In the Current Period and the Prior Period, we reported a tax benefit from stock-based compensation of $21 million and $8 million, respectively.

Outstanding payments from certain disbursement accounts in excess of funded cash balances where no legal right of set-off exists increased $47 million in the Current Period and decreased $10 million in the Prior Period. All disbursements are funded on the day they are presented to our bank using available cash on hand or draws on our revolving bank credit facility.

Sources and Uses of Funds

Cash flow from operations is our primary source of liquidity to meet operating expenses and fund capital expenditures (other than for acquisitions outside our budgeted leasehold and property acquisitions). Cash provided by operating activities was $1.498 billion in the Current Quarter compared to $977 million in the Prior Quarter. The $521 million increase in the Current Quarter was primarily due to higher volumes of natural gas and oil production. Changes in cash flow from operations are largely due to the same factors that affect our net income excluding non-cash items, such as depreciation, depletion and amortization, deferred income taxes and unrealized gains and (losses) on derivatives. See the discussion below under Results of Operations.

Changes in market prices for natural gas and oil directly impact the level of our cash flow from operations. While a decline in natural gas or oil prices would affect the amount of cash flow that would be generated from operations, we currently have natural gas and oil hedges in place covering 74% of our expected remaining natural gas production in 2008 and 72% of our expected remaining oil production in 2008, thereby minimizing the commodity price risk associated with a substantial portion of our 2008 cash flow. Our natural gas and oil hedges as of March 31, 2008 are detailed in Item 3 of Part I of this report. Depending on changes in natural gas and oil futures markets and management’s view of underlying natural gas and oil supply and demand trends, we may increase or decrease our current hedging positions.

As of March 31, 2008, we had a net natural gas and oil derivative liability of $2.232 billion as a result of significant increases in natural gas and oil prices since December 31, 2007. We satisfy commodity derivative liabilities from a portion of the proceeds of natural gas and oil production sold at market prices during the period of contract settlement (which will occur through 2022). The remaining proceeds, representing the derivative contract price, are included in our budget estimates. We have arrangements with our hedging counterparties that allow us to minimize the potential liquidity impact of significant mark-to-market fluctuations in the value of our natural gas and oil hedges by making collateral allocations from our bank credit facility or directly pledging natural gas and oil properties, rather than posting cash or letters of credit with the counterparties.

Our $3.5 billion bank credit facility is another source of liquidity. At May 8, 2008, there was $501 million of borrowing capacity available under the revolving bank credit facility. We use the facility to fund daily operating activities and acquisitions as needed. We borrowed $2.591 billion and repaid $1.377 billion in the Current Quarter, and we borrowed $1.833 billion and repaid $858 million in the Prior Quarter.

Our primary use of funds is for capital expenditures related to exploration, development and acquisition of natural gas and oil properties. We refer you to the table under Investing Activities below, which sets forth the components of our natural gas and oil investing activities for the Current Quarter and the Prior Quarter. Our drilling, land and seismic capital expenditures are currently budgeted at $5.3 billion in 2008. We believe this level of exploration and development will enable us to increase our total production by 21% in 2008 (inclusive of acquisitions completed or scheduled to close in 2008 through the filing date of this report but without regard to any additional acquisitions that may be completed in 2008).

25

Table of Contents

We retain a significant degree of control over the timing of our capital expenditures which permits us to defer or accelerate certain capital expenditures if necessary to address any potential liquidity issues. In addition, higher drilling and field operating costs, drilling results that alter planned development schedules, acquisitions or other factors could cause us to revise our drilling program, which is largely discretionary.

We paid dividends on our common stock of $33 million and $27 million in the Current Quarter and the Prior Quarter, respectively. The board of directors increased the quarterly dividend on common stock from $0.06 to $0.0675 per share beginning with the dividend paid in July 2007. We paid dividends on our preferred stock of $12 million and $26 million in the Current Quarter and the Prior Quarter, respectively. We received $4 million and $3 million from the exercise of employee and director stock options in the Current Quarter and the Prior Quarter, respectively.

In the Current Quarter and Prior Quarter, we paid $33 million and $22 million, respectively, to settle a portion of the derivative liabilities assumed in our November 2005 acquisition of Columbia Natural Resources, LLC.

On January 1, 2006, we adopted SFAS 123(R), which requires tax benefits resulting from stock-based compensation deductions in excess of amounts reported for financial reporting purposes to be reported as cash flows from financing activities. In the Current Quarter and the Prior Quarter, we reported a tax benefit from stock-based compensation of $11 million and $4 million, respectively.

Outstanding payments from certain disbursement accounts in excess of funded cash balances where no legal right of set-off exists increased $44 million in the Current Quarter and decreased $8 million in the Prior Quarter. All disbursements are funded on the day they are presented to our bank using available cash on hand or draws on our revolving bank credit facility.

Sources and Uses of Funds

Cash flow from operations is our primary source of liquidity to meet operating expenses and fund capital expenditures (other than for acquisitions outside our budgeted leasehold and property acquisitions). Cash provided by operating activities was $3.389 billion in the Current Period compared to $2.983 billion in the Prior Period. The $406 million increase in the Current Period was primarily due to higher oil and natural gas production. Changes in cash flow from operations are largely due to the same factors that affect our net income excluding non-cash items, such as depreciation, depletion and amortization ($1.422 billion and $1.041 billion during the Current Period and the Prior Period, respectively), deferred income taxes ($671 million and $963 million during the Current Period and the Prior Period, respectively) and unrealized gains and (losses) on derivatives (($126) million and $453 million during the Current Period and the Prior Period, respectively). Net income decreased to $1.148 billion in the Current Period from $1.532 billion in the Prior Period and is discussed below under Results of Operations.

Changes in market prices for oil and natural gas directly impact the level of our cash flow from operations. While a decline in oil or natural gas prices would affect the amount of cash flow that would be generated from operations, we currently have oil hedges in place covering 99% of our expected oil production in the fourth quarter of 2007 and in 2008, 98% of our expected natural gas production in the fourth quarter of 2007 and 85% of our expected natural gas production in 2008, thereby providing certainty for a substantial portion of our future cash flow. Our oil and natural gas hedges as of September 30, 2007 are detailed in Item 3 of Part I of this report. We have arrangements with our hedging counterparties that allow us to minimize the potential liquidity impact of significant mark-to-market fluctuations in the value of our oil and natural gas hedges by making collateral allocations from our bank credit facility or directly pledging oil and natural gas properties, rather than posting cash or letters of credit with the counterparties. Depending on changes in oil and natural gas futures markets and management’s view of underlying oil and natural gas supply and demand trends, we may increase or decrease our current hedging positions.

On November 2, 2007, we established a new five-year $3.0 billion committed senior secured revolving credit facility that replaced the company’s previous $2.5 billion facility. The new facility reflects the increased scale and scope of the company’s operations and will help accommodate timing differences between cash flow from operations, asset monetizations and planned capital expenditures. At November 7, 2007, there was $288 million of borrowing capacity available under the revolving bank credit facility. We use the facility to fund daily operating activities and acquisitions as needed. We borrowed $5.949 billion and repaid $4.177 billion in the Current Period, and we borrowed $7.058 billion and repaid $5.666 billion in the Prior Period under the credit facility.

We believe our cash flow from operations, in combination with the proceeds expected from our planned producing property monetizations and other asset sales and the $500 million increase in our bank credit facility borrowing ability will provide us sufficient liquidity to execute our business strategy without accessing the public capital markets for the foreseeable future. We intend to use any cash in excess of our operating and capital expenditure needs to pay down indebtedness under our revolving bank credit facility.

In the Current Period, we completed two public offerings of our 2.5% Contingent Convertible Senior Notes due 2037. In the first offering, in May 2007, we issued $1.150 billion of notes and in the second offering, in August 2007, we issued $500 million of notes. Net proceeds of approximately $1.124 billion and $483 million, respectively, were used to repay outstanding borrowings under our revolving bank credit facility. The following table reflects the proceeds from sales of securities we issued in the Current Period and the Prior Period ($ in millions):

Our primary use of funds is our capital expenditures for exploration, development and acquisition of oil and natural gas properties. We refer you to the table under Investing Activities below, which sets forth the components of our oil and natural gas investing activities for the Current Period and the Prior Period. Our drilling, land and seismic capital expenditures are currently budgeted at $5.7 billion to $6.2 billion in 2007 and $5.4 billion to $5.9

28

Table of Contents

billion in 2008. We believe this level of exploration and development will enable us to increase our proved oil and natural gas reserves by more than 20% in 2007 and 13% in 2008 and increase our total production by 21% to 23% in 2007 and 18% to 22% in 2008 (inclusive of acquisitions completed or scheduled to close in 2007 through the filing date of this report but without regard to any additional acquisitions that may be completed in 2007).

We retain a significant degree of control over the timing of our capital expenditures which permits us to defer or accelerate certain capital expenditures if necessary to address any potential liquidity issues. In addition, higher drilling and field operating costs, drilling results that alter planned development schedules, acquisitions or other factors could cause us to revise our drilling program, which is largely discretionary.

We paid dividends on our common stock of $85 million and $62 million in the Current Period and the Prior Period, respectively. The board of directors increased the quarterly dividend on common stock from $0.06 to $0.0675 per share beginning with the dividend paid in July 2007. We paid dividends on our preferred stock of $78 million and $63 million in the Current Period and the Prior Period, respectively. We received $8 million and $71 million from the exercise of employee and director stock options in the Current Period and the Prior Period, respectively. The Prior Period amount included $38 million paid by Tom L. Ward, our former President and Chief Operating Officer, to exercise all of his stock options following his resignation in February 2006.

In the Current Period and Prior Period, we paid $65 million and $68 million, respectively, to settle a portion of the derivative liabilities assumed in our November 2005 acquisition of Columbia Natural Resources, LLC.

On January 1, 2006, we adopted SFAS 123(R), which requires tax benefits resulting from stock-based compensation deductions in excess of amounts reported for financial reporting purposes to be reported as cash flows from financing activities. In the Current Period and the Prior Period, we reported a tax benefit from stock-based compensation of $13 million and $86 million, respectively.

Outstanding payments from certain disbursement accounts in excess of funded cash balances where no legal right of set-off exists decreased by $54 million in the Current Period and increased by $43 million in the Prior Period. All disbursements are funded on the day they are presented to our bank using available cash on hand or draws on our revolving bank credit facility.

Our accounts receivable are primarily from purchasers of oil and natural gas ($604 million at September 30, 2007) and exploration and production companies which own interests in properties we operate ($137 million at September 30, 2007). This industry concentration has the potential to impact our overall exposure to credit risk, either positively or negatively, in that our customers and joint working interest owners may be similarly affected by changes in economic, industry or other conditions. We generally require letters of credit for receivables from parties which are judged to have sub-standard credit, unless the credit risk can otherwise be mitigated.

Sources and Uses of Funds

Our primary source of liquidity to meet operating expenses and fund capital expenditures (other than for certain acquisitions) is cash flow from operations. Based on our current assumptions of production, prices and expenses, we expect our drilling, land and seismic capital expenditures in 2007 to exceed our cash flow from operations. Any additional funds required will be initially provided through additional borrowings under our bank credit facility. Our budget for drilling, land and seismic activities during 2007 is currently between $5.0 billion and $5.2 billion. We believe this level of exploration and development will enable us to increase our proved oil and natural gas reserves in 2007 by more than 10% and increase our total production by 14% to 18% (inclusive of acquisitions completed or scheduled to close in 2007 through the filing date of this report but without regard to any additional acquisitions that may be completed in 2007). However, higher drilling and field operating costs, drilling results that alter planned development schedules, acquisitions or other factors could cause us to revise our drilling program, which is largely discretionary.

Cash provided by operating activities was $977 million in the Current Quarter compared to $967 million in the Prior Quarter. The $10 million increase was primarily due to higher oil and natural gas production. We expect that 2007 production volumes will be higher than in 2006 and that cash provided by operating activities in 2007 will exceed 2006 levels. While a decline in natural gas prices in 2007 would affect the amount of cash flow that would be generated from operations, we currently have oil swaps in place covering 77% of our expected remaining oil production in 2007 at an average NYMEX price of $71.47 per barrel of oil and natural gas swaps in place covering 54% of our expected remaining natural gas production in 2007 at an average NYMEX price of $8.49 per mcf, along with natural gas collars covering 13% of our anticipated remaining natural gas production for 2007 with an average NYMEX floor of $6.88 per mcf and an average NYMEX ceiling of $8.41 per mcf. Additionally, we have written call options covering 13% of our 2007 remaining natural gas production at a weighted average price of $9.48. This level of hedging provides certainty of the cash flow we will receive for a substantial portion of our 2007 production. Depending on changes in oil and natural gas futures markets and management’s view of underlying oil and natural gas supply and demand trends, however, we may increase or decrease our current hedging positions.

Based on fluctuations in natural gas and oil prices, our hedging counterparties may require us to deliver cash collateral or other assurances of performance from time to time. All but two of our commodity price risk management counterparties require us to provide assurances of performance in the event that the counterparties’ mark-to-market exposure to us exceeds certain levels. Most of these arrangements allow us to minimize the potential liquidity impact of significant mark-to-market fluctuations by making collateral allocations from our bank credit facility or directly pledging oil and natural gas properties, rather than posting cash or letters of credit with the counterparties. As of March 31, 2007 and May 4, 2007, we had outstanding collateral allocations and pledges of oil and natural gas properties with respect to commodity price risk management transactions but were not required to post any collateral with our counterparties through letters of credit issued under our bank credit facility. Future collateral requirements are uncertain and will depend on the arrangements with our counterparties and highly volatile natural gas and oil prices.

A significant source of liquidity is our $2.5 billion syndicated revolving bank credit facility which matures in February 2011. At May 4, 2007, there was $886 million of borrowing capacity available under the revolving bank credit facility. We use the facility to fund daily operating activities and acquisitions as needed. We borrowed $1.833 billion and repaid $858 million in the Current Quarter, and we borrowed $2.202 billion and repaid $1.830 billion in the Prior Quarter under the credit facility.

27

Table of Contents

We expect our operating costs, debt service, capital expenditures, short-term contractual obligations and dividend payments in 2007 will, at times, exceed our available cash, cash provided by operating activities and funds available under our revolving bank credit facility. We are considering various alternatives to meet the shortfall.

The public and institutional markets have been our principal source of long-term financing for acquisitions, although there were no issuances of debt or equity securities in the Current Quarter and no issuances of equity securities in the Prior Quarter. We issued $500 million principal amount of 6.5% Senior Notes due 2017 and received net proceeds of $487 million in the Prior Quarter. We have sold debt and equity in both public and private offerings in the past, and we expect that these sources of capital will continue to be available to us in the future. Nevertheless, we caution that ready access to capital on reasonable terms is subject to many uncertainties, as explained under “Risk Factors” in Item 1A of our Form 10-K for the year ended December 31, 2006.

We paid dividends on our common stock of $27 million and $18 million in the Current Quarter and the Prior Quarter, respectively. The board of directors increased the quarterly dividend on common stock from $0.05 to $0.06 per share beginning with the dividend paid in July 2006. We paid dividends on our preferred stock of $26 million and $19 million in the Current Quarter and the Prior Quarter, respectively. We received $3 million and $39 million from the exercise of employee and director stock options in the Current Quarter and the Prior Quarter, respectively. The Prior Quarter amount included $37 million paid by Tom L. Ward, our former President and Chief Operating Officer, to exercise all of his stock options following his resignation in February 2006.

In the Current Quarter and Prior Quarter, we paid $22 million and $30 million, respectively, to settle a portion of the derivative liabilities assumed in our November 2005 acquisition of Columbia Natural Resources, LLC.

On January 1, 2006, we adopted SFAS 123(R), which requires tax benefits resulting from stock-based compensation deductions in excess of amounts reported for financial reporting purposes to be reported as cash flows from financing activities. In the Current Quarter and the Prior Quarter, we reported a tax benefit from stock-based compensation of $4 million and $77 million, respectively.

Outstanding payments from certain disbursement accounts in excess of funded cash balances where no legal right of set-off exists decreased $8 million in the Current Quarter and increased $72 million in the Prior Quarter. All disbursements are funded on the day they are presented to our bank using available cash on hand or draws on our revolving bank credit facility.

Our accounts receivable are primarily from purchasers of oil and natural gas ($627 million at March 31, 2007) and exploration and production companies which own interests in properties we operate ($147 million at March 31, 2007). This industry concentration has the potential to impact our overall exposure to credit risk, either positively or negatively, in that our customers may be similarly affected by changes in economic, industry or other conditions. We generally require letters of credit for receivables from customers which are judged to have sub-standard credit, unless the credit risk can otherwise be mitigated.

28

Table of Contents