NOTE 6 — DERIVATIVES

From time to time, the Company uses commodity derivative instruments to provide a measure of stability to its cash flows in an environment of volatile oil and gas prices and to manage its exposure to commodity price risk. During 2013, the Company did not have any commodity derivative contracts, and during the first six months of 2012, the Company’s natural gas derivative instruments consisted of one costless collar agreement for production from January 1, 2012 through December 31, 2012. During June 2012, the Company monetized this contract for net proceeds of $677,868. Prior to the monetization, the costless collar contained a fixed floor price (purchase put) and ceiling price (written call). The Company received the difference between the published index price and the floor price if the index price was below the floor price. The Company paid the difference between the ceiling price and the index price only if the index price was above the ceiling price. If the index price was between the ceiling and the floor prices, no amounts were paid or received.

On June 15, 2011, the Company issued the June Warrants to purchase 18,750,000 shares of common stock and on August 3, 2011, the Company issued the August Warrants to purchase 11,500,000 shares of common stock. The Warrants have an initial exercise price of $0.35 per share (subject to adjustment) and sixty-month term. The Warrants contain a contingent cash settlement provision at the option of the holder and accordingly, are classified as a derivative liability and are subject to the classification and measurement standards for derivative financial instruments.

The following table details the fair value of the derivatives recorded in the unaudited condensed consolidated balance sheets:

	Location on Consolidated	Fair Value at
	Balance Sheets	June 30, 2013		December 31, 2012

Warrant derivatives	Noncurrent liabilities	$	175,000	$	907,500

The table below summarizes the realized and unrealized gains and losses related to the Company’s derivative instruments for the three and six months ended June 30, 2013 and 2012.

	Three Months Ended June 30,					Six Months Ended June 30,
	2013		2012			2013		2012

Realized gains on commodity instruments	$	—	$	969,528		$	—	$	1,255,948
Change in fair value of commodity instruments	—		(1,062,071		)	—		(865,358		)
Change in fair value of warrant derivatives	127,500		2,117,500			732,500		1,397,500
Total realized and unrealized gains recorded	$	127,500	$	2,024,957		$	732,500	$	1,788,090

These realized and unrealized gains and losses are recorded in the accompanying unaudited condensed consolidated statements of operations as derivative gains (losses).