Derivative Financial Instruments

6 Months Ended

Jun. 30, 2011

Derivative Financial Instruments

Derivative Financial Instruments

4.  Derivative Financial Instruments

Objectives and Strategies

Devon periodically enters into commodity and interest rate derivative financial instruments. These instruments are used to manage the inherent uncertainty of future revenues due to oil, gas and NGL price volatility and to manage exposure to interest rate volatility.  Devon does not hold or issue derivative financial instruments for speculative trading purposes and has elected not to designate any of its derivative instruments for hedge accounting treatment.

Devon's derivative financial instruments include financial price swaps, basis swaps, costless price collars and call options. Under the terms of the price swaps, Devon receives a fixed price for its production and pays a variable market price to the contract counterparty. For the basis swaps, Devon receives a fixed differential between two regional gas index prices and pays a variable differential on the same two index prices to the contract counterparty. The price collars set a floor and ceiling price for the hedged production. If the applicable monthly price indices are outside of the ranges set by the floor and ceiling prices in the various collars, Devon will cash-settle the difference with the counterparty to the collars. Under the terms of the call options, Devon sold to counterparties the right to purchase production at a predetermined price.

Devon periodically enters into interest rate swaps to manage its exposure to interest rate volatility. Devon's interest rate swaps include contracts in which Devon receives a fixed rate and pays a variable rate on a total notional amount. Devon also had forward starting swaps and U.S. Treasury locks. In conjunction with Devon's debt issuance discussed in Note 7, Devon received $35 million from the net settlement of its forward starting swaps and U.S. Treasury locks in July 2011.

Counterparty Risk

By using derivative financial instruments to manage exposures to changes in commodity prices and interest rates, Devon exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. To mitigate this risk, the hedging instruments are placed with a number of counterparties whom Devon believes are minimal credit risks. It is Devon's policy to enter into derivative contracts only with investment grade rated counterparties deemed by management to be competent and competitive market makers. Additionally, Devon's derivative contracts generally require cash collateral to be posted if either its or the counterparty's credit rating falls below investment grade. The mark-to-market exposure threshold, above which collateral must be posted, decreases as the debt rating falls further below investment grade. Such thresholds generally range from zero to $55 million for the majority of Devon's contracts. As of June 30, 2011, the credit ratings of all Devon's counterparties were investment grade.

Commodity Derivatives

As of June 30, 2011, Devon had the following open oil derivative positions. Devon's oil derivatives settle against the average of the prompt month NYMEX West Texas Intermediate futures price.

Production Period	Price Swaps		Price Collars			Call Options Sold
Period	Volume (Bbls/d)	Weighted Average Price ($/Bbl)	Volume (Bbls/d)	Weighted Average Floor Price ($/Bbl)	Weighted Average Ceiling Price ($/Bbl)	Volume (Bbls/d)	Weighted Average Price ($/Bbl)
Q3-Q4 2011	—	—	45,000	$75.00	$108.89	19,500	$95.00
Q1-Q4 2012	22,000	$107.17	54,000	$85.74	$126.42	19,500	$95.00
Q1-Q4 2013	—	—	7,000	$90.00	$125.12	—	—

As of June 30, 2011, Devon had the following open natural gas derivative positions. Devon's natural gas derivative swaps, collars and call options settle against the Inside Ferc first of the month Henry Hub index.

Production Period	Price Swaps		Price Collars			Call Options Sold
Period	Volume (MMBtu/d)	Weighted Average Price ($/MMBtu)	Volume (MMBtu/d)	Weighted Average Floor Price ($/MMBtu)	Weighted Average Ceiling Price ($/MMBtu)	Volume (MMBtu/d)	Weighted Average Price ($/MMBtu)
Q3-Q4 2011	712,500	$5.51	215,000	4.75	5.17	—	—
Q1-Q4 2012	325,000	$5.09	490,000	4.75	5.57	487,500	$6.00

Basis Swaps
Production Period	Index	Volume (MMBtu/d)	Weighted Average Differential to Henry Hub ($/MMBtu)
Q3-Q4 2011	Panhandle Eastern Pipeline	150,000	$(0.33)

As of June 30, 2011, Devon had the following open NGL derivative positions:

Basis Swaps
Production Period	Pay	Volume (Bbls/d)	Weighted Average Differential to WTI ($/Bbl)
Q3-Q4 2011	Natural Gasoline	416	$(9.75)
Q1-Q4 2012	Natural Gasoline	500	$(10.10)
Q1-Q4 2013	Natural Gasoline	500	$(6.80)

Interest Rate Derivatives

As of June 30, 2011, Devon had the following open interest rate derivative positions:

Fixed-to-Floating Swaps
Notional	Fixed Rate Received	Variable Rate Paid	Expiration
(In millions)
$           300	4.30%	Six month LIBOR	July 18, 2011
100	1.90%	Federal funds rate	August 3, 2012
500	3.90%	Federal funds rate	July 18, 2013
250	3.85%	Federal funds rate	July 22, 2013
$        1,150	3.82%

Forward Starting Swaps
Notional	Fixed Rate Paid	Variable Rate Received	Expiration
(In millions)
$           950	3.92%	Three month LIBOR	July 7, 2011

U.S. Treasury Locks
Notional	Fixed Rate Paid	Variable Rate Received	Expiration
(In millions)
$           350	1.56%	Five year U.S. Treasury	July 6, 2011
300	2.96%	Ten year U.S. Treasury	July 6, 2011
$           650	2.21%

Financial Statement Presentation

The following table presents the derivative fair values included in the accompanying consolidated balance sheets.

	Balance Sheet Caption	June 30, 2011	December 31, 2010
		(In millions)
Asset derivatives:
Commodity derivatives	Other current assets	$                      240	$                      248
Commodity derivatives	Other long-term assets	81	1
Interest rate derivatives	Other current assets	78	100
Interest rate derivatives	Other long-term assets	33	40
Total asset derivatives		$                      432	$                      389
Liability derivatives:
Commodity derivatives	Other current liabilities	$                        83	$                        50
Commodity derivatives	Other long-term liabilities	78	142
Total liability derivatives		$                      161	$                      192

The following table presents the cash settlements and unrealized gains and losses on fair value changes included in the accompanying consolidated statements of operations associated with these derivative financial instruments. Cash settlements and unrealized gains and losses on fair value changes associated with Devon's commodity derivatives are presented in the "Oil, gas and NGL derivatives" caption in the accompanying consolidated statements of operations. Cash settlements and unrealized gains and losses on fair value changes associated with Devon's interest rate derivatives are presented in the "Interest-rate and other financial instruments" caption in the accompanying consolidated statements of operations.

	Three Months Ended June 30,		Six Months Ended June 30,
	2011	2010	2011	2010
	(In millions)
Cash settlements:
Commodity derivatives	$               59	$             252	$             145	$             348
Interest rate derivatives	5	4	21	20
Total cash settlements	64	256	166	368
Unrealized gains (losses):
Commodity derivatives	357	(207)	103	317
Interest rate derivatives	(30)	(85)	(29)	(86)
Total unrealized gains (losses)	327	(292)	74	231
Net gain (loss) recognized on statement of operations	$             391	$              (36)	$             240	$             599