Derivative Activities

3 Months Ended

Mar. 31, 2012

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Activities

DERIVATIVE ACTIVITIES

The Company is subject to price fluctuations for natural gas and crude oil. Prices received for natural gas and crude oil sold on the spot market are volatile due to factors beyond the Company’s control. Reductions in crude oil and natural gas prices could have a material adverse effect on the Company’s financial position, results of operations, capital expenditures and quantities of reserves recoverable on an economic basis. Any reduction in reserves, including reductions due to lower prices, can affect the Company’s liquidity and ability to obtain capital for acquisition and development activities.

To mitigate a portion of its exposure to fluctuations in commodity prices, the Company enters into financial price risk management activities with respect to a portion of projected crude oil and natural gas production through financial price swaps, collars and put spreads (collectively, “derivatives”). Additionally, the Company uses basis protection swaps to reduce basis risk. Basis is the difference between the price of the physical commodity being hedged and the price of the futures contract used for hedging. Basis risk is the risk that an adverse change in the futures market will not be completely offset by an equal and opposite change in the cash price of the commodity being hedged. Basis risk exists in natural gas due to the geographic price differentials between a given cash market location and the futures contract delivery locations. Settlement or expiration of the hedges is designed to coincide as closely as possible with the physical sale of the commodity being hedged—daily for oil and monthly for natural gas—to obtain reasonable assurance that a gain in the cash sale will offset the loss on the hedge and vice versa.

The Company utilizes counterparties that the Company believes are credit-worthy entities at the time the transactions are entered into. The Company closely monitors the credit ratings of these counterparties. Additionally, the Company performs both quantitative and qualitative assessments of these counterparties based on their credit ratings and credit default swap rates where applicable. However, the recent events in the financial markets demonstrate there can be no assurance that a counterparty financial institution will be able to meet its obligations to the Company.

None of the Company’s derivative instruments contain credit-risk-related contingent features. Additionally, the Company has not incurred any credit-related losses associated with derivative activities and believes that its counterparties will continue to be able to meet their obligations under these transactions.

In the first quarter 2012, the Company entered into fixed price natural gas swaps for approximately 65% of the post-processing dry natural gas beginning April 2012 through December 2013. For the last nine months of 2012, the Company swapped 4.03 BCF at $2.60 and for fiscal year 2013 the Company swapped 4.24 BCF at $3.50. In connection with these swaps, the Company also entered into a basis swap in which we locked in a natural gas price differential between the NYMEX and the Houston Ship Channel at a price of $0.08. The combination of these trades effectively locks in a sales price to the Company of $2.52 for 4.03 BCF during the last nine months of 2012, and $3.42 for 4.24 BCF during fiscal year 2013.

In the first quarter 2012, the Company entered into fixed price crude oil swaps beginning April 2012 through December 2013. For the last nine months of 2012, the Company swapped 38,565 barrels of oil at $106.40 and for fiscal year 2013, the Company swapped 42,581 barrels of oil at $106.40. For the fiscal year 2014, the Company entered into a costless three-way collar for 35,528 barrels of oil with a ceiling price of $114.10, a floor price of $100 and a sold put at a price of $80. In addition to the fixed price crude oil swaps and costless three-way collar, we bought $100-$90 put spreads for 19,421 barrels of oil for the last six months of 2012, $100 puts for 26,654 barrels of oil in fiscal year 2013, and $95-$75 put spreads for 19,893 barrels of oil in fiscal year 2014.

As a result of hedging transactions entered into in the first quarter, the Company recorded a net derivative asset. This net derivative asset is being accounted for at fair value with the changes in fair value recorded to the consolidated statement of operations.

The following is a summary of the asset and liability fair values of our derivative contracts:

		Asset Fair Value				Liability Fair Value				Net Derivative Fair Value
	Balance Sheet Location	March 31, 2012		December 31, 2011		March 31, 2012		December 31, 2011		March 31, 2012			December 31, 2011
		(in thousands)				(in thousands)				(in thousands)
Derivatives not designated as Hedging Instruments under ASC 815
Natural gas	Current derivative asset	$	662	$	—	$	67	$	—	$	595		$	—
Crude oil	Current derivative asset	225		—		42		—		183			—
Natural gas	Other liabilities – non-current	—		—		81		—		(81		)	—
Crude oil	Derivative instruments – non-current asset	1,047		—		547		—		500			—
		$	1,934	$	—	$	737	$	—	$	1,197		$	—

The following table summarizes the outstanding natural gas and crude oil derivative contracts the Company had in place as of March 31, 2012:

Effective Date	Maturity Date	Notional Amount Per Month	Remaining Notional Amount as of March 31, 2012	Additional Put Options	Floor	Ceiling	Designation under ASC 815
Natural Gas (MMBtu):
4/1/2012	12/31/2012	447,919	4,031,268		$2.60	$2.60	Not designated
1/1/2013	12/31/2013	353,555	4,242,662		$3.50	$3.50	Not designated
Crude Oil (Bbls):
4/1/2012	12/31/2013	3,864	81,146		$106.40	$106.40	Not designated
7/1/2012	12/31/2012	3,237	19,421	$90.00	$100.00		Not designated
1/1/2013	12/31/2013	2,221	26,654		$100.00		Not designated
1/1/2014	12/31/2014	2,961	35,528	$80.00	$100.00	$114.10	Not designated
1/1/2014	12/31/2014	1,658	19,893	$75.00	$95.00		Not designated

All of the above natural gas contracts are settled against NYMEX, and all oil contracts are settled against NYMEX Light Sweet Crude. The NYMEX and NYMEX Light Sweet Crude have historically had a high degree of correlation with the actual prices received by the Company.

Effects of derivative instruments on the Consolidated Statement of Operations

For derivative instruments that are designated and qualify as a cash flow hedge, the effective portion of the gain or loss on the derivative is reported as a component of other comprehensive income ("OCI") and reclassified into earnings in the same period or periods during which the hedged transaction affects earnings. Gains and losses on the derivative representing either hedge ineffectiveness or hedge components excluded from the assessment of effectiveness are recognized in current earnings.

In December 2011, the Company settled its entire hedge portfolio. Under ASC 815-30-40, the Company is required to recognize the balance of the cumulative gain, recorded in accumulated other comprehensive income in the previous periods, over the life of the remaining contractual life of the original hedged transaction. For the three months ended March 31, 2012, the Company recognized $5.3 million of the cumulative gain in oil and gas sales on the consolidated statement of operations. As of March 31, 2012, the balance of the Company's cumulative gain, net of taxes, recorded in accumulated other comprehensive income was $10.5 million, of which $7.5 million will be recognized into earnings through December 31, 2012, with the remainder recognized in 2013.

There were no oil or gas derivatives classified as hedges for the three months ended March 31, 2012. A summary of the effect of the natural gas derivatives qualifying for hedges as of March 31, 2011 is as follows:

	Location of Amounts	Natural Gas Derivatives Qualifying as Hedges
Amount of Gain (Loss) Recognized in OCI on Derivative (Effective Portion)	OCI	236
Amount of Gain Reclassified from Accumulated OCI into Income (Effective Portion)	Oil and Gas Sales	4,445
Amount of Gain (Loss) Recognized in Income on Derivative (Ineffective Portion and Amount Excluded from Effectiveness Testing)	Oil and Gas Sales	408

For derivative instruments that do not qualify as hedges pursuant to ASC 815, changes in the fair value of these derivatives that occur prior to their maturity (i.e., temporary fluctuations in value) are recognized in current earnings. A summary of the effect of the derivatives not qualifying for hedges is as follows:

	Location of Gain (Loss) Recognized in Income on Derivative	Amount of Gain (Loss) Recognized in Income on Derivative
		Three Months Ended March 31,
		2012		2011
		(in thousands)
Realized
Crude oil	Oil and gas sales	$	—	$	—
Unrealized
Natural gas	Unrealized gain or (loss)on derivatives	276		—
Crude oil	Unrealized gain or (loss)on derivatives	514		(444		)
		$	790	$	(444	)

The valuation of our derivative instruments are based on industry standard models that primarily rely on market observable inputs. Substantially all of the assumptions for industry standard models are observable in active markets throughout the full term of the instrument. The Company categorizes these measurements as Level 2. The following table sets forth by level within the fair value hierarchy our derivative instruments, which are our only financial assets and liabilities that were accounted for at fair value on a recurring basis, as of March 31, 2012 and December 31, 2011:

	As of March 31, 2012						As of December 31, 2011
	Quoted Prices  in Active Markets (Level  1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Quoted Prices  in Active Markets (Level  1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
	(in thousands)
Financial assets:
Natural gas derivative instruments	$	—	$	514	$	—	$	—	$	—	$	—
Crude oil derivative instruments	$	—	$	683	$	—	$	—	$	—	$	—