Derivative Instruments/Hedging

6 Months Ended

Jun. 30, 2013

Derivative Instruments/Hedging

Derivative Instruments/Hedging

2. Derivative Instruments/Hedging

We periodically enter into derivative instruments to mitigate a portion of our potential exposure to a decline in commodity prices and the corresponding negative impact on cash flow available for reinvestment.  While the use of these instruments limits the downside risk of adverse price changes, their use may also limit future revenues from favorable price changes.

The following tables summarize our outstanding contracts as of June 30, 2013.  We have elected not to account for these derivatives as cash flow hedges.

Oil Contracts
				Weighted Average Price						Fair Value
Period	Type	Volume/Day	Index(1)	Floor		Ceiling		Swap		(in thousands)
Jul 13 – Dec 13	Collars	6,000 Bbls	WTI	$	85.00	$	102.31	—		$	(18	)
Jul 13 – Dec 13	Swaps	6,000 Bbls	WTI	—		—		$	96.13	$	1,110

(1)           WTI refers to West Texas Intermediate price as quoted on the New York Mercantile Exchange.

Gas Contracts
				Weighted Average Price				Fair Value
Period	Type	Volume/Day	Index(1)	Floor		Ceiling		(in thousands)
Jul 13 – Dec 14	Collars	80,000 MMBtu	PEPL	$	3.51	$	4.57	$	9,200

(1)           PEPL refers to Panhandle Eastern Pipe Line, Tex/OK Mid-Continent Index as quoted in Platt’s Inside FERC.

Under a collar agreement, we receive the difference between the published index price and a floor price if the index price is below the floor.  We pay the difference between the ceiling price and the index price only if the index price is above the contracted ceiling price.  No amounts are paid or received if the index price is between the floor and ceiling prices.  For a swap contract, the counterparty is required to make a payment to us if the settlement price for any settlement period is less than the swap price.  We are required to make a payment to the counterparty if the settlement price for the settlement period is greater than the swap price.

Depending on changes in oil and gas futures markets and management’s view of underlying supply and demand trends, we may increase or decrease our current hedging positions.

The following table summarizes the realized and unrealized gains and (losses) from settlements and changes in fair value of our derivative contracts as presented in our accompanying financial statements.

	Three Months Ended June 30,				Six Months Ended June 30,
(in thousands)	2013		2012		2013		2012
Settlements gains (losses):
Natural gas contracts	$	—	$	—	$	—	$	—
Oil contracts	1,039		—		1,765		—
Total settlements gains (losses)	1,039		—		1,765		—
Unrealized gains (losses) on fair value change:
Natural gas contracts	9,199		—		9,199		—
Oil contracts	3,422		10,078		1,093		5,990
Total unrealized gains (losses) on fair value change	12,621		10,078		10,292		5,990
Gain (loss) on derivative instruments, net	$	13,660	$	10,078	$	12,057	$	5,990

Our derivative contracts are carried at their fair value on our balance sheet using Level 2 inputs.  We estimate the fair value using internal risk-adjusted discounted cash flow calculations.  Cash flows are based on published forward commodity price curves for the underlying commodity as of the date of the estimate.  For collars, we estimate the option value of the contract floors and ceilings using an option pricing model which takes into account market volatility, market prices, and contract terms.

The fair value of our derivative instruments in an asset position includes a measure of counterparty credit risk and the fair value of instruments in a liability position includes a measure of our own nonperformance risk.  These credit risks are based on current published credit default swap rates.

Due to the volatility of commodity prices, the estimated fair value of our derivative instruments is subject to fluctuation from period to period, which could result in significant differences between the current estimated fair value and the ultimate settlement price.  The following table presents the estimated fair value of our derivative assets and liabilities as of June 30, 2013.  All of our derivative contracts entered into prior to January 1, 2013 were settled as of December 31, 2012.  Our derivatives are presented on a gross basis.

June 30, 2013: (in thousands)	Balance Sheet Location	Asset		Liability
Oil contracts	Current assets — Derivative instruments	$	1,151	$	—
Natural gas contracts	Current assets — Derivative instruments	$	6,805	$	—
Natural gas contracts	Noncurrent assets — Derivative instruments	$	2,395	$	—
Oil contracts	Current liabilities — Derivative instruments	$	—	$	59
		$	10,351	$	59

Because we elect not to account for our current derivative contracts as cash flow hedges, we recognize all realized settlements and unrealized changes in fair value in earnings.  Cash settlements of our derivative contracts are included in cash flows from operating activities in our statements of cash flows.

We are exposed to financial risks associated with these contracts from nonperformance by our counterparties.  Counterparty risk is also a component of our estimated fair value calculations.  We have mitigated our exposure to any single counterparty by contracting with a number of financial institutions, each of which has a high credit rating and is a member of our bank credit facility.  Our member banks do not require us to post collateral for our hedge liability positions.