Derivative Instruments/Hedging

6 Months Ended

Jun. 30, 2014

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 hedging contracts as of June 30, 2014:

Oil Contracts

				Weighted Average Price				Fair Value
Period	Type	Volume/Day	Index (1)	Floor		Ceiling		(in thousands)
Jul 14 – Dec 14	Collars	12,000 Bbls	WTI	$	85.00	$	103.47	$	(5,974)

(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 14 – Dec 14	Collars	80,000 MMBtu	PEPL	$	3.51	$	4.57	$	(969)
Jul 14 – Dec 14	Collars	60,000 MMBtu	Perm EP	$	3.62	$	4.50	$	(1,563)

(1)  PEPL refers to Panhandle Eastern Pipe Line, Tex/OK Mid-Continent Index as quoted in Platt’s Inside FERC.  Perm EP refersto El Paso Natural Gas Company, Permian Basin 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 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. 

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 hedging positions.

We have elected not to account for our derivatives as cash flow hedges.  Therefore, we recognize settlements and changes in the assets or liabilities relating to our open derivative contracts in earnings.  Cash settlements of our contracts are included in cash flows from operating activities in our statements of cash flows.

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

	Three Months Ended				Six Months Ended
	June 30,				June 30,
(in thousands)	2014		2013		2014		2013
Gain (loss) on derivative instruments, net:
Natural gas contracts	$	2,062	$	9,199	$	(9,820)	$	9,199
Oil contracts		(4,516)		4,461		(8,369)		2,858
Gain (loss) on derivative instruments, net	$	(2,454)	$	13,660	$	(18,189)	$	12,057
Gains (losses) from settlement of derivative instruments:
Natural gas contracts	$	(37)	$	—	$	(4,824)	$	—
Oil contracts		(980)		1,039		(980)		1,765
Settlement gains (losses)	$	(1,017)	$	1,039	$	(5,804)	$	1,765

Our derivative contracts are carried at their fair value on our balance sheet using Level 2 inputs.  We estimate the fair value with 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 non-performance 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.

Our derivative instruments are subject to enforceable master netting arrangements, which allow us to offset recognized asset and liability fair value amounts on contracts with the same counterparty.  Our policy is to not offset asset and liability positions in our accompanying balance sheets.

The following table presents the amounts and classifications of our derivative assets and liabilities as of June 30, 2014 and December 31, 2013, as well as the potential effect of netting arrangements on contracts with the same counterparty.

June 30, 2014:
(in thousands)	Balance Sheet Location	Asset		Liability
Oil contracts	Current liabilities — Derivative instruments	$	—	$	5,974
Natural gas contracts	Current liabilities — Derivative instruments		—		2,532
Total gross amounts presented in accompanying balance sheet			—		8,506
Less: gross amounts not offset in the accompanying balance sheet			—		—
Net amount:		$	—	$	8,506
December 31, 2013:
(in thousands)	Balance Sheet Location	Asset		Liability
Oil contracts	Current assets — Derivative instruments	$	1,805	$	—
Natural gas contracts	Current assets — Derivative instruments		2,463		—
Oil contracts	Current liabilities — Derivative instruments		—		389
Total gross amounts presented in accompanying balance sheet			4,268		389
Less: gross amounts not offset in the accompanying balance sheet			(389)		(389)
Net amount:		$	3,879	$	—

We are exposed to financial risks associated with our derivative contracts from non-performance by our counterparties.  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.  Because some of the member banks have discontinued hedging activities, in the future we may hedge with counterparties outside our bank group to obtain competitive terms and to spread counterparty risk.