Derivative instruments

Overview

Our results of operations, financial condition and capital resources are highly dependent upon the prevailing market prices of, and demand for, oil and natural gas. These commodity prices are subject to wide fluctuations and market uncertainties. To mitigate a portion of this exposure, we enter into various types of derivative instruments, including commodity price swaps, enhanced price swaps, costless collars, put options, and basis protection swaps. See “Note 1—Nature of operations and summary of significant accounting policies” for additional information regarding our accounting policies for derivative transactions.

For commodity price swaps, we receive a fixed price for the hedged commodity and pay a floating market price to the counterparty. The fixed-price payment and the floating-price payment are netted, resulting in a net amount due to or from the counterparty.

Collars contain a fixed floor price (purchased put) and ceiling price (sold call). If the market price exceeds the call strike price or falls below the put strike price, we receive the fixed price and pay the market price. If the market price is between the call and the put strike price, no payments are due from either party. A three-way collar contract consists of a standard collar contract plus a sold put with a price below the floor price of the collar. The sold put option requires us to make a payment to the counterparty if the market price is below the sold put option price. If the market price is greater than the sold put option price, the result is the same as it would have been with a standard collar contract only. By combining the collar contract with the sold put option, we are entitled to a net payment equal to the difference between the floor price of the standard collar and the sold put option price if the market price falls below the sold put option price. This strategy enables us to increase the floor and the ceiling price of the collar beyond the range of a traditional costless collar utilizing the value associated with the sale of a put option.

We enhance the value of certain oil swaps by combining them with sold puts or put spread contracts. Sold puts require us to make a payment to the counterparty if the market price is below the put strike price at the settlement date. If the market price is greater than the sold put price, the result is the same as it would have been with a swap contract only. A put spread is a combination of a sold put and a purchased put. If the market price falls below the purchased put option price, we will pay the spread between the sold put option price and the purchased put option price from the counterparty. The use of a sold put allows us to receive an above-market swap price while the purchased put provides a measure of downside protection. A put spread may also be constructed by entering into separate sold put and purchased put contracts.

Put options may be purchased from the counterparty by paying a cash premium at the time the put options are purchased or deferring payment until the put options settle. If the market price is below the put strike price at the settlement date, we will receive a payment from the counterparty. Purchased put options are designed to provide a fixed price floor in an environment where prices have declined. In such an environment, put options may also be purchased to offset the downside from sold puts that are originally associated with enhanced swaps or three-way collars. The fair value of our put options include any deferred premiums that are payable under the contract.

We use basis protection swaps to reduce basis risk. Basis is the difference between 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 primarily due to the geographic price differentials between cash market locations and futures contract delivery locations. Natural gas basis protection swaps are arrangements that guarantee a price differential for natural gas from a specified pricing point. We receive a payment from the counterparty if the price differential is greater than the stated terms of the contract and pay the counterparty if the price differential is less than the stated terms of the contract.

We enter into crude oil derivative contracts for a portion of our natural gas liquids production. The following table summarizes our crude oil derivatives outstanding as of December 31, 2014:



		Weighted average fixed price per Bbl
Period and type of contract	Volume MBbls	Swaps		Sold puts		Purchased puts		Sold calls		Average Premium
2015
Swaps	600	$	96.02	$	—	$	—	$	—	$	—
Swaps with deferred premium (1)	6,058	$	92.92	$	—	$	—	$	—	$	14.06
2016
Three-way collars	240	$	—	$	84.00	$	92.00	$	101.01	$	—
Enhanced swaps (2)	3,720	$	92.94	$	80.52	$	—	$	—	$	—
Purchased puts (2)	3,720	$	—	$	—	$	60.00	$	—	$	5.54

____________

(1)

Prior to December 8, 2014, we had outstanding swaps scheduled to mature in 2015 for 5,548,000 barrels of crude oil production that had an associated sold put at $80/barrel and a purchased put at $60/barrel. We also had outstanding swaps scheduled to mature in 2015 for 510,000 barrels of crude oil production that had an associated sold put at $80/barrel and no associated purchased put. On December 8, 2014, we entered into offsetting positions to the sold put and purchased put legs of the swaps described above, effectively terminating those puts and ending with a swap on the associated volumes. Payment of $83,951 for the premiums on the offsetting positions has been deferred until 2015 to coincide with the maturity of the swaps. Premiums of $1,220 were also deferred on the initial $60 purchased puts that are now offset. This results in a total of $85,171 or $14.06 per barrel of deferred premiums related to the above 6,058,000 barrels of crude oil. As a result of offsetting the puts and deferring payment, we now have the above 6,058,000 barrels of crude oil production hedged in 2015 at an effective price of $78.86/barrel.

(2)

Total premiums of $20,609 for the purchased puts were paid at contract inception in December 2014. Excluding the premiums and utilizing an average NYMEX strip price of $62.63 for 2016 as of December 31, 2014, the average realized price from our 3,720,000 barrels of hedged production that have associated sold puts and purchased puts is $75.05/barrel. In the event of further declines in crude oil prices below $60.00/barrel, the purchase of these put options allows us to establish a floor on the realized price for these hedged volumes of $72.42/barrel.

The following tables summarize our natural gas derivative instruments outstanding as of December 31, 2014:



Period and type of contract	Volume BBtu	Weighted average fixed price per MMBtu
2015
Natural gas swaps	19,770	$	4.20
Natural gas basis protection swaps	14,400	$	0.24
2016
Natural gas swaps	14,400	$	4.18
Natural gas basis protection swaps	8,400	$	0.36

On March 26, 2015, we entered into early settlements of certain oil and natural gas derivative contracts originally scheduled to settle between 2015 to 2017 covering 495,000 barrels of oil and 12,280 Bbtu of natural gas for net proceeds of $15,395 in order to maintain compliance with the hedging limits imposed by covenants under our senior secured credit facility. We were in compliance with the aforementioned hedging limits as of March 31, 2015.

Effect of derivative instruments on the consolidated balance sheets

All derivative financial instruments are recorded on the consolidated balance sheets at fair value. See “Note 7—Fair value measurements” for additional information. The estimated fair values of derivative instruments are provided below. The carrying amounts of these instruments are equal to the estimated fair values.



	As of December 31, 2014								As of December 31, 2013
	Assets		Liabilities			Net value			Assets		Liabilities			Net value
Natural gas swaps	$	32,939	$	—		$	32,939		$	1,457	$	(3,706	)	$	(2,249	)
Oil swaps	23,465		—			23,465			112		(2,807		)	(2,695		)
Oil collars	1,175		—			1,175			2,776		(4		)	2,772
Oil enhanced swaps	100,724		—			100,724			6,988		(6,212		)	776
Oil put options	93,268		—			93,268			74		—			74
Natural gas basis differential swaps	292		(309		)	(17		)	1,706		(63		)	1,643
Total derivative instruments	251,863		(309		)	251,554			13,113		(12,792		)	321
Less:
Netting adjustments (1)	232		(232		)	—			4,558		(4,558		)	—
Current portion asset (liability)	179,921		(77		)	179,844			2,152		(8,234		)	(6,082		)
	$	71,710	$	—		$	71,710		$	6,403	$	—		$	6,403

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(1)	Amounts represent the impact of master netting agreements that allow us to net settle positive and negative positions with the same counterparty. Positive and negative positions with a counterparty are netted only to the extent that they relate to the same current versus noncurrent classification on the balance sheet.

We discontinued hedge accounting effective April 1, 2010. Net derivative gains (losses) attributable to derivatives previously subject to hedge accounting were deferred through AOCI. As of December 31, 2014, there are no longer any deferred gains in AOCI as all the previously deferred gains (losses) have been reclassified into earnings upon the sale of the hedged production.

Derivative settlements outstanding were as follows at December 31:



	2014		2013
Derivative settlements receivable included in accounts receivable	$	19,678	$	4,616
Derivative settlements payable included in accounts payable and accrued liabilities	$	—	$	377

Effect of derivative instruments on the consolidated statements of operations

We discontinued hedge accounting effective April 1, 2010. and have since no longer applied hedge accounting to any of our derivative instruments. As a result, all gains and losses associated with our derivative contracts are recognized immediately as non-hedge derivative gains (losses) in the consolidated statements of operations. Net derivative gains (losses) attributable to derivatives previously subject to hedge accounting were deferred through AOCI and upon settlement, were reclassified from AOCI into gain from oil hedging activities which is a component of total revenues in the consolidated statements of operations. As of December 31, 2013, there are no longer any deferred gains in AOCI as all the previously deferred gains (losses) have been reclassified into earnings upon the sale of the hedged production.

Non-hedge derivative gains (losses) in the consolidated statements of operations are comprised of the following:



	2014			2013			2012
Change in fair value of commodity price swaps	$	59,627		$	(20,717	)	$	(8,440	)
Change in fair value of collars	(1,597		)	(23,459		)	21,182
Change in fair value of enhanced swaps and put options	172,533			186			—
Change in fair value of natural gas basis differential contracts	(1,660		)	3,242			(331		)
Receipts from (payments on) settlement of commodity price swaps	(6,607		)	5,122			28,716
Receipts from settlement of collars	7,382			14,548			10,229
Receipts from settlement of commodity enhanced swaps and put options	2,221			—			—
Payments on settlement of natural gas basis differential contracts	(579		)	(557		)	(1,671		)
	$	231,320		$	(21,635	)	$	49,685