Derivative And Financial Instruments

6 Months Ended

Jun. 30, 2017

Derivative And Financial Instruments

Derivative And Financial Instruments

5. DERIVATIVE AND FINANCIAL INSTRUMENTS

To reduce the impact of fluctuations in oil and natural gas prices on our revenues, we periodically enter into derivative contracts with respect to a portion of our projected oil and natural gas production through various transactions that fix or modify the future prices to be realized.  These hedging activities are intended to support oil and natural gas prices at targeted levels and to manage exposure to oil and natural gas price fluctuations.  It is never our intention to enter into derivative contracts for speculative trading purposes.

Under ASC Topic 815, “Derivatives and Hedging,” all derivative instruments are recorded on the condensed consolidated balance sheets at fair value as either short-term or long-term assets or liabilities based on their anticipated settlement date.  We will net derivative assets and liabilities for counterparties where we have a legal right of offset.  Changes in the derivatives’ fair values are recognized currently in earnings unless specific hedge accounting criteria are met.  We have not elected to designate any of our current derivative contracts as hedges; however, changes in the fair value of all of our derivative instruments are recognized in earnings and included in natural gas sales and oil sales in the condensed consolidated statements of operations.

As of June 30, 2017, we had the following derivative contracts in place for the periods indicated, all of which are accounted for as mark-to-market activities:

Fixed Price Basis Swaps–West Texas Intermediate (WTI)

	March 31,			June 30,			September 30,			December 31,			Total
	Volume	Average		Volume	Average		Volume	Average		Volume	Average		Volume	Average
	(Bbls)	Price		(Bbls)	Price		(Bbls)	Price		(Bbls)	Price		(Bbls)	Price
2017	—	$	—	—	$	—	87,304	$	61.42	81,702	$	61.55	169,006	$	61.48
2018	88,854	$	60.82	83,976	$	60.90	79,683	$	60.96	75,864	$	61.02	328,377	$	60.92
2019	78,667	$	61.48	75,326	$	61.53	72,279	$	61.57	69,480	$	61.61	295,752	$	61.54
2020	66,914	$	53.50	64,477	$	53.50	62,251	$	53.50	60,224	$	53.50	253,866	$	53.50
													1,047,001

Fixed Price Swaps—NYMEX (Henry Hub)

	March 31,			June 30,			September 30,			December 31,			Total
	Volume	Average		Volume	Average		Volume	Average		Volume	Average		Volume	Average
	(MMBtu)	Price		(MMBtu)	Price		(MMBtu)	Price		(MMBtu)	Price		(MMBtu)	Price
2017	—	$	—	—	$	—	271,368	$	5.45	257,234	$	5.45	528,602	$	5.45
2018	260,841	$	3.18	248,018	$	3.18	235,810	$	3.18	225,208	$	3.18	969,877	$	3.18
2019	224,303	$	3.10	214,186	$	3.10	205,533	$	3.10	197,455	$	3.10	841,477	$	3.10
2020	188,696	$	2.85	176,946	$	2.85	170,637	$	2.85	164,747	$	2.85	701,026	$	2.85
													3,040,982

The following table sets forth a reconciliation of the changes in fair value of the Partnership’s commodity derivatives for the six months ended June 30, 2017 and the year ended December 31, 2016 (in thousands):

	June 30,		December 31,
	2017		2016
Beginning fair value of commodity derivatives	$	6,436	$	31,018
Net gains (losses) on crude oil derivatives		8,543		(8,355)
Net gains on natural gas derivatives		725		1,116
Net settlements on derivative contracts:
Crude oil		(2,144)		(13,622)
Natural gas		(1,297)		(6,919)
Net premiums on derivative contracts		—		3,198
Ending fair value of commodity derivatives	$	12,263	$	6,436

The effect of derivative instruments on our condensed consolidated statements of operations was as follows (in thousands):

		Amount of Gain (Loss) in Income
		Three Months Ended June 30,				Six Months Ended June 30,
Derivative Type	Location of Gain (Loss) in Income	2017		2016		2017		2016
Commodity – Oil Hedges	Oil sales	$	3,048	$	(6,260)	$	8,543	$	(3,568)
Commodity – Gas Hedges	Natural gas sales		165		(1,466)		725		(168)
		$	3,213	$	(7,726)	$	9,268	$	(3,736)

Derivative instruments expose us to counterparty credit risk.  Our commodity derivative instruments are currently contracted with four counterparties.  We generally execute commodity derivative instruments under master agreements which allow us, in the event of default, to elect early termination of all contracts with the defaulting counterparty.  If we choose to elect early termination, all asset and liability positions with the defaulting counterparty would be net cash settled at the time of election. We include a measure of counterparty credit risk in our estimates of the fair values of derivative instruments. As of June 30, 2017, and December 31, 2016, the impact of non-performance credit risk on the valuation of our derivative instruments was not significant.

Embedded Derivative

The Partnership entered into a contract for the sale of preferred units in October 2015 which contained provisions that were required to be bifurcated from the contract and valued as a derivative. The embedded derivative was valued through the use of a Monte Carlo model which utilized observable inputs, the Partnership’s unit prices at various timelines, as well as unobservable inputs related to the weighted probabilities of certain redemption scenarios. In November 2016, we completed a public offering and private placement of common units. As a result of these equity issuances, the Class B conversion rate was determined and the provisions that were required to bifurcate were removed.  At that time, the fair value of the derivative was transferred to mezzanine equity.

The following table sets forth a reconciliation of the changes in fair value of the Partnership’s embedded derivative for the year ended December 31, 2016 (in thousands):

	December 31,
	2016
Beginning fair value of embedded derivative	$	(193,077)
Gain on embedded derivative		47,794
Transfer to mezzanine equity		145,283
Ending fair value of embedded derivative	$	—