Derivative Financial Instruments

9 Months Ended

Sep. 30, 2011

Derivative Financial Instruments [Abstract]

DERIVATIVE FINANCIAL INSTRUMENTS

6. DERIVATIVE FINANCIAL INSTRUMENTS

We account for our derivative contracts under the provisions of ASC 815, “Derivatives and Hedging.” We have entered into forward-swap contracts and collar contracts to reduce our exposure to price risk in the spot market for oil and natural gas. We also utilize financial basis swap contracts, which address the price differential between market-wide benchmark prices and other benchmark pricing referenced in certain of our crude oil and natural gas sales contracts. Substantially all of our hedging agreements are executed by affiliates of the lenders under the credit facility described in Note 8 below, and are collateralized by the security interests of the respective affiliated lenders in certain of our assets under the credit facility. The contracts settle monthly and are scheduled to coincide with either oil production equivalent to barrels (Bbl) per month or gas production equivalent to volumes in millions of British thermal units (MMbtu) per month. The contracts represent agreements between us and the counter-parties to exchange cash based on a designated price. Prices are referenced to the natural gas spot market benchmark price at the Houston Ship Channel or NYMEX indices. Cash settlement occurs monthly based on the specified price benchmark. We have not designated any of our derivative contracts as fair value or cash flow hedges; accordingly we use mark-to-market accounting, recognizing unrealized gains and losses in the statement of operations at each reporting date. Realized gains and losses on commodities hedging contracts are included in oil and natural gas revenues.

We have entered into a series of interest rate swap agreements with several financial institutions to mitigate the risk of loss due to changes in interest rates. The interest rate swaps are not designated as cash flow hedges in accordance with ASC 815. Both realized gains and losses from settlement and unrealized gains and losses from changes in the fair market value of the interest rate swaps are included in interest expense.

The second table below provides information on the location and amounts of realized and unrealized gains and losses on derivatives included in the consolidated statements of income for each of the three month and nine month periods ended September 30, 2011 and 2010.

The following table summarizes the fair value (see Note 5 for further discussion of fair value) and classification of our derivative instruments, none of which have been designated as hedging instruments under ASC 815:

Fair Values of Derivative Contracts
	Balance Sheet Location at September 30, 2011
	Current asset			Current liability			Long-term asset			Long-term liability
	portion of			portion of			portion of			portion of
	Derivative			Derivative			Derivative			Derivative
	financial			financial			financial			financial
	instruments			instruments			instruments			instruments
				(unaudited)
				(dollars in thousands)
Fair value of oil and gas commodity contracts, assets	$	46,514		$	—		$	47,072		$	—
Fair value of oil and gas commodity contracts, (liabilities)		(20,727	)		—			(22,966	)		—
Fair value of interest rate contracts, (liabilities)		—			(1,959	)		—			—
Total net assets, (liabilities)	$	25,787		$	(1,959	)	$	24,106		$	—

Fair Values of Derivative Contracts
	Balance Sheet Location at December 31, 2010
	Current asset			Current liability			Long-term asset			Long-term liability
	portion of			portion of			portion of			portion of
	Derivative			Derivative			Derivative			Derivative
	financial			financial			financial			financial
	instruments			instruments			instruments			instruments
	(dollars in thousands)
Fair value of oil and gas commodity contracts, assets	$	27,118		$	—		$	34,505		$	—
Fair value of oil and gas commodity contracts, (liabilities)		(16,682	)		—			(20,340	)		—
Fair value of interest rate contracts, (liabilities)		—			(3,092	)		—			(2,296	)
Total net assets, (liabilities)	$	10,436		$	(3,092	)	$	14,165		$	(2,296	)

Commodity contracts are subject to master netting arrangements and are presented on a net basis in the consolidated balance sheets. This netting can cause derivative assets to be ultimately presented in a (liability) account on the consolidated balance sheets. Likewise, derivative (liabilities) could be presented in an asset account.

The following table summarizes the effect of our derivative instruments in the consolidated statements of operations:

Derivatives not
designated as hedging			For the three months ended					For the nine months ended
instruments under ASC	Location of Gain	Classification of	September 30,					September 30,
815	(Loss)	Gain (Loss)	2011		2010			2011			2010
					(unaudited)
					(dollars in thousands)
Natural gas commodity contracts	Natural gas revenues	Realized	$	5,986	$	7,003		$	16,897		$	16,204
Oil commodity contracts	Oil revenues	Realized		162		273			(3,756	)		549
Interest rate contracts	Interest benefit (expense)	Realized		76		(1,384	)		2,004			(3,436	)
Total realized gains (losses) from derivatives not designated as hedges			$	6,224	$	5,892		$	15,145		$	13,317
Natural gas commodity contracts	Unrealized gain (loss) — oil and natural gas derivative contracts	Unrealized	$	7,724	$	8,562		$	6,425		$	23,858
Oil commodity contracts	Unrealized gain (loss) — oil and natural gasderivative contracts	Unrealized		22,377		(5,850	)		18,867			1,762
Interest rate contracts	Interest benefit (expense)	Unrealized		2,921		580			3,429			983
Total unrealized gains (losses) from derivatives not designated as hedges			$	33,022	$	3,292		$	28,721		$	26,603

Although our counterparties provide no collateral, the master derivative agreements with each counterparty effectively allow us, so long as we are not a defaulting party, after a default or the occurrence of a termination event, to set-off an unpaid hedging agreement receivable against the interest of the counterparty in any outstanding balance under the credit facility.

If a counterparty were to default in payment of an obligation under the master derivative agreements, we could be exposed to commodity price fluctuations, and the protection intended by the hedge could be lost. The value of our derivative financial instruments would be impacted.

We had the following open derivative contracts for natural gas at September 30, 2011 (unaudited):

NATURAL GAS DERIVATIVE CONTRACTS

	Volume in		Weighted		Range
Period and Type of Contract	MMbtu		Average		High		Low
2011
Price Swap Contracts		5,815,000	$	5.63	$	8.83	$	4.44
Collar Contracts
Short Call Options		6,760,000		5.67		7.05		5.40
Long Put Options		3,060,000		6.05		6.30		5.75
Long Call Options		600,000		7.45		7.45		7.45
Short Put Options		1,480,000		3.86		4.00		3.65
2012
Price Swap Contracts		7,525,000		6.17		8.83		5.00
Collar Contracts
Short Call Options		7,560,000		5.76		6.00		5.50
Long Put Options		4,350,000		5.93		6.75		5.50
Long Call Options		3,660,000		5.00		5.00		5.00
Short Put Options		9,810,000		4.10		4.50		4.00
2013
Price Swap Contracts		6,650,000		6.18		9.15		5.35
Collar Contracts
Short Call Options		1,500,000		6.50		6.50		6.50
Long Put Options		1,500,000		6.09		6.15		6.00
Short Put Options		900,000		5.00		5.00		5.00
2014
Price Swap Contracts		3,125,000		6.27		7.50		5.60
Collar Contracts
Short Call Options		3,475,000		7.05		9.00		6.00
Long Put Options		1,650,000		6.73		7.00		6.00
Short Put Options		1,200,000		5.50		5.50		5.50
2015
Price Swap Contracts		1,825,000		5.91		5.91		5.91
2016
Collar Contracts
Short Call Options		455,000		7.50		7.50		7.50
Long Put Options		455,000		5.50		5.50		5.50
Short Put Options		455,000		4.00		4.00		4.00

We had the following open derivative contracts for crude oil at September 30, 2011 (unaudited):

OIL DERIVATIVE CONTRACTS

			Weighted		Range
Period and Type of Contract	Volume in Bbls		Average		High		Low
2011
Price Swap Contracts		184,000	$	82.13	$	103.20	$	67.50
Collar Contracts
Short Call Options		419,900		101.01		110.00		82.25
Long Put Options		317,400		86.67		100.00		75.00
Long Call Options		162,300		81.60		85.00		75.00
Short Put Options		402,592		66.42		89.85		55.00
2012
Price Swap Contracts		36,600		80.20		80.20		80.20
Collar Contracts
Short Call Options		1,171,008		121.29		132.00		100.00
Long Put Options		1,190,618		100.32		105.00		70.00
Long Call Options		228,600		103.79		123.50		90.20
Short Put Options		1,311,008		79.34		85.00		60.00

			Weighted		Range
Period and Type of Contract	Volume in Bbls		Average		High		Low
2013
Price Swap Contracts		136,500		84.35		94.74		77.00
Collar Contracts
Short Call Options		527,435		113.38		127.00		90.00
Long Put Options		351,500		81.95		90.00		80.00
Long Call Options		82,500		79.00		79.00		79.00
Short Put Options		434,000		61.58		70.00		60.00
2014
Price Swap Contracts		127,300		87.63		91.05		81.00
Collar Contracts
Short Call Options		273,750		125.70		133.50		107.50
Long Put Options		488,450		85.33		90.00		80.00
Short Put Options		488,450		65.33		70.00		60.00
2015
Collar Contracts
Short Call Options		246,350		125.12		135.98		116.40
Long Put Options		319,350		87.57		90.00		85.00
Short Put Options		319,350		66.86		70.00		60.00
2016
Collar Contracts
Short Call Options		36,400		130.00		130.00		130.00
Long Put Options		36,400		95.00		95.00		95.00
Short Put Options		36,400		75.00		75.00		75.00

In those instances where contracts are identical as to time period, volume and strike price, but opposite as to direction (long and short), the volumes and average prices have been netted in the two tables above. In some instances our counterparties in the offsetting contracts are not the same, and may have different credit ratings.

We had the following open financial basis swap contracts for gas at September 30, 2011 (unaudited):

Volume in MMbtu	Reference Price	Period	Spread ($ per MMbtu)
600,000	Houston Ship Channel	Oct ’11 — Dec ’11		(0.2000)
600,000	Houston Ship Channel	Oct ’11 — Dec ’11		(0.1600)
230,000	Houston Ship Channel	Oct ’11 — Dec ’11		(0.0850)
690,000	Houston Ship Channel	Oct ’11 — Dec ’11		(0.1550)
1,830,000	Houston Ship Channel	Jan ’12 — Dec ’12		(0.1575)
920,000	Houston Ship Channel	Oct ’11 — Dec ’11		(0.1150)
3,660,000	Houston Ship Channel	Jan ’12 — Dec ’12		(0.1400)

We had the following open financial basis swap contract for oil at September 30, 2011 (unaudited):

Volume in BBL	Reference Price	Period	Spread ($ per MMbtu)
46,000	Argus Louisiana Light Sweet Crude	Oct ’11 — Dec ’11		19.40

We had the following open interest rate swap contracts at September 30, 2011 (unaudited):

Interest Rate Swaps

Term	Principal Amount		Interest Rate (1)
	(dollars in thousands)
Floating to Fixed Rate Swaps:
October 2011 — August 2012	$	50,000		4.95	%
October 2011 — October 2011	$	25,000		3.21	%

(1) The floating rate is the three-month LIBOR rate.