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Derivative Financial Instruments
 12 Months Ended
Dec. 31, 2019
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Financial Instruments DERIVATIVE FINANCIAL INSTRUMENTS
Commodity Derivative Instruments and Concentration of Risk
Objective and Strategy
The Company utilizes derivative financial instruments, including three-way collars and swap contracts to (i) reduce the effect of price volatility on the Company’s oil and natural gas revenues and (ii) support the Company’s annual capital budgeting and expenditure plans.
The Company uses collars and swaps to manage commodity price risk for its oil production. A three-way collar is a combination of options: a sold call, a purchased put and a sold put. The purchased put establishes a minimum price (floor), unless the market price falls below the sold put (sub-floor), at which point the minimum price would be the NYMEX index price plus the difference between the purchased put and the sold put strike price. The sold call establishes a maximum price (ceiling) the Company will receive for the volumes under contract.
Additionally, the Company uses swap contracts to mitigate basis risk caused by the volatility of the Company’s basis differentials. The oil swap contracts establish the differential between NYMEX WTI prices and the relevant price index at which oil production is sold. Natural gas swaps establish the differential Henry Hub prices and the relevant price index at which oil production is sold.
Oil Production Derivative Activities
The Company’s material physical sales contracts governing its oil production are typically correlated with NYMEX WTI, including Cushing, Midland, Magellan East Houston (“MEH”) and Brent oil prices. The Company uses put spread options, swaps and three-way collars to manage oil price volatility. The Company uses basis swap contracts to reduce basis risk between NYMEX WTI prices and the actual index prices at which the oil is sold.
As of December 31, 2019, the Company had the following outstanding oil derivative contracts. When aggregating multiple contracts, the weighted average contract price is disclosed.
Three-way collars
 
Year Ending December 31, 2020
 
 
WTI Midland
 
WTI MEH
 
WTI Brent
Volume (MBbls)
 
7,800

 
15,900

 
3,450

Short call price (per Bbl)
 
$
66.92

 
$
73.24

 
$
73.48

Long put price (per Bbl)
 
$
56.00

 
$
58.55

 
$
62.26

Short put price (per Bbl)
 
$
46.00

 
$
48.55

 
$
52.26

 
 
 
 
 
 
 
Oil swaps
 
 
 
Year Ending December 31, 2020
 
 
 
 
Volume (MBbls)
 
Fixed Price Swap (per Bbl)
Oil swap - Midland
 
 
 
600

 
$
55.20

Oil swap - Houston
 
 
 
780

 
$
56.30

 
 
 
 
 
 
 
Basis swaps
 
 
 
Year Ending December 31, 2020
 
 
 
 
Volume (MBbls)
 
Fixed Price Swap (per Bbl)
Basis swap - Midland-Cushing index(1)
 


 
900

 
$
0.25

 
 
 
(1)
Represents swaps that fix the basis differentials between the index prices at which the Company sells its oil and the Cushing WTI price.

The table above excludes 1,800 notional MBbls with a fair value of $9.0 million related to amounts recognized under master netting agreements with derivative counterparties associated with put spreads.
Natural Gas Production Derivative Activities
All material physical sales contracts governing the Company’s natural gas production are tied directly or indirectly to NYMEX Henry Hub natural gas prices or regional index prices where the natural gas is sold. The Company uses swap contracts to manage natural gas price volatility.
The following table sets forth the volumes associated with the Company’s outstanding natural gas derivative contracts expiring during the periods indicated and the weighted average natural gas prices for those contracts:
 
 
Year Ending December 31, 2020
 
 
Volume (MMbtu)
 
Fixed Price Swap (per MMbtu)
Basis swap - Waha(1)
 
17,640,000

 
$
0.88


 
 
 
(1)
Represents swaps that fix the basis differentials between the index prices at which the Company sells its natural gas produced in the Permian Basin and NYMEX Henry Hub price.

Effect of Derivative Instruments on the Consolidated Financial Statements
All of the Company’s derivatives are accounted for as non-hedge derivatives and therefore all changes in the fair values of its derivative contracts are recognized as gains or losses in the earnings of the periods in which they occur. The table below summarizes the Company’s gains (losses) on derivative instruments for the years ended December 31, 2019, 2018 and 2017 (in thousands):
 
Year Ending December 31,
 
2019
 
2018
 
2017
Changes in fair value of derivative instruments
$
(75,728
)
 
$
113,824

 
(44,702
)
Net derivative settlements
(12,206
)
 
8,084

 
15,670

Net premiums on options that settled during the period(1)
(43,278
)
 
(71,566
)
 
(37,103
)
(Loss) gain on derivatives
$
(131,212
)
 
$
50,342

 
$
(66,135
)
 
 
 
(1)
The net premiums on options that settled during the period represents the cumulative cost of premiums paid and received on positions purchased and sold, which expired during the current period. These amounts are included in (Loss) gain on derivatives on the Company’s consolidated statements of operations.

The Company classifies the fair value amounts of derivative assets and liabilities as gross current or noncurrent derivative assets or gross current or noncurrent derivative liabilities, whichever the case may be, excluding those amounts netted under master netting agreements. The fair value of the derivative instruments is discussed in Note 16—Disclosures About Fair Value of Financial Instruments. The Company has agreements in place with all of its counterparties that allow for the financial right of offset for derivative assets and liabilities at settlement or in the event of default under the agreements. Additionally, the Company maintains accounts with its brokers to facilitate financial derivative transactions in support of its risk management activities. Based on the value of the Company’s positions in these accounts and the associated margin requirements, the Company may be required to deposit cash into these broker accounts. During the years ended December 31, 2019, 2018 and 2017, the Company did not receive or post any material margins in connection with collateralizing its derivative positions.
The following table presents the Company’s net exposure from its offsetting derivative asset and liability positions, as well as option premiums payable and receivable as of the reporting dates indicated (in thousands):
 
 
Gross Amount
 
Netting
Adjustments
 
Net
Exposure
December 31, 2019
 
 
 
 
 
 
Derivative assets with right of offset or
   master netting agreements
 
$
136,627

 
$
(8,995
)
 
$
127,632

Derivative liabilities with right of offset or
   master netting agreements
 
(167,517
)
 
8,995

 
(158,522
)
 
 
 
 
 
 
 
December 31, 2018
 
 
 
 
 
 
Derivative assets with right of offset or
   master netting agreements
 
$
236,431

 
$
(25,010
)
 
$
211,421

Derivative liabilities with right of offset or
   master netting agreements
 
(193,973
)
 
25,010

 
(168,963
)

Concentration of Credit Risk
The Company believes that it has limited credit risk with respect to its exchange-traded contracts, as such contracts are subject to financial safeguards and transaction guarantees through NYMEX. Over-the-counter traded options expose the Company to counterparty credit risk. These over-the-counter options are entered into with large multinational financial institutions with investment grade credit ratings or through brokers that require all the transaction parties to collateralize their open option positions. The gross and net credit exposure from the Company’s commodity derivative contracts as of December 31, 2019 and 2018 is summarized in the preceding table.
The Company monitors the creditworthiness of its counterparties, establishes credit limits according to the Company’s credit policies and guidelines and assesses the impact on fair values of its counterparties’ creditworthiness. The Company enters into International Swap Dealers Association Master Agreements (“ISDA Agreements”) with its derivative counterparties. The terms of the ISDA Agreements provide the Company and its counterparties and brokers with rights of net settlement of gross commodity derivative assets against gross commodity derivative liabilities. The Company routinely exercises its contractual right to offset realized gains against realized losses when settling with derivative counterparties. If the Company believes a counterparty’s creditworthiness has declined or is suspect, it may seek to novate the applicable ISDA Agreement to another financial institution that has an ISDA Agreement in place with the Company. The Company did not incur any losses due to counterparty nonperformance during any of the years ended December 31, 2019, 2018 or 2017.
Credit Risk Related Contingent Features in Derivatives
Certain commodity derivative instruments contain provisions that require the Company to either post additional collateral or collateral support (including letters of credit, security interests in an asset, or a performance bond or guarantee), or immediately settle any outstanding liability balances, upon the occurrence of a specified credit risk related event. These events, which are set forth in the Company’s existing commodity derivative contracts, include, among others, downgrades in the credit ratings of the Company and its affiliates, events of default under the Company’s Revolving Credit Agreement (as defined in Note 8—Debt), and the release of collateral (other than as provided under the terms of the Revolving Credit Agreement). Although the Company could be required to post additional collateral or collateral support, or immediately settle any outstanding liability balances, under such conditions, the Company seeks to reduce its potential risk by entering into commodity derivative contracts with several different counterparties.