Derivative Instruments

6 Months Ended

Jun. 30, 2011

Derivative Instruments

The Company’s primary market exposure is to adverse fluctuations in the prices of natural gas. The Company uses derivative instruments, primarily forward contracts, costless collars and swaps, to manage the price risk associated with its gas production, and the resulting impact on cash flow, net income, and earnings per share. The Company does not use derivative instruments for speculative purposes.

The extent of the Company’s risk management activities is controlled through policies and procedures that involve senior management and were approved by the Company’s Board of Directors. Senior management is responsible for proposing hedge recommendations, execution of the approved hedging plan, oversight of the risk management process including methodologies used for valuation and risk measurement and presenting policy changes to the Board. The Company’s Board of Directors is responsible for approving risk management policies and for establishing the Company’s overall risk tolerance levels. The duration of the various derivative instruments depends on senior management’s view of market conditions, available contract prices and the Company’s operating strategy. Under the Company’s credit agreement, the Company can hedge up to 90% of the projected proved developed producing reserves for the next 12 month period, and up to 80% of the projected proved developed producing reserves for the ensuing 24 month period.

The Company recognizes its derivative instruments as either assets or liabilities at fair value on its consolidated balance sheets, and accounts for the derivative instruments as either cash flow hedges or mark to market derivative instruments. On the statements of cash flows, the cash flows from these instruments are classified as operating activities.

Derivative instruments expose the Company to counterparty credit risk. The Company enters into these contracts with third parties and financial institutions that it considers to be creditworthy. In addition, the Company’s master netting agreements reduce credit risk by permitting the Company to net settle for transactions with the same counterparty.

As with most derivative instruments, the Company’s derivative contracts contain provisions that may allow for another party to require security from the counterparty to ensure performance under the contract. The security may be in the form of, but not limited to, a letter of credit, security interest or a performance bond. As of June 30, 2011, no party to any of the Company’s derivative contracts has required any form of security guarantee.

Cash flow hedges

Derivative instruments that are designated and qualify as cash flow hedges are recorded at fair value on the consolidated balance sheets, and the effective portion of the change in fair value is reported as a component of accumulated other comprehensive income (“AOCI”) and is subsequently reclassified into oil and gas sales on the consolidated statements of operations as the contracts settle. As of June 30, 2011, the Company expected approximately $4,243 of unrealized gains before taxes included in AOCI to be reclassified into oil and gas sales in one year or less as the contracts settle.

Mark to market hedging instruments

Unrealized gains and losses resulting from derivatives not designated as cash flow hedges are recorded at fair value on the consolidated balance sheets and changes in fair value are recognized in price risk management activities, net on the consolidated statements of operations. Realized gains and losses resulting from the contract settlement of derivatives not designated as cash flow hedges also are recorded within price risk management activities, net on the consolidated statement of operations.

The Company had the following commodity volumes under derivative contracts as of June 30, 2011:


	Contract Settlement Date
	2011		2012		2013

Natural Gas forward purchase contracts:
Volume (MMcf)		2,392		5,490		4,380

The table below contains a summary of all the Company’s derivative positions reported on the consolidated balance sheet as of June 30, 2011, presented gross of any master netting arrangements:


Derivatives designated as hedging
instruments under ASC 815	Balance Sheet Location	Fair Value
Assets
Commodity derivatives	Assets from price risk management - current	$	4,243

Total		$	4,243


Derivatives not designated as hedging
instruments under ASC 815	Balance Sheet Location	Fair Value
Assets
Commodity derivatives	Assets from price risk management - current	$	1,048
	Assets from price risk management - long term	$	397

Total		$	1,445

The before-tax effect of derivative instruments in cash flow hedging relationships on the consolidated statements of operations for the three months and six months ended June 30, 2011 and 2010, related to the Company’s commodity derivatives was as follows:

Derivatives Designated as Cash Flow Hedging Instruments under ASC 815


	Amount of Gain (Loss) Recognized in OCI ¹on Derivatives for the
	Three months ended June 30,				Six months ended June 30,
	2011		2010		2011		2010

Commodity contracts	$	128	$	791	$	242	$	2,814


Location of Gain Reclassified	Amount of Gain Reclassified from AOCI into Income
from AOCI into Income	Three months ended June 30,				Six months ended June 30,
(effective portion)	2011		2010		2011		2010

Oil and gas sales	$	2,252	$	—	$	4,594	$	—


	Three and six months ended
	2011		2010
Location of Gain Recognized in Income (Ineffective) Portion and Amount Excluded from Effectiveness Testing		N/A		N/A


¹		Other comprehensive income (“OCI”).

The before-tax effect of derivative instruments not designated as hedging instruments on the consolidated statements of operations for the three and six months ended June 30, 2011 and 2010 was as follows:


	Amount of Gain Recognized in Income on Derivatives for the
	Three Months Ended June 30,					Six Months Ended June 30,
	2011		2010			2011		2010

Unrealized gain (loss) on price risk management activities²	$	1,900	$	(1,563	)	$	418	$	6,482
Realized gain (loss) on price risk management activities ²		168		1,666			511		1,443

Total price risk management activites	$	2,068	$	103		$	929	$	7,925


²		Included in price risk management activities, net on the consolidated statements of operations.

Refer to Note 4 for additional information regarding the valuation of the Company’s derivative instruments.