Derivative Instruments

9 Months Ended

Sep. 30, 2011

Derivative Instruments [Abstract]

Derivative Instruments

3. Derivative Instruments

Commodity Contracts

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 or trading 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, and 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 is not limited to, a letter of credit, security interest or a performance bond. As of September 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 as cash flow hedges and qualify for hedge accounting 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 September 30, 2011, the Company expected approximately $2,535 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 September 30, 2011:

	Contract Settlement Date
	2011		2012		2013
Natural Gas forward purchase contracts:
Volume (MMcf)		1,041		5,490		4,380

Interest Rate Swap

In July 2011, the Company entered into a $30 million fixed rate swap contract with a third party to manage the risk associated with the floating interest rate on its credit facility. The contract is effective through December 31, 2012. In accordance with its credit facility, the Company pays interest amounts based upon the Eurodollar LIBOR rate, plus 1%, and plus a spread ranging from 1.25% to 2.0% depending on its outstanding borrowings. Under the interest rate swap terms, the Company swapped its floating LIBOR interest rate for a fixed LIBOR rate of 0.578%. This contract was not designated as a fair value hedge and is recorded at fair value on the consolidated balance sheets and changes in fair value, both realized and unrealized, are recognized in interest expense, net on the consolidated statements of operations. On the statements of cash flows, the cash flows from the interest rate swap are classified as operating activities.

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

Derivatives designated as hedging
instruments under ASC 815	Balance Sheet Location	Fair Value
Assets
Commodity contracts	Assets from price risk management - current	$	2,535
Total		$	2,535

Derivatives not designated as
hedging instruments under ASC 815	Balance Sheet Location	Fair Value
Assets
Commodity contracts	Assets from price risk management - current	$	3,946
	Assets from price risk management - long term	$	2,142
Interest rate swap	Other current liabilities	$	67
Total		$	6,155

The before-tax effect of derivative instruments in cash flow hedging relationships on the consolidated statements of operations for the three months and nine months ended September 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 Recognized in OCI 1 on Derivatives for the
	Three months ended September 30,				Nine months ended September 30,
	2011		2010		2011		2010
Commodity contracts	$	614	$	2,599	$	855	$	5,413

Location of Gain Reclassified	Amount of Gain Reclassified from AOCI into Income
from AOCI into Income	Three months ended September 30,				Nine months ended September 30,
(effective portion)	2011		2010		2011		2010
Oil and gas sales	$	2,322	$	—	$	6,915	$	—

	Three and nine months
	ended September 30,
	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 nine months ended September 30, 2011 and 2010 was as follows:

	Amount of Gain (Loss) Recognized in Income on Derivatives for the
	Three Months Ended September					Nine Months Ended September
	2011			2010		2011			2010
Unrealized gain on commodity contracts 2	$	4,642		$	1,548	$	5,060		$	8,030
Realized gain on commondity contracts 2		161			1,715		672			3,158
Unrealized loss on interest rate swap 3		(67	)		—		(67	)		—
Realized loss on interest rate swap 3		(27	)		—		(27	)		—
Total activity for derivatives not designated as hedging instruments	$	4,709		$	3,263	$	5,638		$	11,188

2	Included in price risk management activities, net on the consolidated statements of operations. Price risk management activities totaled $4,803 and $3,263 for the three months ended September 30, 2011 and 2010, respectively, and $5,732 and $11,188 for the nine months ended September 30, 2011 and 2010, respectively.
3	Included in interest expense, net on the statements of operations.

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