Derivative Instruments

3 Months Ended

Mar. 31, 2014

Derivative Instruments

4. Derivative Instruments

Commodity Contracts

The Company’s primary market exposure is to adverse fluctuations in the price 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 hedging recommendations, executing the approved hedging plan, overseeing the risk management process including methodologies used for valuation and risk measurement and presenting policy changes to the Company’s board of directors. 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 24-month period thereafter.

The Company accounts for its derivative instruments as mark-to-market derivative instruments. Under mark-to-market accounting, derivative instruments are recognized as either assets or liabilities at fair value on the Company’s consolidated balance sheets, and changes in fair value are recognized in the price risk management activities line on the consolidated statements of operations. Realized gains and losses resulting from the contract settlement of derivatives are also recorded in the price risk management activities line on the consolidated statements of operations.

On the consolidated 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 which 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 March 31, 2014, no party to any of the Company’s derivative contracts has required any form of security guarantee.

The Company had the following commodity volumes under derivative contracts as of March 31, 2014:

Type of Contract	Remaining Contractual Volume (Mcf)		Term	Price			Price Index (1)
Fixed Price Swap		1,375,000	01/14-12/14	$	4.27		NYMEX
Costless Collar		1,350,000	01/14-12/14	$	4.00	floor	NYMEX
				$	4.50	ceiling
Fixed Price Swap		1,350,000	01/14-12/14	$	4.20		NYMEX
Fixed Price Swap		405,000	01/14-12/14	$	4.17		NYMEX
Fixed Price Swap		3,000,000	01/15-12/15	$	4.28		NYMEX
Fixed Price Swap		3,600,000	01/15-12/15	$	4.15		NYMEX
Fixed Price Swap		1,830,000	01/16-12/16	$	4.07		NYMEX
Total		12,910,000

(1) New York Mercantile Exchange (“NYMEX”).

In April 2014, the Company entered into an additional swap contract with a third party for 3,660,000 Mcf at $4.15 per Mcf for the period January 1, 2016 through December 31, 2016.  

Interest Rate Swap

As of March 31, 2014, the Company had the following interest rate swap in place with a third party to manage the risk associated with the floating interest rate on its credit facility:

Type of Contract	Contractual Amount		Term	Rate (LIBOR)			Effective InterestRate(1)
Interest Rate Swap	$	30,000	12/31/12-9/30/16		1.050	%		3.55	%

(1) In accordance with its credit facility, the Company pays interest at a daily rate equal to (a) the higher of the Federal Funds rate for such day, plus 0.5%, the Prime Rate for such day or the One-Month Eurodollar LIBOR rate for such day, plus (b) a spread ranging from 0.75% to 2.75% depending on its outstanding borrowings. The effective interest rate shown reflects the interest rate based on the outstanding borrowings at March 31, 2014.

The table below contains a summary of all of the Company’s derivative positions reported on the consolidated balance sheet as of March 31, 2014 presented gross of any master netting arrangements:

	Balance Sheet Location	As of March 31, 2014			As of December 31, 2013
Assets
Commodity derivatives	Assets from price risk management - current	$	—		$	218
	Assets from price risk management - long term		694			402
Total derivative assets		$	694		$	620
Liabilities
Commodity derivatives	Liabilities from price risk management - current	$	(1,626	)	$	(13	)
	Liabilities from price risk management -long term		(134	)		(97	)
Interest rate swap	Other current liabilities		(231	)		(222	)
	Other long term liabilities		(44	)		(90	)
Total derivative liabilities		$	(2,035	)	$	(422	)

The before-tax effect of derivative instruments not designated as hedging instruments on the consolidated statements of operations for the three months ended March 31, 2014 and 2013 was as follows:

	Three Months Ended March 31,
	2014			2013
Unrealized loss on commodity contracts (1)	$	(1,575	)	$	(4,673	)
Realized gain (loss) on commodity contracts (1)		(941	)		1,869
Unrealized gain on interest rate swap (2)		37			37
Realized loss on interest rate swap (2)		(67	)		(63	)
Total activity for derivatives not designated as hedging instruments	$	(2,546	)	$	(2,830	)

(1) Included in price risk management activities on the consolidated statements of operations. Price risk management activities totaled $(2,516) and $(2,804) for the three months ended March 31, 2014 and 2013, respectively.

(2) Included in interest expense, net on the consolidated statements of operations.

Refer to Note 5 for additional information regarding the valuation of the Company’s derivative instruments.