Derivative Activities

6 Months Ended

Jun. 30, 2011

Derivative Activities [Abstract]

DERIVATIVE ACTIVITIES

(12) DERIVATIVE ACTIVITIES

     We use commodity—based derivative contracts to manage exposure to commodity price fluctuations. We do not enter into these arrangements for speculative or trading purposes. We do not utilize complex derivatives such as swaptions, knockouts or extendable swaps. We typically utilize commodity swap, collar or call option contracts to (1) reduce the effect of price volatility of the commodities we produce and sell and (2) support our annual capital budget and expenditure plans. Historically, our derivative activities have consisted of collars and fixed price swaps. At June 30, 2011, we had open swap contracts covering 25.6 Bcf of natural gas at prices averaging $5.00 per mcf and 3.1 million barrels of NGLs (the C5 component of NGLs) at prices averaging $103.24 per barrel. At June 30, 2011, we had collars covering 189.1 Bcf of natural gas at weighted average floor and cap prices of $5.27 to $5.93 per mcf and 0.7 million barrels of oil at weighted average floor and cap prices of $70.00 to $80.00 per barrel. At June 30, 2011, we also had sold call options for 2.7 million barrels of oil at a weighted average price of $83.15. In first quarter 2011, we entered into NGL derivative swap contracts for the natural gasoline (or C5) component of natural gas liquids. The fair value of our commodity derivatives, represented by the estimated amount that would be realized upon termination, based on a comparison of the contract prices and a reference price, generally New York Mercantile Exchange (“NYMEX”), on June 30, 2011, was a net unrealized pre-tax gain of $61.1 million. These contracts expire monthly through December 2013.

     The following table sets forth our derivative volumes and average hedge prices as of June 30, 2011:

			Average
Period	Contract Type	Volume Hedged	Hedge Price
Natural Gas
2012	Swaps	70,192 Mmbtu/day	$	5.00
2011	Collars	333,200 Mmbtu/day	$	5.38-$6.23
2012	Collars	189,641 Mmbtu/day	$	5.32-$5.91
2013	Collars	160,000 Mmbtu/day	$	5.09-$5.65
Crude Oil
2012	Collars	2,000 bbls/day	$	70.00-$80.00
2011	Call options	5,500 bbls/day	$	80.00
2012	Call options	4,700 bbls/day	$	85.00
NGLs (Natural gasoline)
2011	Swaps	7,000 bbls/day	$	104.17
2012	Swaps	5,000 bbls/day	$	102.59

     Every derivative instrument is recorded on the accompanying balance sheets as either an asset or a liability measured at its fair value. Fair value is generally determined based on the difference between the fixed contract price and the underlying market price at the determination date. Changes in the fair value of derivatives that qualify for hedge accounting are recorded as a component of accumulated other comprehensive income (“AOCI”) in the stockholders’ equity section of the accompanying consolidated balance sheets, which is later transferred to natural gas, NGL and oil sales when the underlying physical transaction occurs and the hedging contract is settled. Amounts included in AOCI at June 30, 2011 and December 31, 2010 relate solely to our commodity derivative activities. As of June 30, 2011, an unrealized pre-tax derivative gain of $73.5 million was recorded in AOCI. This gain is expected to be reclassified into earnings as a $44.1 million gain in 2011, a $21.9 million gain in 2012 and a $7.5 million gain in 2013. The actual reclassification to earnings will be based on market prices at the contract settlement date.

     For those derivative instruments that qualify for hedge accounting, settled transaction gains and losses are determined monthly, and are included as increases or decreases to natural gas, NGL and oil sales in the period the hedged production is sold. Natural gas, NGL and oil sales include $24.3 million of gains in the three months ended June 30, 2011 compared to gains of $18.3 million in the same period of 2010 related to settled hedging transactions. Natural gas, NGL and oil sales include $53.9 million of gains in the six months ended June 30, 2011 compared to gains of $19.6 million in the same period of 2010 related to settled hedges. Any ineffectiveness associated with these hedge derivatives is included in derivative fair value income in the accompanying consolidated statements of operations. The ineffective portion is calculated as the difference between the change in fair value of the derivative and the estimated change in future cash flows from the item hedged. The three months ended June 30, 2011 includes ineffective gains (unrealized and realized) of $7.5 million compared to gains of $265,000 in the same period of 2010. The six months ended June 30, 2011 includes ineffective gains (unrealized and realized) of $9.0 million compared to losses of $341,000 in the same period of 2010.

     Through June 30, 2011, we have elected to designate our commodity derivative instruments that qualify for hedge accounting as cash flow hedges. To designate a derivative as a cash flow hedge, we document at the hedge’s inception our assessment that the derivative will be highly effective in offsetting expected changes in cash flows from the item hedged. This assessment, which is updated at least quarterly, is generally based on the most recent relevant historical correlation between the derivative and the item hedged. The ineffective portion of the hedge is calculated as the difference between the change in fair value of the derivative and the estimated change in cash flows from the item hedged. If, during the derivative’s term, we determine the hedge is no longer highly effective, hedge accounting is prospectively discontinued and any remaining unrealized gains or losses, based on the effective portion of the derivative at that date, are reclassified to earnings as natural gas, NGL and oil sales when the underlying transaction occurs. If it is determined that the designated hedge transaction is not probable to occur, any unrealized gains or losses are recognized immediately in derivative fair value income (loss) in the accompanying consolidated statements of operations. During the first three and six months of 2011 or 2010, there were no gains or losses recorded due to the discontinuance of hedge accounting treatment for these derivatives.

     Some of our derivatives do not qualify for hedge accounting or are not designated as a hedge but provide an economic hedge of our exposure to commodity price risk associated with anticipated future natural gas and oil production. These contracts are accounted for using the mark-to-market accounting method. We recognize all unrealized and realized gains and losses related to these contracts in derivative fair value income in the accompanying consolidated statements of operations (for additional information see table below).

Derivative Fair Value Income

     The following table presents information about the components of derivative fair value income in the three and six months ended June 30, 2011 and 2010 (in thousands):

	Three Months Ended						Six Months Ended
	June 30,						June 30,
	2011			2010			2011			2010
Hedge ineffectiveness — realized	$	1,576		$	5		$	2,522		$	(352	)
— unrealized		5,934			260			6,502			11
Change in fair value of derivatives that do not qualify for hedge accounting(a)		48,139			(4,409	)		8,103			42,169
Realized gain on settlements — gas(a) (b)		3,484			10,690			3,090			7,051
Realized loss on settlements — oil (a) (b)		(6,094	)		—			(8,012	)		—
Derivative fair value income	$	53,039		$	6,546		$	12,205		$	48,879

(a)	Derivatives that do not qualify for hedge accounting.
(b)	These amounts represent the realized gains or losses on settled derivatives that do not qualify for hedge accounting, which before settlement are included in the category described above called change in fair value of derivatives that do not qualify for hedge accounting.

     The combined fair value of derivatives included in the accompanying consolidated balance sheets as of June 30, 2011 and December 31, 2010 is summarized below (in thousands). As of June 30, 2011 we have conducted commodity derivative activities with ten financial institutions, of which all but one are secured lenders in our bank credit facility. We believe all of these institutions are acceptable credit risks. At times, such risks may be concentrated with certain counterparties. The credit worthiness of our counterparties is subject to periodic review. In our accompanying consolidated balance sheets, derivative assets and liabilities are netted where derivatives with both gain and loss positions are held by a single counterparty.

	June 30,			December 31,
	2011			2010
Derivative assets:
Natural gas — collars	$	107,258		$	155,159
— collars — discontinued operations		—			8,195
— swaps		4,014			—
Crude oil — collars		(15,830	)		—
— call options		(43,675	)		(31,904	)
NGL — swaps		13,750			—
	$	65,517		$	131,450
Derivative liabilities:
Natural gas — collars	$	3,079		$	27,032
— basis swaps		—			(352	)
— swaps		169			—
Crude oil — collars		—			(12,051	)
— call options		(7,675	)		(28,393	)
NGL — swaps		—			—
	$	(4,427	)	$	(13,764	)

     The table below provides data about the fair value of our derivative contracts. Derivative assets and liabilities shown below are presented as gross assets and liabilities, without regard to master netting arrangements, which are considered in the presentation of derivative assets and liabilities in our accompanying consolidated balance sheets (in thousands):

	June 30, 2011								December 31, 2010
	Assets		(Liabilities)						Assets		(Liabilities)
						Net								Net
	Carrying		Carrying			Carrying			Carrying		Carrying			Carrying
	Value		Value			Value			Value		Value			Value
Derivatives that qualify for cash flow hedge accounting:
Swaps (1)	$	4,184	$	—		$	4,184		$	—	$	—		$	—
Collars(1)		103,907		—			103,907			164,933		—			164,933
Collars (1) — discontinued operations		—		—			—			8,195		—			8,195
	$	108,091	$	—		$	108,091		$	173,128	$	—		$	173,128
Derivatives that do not qualify for hedge accounting:
Swaps (1)	$	13,750	$	—		$	13,750		$	—	$	—		$	—
Collars(1)		6,430		(15,830	)		(9,400	)		17,259		(12,052	)		5,207
Call options(1)		—		(51,351	)		(51,351	)		—		(60,297	)		(60,297	)
Basis swaps(1)		—		—			—			—		(352	)		(352	)
	$	20,180	$	(67,181	)	$	(47,001	)	$	17,259	$	(72,701	)	$	(55,442	)

⁽¹⁾ Included in unrealized derivative gain or loss in the accompanying consolidated balance sheets.

     The effects of our cash flow hedges (or those derivatives that qualify for hedge accounting) on accumulated other comprehensive income (loss) included in the accompanying consolidated balance sheets are summarized below (in thousands):

	Three Months Ended June 30,												Six Months Ended June 30,
							Realized Gain (Loss)												Realized Gain (Loss)
	Change in Hedge						Reclassified from OCI						Change in Hedge						Reclassified from OCI
	Derivative Fair Value						into Revenue (a)						Derivative Fair Value						into Revenue (a)
	2011			2010			2011			2010			2011			2010			2011			2010
Swaps	$	4,655		$	—		$	—		$	—		$	2,115		$	—		$	—		$	—
Collars		23,223			(6,887	)		24,285			18,340			22,424			77,930			53,902			19,555
Collars — discontinued operations		—			19			—			—			412			13			8,607			—
Income taxes		(10,454	)		2,611			(9,107	)		(6,969	)		(7,414	)		(29,618	)		(23,441	)		(7,431	)
	$	17,424		$	(4,257	)	$	15,178		$	11,371		$	17,537		$	48,325		$	39,068		$	12,124

^(a) For realized gains upon contract settlement, the reduction in AOCI is offset by an increase in natural gas, NGL and oil sales. For realized losses upon contract settlement, the increase in AOCI is offset by a decrease in natural gas, NGL and oil sales.

     The effects of our non-hedge derivatives (or those derivatives that do not qualify for hedge accounting) and the ineffective portion of our hedge derivatives included in the accompanying consolidated statements of operations are summarized below (in thousands):

	Three Months Ended June 30,
	Gain (Loss) Recognized in				Gain Recognized in Income				Derivative Fair Value
	Income (Non-hedge Derivatives)				(Ineffective Portion)				(Loss) Income
	2011		2010		2011		2010		2011		2010
Swaps	$	15,613	$	—	$	—	$	—	$	15,613	$	—
Collars		6,452		1,483		7,510		265		13,962		1,748
Call options		23,464		—		—		—		23,464		—
Basis swaps		—		4,798		—		—		—		4,798
Total	$	45,529	$	6,281	$	7,510	$	265	$	53,039	$	6,546

	Six Months Ended June 30,
	Gain (Loss) Recognized in					Gain Recognized in Income					Derivative Fair Value
	Income (Non-hedge Derivatives)					(Ineffective Portion)					(Loss) Income
	2011			2010		2011		2010			2011			2010
Swaps	$	13,750		$	—	$	—	$	—		$	13,750		$	—
Collars		(1,135	)		48,438		9,024		(341	)		7,889			48,097
Call options		(9,391	)		—		—		—			(9,391	)		—
Basis swaps		(43	)		782		—		—			(43	)		782
Total	$	3,181		$	49,220	$	9,024	$	(341	)	$	12,205		$	48,879