(11) 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 as we typically utilize commodity swaps or collars 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. In 2011, we sold NGLs derivative swap contracts (“sold swaps”) for the natural gasoline (or C5) component of natural gas liquids and in 2012, we entered into purchased derivative swaps (“re-purchased swaps”) for C5 volumes. These re-purchased swaps were, in some cases, with the same counterparties as our sold swaps. We entered into these re-purchased swaps to lock in certain natural gasoline derivative gains. In second quarter 2012, we also entered into NGL derivative swap contracts for the propane (or C3) component of NGLs. The fair value of these contracts, represented by the estimated amount that would be realized upon termination, based on a comparison of the contract price and a reference price, generally the New York Mercantile Exchange (“NYMEX”), approximated a net unrealized pre-tax gain of $127.5 million at June 30, 2013. These contracts expire monthly through December 2015. The following table sets forth our derivative volumes by year as of June 30, 2013:

Period	Contract Type	Volume Hedged	Weighted Average Hedge Price
Natural Gas
2013	Collars	280,000 Mmbtu/day	$ 4.59–$ 5.05
2014	Collars	447,500 Mmbtu/day	$ 3.84–$ 4.48
2015	Collars	145,000 Mmbtu/day	$ 4.07–$ 4.56
2013	Swaps	296,685 Mmbtu/day	$	3.79
2014	Swaps	30,000 Mmbtu/day	$	4.17

Crude Oil
2013	Collars	3,000 bbls/day	$ 90.60–$ 100.00
2014	Collars	2,000 bbls/day	$ 85.55–$ 100.00
2013	Swaps	6,325 bbls/day	$	96.77
2014	Swaps	7,000 bbls/day	$	94.14
2015	Swaps	2,000 bbls day	$	90.20

NGLs (Natural Gasoline)
2013	Sold Swaps	8,000 bbls/day	$	89.64
2013	Re-purchased Swaps	1,500 bbls/day	$	76.30

NGLs (Propane)
2013	Swaps	8,000 bbls/day	$	36.79
2014	Swaps	1,000 bbls/day	$	40.32

Every derivative instrument is required to be recorded on the balance sheet as either an asset or a liability measured at its fair value. Fair value is 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 our derivatives that qualified for hedge accounting are recorded as a component of AOCI in the stockholders’ equity section of the accompanying consolidated balance sheets, which is later transferred to natural gas, NGLs and oil sales when the underlying physical transaction occurs and the hedging contract is settled. As of June 30, 2013, an unrealized pre-tax derivative gain of $60.5 million was recorded in AOCI. See additional discussion below regarding the discontinuance of hedge accounting. If the derivative does not qualify as a hedge or is not designated as a hedge, changes in fair value of these non-hedge derivatives are recognized in earnings in derivative fair value income or loss.

For those derivative instruments that qualified or were designated for hedge accounting, settled transaction gains and losses are determined monthly, and are included as increases or decreases to natural gas, NGLs and oil sales in the period the hedged production is sold. Through February 28, 2013, we had elected to designate our commodity derivative instruments that qualified for hedge accounting as cash flow hedges. Natural gas, NGLs and oil sales include $30.5 million of gains in second quarter 2013 compared to gains of $78.6 million in the same period of 2012 related to settled hedging transactions. Natural gas, NGLs and oil sales include $67.0 million of gains in the first six months 2013 compared to gains of $136.2 million in the same period of 2012. Any ineffectiveness associated with these hedge derivatives is reflected in derivative fair value income in the accompanying statements of operations. The ineffective portion is generally calculated as the difference between the changes in fair value of the derivative and the estimated change in future cash flows from the item hedged. Derivative fair value income for the three months ended June 30, 2013 includes no ineffective gains or losses (unrealized and realized) compared to a gain of $1.9 million in the three months ended June 30, 2012. Derivative fair value income for the six months ended June 30, 2013 includes ineffective losses (unrealized and realized) of $2.9 million compared to a gain of $2.1 million in the same period of 2012. During the six months ended June 30, 2013, we recognized a pre-tax gain of $3.2 million in derivative fair value income as a result of the discontinuance of hedge accounting where we determined the transaction was probable not to occur primarily due to the sale of our Delaware and Permian Basin properties in New Mexico and West Texas.

Discontinuance of Hedge Accounting

Effective March 1, 2013, we elected to de-designate all commodity contracts that were previously designated as cash flow hedges and elected to discontinue hedge accounting prospectively. AOCI included $103.6 million ($63.2 million after tax) of unrealized net gains, representing the marked-to-market value of the effective portion of our cash flow hedges as of February 28, 2013. As a result of discontinuing hedge accounting, the marked-to-market values included in AOCI as of the de-designation date were frozen and will be reclassified into earnings in future periods as the underlying hedged transactions occur. As of June 30, 2013, we expect to reclassify into earnings $49.5 million of unrealized net gains in the remaining months of 2013 and $10.9 million of unrealized net gains in 2014 from AOCI.

With the election to de-designate hedging instruments, all of our derivative instruments continue to be recorded at fair value with unrealized gains and losses recognized immediately in earnings rather than in AOCI. These marked-to-market adjustments will produce a degree of earnings volatility that can be significant from period to period, but such adjustments will have no cash flow impact relative to changes in market prices. The impact to cash flow occurs upon settlement of the underlying contract.

Derivative Fair Value Income

The following table presents information about the components of derivative fair value income for the three months and the six months ended June 30, 2013 and 2012 (in thousands):

		Three Months Ended June 30,											Six Months Ended June 30,
		2013							2012				2013							2012
Change in fair value of derivatives that did not qualify or were not designated for hedge accounting (a)		$			159,371			$			135,777	$				62,569			$				83,721
Realized loss on settlement–natural gas (a) (b)					(24,543		)				—					(23,728		)					—
Realized gain (loss) on settlement–oil (a) (b)					(111		)				768					(213		)					(3,854		)
Realized gain on settlement–NGLs (a) (b)					3,043						10,152					2,148							5,760
Hedge ineffectiveness	–realized		(155			)				1,278					409							2,463
	–unrealized			155						594				(3,300			)				(354			)
Derivative fair value income		$			137,760			$			148,569	$				37,885			$				87,736

(a) Derivatives that did not qualify or were not designated for hedge accounting. Change in fair value of derivatives line also includes gains of $103.8 million in second quarter 2013 and gains of $22.4 million in the first six months 2013 related to discontinuance of hedge accounting.

(b) These amounts represent the realized gains and losses on settled derivatives that did not qualify or were not designated for hedge accounting, which before settlement are included in the category in this same table referred to as change in fair value of derivatives that did not qualify or were not designated for hedge accounting.

Derivative Assets and Liabilities

The combined fair value of derivatives included in the accompanying consolidated balance sheets as of June 30, 2013 and December 31, 2012 is summarized below. The assets and liabilities are netted where derivatives with both gain and loss positions are held by a single counterparty and we have master netting arrangements. The tables below provide additional information relating to our master netting arrangements with our derivative counterparties (in thousands):

		June 30, 2013
		Gross Amounts of Recognized Assets		Gross Amounts Offset in the Balance Sheet			Net Amounts of Assets Presented in the Balance Sheet
Derivative assets:
Natural gas	–swaps	$	14,255	$	(3,638	)		$	10,617
	–collars		88,087		(3,703	)			84,384
Crude oil	–swaps		15,980		—				15,980
	–collars		1,979		—				1,979
NGLs	–C5 swaps		11,743		—				11,743
	–C3 swaps		3,589		(773	)			2,816
		$	135,633	$	(8,114	)		$	127,519

		June 30, 2013
		Gross Amounts of Recognized (Liabilities)			Gross Amounts Offset in the Balance Sheet		Net Amounts of (Liabilities) Presented in the Balance Sheet
Derivative (liabilities):
Natural gas	–swaps	$	(3,638	)	$	3,638		$	—
	–collars		(3,703	)		3,703			—
NGLs	–C3 swaps		(773	)		773			—
		$	(8,114	)	$	8,114		$	—

		December 31, 2012
		Gross Amounts of Recognized Assets		Gross Amounts Offset in the Balance Sheet			Net Amounts of Assets Presented in the Balance Sheet
Derivative assets:
Natural gas	–swaps	$	10,746	$	(3,242	)		$	7,504
	–collars		128,410		(6,155	)			122,255
	–basis swaps		993		—				993
Crude oil	–swaps		9,650		—				9,650
	–collars		2,222		—				2,222
NGLs	–C5 swaps		13,055		(2,412	)			10,643
		$	165,076	$	(11,809	)		$	153,267

		December 31, 2012
		Gross Amounts of Recognized (Liabilities)			Gross Amounts Offset in the Balance Sheet				Net Amounts of (Liabilities) Presented in the Balance Sheet
Derivative (liabilities):
Natural gas	–swaps	$	(3,242	)		$	(221	)		$	(3,463	)
	–collars		(9,618	)			9,618				—
NGLs	–C5 swaps		(137	)			2,412				2,275
	–C3 swaps		(6,746	)			—				(6,746	)
		$	(19,743	)		$	11,809			$	(7,934	)

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 the accompanying consolidated balance sheets (in thousands):

	June 30, 2013							December 31, 2012
	Assets		(Liabilities)					Assets			(Liabilities)
	Carrying Value		Carrying Value			Net Carrying Value		Carrying Value			Carrying Value				Net Carrying Value
Derivatives that qualified for cash flow hedge accounting (before discontinuance of hedge accounting):
Swaps (a)	$	11,028	$	(5,952	)	$	5,076		$	22,236		$	(3,242	)		$	18,994
Collars (a)		64,047		(10,356	)		53,691			129,878			(9,721	)			120,157
	$	75,075	$	(16,308	)	$	58,767		$	152,114		$	(12,963	)		$	139,151
Derivatives that did not qualify or were not designated for hedge accounting:
Sold swaps (a)	$	36,505	$	(2,233	)	$	34,272		$	7,316		$	(8,904	)		$	(1,588	)
Re-purchased swaps (a)		1,808		—			1,808			5,920			—				5,920
Collars (a)		33,112		(440	)		32,672			857			—				857
Basis swaps (a)		—		—			—			993			—				993
	$	71,425	$	(2,673	)	$	68,752		$	15,086		$	(8,904	)		$	6,182

(a) Included in unrealized derivatives in the accompanying consolidated balance sheets. See additional discussion above regarding the discontinuance of hedge accounting.

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

	Three Months Ended June 30,													Six Months Ended June 30,
	Change in Hedge Derivative Fair Value					Realized Gain (Loss) Reclassified from OCI into Revenue (a)								Change in Hedge Derivative Fair Value									Realized Gain (Loss) Reclassified from OCI into Revenue (a)
	2013		2012				2013				2012					2013				2012					2013				2012

Swaps	$	—	$	19,665		$		3,875		$		32,335			$		125		$		55,836			$		11,922		$		51,647
Put options		—		648				—				(315	)				—				(914	)				—				(315	)
Collars		—		(12,423	)			27,540				46,561					(7,015	)			84,048					58,272				84,878
Income taxes		—		(3,077	)			(12,252	)			(30,647	)				2,687				(55,183	)				(27,376	)			(52,834	)
	$	—	$	4,813		$		19,163		$		47,934			$		(4,203	)	$		83,787			$		42,818		$		83,376

(a) For realized gains upon derivative contract settlement, the reduction in AOCI is offset by an increase in revenues, NGLs and oil sales. For realized losses upon derivative contract settlement, the increase in AOCI is offset by a decrease in revenues. See additional discussion above regarding the discontinuance of hedge accounting.

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 on our consolidated statements of operations is summarized below (in thousands):

	Three Months Ended June 30,
	Gain (Loss) Recognized in Income (Non‑hedge Derivatives)						Gain (Loss) Recognized in Income (Ineffective Portion)							Derivative Fair Value Income (Loss)
	2013			2012			2013			2012			2013					2012
Swaps	$	65,003		$	129,313			$	—		$	562			$	65,003			$	129,875
Re-purchased swaps		(1,663	)		(8,744	)			—			—				(1,663	)			(8,744	)
Collars		74,420			7,597				—			1,310				74,420				8,907
Call options		—			18,531				—			—				—				18,531
Total	$	137,760		$	146,697			$	—		$	1,872			$	137,760			$	148,569

	Six Months Ended June 30,
	Gain (Loss) Recognized in Income (Non‑hedge Derivatives)						Gain (Loss) Recognized in Income (Ineffective Portion)								Derivative Fair Value Income (Loss)
	2013			2012			2013				2012			2013					2012
Swaps	$	21,927		$	76,328			$	(1,995	)		$	666			$	19,932			$	76,994
Re-purchased swaps		(478	)		(8,744	)			—				—				(478	)			(8,744	)
Collars		19,417			5,095				(896	)			1,443				18,521				6,538
Call options		(90	)		12,948				—				—				(90	)			12,948
Total	$	40,776		$	85,627			$	(2,891	)		$	2,109			$	37,885			$	87,736