DERIVATIVE INSTRUMENTS

6 Months Ended

Jun. 30, 2011

DERIVATIVE INSTRUMENTS

DERIVATIVE INSTRUMENTS

(8) DERIVATIVE INSTRUMENTS

Commodity Derivatives

Forest periodically enters into derivative instruments such as swap and collar agreements as an attempt to moderate the effects of wide fluctuations in commodity prices on Forest’s cash flow and to manage the exposure to commodity price risk. Forest’s commodity derivative instruments generally serve as effective economic hedges of commodity price exposure; however, Forest has elected not to designate its derivatives as hedging instruments for accounting purposes. As such, Forest recognizes all changes in fair value of its derivative instruments as unrealized gains or losses on derivative instruments in the Condensed Consolidated Statement of Operations.

The table below sets forth Forest’s outstanding commodity swaps and costless collars as of June 30, 2011.

Commodity Swaps and Collars

	Natural Gas (NYMEX HH)			Oil (NYMEX WTI)				NGLs (OPIS Refined Products)
Remaining Term	Bbtu Per Day	Weighted Average Hedged Price per MMBtu		Barrels Per Day	Weighted Average Hedged Price per Bbl			Barrels Per Day	Weighted Average Hedged Price per Bbl
Swaps:
July 2011 - December 2011(1)	180	$	5.38	1,000	$	85.00		5,000	$	38.15
Calendar 2012(2)	130	5.26		500	104.25			2,000	45.22
Collars:
July 2011 - December 2011	—	—		3,000	75.00/90.20		(3)	—	—

(1) Includes derivative agreements entered into by LPR Canada for 30 Bbtu per day of gas swaps at a weighted average hedged price per MMBtu of $4.85.

(2) Includes derivative agreements entered into by LPR Canada for (i) 25 Bbtu per day of gas swaps at a weighted average hedged price per MMBtu of $5.09 and (ii) 500 barrels per day of oil swaps at a hedged price per barrel of $104.25.

(3) Represents the weighted average hedged floor and ceiling price per Bbl.

In connection with several natural gas swaps Forest has entered into, Forest granted option instruments (several commodity swaptions and one oil call option) to the natural gas swap counterparties in exchange for Forest receiving premium hedged prices on the natural gas swaps. The table below sets forth the outstanding options as of June 30, 2011 (as of August 2, 2011, none of the options in the table have been exercised by the counterparties).

Commodity Options

			Natural Gas (NYMEX HH)			Oil (NYMEX WTI)
Instrument	Option Expiration	Underlying Swap Term	Underlying Swap Bbtu Per Day	Underlying Swap Weighted Average Hedged Price per MMBtu		Underlying Swap Barrels Per Day	Underlying Swap Hedged Price per Bbl
Gas Swaptions	December 2011	Calendar 2012	50	$	5.28	—	$	—
Oil Swaptions	December 2011	Calendar 2012	—	—		3,000	90.00
Oil Swaptions	December 2012	Calendar 2013	—	—		2,000	120.00
Oil Call Option	Monthly in 2011	Monthly in 2011	—	—		1,000	90.00

Subsequent to June 30, 2011, through August 2, 2011, LPR Canada entered into the following swaps:

Commodity Swaps

	Oil (NYMEX WTI)
Swap Term	Barrels Per Day	Weighted Average Hedged Price per Bbl
August 2011 - December 2011	2,000	$	100.29
Calendar 2012	1,500	101.72

Interest Rate Derivatives

Forest periodically enters into interest rate derivative agreements in an attempt to manage the mix of fixed and floating interest rates within its debt portfolio. The Company has elected not to designate its derivatives as hedging instruments. As such, the Company recognizes all changes in fair value of its derivative instruments as unrealized gains or losses on derivative instruments in the Condensed Consolidated Statement of Operations. The table below sets forth Forest’s outstanding fixed-to-floating interest rate swaps as of June 30, 2011.

Interest Rate Swaps

Remaining Swap Term	Notional Amount (In Thousands)		Weighted Average Floating Rate	Weighted Average Fixed Rate
July 2011 - February 2014	$	500,000	1 month LIBOR + 5.89%	8.50	%

Fair Value and Gains and Losses

The table below summarizes the location and fair value amounts of Forest’s derivative instruments reported in the Condensed Consolidated Balance Sheets as of the dates indicated. These derivative instruments are not designated as hedging instruments for accounting purposes. For financial reporting purposes, Forest does not offset asset and liability fair value amounts recognized for derivative instruments with the same counterparty under its master netting arrangements. See Note 7 to the Condensed Consolidated Financial Statements for more information on the fair values of Forest’s derivative instruments.

	June 30, 2011		December 31, 2010
	(In Thousands)
Assets:
Commodity derivatives:
Current assets: derivative instruments	$	41,713	$	49,415
Derivative instruments	8,463		—
Interest rate derivatives:
Current assets: derivative instruments	10,894		10,767
Derivative instruments	9,879		8,244
Total assets	70,949		68,426
Liabilities:
Commodity derivatives:
Current liabilities: derivative instruments	42,428		36,413
Derivative instruments	5,390		—
Total liabilities	47,818		36,413
Net derivative fair value	$	23,131	$	32,013

The table below summarizes the amount of derivative instrument gains and losses reported in the Condensed Consolidated Statements of Operations as “Realized and unrealized gains on derivative instruments, net,” for the periods indicated. These derivative instruments are not designated as hedging instruments for accounting purposes.

	Three Months Ended June 30,						Six Months Ended June 30,
	2011			2010			2011			2010
	(In Thousands)
Commodity derivatives:
Realized gains	$	(2,271	)	$	(31,215	)	$	(12,839	)	$	(37,663	)
Unrealized (gains) losses	(35,716		)	25,005			10,642			(54,617		)
Interest rate derivatives:
Realized gains	(2,872		)	(3,310		)	(5,842		)	(6,831		)
Unrealized gains	(5,188		)	(15,511		)	(1,762		)	(19,131		)
Realized and unrealized gains on derivative instruments, net	$	(46,047	)	$	(25,031	)	$	(9,801	)	$	(118,242	)

Due to the volatility of natural gas and liquids prices, the estimated fair values of Forest’s commodity derivative instruments are subject to large fluctuations from period to period. Forest has experienced the effects of these commodity price fluctuations in both the current period and prior periods and expects that volatility in commodity prices will continue.

Credit Risk

Forest executes with each of its derivative counterparties an International Swap and Derivatives Association, Inc. (“ISDA”) Master Agreement, which is a standard industry form contract containing general terms and conditions applicable to many types of derivative transactions. Additionally, Forest executes, with each of its derivative counterparties, a Schedule, which modifies the terms and conditions of the ISDA Master Agreement according to the parties’ requirements and the specific types of derivatives to be traded. As of June 30, 2011, all of the derivative counterparties are lenders, or affiliates of lenders, under either the U.S. Credit Facility or the Canadian Credit Facility (collectively, the “Credit Facilities” and each a “Credit Facility”).  The terms of each Credit Facility provide that any security granted by Forest under the Credit Facilities shall also extend to and be available to those lenders that are counterparties to derivative transactions. None of these counterparties require collateral beyond that already pledged under the Credit Facilities.  Derivatives related to U.S. oil, natural gas, and NGL production, or related to U.S. interest rates, are entered into by Forest Oil Corporation and security therefore is provided by the U.S. Credit Facility.  Derivatives related to Canadian oil and gas production, or Canadian interest rates, are entered into by LPR Canada and security therefore is provided by the Canadian Credit Facility.

The ISDA Master Agreements and Schedules contain cross-default provisions whereby a default under the applicable Credit Facility will also cause a default under the derivative agreements. Such events of default include non-payment, breach of warranty, non-performance of financial covenants, default on other indebtedness, certain pension plan events, certain adverse judgments, change of control, and a failure of the liens securing the Credit Facilities.  In addition, bankruptcy and insolvency events with respect to Forest or certain of its U.S. subsidiaries, in the United States, or Lone Pine and its subsidiaries, in Canada, will result in an automatic acceleration of the indebtedness under the Credit Facilities. None of these events of default are specifically credit-related, but some could arise if there were a general deterioration of Forest’s or LPR Canada’s credit. The ISDA Master Agreements and Schedules contain a further credit-related termination event that would occur if Forest, on the one hand, or Lone Pine, on the other hand, were to merge with another entity and the creditworthiness of the resulting entity was materially weaker than that of Forest or Lone Pine, respectively.

The derivative counterparties are all financial institutions that are engaged in similar activities and have similar economic characteristics that, in general, could cause their ability to meet contractual obligations to be similarly affected by changes in economic or other conditions. Forest does not require the posting of collateral for its benefit under its derivative agreements. However, the ISDA Master Agreements and Schedules generally contain netting provisions whereby if on any date amounts would otherwise be payable by each party to the other, then on such date the party that owes the larger amount will pay the excess of that amount over the smaller amount owed by the other party, thus satisfying each party’s obligations. These provisions generally apply to all derivative transactions, or all derivative transactions of the same type (e.g., commodity, interest rate, etc.), with the particular counterparty. If all counterparties failed, Forest would be exposed to a risk of loss equal to this net amount owed to Forest, the fair value of which was $29.1 million at June 30, 2011. If Forest suffered an event of default, each counterparty could demand immediate payment, subject to notification periods, of the net obligations due to it under the derivative agreements. At June 30, 2011, Forest owed a net derivative liability to four counterparties, the fair value of which was $6.0 million. In the absence of netting provisions, at June 30, 2011, Forest would be exposed to a risk of loss of $70.9 million under its derivative agreements and Forest’s derivative counterparties would be exposed to a risk of loss of $47.8 million.

On July 21, 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act (the “Dodd-Frank Act”) was enacted which, as part of a broader financial regulatory reform, includes derivatives reform that may impact Forest’s business. Congress delegated many of the details of the Dodd-Frank Act to federal regulatory agencies, which are in the process of writing and implementing new rules. Forest is monitoring the impact, if any, that the Dodd-Frank Act and related rules will have on its existing derivative transactions under its outstanding ISDA Master Agreements and Schedules, as well as its ability to enter into such transactions and agreements in the future.