Derivative Instruments and Hedging Activities

12 Months Ended

Dec. 31, 2012

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Instruments and Hedging Activities

Derivative Instruments and Hedging Activities

Objective and Strategies for Using Derivative Instruments   In order to mitigate the effect of commodity price volatility and enhance the predictability of cash flows relating to the marketing of our crude oil and natural gas, we enter into crude oil and natural gas price hedging arrangements with respect to a portion of our expected production. The derivative instruments we use include variable to fixed price commodity swaps, two-way and three-way collars and basis swaps.

The fixed price swap, two-way collar, and basis swap contracts entitle us (floating price payor) to receive settlement from the counterparty (fixed price payor) for each calculation period in amounts, if any, by which the settlement price for the scheduled trading days applicable for each calculation period is less than the fixed strike price or floor price. We would pay the counterparty if the settlement price for the scheduled trading days applicable for each calculation period is more than the fixed strike price or ceiling price. The amount payable by us, if the floating price is above the fixed or ceiling price, is the product of the notional quantity per calculation period and the excess of the floating price over the fixed or ceiling price in respect of each calculation period. The amount payable by the counterparty, if the floating price is below the fixed or floor price, is the product of the notional quantity per calculation period and the excess of the fixed or floor price over the floating price in respect of each calculation period.

A three-way collar consists of a two-way collar contract combined with a put option contract sold by us with a strike price below the floor price of the two-way collar.  We receive price protection at the purchased put option floor price of the two-way collar if commodity prices are above the sold put option strike price. If commodity prices fall below the sold put option strike price, we receive the cash market price plus the delta between the two put option strike prices. This type of instrument allows us to capture more value in a rising commodity price environment, but limits our benefits in a downward commodity price environment.

We also may enter into forward contracts to hedge anticipated exposure to interest rate risk associated with public debt financing.

While these instruments mitigate the cash flow risk of future reductions in commodity prices or increases in interest rates, they may also curtail benefits from future increases in commodity prices or decreases in interest rates.

See Note 15.  Fair Value Measurements and Disclosures for a discussion of methods and assumptions used to estimate the fair values of our derivative instruments.

Counterparty Credit Risk   Derivative instruments expose us to counterparty credit risk. Our commodity derivative instruments are currently with a diversified group of major banks or market participants, and we monitor and manage our level of financial exposure. Our commodity derivative contracts are executed under master agreements which allow us, in the event of default, to elect early termination of all contracts with the defaulting counterparty. If we choose to elect early termination, all asset and liability positions with the defaulting counterparty would be net settled at the time of election.

We monitor the creditworthiness of our commodity derivatives counterparties. However, we are not able to predict sudden changes in counterparties’ creditworthiness. In addition, even if such changes are not sudden, we may be limited in our ability to mitigate an increase in counterparty credit risk.

Possible actions would be to transfer our position to another counterparty or request a voluntary termination of the derivative contracts resulting in a cash settlement. Should one of these financial counterparties not perform, we may not realize the benefit of some of our derivative instruments under lower commodity prices or higher interest rates, and could incur a loss. 

Interest Rate Derivative Instrument   In January 2010, we entered into an interest rate forward starting swap to effectively fix the cash flows related to interest payments on our anticipated March 2011 debt issuance. During first quarter 2011, the net liability position on the swap was reduced in our mark to market calculation, and we recognized a corresponding gain of $23 million, net of tax, in AOCL. On February 15, 2011 we settled the interest rate swap, which had a net liability position of $40 million at the time of settlement. Approximately $26 million, net of tax, was recorded in accumulated other comprehensive loss (AOCL) and is being reclassified to interest expense over the term of the notes. The ineffective portion of the interest rate swap was de minimis.

Unsettled Derivative Instruments   As of December 31, 2012, we had entered into the following crude oil derivative instruments:

				Swaps		Collars
Settlement Period	Type of Contract	Index	Bbls Per Day	Weighted Average Fixed Price		Weighted Average  Short Put  Price		Weighted Average Floor Price		Weighted Average  Ceiling Price
Instruments Entered Into as of December 31, 2012
2013	Swaps	NYMEX WTI	8,000	$	89.63	$	—	$	—	$	—
2013	Swaps	Dated Brent	3,000	98.03		—		—		—
2013	Two-Way Collars	NYMEX WTI	5,000	—		—		95.00		115.00
2013	Three-Way Collars	NYMEX WTI	7,000	—		63.57		83.57		109.04
2013	Three-Way Collars	Dated Brent	26,000	—		82.50		100.93		126.63
2014	Swaps	NYMEX WTI	11,000	90.26		—		—		—
2014	Swaps	Dated Brent	10,000	105.14		—		—		—
2014	Three-Way Collars	NYMEX WTI	4,000	—		77.00		92.00		106.13
2014	Three-Way Collars	Dated Brent	11,000	—		85.45		99.09		128.40

As of December 31, 2012, we had entered into the following natural gas derivative instruments:

				Swaps		Collars
Settlement Period	Type of Contract	Index	MMBtu Per Day	Weighted Average Fixed Price		Weighted Average Short Put  Price		Weighted Average Floor Price		Weighted Average Ceiling Price
Instruments Entered Into as of December 31, 2012
2013	Swaps	NYMEX HH	60,000	$	4.58	$	—	$	—	$	—
2013	Two-Way Collars	NYMEX HH	40,000	—		—		3.25		5.14
2013	Three-Way Collars	NYMEX HH	100,000	—		3.88		4.75		5.63
2014	Swaps	NYMEX HH	60,000	4.24		—		—		—
2014	Three-Way Collars	NYMEX HH	130,000	—		2.56		3.56		5.21

Fair Value Amounts and Gains and Losses on Derivative Instruments   The fair values of derivative instruments in our consolidated balance sheets were as follows: 

Fair Value of Derivative Instruments
	Asset Derivative Instruments						Liability Derivative Instruments
	December 31, 2012			December 31, 2011			December 31, 2012			December 31, 2011
	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair  Value		Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
(millions)
Commodity DerivativeInstruments	Current Assets	$	63	Current Assets	$	10	Current Liabilities	$	7	Current Liabilities	$	76
	Noncurrent Assets	21		Noncurrent Assets	37		Noncurrent Liabilities	3		Noncurrent Liabilities	7
Total		$	84		$	47		$	10		$	83

The effect of derivative instruments on our consolidated statements of operations was as follows: 

	Year Ended December 31,
	2012			2011			2010
(millions)
Realized Mark-to-Market (Gain) Loss	$	34		$	(64	)	$	(87	)
Unrealized Mark-to-Market (Gain) Loss	(109		)	22			(70		)
Total (Gain) Loss on Commodity Derivative Instruments	$	(75	)	$	(42	)	$	(157	)

Derivative Instruments in Cash Flow Hedge Relationships
	Amount of (Gain) Loss on Derivative Instruments Recognized in Other Comprehensive (Income) Loss							Amount of (Gain) Loss on Derivative Instruments Reclassified from Accumulated Other Comprehensive (Income) Loss
	2012		2011			2010		2012		2011		2010
(millions)
Commodity Derivative Instruments in Previously Designated Cash Flow Hedging Relationships (1)
Crude Oil	$	—	$	—		$	—	$	—	$	—	$	19
Natural Gas	—		—			—		—		—		1
Interest Rate Derivative Instruments in Cash Flow Hedging Relationships	—		(23		)	63		1		1		1
Total	$	—	$	(23	)	$	63	$	1	$	1	$	21

⁽¹⁾  Includes effect of commodity derivative instruments previously accounted for as cash flow hedges. All net derivative gains and losses that were deferred in AOCL as a result of previous cash flow hedge accounting, had been reclassified to earnings by December 31, 2010.

AOCL at December 31, 2012 included deferred losses of $25 million, net of tax, related to interest rate derivative instruments. This amount will be reclassified to earnings as an adjustment to interest expense over the terms of our senior notes due April 2014 and March 2041.  Approximately $2 million of deferred losses (net of tax) will be reclassified to earnings during the next 12 months and will be recorded as an increase in interest expense.