Derivatives and Risk Management

12 Months Ended

Dec. 31, 2012

Derivatives And Risk Management [Abstract]

Derivatives and Risk Management

(5) DERIVATIVES AND RISK MANAGEMENT

The Company is exposed to volatility in market prices and basis differentials for natural gas and oil which impacts the predictability of its cash flows related to the sale of natural gas and oil. These risks are managed by the Company’s use of certain derivative financial instruments.  As of December 31, 2012 and 2011, the Company’s derivative financial instruments consisted of price swaps, costless-collars, call options and basis swaps. A description of the Company’s derivative financial instruments is provided below:

Fixed price swapsThe Company receives a fixed price for the contract and pays a floating market price to the counterparty.

Floating price swapsThe Company receives a floating market price from the counterparty and pays a fixed price.

Costless-collarsArrangements that contain a fixed floor price (put) and a fixed ceiling price (call). If the market price exceeds the call strike price or falls below the put strike price, the Company receives the fixed price and pays the market price. If the market price is between the call and the put strike price, no payments are due from either party.

Basis swapsArrangements that guarantee a price differential for natural gas from a specified delivery point. The Company receives a payment from the counterparty if the price differential is greater than the stated terms of the contract and pays the counterparty if the price differential is less than the stated terms of the contract.  

Fixed price call options The Company sells call options in exchange for a premium.  At the time of settlement, if the market price exceeds the fixed price of the call option, the Company pays the counterparty such excess on sold call options.  If the market price settles below the fixed price of the call option, no payment is due from either party.

GAAP requires that all derivatives be recognized in the balance sheet as either an asset or liability and be measured at fair value. Under GAAP, certain criteria must be satisfied in order for derivative financial instruments to be classified and accounted for as either a cash flow or a fair value hedge. Accounting for qualifying hedges requires a derivative’s gains and losses to be recorded either in earnings or as a component of other comprehensive income. Gains and losses on derivatives that are not elected for hedge accounting treatment or that do not meet hedge accounting requirements are recorded in earnings.

The Company utilizes counterparties for its derivative instruments that it believes are credit-worthy at the time the transactions are entered into and the Company closely monitors the credit ratings of these counterparties. Additionally, the Company performs both quantitative and qualitative assessments of these counterparties based on their credit ratings and credit default swap rates where applicable. However, the events in the financial markets in recent years demonstrate there can be no assurance that a counterparty will be able to meet its obligations to the Company.

The balance sheet classification of the derivative financial instruments are summarized below as of December 31, 2012 and 2011:

	Derivative Assets
	December 31, 2012					December 31, 2011
	Balance Sheet Classification	Fair Value				Balance Sheet Classification	Fair Value
	(in thousands)
Derivatives designated as hedging instruments:
Fixed and floating price swaps	Hedging asset		$	279,443	Hedging asset				$		333,479
Costless-collars	Hedging asset			–	Hedging asset						179,080
Fixed and floating price swaps	Other assets			8,550	Other assets						201,081
Total derivatives designated as hedging instruments			$	287,993					$		713,640
Derivatives not designated as hedging instruments:
Basis swaps	Hedging asset		$	3,250	Hedging asset				$		1,906
Basis swaps	Other assets			901	Other assets						1,797
Total derivatives not designated as hedging instruments			$	4,151					$		3,703
Total derivative assets			$	292,144					$		717,343
	Derivative Liabilities
	December 31, 2012				December 31, 2011
	Balance Sheet Classification		Fair Value		Balance Sheet Classification				Fair Value
	(in thousands)
Derivatives designated as hedging instruments:
Fixed and floating price swaps	Other current liabilities		$	–	Other current liabilities			$		11,849
Costless-collars	Other current liabilities			–	Other current liabilities					209
Total derivatives designated as hedging instruments			$	–				$		12,058
Derivatives not designated as hedging instruments:
Basis swaps	Other current liabilities		$	138	Other current liabilities			$		400
Basis swaps	Other long-term liabilities			–	Other long-term liabilities					55
Fixed price call options	Other long-term liabilities			4,128	Other long-term liabilities					–
Total derivatives not designated as hedging instruments			$	4,266				$		455
Total derivative liabilities			$	4,266				$		12,513

Cash Flow Hedges

The reporting of gains and losses on cash flow derivative hedging instruments depends on whether the gains or losses are effective at offsetting changes in the cash flows of the hedged item. The effective portion of the gains and losses on the derivative hedging instruments are recorded in other comprehensive income until recognized in earnings during the period that the hedged transaction takes place. The ineffective portion of the gains and losses from the derivative hedging instrument recognized in earnings immediately.

As of December 31, 2012, the Company had cash flow hedges on the following volumes of natural gas production and gas-in-underground storage (in Bcf):

Year	Fixed price swaps
2013	185.6
2014	18.3

As of December 31, 2012, the Company recorded a gain in accumulated other comprehensive income related to its hedging activities of $172.2 million net of a deferred income tax liability of $112.9 million. The amount recorded in accumulated other comprehensive income will be relieved over time and recognized in the statement of operations as the physical transactions being hedged occur. Assuming the market prices of natural gas futures as of December 31, 2012 remain unchanged, the Company would expect to transfer an aggregate after-tax net gain of approximately $167.2 million from accumulated other comprehensive income to earnings during the next 12 months. Gains or losses from derivative instruments designated as cash flow hedges are reflected as adjustments to natural gas sales in the consolidated statements of operations. Natural gas sales included a realized gain from settled contracts of $631.5 million for the year ended December 31, 2012 compared to a realized gain of $320.1 million for the year ended December 31, 2011. Volatility in net income, comprehensive income and accumulated other comprehensive income may occur in the future as a result of the Company’s derivative activities.

The following tables summarize the before tax effect of all cash flow hedges on the consolidated financial statements for the years ended December 31, 2012 and 2011.

			Gain Recognized in Other Comprehensive Income
			(Effective Portion)
		For the years ended
		December 31,
Derivative Instrument		2012		2011
		(in thousands)
Fixed price swaps		$	178,660	$	714,740
Costless-collars		$	39,247	$	144,126
	Classification of Gain	Gain Reclassified from Accumulated Other Comprehensive Income into Earnings
	Reclassified from Accumulated	(Effective Portion)
	Other Comprehensive Income	For the years ended
	into Earnings	December 31,
Derivative Instrument	(Effective Portion)	2012		2011
		(in thousands)
Fixed price swaps	Gas Sales	$	413,410	$	256,229
Costless-collars	Gas Sales	$	218,119	$	65,047
		Gain (Loss) Recognized in Earnings
		(Ineffective Portion)
	Classification of Gain (Loss)	For the years ended
	Recognized in Earnings	December 31,
Derivative Instrument	(Ineffective Portion)	2012		2011
		(in thousands)
Fixed price swaps	Gas Sales	$	2,450	$	(4,018)
Costless-collars	Gas Sales	$	(24)	$	(137)

Fair Value Hedges

For fair value hedges, the gain or loss on the derivative instrument as well as the offsetting gain or loss on the hedged item are recognized in earnings immediately. As of December 31, 2012, the Company had no fair value hedges, and no material fair value hedges at December 31, 2011.

Other Derivative Contracts

Although the Company’s basis swaps meet the objective of managing commodity price exposure, these trades are typically not entered into concurrent with the Company’s derivative instruments that qualify as cash flow hedges and therefore do not generally qualify for hedge accounting. Selling call options allows the Company to obtain above-market swaps on a portion of the Company’s projected natural gas production, these trades do not qualify for hedge accounting.  Basis swap and call option derivative instruments that do not qualify as cash flow hedges are recorded on the balance sheet at their fair values under hedging assets, other assets, other current liabilities, and other long-term liabilities, as applicable and all realized and unrealized gains and losses related to these contracts are recognized immediately in the consolidated statements of operations as a component of natural gas sales.

As of December 31, 2012, the Company had basis swaps on natural gas production that did not qualify for hedge accounting treatment of 30.1 Bcf for 2013 and 9.1 Bcf for 2014. As of December 31, 2012, the Company had call options on natural gas production that did not qualify for hedge accounting treatment of 18.3 Bcf for 2015.

The following tables summarizes the before tax effect of basis swaps that did not qualify for hedge accounting on the uncondensed consolidated statements of operations for the years ended December 31, 2012 and 2011.

		Unrealized Gain (Loss)
		Recognized in Earnings
	Income Statement	For the years ended
	Classification	December 31,
Derivative Instrument	of Unrealized Loss	2012		2011
		(in thousands)
Basis swaps	Gas Sales	$	766	$	5,222
Fixed price call options	Gas Sales		(4,128)		–
		Realized Gain (Loss)
		Recognized in Earnings
	Income Statement	For the years ended
	Classification	December 31,
Derivative Instrument	of Realized Gain (Loss)	2012		2011
		(in thousands)
Basis swaps	Gas Sales	$	2,125	$	(2,135)