(6) 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, NGLs and oil. These risks are managed by the Company’s use of certain derivative financial instruments. As of September 30, 2015 and December 31, 2014, the Company’s derivative financial instruments consisted of fixed price swaps, floating price swaps, basis swaps, fixed price call options, and interest rate swaps. A description of the Company’s derivative financial instruments is provided below:


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

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

Basis swaps	Arrangements 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 fixed price 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 fixed price call options. If the market price settles below the fixed price of the call option, no payment is due from either party.

Interest rate swaps	Interest rate swaps are used to fix or float interest rates on existing or anticipated indebtedness. The purpose of these instruments is to manage the Company’s existing or anticipated exposure to unfavorable interest rate changes.

All derivatives are recognized in the balance sheet as either an asset or liability and are measured at fair value other than transactions for which normal purchase/normal sale is applied. 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. In the period of settlement, the Company recognizes the gains and losses from these qualifying hedges in operating revenues. Gains and losses on derivatives that are not designated for hedge accounting treatment or that do not meet hedge accounting requirements are recorded in earnings as a component of gain (loss) on derivatives. Within the gain (loss) on derivatives component of the statement of operations are gains (losses) on derivatives excluding derivatives, settled and gains (losses) on derivatives, settled. The Company calculates gains (losses) on derivatives, settled, as the summation of gains and losses on positions which have settled within the period.

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 assets related to derivative financial instruments are summarized below as of September 30, 2015 and December 31, 2014:


	Derivative Assets
	September 30, 2015			December 31, 2014
	Balance Sheet Classification	Fair Value		Balance Sheet Classification	Fair Value
	(in millions)
Derivatives designated as hedging instruments:
Fixed price swaps	Derivative assets	$	55	Derivative assets	$	165
Total derivatives designated as hedging instruments		$	55		$	165

Derivatives not designated as hedging instruments:
Basis swaps	Derivative assets	$	3	Derivative assets	$	9
Fixed price swaps	Derivative assets		54	Derivative assets		163
Basis swaps	Other long-term assets		–	Other long-term assets		1
Interest rate swaps	Other long-term assets		–	Other long-term assets		1
Total derivatives not designated as hedging instruments		$	57		$	174

Total derivative assets		$	112		$	339

	Derivative Liabilities
	September 30, 2015			December 31, 2014
	Balance Sheet Classification	Fair Value		Balance Sheet Classification	Fair Value
	(in millions)
Derivatives not designated as hedging instruments:
Basis swaps	Derivative liabilities	$	3	Derivative liabilities	$	4
Fixed price call options	Derivative liabilities		–	Derivative liabilities		2
Interest rate swaps	Derivative liabilities		3	Derivative liabilities		3
Basis swaps	Other long-term liabilities		–	Other long-term liabilities		2
Fixed price call options	Other long-term liabilities		1	Other long-term liabilities		10
Interest rate swaps	Other long-term liabilities		4	Other long-term liabilities		2
Total derivatives not designated as hedging instruments		$	11		$	23

Total derivative liabilities		$	11		$	23

As of September 30, 2015, the Company had fixed price swap derivatives designated for hedge accounting and not designated for hedge accounting on the following volumes of natural gas production (in Bcf):

Year

Fixed price swaps designated for hedge accounting

Fixed price swaps not designated for

hedge accounting

Total

Weighted Average Swap Price ($/MMBtu) (1)

2015

$4.40

⁽¹⁾

The weighted average swap price is $4.40 for each category and in total.

Cash Flow Hedges

The Company has certain fixed price swaps that are designated for hedge accounting. 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 are recognized in earnings immediately and had an inconsequential impact to the unaudited condensed consolidated statement of operations for the three and nine months ended September 30, 2015 and 2014.

As of September 30, 2015, accumulated other comprehensive income includes a gain related to its hedging activities of $31 million net of a deferred income tax liability of $23 million. The amount included 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 September 30, 2015 remain unchanged, the Company would expect to transfer an aggregate after-tax net gain of approximately $31 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. 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 fixed price swaps designated for hedge accounting on the unaudited condensed consolidated financial statements for the three and nine months ended September 30, 2015 and 2014:


		Gain (Loss) Recognized in Other Comprehensive Loss
		(Effective Portion)
		For the three months ended				For the nine months ended
		September 30,				September 30,
Derivative Instrument		2015		2014		2015		2014
		(in millions)
Fixed price swaps		$	14	$	80	$	35	$	(2)

	Classification of Gain (Loss)	Gain (Loss) Reclassified from Accumulated
	Reclassified from	Other Comprehensive Income
	Accumulated Other	into Earnings (Effective Portion)
	Comprehensive Income	For the three months ended				For the nine months ended
	into Earnings	September 30,				September 30,
Derivative Instrument	(Effective Portion)	2015		2014		2015		2014
		(in millions)
Fixed price swaps	Gas sales	$	50	$	18	$	145	$	(48)

Other Derivative Contracts

For other derivative contracts, 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 through gain (loss) on derivatives. 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. Basis swap derivative instruments that are not designated for hedge accounting are recorded on the balance sheet at their fair values under derivative assets, other long-term assets, other current liabilities, and other long-term liabilities, as applicable and all gains and losses related to these contracts are recognized immediately in the unaudited condensed consolidated statement of operations as a component of gain (loss) on derivatives. As of September 30, 2015, the Company had basis swaps on natural gas production that were not designated for hedge accounting of 4 Bcf and 4 Bcf in 2015 and 2016, respectively.

As of September 30, 2015, the Company had fixed price call options on 50 Bcf and 120 Bcf of natural gas production in 2015 and 2016, respectively, not designated for hedge accounting and fixed price swaps of 30 Bcf of natural gas production in 2015 not designated for hedge accounting.

As of September 30, 2015 the Company had a floating price swap on less than 1 Bcf of natural gas production in 2015 not designated for hedge accounting which had an inconsequential impact on the unaudited consolidated financial statements.

The Company is a party to interest rate swaps that were entered into to mitigate the Company’s exposure to volatility in interest rates. The interest rate swaps have a notional amount of $170 million and expire in June 2020. The Company did not designate the interest rate swaps for hedge accounting. Changes in the fair value of the interest rate swaps are included in gain (loss) on derivatives in the unaudited condensed consolidated statements of operations.

The following tables summarize the before tax effect of fixed price swaps, basis swaps, fixed price call options and interest rate swaps not designated for hedge accounting on the unaudited condensed consolidated statements of operations for the three and nine months ended September 30, 2015 and 2014:


		Gain (Loss) on Derivatives
		Excluding Derivatives, Settled
		Recognized in Earnings
	Consolidated Statement of Operations	For the three months ended				For the nine months ended
	Classification of Gain (Loss) on	September 30,				September 30,
Derivative Instrument	Derivatives, Net of Settlement	2015		2014		2015		2014
		(in millions)
Basis swaps	Gain (Loss) on Derivatives	$	1	$	(3)	$	(4)	$	(16)
Fixed price call options	Gain (Loss) on Derivatives	$	3	$	11	$	11	$	(11)
Fixed price swaps	Gain (Loss) on Derivatives	$	(37)	$	45	$	(110)	$	24
Interest rate swaps	Gain (Loss) on Derivatives	$	(1)	$	1	$	(2)	$	(4)

		Gain (Loss)
		on Derivatives, Settled (1)
		Recognized in Earnings
	Consolidated Statement of Operations	For the three months ended				For the nine months ended
	Classification of Gain (Loss)	September 30,				September 30,
Derivative Instrument	on Derivatives, Settled (1)	2015		2014		2015		2014
		(in millions)
Basis swaps	Gain (Loss) on Derivatives	$	–	$	9	$	(6)	$	–
Fixed price swaps	Gain (Loss) on Derivatives	$	49	$	15	$	143	$	(21)
Interest rate swaps	Gain (Loss) on Derivatives	$	–	$	–	$	(2)	$	(1)

⁽¹⁾

The Company calculates gain (loss) on derivatives, settled, as the summation of gains and losses on positions that have settled within the period reported.