(6) DERIVATIVES AND RISK MANAGEMENT

The Company is exposed to volatility in market prices and basis differentials for natural gas, oil and NGLs which impacts the predictability of its cash flows related to the sale of those commodities. These risks are managed by the Company’s use of certain derivative financial instruments. As of September 30, 2017 and December 31, 2016, the Company’s derivative financial instruments consisted of fixed price swaps, two-way costless collars, three-way costless collars, basis swaps, put and 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.

Purchased put options	The Company purchases put options based on an index price from the counterparty by payment of a cash premium. If the index price is lower than the put’s strike price at the time of settlement, the Company receives from the counterparty such difference between the index price and the purchased put strike price. If the market price settles above the put’s strike price, no payment is due from either party.

Two-way costless collars	Arrangements that contain a fixed floor price (purchased put option) and a fixed ceiling price (sold call option) based on an index price which, in aggregate, have no net cost. At the contract settlement date, (1) if the index price is higher than the ceiling price, the Company pays the counterparty the difference between the index price and ceiling price, (2) if the index price is between the floor and ceiling prices, no payments are due from either party, and (3) if the index price is below the floor price, the Company will receive the difference between the floor price and the index price.

Three-way costless collars	Arrangements that contain a purchased put option, a sold call option and a sold put option based on an index price which, in aggregate, have no net cost. At the contract settlement date, (1) if the index price is higher than the sold call strike price, the Company pays the counterparty the difference between the index price and sold call strike price, (2) if the index price is between the purchased put strike price and the sold call strike price, no payments are due from either party, (3) if the index price is between the sold put strike price and the purchased put strike price, the Company will receive the difference between the purchased put strike price and the index price, and (4) if the index price is below the sold put strike price, the Company will receive the difference between the purchased put strike price and the sold put strike 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.

Sold call options	The Company sells call options in exchange for a premium. If the market price exceeds the strike price of the call option at the time of settlement, the Company pays the counterparty such excess on sold call options. If the market price settles below the call’s strike price, 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.

The Company utilizes counterparties for its derivative instruments that it believes are creditworthy 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, there can be no assurance that a counterparty will be able to meet its obligations to the Company.

The following table provides information about the Company’s financial instruments that are sensitive to changes in commodity prices and that are used to protect the Company’s exposure. None of the financial instruments below are designated for hedge accounting treatment. The table presents the notional amount in Bcf, the weighted average contract prices and the fair value by expected maturity dates as of September 30, 2017:


		Weighted Average Price per MMBtu
	Volume (Bcf)	Swaps		Sold Puts		Purchased Puts		Sold Calls		Basis Differential		Fair Value at September 30, 2017 (in millions)
Financial protection on production
2017
Fixed price swaps	73	$	3.06	$	–	$	–	$	–	$	–	$	1
Two-way costless-collars	31		–		–		2.96		3.38		–		1
Three-way costless-collars	34		–		2.29		2.97		3.30		–		–
Total	138											$	2
2018
Fixed price swaps	178	$	3.02	$	–	$	–	$	–	$	–	$	(4)
Two-way costless-collars	23		–		–		2.97		3.56		–		(1)
Three-way costless-collars	272		–		2.40		2.97		3.37		–		7
Total	473											$	2
2019
Three-way costless-collars	108	$	–	$	2.50	$	2.95	$	3.32	$	–	$	(1)
Total	108											$	(1)

Basis Swaps
2017	32	$	–	$	–	$	–	$	–	$	(0.95)	$	12
2018	25		–		–		–		–		(0.63)		(16)
Total	57											$	(4)


		Weighted Average Price per MMBtu
	Volume (Bcf)	Sold Calls		Fair Value at September 30, 2017 (in millions)
Call options
2017	21	$	3.68	$	–	(1)
2018	63		3.50		(9)
2019	52		3.50		(8)
2020	32		3.75		(5)
Total	168			$	(22)

(1)

Excludes $2 million in premiums paid related to certain call options recognized as a component of derivative assets within current assets on the unaudited condensed consolidated balance sheet. As certain call options settle, the premium will be amortized and recognized as a component of gain (loss) on derivatives on the unaudited condensed consolidated statements of operations.

The balance sheet classification of the assets and liabilities related to derivative financial instruments (none of which are designated for hedge accounting treatment) are summarized below as of September 30, 2017 and December 31, 2016:


	Derivative Assets
	Balance Sheet Classification		Fair Value
			September 30, 2017			December 31, 2016
		(in millions)
Derivatives not designated as hedging instruments:
Fixed price swaps	Derivative assets		$	12		$	–
Two-way costless collars	Derivative assets			7			8
Three-way costless collars	Derivative assets			50			11
Basis swaps	Derivative assets			19			32
Call options	Derivative assets			1			–
Fixed price swaps	Other long-term assets			1			1
Two-way costless collars	Other long-term assets			–			2
Three-way costless collars	Other long-term assets			56			100
Basis swaps	Other long-term assets			–			1
Total derivative assets			$	146	(1)	$	155

	Derivative Liabilities
	Balance Sheet Classification		Fair Value
			September 30, 2017			December 31, 2016
			(in millions)
Derivatives not designated as hedging instruments:
Fixed price swaps	Derivative liabilities		$	14		$	175
Two-way costless collars	Derivative liabilities			7			49
Three-way costless collars	Derivative liabilities			44			70
Basis swaps	Derivative liabilities			23			13
Call options	Derivative liabilities			8			46
Interest rate swaps	Derivative liabilities			1			2
Fixed price swaps	Other long-term liabilities			2			3
Two-way costless collars	Other long-term liabilities			–			9
Three-way costless collars	Other long-term liabilities			56			122
Basis swaps	Other long-term liabilities			–			5
Call options	Other long-term liabilities			15			35
Interest rate swaps	Other long-term liabilities			1			1
Total derivative liabilities			$	171		$	530

(1)

Excludes $2 million in premiums paid related to certain call options currently recognized as a component of derivative assets within current assets on the unaudited condensed consolidated balance sheet. As certain call options settle, the premium will be amortized and recognized as a component of gain (loss) on derivatives on the unaudited condensed consolidated statements of operations.

At September 30, 2017, the net fair value of the Company’s financial instruments related to natural gas was a $23 million liability. The net fair value of the Company’s interest rate swaps was a $2 million liability as of September 30, 2017. The Company had ethane fixed price swaps with an immaterial fair value as of September 30, 2017.

Derivative Contracts Not Designated for Hedge Accounting

As of September 30, 2017, the Company had no positions designated for hedge accounting treatment. Gains and losses on derivatives that are not designated for hedge accounting treatment, or that do not meet hedge accounting requirements, are recorded as a component of gain (loss) on derivatives on the unaudited condensed consolidated statements of operations. Accordingly, the gain (loss) on derivatives component of the statements of operations reflects the gains and losses on both settled and unsettled derivatives. The Company calculates gains and losses on settled derivatives as the summation of gains and losses on positions which have settled within the reporting period. Only the settled gains and losses are included in the Company’s realized commodity price calculations.

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 treatment. Changes in the fair value of the interest rate swaps are included in gain (loss) on derivatives on the unaudited condensed consolidated statements of operations.

The following tables summarize the before-tax effect of fixed price swaps, purchased put options, two-way costless collars, three-way costless collars, basis swaps, 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, 2017 and 2016:


		Gain (Loss) on Derivatives, Unsettled Recognized in Earnings
	Consolidated Statements of Operations	For the three months ended				For the nine months ended
	Classification of Gain (Loss)	September 30,				September 30,
Derivative Instrument	on Derivatives, Unsettled	2017		2016		2017		2016
		(in millions)
Fixed price swaps (1)	Gain (Loss) on Derivatives	$	(2)	$	23	$	174	$	(17)
Two-way costless collars	Gain (Loss) on Derivatives		3		5		48		–
Three-way costless collars	Gain (Loss) on Derivatives		(1)		1		87		(1)
Basis swaps	Gain (Loss) on Derivatives		24		31		(19)		27
Call options	Gain (Loss) on Derivatives		6		21		59		(54)
Interest rate swaps	Gain (Loss) on Derivatives		1		–		1		(3)
Total gain (loss) on unsettled derivatives		$	31	$	81	$	350	$	(48)

		Gain (Loss) on Derivatives, Settled (2)
		Recognized in Earnings
	Consolidated Statements 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	2017		2016		2017		2016
		(in millions)
Fixed price swaps (1)	Gain (Loss) on Derivatives	$	7	$	(9)	$	(18)	$	7
Purchased put options	Gain (Loss) on Derivatives		–		−		–		11
Two-way costless collars	Gain (Loss) on Derivatives		–		−		(3)		−
Three-way costless collars	Gain (Loss) on Derivatives		1		−		(4)		−
Basis swaps	Gain (Loss) on Derivatives		9		−		(21)		4
Call options	Gain (Loss) on Derivatives		–		−		(6)		−
Interest rate swaps	Gain (Loss) on Derivatives		–		(1)		–		(2)
Total gain (loss) on settled derivatives (3) (4)		$	17	$	(10)	$	(52)	$	20

Total gain (loss) on derivatives (4)		$	48	$	71	$	298	$	(28)

(1)

Includes the Company’s fixed price swaps on natural gas and ethane. As of September 30, 2017, the amount of unsettled and settled fixed price swaps related to ethane was immaterial.

(2)

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

(3)

Excluding interest rate swaps and settled ethane fixed price swaps, these amounts are included, along with gas sales revenues, in the calculation of the Company’s realized natural gas price. Settled ethane fixed price swaps are included, along with NGL sales revenues, in the calculation of the Company’s realized NGL price.

(4)

Excludes $3 million amortization of premiums paid related to certain call options for the three and nine months ended September 30, 2017, which is included in gain (loss) on derivatives on the condensed consolidated statements of operations.

Derivative Contracts Designated for Hedge Accounting

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 designated for hedge accounting. Unrealized gains and losses related to unsettled derivatives that have been designated for hedge accounting treatment are recorded in either earnings or as a component of other comprehensive income until settled. In the period of settlement, the Company recognizes the gains and losses from these qualifying hedges in gas sales revenues. As of September 30, 2017 and 2016, the Company had no positions designated for hedge accounting treatment.