(4) 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 December 31, 2017, the Company’s derivative financial instruments consisted of fixed price swaps, two-way costless collars, three-way costless collars, basis swaps, sold call options and interest rate swaps. During 2016, the Company settled all of its purchased put options. The Company had basis swaps, sold call options and interest rate swaps as of December 31, 2015. 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.
Purchased call options	The Company purchases 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 receives from the counterparty such difference between the index price and the purchased call strike price. If the market price settles below the call’s strike price, no payment is due from either party.
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, 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 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 December 31, 2017:


		Weighted Average Price per MMBtu
Financial protection on production	Volume (Bcf)	Swaps		Sold Puts		Purchased Puts		Sold Calls		Basis Differential		Fair value at December 31, 2017 ($ in millions)
2018
Fixed price swaps	194	$	3.02	$	–	$	–	$	–	$	–	$	38
Two-way costless collars	23		–		–		2.97		3.56		–		4
Three-way costless collars	272		–		2.40		2.97		3.37		–		46
Total	489											$	88
2019
Fixed price swaps	93	$	3.00	$	–	$	–	$	–	$	–	$	17
Three-way costless collars	108		–		2.50		2.95		3.32		–		9
Total	201											$	26

Basis swaps
2018	44	$	–	$	–	$	–	$	–	$	(0.48)	$	(21)
2019	–		–		–		–		–		(0.59)		–
Total	44											$	(21)


Purchased call options	Volume (Bcf)	Weighted Average Strike Price per MMBtu		Fair value at December 31, 2017 ($ in millions)
2018	13	$	3.23	$	2	(1)
	13			$	2

Sold call options
2018	63	$	3.50	$	(3)
2019	52		3.50		(5)
2020	68		3.63		(4)
2021	57		3.52		(6)
Total	240			$	(18)

(1)

Excludes $1 million in premiums paid related to certain call options recognized as a component of derivative assets within current assets on the 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 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 December 31, 2017 and 2016:


	Derivative Assets
	Balance Sheet Classification		Fair Value at December 31,
			2017			2016
Derivatives not designated as hedging instruments:		(in millions)
Fixed price swaps	Derivative assets		$	38		$	–
Two-way costless collars	Derivative assets			5			8
Three-way costless collars	Derivative assets			82			11
Basis swaps	Derivative assets			2			32
Purchased call options	Derivative assets			2			–
Fixed price swaps	Other long-term assets			18			1
Two-way costless collars	Other long-term assets			–			2
Three-way costless collars	Other long-term assets			39			100
Basis swaps	Other long-term assets			–			1
Total derivative assets			$	186	(1)	$	155

	Derivative Liabilities
	Balance Sheet Classification		Fair Value at December 31,
			2017			2016
Derivatives not designated as hedging instruments:			(in millions)
Fixed price swaps	Derivative liabilities		$	–			175
Two-way costless collars	Derivative liabilities			1			49
Three-way costless collars	Derivative liabilities			36			70
Basis swaps	Derivative liabilities			23			13
Sold call options	Derivative liabilities			3			46
Interest rate swaps	Derivative liabilities			1			2
Fixed price swaps	Other long-term liabilities			1			3
Two-way costless collars	Other long-term liabilities			–			9
Three-way costless collars	Other long-term liabilities			30			122
Basis swaps	Other long-term liabilities			–			5
Sold call options	Other long-term liabilities			15			35
Interest rate swaps	Other long-term liabilities			–			1
Total derivative liabilities			$	110		$	530

(1)

Excludes $1 million in premiums paid related to certain call options currently recognized as a component of derivative assets within current assets on the 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 consolidated statements of operations.

At December 31, 2017, the net fair value of the Company’s financial instruments related to commodities was a $77 million asset. The net fair value of the Company’s interest rate swaps was a $1 million liability as of December 31, 2017.

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 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 December 31, 2017 and 2016, the Company had no positions designated for hedge accounting treatment. In 2015, the Company had certain fixed price swaps that were designated for hedge accounting. For the year ended December 31, 2015, the Company reported pre-tax gains in other comprehensive income of $45 million related to the effective portion of the unsettled fixed price swaps. The ineffective portion of those fixed price swaps was recognized in earnings and had an inconsequential impact to the consolidated statement of operations for the year ended December 31, 2015. For the year ended December 31, 2015, pre-tax gains of $209 million on settled fixed price swaps were transferred from other comprehensive income into gas sales revenues in the consolidated statement of operations.

Derivative Contracts Not Designated for Hedge Accounting

As of December 31, 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 consolidated statements of operations. Accordingly, the gain (loss) on derivatives component of the statement 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 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, sold call options and interest rate swaps not designated for hedge accounting on the consolidated statements of operations for the years ended December 31, 2017 and 2016:


		Gain (Loss) on Derivatives, Unsettled
		Recognized in Earnings
	Consolidated Statement of Operations	For the years ended
	Classification of Gain (Loss)	December 31,
Derivative Instrument	on Derivatives, Unsettled	2017			2016
		(in millions)
Fixed price swaps (1)	Gain (Loss) on Derivatives	$	232		$	(177)
Two-way costless collars	Gain (Loss) on Derivatives		52			(48)
Three-way costless collars	Gain (Loss) on Derivatives		136			(81)
Basis swaps	Gain (Loss) on Derivatives		(36)			12
Purchased call options	Gain (Loss) on Derivatives		2			–
Sold call options	Gain (Loss) on Derivatives		63			(81)
Interest rate swaps	Gain (Loss) on Derivatives		2			2
Total gain (loss) on unsettled derivatives		$	451		$	(373)

		Gain (Loss) on Derivatives, Settled (2)
		Recognized in Earnings
	Consolidated Statement of Operations	For the years ended
	Classification of Gain (Loss)	December 31,
Derivative Instrument	on Derivatives, Settled	2017			2016
		(in millions)
Fixed price swaps (1)	Gain (Loss) on Derivatives	$	(9)		$	–
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)			1
Basis swaps	Gain (Loss) on Derivatives		(6)			21
Sold call options	Gain (Loss) on Derivatives		(11)	(3)		–
Interest rate swaps	Gain (Loss) on Derivatives		(2)			(2)
Total gain (loss) on settled derivatives (4)		$	(29)		$	34

Total gain (loss) on derivatives		$	422		$	(339)

(1)

Includes the Company’s fixed price swaps on natural gas, ethane and propane. As of December 31, 2017, the amount of unsettled and settled fixed price swaps related to ethane and propane 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)

Includes $5 million amortization of premiums paid related to certain call options for the year ended December 31, 2017.

(4)

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.