DERIVATIVES

Commodity Derivatives

We have entered into various types of derivative transactions covering some of our projected natural gas, NGLs, and oil production. These transactions are intended to reduce our exposure to market price volatility by setting the price(s) we will receive for that production. Our decisions on the price(s), type, and quantity of our production hedged is based, in part, on our view of current and future market conditions. As of September 30, 2012, our derivative transactions consisted of the following types of hedges:


•	Swaps. We receive or pay a fixed price for the hedged commodity and pay or receive a floating market price to the counterparty. The fixed-price payment and the floating-price payment are netted, resulting in a net amount due to or from the counterparty.


•	Collars. A collar contains a fixed floor price (put) and a ceiling price (call). If the market price exceeds the call strike price or falls below the put strike price, we receive the fixed price and pay the market price. If the market price is between the call and the put strike price, no payments are due from either party.

We have documented policies and procedures to monitor and control the use of derivative instruments. We do not engage in derivative transactions for speculative purposes. In August 2012, we determined on a prospective basis, to enter into economic hedges without electing cash flow hedge accounting. Therefore, the change in fair value, on all commodity derivatives entered into after that determination, will be reflected in the income statement and not in accumulated other comprehensive income (OCI).

At September 30, 2012, the following cash flow hedges were outstanding:



Term	Commodity	Hedged Volume	Weighted Average Fixed Price for Swaps	Hedged Market
Oct’12 – Dec’12	Crude oil – swap	6,250 Bbl/day	$97.72	WTI – NYMEX
Jan’13 – Dec’13	Crude oil – swap	5,500 Bbl/day	$99.71	WTI – NYMEX
Oct’12 – Dec’12	Natural gas – swap	30,000 MMBtu/day	$5.05	IF – NYMEX (HH)
Oct’12 – Dec’12	Natural gas – swap	15,000 MMBtu/day	$5.62	IF – PEPL
Jan’13 – Dec’13	Natural gas – swap	60,000 MMBtu/day	$3.56	IF – NYMEX (HH)
Jan’13 – Dec’13	Natural gas – collar	20,000 MMBtu/day	$3.25-3.72	IF – NYMEX (HH)
Oct’12 – Dec’12	Liquids – swap (1)	180,006 Gal/mo	$2.11	OPIS – Conway
Oct’12 – Dec’12	Liquids – swap (2)	310,000 Gal/mo	$0.67	OPIS – Mont Belvieu

(1)Types of liquids involved are natural gasoline.

(2)Types of liquids involved are ethane.

After September 30, 2012, we entered into the following non-designated hedges:



Term	Commodity	Hedged Volume	Weighted Average Fixed Price for Swaps	Hedged Market
Jan’13 – Dec’13	Natural gas – swap	20,000 MMBtu/day	$3.94	IF – NYMEX (HH)

The following tables present the fair values and locations of the derivative transactions recorded in our unaudited condensed consolidated balance sheets:



		Derivative Assets
		Fair Value
	Balance Sheet Location	September 30, 2012		December 31, 2011
		(In thousands)
Derivatives designated as hedging instruments
Commodity derivatives:
Current	Current derivative asset	$	14,517	$	31,938
Long-term	Non-current derivative asset	1,948		4,514
Total derivatives designated as hedging instruments		16,465		36,452
Total derivative assets		$	16,465	$	36,452



		Derivative Liabilities
		Fair Value
	Balance Sheet Location	September 30, 2012		December 31, 2011
		(In thousands)
Derivatives designated as hedging instruments
Commodity derivatives:
Current	Current portion of derivative liabilities	$	851	$	2,657
Long-term	Non-current derivative liabilities	1,214		—
Total derivatives designated as hedging instruments		2,065		2,657
Total derivative liabilities		$	2,065	$	2,657

If a legal right of set-off exists, we net the value of the derivative transactions we have with the same counterparty in our unaudited condensed consolidated balance sheets.

For derivative transactions entered into before October 2012, we recognize in accumulated OCI the effective portion of any changes in fair value and reclassify the recognized gains (losses) on the sales to revenue and the purchases to expense as the underlying transactions are settled. As of September 30, 2012 and 2011, we had a gain of $9.9 million and $37.3 million, net of tax, respectively, in accumulated OCI.

Based on market prices at September 30, 2012, we expect to transfer over the next 12 months (in the related month of settlement) a gain of approximately $8.3 million, net of tax, into OCI. The commodity derivative instruments existing as of September 30, 2012 are expected to mature by December 2013.

Certain derivatives do not qualify as cash flow hedges. As of September 30, 2012, all of our derivatives qualify for cash flow treatment; however, during 2011, we had three basis swaps that did not qualify as cash flow hedges. For those types of derivatives, any changes in the fair value that occurred before their maturity (i.e., temporary fluctuations in value) were reported in the unaudited condensed consolidated statements of income within our oil and natural gas revenues. Changes in the fair value of derivative instruments designated as cash flow hedges, to the extent they are effective in offsetting cash flows attributable to the hedged risk, are recorded in OCI until the hedged item is recognized into earnings. Any change in fair value resulting from ineffectiveness is recognized in our oil and natural gas revenues.

Effect of derivative instruments on the unaudited condensed consolidated statements of income (cash flow hedges) for the nine months ended September 30:



Derivatives in Cash Flow Hedging Relationships	Amount of Gain or (Loss) Recognized in Accumulated OCI on Derivative (Effective Portion) ⁽¹⁾
	2012		2011
	(In thousands)
Commodity derivatives	$	9,912	$	37,323
Total	$	9,912	$	37,323

(1) Net of taxes.

Effect of derivative instruments on the unaudited condensed consolidated statements of income (cash flow hedges) for the three months ended September 30:



Derivative Instrument	Location of Gain or (Loss) Reclassified from Accumulated OCI into Income & Location of Gain or (Loss) Recognized in Income	Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income ⁽¹⁾				Amount of Gain or (Loss) Recognized in Income ⁽²⁾
		2012		2011		2012			2011
		(In thousands)
Commodity derivatives	Oil and natural gas revenue	$	14,243	$	2,003	$	(4,015	)	$	2,336
Interest rate swaps	Interest, net	—		—		—			—
Total		$	14,243	$	2,003	$	(4,015	)	$	2,336


(1)	Effective portion of gain (loss).


(2)	Ineffective portion of gain (loss).

Effect of derivative instruments on the condensed consolidated statements of income (derivatives not designated as hedging instruments) for the three months ended September 30:



Derivatives Not Designated as Hedging Instruments	Location of Gain or (Loss) Recognized in Income on Derivative	Amount of Gain or (Loss) Recognized in Income on Derivative
		2012		2011
		(In thousands)
Commodity derivatives (basis swaps)	Oil and natural gas revenue	$	—	$	(61	)
Total		$	—	$	(61	)

Effect of derivative instruments on the unaudited condensed consolidated statements of income (cash flow hedges) for the nine months ended September 30:



Derivative Instrument	Location of Gain or (Loss) Reclassified from Accumulated OCI into Income & Location of Gain or (Loss) Recognized in Income	Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income ⁽¹⁾					Amount of Gain or (Loss) Recognized in Income ⁽²⁾
		2012		2011			2012			2011
		(In thousands)
Commodity derivatives	Oil and natural gas revenue	$	38,088	$	(882	)	$	(4,621	)	$	4,158
Interest rate swaps	Interest, net	—		(1,734		)	—			—
Total		$	38,088	$	(2,616	)	$	(4,621	)	$	4,158


(1)	Effective portion of gain (loss).


(2)	Ineffective portion of gain (loss).

Effect of derivative instruments on the condensed consolidated statements of income (derivatives not designated as hedging instruments) for the nine months ended September 30:



Derivatives Not Designated as Hedging Instruments	Location of Gain or (Loss) Recognized in Income on Derivative	Amount of Gain or (Loss) Recognized in Income on Derivative
		2012		2011
		(In thousands)
Commodity derivatives (basis swaps)	Oil and natural gas revenue	$	—	$	(1,008	)
Total		$	—	$	(1,008	)