DERIVATIVE INSTRUMENTS

9 Months Ended

Sep. 30, 2011

DERIVATIVE INSTRUMENTS

DERIVATIVE INSTRUMENTS

5.             DERIVATIVE INSTRUMENTS

At the end of each reporting period we record on our balance sheet the mark-to-market valuation of our derivative instruments.  We recorded net assets for derivative instruments of $5.9 million and $3.8 million at September 30, 2011 and December 31, 2010, respectively.  As a result of these agreements, we recorded a non-cash unrealized gain for unsettled contracts, of $2.1 million and $0.3 million for the nine months ended September 30, 2011 and 2010, respectively.  The estimated change in fair value of the derivatives is reported in other income (expense) as unrealized gain (loss) on derivative instruments.  The realized gain (loss) on derivative instruments is included in natural gas, crude oil and natural gas liquids sales for our commodity price hedges and as an (increase) decrease in interest expense for our interest rate swaps.  Our final interest rate swap terminated on May 8, 2011.

In the past we have entered into, and may in the future enter into, certain derivative arrangements with respect to portions of our natural gas and crude oil production, to reduce our sensitivity to volatile commodity prices, and with respect to portions of our debt, to reduce our sensitivity to volatile interest rates.  None of our derivative instruments are designated as cash flow or fair value hedges.  We believe that these derivative arrangements, although not free of risk, allow us to achieve a more predictable cash flow and to reduce exposure to commodity price and interest rate fluctuations.  However, derivative arrangements limit the benefit of increases in the prices of natural gas, crude oil and natural gas liquids sales and limit the benefit of decreases in interest rates.  Moreover, our derivative arrangements apply only to a portion of our production and our debt and provide only partial protection against declines in commodity prices and increases in interest rates, respectively.  Such arrangements may expose us to risk of financial loss in certain circumstances.  We continuously reevaluate our hedging programs in light of changes in production, market conditions, commodity price forecasts, capital spending, interest rate forecasts and debt service requirements.

We use a mix of commodity swaps, put options, costless collars and interest rate swaps to accomplish our hedging strategy.  Derivative assets and liabilities with the same counterparty, subject to contractual terms which provide for net settlement, are reported on a net basis on our consolidated balance sheets.  We have exposure to financial institutions in the form of derivative transactions in connection with our hedges.  These transactions are with counterparties in the financial services industry, and specifically with members of our bank group.  These transactions could expose us to credit risk in the event of default of our counterparties.  We believe our counterparty risk is low in part because of the offsetting relationship we have with each of our counterparties provided for in our revolving credit agreement and various hedge contracts.  See Note 4 — “Fair Value Measurements” for further information.

The following derivative contracts were in place at September 30, 2011:

Crude Oil		Volume/Month	Price/Unit	Fair Value
Oct 2011-Dec 2011	Swap	3,300 Bbls	$70.74	$		(85,475	)
Oct 2011-Dec 2011	Collar	7,000 Bbls	$64.50-$69.50	(222,537			)
Oct 2011-Dec 2011	Swap	3,100 Bbls	$85.65	(9,708			)
Oct 2011-Dec 2011	Collar	5,300 Bbls	$90.00-$112.60	188,219
Jan 2012-Dec 2012	Collar	4,500 Bbls	$90.00-$110.46	743,057
Jan 2012-Dec 2012	Collar	5,000 Bbls	$85.00-$102.70	575,509
Jan 2012-Dec 2012	Collar	5,100 Bbls	$80.00-$107.30	483,355
Natural Gas
Oct 2011-Dec 2011	Collar	266,000 Mmbtu	$7.32-$8.70	2,793,657
Oct 2011-Dec 2011	Swap	232,500 Mmbtu	$4.39	410,950
Jan 2012-Dec 2012	Put	320,000 Mmbtu	$5.00	1,060,800
Natural Gas Liquids
Oct 2011-Dec 2011 (1)	Swap	210,000 Gallons	$1.362	(85,308			)
	Commodity price derivative instruments			5,852,519
	Total net fair value of derivative instruments			$	5,852,519

(1)Propane contract

The following table details the effect of derivative contracts on the Consolidated Statements of Operations for the three months and nine months ended September 30, 2011 and 2010, respectively:

Contract Type	Location of Gain or (Loss) Recognized in Income	Amount of Gain or (Loss) Recognized in Income
		Three months ended September 30,					Nine months ended September 30,
		2011		2010			2011			2010
Commodity price contracts	Operating revenues	$	1,913,473	$	5,335,384		$	4,818,665		$	15,243,462
Interest rate contracts	Interest expense	—		(1,145,628		)	(1,410,764		)	(3,438,406		)
	Realized gain	$	1,913,473	$	4,189,756		$	3,407,901		$	11,805,056
Commodity price contracts	Other income (expense)	$	4,222,523	$	(2,070,129	)	$	666,493		$	(1,816,011	)
Interest rate contracts	Other income (expense)	—		811,803			1,392,740			2,081,910
	Unrealized gain (loss)	$	4,222,523	$	(1,258,326	)	$	2,059,233		$	265,899