Derivative Instruments

12 Months Ended

Dec. 31, 2012

Derivative Instruments

Derivative Instruments

6. 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 $2.0 million and $4.2 million at December 31, 2012 and December 31, 2011, respectively.  As a result of these agreements, we recorded non-cash unrealized losses for unsettled contracts, of $2.3 million and $6.5 million for the years ended December 31, 2012 and 2010, respectively and a non-cash unrealized gain for unsettled contracts of $0.5 million for the year ended December 31, 2011.  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 crude oil, natural gas 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 crude oil, natural gas 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 senior secured revolving credit agreement and various hedge contracts.  See Note 5 - “Fair Value Measurements” for further information.

The following derivative contracts were in place at December 31, 2012:

Crude Oil		Volume/Month	Price/Unit	Fair Value
Jan 2013-Dec 2013	Swap	14,000 Bbls	$101.25 (1)	$	1,346,343
Jan 2013-Dec 2013	Swap	9,000 Bbls	$109.13 (2)	232,424
Jan 2013-Jun 2013	Swap	6,000 Bbls	$108.35 (2)	(9,626		)
Jan 2013-Dec 2013	Swap	6,000 Bbls	$107.10 (2)	9,047
Jan 2013-Mar 2013	Swap	11,000 Bbls	$106.90 (2)	(87,050		)
Apr 2013-Jun 2013	Swap	7,000 Bbls	$104.80 (2)	(60,153		)
Jul 2013-Sep 2013	Swap	6,000 Bbls	$103.47 (2)	(45,781		)
Oct 2013-Dec 2013	Swap	3,000 Bbls	$102.30 (2)	(21,320		)
Jan 2014-Dec 2014	Swap	7,500 Bbls	$102.10 (2)	9,304
Natural Gas
Jan 2013-Jun 2013	Collar	50,000 MMBtu	$3.75 - $4.00 (3)	113,637
Jan 2013-Dec 2013	Collar	75,000 MMBtu	$3.00 - $4.25 (3)	(22,768		)
Jan 2013-Dec 2013	Collar	75,000 MMBtu	$3.25 - $4.00 (3)	124
Jan 2013-Dec 2013	Collar	35,000 MMBtu	$3.75 - $4.21 (3)	131,550
Jan 2013-Dec 2014	Collar	42,500 MMBtu	$3.75 - $4.60 (3)	217,794
Jan 2013-Dec 2014	Collar	42,500 MMBtu	$3.50 - $5.00 (3)	146,480
		Total net fair value of derivative instruments		$	1,960,005

(1) Commodity derivative based on West Texas Intermediate crude oil prices

(2) Commodity derivative based on Brent crude oil prices

(3) Commodity derivative based on Henry Hub NYMEX natural gas prices

We also entered into the following commodity swaps with a counterparty in our bank group on February 8, 2013:

Crude Oil		Volume/Month	Price/Unit
Jan 2014 — Jun 2014	Swap	2,000 Bbls	$108.07 (1)
Jan 2014 — Dec 2014	Swap	6,000 Bbls	$106.40 (1)

(1) Commodity derivative based on Brent crude oil prices

The following table details the effect of derivative contracts on the Consolidated Statements of Operations:

		Amount of Gain or (Loss) Recognized in Income
	Location of Gain or (Loss)	Twelve months ended December 31,
Contract Type	Recognized in Income	2012			2011			2010
Crude oil contracts	Crude oil sales	$	1,093,148		$	(3,531,207	)	$	1,446,686
Natural gas contracts	Natural gas sales	5,872,660			11,283,031			19,465,873
Natural gas liquids contract	Natural gas liquids sales	—			(254,220		)	—
Interest rate contracts	Interest expense	—			(1,410,764		)	(4,594,968		)
Realized gain		$	6,965,808		$	6,086,840		$	16,317,591
Crude oil contracts	Unrealized (loss) gain on derivative instruments	$	1,483,337		$	2,699,354		$	(1,477,423	)
Natural gas contracts	Unrealized (loss) gain on derivative instruments	(3,771,526		)	(3,637,188		)	(8,241,131		)
Interest rate contracts	Unrealized (loss) gain on derivative instruments	—			1,392,740			3,217,729
Unrealized gain (loss)		$	(2,288,189	)	$	454,906		$	(6,500,825	)