DERIVATIVE INSTRUMENTS

3 Months Ended

Mar. 31, 2013

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 $77,014 and $2.0 million at March 31, 2013 and December 31, 2012, respectively.  As a result of these agreements, we recorded non-cash unrealized losses for unsettled contracts of $1.9 million and $0.5 million for the three months ended March 31, 2013 and 2012, 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 crude oil, natural gas and natural gas liquids sales for our commodity price hedges.

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 provide only partial protection against declines in commodity prices.  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 and costless collars 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 4 — “Fair Value Measurements” for further information.

The following derivative contracts were in place at March 31, 2013:

Crude Oil			Volume/Month		Price/Unit		Fair Value
Apr 2013-Dec 2013		Swap	14,000 Bbls	$	101.25 (1)	$	559,262
Apr 2013-Dec 2013		Swap	9,000 Bbls		109.13 (2)		90,989
Apr 2013-Jun 2013		Swap	6,000 Bbls		108.35 (2)		(21,678	)
Apr 2013-Dec 2013		Swap	6,000 Bbls		107.10 (2)		(48,805	)
Apr 2013-Jun 2013		Swap	7,000 Bbls		104.80 (2)		(99,799	)
Jul 2013-Sep 2013		Swap	6,000 Bbls		103.47 (2)		(82,032	)
Oct 2013-Dec 2013		Swap	3,000 Bbls		102.30 (2)		(36,529	)
Jan 2014-Dec 2014		Swap	7,500 Bbls		102.10 (2)		(79,460	)
Jan 2014-Jun 2014		Swap	2,000 Bbls		108.07 (2)		45,665
Jan 2014-Dec 2014		Swap	6,000 Bbls		106.40 (2)		236,162
Natural Gas
Apr 2013-Jun 2013		Collar	50,000 Mmbtu		Put $3.75-$4.00 Call (3)		(12,110	)
Apr 2013-Dec 2013		Collar	75,000 Mmbtu		Put $3.00-$4.25 Call (3)		(127,094	)
Apr 2013-Dec 2013		Collar	75,000 Mmbtu		Put $3.25-$4.00 Call (3)		(185,288	)
Apr 2013-Dec 2013		Collar	35,000 Mmbtu		Put $3.75-$4.21 Call (3)		(33,805	)
Apr 2013-Dec 2013		Swap	70,000 Mmbtu		$4.02 (3)		(53,207	)
Apr 2013-Dec 2014		Collar	42,500 Mmbtu		Put $3.75-$4.60 Call (3)		(42,669	)
Apr 2013-Dec 2014		Collar	42,500 Mmbtu		Put $3.50-$5.00 Call (3)		(32,588	)
	Total net fair value of derivative instruments					$	77,014

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

(2)   Commodity derivative based on Brent crude oil

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

The following table details the effect of derivative contracts on the Consolidated Statements of Operations for the three months ended March 31, 2013 and 2012, respectively:

Contract Type	Location of Gain or (Loss) Recognized in Income	Amount of Gain or (Loss) Recognized in Income
		Three months ended March 31,
		2013			2012
Crude oil contracts	Crude oil sales	$	(207,269	)	$	(161,597	)
Natural gas contracts	Natural gas sales		144,325			1,535,460
	Realized (loss) gain	$	(62,944	)	$	1,373,863
Crude oil contracts	Unrealized (loss) gain on derivative instruments	$	(809,413	)	$	(1,532,130	)
Natural gas contracts	Unrealized (loss) gain on derivative instruments		(1,073,577	)		1,006,497
	Unrealized loss	$	(1,882,990	)	$	(525,633	)

Balance Sheet Presentation

Our derivatives are presented on a net basis in derivative instruments on the Consolidated Balance Sheets.  The following summarizes the fair value of derivatives outstanding on a gross and net basis:

	March 31, 2013
	Gross		Netting (1)			Total
Assets:
Commodity derivatives	$	932,078	$	(697,665	)	$	234,413
Liabilities:
Commodity derivatives		855,064		(697,665	)		157,399

	December 31, 2012
	Gross		Netting (1)			Total
Assets:
Commodity derivatives	$	2,206,705	$	(246,700	)	$	1,960,005
Liabilities:
Commodity derivatives		246,700		(246,700	)		—

(1)   Represents counterparty netting under agreements governing such derivatives