DERIVATIVE INSTRUMENTS

6 Months Ended

Jun. 30, 2013

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 $2.7 million and $2.0 million at June 30, 2013 and December 31, 2012, respectively.  As a result of these agreements, we recorded non-cash unrealized gains for unsettled contracts of $0.8 million and $2.5 million for the six months ended June 30, 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.

In the past we have entered into, and may in the future enter into, certain derivative arrangements with respect to portions of our crude oil and natural gas 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 typically 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 as provided for in our revolving credit agreement and various hedge contracts.  See Note 5 — “Fair Value Measurements” for further information.

The following derivative contracts were in place at June 30, 2013:

		Volume/Month	Price/Unit		Fair Value
Crude Oil
Jul 2013-Dec 2013	Swap	14,000 Bbls	$	101.25 (1)	$	513,926
Jul 2013-Dec 2013	Swap	9,000 Bbls	109.13 (2)		444,279
Jul 2013-Dec 2013	Swap	6,000 Bbls	107.10 (2)		223,175
Jul 2013-Sep 2013	Swap	6,000 Bbls	103.47 (2)		35,530
Oct 2013-Dec 2013	Swap	3,000 Bbls	102.30 (2)		18,245
Jan 2014-Dec 2014	Swap	7,500 Bbls	102.10 (2)		394,075
Jan 2014-Jun 2014	Swap	2,000 Bbls	108.07 (2)		111,523
Jan 2014-Dec 2014	Swap	6,000 Bbls	106.40 (2)		622,903
Natural Gas
Jul 2013-Dec 2013	Collar	75,000 Mmbtu	Put $3.00-$4.25 Call (3)		(14,454		)
Jul 2013-Dec 2013	Collar	75,000 Mmbtu	Put $3.25-$4.00 Call (3)		(15,256		)
Jul 2013-Dec 2013	Collar	35,000 Mmbtu	Put $3.75-$4.21 Call (3)		40,606
Jul 2013-Dec 2013	Swap	70,000 Mmbtu	$4.02 (3)		153,979
Jul 2013-Dec 2014	Collar	42,500 Mmbtu	Put $3.75-$4.60 Call (3)		120,855
Jul 2013-Dec 2014	Collar	42,500 Mmbtu	Put $3.50-$5.00 Call (3)		70,850
Total net fair value of derivative instruments					$	2,720,236

(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

In July 2013, we entered into another crude oil swap for 40,000 Bbl/month for the remainder of the 2013 calendar year at $99.00 per barrel (WTI).  This new hedge is part of our ongoing hedging strategy.

The following table details the effect of derivative contracts on the Consolidated Statements of Operations for the three and six months ended June 30, 2013 and 2012, respectively:

		Amount of Gain or (Loss) Recognized in Income
	Location of Gain or (Loss)	Three months ended June 30,						Six months ended June 30,
Contract Type	Recognized in Income	2013			2012			2013			2012
Crude oil contracts	Crude oil sales	$	603,205		$	586,360		$	395,936		$	424,673
Natural gas contracts	Natural gas sales	(82,495		)	1,990,720			61,830			3,526,180
	Realized gain	$	520,710		$	2,577,080		$	457,766		$	3,950,853
Crude oil contracts	Unrealized gain on derivative instruments	$	1,799,880		$	5,724,945		$	1,650,927		$	4,192,815
Natural gas contracts	Unrealized (loss) gain on derivative instruments	843,341			(2,687,212		)	(890,696		)	(1,680,715		)
	Unrealized gain	$	2,643,221		$	3,037,733		$	760,231		$	2,512,100

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:

	June 30, 2013
	Gross		Netting (1)			Total
Assets:
Commodity derivatives	$	2,749,946	$	(29,710	)	$	2,720,236
Liabilities:
Commodity derivatives	29,710		(29,710		)	—

	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