Derivative Instruments and Hedging Activities

9 Months Ended

Sep. 30, 2012

Derivative Instruments and Hedging Activities

Note 3 – Derivative Instruments and Hedging Activities

Our hedging strategy is designed to protect our near and intermediate term cash flow from future declines in oil and natural gas prices. This protection is essential to capital budget planning, which is sensitive to expenditures that must be committed to in advance such as rig contracts and the purchase of tubular goods. We enter into hedging transactions to secure a commodity price for a portion of future production that is acceptable at the time of the transaction. These hedges are designated as cash flow hedges upon entering into the contract. We do not enter into hedging transactions for trading purposes. We have no fair value hedges.

The nature of a derivative instrument must be evaluated to determine if it qualifies for hedge accounting treatment. If the instrument qualifies for hedge accounting treatment, it is recorded as either an asset or liability measured at fair value and subsequent changes in the derivative’s fair value are recognized in equity through other comprehensive income (loss), net of related taxes, to the extent the hedge is considered effective. Additionally, monthly settlements of effective hedges are reflected in revenue from oil and gas production and cash flows from operations. Instruments not qualifying for hedge accounting treatment are recorded in the balance sheet at fair value and changes in fair value are recognized in earnings through derivative expense (income). Typically, a small portion of our derivative contracts are determined to be ineffective. This is because oil and natural gas price changes in the markets in which we sell our products are not 100% correlative to changes in the underlying price basis indicated in the derivative contracts. Monthly settlements of ineffective hedges are recognized in earnings through derivative expense (income) and cash flows from operations.

We have entered into fixed-price swaps with various counterparties for a portion of our expected 2012, 2013, 2014 and 2015 oil and natural gas production from the Gulf Coast Basin. Some of our fixed-price oil swap settlements are based on an average of the New York Mercantile Exchange (“NYMEX”) closing price for West Texas Intermediate (“WTI”) during the entire calendar month, and some are based on the average of the Intercontinental Exchange (“ICE”) closing price for Brent crude oil during the entire calendar month. Our fixed-price gas swap settlements are based on the NYMEX price for the last day of a respective contract month. Swaps typically provide for monthly payments by us if prices rise above the swap price or to us if prices fall below the swap price. Our fixed-price swap contracts are with The Toronto-Dominion Bank, Barclays Bank PLC, BNP Paribas, The Bank of Nova Scotia, Bank of America and Natixis.

All of our derivative instruments at September 30, 2012 and December 31, 2011 were designated as effective cash flow hedges; however, during the nine-month periods ended September 30, 2012 and 2011, certain of our derivative contracts were determined to be partially ineffective. The following tables disclose the location and fair value amounts of derivative instruments reported in our balance sheet at September 30, 2012 and December 31, 2011.

Fair Value of Derivative Instruments at September 30, 2012
(in millions)
	Asset Derivatives			Liability Derivatives
Description	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Commodity contracts	Current assets: Fair value of hedging contracts	$	34.0	Current liabilities: Fair value of hedging contracts	($	1.1	)
	Long-term assets: Fair value of hedging contracts		18.2	Long-term liabilities: Fair value of hedging contracts		(2.3	)
		$	52.2		($	3.4	)

Fair Value of Derivative Instruments at December 31, 2011
(in millions)
	Asset Derivatives			Liability Derivatives
Description	Balance Sheet Location	Fair Value		Balance Sheet Location	Fair Value
Commodity contracts	Current assets: Fair value of hedging contracts	$	25.2	Current liabilities: Fair value of hedging contracts	($	11.1	)
	Long-term assets: Fair value of hedging contracts		22.5	Long-term liabilities: Fair value of hedging contracts		(0.8	)
		$	47.7		($	11.9	)

The following tables disclose the effect of derivative instruments in the statement of operations for the three and nine-month periods ended September 30, 2012 and 2011.

The Effect of Derivative Instruments on the Statement of Operations for the Three Months Ended September 30, 2012 and 2011 (in millions)
Derivatives in Cash Flow Hedging Relationships	Amount of Gain (Loss) Recognized in OCI on Derivatives (a)					Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) (b)					Gain (Loss) Recognized in Income on Derivatives (Ineffective Portion)
	2012			2011		Location	2012		2011		Location	2012			2011
Commodity contracts	($	33.2	)	$	76.0	Operating revenue – oil/gas production	$	10.0	$	1.3	Derivative income (expense), net	($	1.8	)	$	4.1
Total	($	33.2	)	$	76.0		$	10.0	$	1.3		($	1.8	)	$	4.1

(a) Net of related tax effect of ($19.2) million and $40.4 million for the three months ended September 30, 2012 and 2011, respectively.

(b) For the three months ended September 30, 2012, effective hedging contracts increased oil revenue by $4.1 million and increased gas revenue by $5.9 million. For the three months ended September 30, 2011, effective hedging contracts decreased oil revenue by $3.3 million and increased gas revenue by $4.6 million.

The Effect of Derivative Instruments on the Statement of Operations for the Nine Months Ended September 30, 2012 and 2011 (in millions)
Derivatives in Cash Flow Hedging Relationships	Amount of Gain (Loss) Recognized in OCI on Derivatives (a)				Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion) (b)						Gain (Loss) Recognized in Income on Derivatives (Ineffective Portion)
	2012		2011		Location	2012		2011			Location	2012		2011
Commodity contracts	$	7.9	$	79.6	Operating revenue – oil/gas production	$	18.4	($	13.1	)	Derivative income, net	$	3.1	$	3.3
Total	$	7.9	$	79.6		$	18.4	($	13.1	)		$	3.1	$	3.3

(a) Net of related tax effect of $4.6 million and $44.4 million for the nine months ended September 30, 2012 and 2011, respectively.

(b) For the nine months ended September 30, 2012, effective hedging contracts increased oil revenue by $1.1 million and increased gas revenue by $17.3 million. For the nine months ended September 30, 2011, effective hedging contracts decreased oil revenue by $26.1 million and increased gas revenue by $13.0 million.

At September 30, 2012, we had accumulated other comprehensive income of $29.8 million, net of tax, which related to the fair value of our swap contracts that were outstanding as of September 30, 2012. We believe that approximately $19.9 million of the accumulated other comprehensive income will be reclassified into earnings in the next 12 months.

The following table illustrates our hedging positions for calendar years 2012, 2013, 2014 and 2015 as of November 2, 2012:

	Fixed-Price Swaps NYMEX (except where noted)
	Natural Gas				Oil
	Daily Volume (MMBtus/d)		Swap Price ($)		Daily  Volume (Bbls/d)			Swap Price ($)
2012		10,000		5.035		1,000			90.30
2012		10,000		5.040		1,000			90.41
2012		10,000		5.050		1,000			90.45
2012						1,000			95.50
2012						2,000			97.60
2012						1,000			98.15
2012						1,000			100.00
2012						1,000			101.55
2012						1,000			104.25
2012						1,000	*		111.02
2013		10,000		4.000		1,000			92.80
2013		10,000		5.270		2,000	**		94.05
2013		10,000		5.320		1,000			94.45
2013						1,000			94.60
2013						1,000			97.15
2013						1,000			101.53
2013						1,000			103.00
2013						1,000			103.15
2013						1,000			104.25
2013						1,000			104.47
2013						1,000			104.50
2013						1,000	*		107.30
2014		10,000		4.000		1,000			90.06
2014		10,000		4.250		1,000			93.55
2014						1,000			98.00
2014						1,000			98.30
2014						1,000			99.65
2014						1,000	*		103.30
2015		10,000		4.005		1,000			90.00

* Brent oil contract

** January through June