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Derivative Instruments and Hedging Activities
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Mar. 31, 2012
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| Derivative Instruments and Hedging Activities Disclosure [Abstract] | ||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
| Derivative Instruments and Hedging Activities |
Derivative Instruments and Hedging Activities
Objectives and Strategies for Using Derivative Instruments
The Company is exposed to fluctuations in crude oil and natural gas prices on its production. Consequently, the Company believes it is prudent to manage the variability in cash flows on a portion of its crude oil and natural gas production. The Company utilizes primarily collars and swap derivative financial instruments to manage fluctuations in cash flows resulting from changes in commodity prices. The Company does not use these instruments for speculative purposes.
Counterparty Risk
The use of derivative transactions exposes the Company to counterparty credit risk, or the risk that a counterparty will be unable to meet its commitments. To reduce the Company’s risk in this area, counterparties to the Company’s commodity derivative instruments include a large, well-known financial institution and/or a large, well-known oil and gas company. The Company monitors counterparty creditworthiness on an ongoing basis; however, it cannot predict sudden changes in counterparties’ creditworthiness. In addition, even if such changes are not sudden, the Company may be limited in its ability to mitigate an increase in counterparty credit risk. Should one of these counterparties not perform, the Company may not realize the benefit of some of its derivative instruments under lower commodity prices.
The Company executes commodity derivative transactions under master agreements that have netting provisions that provide for offsetting payables against receivables. In general, if a party to a derivative transaction incurs an event of default, as defined in the applicable agreement, the other party will have the right to demand the posting of collateral, demand a transfer or terminate the arrangement.
Settlements and Financial Statement Presentation
Settlements of the Company’s oil and natural gas collar derivative contracts are based on the difference between the contract price or prices specified in the derivative instrument and a New York Mercantile Exchange (“NYMEX”) price. The estimated fair value of these collar contracts is based upon closing exchange prices on NYMEX and the time value of options. See Note 6, “Fair Value Measurements.”
Listed in the table below are the outstanding oil and natural gas derivative contracts as of March 31, 2012:
Derivatives designated as hedging instruments
The Company’s 2012 derivative contracts are designated as cash flow hedges, and are recorded at fair market value with the changes in fair value recorded net of tax through other comprehensive income (loss) (“OCI”) in stockholders’ equity. The cash settlements on contracts for future production are recorded as an increase or decrease in oil and natural gas sales. Both changes in fair value and cash settlements of ineffective derivative contracts are recognized as derivative expense (income).
The tables below present the effect of the Company's derivative financial instruments on the consolidated statements of operations as an increase (decrease) to oil and natural gas sales for the effective portion and as an increase (decrease) to other (income) expense for the ineffective portion and amounts excluded from effectiveness testing:
Derivatives not designated as hedging instruments
As discussed in the Company's Form 10-K for the year ended December 31, 2011, in February 2012 the Company elected not to designate its 2013 derivative contract, nor does it expect to designate future derivative contracts, as an accounting hedge under FASB ASC 815-20-25. Consequently, any derivative contract not designated as an accounting hedge is carried at its fair value on the balance sheet with both realized and unrealized (mark-to-market) gains or losses on these derivatives recorded on the statement of operations as a component of the Company's other income and expenses.
For the periods indicated, the Company recorded the following related to its derivative instruments that were not designated as accounting hedges:
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