Annual report pursuant to Section 13 and 15(d)

Derivative Instruments and Hedging Activities

v2.4.0.6
Derivative Instruments and Hedging Activities
 12 Months Ended
Dec. 31, 2012
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 the majority of 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 trading 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 predominantly 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.

Financial statement presentation and settlements

Settlements of the Company's derivative instruments 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 fair value of the Company's derivative instruments, depending on the type of instruments, was determined by the use of present value methods or standard option valuation models with assumptions about commodity prices based on those observed in underlying markets. See Note 7 for additional information regarding fair value.

During 2012, the Company elected not to designate its derivative contracts, nor does it expect to designate future derivative contracts, as an accounting hedge under FASB ASC 815. Consequently, any derivative contract not designated as an accounting hedge will be carried at its fair value on the balance sheet and marked-to-market at the end of each period, with the change in value reflected as a gain or loss on the statement of operations.

Prior to 2012, the Company's derivative contracts recorded on the Consolidated Balance Sheets were designated as cash flow hedges, and were recorded at fair market value with the changes in fair value recorded net of tax through OCI in stockholders' equity. The future cash settlements on effective derivative contracts were recorded as an increase or decrease in crude oil and natural gas sales. Both changes in fair value and cash settlements on effective derivative contracts were recognized as derivative expense (income).

The following table reflects the fair values of the Company's derivative instruments for the periods indicated:

 
 
Balance Sheet Presentation
 
Asset Fair Value
 
Liability Fair Value
 
Net Derivative Fair Value
Commodity
 
Classification
 
Line Description
 
12/31/12
 
12/31/11
 
12/31/12
 
12/31/11
 
12/31/12
 
12/31/11
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives not designated as Hedging Instruments under ASC 815
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Natural gas
 
Current
 
Fair market value of derivatives
 
$
—

 
$
—

 
$
(125
)
 
$
—

 
$
(125
)
 
$
—

Natural gas
 
Non-current
 
Other long-term liabilities
 
—

 
—

 
(116
)
 
—

 
(116
)
 
—

Crude oil
 
Current
 
Fair market value of derivatives
 
1,674

 
—

 
—

 
—

 
1,674

 
—

Crude oil
 
Non-current
 
Other long-term assets
 
250

 
—

 
—

 
—

 
250

 
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Subtotals
 
 
 
$
1,924

 
$
—

 
$
(241
)
 
$
—

 
$
1,683

 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivatives designated as Hedging Instruments under ASC 815
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Natural gas
 
Current
 
Fair market value of derivatives
 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
—

Natural gas
 
Non-current
 
Other long-term assets
 
—

 
—

 
—

 
—

 
—

 
—

Crude oil
 
Current
 
Fair market value of derivatives
 
—

 
—

 
—

 
2,499

 
—

 
2,499

Crude oil
 
Non-current
 
Other long-term liabilities
 
—

 
—

 
—

 
—

 
—

 
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Subtotals
 
 
 
$
—

 
$
—

 
$
—

 
$
2,499

 
$
—

 
$
2,499

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Totals
 
 
 
$
1,924

 
$
—

 
$
(241
)
 
$
2,499

 
$
1,683

 
$
2,499



Derivatives not designated as hedging instruments under ASC 815

For the periods indicated, the Company recorded the following related to its derivative instruments that were not designated as accounting hedges and are recorded in the Statement of Operations as the gain or loss on derivative contracts:
 
 
For the year ended December 31,
 
 
2012
 
2011
 
2010
Natural gas derivatives
 
 
 
 
 
 
     Realized gain, net
 
$
34

 
$
—

 
$
—

     Unrealized loss, net
 
(241
)
 
—

 
—

          Subtotal loss, net
 
$
(207
)
 
$
—

 
$
—

 
 
 
 
 
 
 
Crude oil derivatives
 
 
 
 
 
 
     Realized gain, net
 
$
—

 
$
—

 
$
—

     Unrealized gain, net
 
1,924

 
—

 
—

          Subtotal gain, net
 
$
1,924

 
$
—

 
$
—

 
 
 
 
 
 
 
Total gain on derivative instruments, net
 
$
1,717

 
$
—

 
$
—



Derivatives designated as hedging instruments under ASC 815

The tables below present the effect of the Company’s derivative financial instruments on the consolidated statements of operations as an increase (decrease) to crude oil and natural gas sales:
 
For the year ended December 31,
 
2012
 
2011
 
2010
Amount of gain (loss) reclassified from OCI into income (effective portion)
$
1,420

 
$
(375
)
 
$
632

Amount of gain (loss) recognized in income (ineffective portion and amount excluded from effectiveness testing)
—

 
—

 
—



Derivative positions

Listed in the table below are the outstanding oil and natural gas derivative contracts as of December 31, 2012:
Product
Instrument
 
Average Volumes per Month
 
Quantity Type
 
Average Floor Price per Hedge
 
Average Ceiling Price per Hedge
 
Period
Crude oil (a) (b)
Collar
 
40
 
Bbls
 
$
90.00

 
$
116.00

 
Jan13 - Dec13
 
 
 
 
 
 
 
 
 
 
 
 
Product
Instrument
 
Average Volumes per Month
 
Quantity Type
 
Put/Call Price
 
Fixed-Price Swap
 
Period
Natural gas (c)
Swap
 
91
 
MMbtu
 
n/a

 
$
3.52

 
Jan13 - Dec13
Natural gas (c)
Put Option
 
91
 
MMbtu
 
$
3.00

 
n/a

 
Jan13 - Dec13
Natural gas (c)
Call Option
 
38
 
MMbtu
 
$
4.75

 
n/a

 
Jan14 - Dec14

(a)
See "Subsequent Event" discussion below regarding the replacement of this crude oil derivative contract in January 2013.

(b)
A collar is a combination of a sold call option (ceiling) and a purchased put option (floor).

(c)
The natural gas swap, put and call option were executed contemporaneously. The "above market" $3.52/MMbtu swap price the Company received was offset by the value of the two options sold by the Company. The short natural gas put option, when combined with the swap, creates the potential for a reduction in the effective swap price if NYMEX natural gas prices are below $3.00/MMbtu in 2013. The short natural gas call option, when combined with the Company's long production position, represents a "covered call," and creates a $4.75/MMbtu ceiling during the covered period.

Subsequent Event:

Derivative contracts executed subsequent to December 31, 2012 include the following:
Product
Instrument
 
Average Volumes per Month
 
Quantity Type
 
Put Price
 
Fixed-Price Swap
 
Period
Crude oil (a)
Swap
 
40
 
Bbls
 
n/a

 
$
101.30

 
Feb13 - Dec13
Crude oil
Swap
 
30
 
Bbls
 
n/a

 
$
93.35

 
Jan14 - Dec14
Crude oil (a)
Put
 
30
 
Bbls
 
$
70.00

 
n/a

 
Jan14 - Dec14

(a)
During January 2013, the Company monetized the remaining portion (Feb13-Dec13) of its 2013 crude oil collar positions of 40 Bbls per month reflected in previous table. The proceeds from this transaction, combined with the proceeds from the sale of the listed put for 30 Bbls per month, were used to finance the uplift in the crude oil swap for the period Feb13-Dec13.