Quarterly report pursuant to Section 13 or 15(d)

Derivative Instruments and Hedging Activities

v2.4.0.8
Derivative Instruments and Hedging Activities
 9 Months Ended
Sep. 30, 2013
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 realized crude oil and natural gas prices for 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 primarily utilizes collars, put and call options 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 and offsetting

The use of derivative transactions exposes the Company to the risk that a counterparty will be unable to meet its commitments. To manage this risk, the Company’s established counterparties for commodity derivative instruments include a large, well-known financial institution and a large, well-known oil and gas company. While the Company monitors counterparty creditworthiness on an ongoing basis, 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. Counterparty credit risk is considered when determining a derivative instruments’ fair value; See Note 6 for additional information.
     
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 cash payment transfer or terminate the arrangement.
Financial statement presentation and settlements
In the first quarter of 2013, the Company monetized the remaining portion (covering the period Feb13-Dec13) of its 2013 crude oil collar positions of 40 Bbls per month. The proceeds from this transaction, combined with the proceeds from the sale of the below listed put for 30 Bbls per month, were used to finance the uplift in the crude oil swap for the period Feb13-Dec13.

Listed in the table below are the outstanding crude oil and natural gas derivative contracts as of September 30, 2013:
Commodity
 
Instrument
 
Average Notional Volumes per Month
 
Quantity Type
 
Put/Call Price
 
Fixed-Price Swap
 
Period
 
Designation under ASC 815
Natural gas
 
Swap
 
91
 
MMbtu
 
n/a

 
$
3.52

 
Oct13 - Dec13
 
Not Designated
Natural gas
 
Put Option
 
91
 
MMbtu
 
$
3.00

 
n/a

 
Oct13 - Dec13
 
Not Designated
Crude oil
 
Swap
 
40
 
Bbls
 
n/a

 
$
101.30

 
Oct13 - Dec13
 
Not Designated
Natural gas
 
Call Option
 
38
 
MMbtu
 
$
4.75

 
n/a

 
Jan14 - Dec14
 
Not Designated
Crude oil
 
Swap
 
30
 
Bbls
 
n/a

 
$
93.35

 
Jan14 - Dec14
 
Not Designated
Crude oil
 
Put Option
 
30
 
Bbls
 
$
70.00

 
n/a

 
Jan14 - Dec14
 
Not Designated
Crude oil
 
Swap
 
18
 
Bbls
 
n/a

 
$
102.08

 
Oct13 - Dec13
 
Not Designated
Crude oil
 
Swap
 
9
 
Bbls
 
n/a

 
$
94.58

 
Jan14 - Dec14
 
Not Designated

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 6 for additional information regarding fair value.

The following table reflects the fair values of the Company’s derivative instruments for the periods presented (none of which were designated as hedging instruments under ASC 815):
 
 
Balance Sheet Presentation
 
Asset Fair Value
 
Liability Fair Value
 
Net Derivative Fair Value
Commodity
 
Classification
 
Line Description
 
09/30/13
 
12/31/12
 
09/30/13
 
12/31/12
 
09/30/13
 
12/31/12
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Natural gas
 
Current
 
Fair market value of derivatives
 
$
—

 
$
—

 
$
(45
)
 
$
(125
)
 
$
(45
)
 
$
(125
)
Natural gas
 
Non-current
 
Other long-term liabilities
 
—

 
—

 
(18
)
 
(116
)
 
(18
)
 
(116
)
Crude oil
 
Current
 
Fair market value of derivatives
 
—

 
1,674

 
(1,094
)

—

 
(1,094
)

1,674

Crude oil
 
Non-current
 
Other long-term assets
 
36

 
250

 
—

 
—

 
36

 
250

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Totals
 
 
 
$
36

 
$
1,924

 
$
(1,157
)

$
(241
)
 
$
(1,121
)
 
$
1,683



The Company’s derivative contracts are subject to netting arrangements and, being representative of the way in which the contracts settle, are presented in the balance sheet at their fair values on a net basis based on the underlying commodity being hedged. The following presents the impact of this presentation to the Company’s recognized assets and liabilities at September 30, 2013:
 
 
Presented without
 
 
 
As Presented with
 
 
Effects of Netting
 
Effects of Netting
 
Effects of Netting
Current assets: Fair value of hedging contracts
 
$
96

 
$
(96
)
 
$
—

Long-term assets: Fair value of hedging contracts
 
155

 
(119
)
 
36

Current liabilities: Fair value of hedging contracts
 
(1,235
)
 
96

 
(1,139
)
Long-term liabilities: Fair value of hedging contracts
 
(137
)
 
119

 
(18
)


Derivatives not designated as hedging instruments

As discussed in the Company’s Form 10-K for the year ended December 31, 2012, the Company elected not to designate as an accounting hedge under FASB ASC 815 any of its derivative contracts executed subsequent to December 31, 2011, nor does it expect to designate future derivative contracts. Derivative contracts not designated as accounting hedges are carried at fair value on the balance sheet with both realized and unrealized (i.e. mark-to-market) gains or losses 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:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2013
 
2012
 
2013
 
2012
Natural gas derivatives
 
 
 
 
 
 
 
 
     Realized gain (loss), net
 
$
(16
)
 
$
—

 
$
(123
)
 
$
—

     Unrealized gain (loss), net
 
81

 
(205
)
 
178

 
(536
)
          Sub-total gain (loss), net
 
$
65

 
$
(205
)
 
$
55

 
$
(536
)
 
 
 
 
 
 
 
 
 
Crude oil derivatives
 
 
 
 
 
 
 
 
     Realized gain (loss), net
 
$
(618
)
 
$
—

 
$
804

 


     Unrealized gain (loss), net
 
(3,133
)
 
(1,393
)
 
(2,982
)
 
2,513

          Sub-total gain (loss), net
 
$
(3,751
)
 
$
(1,393
)
 
$
(2,178
)
 
$
2,513

 
 
 
 
 
 
 
 
 
Total gain (loss) on derivative instruments, net
 
$
(3,686
)
 
$
(1,598
)
 
$
(2,123
)
 
$
1,977



Derivatives designated as hedging instruments

As previously discussed, the Company elected to discontinue hedge accounting at the start of 2012, though certain of the Company’s crude oil derivative contracts designated as cash flow hedges were executed in prior periods and were in effect during 2012. Consequently, these designated contracts were recorded at fair market value with the effective portion of 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 were recorded as an increase or decrease in crude oil revenues. Both changes in fair value and cash settlements of ineffective derivative contracts were recognized as derivative expense (income). All contracts previously designated as hedging instruments expired during 2012.

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 revenues for the effective portion and as an increase (decrease) to other (income) expense for the ineffective portion and amounts excluded from effectiveness testing:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2013
 
2012
 
2013
 
2012
Amount of gain reclassified from OCI into income (effective portion)
 
$
—

 
$
260

 
$
—

 
$
772

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

 
(282
)
 
—

 
40