Derivative Instruments and Hedging Activities
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Mar. 31, 2014
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Derivative Instruments and Hedging Activities Disclosure [Abstract] | |||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||||
Derivative Instruments and Hedging Activities |
Note 5 - Derivative Instruments and Hedging Activities
Objectives and strategies for using derivative instruments
The Company is exposed to fluctuations in oil and natural gas prices received for its production. Consequently, the Company believes it is prudent to manage the variability in cash flows on a portion of its oil and natural gas production. The Company utilizes a mix of collar, swap, put, call and similar derivative financial instruments to manage fluctuations in cash flows resulting from changes in commodity prices. The Company does not use these instruments for speculative or trading 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. 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 while continuing to be obligated under higher commodity price contracts subject to any right of offset under the agreements. Counterparty credit risk is considered when determining a derivative instruments’ fair value; see Note 6 for additional information regarding fair value.
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
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 benchmark price, such as the New York Mercantile Exchange (“NYMEX”) price. To determine the fair value of the Company’s derivative instruments, depending on the type of instrument, the Company utilizes present value methods or standard option valuation models that include assumptions about commodity prices based on those observed in underlying markets. See Note 6 for additional information regarding fair value.
Derivatives not designated as hedging instruments
The Company has elected not to designate its derivative contracts as accounting hedges under Accounting Standards Codification 815. Consequently, the Company records its derivative contracts at their fair values on the balance sheet and marks-to-market these contracts at the end of each period. The Company records changes in fair values as a gain or loss on the statement of operations as a component of gain (loss) on derivative contracts. The gain (loss) on derivative contracts in the statement of operations includes the mark-to-market adjustments on outstanding contracts and the impact of cash settlements.
The following table reflects the fair values of the Company’s derivative instruments for the periods presented:
As previously discussed, the Company’s derivative contracts are subject to master netting arrangements. The Company’s policy is to present the fair value of derivative contracts 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 March 31, 2014:
For the periods indicated, the Company recorded the following related to its derivatives in the statement of operations as gain or loss on derivative contracts:
Derivative positions
Listed in the table below are the outstanding oil and natural gas derivative contracts as of March 31, 2014 (volumes in thousands):
Excluded from the table above are offsetting natural gas long and short call options of 38,000 MMBtu per month for the period Apr14 – Dec14, each at a strike price of $4.75 per MMBtu.
The following derivative contracts were executed subsequent to March 31, 2014 (volumes in thousands):
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