Risk Management and Derivative Instruments

6 Months Ended

Jun. 30, 2012

Risk Management and Derivative Instruments

Risk Management and Derivative Instruments

4. Risk Management and Derivative Instruments

The Company is exposed to fluctuations in crude oil and natural gas prices on its production. The Company believes it is prudent to manage the variability in cash flows by entering into derivative financial instruments to economically hedge a portion of its crude oil and natural gas production. The Company utilizes various types of derivative financial instruments, including swaps and options, to manage fluctuations in cash flows resulting from changes in commodity prices. These derivative contracts are generally placed with major financial institutions that the Company believes are minimal credit risks. The oil and gas reference prices, upon which the commodity derivative contracts are based, reflect various market indices that management believes have a high degree of historical correlation with actual prices received by the Company for its oil and gas production.

Inherent in the Company’s portfolio of commodity derivative contracts are certain business risks, including market risk and credit risk. Market risk is the risk that the price of the commodity will change, either favorably or unfavorably, in response to changing market conditions. Credit risk is the risk of loss from nonperformance by the Company’s counterparty to a contract. The Company does not require collateral from its counterparties but does attempt to minimize its credit risk associated with derivative instruments by entering into derivative instruments only with counterparties that are large financial institutions, which management believes present minimal credit risk. In addition, to mitigate its risk of loss due to default, the Company has entered into agreements with its counterparties on its derivative instruments that allow the Company to offset its asset position with its liability position in the event of default by the counterparty. Due to the netting arrangements, had the Company’s counterparties failed to perform under existing commodity derivative contracts, the maximum loss at June 30, 2012 would have been approximately $18.3 million.

Commodity Derivative Contracts

As of June 30, 2012, the Company had the following open commodity positions:

	Hedged Volume	Weighted-Average Fixed Price
Oil (Bbls):
WTI Swaps — 2012	411,100	$		84.36
WTI Swaps — 2013	679,125			84.73
WTI Swaps — 2014	262,450			83.00
WTI Collars — 2012	82,800	$	85.00  -	127.28
WTI Deferred Premium Puts — 2012 (1)	276,000	$		79.01
WTI Basis Differential Swaps — 2012 (2)	505,300	$		9.73
WTI Basis Differential Swaps — 2013 (2)	679,125			6.30
LLS Swaps - 2012	315,180	$		116.55
Brent Swaps - 2013	1,021,749	$		111.89

(1)2012 deferred premium puts represent the net effective floor price of a put with a strike price of $85.00/Bbl and a deferred premium of $5.99/Bbl. The premiums for these instruments are paid each month, concurrently with the settlement of the monthly put contracts.

(2)The Company enters into swap arrangements intended to capture the positive differential between the Louisiana Light Sweet (“LLS”) pricing and West Texas Intermediate (“NYMEX WTI”) pricing.

Balance Sheet Presentation

The following table summarizes the gross fair value of derivative instruments by the appropriate balance sheet classification, even when the derivative instruments are subject to netting arrangements and qualify for net presentation in the Company’s condensed consolidated balance sheets at June 30, 2012 and December 31, 2011, respectively (in thousands):

Type	Balance Sheet Location (1)	June 30, 2012			December 31, 2011
Oil Swaps	Derivative financial instruments — Current Assets	$	6,633		$	—
Oil Swaps	Derivative financial instruments — Non-Current Assets	8,166			—
Oil Swaps	Derivative financial instruments — Current Liabilities	(2,225		)	(13,046		)
Oil Swaps	Derivative financial instruments — Non-Current Liabilities	(2,172		)	(10,116		)
Deferred Premium Puts	Derivative financial instruments — Current Assets	1,015			1,673
Deferred Premium Puts	Derivative financial instruments — Non-Current Assets	—			—
Deferred Premium Puts	Derivative financial instruments — Current Liabilities	(180		)	(278		)
Deferred Premium Puts	Derivative financial instruments — Non-Current Liabilities	—			(62		)
Collars	Derivative financial instruments — Current Assets	380			397
Collars	Derivative financial instruments — Non-Current Assets	—			—
Collars	Derivative financial instruments — Current Liabilities	(10		)	—
Collars	Derivative financial instruments — Non-Current Liabilities	—			—
Basis Differential Swaps	Derivative financial instruments — Current Assets	7,060			3,612
Basis Differential Swaps	Derivative financial instruments — Non-Current Assets	311			588
Basis Differential Swaps	Derivative financial instruments — Current Liabilities	(996		)	—
Basis Differential Swaps	Derivative financial instruments — Non-Current Liabilities	(57		)	—
Total		$	17,925		$	(17,232	)

(1)   The fair value of derivative instruments reported in the Company’s condensed consolidated balance sheets are subject to netting arrangements and qualify for net presentation. The following table reports the net derivative fair values as reported in the Company’s condensed consolidated balance sheets as of June 30, 2012 and December 31, 2011, respectively (in thousands):

	June30, 2012		December31, 2011
Consolidated balance sheet classification:
Current derivative instruments:
Assets	12,038		4,957
Liabilities	(360	)	(12,599	)
Non-current derivative instruments :
Assets	6,247		588
Liabilities	—		(10,178	)

Gains/Losses on Commodity Derivative Contracts

The Company does not designate its commodity derivative contracts as hedging instruments for financial reporting purposes. Accordingly, all gains and losses, including unrealized gains and losses from changes in the derivative instruments’ fair values, have been recorded in “Gains (losses) on commodity derivative contracts — net”, within revenues in the condensed consolidated statements of operations.

The following table presents realized net gains (losses) and unrealized net gains (losses) recorded by the Company related to the change in fair value of the derivative financial instruments in “Gains (losses) on commodity derivative contracts — net” for the periods presented (in thousands):

	For the Three Months Ended June 30,				For the Six Months Ended June 30,
	2012		2011		2012		2011
Realized net gains (losses)	(5,180	)	(6,130	)	(11,679	)	(8,137	)
Unrealized net gains (losses)	53,323		16,607		35,157		(9,982	)