DERIVATIVE COMMODITY INSTRUMENTS

Energen Resources Corporation, Energen's oil and gas subsidiary, recognizes all derivatives on the balance sheet and measures all derivatives at fair value. If a derivative is designated as a cash flow hedge, the effectiveness of the hedge, or the degree that the gain (loss) for the hedging instrument offsets the loss (gain) on the hedged item, is measured at each reporting period. The effective portion of the gain or loss on the derivative instrument is recognized in other comprehensive income (OCI) as a component of shareholders’ equity and subsequently reclassified as operating revenues when the forecasted transaction affects earnings. The ineffective portion of a derivative's change in fair value is required to be recognized in operating revenues immediately. All derivative transactions are included in operating activities on the consolidated condensed statements of cash flows.

Energen Resources periodically enters into derivative commodity instruments that qualify as cash flow hedges to hedge its exposure to price fluctuations on oil, natural gas and natural gas liquids production. In addition, Alagasco periodically enters into cash flow derivative commodity instruments to hedge its exposure to price fluctuations on its gas supply. Such instruments may include over-the-counter (OTC) swaps and basis hedges with major energy derivative product specialists. The counterparties to the commodity instruments are investment banks and energy-trading firms. The Company is at risk for economic loss based upon the creditworthiness of its counterparties. Energen Resources was in a net loss position with ten of its active counterparties and in a net gain position with the remaining one at June 30, 2011. The four largest counterparty positions at June 30, 2011, Morgan Stanley Capital Group, Inc., Citibank, N.A., J Aron & Company and Shell Energy North America (US), L.P., constituted approximately $57.9 million, $36.2 million, $20.8 million and $20.2 million, respectively, of Energen Resources’ net loss on fair value of derivatives. Barclays Bank PLC was the only counterparty in a gain position of $6.7 million.

The current policy of the Company is to not enter into agreements that require the posting of collateral. The Company has a few older agreements, none of which have active positions as of June 30, 2011, which include collateral posting requirements based on the amount of exposure and counterparty credit ratings. The majority of the Company’s counterparty agreements include provisions for net settlement of transactions payable on the same date and in the same currency. Most of the agreements include various contractual set-off rights which may be exercised by the non-defaulting party in the event of an early termination due to a default.

The Company may also enter into derivative transactions that do not qualify for cash flow hedge accounting but are considered by management to represent valid economic hedges and are accounted for as mark-to-market transactions. These economic hedges may include, but are not limited to, basis hedges without a corresponding New York Mercantile Exchange hedge and hedges on non-operated or other properties for which all of the necessary information to qualify for cash flow hedge accounting is either not readily available or subject to change. Derivatives that do not qualify for hedge treatment are recorded at fair value with gains or losses recognized in operating revenues in the period of change.

The following tables detail the fair values of commodity contracts by business segment on the balance sheets:



(in thousands)	June 30, 2011
	Oil and Gas Operations				Natural Gas Distribution			Total
Derivative assets or (liabilities) designated as hedging instruments
Accounts receivable	$	49,182			$	—		$	49,182
Long-term asset derivative instruments	10,427			*	—			10,427
Total derivative assets	59,609				—			59,609
Accounts receivable	(37,177		)	*	—			(37,177		)
Accounts payable	(54,926		)		—			(54,926		)
Long-term liability derivative instruments	(120,273		)		—			(120,273		)
Total derivative liabilities	(212,376		)		—			(212,376		)
Total derivatives designated	(152,767		)		—			(152,767		)
Derivative assets or (liabilities) not designated as hedging instruments
Accounts payable	(68		)		(32,159		)	(32,227		)
Long-term liability derivative instruments	—				(17,657		)	(17,657		)
Total derivative liabilities	(68		)		(49,816		)	(49,884		)
Total derivatives not designated	(68		)		(49,816		)	(49,884		)
Total derivatives	$	(152,835	)		$	(49,816	)	$	(202,651	)



(in thousands)	December 31, 2010
	Oil and Gas Operations				Natural Gas Distribution			Total
Derivative assets or (liabilities) designated as hedging instruments
Accounts receivable	$	85,867			$	—		$	85,867
Long-term asset derivative instruments	3,156			*	—			3,156
Total derivative assets	89,023				—			89,023
Accounts receivable	(25,315		)	*	—			(25,315		)
Accounts payable	(50,508		)		—			(50,508		)
Long-term liability derivative instruments	(83,631		)		—			(83,631		)
Total derivative liabilities	(159,454		)		—			(159,454		)
Total derivatives designated	(70,431		)		—			(70,431		)
Derivative assets or (liabilities) not designated as hedging instruments
Accounts payable	(110		)		(27,906		)	(28,016		)
Long-term liability derivative instruments	—				(32,461		)	(32,461		)
Total derivative liabilities	(110		)		(60,367		)	(60,477		)
Total derivatives not designated	(110		)		(60,367		)	(60,477		)
Total derivatives	$	(70,541	)		$	(60,367	)	$	(130,908	)

* Amounts classified in accordance with accounting guidance which permits offsetting fair value amounts recognized for multiple derivative instruments executed with the same counterparty under a master netting arrangement.

The Company had a net $55.6 million and a net $26.8 million deferred tax asset included in current and noncurrent deferred income taxes on the consolidated condensed balance sheets related to derivative items included in OCI as of June 30, 2011, and December 31, 2010, respectively.

Alagasco recognizes all derivatives as either assets or liabilities on the balance sheet with a corresponding regulatory asset or liability. Any gains or losses are passed through to customers using the mechanisms of the GSA in compliance with Alagasco's APSC-approved tariff.

The following table details the effect of derivative commodity instruments in cash flow hedging relationships on the financial statements:



(in thousands)	Location on Income Statement	Three months ended June 30, 2011			Three months ended June 30, 2010
Gain recognized in OCI on derivative (effective portion), net of tax of $30.3 million and $26.3 million	—	$	49,449		$	42,917
Gain (loss) reclassified from accumulated OCI into income (effective portion)	Operating revenues	$	(5,770	)	$	56,666
Gain (loss) recognized in income on derivative (ineffective portion and amount excluded from effectiveness testing)	Operating revenues	$	(740	)	$	175



(in thousands)	Location on Income Statement	Six months ended June 30, 2011			Six months ended June 30, 2010
Gain (loss) recognized in OCI on derivative (effective portion), net of tax of ($29.1) million and $60.3 million	—	$	(47,425	)	$	98,385
Gain reclassified from accumulated OCI into income (effective portion)	Operating revenues	$	1,821		$	93,390
Gain (loss) recognized in income on derivative (ineffective portion and amount excluded from effectiveness testing)	Operating revenues	$	(2,391	)	$	1,879

The following table details the effect of derivative commodity instruments not designated as hedging instruments on the income statements:



(in thousands)	Location on Income Statement	Three months ended June 30, 2011			Three months ended June 30, 2010
Loss recognized in income on derivative	Operating revenues	$	(1	)	$	(1	)

(in thousands)	Location on Income Statement	Six months ended June 30, 2011			Six months ended June 30, 2010
Loss recognized in income on derivative	Operating revenues	$	(1	)	$	(4	)

As of June 30, 2011, $22.6 million, net of tax, of deferred net losses on derivative instruments recorded in accumulated other comprehensive income are expected to be reclassified and reported in earnings as operating revenues during the next twelve-month period. The actual amount that will be reclassified to earnings over the next year could vary materially from this amount due to changes in market conditions. As of June 30, 2011, the Company had 7 thousand barrels (MBbl) of oil hedges which expire during 2011 that did not meet the definition of a cash flow hedge but are considered by the Company to be economic hedges.

Energen Resources entered into the following transactions for the remainder of 2011 and subsequent years:



Production Period	Total Hedged Volumes	Average Contract Price	Description
Natural Gas
2011	7.1 Bcf	$6.47 Mcf	NYMEX Swaps
	19.4 Bcf	$5.65 Mcf	Basin Specific Swaps
2012	11.0 Bcf	$5.07 Mcf	NYMEX Swaps
	29.5 Bcf	$4.60 Mcf	Basin Specific Swaps
2013	8.8 Bcf	$5.30 Mcf	NYMEX Swaps
	25.1 Bcf	$4.88 Mcf	Basin Specific Swaps
2014	3.0 Bcf	$5.72 Mcf	NYMEX Swaps
	6.0 Bcf	$5.34 Mcf	Basin Specific Swaps
Oil
2011	2,242 MBbl	$80.47 Bbl	NYMEX Swaps
2012	3,881 MBbl	$83.53 Bbl	NYMEX Swaps
2013	3,296 MBbl	$85.97 Bbl	NYMEX Swaps
2014	2,818 MBbl	$87.92 Bbl	NYMEX Swaps
Oil Basis Differential
2011	1,103 MBbl	*	Basis Swaps
2012	753 MBbl	*	Basis Swaps
Natural Gas Liquids
2011	21.1 MMGal	$0.90 Gal	Liquids Swaps
2012	39.9 MMGal	$0.86 Gal	Liquids Swaps
2013	35.2 MMGal	$1.02 Gal	Liquids Swaps
* Average contract prices are not meaningful due to the varying nature of each contract.

Alagasco entered into the following natural gas transactions for the remainder of 2011 and subsequent years:



Production Period	Total Hedged Volumes	Description
2011	6.0 Bcf	NYMEX Swaps
2012	17.2 Bcf	NYMEX Swaps
2013	1.5 Bcf	NYMEX Swaps

As of June 30, 2011, the maximum term over which Energen Resources and Alagasco have hedged exposures to the variability of cash flows is through December 31, 2014, and December 31, 2013, respectively.

Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). The fair value hierarchy that prioritizes the inputs used to measure fair value is as follows:


Level 1 -	Unadjusted quoted prices in active markets for identical assets or liabilities;


Level 2 -	Pricing inputs other than quoted prices in active markets included within Level 1, which are either directly or indirectly observable through correlation with market data as of the reporting date;


Level 3 -	Pricing that requires inputs that are both significant and unobservable to the calculation of the fair value measure. The fair value measure represents estimates of the assumption that market value participants would use in pricing the asset or liability.

Derivative commodity instruments are over-the-counter (OTC) derivatives valued using market transactions and other market evidence whenever possible, including market-based inputs to models and broker or dealer quotations. These OTC derivative contracts trade in less liquid markets with limited pricing information as compared to markets with actively traded, unadjusted quoted prices; accordingly, the determination of fair value is inherently more difficult. OTC derivatives for which the Company is able to substantiate fair value through directly observable market prices are classified within Level 2 of the fair value hierarchy. These Level 2 fair values consist of swaps priced in reference to New York Mercantile Exchange (NYMEX) natural gas and oil futures. OTC derivatives valued using unobservable market prices have been classified within Level 3 of the fair value hierarchy. These Level 3 fair values include basin specific, basis and liquids swaps.

The following sets forth derivative assets and liabilities that were measured at fair value on a recurring basis:



	June 30, 2011
(in thousands)	Level 2*			Level 3*			Total
Current assets	$	(7,773	)	$	19,778		$	12,005
Noncurrent assets	78			$	924		$	1,002
Current liabilities	(81,752		)	(5,401		)	(87,153		)
Noncurrent liabilities	(126,650		)	(1,855		)	(128,505		)
Net derivative asset (liability)	$	(216,097	)	$	13,446		$	(202,651	)



	December 31, 2010
(in thousands)	Level 2*			Level 3*			Total
Current assets	$	10,316		$	50,236		$	60,552
Current liabilities	(76,527		)	(1,997		)	(78,524		)
Noncurrent liabilities	(107,452		)	(5,484		)	(112,936		)
Net derivative asset (liability)	$	(173,663	)	$	42,755		$	(130,908	)

As of June 30, 2011, Alagasco had $32.2 million and $17.7 million of derivative instruments which are classified as Level 2 fair values and are included in the above table as current liabilities and noncurrent liabilities, respectively. As of December 31, 2010, Alagasco had $27.9 million and $32.5 million of derivative instruments which are classified as Level 2 fair values and are included in the above table as current and noncurrent liabilities, respectively. Alagasco had no derivative instruments classified as Level 3 fair values as of June 30, 2011, and December 31, 2010.

The tables below set forth a summary of changes in the fair value of the Company’s Level 3 derivative commodity instruments as follows:



	Three months ended			Three months ended
(in thousands)	June 30, 2011			June 30, 2010
Balance at beginning of period	$	16,927		$	114,440
Realized (gains) losses	1,204			(303		)
Unrealized gains (losses) relating to instruments held at the reporting date	7,720			9,215
Settlements during period	(12,405		)	(31,535		)
Balance at end of period	$	13,446		$	91,817



	Six months ended			Six months ended
(in thousands)	June 30, 2011			June 30, 2010
Balance at beginning of period	$	42,755		$	64,517
Realized (gains) losses	1,204			(303		)
Unrealized gains (losses) relating to instruments held at the reporting date	(3,554		)	75,886
Settlements during period	(26,959		)	(48,283		)
Balance at end of period	$	13,446		$	91,817