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 to hedge its exposure to price fluctuations on oil, natural gas and natural gas liquids production. In prior years, Alagasco entered into cash flow derivative commodity instruments to hedge its exposure to price fluctuations on its gas supply. Hedge transactions are pursuant to standing authorizations by the Board of Directors, which do not authorize speculative positions. Such instruments may include over-the-counter (OTC) swaps and basis hedges typically with investment and commercial 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 six of its active counterparties at March 31, 2013. The two largest counterparty net loss positions at March 31, 2013, Morgan Stanley Capital Group, Inc and Barclays Bank PLC, constituted approximately $24.7 million and $5.1 million, respectively, of Energen Resources’ total net loss on fair value of derivatives. Energen Resources was in a net gain position with seven of its active counterparties at March 31, 2013. The two largest counterparty net gain positions at March 31, 2013, Macquarie Bank Limited and BP Corporation North America Inc., constituted approximately $10.3 million and $5.3 million, respectively, of Energen Resources’ net gain on fair value of derivatives.

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 March 31, 2013, 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 periodically enters 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, hedges on estimated future production not yet flowing, basis hedges without a corresponding New York Mercantile Exchange (NYMEX) 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 or are not designated as cash flow hedges are recorded at fair value with gains or losses recognized in operating revenues in the period of change. Effective March 31, 2013, Energen Resources dedesignated 5,078 thousand barrels (MBbl) of various Permian Basin NYMEX oil contracts due to lack of correlation. Any gains or losses from inception of the hedge to March 31, 2013 were frozen and will remain in accumulated other comprehensive income until the forecasted transactions actually occur. Any subsequent gains or losses will be accounted for as mark-to-market and recognized immediately through operating revenues.

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



(in thousands)	March 31, 2013
	Oil and Gas Operations				Natural Gas Distribution		Total
Derivative assets or (liabilities) designated as hedging instruments
Accounts receivable	$	51,277			$	—	$	51,277
Long-term asset derivative instruments	25,921				—		25,921
Total derivative assets	77,198				—		77,198
Accounts receivable	(36,245		)	*	—		(36,245		)
Long-term asset derivative instruments	(6,594		)	*	—		(6,594		)
Accounts payable	(11,983		)		—		(11,983		)
Long-term liability derivative instruments	(7,275		)		—		(7,275		)
Total derivative liabilities	(62,097		)		—		(62,097		)
Total derivatives designated	15,101				—		15,101
Derivative assets or (liabilities) not designated as hedging instruments
Accounts receivable	(4,342		)	*	—		(4,342		)
Long-term asset derivative instruments	6,872				—		6,872
Total derivative assets	2,530				—		2,530
Accounts payable	(20,816		)		—		(20,816		)
Long-term liability derivative instruments	(1,074		)		—		(1,074		)
Total derivative liabilities	(21,890		)		—		(21,890		)
Total derivatives not designated	(19,360		)		—		(19,360		)
Total derivatives	$	(4,259	)		$	—	$	(4,259	)



(in thousands)	December 31, 2012
	Oil and Gas Operations				Natural Gas Distribution			Total
Derivative assets or (liabilities) designated as hedging instruments
Accounts receivable	$	87,514			$	—		$	87,514
Long-term asset derivative instruments	37,954				—			37,954
Total derivative assets	125,468				—			125,468
Accounts receivable	(37,326		)	*	—			(37,326		)
Long-term asset derivative instruments	(6,810		)	*	—			(6,810		)
Long-term liability derivative instruments	(8,726		)		—			(8,726		)
Total derivative liabilities	(52,862		)		—			(52,862		)
Total derivatives designated	72,606				—			72,606
Derivative assets or (liabilities) not designated as hedging instruments
Accounts receivable	14,604				—			14,604
Long-term asset derivative instruments	9,433				—			9,433
Total derivative assets	24,037				—			24,037
Accounts payable	—				(2,593		)	(2,593		)
Long-term liability derivative instruments	(874		)		—			(874		)
Total derivative liabilities	(874		)		(2,593		)	(3,467		)
Total derivatives not designated	23,163				(2,593		)	20,570
Total derivatives	$	95,769			$	(2,593	)	$	93,176

* 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 $5.4 million and a net $28.4 million deferred tax liability included in current and noncurrent deferred income taxes on the consolidated condensed balance sheets related to derivative items included in OCI as of March 31, 2013, and December 31, 2012, respectively.

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



(in thousands)	Location on Statement of Income	Three months ended March 31, 2013			Three months ended March 31, 2012
Loss recognized in OCI on derivatives (effective portion), net of tax of ($16.4) million and ($7.5) million	—	$	(26,798	)	$	(12,234	)
Gain reclassified from accumulated OCI into income (effective portion)	Operating revenues	$	17,824		$	1,872
Loss recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)	Operating revenues	$	(534	)	$	(2,666	)

The following table details the effect of open and closed derivative commodity instruments not designated as hedging instruments on the income statement:



(in thousands)	Location on Statement of Income	Three months ended March 31, 2013			Three months ended March 31, 2012
Loss recognized in income on derivatives	Operating revenues	$	(31,501	)	$	(44,005	)

As of March 31, 2013, $1.6 million, net of tax, of deferred net gains 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 March 31, 2013, the Company had 4.2 billion cubic feet (Bcf) and 9.7 Bcf of natural gas hedges which expire during 2013 and 2014, respectively, that did not meet the definition of a cash flow hedge but are considered by the Company to be economic hedges. The Company had 10.5 million barrels (MMBbl), 8.2 MMBbl and 0.7 MMBbl of oil and oil basis hedges which expire during 2013, 2014 and 2015, respectively, that did not meet the definition of a cash flow hedge but are considered by the Company to be economic hedges. The Company had 1.6 million gallons (MMgal) of natural gas liquid hedges which expire during 2013 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 2013 and subsequent years:



Production Period	Total Hedged Volumes		Average Contract Price	Description
Natural Gas
2013	9.4	Bcf	$4.83 Mcf	NYMEX Swaps
	24.4	Bcf	$4.56 Mcf	Basin Specific Swaps - San Juan
	3.4	Bcf	$3.45 Mcf	Basin Specific Swaps - Permian
2014	10.6	Bcf	$4.55 Mcf	NYMEX Swaps
	25.7	Bcf	$4.72 Mcf	Basin Specific Swaps - San Juan
	9.7	Bcf	$3.81 Mcf	Basin Specific Swaps - Permian
Oil
2013	6,752	MBbl	$90.99 Bbl	NYMEX Swaps
2014	9,796	MBbl	$92.64 Bbl	NYMEX Swaps
2015	720	MBbl	$90.10 Bbl	NYMEX Swaps
Oil Basis Differential
2013	2,701	MBbl	$(3.02) Bbl	WTS/WTI Basis Swaps*
	2,995	MBbl	$(1.00) Bbl	WTI/WTI Basis Swaps**
Natural Gas Liquids
2013	33.9	MMGal	$1.02 Gal	Liquids Swaps
*WTS - West Texas Sour/Midland, WTI - West Texas Intermediate/Cushing
**WTI - West Texas Intermediate/Midland, WTI - West Texas Intermediate/Cushing

As of March 31, 2013, the maximum term over which Energen Resources has hedged exposures to the variability of cash flows is through December 31, 2015. Alagasco has not entered into any cash flow derivative transactions on its gas supply since 2010.

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



	March 31, 2013
(in thousands)	Level 2*			Level 3*			Total
Current assets	$	(12,452	)	$	23,142		$	10,690
Noncurrent assets	12,194			14,005			26,199
Current liabilities	(24,834		)	(7,965		)	(32,799		)
Noncurrent liabilities	(5,626		)	(2,723		)	(8,349		)
Net derivative asset (liability)	$	(30,718	)	$	26,459		$	(4,259	)



	December 31, 2012
(in thousands)	Level 2*			Level 3*			Total
Current assets	$	(3,629	)	$	68,421		$	64,792
Noncurrent assets	18,899			21,678			40,577
Current liabilities	(2,593		)	—			(2,593		)
Noncurrent liabilities	(8,520		)	(1,080		)	(9,600		)
Net derivative asset	$	4,157		$	89,019		$	93,176

As of March 31, 2013, Alagasco had no derivative instruments. As of December 31, 2012, Alagasco had $2.6 million of derivative instruments which are classified as Level 2 fair values and are included in the above table as current liabilities. Alagasco had no derivative instruments classified as Level 3 fair values as of December 31, 2012.

The Company has prepared a sensitivity analysis to evaluate the hypothetical effect that changes in the prices used to estimate fair value would have on the fair value of its derivative instruments. The Company estimates that a 10 percent increase or decrease in commodity prices would result in an approximate $28 million change in the fair value of open Level 3 derivative contracts. The resulting impact upon the results of operations would be an approximate $5.2 million associated with open Level 3 mark-to-market derivative contracts. Cash flow requirements to meet the obligation would not be significantly impacted as gains and losses on the derivative contracts would be similarly offset by sales at the spot market price.

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)	March 31, 2013			March 31, 2012
Balance at beginning of period	$	89,019		$	65,801
Realized gains	27,107			13,181
Unrealized gains (losses) relating to instruments held at the reporting date*	(63,482		)	39,767
Settlements during period	(26,185		)	(13,826		)
Balance at end of period	$	26,459		$	104,923

*Includes $12.4 million in mark-to-market losses and $3.8 million in mark-to-market gains for the three months ended March 31, 2013 and 2012.

The tables below set forth quantitative information about the Company’s Level 3 fair value measurements of derivative commodity instruments as follows:



(in thousands)	Fair Value as of March 31, 2013			Valuation Technique*	Unobservable Input*	Range
Natural Gas Basis - San Juan
2013	$	14,529		Discounted Cash Flow	Forward Basis	($0.14 - $0.16) Mcf
2014	$	16,066		Discounted Cash Flow	Forward Basis	($0.14 - $0.16) Mcf
Natural Gas Basis - Permian
2013	$	(1,854	)	Discounted Cash Flow	Forward Basis	($0.12) Mcf
2014	$	(2,731	)	Discounted Cash Flow	Forward Basis	($0.12 - $0.14) Mcf
Oil Basis - WTS/WTI
2013	$	(6,209	)	Discounted Cash Flow	Forward Basis	($0.66) Bbl
Oil Basis - WTI/WTI
2013	$	(2,207	)	Discounted Cash Flow	Forward Basis	($0.18 - $0.28) Bbl
Natural Gas Liquids
2013	$	8,865		Discounted Cash Flow	Forward Price	$0.75 - $0.83 Gal

*Discounted cash flow represents an income approach in calculating fair value including the referenced unobservable input and a discount reflecting credit quality of the counterparty.

The tables below set forth information about the offsetting of derivative assets and liabilities as follows:



	March 31, 2013
								Gross Amounts Not Offset in the Balance Sheets
(in thousands)	Gross Amounts Recognized		Gross Amounts Offset in the Balance Sheets			Net Amount Presented in the Balance Sheets		Financial Instruments		Cash Collateral Received		Net Amount
Derivative assets	$	79,728	$	(42,839	)	$	36,889	$	—	$	—	$	36,889
Derivative liabilities	$	83,987	$	(42,839	)	$	41,148	$	—	$	—	$	41,148



	December 31, 2012
								Gross Amounts Not Offset in the Balance Sheets
(in thousands)	Gross Amounts Recognized		Gross Amounts Offset in the Balance Sheets			Net Amount Presented in the Balance Sheets		Financial Instruments		Cash Collateral Received		Net Amount
Derivative assets	$	149,504	$	(44,135	)	$	105,369	$	—	$	—	$	105,369
Derivative liabilities	$	56,328	$	(44,135	)	$	12,193	$	—	$	—	$	12,193