DERIVATIVE COMMODITY INSTRUMENTS

Energen Resources Corporation, Energen’s oil and gas subsidiary, periodically enters into derivative commodity instruments to hedge its exposure to price fluctuations on oil, natural gas liquids and natural gas production. Such instruments may include over-the-counter (OTC) swaps and basis swaps typically executed with investment and commercial banks and energy-trading firms. Derivative transactions are pursuant to standing authorizations by the Board of Directors, which do not authorize speculative positions.

The Company is at risk for economic loss based upon the creditworthiness of its counterparties. Energen Resources was in a net gain position with two of its active counterparties and in a net loss position with the remaining twelve at March 31, 2014. The largest counterparty net gain position at March 31, 2014, Macquarie Bank Limited, constituted approximately $3.0 million of Energen Resources’ total net loss on fair value of derivatives.

The current policy of the Company is to not enter into agreements that require the posting of collateral. 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.

Prior to June 30, 2013, the Company utilized cash flow hedge accounting where applicable for its derivative transactions. The effective portion of the gain or loss on the derivative instrument was recognized in accumulated other comprehensive income 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 was required to be recognized in operating revenues immediately. All other derivative transactions not designated as cash flow hedge accounting are accounted for as mark-to-market transactions with gains or losses recognized in operating revenues in the period of change.

Effective March 31, 2013 and June 30, 2013, Energen Resources dedesignated from cash flow hedge accounting 5,078 thousand barrels (MBbl) and 2,353 MBbl, respectively, of various New York Mercantile Exchange (NYMEX) oil contracts associated with the Permian Basin due to lack of correlation. Gains and losses from inception of the hedge to the dedesignation date were frozen and will remain in accumulated other comprehensive income until the forecasted transactions actually occur. Subsequent gains or losses will be accounted for as mark-to-market and recognized immediately through operating revenues.

Effective June 30, 2013, the Company elected to discontinue the use of cash flow hedge accounting and to dedesignate all remaining derivative commodity instruments that were previously designated as cash flow hedges. As a result of discontinuing hedge accounting, any gains or losses from inception of the hedge to June 30, 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. As a result of the Company’s election to discontinue hedge accounting, all derivative transactions entered into subsequent to June 30, 2013 will be accounted for as mark-to-market transactions with gains or losses recognized in operating revenues in the period of change.

The following tables detail the fair values of derivative commodity instruments on the balance sheets:



(in thousands)	March 31, 2014
Derivative assets or (liabilities) not designated as hedging instruments
Accounts receivable	$	17,522
Long-term asset derivative instruments	4,989
Total derivative assets	22,511
Accounts receivable	(14,165		)	*
Long-term asset derivative instruments	(2,351		)	*
Accounts payable	(52,602		)
Long-term liability derivative instruments	(802		)
Total derivative liabilities	(69,920		)
Total derivatives not designated	$	(47,409	)



(in thousands)	December 31, 2013
Derivative assets or (liabilities) not designated as hedging instruments
Accounts receivable	$	36,224
Long-term asset derivative instruments	7,992
Total derivative assets	44,216
Accounts receivable	(18,761		)	*
Long-term asset derivative instruments	(2,553		)	*
Accounts payable	(30,302		)
Total derivative liabilities	(51,616		)
Total derivatives not designated	$	(7,400	)

*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 $6.7 million and a net $8.2 million deferred tax liability included in current deferred income taxes on the balance sheets related to derivative items included in accumulated other comprehensive income as of March 31, 2014, and December 31, 2013, respectively.

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



(in thousands)	Location on Statements of Income	Three months ended March 31, 2014		Three months ended March 31, 2013
Net gain (loss) recognized in other comprehensive income on derivatives (effective portion), net of tax of $1 and ($16,424)	—	$	2	$	(26,798	)
Gain reclassified from accumulated other comprehensive income into income (effective portion)	Operating revenues	$	4,054	$	17,824
Loss recognized in income on derivatives (ineffective portion and amount excluded from effectiveness testing)	Operating revenues	$	—	$	(534	)

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 Statements of Income	Three months ended March 31, 2014			Three months ended March 31, 2013
Loss recognized in income on derivatives	Operating revenues	$	(57,446	)	$	(31,501	)

As of March 31, 2014, $10.9 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. As of March 31, 2014, the Company had 7.4 million barrels (MMBbl) and 7.3 MMBbl of oil swaps which expire during 2014 and 2015, respectively, that are considered mark-to-market transactions. The Company had 44.9 billion cubic feet (Bcf) and 12.0 Bcf of natural gas and natural gas basis swaps which expire during 2014 and 2015, respectively, that are considered mark-to-market transactions. During 2013, the Company had a discontinuance of hedge accounting when Energen Resources determined it was probable certain forecasted volumes would not occur due to certain properties being sold. This discontinuance of hedge accounting resulted in $2.6 million after-tax losses being recognized into operating revenues during the three months ended March 31, 2014.

As of March 31, 2014, Energen Resources entered into the following transactions for the remainder of 2014 and subsequent years:



Production Period	Total Hedged Volumes		Average Contract Price	Description
Oil
2014	7,392	MBbl	$92.65 Bbl	NYMEX Swaps
2015	7,260	MBbl	$89.07 Bbl	NYMEX Swaps
Natural Gas
2014	7.9	Bcf	$4.55 Mcf	NYMEX Swaps
2014	23.5	Bcf	$4.60 Mcf	Basin Specific Swaps - San Juan
2014	7.4	Bcf	$3.81 Mcf	Basin Specific Swaps - Permian
2015	12.0	Bcf	$4.05 Mcf	Basin Specific Swaps - San Juan
Natural Gas Basis Differential
2014	4.6	Bcf	$(0.09) Mcf	San Juan Basis Swaps
2014	1.5	Bcf	$(0.17) Mcf	Permian Basis Swaps

As of March 31, 2014, the maximum term over which Energen Resources has hedged exposures to the variability of cash flows is through December 31, 2015.

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



	March 31, 2014
(in thousands)	Level 2*			Level 3*			Total
Current assets	$	(6,646	)	$	10,003		$	3,357
Noncurrent assets	1,192			1,446			2,638
Current liabilities	(42,531		)	(10,071		)	(52,602		)
Noncurrent liabilities	(802		)	—			(802		)
Net derivative asset (liability)	$	(48,787	)	$	1,378		$	(47,409	)



	December 31, 2013
(in thousands)	Level 2*			Level 3*			Total
Current assets	$	(1,658	)	$	19,121		$	17,463
Noncurrent assets	4,383			1,056			5,439
Current liabilities	(28,414		)	(1,888		)	(30,302		)
Net derivative asset (liability)	$	(25,689	)	$	18,289		$	(7,400	)

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 $18 million change in the fair value of open Level 3 derivative contracts. The resulting impact upon the results of operations would be an approximate $18 million associated with open Level 3 mark-to-market derivative contracts. Liquidity 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, 2014			March 31, 2013
Balance at beginning of period	$	18,289		$	89,019
Realized gains (losses)	(3,019		)	27,107
Unrealized losses relating to instruments held at the reporting date*	(16,835		)	(63,482		)
Settlements during period	2,943			(26,185		)
Balance at end of period	$	1,378		$	26,459

*Includes $13.2 million and $12.4 million in mark-to-market losses for the three months ended March 31, 2014 and 2013, respectively.

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, 2014			Valuation Technique*	Unobservable Input*	Range
Natural Gas Basis - San Juan
2014	$	5,326		Discounted Cash Flow	Forward Basis	($0.06 - $0.09) Mcf
2015	$	(129	)	Discounted Cash Flow	Forward Basis	($0.14) Mcf
Natural Gas Basis - Permian
2014	$	(3,819	)	Discounted Cash Flow	Forward Basis	($0.12 - $0.13) Mcf

*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, 2014
								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	$	22,511	$	(16,516	)	$	5,995	$	—	$	—	$	5,995
Derivative liabilities	$	69,920	$	(16,516	)	$	53,404	$	—	$	—	$	53,404



	December 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	$	44,215	$	(21,313	)	$	22,902	$	—	$	—	$	22,902
Derivative liabilities	$	51,615	$	(21,313	)	$	30,302	$	—	$	—	$	30,302