DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

9 Months Ended

Sep. 30, 2012

DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

3. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

Objectives and Strategies

The Company is exposed to fluctuations in crude oil and natural gas prices on the majority of its worldwide production. Apache manages the variability in its cash flows by occasionally entering into derivative instruments on 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. Derivatives entered into are typically designated as cash flow hedges.

Counterparty Risk

The use of derivative instruments exposes the Company to counterparty credit risk, or the risk that a counterparty will be unable to meet its commitments. To reduce the concentration of exposure to any individual counterparty, Apache utilizes a diversified group of investment-grade rated counterparties, primarily financial institutions, for its derivative transactions. As of September 30, 2012, Apache had derivative positions with 17 counterparties. The Company monitors counterparty creditworthiness on an ongoing basis; however, 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, Apache may not realize the benefit of some of its derivative instruments resulting from lower commodity prices.

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 a material deterioration in its credit ratings, as defined in the applicable agreement, the other party has the right to demand the posting of collateral, demand a transfer, or terminate the arrangement.

Derivative Instruments

As of September 30, 2012, Apache had the following open crude oil derivative positions:

	Fixed-Price Swaps				Collars
Production Period	Mbbls		Weighted Average Fixed Price (1)		Mbbls		Weighted Average Floor Price (1)		Weighted Average Ceiling Price (1)
2012		941	$	74.32		2,808	$	77.66	$	103.08
2013		1,972		74.29		5,701		82.84		111.63
2014		76		74.50		–		–		–

⁽¹⁾  Crude oil prices represent a weighted average of several contracts entered into on a per-barrel basis. Crude oil contracts are primarily settled against NYMEX WTI Cushing Index. Approximately 31 percent of 2012 collars and 58 percent of 2013 collars are settled against Dated Brent.

As of September 30, 2012, Apache had the following open natural gas derivative positions:

	Fixed-Price Swaps						Collars
Production Period	MMBtu (in 000’s)		GJ (in 000’s)		Weighted Average Fixed Price (1)		MMBtu (in  000’s)		GJ (in 000’s)		Weighted Average Floor  Price (1)		Weighted Average Ceiling  Price (1)
2012		11,386		—	$	6.24		5,520		—	$	5.54	$	7.30
2012		—		11,040	C$	6.61		—		1,840	C$	6.50	C$	7.27
2013		10,095		—	$	6.74		6,825		—	$	5.35	$	6.67
2014		1,295		—	$	6.72		—		—	$	—	$	—

⁽¹⁾  U.S. natural gas prices represent a weighted average of several contracts entered into on a per-million British thermal units (MMBtu) basis and are settled primarily against NYMEX Henry Hub and various Inside FERC indices. The Canadian gas contracts are entered into on a per-gigajoule (GJ) basis and are settled against AECO Index. The Canadian natural gas prices represent a weighted average of AECO Index prices and are shown in Canadian dollars.

Fair Value Measurements

Apache’s commodity derivative instruments consist of variable-to-fixed price commodity swaps and options. The Company uses a market approach to estimate the fair values of its derivative instruments. A market approach uses prices and other relevant information generated by market transactions involving identical or comparable assets or liabilities. The Company’s derivatives are not actively quoted in the open market but are valued utilizing commodity futures price strips for the underlying commodities, which are provided by a reputable third party. For additional information regarding fair value measurements, please see Note 11—Fair Value Measurements of our Annual Report on Form 10-K for the year ended December 31, 2011.

The following table presents the Company’s derivative assets and liabilities measured at fair value on a recurring basis:

	Fair Value Measurements Using
	Quoted Price in Active Markets (Level 1)		Significant Other Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total Fair Value		Netting (1)			Carrying Amount
	(In millions)
September 30, 2012
Assets:
Commodity Derivative Instruments	$	—	$	138	$	—	$	138	$	(28	)	$		110
Liabilities:
Commodity Derivative Instruments		—		87		—		87		(28	)		59
December 31, 2011
Assets:
Commodity Derivative Instruments	$	—	$	428	$	—	$	428	$	(96	)	$		332
Liabilities:
Commodity Derivative Instruments		—		250		—		250		(96	)		154

⁽¹⁾ The derivative fair values are based on analysis of each contract on a gross basis, even where the legal right of offset exists.

Derivative Assets and Liabilities Recorded in the Consolidated Balance Sheet

All derivative instruments are reflected as either assets or liabilities at fair value in the consolidated balance sheet. These fair values are recorded by netting asset and liability positions where counterparty master netting arrangements contain provisions for net settlement. The carrying value of the Company’s derivative assets and liabilities and their locations on the consolidated balance sheet are as follows:

	September 30, 2012		December 31, 2011
	(In millions)
Current Assets: Derivative instruments	$	104	$	304
Other Assets: Deferred charges and other		6		28
Total Assets	$	110	$	332
Current Liabilities: Derivative instruments	$	56	$	113
Noncurrent Liabilities: Other		3		41
Total Liabilities	$	59	$	154

Derivative Activity Recorded in Statement of Consolidated Operations

The following table summarizes the effect of derivative instruments on the Company’s statement of consolidated operations:

	Gain (Loss) on Derivatives Recognized in Income	For the Quarter Ended September 30,				For the Nine Months Ended September 30,
		2012		2011		2012		2011
		(In millions)
Gain (loss) reclassified from accumulated other comprehensive income (loss) into operations (effective portion)	Oil and Gas Production Revenues	$	83	$	11	$	202	$	(36	)
Gain on derivatives recognized in operations (ineffective portion and basis)	Revenues and Other: Other	$	1	$	15	$	1	$	16

Derivative Activity in Accumulated Other Comprehensive Income (Loss)

A reconciliation of the components of accumulated other comprehensive income (loss) in the statement of consolidated shareholders’ equity related to Apache’s cash flow hedges is presented in the table below:

	For the Nine Months Ended September 30,
	2012						2011
	Before tax			After tax			Before tax			After tax
	(In millions)
Unrealized gain (loss) on derivatives at beginning of period	$	145		$	113		$	(54	)	$	(19	)
Realized amounts reclassified into earnings		(202	)		(151	)		36			32
Net change in derivative fair value		97			71			304			181
Ineffectiveness reclassified into earnings		(1	)		—			(16	)		(10	)
Unrealized gain on derivatives at end of period	$	39		$	33		$	270		$	184

Gains and losses on existing hedges will be realized in future earnings through mid-2014, in the same period as the related sales of natural gas and crude oil production occur. Included in accumulated other comprehensive income as of September 30, 2012, is a net gain of approximately $37 million ($31 million after tax) that applies to the next 12 months; however, estimated and actual amounts are likely to vary materially as a result of changes in market conditions.