(7) DERIVATIVES AND RISK MANAGEMENT

The Company is exposed to volatility in market prices and basis differentials for natural gas and crude oil which impacts the predictability of its cash flows related to the sale of natural gas and oil, and is exposed to volatility in interest rates. These risks are managed by the Company’s use of certain derivative financial instruments. At March 31, 2014 and December 31, 2013, the Company’s derivative financial instruments consisted of fixed price swaps, basis swaps, fixed price call options, and interest rate swaps. A description of the Company’s derivative financial instruments is provided below:


Fixed price swaps	The Company receives a fixed price for the contract and pays a floating market price to the counterparty.

Basis swaps	Arrangements that guarantee a price differential for natural gas from a specified delivery point. The Company receives a payment from the counterparty if the price differential is greater than the stated terms of the contract and pays the counterparty if the price differential is less than the stated terms of the contract.

Fixed price call options	The Company sells fixed price call options in exchange for a premium. At the time of settlement, if the market price exceeds the fixed price of the call option, the Company pays the counterparty such excess on sold fixed price call options. If the market price settles below the fixed price of the call option, no payment is due from either party.

Interest rate swaps	Interest-rate swaps are used to fix or float interest rates on existing or anticipated indebtedness. The purpose of these instruments is to manage the Company’s existing or anticipated exposure to unfavorable interest-rate changes.

GAAP requires that all derivatives be recognized in the balance sheet as either an asset or liability and be measured at fair value other than transactions for which normal purchase/normal sale is applied. Under GAAP, certain criteria must be satisfied in order for derivative financial instruments to be classified and accounted for as either a cash flow or a fair value hedge. Accounting for qualifying hedges requires a derivative’s gains and losses to be recorded either in earnings or as a component of other comprehensive income. Gains and losses on derivatives that are not elected for hedge accounting treatment or that do not meet hedge accounting requirements are recorded in earnings as a component of gain (loss) on derivatives. Within the gain (loss) on derivatives component of the statement of operations are gains (losses) on derivatives, net of settlement and gains (losses) on derivatives, settled. The Company calculates gains (losses) on derivatives, settled, as the summation of gains and losses on positions which have settled within the period.

The Company utilizes counterparties for its derivative instruments that it believes are credit-worthy at the time the transactions are entered into and the Company closely monitors the credit ratings of these counterparties. Additionally, the Company performs both quantitative and qualitative assessments of these counterparties based on their credit ratings and credit default swap rates where applicable. However, the events in the financial markets in recent years demonstrate there can be no assurance that a counterparty will be able to meet its obligations to the Company.

The balance sheet classification of the assets related to derivative financial instruments are summarized below at March 31, 2014 and December 31, 2013:


	Derivative Assets
	March 31, 2014			December 31, 2013
	Balance Sheet Classification	Fair Value		Balance Sheet Classification	Fair Value

	(in thousands)
Derivatives designated as hedging instruments:
Fixed price swaps	Derivative assets	$	1,362	Derivative assets	$	20,631
Total derivatives designated as hedging instruments		$	1,362		$	20,631

Derivatives not designated as hedging instruments:
Basis swaps	Derivative assets	$	9,692	Derivative assets	$	12,858
Fixed price swaps	Derivative assets		390	Derivative assets		37,382
Basis swaps	Other long-term assets		–	Other long-term assets		107
Fixed price swaps	Other long-term assets		30,245	Other long-term assets		–
Interest rate swaps	Other long-term assets		5,464	Other long-term assets		7,525
Total derivatives not designated as hedging instruments		$	45,791		$	57,872

Total derivative assets		$	47,153		$	78,503

	Derivative Liabilities
	March 31, 2014			December 31, 2013
	Balance Sheet Classification	Fair Value		Balance Sheet Classification	Fair Value

	(in thousands)
Derivatives designated as hedging instruments:
Fixed price swaps	Other current liabilities	$	32,971	Other current liabilities	$	3,884
Total derivatives designated as hedging instruments		$	32,971		$	3,884
Derivatives not designated as hedging instruments:
Basis swaps	Other current liabilities	$	7,808	Other current liabilities	$	1,501
Fixed price swaps	Other current liabilities		16,022	Other current liabilities		185
Fixed price call options	Other current liabilities		17,273	Other current liabilities		–
Interest rate swaps	Other current liabilities		2,177	Other current liabilities		1,520
Basis swaps	Other long-term liabilities		603	Other long-term liabilities		–
Fixed price call options	Other long-term liabilities		40,029	Other long-term liabilities		30,388
Interest rate swaps	Other long-term liabilities		2,495	Other long-term liabilities		3,012
Total derivatives not designated as hedging instruments		$	86,407		$	36,606

Total derivative liabilities		$	119,378		$	40,490

As of March 31, 2014, the Company had derivatives designated as cash flow hedges and derivatives not designated as hedges on the following volumes of natural gas production (in Bcf):


Year	Fixed price swaps	Fixed price swaps not designated for hedge accounting	Total
2014	211.8	136.8	348.6
2015	-	119.5	119.5

Cash Flow Hedges

The reporting of gains and losses on cash flow derivative hedging instruments depends on whether the gains or losses are effective at offsetting changes in the cash flows of the hedged item. The effective portion of the gains and losses on the derivative hedging instruments are recorded in other comprehensive income until recognized in earnings during the period that the hedged transaction takes place. The ineffective portion of the gains and losses from the derivative hedging instrument is recognized in earnings immediately.

As of March 31, 2014, the Company recorded a net loss in accumulated other comprehensive income related to its hedging activities of $18.6 million net of a deferred income tax benefit of $12.4 million. The amount recorded in accumulated other comprehensive income will be relieved over time and recognized in the statement of operations as the physical transactions being hedged occur. Assuming the market prices of natural gas futures as of March 31, 2014 remain unchanged, the Company would expect to transfer an aggregate after-tax net loss of $18.6 million from accumulated other comprehensive income to earnings during the next 12 months. Gains or losses from derivative instruments designated as cash flow hedges are reflected as adjustments to natural gas sales in the consolidated statements of operations. Volatility in net income, comprehensive income and comprehensive income may occur in the future as a result of the Company’s derivative activities.

The following tables summarize the before tax effect of all cash flow hedges on the unaudited condensed consolidated financial statements for the three-month period ended March 31, 2014 and 2013:


		Loss Recognized in Other Comprehensive Income
		(Effective Portion)
		For the three months ended
		March 31,
Derivative Instrument		2014		2013
		(in thousands)
Fixed price swaps		$	(90,334)	$	(73,902)

	Classification of Gain (Loss)	Gain (Loss) Reclassified from Accumulated
	Reclassified from	Other Comprehensive Income
	Accumulated Other	into Earnings (Effective Portion)
	Comprehensive Income	For the three months ended
	into Earnings	March 31,
Derivative Instrument	(Effective Portion)	2014		2013
		(in thousands)
Fixed price swaps	Gas sales	$	(41,978)	$	78,621

		Gain (Loss) Recognized in Earnings
		(Ineffective Portion)
	Classification of Gain (Loss)	For the three months ended
	Recognized in Earnings	March 31,
Derivative Instrument	(Ineffective Portion)	2014		2013
		(in thousands)
Fixed price swaps	Gas sales	$	(1,940)	$	1,301

Fair Value Hedges and Other Derivative Contracts

For fair value hedges, the gain or loss on the derivative instrument as well as the offsetting gain or loss on the hedged item are recognized in earnings immediately.

Although the Company’s basis swaps meet the objective of managing commodity price exposure, these trades are typically not entered into concurrent with the Company’s derivative instruments that qualify as cash flow hedges and therefore do not generally qualify for hedge accounting. Basis swap derivative instruments that are not designated for hedge accounting are recorded on the balance sheet at their fair values under derivative assets, other long-term assets, other current liabilities, and other long-term liabilities, as applicable and all gains and losses related to these contracts are recognized immediately in the consolidated statement of operations as a component of gain (loss) on derivatives.

As of March 31, 2014, the Company had basis swaps on natural gas production that were not designated for hedge accounting of 21.1 Bcf, 8.7 Bcf, and 0.9 Bcf in 2014, 2015, and 2016, respectively.

As of March 31, 2014, the Company had fixed price call options on 199.8 Bcf and 119.9 Bcf of 2015 and 2016 natural gas production, respectively, not designated for hedge accounting treatment and fixed price swaps of 136.8 Bcf and 119.5 Bcf of 2014 and 2015 natural gas production not designated for hedge accounting.

The Company is a party to interest rate swaps that were entered into in order to mitigate the Company’s exposure to volatility in interest rates related to construction of its new corporate office complex. The interest rate swaps build to a notional amount of $170.0 million and expire on June 20, 2020. The Company did not designate the interest rate swaps for hedge accounting. Changes in the fair value of the interest rate swaps are included in gain (loss) on derivatives in the consolidated statements of operations.

The following table summarizes the before tax effect of fair value hedges, fixed price call and basis swaps that were not designated for hedge accounting, and fixed price swaps and interest rate swaps not designated for hedge accounting on the uncondensed consolidated statements of operations for the three-month period ended March 31, 2014 and 2013:


		Gain (Loss) on Derivatives
		net of settlement
		Recognized in Earnings
		For the three months ended
	Consolidated Statement of Operations	March 31,
Derivative Instrument	Classification of Gain (Loss) on Derivatives, Net of Settlement	2014		2013
		(in thousands)
Basis swaps	Gain (Loss) on Derivatives	$	(10,184)	$	(2,950)
Fixed price call options	Gain (Loss) on Derivatives	$	(26,913)	$	(57,082)
Fixed price swaps	Gain (Loss) on Derivatives	$	(22,585)	$	29,232
Interest rate swaps	Gain (Loss) on Derivatives	$	(2,202)	$	–

		Gain (Loss)
		on Derivatives, Settled (1)
		Recognized in Earnings
	Consolidated Statement of Operations	For the three months ended
	Classification of Gain (Loss)	March 31,
Derivative Instrument	on Derivatives, Settled (1)	2014		2013
		(in thousands)
Basis swaps	Gain (Loss) on Derivatives	$	(14,270)	$	1,007
Fixed price swaps	Gain (Loss) on Derivatives	$	(23,453)	$	–
Interest rate swaps	Gain (Loss) on Derivatives	$	(113)	$	–

⁽¹⁾

The Company calculates gain (loss) on derivatives, settled, as the summation of gains and losses on positions that have settled within the period reported.