Derivative Instruments

3 Months Ended

Mar. 31, 2014

Derivative Instruments and Hedging Activities Disclosure [Abstract]

Derivative Instruments

Derivative Instruments

The Company hedges a significant portion of its forecasted oil production to reduce exposure to commodity price fluctuations and provide long-term cash flow predictability to manage its business. The current direct NGL hedging market is constrained in terms of price, volume, duration and number of counterparties, which limits the Company’s ability to effectively hedge its NGL production. As a result, currently, the Company does not directly hedge its NGL production. The Company also, from time to time, enters into derivative contracts for a portion of its natural gas consumption.

The Company enters into commodity hedging transactions primarily in the form of swap contracts, collars and three-way collars. Swap contracts are designed to provide a fixed price. Collar contracts specify floor and ceiling prices to be received as compared to floating market prices. Three-way collar contracts combine a short put (the lower price), a long put (the middle price) and a short call (the higher price) to provide a higher ceiling price as compared to a regular collar and limit downside risk to the market price plus the difference between the middle price and the lower price if the market price drops below the lower price.

The Company enters into these transactions with respect to a portion of its projected production to provide an economic hedge of the risk related to the future commodity prices received. The Company does not enter into derivative contracts for trading purposes. The Company did not designate any of these contracts as cash flow hedges; therefore, the changes in fair value of these instruments are recorded in current earnings. See Note 6 for fair value disclosures about oil and natural gas commodity derivatives.

The following table summarizes derivative positions for the periods indicated as of March 31, 2014:

	April 1 - December31, 2014		2015
Oil positions:
Fixed price swaps (NYMEX WTI):
Hedged volume (MBbls)	3,713		—
Average price ($/Bbl)	$	91.26	$	—
Collars (NYMEX WTI):
Hedged volume (MBbls)	550		—
Average floor price ($/Bbl)	$	90.00	$	—
Average ceiling price ($/Bbl)	$	102.87	$	—
Three-way collars (NYMEX WTI):
Hedged volume (MBbls)	2,338		1,095
Short put ($/Bbl)	$	72.11	$	70.00
Long put ($/Bbl)	$	93.76	$	90.00
Short call ($/Bbl)	$	109.79	$	101.62
Three-way collars (ICE Brent):
Hedged volume (MBbls)	275		—
Short put ($/Bbl)	$	80.00	$	—
Long put ($/Bbl)	$	100.00	$	—
Short call ($/Bbl)	$	114.05	$	—
Oil basis differential positions:
ICE Brent - NYMEX WTI basis swaps:
Hedged volume (MBbls)	2,750		2,920
Hedged differential ($/Bbl)	$	11.60	$	11.60
Oil timing differential positions:
Trade month roll swaps (NYMEX WTI): (1)
Hedged volume (MBbls)	1,375		—
Hedged differential ($/Bbl)	$	0.32	$	—

⁽¹⁾  The Company hedges the timing risk associated with the sales price of oil in the Permian Basin. In this operating area, the Company generally sells oil for the delivery month at a sales price based on the average NYMEX WTI price during that month, plus an adjustment calculated as a spread between the weighted average prices of the delivery month, the next month and the following month during the period when the delivery month is prompt (the “trade month roll”).

Settled derivatives on oil production for the three months ended March 31, 2014, included volumes of 2,250 MBbls at an average contract price of $92.16 per Bbl. The oil derivatives are settled based on the average closing price of NYMEX light crude oil for each day of the delivery month.

Balance Sheet Presentation

The Company’s commodity derivatives are presented on a net basis in “derivative instruments” on the balance sheets. The following summarizes the fair value of derivatives outstanding on a gross basis:

	March 31, 2014		December 31, 2013
	(in thousands)
Assets:
Commodity derivatives	$	28,273	$	28,291
Liabilities:
Commodity derivatives	$	39,087	$	45,226

By using derivative instruments to economically hedge exposures to changes in commodity prices, the Company exposes itself to credit risk and market risk. Credit risk is the failure of the counterparty to perform under the terms of the derivative contract. When the fair value of a derivative contract is positive, the counterparty owes the Company, which creates credit risk. The Company’s counterparties are current participants or affiliates of participants in its Credit Facility or were participants or affiliates of participants in its Credit Facility at the time it originally entered into the derivatives. The Credit Facility is secured by the Company’s oil and natural gas reserves; therefore, the Company is not required to post any collateral. The Company does not receive collateral from its counterparties. The maximum amount of loss due to credit risk that the Company would incur if its counterparties failed completely to perform according to the terms of the contracts, based on the gross fair value of financial instruments, was approximately $28 million at March 31, 2014. The Company minimizes the credit risk in derivative instruments by: (i) limiting its exposure to any single counterparty; (ii) entering into derivative instruments only with counterparties that meet the Company’s minimum credit quality standard, or have a guarantee from an affiliate that meets the Company’s minimum credit quality standard; and (iii) monitoring the creditworthiness of the Company’s counterparties on an ongoing basis. In accordance with the Company’s standard practice, its commodity derivatives are subject to counterparty netting under agreements governing such derivatives and therefore the risk of loss is somewhat mitigated.

Gains (Losses) on Derivatives

Gains (losses) on oil and natural gas derivatives were net gains of approximately $3 million for the three months ended March 31, 2014, and net losses of approximately $737,000 for the three months ended March 31, 2013. These amounts are reported on the condensed statements of operations in “gains (losses) on oil and natural gas derivatives.”