NOTE 10 – DERIVATIVES

Interest Rate Swaps

From time to time we enter into interest rate swaps to manage our exposure to possible future interest rate increases under our credit agreement. Under these transactions we swap the variable interest rate we would otherwise pay on a portion of our bank debt for a fixed interest rate. In May 2011, in association with the repayment of outstanding borrowings under our credit agreement, we terminated our two outstanding interest rate swaps that were previously accounted for as cash flow hedges, resulting in an increase of approximately $1.5 million in interest expense. Approximately $1.1 million of that expense was capitalized and will be amortized over the life of the assets.

Commodity Derivatives

We have entered into various types of derivative transactions covering some of our projected natural gas, NGLs and oil production. These transactions are intended to reduce our exposure to market price volatility by setting the price(s) we will receive for that production. Our decisions on the price(s), type and quantity of our production hedged is based, in part, on our view of current and future market conditions. As of September 30, 2011, our derivative transactions consisted of the following types of hedges:

•

Swaps. We receive or pay a fixed price for the hedged commodity and pay or receive a floating market price to the counterparty. The fixed-price payment and the floating-price payment are netted, resulting in a net amount due to or from the counterparty.

•

Basis Swaps. We receive or pay the NYMEX settlement value plus or minus a fixed delivery point price for the hedged commodity and pay or receive the published index price at the specified delivery point. We use basis swaps to hedge the price risk between NYMEX and its physical delivery points.

Oil and Natural Gas Segment:

At September 30, 2011, the following cash flow hedges were outstanding:


Term	Commodity	Hedged Volume	Weighted Average Fixed Price for Swaps	Hedged Market
Oct'11– Dec'11	Crude oil – swap	4,000 Bbl/day	$84.28	WTI – NYMEX
Jan'12– Dec'12	Crude oil – swap	4,500 Bbl/day	$95.91	WTI – NYMEX
Jan'13 – Dec'13	Crude oil – swap	2,000 Bbl/day	$102.05	WTI – NYMEX

Oct'11 – Dec'11	Natural gas – swap	10,000 MMBtu/day	$4.43	CEGT
Oct'11– Dec'11	Natural gas – swap	70,000 MMBtu/day	$4.87	IF – NYMEX (HH)
Oct'11– Dec'11	Natural gas – basis differential swap	15,000 MMBtu/day	($0.14)	Tenn Zone 0 – NYMEX
Jan'12 – Dec'12	Natural gas – swap	30,000 MMBtu/day	$5.05	IF – NYMEX (HH)
Jan'12– Dec'12	Natural gas – swap	15,000 MMBtu/day	$5.62	IF – PEPL

Oct'11– Dec'11	Liquids – swap (1)	2,024,418 Gal/mo	$1.07	OPIS – Conway
Oct'11– Dec'11	Liquids – swap (1)	1,240,068 Gal/mo	$1.00	OPIS – Mont Belvieu
Jan'12– Mar'12	Liquids – swap (1)	1,350,014 Gal/mo	$1.10	OPIS – Conway
Jan'12– Mar'12	Liquids – swap (1)	1,155,018 Gal/mo	$0.91	OPIS – Mont Belvieu
Apr'12 – Dec'12	Liquids – swap (2)	180,006 Gal/mo	$2.11	OPIS – Conway
Apr'12– Jun'12	Liquids – swap (3)	690,028 Gal/mo	$0.79	OPIS – Mont Belvieu

(1) Types of liquids involved are natural gasoline, ethane, propane, isobutane and normal butane.

(2) Types of liquids involved are natural gasoline.

(3) Types of liquids involved are natural gasoline and ethane.

At September 30, 2011, the following non-qualifying cash flow derivatives were outstanding:

Term

Commodity

Hedged Volume

Basis Differential

Hedged Market

Oct'11– Dec'11

Natural gas – basis differential swap

15,000 MMBtu/day

($0.14)

Tenn Zone 0 – NYMEX

Oct'11– Dec'11

Natural gas – basis differential swap

10,000 MMBtu/day

($0.21)

CEGT – NYMEX

Oct'11– Dec'11

Natural gas – basis differential swap

10,000 MMBtu/day

($0.23)

PEPL – NYMEX

The following tables present the fair values of our derivative transactions and the location within our balance sheets where those values are recorded:


		Derivative Assets
		Fair Value
	Balance Sheet Location	September 30, 2011		December 31, 2010
		(In thousands)
Derivatives designated as hedging instruments

Commodity derivatives:
Current	Current derivative assets	$	41,257	$	5,091
Long-term	Non-current derivative assets		23,989		2,537

Total derivatives designated as hedging instruments			65,246		7,628


Derivatives not designated as hedging instruments

Commodity derivatives:
Current	Current derivative assets		0		477

Total derivatives not designated as hedging instruments			0		477


Total derivative assets		$	65,246	$	8,105


		Derivative Liabilities
		Fair Value
	Balance Sheet Location	September 30, 2011		December 31, 2010
		(In thousands)
Derivatives designated as hedging instruments

Interest rate swaps:
Current	Current derivative liabilities	$	0	$	1,139
Long-term	Non-current derivative liabilities		0		475
Commodity derivatives:
Current	Current derivative liabilities		342		13,166
Long-term	Non-current derivative liabilities		0		3,884

Total derivatives designated as hedging instruments			342		18,664


Derivatives not designated as hedging instruments

Commodity derivatives (basis swaps):
Current	Current derivative liabilities		210		141

Total derivatives not designated as hedging instruments			210		141


Total derivative liabilities		$	552	$	18,805

If a legal right of set-off exists, we net the value of the derivative transactions we have with the same counterparty in our balance sheets.

We recognize in accumulated other comprehensive income (OCI) the effective portion of any changes in fair value and reclassify the recognized gains (losses) on the sales to revenue and the purchases to expense as the underlying transactions are settled. As of September 30, 2011 and 2010, we had a gain of $37.3 million and $12.3 million, net of tax, respectively, in accumulated OCI.

Based on market prices at September 30, 2011, we expect to transfer a gain of approximately $25.0 million, net of tax, included in accumulated OCI during the next 12 months in the related month of settlement. The commodity derivative instruments existing as of September 30, 2011 are expected to mature by December 2013.

Certain derivatives do not qualify as cash flow hedges. Currently, three of our basis swaps do not qualify as cash flow hedges. For these derivatives, any changes in their fair value occurring before their maturity (i.e., temporary fluctuations in value) are reported in oil and natural gas revenues in our unaudited condensed consolidated statements of income. Changes in the fair value of derivatives designated as cash flow hedges, to the extent they are effective in offsetting cash flows attributable to the hedged risk, are recorded in OCI until the hedged item is recognized into earnings. Any change in fair value resulting from ineffectiveness is recognized in our oil and natural gas revenues.

Effect of Derivative Instruments on the Unaudited Condensed Consolidated Statement of Income (cash flow hedges) for the nine months ended September 30:


Derivatives in Cash Flow Hedging Relationships	Amount of Gain or (Loss) Recognized in Accumulated OCI on Derivative (Effective Portion) ⁽¹⁾
	2011		2010
	(In thousands)
Interest rate swaps	$	0	$	(1,193	)
Commodity derivatives		37,323		13,459

Total	$	37,323	$	12,266

(1) Net of taxes.

Effect of Derivative Instruments on the Unaudited Condensed Consolidated Statement of Income (cash flow hedges) for the three months ended September 30:


Derivative Instrument	Location of Gain or (Loss) Reclassified from Accumulated OCI into Income & Location of Gain or (Loss) Recognized in Income	Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income ⁽¹⁾					Amount of Gain or (Loss) Recognized in Income ⁽²⁾
		2011		2010			2011		2010
		(In thousands)
Commodity derivatives	Oil and natural gas revenue	$	2,003	$	14,760		$	2,336	$	176
Interest rate swaps	Interest, net		0		(298	)		0		0

	Total	$	2,003	$	14,462		$	2,336	$	176

(1)

Effective portion of gain (loss).

(2)

Ineffective portion of gain (loss).

Effect of Derivative Instruments on the Unaudited Condensed Consolidated Statement of Income (derivatives not designated as hedging instruments) for the three months ended September 30:


Derivatives Not Designated as Hedging Instruments	Location of Gain or (Loss) Recognized in Income on Derivative	Amount of Gain or (Loss) Recognized in Income on Derivative
		2011			2010
		(In thousands)
Commodity derivatives (basis swaps)	Oil and natural gas revenue	$	(61	)	$	(427	)

Total		$	(61	)	$	(427	)

Effect of Derivative Instruments on the Unaudited Condensed Consolidated Statement of Income (cash flow hedges) for the nine months ended September 30:


Derivative Instrument	Location of Gain or (Loss) Reclassified from Accumulated OCI into Income & Location of Gain or (Loss) Recognized in Income	Amount of Gain or (Loss) Reclassified from Accumulated OCI into Income ⁽¹⁾						Amount of Gain or (Loss) Recognized in Income ⁽²⁾
		2011			2010			2011		2010
		(In thousands)
Commodity derivatives	Oil and natural gas revenue	$	(882	)	$	36,447		$	4,158	$	605
Interest rate swaps	Interest, net		(1,734	)		(907	)		0		0

	Total	$	(2,616	)	$	35,540		$	4,158	$	605

(1)

Effective portion of gain (loss).

(2)

Ineffective portion of gain (loss).

Effect of Derivative Instruments on the Unaudited Condensed Consolidated Statement of Income (derivatives not designated as hedging instruments) for the nine months ended September 30:


Derivatives Not Designated as Hedging Instruments	Location of Gain or (Loss) Recognized in Income on Derivative	Amount of Gain or (Loss) Recognized in Income on Derivative
		2011			2010
		(In thousands)
Commodity derivatives (basis swaps)	Oil and natural gas revenue	$	(1,008	)	$	597

Total		$	(1,008	)	$	597