Note 5 — Oil and Gas Properties

We follow the successful efforts method of accounting for our interests in oil and gas properties. Under the successful efforts method, the costs of successful wells and leases containing productive reserves are capitalized. Costs incurred to drill and equip development wells, including unsuccessful development wells, are capitalized. Costs incurred relating to unsuccessful exploratory wells are expensed in the period the drilling is determined to be unsuccessful.

At December 31, 2011, we had capitalized costs associated with ongoing exploration and/or appraisal activities totaling $5.8 million. These capitalized costs may be charged against earnings in future periods if management determines that commercial quantities of hydrocarbons have not been discovered or that future appraisal drilling or development activities are not likely to occur. The following table provides a detail of our capitalized exploratory project costs at December 31, 2011 and 2010 (in thousands):

		2011		2010
Wang (1)	$	3,096	$	3,095
Danny 2 (1)		2,619		32
Other		125		125
Total	$	5,840	$	3,252

(1)

Amounts primarily reflect pre-engineering costs. The Wang prospect is located in proximity of our Phoenix field that commenced production in October 2010. The Danny 2 (formerly Kathleen) prospect is located within our Bushwood field at Garden Banks Blocks 462, 463, 506 and 507. Both Wang and Danny 2 are budgeted exploration capital expenditures for 2012.

The following table reflects net changes in exploratory well costs during the years ended December 31, 2011, 2010 and 2009 (in thousands):

		2011		2010			2009

Beginning balance at January 1,	$	3,252	$	3,059		$	2,105
Additions pending the determination of proved reserves		2,513		(944	)		36,208
Reclassifications to proved properties		5		713			(34,622	)
Charged to dry hole expense		70		424			(632	)
Ending balance at December 31,	$	5,840	$	3,252		$	3,059

Further, the following table details the components of exploration expense for the years ended December 31, 2011, 2010 and 2009 (in thousands):


		Years Ended December 31,
		2011			2010			2009

Delay rental and geological and geophysical costs	$	2,650		$	2,306		$	3,016
Impairment of unproved properties		8,334			6,394			20,130
Dry hole expense		(70	)		(424	)		1,237
Total exploration expense	$	10,914		$	8,276		$	24,383

Our oil and gas activities in the United States are regulated by the federal government and require significant third-party involvement, such as refinery processing and pipeline transportation. We record revenue from our offshore properties net of royalties paid to the Office of Natural Resources Revenues. Royalty fees paid totaled approximately $85.4 million, $37.2 million and $26.8 million for the years ended December 31, 2011, 2010 and 2009, respectively.

Gulf of Mexico Acquisitions and Dispositions.

In August 2006, we acquired a 100% working interest in the Typhoon oil field (Green Canyon Blocks 236/237), the Boris oil field (Green Canyon Block 282) and the Little Burn oil field (Green Canyon Block 238) in exchange for the assumption of certain asset retirement obligations. We renamed this field "Phoenix". We sold a 30% working interest in these fields to a third party in 2007 for $40 million. Production was re-established from the Phoenix field on October 19, 2010. The Little Burn oil field commenced production in August 2011.

In the first quarter of 2009, we sold our interest in East Cameron Block 316 for gross proceeds of approximately $18 million. In the second quarter of 2009, we sold three fields for gross proceeds of $0.8 million resulting in an aggregate gain of $1.2 million, including the transfer of the fields' asset retirement obligations.

In 2009, we farmed-out our 100% leasehold interests in Green Canyon Block 490 located in the deepwater of the Gulf of Mexico. Our farm out agreement was structured such that the operator paid 100% of the drilling costs to evaluate the prospective reservoir. The operator drilled a successful exploration well and we subsequently elected to participate for a 25 percent working interest in the field. Well completion and development commenced in 2011. In December 2011, we sold our ownership interest in this field for gross proceeds of approximately $31 million and recorded a pre-tax gain of $4.5 million. The transaction is also subject to certain customary closing conditions, which will result in the receipt of additional proceeds for capital expenditures we paid subsequent to the sale transaction effective date.

Royalty Claims

We and other industry participants were involved in a dispute with the U.S. Department of the Interior Minerals Management Service ("MMS"), predecessor of the BOEMRE and more recently the BOEM and BSEE, over royalties associated with production from certain deepwater oil and gas leases. As a result of this dispute, we recorded reserves for the disputed royalties (and any other royalties that may be claimed for production during 2005, 2006, 2007 and 2008) plus interest at 5% for our portion the MMS claim, which affected our Garden Banks Blocks 667, 668 and 669 ("Gunnison") leases. The result of accruing these reserves since 2005 reduced our oil and gas revenues. In the first quarter of 2009, following the decision of the United States Court of Appeals for the Fifth Circuit Court affirming the district court's previous ruling in favor of the plaintiffs in that case, which pertained to the Gunnison leases, we reversed our previously accrued royalties ($73.5 million) to oil and gas revenues. On October 5, 2009, the United States Supreme Court denied the government's petition for a writ of certiorari, and the MMS subsequently withdrew its orders to pay the royalty.

United Kingdom Property

Since 2006, we have maintained an ownership interest in the Camelot field, located offshore in the North Sea. In 2007, we sold half of our 100% working interest in Camelot to a third party with whom we agreed to jointly pursue future development and production of the field. In February 2010, we acquired this third party thereby assuming its obligations, most notably the asset retirement obligation, related to its 50% working interest in the field. The following table contains the fair value of the assets acquired and liabilities assumed in our acquisition of this third party and its 50% working interest in the Camelot field (in thousands):

Cash	$	10,156
Deferred tax asset		2,083
Accrued liabilities		(439	)
Asset retirement obligation		(5,841	)
Gain on acquisition of assets	$	5,959

In connection with the valuation of assets acquired and liabilities assumed in this acquisition, we reassessed the fair value associated with our original 50% interest in the field. Based on these evaluations, it was concluded that an impairment of the property was required based on the unlikely probability of our spending the future capital necessary to further develop the Camelot field. We recorded $5.0 million of total impairment charges to fully impair the property in 2010.

Our plan is to fully abandon the field in 2012 in accordance with applicable regulations in the United Kingdom. Modifications to U.K regulations over such operations required us to reassess our existing abandonment plan and cost estimates in 2011. The results of this review concluded that the scope of work that needs to be performed in the abandoning of the wells in the field would be significantly expanded and as a result our cost estimates have significantly increased. Based on our abandonment plan for 2012, we increased the asset retirement obligation by $20.0 million in 2011, which is reflected as a component of our impairment of oil and gas properties in the accompanying consolidated statements of operations. At December 31, 2011, the recorded asset retirement obligation for the Camelot field was $27.3 million.

Impairments

Proved property impairment charges are reflected as reductions in cost of sales in the accompanying consolidated statements of operations. However, because of the materiality of our oil and gas property impairment charges we reflect these as a separate line item within cost of sales in the accompanying consolidated statements of operations.

In 2011, we recorded $132.6 million of oil and gas property impairment charges, including $20.0 million related to our one U.K oil and gas property (see "United Kingdom Property" above). The $112.6 million of impairment charges associated with 27 of our Gulf of Mexico oil and gas fields included $21.7 million related to increasing the estimated asset retirement obligation for fields that are no longer producing. The impairment charges associated with producing fields totaled $90.9 million and were primarily related to changes in the related field economics of the affected oil and gas properties. During 2011, the price of natural gas decreased significantly. When natural gas prices decrease this often affects the assumptions regarding future development of certain fields as some or all of those proved reserves may become uneconomic to develop or produce. Our impairment charges also reflect end of field life factors, including premature depletion or capital allocation decisions, primarily those affecting third party operated fields.

In 2010, we recorded $181.1 million of oil and gas property impairment charges, including $5.0 million related to our one U.K. oil and gas property. A total of 28 of our Gulf of Mexico oil and gas properties were affected by impairments charges in 2010. The impairment charges associated with producing fields totaled $172.6 million, which primarily reflected reduction in our estimated proved reserves (Note 19). We also recorded $3.5 million of impairment charges to increase certain non-producing field's estimated asset retirement obligations.

In 2009, we recorded $120.6 million of oil and gas property impairment charges. We impaired a total of 47 of our Gulf of Mexico oil and gas properties. The impairment charges associated with producing fields totaled $72.4 million, which reflected decreases in estimated proved reserves associated with mechanical and production issues at certain fields. We also recorded $48.2 million of impairment charges to increase certain fields estimated asset retirement obligations, including $43.8 million of impairment related charges recorded to properties that were severely damaged by Hurricane Ike (Note 4).