Derivative Instruments

9 Months Ended

Sep. 30, 2011

Derivative Instruments [Abstract]

Derivative Instruments

Note 8 — Derivative Instruments

The Company seeks to reduce its exposure to commodity price volatility by hedging a portion of its production through commodity derivative instruments. The Company accounts for commodity derivatives in accordance with ASC Topic 815. When the conditions for hedge accounting specified in ASC Topic 815 are met, the Company may designate its commodity derivatives as cash flow hedges. The changes in fair value of derivative instruments that qualify for hedge accounting treatment are recorded in other comprehensive income (loss) until the hedged oil or natural gas quantities are produced. If a hedge becomes ineffective because the hedged production does not occur, or the hedge otherwise does not qualify for hedge accounting treatment, the changes in the fair value of the derivative would be recorded in the income statement as derivative income or expense. At September 30, 2011, the Company’s outstanding derivative instruments were considered effective cash flow hedges.

Oil and gas sales include additions related to the settlement of gas hedges of $478,000 and $4,550,000 and oil hedges of $178,000 and zero for the three months ended September 30, 2011 and 2010, respectively. For the nine month periods ended September 30, 2011 and 2010, oil and gas sales include additions (reductions) related to the settlement of gas hedges of $864,000 and $10,837,000 and oil hedges of ($211,000) and zero, respectively.

As of September 30, 2011, the Company had entered into the following oil and gas contracts accounted for as cash flow hedges:

	Instrument		Weighted
Production Period	Type	Daily Volumes	Average Price
Natural Gas:
October-December 2011	Costless Collar	15,000 Mmbtu	$	4.17 - 4.90
October-December 2011	Swap	10,000 Mmbtu	$	4.52
January-December 2012	Costless Collar	10,000 Mmbtu	$	5.00 - 5.29
Crude Oil:
October-December 2011	Costless Collar	500 Bbls	$	90.00 - 97.78

At September 30, 2011, the Company recognized an asset of approximately $4.7 million related to the estimated fair value of these derivative instruments. Based on estimated future commodity prices as of September 30, 2011, the Company would realize a $2.6 million gain, net of taxes, during the next 12 months. These gains are expected to be reclassified based on the schedule of oil and gas volumes stipulated in the derivative contracts.

All of the Company’s derivative instruments at September 30, 2011 were designated as hedging instruments under ASC Topic 815. The following tables reflect the fair value of the Company’s derivative instruments in the consolidated financial statements (in thousands):

Effect of Derivative Instruments on the Consolidated Balance Sheet at September 30, 2011 and December 31, 2010:

	Commodity Derivatives
	Balance Sheet
Period	Location	Fair Value
September 30, 2011	Hedge asset	$	4,178
September 30, 2011	Other assets	$	534
December 31, 2010	Other accrued liabilities	$	(1,089	)

Effect of Derivative Instruments on the Consolidated Statement of Operations for the three months ended September 30, 2011 and 2010:

	Amount of Gain (Loss)			Location of	Amount of Gain
	Recognized in Other			Gain Reclassified	Reclassified into
Instrument	Comprehensive Income			into Income	Income
Commodity Derivatives at Sept 30, 2011	$	2,402		Oil and gas sales	$	656
Commodity Derivatives at Sept 30, 2010	$	(186	)	Oil and gas sales	$	4,550

Effect of Derivative Instruments on the Consolidated Statement of Operations for the nine months ended September 30, 2011 and 2010:

	Amount of Gain		Location of	Amount of Gain
	Recognized in Other		Gain Reclassified	Reclassified into
Instrument	Comprehensive Income		into Income	Income
Commodity Derivatives at Sept 30, 2011	$	4,048	Oil and gas sales	$	653
Commodity Derivatives at Sept 30, 2010	$	2,117	Oil and gas sales	$	10,837

As defined in ASC Topic 820, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. ASC Topic 820 establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. As presented in the tables below, this hierarchy consists of three broad levels:

• Level 1: valuations consist of unadjusted quoted prices in active markets for identical assets and liabilities and has the highest priority;

• Level 2: valuations rely on quoted prices in markets that are not active or observable inputs over the full term of the asset or liability;

• Level 3: valuations are based on prices or third party or internal valuation models that require inputs that are significant to the fair value measurement and are less observable and thus have the lowest priority.

The Company classifies its commodity derivatives based upon the data used to determine fair value. The Company’s derivative instruments at September 30, 2011 were in the form of costless collars and swaps based on NYMEX pricing. The fair value of these derivatives is derived using an independent third-party’s valuation model that utilizes market-corroborated inputs that are observable over the term of the derivative contract. The Company’s fair value calculations also incorporate an estimate of the counterparties’ default risk for derivative assets and an estimate of the Company’s default risk for derivative liabilities. As a result, the Company designates its commodity derivatives as Level 2 in the fair value hierarchy.

The following table summarizes the net valuation of the Company’s derivatives subject to fair value measurement on a recurring basis as of September 30, 2011 and December 31, 2010 (in thousands):

	Fair Value Measurements Using
	Quoted Prices		Significant Other			Significant
	in Active		Observable			Unobservable
Instrument	Markets (Level 1)		Inputs (Level 2)			Inputs (Level 3)
Commodity Derivatives:
At September 30, 2011	$	—	$	4,712		$	—
At December 31, 2010	$	—	$	(1,089	)	$	—