Derivative Instruments

3 Months Ended

Mar. 31, 2012

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. When the conditions for hedge accounting 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 March 31, 2012, the Company’s outstanding derivative instruments were considered effective cash flow hedges.

Oil and gas sales include additions (reductions) related to the settlement of gas hedges of $2,155,000 and $200,000 and oil hedges of ($53,000) and ($100,000) for the three months ended March 31, 2012 and 2011, respectively.

As of March 31, 2012, the Company had entered into the following oil and gas contracts accounted for as cash flow hedges:

Production Period	Instrument Type	Daily Volumes	Weighted Average  Price
Natural Gas:
April—December 2012	Costless Collar	10,000 Mmbtu	$	5.00 - 5.29
April—October 2012	Swap	20,000 Mmbtu	$	2.60
Crude Oil:
April—December 2012	Swap	250 Bbls	$	100.77

At March 31, 2012, the Company recognized a net asset of approximately $7.6 million related to the estimated fair value of these derivative instruments. Based on estimated future commodity prices as of March 31, 2012, the Company would realize a $4.8 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 March 31, 2012 were designated as cash flow hedges. 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 March 31, 2012 and December 31, 2011:

	Commodity Derivatives
Period	Balance Sheet Location		Fair Value
March 31, 2012		Hedge asset	$	7,635
December 31, 2011		Hedge asset	$	6,418

Effect of Derivative Instruments on the Consolidated Statement of Operations for the three months ended March 31, 2012 and 2011:

Instrument	Amount of Gain (Loss) Recognized in Other Comprehensive Income			Location of Gain Reclassified into Income	Amount of Gain Reclassified into Income
Commodity Derivatives at March 31, 2012	$	764		Oil and gas sales	$	2,102
Commodity Derivatives at March 31, 2011	$	(728	)	Oil and gas sales	$	100

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 March 31, 2012 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 March 31, 2012 and December 31, 2011 (in thousands):

	Fair Value Measurements Using
Instrument	Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)
Commodity Derivatives:
At March 31, 2012	$	—	$	7,635	$	—
At December 31, 2011	$	—	$	6,418	$	—