Quarterly report pursuant to Section 13 or 15(d)

Hedging Activities

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Hedging Activities
 6 Months Ended
Jun. 30, 2011
Hedging Activities  
Hedging Activities
14.   HEDGING ACTIVITIES

The Company seeks to reduce its exposure to unfavorable changes in oil prices, which are subject to significant and often volatile fluctuation, by entering into fixed price swaps. These contracts allow the Company to predict with greater certainty the effective oil prices to be received for hedged production and benefit operating cash flows and earnings when market prices are less than the fixed prices provided in the contracts. However, the Company will not benefit from market prices that are higher than the fixed prices in the contracts for hedged production.

The Company accounts for its oil derivative instruments as cash flow hedges for accounting purposes under FASB ASC 815 and related pronouncements. All derivative contracts are marked to market each quarter end and are included in the accompanying consolidated balance sheets as derivative assets and liabilities.

During the fourth quarter of 2010, the Company entered into fixed price swap contracts for 2011 with the purchaser of the Company's WCBB oil and another financial institution. The Company will pay the counterparty the excess of the oil market price over the fixed price and will receive the excess of the fixed price over the market prices as defined in each contract. The Company's fixed price swap contracts are tied to the commodity prices on the New York Mercantile Exchange ("NYMEX"). The Company will receive the fixed price amount stated in the contract and pay to its counterparty the current market price for oil as listed on the NYMEX West Texas Index ("WTI"). However, due to the geographic location of the Company's assets and the cost of transporting oil to another market, the amount that the Company receives when it actually sells its oil differs from the index price. At June 30, 2011, the Company had the following fixed price swaps in place:

 

     Daily Volume
(Bbls/day)		      Weighted
Average Price		  

July - December 2011

      2,000       $ 86.96   

At June 30, 2011, the fair value of derivative liabilities related to the fixed price swaps is as follows:

 

     June 30, 2011  

Short-term derivative instruments - liability

    $ 3,431,000   

All fixed price swaps have been executed in connection with the Company's oil price hedging program. For fixed price swaps qualifying as cash flow hedges pursuant to FASB ASC 815, the realized contract price is included in oil sales in the period for which the underlying production was hedged.

For derivatives designated as cash flow hedges and meeting the effectiveness guidelines of FASB ASC 815, changes in fair value are recognized in accumulated other comprehensive income until the hedged item is recognized in earnings. Amounts reclassified out of accumulated other comprehensive income into earnings as a component of oil and condensate sales for the six months ended June 30, 2011 and 2010 are presented below.

 

     Six months ended June 30,  
     2011     2010  

Reduction to oil and condensate sales

    $ (2,011,000 )    $ (9,378,000 ) 

The Company expects to reclassify $3,431,000 out of accumulated other comprehensive income into earnings as a component of oil and condensate sales during the remainder of the year ended December 31, 2011 related to fixed price swaps.

Hedge effectiveness is measured at least quarterly based on the relative changes in fair value between the derivative contract and the hedged item over time. Any change in fair value resulting from ineffectiveness is recognized immediately in earnings. The Company did not recognize into earnings any amount related to hedge ineffectiveness for the three months and six months ended June 30, 2011 and 2010, however, the hedges could be considered ineffective in future periods.