Coterra Energy Inc. - Quarter Report: 2011 September (Form 10-Q)

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

WASHINGTON, D.C. 20549

 

 

FORM 10-Q

 

 

 

For the quarterly period ended September 30, 2011

 

 

Commission file number 1-10447

 

 

CABOT OIL & GAS CORPORATION

(Exact name of registrant as specified in its charter)

 

 

 

Three Memorial City Plaza

840 Gessner Road, Suite 1400, Houston, Texas 77024

(Address of principal executive offices including ZIP code)

 

(281) 589-4600

(Registrant’s telephone number, including area code)

 

 

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months and (2) has been subject to such filing requirements for the past 90 days.  Yes x  No o

 

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files).  Yes x  No o

 

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See the definitions of “large accelerated filer,” “accelerated filer” and “smaller reporting company” in Rule 12b-2 of the Exchange Act. (Check one):

 

 

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act).  Yes o  No x

 

As of October 24, 2011, there were 104,494,374 shares of Common Stock, Par Value $.10 Per Share, outstanding.

 

 

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CABOT OIL & GAS CORPORATION

 

INDEX TO FINANCIAL STATEMENTS

 

	Page
Part I. Financial Information
Item 1.      Financial Statements
Condensed Consolidated Statement of Operations for the Three Months and Nine Months Ended September 30, 2011 and 2010	3
Condensed Consolidated Balance Sheet at September 30, 2011 and December 31, 2010	4
Condensed Consolidated Statement of Cash Flows for the Nine Months Ended September 30, 2011 and 2010	5
Notes to the Condensed Consolidated Financial Statements	6
Report of Independent Registered Public Accounting Firm on Review of Interim Financial Information	20
Item 2.      Management’s Discussion and Analysis of Financial Condition and Results of Operations	21
Item 3.      Quantitative and Qualitative Disclosures about Market Risk	32
Item 4.      Controls and Procedures	34
Part II. Other Information
Item 1.      Legal Proceedings	35
Item 1A.   Risk Factors	35
Item 2.      Unregistered Sales of Equity Securities and Use of Proceeds	35
Item 6.      Exhibits	36
Signatures	37

 

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PART I. FINANCIAL INFORMATION

 

ITEM  1.                           Financial Statements

 

CABOT OIL & GAS CORPORATION

 

CONDENSED CONSOLIDATED STATEMENT OF OPERATIONS (Unaudited)

 

		Three Months Ended						Nine Months Ended
		September 30,						September 30,
(In thousands, except per share amounts)		2011			2010			2011			2010
OPERATING REVENUES
Natural Gas		$	218,521		$	192,026		$	588,976		$	526,424
Brokered Natural Gas		9,467			11,675			38,947			49,896
Crude Oil and Condensate		33,158			19,234			79,792			60,427
Other		971			1,127			4,124			3,901
		262,117			224,062			711,839			640,648
OPERATING EXPENSES
Brokered Natural Gas Cost		8,204			10,281			33,362			43,342
Direct Operations		27,292			26,466			76,878			73,796
Transportation and Gathering		19,768			4,932			48,710			13,488
Taxes Other Than Income		7,042			8,489			21,070			31,135
Exploration		20,190			9,665			31,090			28,324
Impairment of Oil and Gas Properties		—			35,789			—			35,789
Depreciation, Depletion and Amortization		90,293			85,355			250,642			235,579
General and Administrative		27,949			21,077			78,254			49,675
		200,738			202,054			540,006			511,128
Gain / (Loss) on Sale of Assets		3,854			265			36,408			5,411
INCOME FROM OPERATIONS		65,233			22,273			208,241			134,931
Interest Expense and Other		18,517			16,758			53,928			47,439
Income Before Income Taxes		46,716			5,515			154,313			87,492
Income Tax Expense		18,234			1,617			58,268			33,215
NET INCOME		$	28,482		$	3,898		$	96,045		$	54,277
Earnings Per Share
Basic		$	0.27		$	0.04		$	0.92		$	0.52
Diluted		$	0.27		$	0.04		$	0.91		$	0.52
Weighted-Average Shares Outstanding
Basic		104,285			103,955			104,232			103,889
Diluted		105,460			105,225			105,316			105,144
Dividends Per Common Share		$	0.03		$	0.03		$	0.09		$	0.09

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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CABOT OIL & GAS CORPORATION

 

CONDENSED CONSOLIDATED BALANCE SHEET (Unaudited)

 

		September 30,			December 31,
(In thousands, except share amounts)		2011			2010
ASSETS
Current Assets
Cash and Cash Equivalents		$	62,928		$	55,949
Accounts Receivable, Net		101,612			94,488
Income Taxes Receivable		10,158			—
Inventories		28,296			29,667
Derivative Instruments		100,489			16,926
Other Current Assets		6,554			5,978
Total Current Assets		310,037			203,008
Properties and Equipment, Net (Successful Efforts Method)		4,103,317			3,762,760
Other Assets		59,043			39,263
		$	4,472,397		$	4,005,031
LIABILITIES AND STOCKHOLDERS’ EQUITY
Current Liabilities
Accounts Payable		$	207,798		$	229,981
Income Taxes Payable		—			25,957
Deferred Income Taxes		31,975			—
Accrued Liabilities		49,204			47,897
Total Current Liabilities		288,977			303,835
Pension and Postretirement Benefits		39,443			34,053
Long-Term Debt		1,205,000			975,000
Deferred Income Taxes		785,146			714,953
Asset Retirement Obligation		74,784			72,311
Other Liabilities		35,877			32,179
Total Liabilities		2,429,227			2,132,331
Commitments and Contingencies
Stockholders’ Equity
Common Stock:
Authorized – 240,000,000 Shares of $0.10 Par Value in 2011 and 2010 Issued–104,492,690 Shares and 104,210,084 Shares in 2011 and 2010, respectively		10,449			10,421
Additional Paid-in Capital		730,985			720,920
Retained Earnings		1,235,059			1,148,391
Accumulated Other Comprehensive Income/(Loss)		70,026			(3,683		)
Less Treasury Stock, at Cost:
202,200 Shares in 2011 and 2010, respectively		(3,349		)	(3,349		)
Total Stockholders’ Equity		2,043,170			1,872,700
		$	4,472,397		$	4,005,031

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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CABOT OIL & GAS CORPORATION

 

CONDENSED CONSOLIDATED STATEMENT OF CASH FLOWS (Unaudited)

 

		Nine Months Ended September 30,
(In thousands)		2011			2010
CASH FLOWS FROM OPERATING ACTIVITIES
Net Income		$	96,045		$	54,277
Adjustments to Reconcile Net Income to Cash Provided by Operating Activities:
Depreciation, Depletion and Amortization		250,642			235,579
Impairment of Oil and Gas Properties		—			35,789
Deferred Income Tax Expense		57,381			30,465
(Gain) / Loss on Sale of Assets		(36,408		)	(5,411		)
Exploration Expense		13,851			10,473
Unrealized Loss / (Gain) on Derivative Instruments		950			(162		)
Amortization of Debt Issuance Costs		3,317			8,298
Stock-Based Compensation, Pension and Other		42,432			12,886
Changes in Assets and Liabilities:
Accounts Receivable, Net		(7,124		)	4,842
Income Taxes		(36,115		)	4,937
Inventories		1,371			(4,353		)
Other Current Assets		(832		)	3,070
Accounts Payable and Accrued Liabilities		(9,941		)	(14,252		)
Other Assets and Liabilities		(203		)	(8,838		)
Stock-Based Compensation Tax Benefit		—			(108		)
Net Cash Provided by Operating Activities		375,366			367,492
CASH FLOWS FROM INVESTING ACTIVITIES
Capital Expenditures		(668,987		)	(658,123		)
Proceeds from Sale of Assets		82,109			21,033
Net Cash Used in Investing Activities		(586,878		)	(637,090		)
CASH FLOWS FROM FINANCING ACTIVITIES
Borrowings from Debt		330,000			300,000
Repayments of Debt		(100,000		)	(10,000		)
Dividends Paid		(9,379		)	(9,348		)
Capitalized Debt Issuance Costs		(1,025		)	(13,696		)
Other		(1,105		)	72
Net Cash Provided by Financing Activities		218,491			267,028
Net Increase / (Decrease) in Cash and Cash Equivalents		6,979			(2,570		)
Cash and Cash Equivalents, Beginning of Period		55,949			40,158
Cash and Cash Equivalents, End of Period		$	62,928		$	37,588

 

The accompanying notes are an integral part of these condensed consolidated financial statements.

 

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CABOT OIL & GAS CORPORATION

 

NOTES TO THE CONDENSED CONSOLIDATED FINANCIAL STATEMENTS (Unaudited)

 

1. FINANCIAL STATEMENT PRESENTATION

 

During interim periods, Cabot Oil & Gas Corporation (the Company) follows the same accounting policies used in its Annual Report on Form 10-K for the year ended December 31, 2010 (Form 10-K) filed with the Securities and Exchange Commission (SEC). The interim financial statements should be read in conjunction with the notes to the consolidated financial statements and information presented in the Form 10-K. In management’s opinion, the accompanying interim condensed consolidated financial statements contain all material adjustments, consisting only of normal recurring adjustments, necessary for a fair statement. The results for any interim period are not necessarily indicative of the expected results for the entire year.

 

Certain reclassifications have been made to prior year statements to conform to current year presentation. These reclassifications have no impact on previously reported net income.

 

With respect to the unaudited financial information of the Company as of September 30, 2011 and for the three and nine months ended September 30, 2011 and 2010, PricewaterhouseCoopers LLP reported that they have applied limited procedures in accordance with professional standards for a review of such information. However, their separate report dated October 28, 2011 appearing herein states that they did not audit and they do not express an opinion on that unaudited financial information. Accordingly, the degree of reliance on their report on such information should be restricted in light of the limited nature of the review procedures applied. PricewaterhouseCoopers LLP is not subject to the liability provisions of Section 11 of the Securities Act of 1933 for their report on the unaudited financial information because that report is not a “report” or a “part” of the registration statement prepared or certified by PricewaterhouseCoopers LLP within the meaning of Sections 7 and 11 of the Act.

 

Recently Issued Accounting Pronouncements

 

In May 2011, the Financial Accounting Standards Board (FASB) issued Accounting Standards Update (ASU) No. 2011-04, “Amendments to Achieve Common Fair Value Measurement and Disclosure Requirements in U.S. GAAP and IFRS.” The amendments in ASU No. 2011-04 generally represent clarifications of Topic 820, but also include some instances where a particular principle or requirement for measuring fair value or disclosing information about fair value measurements has changed. ASU No. 2011-04 results in common principles and requirements for measuring fair value and for disclosing information about fair value measurements in accordance with U.S. GAAP and IFRS. The amendments in ASU No. 2011-04 are to be applied prospectively. For public entities, the amendments are effective for interim and annual periods beginning after December 15, 2011. Early application by public entities is not permitted. The Company does not expect this guidance to have a significant impact on its consolidated financial position, results of operations or cash flows.

 

In June 2011, the FASB issued ASU No. 2011-05, “Presentation of Comprehensive Income,” requiring most entities to present items of net income and other comprehensive income either in one continuous statement—referred to as the statement of comprehensive income—or in two separate, but consecutive, statements of net income and other comprehensive income. The new requirements are effective for public entities for fiscal years (including interim periods) beginning after December 15, 2011. The Company does not expect this guidance to have a significant impact on its consolidated financial position, results of operations or cash flows.

 

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2. PROPERTIES AND EQUIPMENT, NET

 

Properties and equipment, net are comprised of the following:

 

		September 30,			December 31,
(In thousands)		2011			2010
Proved Oil and Gas Properties		$	5,377,363		$	4,794,650
Unproved Oil and Gas Properties		505,131			490,181
Gathering and Pipeline Systems		237,666			237,043
Land, Building and Other Equipment		79,109			86,248
		6,199,269			5,608,122
Accumulated Depreciation, Depletion and Amortization		(2,095,952		)	(1,845,362		)
		$	4,103,317		$	3,762,760

 

At September 30, 2011, the Company did not have any projects that had exploratory well costs that were capitalized for a period of greater than one year after drilling.

 

In the third quarter of 2010, the Company recorded a $35.8 million impairment of oil and gas properties due to continued price declines and limited activity in two south Texas fields. These fields were reduced to fair value of approximately $15.4 million using discounted future cash flows. The fair value of these fields was based on significant inputs that were not observable in the market and are considered to be Level 3 inputs as defined in ASC 820. Refer to Note 8 for more information and a description of fair value hierarchy. Key assumptions include (1) oil and natural gas prices (adjusted to quality and basis differentials), (2) projections of estimated quantities of oil and gas reserves and production, (3) estimates of future development and production costs and (4) risk adjusted discount rates (14% at September 30, 2010).

 

Haynesville/Bossier Shale Joint Ventures

 

During the first nine months of 2011, the Company entered into two participation agreements with third parties related to certain of its Haynesville and Bossier Shale leaseholds in east Texas. Under the terms of the participation agreements, the third parties agreed to fund 100% of the cost to drill and complete certain Haynesville and Bossier Shale wells in the related leaseholds over a multi-year period in exchange for a 75% working interest in the leaseholds. During the first nine months of 2011, the Company received a reimbursement of drilling costs incurred of approximately $11.2 million associated with the wells that had commenced drilling prior to the execution of the participation agreements.

 

In May 2011, the Company sold certain of its Haynesville and Bossier Shale oil and gas properties in east Texas to a third party. The Company received approximately $47.0 million in cash proceeds and recognized a $34.2 million gain on sale of assets.

 

Other Divestitures

 

In July 2011, the Company entered into a purchase and sale agreement to sell certain oil and gas properties located in Colorado, Utah and Wyoming to BreitBurn Energy Partners L.P. for $285 million. This transaction closed on October 6, 2011 and is subject to certain post-closing adjustments scheduled to occur in the fourth quarter of 2011.  The net book value associated with the oil and gas properties and the related asset retirement obligation held for sale as of September 30, 2011 were $291.3 million and $12.1 million, respectively, and are included in Properties and Equipment, Net and Asset Retirement Obligation, respectively, in the Condensed Consolidated Balance Sheet.

 

In June 2010, the Company sold its Woodford shale prospect located in Oklahoma to Continental Resources Inc. The Company received approximately $15.9 million in cash proceeds and recognized a $10.3 million gain on sale of assets.

 

In July 2010, the Company sold certain oil and gas properties located in Colorado to Patera Oil & Gas LLC for approximately $3.0 million. During the second quarter of 2010, the Company recognized an impairment loss of approximately $5.8 million associated with the proposed sale of these properties. The impairment charge was included in Gain / (Loss) on Sale of Assets in the Condensed Consolidated Statement of Operations. Fair value of the impaired properties was determined using a market approach which considered the execution of a purchase and sale agreement the Company entered into on June 30, 2010. Accordingly, the inputs associated with the fair value of these properties were considered Level 2 in the fair value hierarchy.

 

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3. ADDITIONAL BALANCE SHEET INFORMATION

 

Certain balance sheet amounts are comprised of the following:

 

		September 30,			December 31,
(In thousands)		2011			2010
ACCOUNTS RECEIVABLE, NET
Trade Accounts		$	98,661		$	91,077
Joint Interest Accounts		5,871			4,901
Other Accounts		810			2,603
		105,342			98,581
Allowance for Doubtful Accounts		(3,730		)	(4,093		)
		$	101,612		$	94,488
INVENTORIES
Natural Gas in Storage		$	18,633		$	13,371
Tubular Goods and Well Equipment		10,150			17,072
Pipeline Imbalances		(487		)	(776		)
		$	28,296		$	29,667
OTHER CURRENT ASSETS
Drilling Advances		$	821		$	2,796
Prepaid Balances		3,499			2,925
Restricted Cash		2,234			—
Deferred Income Taxes		—			257
		$	6,554		$	5,978
OTHER ASSETS
Rabbi Trust Deferred Compensation Plan		15,503			15,788
Debt Issuance Costs		18,744			22,061
Derivative Instruments		23,453			—
Other Accounts		1,343			1,414
		$	59,043		$	39,263
ACCOUNTS PAYABLE
Trade Accounts		$	18,570		$	27,401
Natural Gas Purchases		6,047			3,596
Royalty and Other Owners		43,025			36,034
Accrued Capital Costs		127,489			146,824
Taxes Other Than Income		2,477			2,655
Wellhead Gas Imbalances		4,498			5,142
Other Accounts		5,692			8,329
		$	207,798		$	229,981
ACCRUED LIABILITIES
Employee Benefits		$	15,921		$	10,790
Pension and Postretirement Benefits		1,688			1,688
Taxes Other Than Income		15,151			14,576
Interest Payable		15,708			19,488
Other Accounts		736			1,355
		$	49,204		$	47,897
OTHER LIABILITIES
Rabbi Trust Deferred Compensation Plan		$	24,362		$	21,600
Derivative Instruments		—			2,180
Other Accounts		11,515			8,399
		$	35,877		$	32,179

 

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4. LONG-TERM DEBT

 

The Company’s debt consisted of the following:

 

(In thousands)		September 30, 2011			December 31, 2010
Long-Term Debt
7.33% Weighted-Average Fixed Rate Notes		$	95,000		$	95,000
6.51% Weighted-Average Fixed Rate Notes		425,000			425,000
9.78% Notes		67,000			67,000
5.58% Weighted-Average Fixed Rate Notes		175,000			175,000
Credit Facility		443,000			213,000
		$	1,205,000		$	975,000

 

The Company’s revolving credit facility provides for an available line of credit of $900 million and contains an accordion feature allowing the Company to increase the available credit line to $1.0 billion, if any one or more of the existing banks or new banks agree to provide such increased commitment amount. Effective April 1, 2011, the lenders under the Company’s revolving credit facility approved an increase in the Company’s Borrowing Base from $1.5 billion to $1.7 billion as part of the annual redetermination under the terms of the credit facility. The Company’s plan to sell certain oil and gas properties located in Colorado, Utah and Wyoming, triggered an interim redetermination of the Company’s Borrowing Base and the $1.7 billion Borrowing Base was reaffirmed by the lenders effective September 27, 2011.

 

At September 30, 2011, the Company had $443.0 million of borrowings outstanding under its revolving credit facility at a weighted-average interest rate of 4.0% and $456.8 million available for future borrowings. In addition, the Company had letters of credit outstanding at September 30, 2011 of $0.3 million.

 

5. EARNINGS PER COMMON SHARE

 

Basic EPS is computed by dividing net income (the numerator) by the weighted-average number of common shares outstanding for the period (the denominator). Diluted EPS is similarly calculated except that the denominator is increased using the treasury stock method to reflect the potential dilution that could occur if outstanding stock options and stock appreciation rights were exercised and stock awards were vested at the end of the applicable period.

 

The following is a calculation of basic and diluted weighted-average shares outstanding:

 

		Three Months Ended				Nine Months Ended
		September 30,				September 30,
(In thousands)		2011		2010		2011		2010
Weighted-Average Shares - Basic		104,285		103,955		104,232		103,889
Dilution Effect of Stock Options, Stock Appreciation Rights and Stock Awards at End of Period		1,175		1,270		1,084		1,255
Weighted-Average Shares - Diluted		105,460		105,225		105,316		105,144
Weighted-Average Stock Awards and Shares Excluded from Diluted Earnings per Share due to the Anti-Dilutive Effect		—		—		—		220

 

6. COMMITMENTS AND CONTINGENCIES

 

Contingencies

 

The Company is a defendant in various legal proceedings arising in the normal course of business. When deemed necessary, the Company establishes reserves for certain legal proceedings. All known liabilities are accrued based on an estimation process that includes the advice of legal counsel and subjective judgment of management. While the outcome and impact of such legal proceedings on the Company cannot be predicted with certainty, management believes that the resolution of these proceedings through settlement or adverse judgment will not have a material adverse effect on the Company’s condensed consolidated financial position or cash flow. Operating results, however, could be significantly impacted in the reporting periods in which such matters are resolved.

 

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Environmental Matters

 

On November 4, 2009, the Company and the Pennsylvania Department of Environmental Protection (PaDEP) entered into a single settlement agreement (Consent Order) covering a number of separate, unrelated environmental issues occurring in 2008 and 2009, including releases of drilling mud and other substances, record keeping violations at various wells and alleged natural gas contamination of 13 water wells in Susquehanna County, Pennsylvania. The Company paid an aggregate $120,000 civil penalty with respect to all the matters covered by the Consent Order, which were consolidated at the request of the PaDEP.

 

On April 15, 2010, the Company and the PaDEP reached agreement on modifications to the Consent Order (First Modified Consent Order). In the First Modified Consent Order, the PaDEP and the Company agreed that the Company will provide a permanent source of potable water to 14 households, most of which the Company has already been supplying with water. The Company agreed to plug and abandon three vertical wells in close proximity to two of the households and to bring into compliance a fourth well in the nine square mile area of concern in Susquehanna County. The Company agreed to complete these actions prior to any new well drilling permits being issued for drilling in Pennsylvania, and prior to initiating hydraulic fracturing of seven wells already drilled in the area of concern. The Company also agreed to postpone drilling of new wells in the area of concern until all obligations under the consent orders are fulfilled. In addition, the Company agreed to take certain other actions if requested by the PaDEP, which could include the plugging and abandonment of up to 10 additional wells. Under the First Modified Consent Order, the Company paid a $240,000 civil penalty and agreed to pay an additional $30,000 per month until all obligations under the First Modified Consent Order are satisfied.

 

On July 19, 2010, the Company and the PaDEP entered a Second Modification to Consent Order (Second Modified Consent Order) under which the Company and the PaDEP agreed that the Company has satisfactorily plugged and abandoned the three vertical wells and brought the fourth well into compliance. As a result, the Company and the PaDEP agreed that the PaDEP will commence the processing and issuance of new well drilling permits outside the area of concern so long as the Company continues to provide temporary potable water and offers to provide gas/water separators to the 14 households. No penalties were assessed under the Second Modified Consent Order.

 

As required by the Second Modified Consent Order, the Company made offers to provide whole-house water treatment systems to the 14 households. As required by the First Modified Consent Order, on August 5, 2010 the Company filed with the PaDEP its report, prepared by its experts, finding that the Company’s well drilling and development activities are not the source of methane gas reported to be in the groundwater and water wells in the area of concern.

 

Despite the Company’s vigorous efforts to comply with the various consent orders, in a September 14, 2010 letter to the Company, the PaDEP rejected the Company’s expert report and determined that the Company’s drilling activities continue to cause the unpermitted discharge of natural gas into the groundwater and continue to affect residential water supplies in the area of concern. The PaDEP directed the Company, in accordance with the First Modified Consent Order, to plug or take other remedial actions at the remaining 10 wells and to contact the PaDEP to discuss connecting the impacted water supplies into a community public water system to permanently eliminate the continuing adverse affect to those water supplies.

 

The Company believed that it was in full compliance with the various consent orders. In a September 28, 2010 reply letter to the PaDEP, the Company disagreed with the PaDEP’s rejection of the Company’s expert report, disagreed that the remaining 10 wells continue to impact groundwater and affect residential water supplies and disagreed that a community public water system is necessary or feasible. The Company believed that offering installation of a whole-house water treatment system to the 14 households constituted compliance with the Company’s obligations under these consent orders.

 

On December 15, 2010, the Company entered a global settlement agreement and new consent order with the PaDEP (Global Settlement Agreement), which supersedes the Consent Order, the First Modified Consent Order and the Second Modified Consent Order. Under the Global Settlement Agreement, among other things, the Company agreed to pay a total of $4.2 million into separate escrow accounts for the benefit of each affected household, pay $500,000 to the PaDEP to reimburse the PaDEP for its costs, remediate two wells in the affected area, provide pressure, water quality and well headspace data to the PaDEP and offer water treatment to the affected households. The Global Settlement Agreement settles all outstanding issues and claims that are known and that could have been brought against the Company by the PaDEP relating to the wells in the affected area and the Consent Order, the First Modified Consent Order and the Second Modified Consent Order. It also allows the Company to begin hydraulic fracturing and to commence drilling new wells in the affected areas after providing the PaDEP with well pressure data. Under the Global Settlement Agreement, the Company has no obligation to connect the impacted water supplies to a community public water system.

 

On January 11, 2011, certain of the affected households appealed the Global Settlement Agreement to the Pennsylvania Environmental Hearing Board. A hearing on the merits of this appeal is not expected to occur until 2012.

 

As of the date of this report, the Company is in continuing discussions with the PaDEP to address the results of the Company’s well pressure tests, water quality sampling and well headspace screenings. The Company requested PaDEP approval to resume hydraulic fracturing and new well drilling operations in the affected area, along with a request to cease temporary water deliveries to the affected

 

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households.  On October 18, 2011, the PaDEP concurred that temporary water deliveries to the property owners who are subject to the Global Settlement Agreement are no longer required.

 

As of September 30, 2011, the Company has paid $1.3 million in fines and penalties to the PaDEP related to this matter, paid $2.0 million to seven of the affected households and accrued a $2.2 million settlement liability that represents the unpaid escrow balance, which is included in Other Liabilities in the Condensed Consolidated Balance Sheet.

 

Transportation Agreements

 

During the first nine months of 2011, the Company amended certain gas transportation and gathering agreements with third party pipelines that increased the minimum daily quantity, increased the transportation fee and/or extended the term of the agreement.

 

Future minimum obligations under gas transportation agreements as of September 30, 2011 are as follows:

 

(In thousands)
2011		$	11,969
2012		57,066
2013		56,965
2014		56,965
2015		56,965
Thereafter		555,268
		$	795,198

 

For further information on the Company’s gas transportation agreements, please refer to Note 8 of the Notes to the Consolidated Financial Statements in the Form 10-K.

 

Drilling Rig Commitments

 

As of September 30, 2011, the Company has a three-year drilling rig commitment for its capital program in the Marcellus Shale in northeast Pennsylvania commencing in the fourth quarter of 2011.  As of September 30, 2011, the aggregate minimum future drilling rig commitment was approximately $20.4 million.

 

7. DERIVATIVE INSTRUMENTS AND HEDGING ACTIVITIES

 

The Company periodically enters into commodity derivative instruments to hedge its exposure to price fluctuations on natural gas and crude oil production. The Company’s credit agreement restricts the ability of the Company to enter into commodity hedges other than to hedge or mitigate risks to which the Company has actual or projected exposure or as permitted under the Company’s risk management policies and not subjecting the Company to material speculative risks. All of the Company’s derivatives are used for risk management purposes and are not held for trading purposes. As of September 30, 2011, the Company had 42 derivative contracts open: 27 natural gas price swap arrangements, five natural gas collar arrangements, six natural gas basis swaps, one crude oil price collar arrangement and three crude oil price swap arrangements. During the first nine months of 2011, the Company entered into 31 new derivative contracts covering anticipated natural gas and crude oil production for 2011, 2012 and 2013.

 

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As of September 30, 2011, the Company had the following outstanding commodity derivatives:

 

Commodity and Derivative Type		Weighted-Average Contract Price			Volume			Contract Period
Derivatives Designated as Hedging Instruments
Natural Gas Swaps		$6.24	per Mcf		3,254	Mmcf		Oct. 2011 - Dec. 2011
Natural Gas Swaps		$5.18	per Mcf		98,302	Mmcf		Oct. 2011 - Dec. 2012
Natural Gas Swaps		$5.28	per Mcf		17,854	Mmcf		Jan. 2012 - Dec. 2012
Natural Gas Collars		$6.17 Ceiling/ $5.13 Floor	per Mcf		17,805	Mmcf		Jan. 2013 - Dec. 2013
Crude Oil Collars		$93.25 Ceiling / $80.00 Floor	per Bbl		92	Mbbl		Oct. 2011- Dec. 2011
Crude Oil Swaps		$106.20	per Bbl		92	Mbbl		Oct. 2011 - Dec. 2011
Crude Oil Swaps		$105.00	per Bbl		366	Mbbl		Jan. 2012 - Dec. 2012
Derivatives Not Designated as Hedging Instruments
Natural Gas Basis Swaps		$(0.27	)  per Mcf		16,123	Mmcf		Jan. 2012 - Dec. 2012

 

The change in fair value of derivatives designated as hedges that is effective is recorded to Accumulated Other Comprehensive Income / (Loss) in Stockholders’ Equity in the Condensed Consolidated Balance Sheet. The ineffective portion of the change in fair value of derivatives designated as hedges, and the change in fair value of derivatives not designated as hedges, are recorded currently in earnings as a component of Natural Gas Revenue and Crude Oil and Condensate Revenue, as appropriate, in the Condensed Consolidated Statement of Operations.

 

The following disclosures reflect the impact of derivative instruments on the Company’s condensed consolidated financial statements:

 

Effect of Derivative Instruments on the Condensed Consolidated Balance Sheet

 

				Fair Value Asset (Liability)
(In thousands)		Balance Sheet Location		September 30, 2011			December 31, 2010
Derivatives Designated as Hedging Instruments
Commodity Contracts		Derivative Instruments (current assets)		$	102,908		$	16,926
Commodity Contracts		Other Assets		24,164			—
				127,072			16,926
Derivatives Not Designated as Hedging Instruments
Commodity Contracts		Derivative Instruments (current assets)		(2,419		)	—
Commodity Contracts		Other Assets		(711		)	—
Commodity Contracts		Other Liabilities		—			(2,180		)
				(3,130		)	(2,180		)
				$	123,942		$	14,746

 

At September 30, 2011 and December 31, 2010, unrealized gains of $127.1 million ($78.8 million, net of tax) and $16.9 million ($10.5 million, net of tax), respectively, were recorded in Accumulated Other Comprehensive Income / (Loss). Based upon estimates at September 30, 2011, the Company expects to reclassify $63.8 million in after-tax income associated with its commodity hedges from Accumulated Other Comprehensive Income / (Loss) to the Condensed Consolidated Statement of Operations over the next 12 months.

 

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Effect of Derivative Instruments on the Condensed Consolidated Statement of Operations

 

		Amount of Gain (Loss) Recognized in OCI on Derivatives (Effective Portion)												Location of Gain (Loss) Reclassified from		Amount of Gain (Loss) Reclassified from Accumulated OCI into Income (Effective Portion)
Derivatives Designated as Hedging Instruments		Three Months Ended September 30,						Nine Months Ended September 30,						Accumulated OCI into Income		Three Months Ended September 30,						Nine Months Ended September 30,
(In thousands)		2011			2010			2011			2010			(In thousands)		2011			2010			2011			2010
Commodity Contracts		$	98,143		$	24,758		$	159,030		$	79,514		Natural Gas Revenues		$	21,170		$	39,461		$	48,318		$	109,714
														Crude Oil and Condensate Revenues		1,382			5,160			566			14,522
																$	22,552		$	44,621		$	48,884		$	124,236

 

For the three and nine months ended September 30, 2011 and 2010, respectively, there was no ineffectiveness recorded in our Condensed Consolidated Statement of Operations related to our derivative instruments.

 

Derivatives Not Designated as Hedging Instruments		Location of Gain (Loss) Recognized in Income on		Three Months Ended September 30,						Nine Months Ended September 30,
(In thousands)		Derivatives		2011			2010			2011			2010
Commodity Contracts		Natural Gas Revenues		$	(64	)	$	(193	)	$	(950	)	$	162

 

Additional Disclosures about Derivative Instruments and Hedging Activities

 

The use of derivative instruments involves the risk that the counterparties will be unable to meet their obligation under the agreement. The Company enters into derivative contracts with multiple counterparties in order to limit its exposure to individual counterparties. The Company also has netting arrangements with all of its counterparties that allow it to offset payables against receivables from separate derivative contracts with that counterparty.

 

The counterparties to the Company’s derivative instruments are also lenders under its credit facility. The Company’s credit facility and derivative instruments contain certain cross default and acceleration provisions that may require immediate payment of its derivative liability in certain situations.

 

8. FAIR VALUE MEASUREMENTS

 

Accounting Standards Codification (ASC) 820, “Fair Value Measurements and Disclosures,” established a formal framework for measuring fair values of assets and liabilities in financial statements that are already required by generally accepted accounting principles (GAAP) to be measured at fair value. 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 (exit price). The transaction is based on a hypothetical transaction in the principal or most advantageous market considered from the perspective of the market participant that holds the asset or owes the liability.

 

The Company utilizes market data or assumptions that market participants who are independent, knowledgeable and willing and able to transact would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated or generally unobservable. The Company attempts to utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. The Company is able to classify fair value balances based on the observability of those inputs. ASC 820 establishes formal fair value hierarchy based on the inputs used to measure fair value. The hierarchy gives the highest priority to Level 1 measurements and the lowest priority to Level 3 measurements.

 

The Company has classified its assets and liabilities into these levels depending upon the data relied on to determine the fair values. For further information regarding the fair value hierarchy, refer to Note 14 of the Notes to the Consolidated Financial Statements in the Form 10-K.

 

Non-Financial Assets and Liabilities

 

The Company discloses or recognizes its non-financial assets and liabilities, such as impairments of long-lived assets, at fair value on a nonrecurring basis. During the nine month period ended September 30, 2010, the Company recorded an impairment related to certain oil and gas properties. Refer to Note 2 for additional disclosures related to fair value associated with the impaired properties.

 

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As none of the Company’s other non-financial assets and liabilities were impaired as of September 30, 2011 and 2010 and no other fair value measurements were required to be recognized on a non-recurring basis, additional disclosures are not provided.

 

Financial Assets and Liabilities

 

Our financial assets and liabilities are measured at fair value on a recurring basis. The following fair value hierarchy table presents information about the Company’s financial assets and liabilities measured at fair value on a recurring basis as of September 30, 2011 and December 31, 2010:

 

(In thousands)		Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Balance as of September 30, 2011
Assets
Rabbi Trust Deferred Compensation Plan		$	15,503		$	—		$	—		$	15,503
Derivative Contracts		—			—			123,942			123,942
Total Assets		$	15,503		$	—		$	123,942		$	139,445
Liabilities
Rabbi Trust Deferred Compensation Plan		$	24,362		$	—		$	—		$	24,362
Derivative Contracts		—			—			—			—
Total Liabilities		$	24,362		$	—		$	—		$	24,362

 

(In thousands)		Quoted Prices in Active Markets for Identical Assets (Level 1)			Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Balance as of December 31, 2010
Assets
Rabbi Trust Deferred Compensation Plan		$	15,788		$	—		$	—		$	15,788
Derivative Contracts		—			—			16,926			16,926
Total Assets		$	15,788		$	—		$	16,926		$	32,714
Liabilities
Rabbi Trust Deferred Compensation Plan		$	21,600		$	—		$	—		$	21,600
Derivative Contracts		—			—			2,180			2,180
Total Liabilities		$	21,600		$	—		$	2,180		$	23,780

 

The Company’s investments associated with its Rabbi Trust Deferred Compensation Plan consist of mutual funds and deferred shares of the Company’s common stock that are publicly traded and for which market prices are readily available.

 

The derivative contracts were measured based on quotes from the Company’s counterparties. Such quotes have been derived using valuation models that consider various inputs including current market and contractual prices for the underlying instruments, quoted forward prices for natural gas and crude oil, volatility factors and interest rates, such as a LIBOR curve for a similar length of time as the derivative contract term as applicable. These estimates are verified using relevant NYMEX futures contracts or are compared to multiple quotes obtained from counterparties for reasonableness. The Company measured the non-performance risk of its counterparties by reviewing credit default swap spreads for the various financial institutions in which it has derivative transactions, while non-performance risk of the Company is evaluated using a market credit spread provided by the Company’s bank. The impact of non-performance risk relative to the Company’s derivative contracts was $1.5 million and $0.5 million at September 30, 2011 and December 31, 2010, respectively.

 

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