DERIVATIVE FINANCIAL INSTRUMENTS | 3 Months Ended |
Mar. 31, 2014 |
DERIVATIVE FINANCIAL INSTRUMENTS | ' |
DERIVATIVE FINANCIAL INSTRUMENTS | ' |
6. DERIVATIVE FINANCIAL INSTRUMENTS |
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The Company is exposed to certain risks relating to its ongoing business operations, and Whiting uses derivative instruments to manage its commodity price risk. Whiting follows FASB ASC Topic 815, Derivatives and Hedging, to account for its derivative financial instruments. |
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Commodity Derivative Contracts—Historically, prices received for crude oil and natural gas production have been volatile because of seasonal weather patterns, supply and demand factors, worldwide political factors and general economic conditions. Whiting enters into derivative contracts, primarily costless collars and swaps, to achieve a more predictable cash flow by reducing its exposure to commodity price volatility. Commodity derivative contracts are thereby used to ensure adequate cash flow to fund the Company’s capital programs and to manage returns on acquisitions and drilling programs. Costless collars are designed to establish floor and ceiling prices on anticipated future oil or gas production, while swaps are designed to establish a fixed price for anticipated future oil or gas production. While the use of these derivative instruments limits the downside risk of adverse price movements, they may also limit future revenues from favorable price movements. The Company does not enter into derivative contracts for speculative or trading purposes. |
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Whiting Derivatives. The table below details the Company’s costless collar derivatives, including its proportionate share of Whiting USA Trust II (“Trust II”) derivatives, entered into to hedge forecasted crude oil production revenues, as of April 1, 2014. |
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| | | | Whiting Petroleum Corporation | | | | | | |
Derivative | | Period | | Contracted Crude Oil | | Weighted Average NYMEX Price | | | | | | |
Instrument | Volumes (Bbl) | Collar Ranges for Crude Oil | | | | | |
| | (per Bbl) | | | | | |
Collars | | Apr – Dec 2014 | | 36,540 | | $80.00 - $122.50 | | | | | | |
Three-way collars (1) | | Apr – Dec 2014 | | 12,420,000 | | $71.23 - $85.36 - $103.54 | | | | | | |
| | Total | | 12,456,540 | | | | | | | | |
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(1) A three-way collar is a combination of options: a sold call, a purchased put and a sold put. The sold call establishes a maximum price (ceiling) Whiting will receive for the volumes under contract. The purchased put establishes a minimum price (floor), unless the market price falls below the sold put (sub-floor), at which point the minimum price would be NYMEX plus the difference between the purchased put and the sold put strike price. |
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In March 2013, Whiting entered into certain crude oil swap contracts in order to achieve more predictable cash flows and manage returns on certain oil and gas properties that the Company was considering for monetization. Accordingly, the acquisition of these swap contracts and cash receipts from settlements of these swap positions have been reflected as an investing activity in the statement of cash flows. On July 15, 2013, upon closing of the sale of the Postle Properties discussed in the Acquisitions and Divestitures footnote, these crude oil swaps were novated to the buyer. Cash settlements that do not relate to investing derivatives or that do not have a significant financing element are reflected as operating activities in the statement of cash flows. |
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Derivatives Conveyed to Whiting USA Trust II. In connection with the Company’s conveyance in March 2012 of a term net profits interest to Trust II and related sale of 18,400,000 Trust II units to the public, the right to any future hedge payments made or received by Whiting on certain of its derivative contracts have been conveyed to Trust II, and therefore such payments will be included in Trust II’s calculation of net proceeds. Under the terms of the aforementioned conveyance, Whiting retains 10% of the net proceeds from the underlying properties, which results in third-party public holders of Trust II units receiving 90%, and Whiting retaining 10%, of the future economic results of commodity derivative contracts conveyed to Trust II. The relative ownership of the future economic results of such commodity derivatives is reflected in the tables below. No additional hedges are allowed to be placed on Trust II assets. |
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The 10% portion of Trust II derivatives that Whiting has retained the economic rights to (and which are also included in the first derivative table above) are as follows: |
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| | | | Whiting Petroleum Corporation | | | | | | |
Derivative | | Period | | Contracted Crude Oil | | NYMEX Price Collar Ranges for | | | | | | |
Instrument | Volumes (Bbl) | Crude Oil (per Bbl) | | | | | |
Collars | | Apr – Dec 2014 | | 36,540 | | $80.00 - $122.50 | | | | | | |
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The 90% portion of Trust II derivative contracts of which Whiting has transferred the economic rights to third-party public holders of Trust II units (and which have not been reflected in the above tables) are as follows: |
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| | | | Third-party Public Holders of Trust II Units | | | | | | |
Derivative | | Period | | Contracted Crude Oil | | NYMEX Price Collar Ranges for | | | | | | |
Instrument | Volumes (Bbl) | Crude Oil (per Bbl) | | | | | |
Collars | | Apr – Dec 2014 | | 328,860 | | $80.00 - $122.50 | | | | | | |
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Embedded Commodity Derivative Contract—In May 2011, Whiting entered into a long-term contract to purchase CO2 from 2015 through 2029 for use in its EOR project that is being carried out at its North Ward Estes field in Texas. This contract contains a price adjustment clause that is linked to changes in NYMEX crude oil prices. The Company has determined that the portion of this contract linked to NYMEX oil prices is not clearly and closely related to the host contract, and the Company has therefore bifurcated this embedded pricing feature from its host contract and reflected it at fair value in the consolidated financial statements. As of March 31, 2014, the estimated fair value of the embedded derivative in this CO2 purchase contract was an asset of $22.1 million. |
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Although CO2 is not a commodity that is actively traded on a public exchange, the market price for CO2 generally fluctuates in tandem with increases or decreases in crude oil prices. When Whiting enters into a long-term CO2 purchase contract where the price of CO2 is fixed and does not adjust with changes in oil prices, the Company is exposed to the risk of paying higher than the market rate for CO2 in a climate of declining oil and CO2 prices. This in turn could have a negative impact on the project economics of the Company’s CO2 flood at North Ward Estes. As a result, the Company reduces its exposure to this risk by entering into certain CO2 purchase contracts which have prices that fluctuate along with changes in crude oil prices. |
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Derivative Instrument Reporting—All derivative instruments are recorded in the consolidated financial statements at fair value, other than derivative instruments that meet the “normal purchase normal sale” exclusion. The following tables summarize the effects of commodity derivative instruments on the consolidated statements of income for the three months ended March 31, 2014 and 2013 (in thousands): |
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| | | | Loss Reclassified from AOCI into | | | | |
Income (Effective Portion) (1) | | | |
ASC 815 Cash Flow | | | | Three Months Ended March 31, | | | | |
Hedging Relationships (1) | | Income Statement Classification | | 2014 | | 2013 | | | | |
Commodity contracts | | Loss on hedging activities | | $ | — | | $ | (211 | ) | | | |
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(1) Effective April 1, 2009, the Company elected to de-designate all of its commodity derivative contracts that had been previously designated as cash flow hedges and elected to discontinue hedge accounting prospectively. As a result, such mark-to-market values at March 31, 2009 were frozen in AOCI as of the de-designation date and were being reclassified into earnings as the original hedged transactions affected income. As of December 31, 2013, all amounts previously in AOCI had been reclassified into earnings. |
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| | | | (Gain) Loss Recognized in Income | | | | |
Not Designated as | | | | Three Months Ended March 31, | | | | |
ASC 815 Hedges | | Income Statement Classification | | 2014 | | 2013 | | | | |
Commodity contracts | | Commodity derivative loss, net | | $ | 10,187 | | $ | 34,260 | | | | |
Embedded commodity contracts | | Commodity derivative loss, net | | 14,348 | | (3,003 | ) | | | |
Total | | | | $ | 24,535 | | $ | 31,257 | | | | |
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Offsetting of Derivative Assets and Liabilities. With each individual derivative counterparty, the Company typically has numerous hedge positions that span a several-month time period and that typically result in both fair value asset and liability positions held with that counterparty, which positions are all offset to a single fair value asset or liability amount at the end of each reporting period. The Company nets its derivative instrument fair value amounts executed with the same counterparty pursuant to ISDA master agreements, which provide for net settlement over the term of the contract and in the event of default or termination of the contract. The following tables summarize the location and fair value amounts of all derivative instruments in the consolidated balance sheets, as well as the gross recognized derivative assets, liabilities and amounts offset in the consolidated balance sheets (in thousands): |
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| | | | March 31, 2014 (1) | |
Not Designated as | | Balance Sheet Classification | | Gross | | Gross | | Net | |
ASC 815 Hedges | Recognized | Amounts | Recognized |
| Assets/ | Offset | Fair Value |
| Liabilities | | Assets/ |
| | | Liabilities |
Derivative assets: | | | | | | | | | |
Commodity contracts | | Prepaid expenses and other | | $ | 12,058 | | $ | (11,912 | ) | $ | 146 | |
Embedded commodity contracts | | Prepaid expenses and other | | 433 | | — | | 433 | |
Embedded commodity contracts | | Other long-term assets | | 21,635 | | — | | 21,635 | |
Total derivative assets | | | | $ | 34,126 | | $ | (11,912 | ) | $ | 22,214 | |
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Derivative liabilities: | | | | | | | | | |
Commodity contracts | | Current derivative liabilities | | $ | 23,711 | | $ | (11,912 | ) | $ | 11,799 | |
Total derivative liabilities | | | | $ | 23,711 | | $ | (11,912 | ) | $ | 11,799 | |
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| | | | December 31, 2013 (1) | |
Not Designated as | | Balance Sheet Classification | | Gross | | Gross | | Net | |
ASC 815 Hedges | Recognized | Amounts | Recognized |
| Assets/ | Offset | Fair Value |
| Liabilities | | Assets/ |
| | | Liabilities |
Derivative assets: | | | | | | | | | |
Commodity contracts | | Prepaid expenses and other | | $ | 23,752 | | $ | (22,478 | ) | $ | 1,274 | |
Embedded commodity contracts | | Other long-term assets | | 36,416 | | — | | 36,416 | |
Total derivative assets | | | | $ | 60,168 | | $ | (22,478 | ) | $ | 37,690 | |
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Derivative liabilities: | | | | | | | | | |
Commodity contracts | | Current derivative liabilities | | $ | 25,960 | | $ | (22,478 | ) | $ | 3,482 | |
Total derivative liabilities | | | | $ | 25,960 | | $ | (22,478 | ) | $ | 3,482 | |
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(1) Because counterparties to the Company’s derivative contracts are lenders under Whiting Oil and Gas’ credit agreement, which eliminates its need to post or receive collateral associated with its derivative positions, columns for cash collateral pledged or received have not been presented in the tables above. |
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Contingent Features in Derivative Instruments. None of the Company’s derivative instruments contain credit-risk-related contingent features. Counterparties to the Company’s derivative contracts are high credit-quality financial institutions that are lenders under Whiting’s credit agreement. The Company uses only credit agreement participants to hedge with, since these institutions are secured equally with the holders of Whiting’s bank debt, which eliminates the potential need to post collateral when Whiting is in a derivative liability position. As a result, the Company is not required to post letters of credit or corporate guarantees for its derivative counterparties in order to secure contract performance obligations. |