Contingencies

Liabilities and other contingencies are recognized upon determination of an exposure, which when analyzed indicates that it is both probable that an asset has been impaired or that a liability has been incurred and that the amount of such loss is reasonably estimable.

VOLATILITY OF OIL AND NATURAL GAS PRICES

Our revenues, future rate of growth, results of operations, financial condition and ability to borrow funds or obtain additional capital, as well as the carrying value of our properties, are substantially dependent upon prevailing prices of oil and natural gas. See "Management's Discussion and Analysis of Financial Condition and Results of Operations--Risk Factors--Natural gas and oil prices are highly volatile, and lower prices will negatively affect our financial results."

We periodically review the carrying value of our oil and natural gas properties under the full cost accounting rules of the Commission. See "--Critical Accounting Policies and Estimates--Oil and Natural Gas Properties" and "--Risk Factors-- We may record ceiling limitation write-downs that would reduce our shareholders' equity."

Total oil purchased and sold under swaps and collars during 2002, 2003 and 2004 were 131,300 Bbls, 193,600 Bbls and 121,700, respectively. Total natural gas purchased and sold under swaps and collars in 2002, 2003 and 2004 were 2,314,000 MMBtu, 2,739,000 MMBtu and 3,936,000 MMBtu, respectively. The net gains and (losses) realized by us under such hedging arrangements were $(0.9 million), $(1.8 million) and $1.0 million for 2002, 2003 and 2004, respectively, and are included in oil and natural gas revenues.

To mitigate some of our commodity price risk, we engage periodically in certain other limited hedging activities including price swaps, costless collars and, occasionally, put options, in order to establish some price floor protection. We record the costs and any benefits derived from these price floors as a reduction or increase, as applicable, in natural gas and oil sales revenue; these reductions and increases were not significant for any year presented in the financial information included in this report. The costs to purchase put options are amortized over the option period. We do not hold or issue derivative instruments for trading purposes.

As of December 31, 2004, $59,000, net of tax of $34,000, remained in accumulated other comprehensive income related to the valuation of our hedging positions.

While the use of hedging arrangements limits the downside risk of adverse price movements, it may also limit our ability to benefit from increases in the prices of natural gas and oil. We enter into the majority of our hedging transactions with two counterparties and have a netting agreement in place with those counterparties. We do not obtain collateral to support the agreements but monitor the financial viability of counterparties and believe our credit risk is minimal on these transactions. Under these arrangements, payments are received or made based on the differential between a fixed and a variable product price. These agreements are settled in cash at expiration or exchanged for physical delivery contracts. In the event of nonperformance, we would be exposed again to price risk. We have some risk of financial loss because the price received for the product at the actual physical delivery point may differ from the prevailing price at the delivery point required for settlement of the hedging transaction. Moreover, our hedging arrangements generally do not apply to all of our production and thus provide only partial price protection against declines in commodity prices. We expect that the amount of our hedges will vary from time to time.

Our gas derivative transactions are generally settled based upon the average of the reporting settlement prices on the NYMEX for the last three trading days of a particular contract month. Our oil derivative transactions are generally settled based on the average reporting settlement prices on the NYMEX for each trading day of a particular calendar month. For the month of December 2004, a $0.10 change in the price per Mcf of gas sold would have changed revenue by $71,000. A $0.70 change in the price per barrel of oil would have changed revenue by $16,000.

The table below summarizes our total natural gas production volumes subject to derivative transactions during 2004 and the weighted average NYMEX reference price for those volumes.

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