Upon
entering into a derivative contract, the Company must either designate the derivative
instrument as a hedge of the variability of cash flow to be received (cash flow
hedge) or the derivative must be accounted for as a non-designated derivative.
The Company documents all relationships between hedging instruments and hedged
items, as well as its risk management objectives and strategy for undertaking
various hedge transactions. This process includes linking all derivatives that
are designated cash flow hedges to forecasted transactions. The Company also assesses
whether the derivatives that are used in hedging transactions are highly effective
in offsetting changes in cash flows of hedged transactions. The cash flow hedges
are marked-tomarket each reporting period and are recorded as either an asset
or as a liability on the balance sheet with the corresponding amount recorded
as other comprehensive income, net of tax, within equity. Changes in the fair
value of a cash flow hedge are recorded in other comprehensive income to the extent
that the derivative is effective in offsetting changes in the fair value of the
hedged item. Any ineffectiveness in the relationship between the cash flow hedge
and the hedged item is recognized currently in income. Gains and losses accumulated
in other comprehensive income associated with the cash flow hedge are recognized
in earnings as oil and natural gas revenues when the forecasted transaction occurs.
However, in connection with the preparation of the Company's financial statements
for the year ended December 31, 2005, the Company determined that it had not timely
designated its derivative instruments as cash flow hedges and lacked certain documentation
for the derivatives entered into during the periods of 2004 and 2005 to qualify
for cash flow hedge accounting treatment. Alternatively, the Company must account
for its non-designated derivative activities by marking the instruments to market
and record the unrealized gains and/or loss to earnings. As a result, the Company
is restating in this Form 10-K/A the consolidated financial statements for 2004
and the quarterly financial data for all periods in 2004 and the first three quarters
in 2005. See Note 3 of the notes to the consolidated financial statements for
further discussion of this financial restatement. When
hedge accounting is discontinued because it is probable that a forecasted transaction
will not occur, the derivative will continue to be carried on the balance sheet
at its fair value and gains and losses that were accumulated in other comprehensive
income will be recognized in earnings immediately. In all other situations in
which hedge accounting is discontinued, the derivative will be carried at fair
value on the balance sheet with future changes in its fair value recognized in
future earnings. See Note 12 with respect to the Company’s positions with an affiliate
of Enron Corp. During the third quarter of 2005, we
entered into interest rate swap agreements with respect to amounts outstanding
under the Second Lien Credit Facility. These arrangements are designed to manage
our exposure to interest rate fluctuations during the period beginning January
1, 2006 through June 30, 2007 by effectively exchanging existing obligations to
pay interest based on floating rates for obligations to pay interest based on
fixed LIBO rates. These derivatives will be marked-to-market at the end of each
period and the realized and unrealized gain or loss will be recorded as market
to market gains and losses on derivatives, net within other income (expense) on
the Company’s Statement of Operations. The Company’s
Board of Directors sets all of the Company’s risk management policies, including
volumes, types of instruments and counterparties, on a quarterly basis. These
policies are implemented by management through the execution of trades by either
the President or Chief Financial Officer after consultation and concurrence by
the President, Chief Financial Officer and Chairman of the Board. The master contracts
with the authorized counterparties identify the President and Chief Financial
Officer as the only Company representatives authorized to execute trades. The
Board of Directors also reviews the status and results of derivative activities
quarterly. Income Taxes Under
Statement of Financial Accounting Standards No. 109 (“SFAS No. 109”), “Accounting
for Income Taxes,” deferred income taxes are recognized at each year end for the
future tax consequences of differences between the tax bases of assets and liabilities
and their financial reporting amounts based on tax laws and statutory tax rates
applicable to the periods in which the differences are expected to affect taxable
income. We routinely assess the realizability of our deferred tax assets. We consider
future taxable income in making such assessments. If we conclude that it is more
likely than not that some portion or all of the deferred tax assets will not be
realized under accounting standards, it is reduced by a valuation allowance. However,
despite our attempt to make an accurate estimate, the ultimate utilization of
our deferred tax assets is highly dependent upon our actual production and the
realization of taxable income in future periods. Concentration
of Credit Risk Substantially all of the Company's
accounts receivable result from oil and natural gas sales or joint interest billings
to third parties in the oil and natural gas industry. This concentration of customers
and joint interest owners may impact the Company's overall credit risk in that
these entities may be similarly affected by changes in economic and other industry
conditions. The Company does not require collateral from its customers and the
Company has not experienced material credit losses on such receivables. Further,
the Company generally has the right to offset revenue against related billings
to joint interest owners. Derivative contracts subject the Company to a concentration
of credit risk. The Company transacts the majority of its derivative contracts
with two counterparties. The Company maintains its cash with major U.S. banks.
From time to time, cash amounts may | 
