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entered into a transition services agreement with Pinnacle pursuant to which the
Company provided certain accounting, treasury, tax, insurance and financial reporting
functions to Pinnacle for a monthly fee equal to the Company’s actual cost to
provide such services. No such services were provided during 2004 and 2005. 12.
DERIVATIVE FINANCIAL INSTRUMENTS The
Company’s operations involve managing market risks related to changes in commodity
prices. Derivative financial instruments, specifically swaps, futures, options
and other contracts, are used to reduce and manage those risks. The Company addresses
market risk by selecting instruments whose value fluctuations correlate strongly
with the underlying commodity being hedged. The Company enters into swaps, options,
collars and other derivative contracts to manage price risks associated with a
portion of anticipated future oil and natural gas production. While the use of
derivative financial instruments limits the downside risk of adverse price movements,
it may also limit future gains from favorable movements. Under these agreements,
payments are received or made based on the differential between a fixed and a
variable product price. These agreements are settled in cash at termination, expiration
or exchanged for physical delivery contracts. The Company enters into the majority
of its derivative transactions with two counterparties and netting agreements
are in place with those counterparties. The Company does not obtain collateral
to support the agreements but monitors the financial viability of counterparties
and believes its credit risk is minimal on these transactions. In the event of
nonperformance, the Company would be exposed to price risk. The Company has some
risk of accounting loss since 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 financial instruments. As
of December 31, 2004 and 2005, the unrealized gain (loss) on oil and gas derivative
instruments related to the mark-tomarket valuation, was a $0.4 million benefit
and a ($3.6) million charge, respectively, which are presented as mark-to-market
gain (loss) on derivatives, net in the other income and expense section of our
Statement of Operations. Total oil purchased and sold
under swaps and collars during 2003, 2004 and 2005 were 193,600 Bbls, 121,700
Bbls and 108,500 Bbls, respectively. Total natural gas purchased and sold under
swaps and collars in 2003, 2004 and 2005 were 2,739,000 MMBtu, 3,936,000 MMBtu
and 3,892,000 MMBtu, respectively. The net losses realized by the Company under
such arrangements were $(1.8) million, $(1.0) million and $(2.3) million for 2003,
2004 and 2005, respectively, and are included in other income (expense). At
December 31, 2004 and 2005 the Company had the following outstanding derivative
positions: 
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