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entered into with other third parties. Additionally,
the Company operates four producing wells in which affiliates of
Black Stone Minerals hold a royalty interest for which the Company
paid approximately $0.8 million in 2007.
See Note 3 for a discussion of the investment
in Pinnacle.
Steven A. Webster, Chairman of the Board
of the Company, is also Chairman of Avista Capital Holdings, L.P.
and is therefore a related party to the Pinnacle transaction.
10. DERIVATIVE
FINANCIAL INSTRUMENTS
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 obtaincollateral 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. The Company also uses interest rate
swap agreements tomanage the Company’s exposure to interest
rate fluctuations on the Second Lien Credit Facility.
Commodity Derivative Instruments. The
Company accounts for its oil and natural gas derivatives and interest
rate swap agreements as non-designated hedges. These derivatives
are marked-to-market at each balance sheet date and the unrealized
gains(losses) are reported in the net gain (loss) on derivatives
in Other Income and Expenses in the Consolidated Statement of Operations.
In addition, the Company records the realized gains (losses) associated
with the cash settlements of these derivative instruments in the
net gain (loss) on derivatives in Other Income and Expense in the
Consolidated Statement of Operations. Forthe years ended December
31, 2007, 2006 and 2005, the Company recorded the following related
to its derivatives:
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