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 andnatural gas. See “Item 1A. Risk Factors—Natural gas and oil prices are highly volatile, and lower prices will negatively affectour 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 “—Summary of Critical Accounting Policies—Oil and Natural Gas Properties” and “Item 1A. Risk Factors— We may record ceiling limitation write-downs that would reduce our shareholders’ equity.”

To mitigate some of our commodity price risk, we engage periodically in certain other limited derivative activities including price swaps, costless collars and, occasionally, put options, in order to establish some price floor protection. We do not hold or issue derivative instruments for trading purposes.

The following table includes oil and natural gas derivative positions settled during the years ended December 31, 2007, 2006 and 2005 and the unrealized gain/(loss) associated with the outstanding oil and natural gas derivatives at December 31, 2007, 2006 and 2005.

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⁽¹⁾ Included in gain (loss) on derivatives, net in the Consolidated Statements of Operations.

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 derivative transactions with twocounterparties 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 again be exposed to price risk. We have additional 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 derivative 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 natural gas derivative transactions are generally settled based upon the average of the reporting settlement prices on the Houston Ship Channel index for the last three trading days of a particular contract month. Our oil derivative transactions aregenerally settled based on the average reporting settlement prices on the West Texas Intermediate index for each trading day ofa particular calendar month.