Product Markets and Major Customers
Our revenues are highly dependent upon the prices of, and demand for, oil and gas. The markets
for oil and gas have historically been volatile and are likely to continue to be volatile in the future. The
prices we receive for our oil and gas production are subject to wide fluctuations and depend on
numerous factors beyond our control, including location and quality differentials, seasonality, economic
conditions, foreign imports, political conditions in other oil-producing and gas-producing countries, the
actions of OPEC, and domestic government regulation, legislation and policies. Decreases in oil and
gas prices have had, and could have in the future, an adverse effect on the carrying value and volumes
of our proved reserves and our revenues, profitability and cash flow.
We use various derivative instruments to manage our exposure to commodity price risk on sales
of oil and gas production. Derivatives provide us protection on the sales revenue streams if prices
decline below the prices at which the derivatives are set. However, ceiling prices in derivatives may
result in us receiving less revenue on the volumes than would be received in the absence of the
derivatives. Our derivative instruments currently consist of crude oil put option and collar contracts and
natural gas put option, collar and swap contracts entered into with financial institutions.
A substantial portion of our oil reserves are located in California and approximately 56% of our
production is attributable to heavy crude (generally 21 degree API gravity crude oil or lower).
Historically, the market price for California crude oil differs from the established market indices in the
United States due principally to the higher transportation and refining costs associated with heavy oil.
Recently, however, the market price for California crude oil has strengthened relative to NYMEX and
WTI primarily due to world demand and declining domestic supplies of both Alaskan and California
crude oil.
Our heavy crude is primarily sold to ConocoPhillips. In August 2011, we replaced our previous
contract with a new marketing contract with ConocoPhillips effective January 1, 2012 that covers
approximately 90% of our California production, extends the dedication from January 1, 2015 to
January 1, 2023 and replaces the percent of NYMEX index pricing mechanism with a market-based
pricing approach. During 2011, we received approximately 89% of the NYMEX index price for crude oil
sold under the ConocoPhillips contract, which represented approximately 50% of our total crude oil
production. Separately, we executed an agreement with a third party purchaser to sell a large portion
of our Eagle Ford Shale crude oil using a Light Louisiana Sweet based pricing mechanism. Due to
these new marketing contracts, we expect oil price realizations on a significant portion of our crude oil
production to increase relative to WTI beginning in 2012.
Approximately 20% of our 2011 crude oil production was sold under contracts that provide for
NYMEX less a fixed price differential (as of December 31, 2011 the fixed price differential averaged
$4.66 per barrel) with the remainder sold under contracts that provide for monthly field posted prices.
Our share of production from the Haynesville Shale is sold by Chesapeake under the terms of a
fifteen-year contract with a primary term which expires on September 1, 2023. The contract with
Chesapeake provides that Chesapeake will sell our production along with its own for which
Chesapeake charges a marketing fee.
Prices received for our gas are subject to seasonal variations and other fluctuations.
Approximately 50% of our gas production is sold monthly based on industry recognized, published
index pricing. The remainder is priced daily on the spot market. Fluctuations between spot and index
prices can significantly impact the overall differential to the Henry Hub.
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