Berry Petroleum Company | Annual Report 2008

ITEM 7A — Quantitative and Qualitative Disclosures About Market Risk

As discussed in Note 18 to the financial statements, to minimize the effect of a downturn in oil and gas prices and to protect our profitability and the economics of our development plans, we enter into crude oil and natural gas hedge contracts from time to time. The terms of contracts depend on various factors, including management's view of future crude oil and natural gas prices, acquisition economics on purchased assets and our future financial commitments. This price hedging program is designed to moderate the effects of a severe crude oil and natural gas price downturn while allowing us to participate in any commodity price increases. In California, we benefit from lower natural gas pricing as we are a consumer of natural gas in our operations and elsewhere we benefit from higher natural gas pricing. We have hedged, and may hedge in the future both natural gas purchases and sales as determined appropriate by management. Management regularly monitors the crude oil and natural gas markets and our financial commitments to determine if, when, and at what level, some form of crude oil and/or natural gas hedging and/or basis adjustments or other price protection is appropriate in accordance with policy established by our board of directors.

Currently, our hedges are in the form of swaps and collars. However, we may use a variety of hedge instruments in the future to hedge WTI or the index gas price. We have crude oil sales contracts in place which are priced based on a correlation to WTI. Natural gas (for cogeneration and conventional steaming operations) is purchased at the SoCal border price and we sell our produced gas in Colorado and Utah at the CIG, PEPL and Questar index prices, respectively.

The following table summarizes our commodity hedge positions as of December 31, 2008:

	Average			Average
	Barrels	Floor/Ceiling		MMBtu	Average
Term	Per Day	Prices	Term	Per Day	Price
Crude Oil Sales (NYMEX WTI) Collars			Natural Gas Sales (NYMEX HH TO PEPL) Basis Swaps
Full year 2009	295	$80.00/$91.00	1st Quarter 2009	15,400	$1.17
Full year 2009	1,000	$100.00/$163.60	2nd Quarter 2009	15,400	$1.12
Full year 2009	1,000	$100.00/$150.30	3rd Quarter 2009	15,400	$0.97
Full year 2009	1,000	$100.00/$160.00	4th Quarter 2009	15,400	$1.05
Full year 2009	1,000	$100.00/$150.00	Full year 2009	2,000	$1.24
Full year 2009	1,000	$100.00/$157.48	Full year 2009	3,000	$1.19
Full year 2010	1,000	$60.00 / $80.00	Full year 2010	2,000	$1.05
Full year 2010	1,000	$55.00 / $76.20	Full year 2010	3,000	$1.00
Full year 2010	1,000	$55.00 / $77.75
Full year 2010	1,000	$55.00 / $77.70
Full year 2010	1,000	$55.00 / $83.10
Full year 2010	1,000	$60.00 / $75.00	Natural Gas Sales (NYMEX HH) Swaps
Full year 2010	1,000	$65.15 / $75.00	Full year 2009	15,400	$8.50
Full year 2010	1,000	$65.50 / $78.50	Full year 2009	2,000	$6.15
Full year 2010	280	$80.00 / $90.00	Full year 2009	3,000	$6.19
Full year 2010	1,000	$100.00/$161.10
Full year 2010	1,000	$100.00/$150.30
Full year 2010	1,000	$100.00/$160.00	Natural Gas Sales (NYMEX HH) Collars		Floor/Ceiling Prices
Full year 2010	1,000	$100.00/$150.00	Full year 2010	2,000	$6.00/$8.60
Full year 2010	1,000	$100.00/$158.50	Full year 2010	3,000	$6.00/$8.65
Full year 2010	1,000	$70.00/$86.00
Full year 2011	270	$80.00 / $90.00

Crude Oil Sales (NYMEX WTI) Swaps		Average Price
Full year 2009	240	$71.50
Full year 2009	1,000	$70.30
Full year 2009	1,000	$70.50
1^st Quarter 2009	2,000	$51.70
2nd, 3rd & 4th Quarters 2009	2,000	$55.00
Full year 2009	1,000	$54.67
Full year 2009	2,000	$54.10
Full year 2009	5,000	$54.39

Payments to our counterparties are triggered when the monthly average prices are above the swap or ceiling price in the case of our crude oil and natural gas sales hedges and below the swap price for our natural gas sales basis hedge positions. Conversely, payments from our counterparties are received when the monthly average prices are below the swap or floor price for our crude oil and natural gas sales hedges and above the swap price for our natural gas sales basis hedge positions.

From January 1, 2009 to February 25, 2009, we entered into gas collars for 4,000 MMBtu/D with a floor of $6.50 and ceilings ranging from $8.75 to $8.90, for the full year 2010 and E. Texas basis swaps on the same volumes for average prices of $0.38 and $0.49. We converted 6,000 Bbl/D oil collars ranging from floors of $55.00 to $60.00 and ceilings of $75.00 to $83.10 for the full year 2010 for swaps for the same volumes ranging from $61.00 to $64.80. We also entered into oil collars for 3,000 Bbl/D for the full year 2011 with a floor of $55.00 to $55.20 and a ceiling of $ 68.65 to $70.50, an oil swap for 500 Bbl/D for the third quarter of 2009 for $52.40, an oil swap for 650 Bbl/D for the full year 2010 for $56.90 and oil swaps for 1,750 Bbl/D for the full year 2011 for average prices from $56.36 to $61.80.

The collar strike prices will allow us to protect a significant portion of our future cash flow if 1) oil prices decline below our floor prices which range from $55.00 to $100.00 per barrel while still participating in any oil price increase up to the ceiling prices which range from $75.00 to $163.60 per barrel on the volumes indicated above, and if 2) gas prices decline below our floor price of $6.00 per MMBtu while still participating in any gas price increase up to the ceiling prices, which range from $8.60 to $8.65 per MMBtu on the respective volumes. These hedges improve our financial flexibility by locking in significant revenues and cash flow upon a substantial decline in crude oil or natural gas prices, including certain basis differentials. It also allows us to develop our long-lived assets and pursue exploitation opportunities with greater confidence in the projected economic outcomes and allows us to borrow a higher amount under our senior unsecured revolving credit facility.

While we have designated our hedges as cash flow hedges in accordance with SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, it is possible that a portion of the hedge related to the movement in the WTI to California heavy crude oil price differential may be determined to be ineffective. Likewise, we may have some ineffectiveness in our natural gas hedges due to the movement of HH pricing as compared to actual sales points. If this occurs, the ineffective portion will directly impact net income rather than being reported as Other Comprehensive Income (Loss). If the differential were to change significantly, it is possible that our hedges, when marked-to-market, could have a material impact on earnings in any given quarter and, thus, add increased volatility to our net income. The marked-to-market values reflect the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participant at the measurement date.

We entered into derivative contracts (natural gas swaps and collar contracts) in March 2006 that did not qualify for hedge accounting under SFAS 133 because the price index for the location in the derivative instrument did not correlate closely with the item being hedged. These contracts were recorded in the first quarter of 2006 at their fair value on the Balance Sheet and we recognized an unrealized net loss of approximately $4.8 million on the Statements of Income under the caption "Commodity derivatives." We entered into natural gas basis swaps on the same volumes and maturity dates as the previous hedges in May 2006 which allowed for these derivatives to be designated as cash flow hedges going forward, causing an unrealized net gain of $5.6 million to be recognized in the second quarter of 2006. The difference of $0.8 million was recorded in other comprehensive income at the date the hedges were designated.

In 2008 we exchanged 10,000 Bbl/D oil collar contracts for calendar 2009 with a floor of $47.50 and a ceiling of $70.00 for swaps with strike prices ranging from $54.10 to $55.00. The collars were exchanged for the swaps on the same day and the collars were dedesignated and the swaps were redesignated in the same day.

The related cash flow impact of all of our derivative activities are reflected as cash flows from operating activities.

Irrespective of the unrealized gains reflected in Other Comprehensive Income, the ultimate impact to net income over the life of the hedges will reflect the actual settlement values.

At December 31, 2008, Accumulated Other Comprehensive Income, net of income taxes, consisted of $114 million of unrealized gains from our crude oil and natural gas hedges. Deferred net gains recorded in Accumulated Other Comprehensive Income at December 31, 2008 are expected to be reclassified to earnings in the same period as the hedged transaction. The 10,000 Bbl/D oil collars that were exchanged in 2008 for oil swaps were frozen in Accumulated Other Comprehensive Income on the day of conversion and will be reclassified to earning in the same period as the hedged transaction. The use of hedging transactions also involves the risk that the counterparties will be unable to meet the financial terms of such transactions. With respect to our hedging activities, we utilize multiple counterparties on our hedges and monitor each counterparty's credit rating.

	2008		2007		2006
Net reduction of sales of oil and gas revenue due to hedging activities (in millions)	$	121.5	$	21.8	$	15.7
Net reduction of cost of gas due to hedging activities (in millions)	$	-	$	-	$	1.6
Net reduction in revenue per BOE due to hedging activities	$	10.41	$	2.22	$	1.71

Based on NYMEX futures prices as of December 31, 2008 (WTI $61.47; HH $6.84), we would expect to receive payments over the remaining term of our crude oil and natural gas hedges in place as follows:

				Impact of percent change in futures prices
		12/31/08		on pretax future cash (payments) and receipts
		NYMEX Futures		-40%		-20%		+20%		+40%
Average WTI Futures Price (2009 – 2011)	$	61.47	$	36.88	$	49.18	$	73.77	$	86.06
Average HH Futures Price (2009)		6.84		4.10		5.47		8.22		9.59

Crude Oil gain/(loss) (in millions)	$	185.2	$	353.5	$	254.0	$	116.7	$	29.5
Natural Gas gain/(loss) (in millions)		12.2		34.0		20.8		1.7		(10.6	)
Total	$	197.4	$	387.5	$	274.8	$	118.4	$	18.9

Net pretax future cash (payments) and receipts by year (in millions) based on average price in each year:
2009 (WTI $52.88; HH $6.42)	$	120.5	$	178.7	$	142.9	$	76.8	$	38.1
2010 (WTI $63.10)		75.8		204.9		131.9		41.6		(18.6	)
2011 (WTI $68.44)		1.1		3.9		-		-		(0.6	)
Total	$	197.4	$	387.5	$	274.8	$	118.4	$	18.9

Interest Rates. Our exposure to changes in interest rates results primarily from long-term debt. In October 2006, we issued $200 million of 8.25% senior subordinated notes due 2016 in a public offering. Total long-term debt outstanding at December 31, 2008 and 2007 was $1.13 billion and $445 million, respectively. Interest on amounts borrowed under our revolving credit facility is charged at LIBOR plus 1.375% to 2.125%, subject to our interest rate hedges, plus the senior unsecured revolving credit facility's margin through June 30, 2012. Based on year end 2008 credit facility borrowings, a 1% change in interest rates would have a $3.7 million after tax impact on our financial statements.

In June 2006 and July 2006 we entered into five year interest rate swaps for a fixed rate of approximately 5.5% on $100 million of our outstanding borrowings under our credit facility. These interest rate swaps have been designated as cash flow hedges. In 2008, $50 million of these interest rate swaps were extended one year, resulting in a fixed rate of approximately 4.8%.
In 2008 we also entered into three year interest rate swaps for a fixed rate of approximately 2.2% on an additional $275 million of our outstanding borrowings under our credit facility for three years beginning on April 15 and September 15, 2009. These interest rate swaps have been designated as cash flow hedges. As of December 31, 2008, we had a total of $575 million of fixed rate positions averaging 4.8% resulting from the $200 million of 8.25% senior subordinated notes and $375 million of interest rate swaps for a fixed rate of approximately 2.2%.

From January 1, 2009 through February 25, 2009, we entered into three year interest rates swaps for a fixed rate of approximately 2.0% on an additional $100 million of our outstanding borrowings under our credit facility for three years beginning on April 15 and December 15, 2009. These interest rate swaps have been designated as cash flow hedges. As a result of these 2009 hedge contracts, we have a total of $675 million of fixed rate positions averaging 4.4%.