Aug. 14--The second quarter should have been a boon for Houston's Linn Energy. Crude prices reached all-time highs, natural gas prices hit double digits and production rose, thanks to acquisitions and drilling.

The same applies to other independent oil and gas producers that can embrace record-high crude prices unencumbered by refining operations that dampen the buzz with low margins.

But Linn and plenty of its peers in recent weeks reported second-quarter losses in the hundreds of millions, mostly because of how they account for energy prices that rise higher than hedges, or prices they lock in to sell oil and natural gas in the future.

What's more, most of those losses are only on paper and can be reversed if prices fall, as they have in the last month, and stay lower.

It comes down to how companies account for hedging, or locking in future selling prices of oil and gas they produce, said Michael Linn, CEO of the energy company bearing his name.

"It's an insurance policy that we all do," he said.

The common practice is intended to help companies maintain some earnings consistency rather than ride the ups and downs of volatile markets.

However, if futures market prices rise higher than hedged, as they did for Linn and other companies during the second quarter, companies have to reflect those losses -- largely "unrealized," or on paper only -- in earnings results. The process, known as "mark-to-market," accounts for contracts to reflect market prices.

The losses are essentially lost opportunities to sell the commodity at the market price rather than the lower hedged price, Linn said.

However, if prices fall back to match hedges before those futures contracts are settled -- or before the actual commodity is sold in the month of the contract -- companies can report paper-only gains that make back those losses. Companies can settle contracts by selling them before the commodity is delivered or at the time of delivery.

So if market prices are higher than hedges, they report noncash losses. If the market price falls below the hedge price, they report gains.

"It's absolutely counterintuitive," said Clay Jeansonne, vice president of investor relations for Linn Energy. "Hedging is important, but it cuts both ways."

Analysts generally ignore those issues, paying more attention to cash flow and production levels. But the losses could raise questions from investors who wonder how exploration and production companies with healthy operations could appear to lose money in the current price environment.