XML 53 R11.htm IDEA: XBRL DOCUMENT v2.4.0.6
Fair Value Measurements
 9 Months Ended
Sep. 30, 2012
Fair Value Measurements

5. Fair Value Measurements

In accordance with the FASB’s authoritative guidance on fair value measurements, the Company’s financial assets and liabilities are measured at fair value on a recurring basis. The Company recognizes its non-financial assets and liabilities, such as asset retirement obligations and proved oil and natural gas properties upon impairment, at fair value on a non-recurring basis.

As defined in the authoritative guidance, fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (“exit price”). To estimate fair value, the Company utilizes market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated or generally unobservable.

 

The authoritative guidance establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (“Level 1” measurements) and the lowest priority to unobservable inputs (“Level 3” measurements). The three levels of the fair value hierarchy are as follows:

Level 1 — Unadjusted quoted prices are available in active markets for identical assets or liabilities as of the reporting date. Active markets are those in which transactions for the asset or liability occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2 — Pricing inputs, other than unadjusted quoted prices in active markets included in Level 1, are either directly or indirectly observable as of the reporting date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. These models are primarily industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument and can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace.

Level 3 — Pricing inputs are generally less observable from objective sources, requiring internally developed valuation methodologies that result in management’s best estimate of fair value.

Financial Assets and Liabilities

As required, financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. The Company’s assessment of the significance of a particular input to the fair value measurement requires judgment and may affect the valuation of fair value assets and liabilities and their placement within the fair value hierarchy levels. The following tables set forth by level within the fair value hierarchy the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis:

 

     At fair value as of September 30, 2012  
     Level 1      Level 2      Level 3      Total  
     (In thousands)  

Assets:

            

Money market funds

    $ 165,737       $ —         $ —         $ 165,737   

Commodity derivative instruments (see Note 6)

      —           27,367         —           27,367   
  

 

 

     

 

 

     

 

 

     

 

 

  

Total assets

    $ 165,737       $ 27,367       $ —         $ 193,104   
  

 

 

     

 

 

     

 

 

     

 

 

  

Liabilities:

            

Commodity derivative instruments (see Note 6)

    $ —         $ 1,633       $ —         $ 1,633   
  

 

 

     

 

 

     

 

 

     

 

 

  

Total liabilities

    $ —         $ 1,633       $         $ 1,633   
  

 

 

     

 

 

     

 

 

     

 

 

  

 

     At fair value as of December 31, 2011  
     Level 1      Level 2      Level 3      Total  
     (In thousands)  

Assets:

            

Money market funds

    $ 250,419       $ —         $ —         $ 250,419   

Commodity derivative instruments (see Note 6)

      —           —           4,362         4,362   
  

 

 

     

 

 

     

 

 

     

 

 

  

Total assets

    $ 250,419       $ —         $ 4,362       $ 254,781   
  

 

 

     

 

 

     

 

 

     

 

 

  

Liabilities:

            

Commodity derivative instruments (see Note 6)

    $ —         $ —         $ 9,412       $ 9,412   
  

 

 

     

 

 

     

 

 

     

 

 

  

Total liabilities

    $ —         $ —         $ 9,412       $ 9,412   
  

 

 

     

 

 

     

 

 

     

 

 

  

The Level 1 instruments presented in the tables above consist of money market funds included in cash and cash equivalents on the Company’s Condensed Consolidated Balance Sheet at September 30, 2012 and December 31, 2011. The Company’s money market funds represent cash equivalents backed by the assets of high-quality major banks and financial institutions. The Company identified the money market funds as Level 1 instruments due to the fact that the money market funds have daily liquidity, quoted prices for the underlying investments can be obtained and there are active markets for the underlying investments.

 

The Level 2 and Level 3 instruments presented in the tables above consist of oil collars, swaps and puts. The fair values of the Company’s oil collars, swaps and puts are based upon a third-party preparer’s calculation using mark-to-market valuation reports provided by the Company’s counterparties for monthly settlement purposes to determine the valuation of its derivative instruments. The Company has the third-party preparer evaluate other readily available market prices for its derivative contracts as there is an active market for these contracts. The third-party preparer performs its independent valuation using an options pricing model similar to Black-Scholes. The significant inputs used are crude oil prices, volatility, skew, discount rate and the contract terms of the derivative instruments. However, the Company does not have access to the specific proprietary valuation models or inputs used by its counterparties or third-party preparer. The determination of the fair values also incorporates a credit adjustment for non-performance risk, as required by GAAP. The Company calculated the credit adjustment for derivatives in an asset position using current credit default swap values for each counterparty. The credit adjustment for derivatives in a liability position is based on the Company’s market credit spread. Based on these calculations, the Company recorded a downward adjustment to the fair value of its net derivative asset in the amount of $39,000 at September 30, 2012 and a downward adjustment to the fair value of its net derivative liability in the amount of $0.3 million at December 31, 2011.

The Company has adopted the FASB’s authoritative guidance amending certain accounting and disclosure requirements related to fair value measurements. The guidance clarifies and modifies some fair value measurement principles under GAAP, including a change in the valuation premise and the application of premiums and discounts, and contains some new disclosure requirements under GAAP. The guidance had no impact on the Company’s financial position, cash flows or results of operations for the nine months ended September 30, 2012.

The following table presents a reconciliation of the changes in fair value of the derivative instruments classified as Level 3 in the fair value hierarchy for the periods presented.

 

     2012     2011  
     (In thousands)  

Balance as of January 1

    $ (5,050 )    $ (10,486 ) 

Total gains or (losses) (realized or unrealized):

     

Included in earnings

      —          67,105   

Included in other comprehensive income

      —          —     

Settlements

      —          4,831   

Transfers in and out of Level 3 (1)

      5,050        —     
  

 

 

    

 

 

  

Balance as of September 30

    $ —        $ 61,450   
  

 

 

    

 

 

  

Change in unrealized losses included in earnings relating to derivatives still held at September 30

    $ —        $ 71,936   
  

 

 

    

 

 

  

 

(1) During the first nine months of 2012, the inputs used to value the Company’s commodity derivative instruments were directly or indirectly observable and those contracts were transferred to Level 2.

Fair Value of Other Financial Instruments

The Company’s financial instruments, including certain cash and cash equivalents, short-term investments, accounts receivable and accounts payable, are carried at amortized cost, which approximates cost and fair value due to the short-term maturity of these instruments. At September 30, 2012, the Company’s cash equivalents and short-term investments were all Level 1 assets. The carrying amount of the Company’s long-term debt (senior unsecured notes due 2019, 2021 and 2023 – see Note 7) reported in the Condensed Consolidated Balance Sheet at September 30, 2012 is $1,200.0 million with a fair value of $1,276.0 million. The Company’s senior unsecured notes are publicly traded and therefore categorized as a Level 1 liability.

Nonfinancial Assets and Liabilities

Asset retirement obligations. The carrying amount of the Company’s asset retirement obligations (“ARO”) in the Condensed Consolidated Balance Sheet at September 30, 2012 is $20.8 million (see Note 8 – Asset Retirement Obligations). The Company determines the ARO by calculating the present value of estimated cash flows related to the liability. Estimating the future ARO requires management to make estimates and judgments regarding timing and existence of a liability, as well as what constitutes adequate restoration. Inherent in the fair value calculation are numerous assumptions and judgments, including the ultimate costs, inflation factors, credit adjusted discount rates, timing of settlement and changes in the legal, regulatory, environmental and political environments. These assumptions represent Level 3 inputs. To the extent future revisions to these assumptions impact the fair value of the existing ARO liability, a corresponding adjustment is made to the related asset.

 

Impairment. The Company reviews its proved oil and natural gas properties for impairment whenever events and circumstances indicate that a decline in the recoverability of their carrying value may have occurred. The Company estimates the expected undiscounted future cash flows of its oil and natural gas properties and compares such undiscounted future cash flows to the carrying amount of the oil and natural gas properties to determine if the carrying amount is recoverable. If the carrying amount exceeds the estimated undiscounted future cash flows, the Company will adjust the carrying amount of the oil and natural gas properties to fair value. The factors used to determine fair value are subject to management’s judgment and expertise and include, but are not limited to, recent sales prices of comparable properties, the present value of future cash flows, net of estimated operating and development costs using estimates of proved reserves, future commodity pricing, future production estimates, anticipated capital expenditures and various discount rates commensurate with the risk and current market conditions associated with realizing the expected cash flows projected. These assumptions represent Level 3 inputs. No impairment charges on proved oil and natural gas properties were recorded for the three and nine months ended September 30, 2012 or 2011.