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Fair Value of Financial Instruments
 12 Months Ended
Dec. 31, 2018
Fair Value Disclosures [Abstract]  
Fair Value of Financial Instruments

16. FAIR VALUE OF FINANCIAL INSTRUMENTS

 

Our fair value measurements are estimated pursuant to a fair value hierarchy that requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date, giving highest priority to quoted prices in active markets (Level 1) and the lowest priority to unobservable data (Level 3). In some cases, the inputs used to measure fair value might fall in different levels of the fair value hierarchy. The lowest level input that is significant to a fair value measurement in its entirety determines the applicable level in the fair value hierarchy. Assessing the significance of a particular input to the fair value measurement in its entirety requires judgment, considering factors specific to the asset or liability, and may affect the valuation of the assets and liabilities and their placement within the hierarchy level. The three levels of inputs that may be used to measure fair value are defined as:

 

Level 1 - Quoted prices for identical assets and liabilities traded in active exchange markets.

 

Level 2 - Observable inputs other than Level 1 that are directly or indirectly observable for the asset or liability, including quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities inactive markets, or other observable inputs that can be corroborated by observable market data.

 

Level 3 - Unobservable inputs supported by little or no market activity for financial instruments whose value is determined using pricing models, discounted cash flow methodologies, or similar techniques, as well as instruments for which the determination of fair value requires significant management judgment or estimation.

 

 

The Company has processes and controls in place to attempt to ensure that fair value is reasonably estimated. The Company performs due diligence procedures over third-party pricing service providers in order to support their use in the valuation process. Where market information is not available to support internal valuations, independent reviews of the valuations are performed and any material exposures are evaluated through a management review process.

 

While the Company believes its valuation methods are appropriate and consistent with other market participants, the use of different methodologies or assumptions to determine the fair value of certain financial instruments could result in a different estimate of fair value at the reporting date. The following is a description of the valuation methodologies used for complex financial instruments measured at fair value:

 

Oil and Natural Gas Price Risk Derivative Valuation Methodologies

 

The Company determines its estimate of the fair value of derivative instruments using a market approach based on several factors, including quoted market prices in active markets, quotes from third parties, the credit rating of the counterparty and the Company’s own credit rating. In consideration of counterparty credit risk, the Company assesses the likelihood that the counterparty to the derivative would default by failing to make any contractually required payments. Additionally, the Company considers that it is of adequate credit quality and has the financial resources and willingness to meet its potential repayment obligations associated with the derivative transactions. The crude oil derivative markets are highly active. Although the Company’s derivative instruments are valued using indices, the instruments themselves are traded with third-party counterparties and are not openly traded on an exchange. As such, the Company has classified these instruments as Level 2.

 

Warrant Valuation Methodologies

 

The warrants contain a dilutive issuance and other liability provisions that cause the warrants to be accounted for as a liability. Such warrant instruments are initially recorded and valued as a Level 3 liability and are accounted for at fair value with changes in fair value reported in earnings. There were no changes in the methodology to value the warrants during 2018. The Company worked with a third-party valuation expert estimating the value of the warrants at December 31, 2018 and 2017 using a Lattice model, with the following assumptions:

 

   2018   2017 
     
Number of warrants outstanding   1,000,000    1,000,000 
Expiration date   June 21, 2022    June 21, 2022 
Exercise price  $1.13   $2.05 
Stock price  $0.67   $1.50 
Dividend yield   0%   0%
Average volatility rate   90%   90%
Risk free interest rate   2.47%   2.15%

 

An increase in any of the variables would cause an increase in the fair value of the warrants. Likewise, a decrease in any variable would cause a decrease in the value of the warrants. As of December 31, 2018, and 2017, the fair value of the warrants was $0.4 million and $1.2 million, respectively.

 

Marketable Equity Securities Valuation Methodologies

 

The fair value of marketable equity securities is based on quoted market prices obtained from independent pricing services. The Company has investments in the marketable equity securities of Anfield Resources Inc, (“Anfield”) and Sutter Gold Mining Compnay, (“Sutter”). Anfield is traded is traded in an active market and has been classified as Level 1, Sutter is traded in a less active market, and accordingly has been classified as Level 2.

 

Other Financial Instruments

 

The carrying amount of cash and equivalents, oil and natural gas sales receivable, other current assets, accounts payable and accrued expenses approximate fair value because of the short-term nature of those instruments. The recorded amount for the credit facility discussed in Note 9-Debt, approximates the fair market value due to its expiration in July 2019 and the variable nature of the interest rate.

 

 

Recurring Fair Value Measurements

 

Recurring measurements of the fair value of assets and liabilities as of December 31, 2018 and 2017 are as follows:

 

   December 31, 2018   December 31, 2017 
   Level 1   Level 2   Level 3   Total   Level 1   Level 2   Level 3   Total 
(in thousands)
Assets:                                
Marketable Equity Securities   533    3    -    536    868    8    -    876 
Total  $533   $3   $-   $536   $868   $8   $-   $876 
Liabilities:                                        
Warrants   -    -    425    425    -    -    1,200    1,200 
Derivatives   -    -    -    -    -    161    -    161 
Total  $-   $-   $425   $425   $-   $161   $1,200   $1,361 

 

The following table presents a reconciliation of our Level 3 warrants measured at fair value

 

   Year Ended December 31, 
   2018   2017 
   (in thousands) 
Fair value of Level 3 instruments liabilities beginning of period  $1,200   $1,030 
           
Net unrealized (gain) loss on warrant valuation   (775)   170 
    -      
 Fair value of Level 3 instruments liabilities end of period  $425   $1,200