Fair value measurements

Recurring fair value measurements

Our financial instruments recorded at fair value on a recurring basis consist of commodity derivative contracts (see “Note 6—Derivative instruments”). We have no Level 1 assets or liabilities as of December 31, 2013 or December 31, 2012. Our derivative contracts classified as Level 2 as of December 31, 2013 and December 31, 2012 consist of commodity price swaps and basis protection swaps, which are valued using an income approach. Future cash flows from the derivatives are estimated based on the difference between the fixed contract price and the underlying published forward market price, and are discounted at the LIBOR swap rate.

As of December 31, 2013, our derivative contracts classified as Level 3 consisted of three-way collars, enhanced swaps, and purchased puts. As of December 31, 2012, our derivative contracts classified as Level 3 consisted of three-way collars. The fair value of these contracts is developed by a third-party pricing service using a proprietary valuation model, which we believe incorporates the assumptions that market participants would have made at the end of each period. Observable inputs include contractual terms, published forward pricing curves, and yield curves. Significant unobservable inputs are implied volatilities. Significant increases (decreases) in implied volatilities in isolation would result in a significantly higher (lower) fair value measurement. We review these valuations and the changes in the fair value measurements for reasonableness.

All derivative instruments are discounted further using a rate that incorporates our nonperformance risk for derivative liabilities and our counterparties’ nonperformance risk for derivative assets. If available, we use our counterparties’ credit default swap values or the spread between the risk-free interest rate and the yield on our counterparties’ publicly traded debt having similar maturities to our derivative contracts as the measure of our counterparties’ nonperformance risk. As of December 31, 2013 and December 31, 2012, the rate reflecting our nonperformance risk was 1.75% and 1.50%, respectively. The weighted-average rate reflecting our counterparties’ nonperformance risk was approximately 0.31% and 0.32% as of December 31, 2013 and December 31, 2012, respectively.

The fair value hierarchy for our financial assets and liabilities is shown by the following table:



	As of December 31, 2013									As of December 31, 2012
	Derivative assets			Derivative liabilities			Net assets (liabilities)			Derivative assets			Derivative liabilities			Net assets (liabilities)
Significant other observable inputs (Level 2)	$	3,275		$	(6,576	)	$	(3,301	)	$	18,599		$	(4,425	)	$	14,174
Significant unobservable inputs (Level 3)	9,838			(6,216		)	3,622			27,411			(1,180		)	26,231
Netting adjustments (1)	(4,558		)	4,558			—			(2,977		)	2,977			—
	$	8,555		$	(8,234	)	$	321		$	43,033		$	(2,628	)	$	40,405

___________


(1)	Amounts represent the impact of master netting agreements that allow us to net settle positive and negative positions with the same counterparty.

Changes in the fair value of net commodity derivatives classified as Level 3 in the fair value hierarchy at December 31 were:



Net derivative assets	2013			2012
Beginning balance	$	26,231		$	5,049
Realized and unrealized (losses) gains included in non-hedge derivative (losses) gains	(8,725		)	31,411
Purchases	664			—
Settlements received	(14,548		)	(10,229		)
Ending balance	$	3,622		$	26,231
Gains relating to instruments still held at the reporting date included in non-hedge derivative gains for the period	$	3,177		$	21,534

Nonrecurring fair value measurements

Allocation of purchase price in business combinations. The estimated fair values of proved oil and gas properties and asset retirement obligations assumed in business combinations are based on a discounted cash flow model and market assumptions as to future commodity prices, projections of estimated quantities of oil and natural gas reserves, expectations for timing and amount of future development and operating costs, projections of future rates of production, expected recovery rates, and risk-adjusted discount rates. The estimated fair values of unevaluated oil and gas properties was based on geological studies, historical well performance, location and applicable mineral lease terms. Based on the unobservable nature of certain of these assumptions, they are considered Level 3 inputs under the fair value hierarchy. See “Note 3—Acquisitions and divestitures” for additional information regarding our acquisitions.

Asset retirement obligations. Additions to the asset and liability associated with our asset retirement obligations are measured at fair value on a nonrecurring basis. Our asset retirement obligations consist of the estimated present value of future costs to plug and abandon or otherwise dispose of our oil and natural gas properties and related facilities. Significant inputs used in determining such obligations include estimates of plugging and abandonment costs, inflation rates, discount rates, and well life, all of which are Level 3 inputs according to the fair value hierarchy. The estimated future costs to dispose of properties added during the years ended December 31, 2013 and 2012 were escalated using an annual inflation rate of 2.95% and 2.95%, respectively, and discounted using our credit-adjusted risk-free interest rate of 6.60% and 7.10%, respectively. These estimates may change based upon future inflation rates and changes in statutory remediation rules. During 2013 and 2012, additions to our asset retirement obligations were $2,313 and $1,079, respectively. See “Note 8—Asset retirement obligations” for additional information regarding our asset retirement obligations.

Impairment of long-lived assets. During the fourth quarter of 2012, we finalized a plan to dispose of three of our owned drilling rigs by sale that we no longer intended to utilize in oil and natural gas production. The estimated fair value related to the impairment assessment for our three drilling rigs no longer in service was primarily based on broker opinion and, therefore, is classified within Level 3 of the fair value hierarchy. During the years ended December 31, 2013 and 2012, we recognized impairment losses of $3,490 and $2,000, respectively, related to our three drilling rigs no longer in service and drill pipe based on broker opinion.

Fair value of other financial instruments

Our significant financial instruments, other than derivatives, consist primarily of cash and cash equivalents, accounts receivable, accounts payable, and long-term debt. We believe the carrying values of cash and cash equivalents, accounts receivable, and accounts payable approximate fair values due to the short-term maturities of these instruments.

The carrying value and estimated fair value of our long-term debt at December 31, 2013 and 2012 were as follows:



	December 31, 2013				December 31, 2012
Level 2	Carrying value		Estimated fair value		Carrying value		Estimated fair value
9.875% Senior Notes due 2020	$	294,556	$	340,140	$	294,031	$	341,250
8.25% Senior Notes due 2021	400,000		437,000		400,000		434,000
7.625% Senior Notes due 2022	555,719		583,275		556,631		574,750
Senior secured revolving credit facility	272,000		272,000		25,000		25,000
Other secured long-term debt	16,437		16,437		17,740		17,740
	$	1,538,712	$	1,648,852	$	1,293,402	$	1,392,740

The fair value of our Senior Notes was estimated based on quoted market prices. The carrying value of our senior secured revolving credit facility approximates fair value because it has a variable interest rate and incorporates a measure of our credit risk. The carrying value of our other secured long-term debt approximates fair value because the rates are comparable to those at which we could currently borrow under similar terms.

See “Note 1—Nature of operations and summary of significant accounting policies” for additional information regarding our accounting policies for fair value measurements.

Concentrations of credit risk

Financial instruments which potentially subject us to concentrations of credit risk consist principally of derivative instruments and accounts receivable. Derivative instruments are exposed to credit risk from counterparties. Our derivative contracts are executed with institutions, or affiliates of institutions, that are parties to our senior secured revolving credit facility at the time of execution, and we believe the credit risks associated with all of these institutions are acceptable. We do not require collateral or other security from counterparties to support derivative instruments. Master agreements are in place with each of our derivative counterparties which provide for net settlement in the event of default or termination of the contracts under each respective agreement. As a result of the netting provisions, our maximum amount of loss under derivative transactions due to credit risk is limited to the net amounts due from the counterparties under the derivatives. Our loss is further limited as any amounts due from a defaulting counterparty that is a lender, or an affiliate of a lender, under our senior secured revolving credit facility can be offset against current amounts owed to such counterparty lender under our senior secured revolving credit facility. As of December 31, 2013, the counterparties to our open derivative contracts consisted of twelve financial institutions, of which eleven were subject to our rights of offset under our senior secured revolving credit facility.

The following table summarizes our derivative assets and liabilities which are offset in the consolidated balance sheets under our master netting agreements. It also reflects the amounts outstanding under our senior secured revolving credit facility that are available to offset our net derivative assets due from counterparties that are lenders under our senior secured revolving credit facility.



	Offset in the consolidated balance sheets									Gross amounts not offset in the consolidated balance sheets
	Gross assets (liabilities)			Offsetting assets (liabilities)			Net assets (liabilities)			Amounts outstanding under senior secured revolving credit facility			Net amount
As of December 31, 2013
Derivative assets	$	13,113		$	(8,042	)	$	5,071		$	(4,211	)	$	860
Derivative liabilities	(12,792		)	8,042			(4,750		)	—			(4,750		)
	$	321		$	—		$	321		$	(4,211	)	$	(3,890	)
As of December 31, 2012
Derivative assets	$	46,010		$	(4,721	)	$	41,289		$	(9,180	)	$	32,109
Derivative liabilities	(5,605		)	4,721			(884		)	—			(884		)
	$	40,405		$	—		$	40,405		$	(9,180	)	$	31,225

We did not post additional collateral under any of these contracts as all of our counterparties are secured by the collateral under our senior secured revolving credit facility. Payment on our derivative contracts would be accelerated in the event of a default on our senior secured revolving credit facility. The aggregate fair value of our derivative liabilities subject to acceleration in the event of default was $12,792 at December 31, 2013.

Accounts receivable are primarily from purchasers of oil and natural gas products, and exploration and production companies who own interests in properties we operate. The industry concentration has the potential to impact our overall exposure to credit risk, either positively or negatively, in that customers may be similarly affected by changes in economic, industry or other conditions.

Commodity sales to two purchasers accounted for 20.1% and 19.1% of total commodity sales, excluding the effects of hedging activities, during the year ended December 31, 2013. Commodity sales to three purchasers accounted for 19.6%, 13.9%, and 12.7% of total commodity sales, excluding the effects of hedging activities, during the year ended December 31, 2012. Commodity sales to three purchasers accounted for 15.1% and 13.6%, and 10.4% of total commodity sales, excluding the effects of hedging activities, during the year ended December 31, 2011. If we were to lose a purchaser, we believe we could replace it with a substitute purchaser.