Note 8: Fair value measurements

Fair value is defined by the FASB as 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. Where available, fair value is based on observable market prices or parameters or derived from such prices or parameters. Where observable prices or inputs are not available, valuation models are applied. These valuation techniques involve some level of management estimation and judgment, the degree of which is dependent on the price transparency for the instruments or market and the instruments’ complexity.

Fair value measurements are categorized according to the fair value hierarchy defined by the FASB. The hierarchical levels are based upon the level of judgment associated with the inputs used to measure the fair value of the assets and liabilities as follows:

•

Level 1 inputs are unadjusted quoted prices in active markets for identical assets or liabilities at the measurement date.

•

Level 2 inputs include quoted prices for identical or similar instruments in markets that are not active and inputs other than quoted prices that are observable for the asset or liability.

•

Level 3 inputs are unobservable inputs for the asset or liability, and include situations where there is little, if any, market activity for the asset or liability.

In certain cases, the inputs used to measure fair value may fall into different levels of the fair value hierarchy. In such cases, the asset or liability is categorized based on the lowest level input that is significant to the fair value measurement in its entirety. Our assessment of the significance of a particular input to the fair value measurement in its entirety requires judgment, and may affect the placement of assets and liabilities within the levels of the fair value hierarchy.

Recurring fair value measurements

As of September 30, 2017, and December 31, 2016, our financial instruments recorded at fair value on a recurring basis consisted of commodity derivative contracts (see “Note 7—Derivative instruments”). We had no Level 1 assets or liabilities. Our derivative contracts classified as Level 2 consisted of commodity price swaps which are valued using an income approach. Future cash flows from the commodity price swaps are estimated based on the difference between the fixed contract price and the underlying published forward market price. Our derivative contracts classified as Level 3 consisted of 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 recorded at fair value and include a measure of our own nonperformance risk for derivative liabilities or our counterparty credit risk for derivative assets.

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

	Successor								Predecessor
	September 30, 2017								December 31, 2016
	Derivative assets			Derivative liabilities			Net assets (liabilities)		Derivative assets			Derivative liabilities			Net assets (liabilities)
Significant other observable inputs (Level 2)	$	14,027		$	(363	)	$	13,664	$	184		$	(13,455	)	$	(13,271	)
Significant unobservable inputs (Level 3)		456			—			456		—			(98	)		(98	)
Netting adjustments (1)		(363	)		363			—		(184	)		184			—
	$	14,120		$	—		$	14,120	$	—		$	(13,369	)	$	(13,369	)

(1)

Amounts represent the impact of master netting agreements that allow us to net settle positive and negative positions with the same counterparty. Positive and negative positions with counterparties are netted on the balance sheet only to the extent that they relate to the same current versus noncurrent classification.

Changes in the fair value of our derivative instruments, classified as Level 3 in the fair value hierarchy, were as follows for the periods presented:

	Successor			Predecessor
	Period from			Period from
	March 22, 2017			January 1, 2017			Nine months
	through			through			ended
Net derivative assets (liabilities)	September 30, 2017			March 21, 2017			September 30, 2016
Beginning balance	$	715		$	(98	)	$	123,068
Realized and unrealized (losses) gains included in derivative (losses) gains		(259	)		813			(9,216	)
Settlements received		—			—			(113,852	)
Ending balance	$	456		$	715		$	—
(Losses) gains relating to instruments still held at the reporting date included in derivative (losses) gains for the period	$	(259	)	$	813		$	—

Nonrecurring fair value measurements

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 first nine months of 2017 and 2016 were escalated using an annual inflation rate of 2.30% and 2.42%, respectively. The estimated future costs to dispose of properties added once we emerged from bankruptcy through September 30, 2017, were discounted, depending on the economic remaining estimated life of the property or the expected timing of the plugging and abandonment activity, with a credit-adjusted risk-free rate ranging from 5.13% to 7.63%. The discount rate used for the nine months ended September 30, 2016, was our weighted average credit-adjusted risk-free interest rate of 20.00%. These estimates may change based upon future inflation rates and changes in statutory remediation rules. See “Note 9—Asset retirement obligations” for additional information regarding our asset retirement obligations.

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 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 debt were as follows:

	Successor				Predecessor
	September 30, 2017				December 31, 2016
Level 2	Carrying value (1)		Estimated fair value		Carrying value (1)		Estimated fair value
New Revolver	$	153,000	$	153,000	$	—	$	—
New Term Loan		149,192		149,192		—		—
Other secured debt		9,338		9,338		10,029		10,029
9.875% Senior Notes due 2020		—		—		298,000		268,200
8.25% Senior Notes due 2021		—		—		384,045		344,680
7.625% Senior Notes due 2022		—		—		525,910		470,689

(1)	The carrying value excludes deductions for debt issuance costs and discounts.

The carrying value of our New Revolver, New Term Loan and other secured long-term debt approximates fair value because the rates are comparable to those at which we could currently borrow under similar terms, are variable and incorporate a measure of our credit risk. The fair value of our Senior Notes was estimated based on quoted market prices. We have not disclosed the fair value of outstanding amounts under our Prior Credit Facility as of December 31, 2016, as it was not practicable to obtain a reasonable estimate of such value while the Predecessor was in bankruptcy.

Counterparty credit risk

Our derivative contracts are executed with institutions, or affiliates of institutions, that are parties to our credit facilities 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 credit facilities can be offset against amounts owed to such counterparty Lender. As of September 30, 2017, the counterparties to our open derivative contracts consisted of four financial institutions.

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 credit facilities that are available to offset our net derivative assets due from counterparties that are lenders under our credit facilities.

	Offset in the consolidated balance sheets									Gross amounts not offset in the consolidated balance sheets
	Gross assets (liabilities)			Offsetting assets (liabilities)			Net assets (liabilities)			Derivatives (1)		Amounts outstanding under credit facilities			Net amount
Successor - September 30, 2017
Derivative assets	$	14,483		$	(363	)	$	14,120		$	—	$	(14,120	)	$	—
Derivative liabilities		(363	)		363			—			—		—			—
	$	14,120		$	—		$	14,120		$	—	$	(14,120	)	$	—


Predecessor - December 31, 2016
Derivative assets	$	184		$	(184	)	$	—		$	—	$	—		$	—
Derivative liabilities		(13,553	)		184			(13,369	)		—		—			(13,369	)
	$	(13,369	)	$	—		$	(13,369	)	$	—	$	—		$	(13,369	)

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(1) Since positive and negative positions with a counterparty are netted on the balance sheet only to the extent that they relate to the same current versus noncurrent classification, these represent remaining amounts that could have been offset under our master netting agreements.

We did not post additional collateral under any of these contracts as all of our counterparties are secured by the collateral under our credit facilities. Payment on our derivative contracts could be accelerated in the event of a default on our New Credit Facility. The aggregate fair value of our derivative liabilities subject to acceleration in the event of default was $363 at September 30, 2017.