4. FAIR VALUE MEASUREMENTS

Measurements of fair value of derivative instruments are classified according to the fair value hierarchy, which prioritizes the inputs to the valuation techniques used to measure fair value. Fair value is the price that would be received upon the sale of an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. Fair value measurements are classified and disclosed in one of the following categories:

Level 1 – Measured based on unadjusted quoted prices in active markets that are accessible at the measurement date for identical, unrestricted assets or liabilities. Active markets are considered those in which transactions for the assets or liabilities occur in sufficient frequency and volume to provide pricing information on an ongoing basis.

Level 2 – Measured based on quoted prices in markets that are not active, or inputs which are observable, either directly or indirectly, for substantially the full term of the asset or liability. This category includes those derivative instruments that can be valued using observable market data. Substantially all of these inputs are observable in the marketplace throughout the term of the derivative instrument, can be derived from observable data, or supported by observable levels at which transactions are executed in the marketplace.

Level 3 – Measured based on prices or valuation models that require inputs that are both significant to the fair value measurement and less observable from objective sources (i.e., supported by little or no market activity). The valuation models used to value derivatives associated with the Partnership's oil and natural gas production are primarily industry standard models that consider various inputs including: (a) quoted forward prices for commodities, (b) time value, and (c) current market and contractual prices for the underlying instruments, as well as other relevant economic measures. Although third party quotes are utilized to assess the reasonableness of the prices and valuation techniques, there is not sufficient corroborating evidence to support classifying these assets and liabilities as Level 2.

Financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement. Management's assessment of the significance of a particular input to the fair value measurement requires judgment, and may affect the valuation of the fair value of assets and liabilities and their placement within the fair value hierarchy levels.

The following table summarizes the fair value of our assets and liabilities that were accounted for at fair value on a recurring basis as of December 31, 2015 (in thousands):


	Fair Value Measurements at December 31, 2015
	Active Markets for		Observable
	Identical Assets		Inputs		Unobservable Inputs		Netting Cash and		Fair Value at
	(Level 1)		(Level 2)		(Level 3)		Collateral		December 31, 2015
Derivative assets	$	—	$	31,018	$	—	$	—	$	31,018
Derivative liabilities		—		—		—		—		—
Embedded derivative		—		—		(193,077)				(193,077)
Total net assets	$	—	$	31,018	$	(193,077)	$	—	$	(162,059)

The following table summarizes the fair value of our assets and liabilities that were accounted for at fair value on a recurring basis as of December 31, 2014 (in thousands):


	Fair Value Measurements at December 31, 2014
	Active Markets for		Observable
	Identical Assets		Inputs		Unobservable Inputs		Netting Cash and		Fair Value at
	(Level 1)		(Level 2)		(Level 3)		Collateral		December 31, 2014
Derivative assets	$	—	$	22,919	$	—	$	(90)	$	22,829
Derivative liabilities		—		(90)		—		90		—
Total net assets	$	—	$	22,829	$	—	$	—	$	22,829

As of December 31, 2015 and December 31, 2014, the estimated fair value of cash and cash equivalents, accounts receivable, other current assets and current liabilities approximated their carrying value due to their short-term nature.

Fair Value on a Non-Recurring Basis

The Partnership follows the provisions of Accounting Standards Codification (“ASC”) Topic 820-10 for nonfinancial assets and liabilities measured at fair value on a non-recurring basis. The fair value measurements of assets acquired and liabilities assumed are based on inputs that are not observable in the market and therefore represent Level 3 inputs under the fair value hierarchy. The fair values of oil and natural gas properties and asset retirement obligations were measured using valuation techniques that convert future cash flows to a single discounted amount. Significant inputs to the valuation of oil and natural gas properties include estimates of: (i) reserves; (ii) future operating and development costs; (iii) future commodity prices; (iv) estimated future cash flows; and (v) a market-based weighted average cost of capital rate. These inputs require significant judgments and estimates by the Partnership’s management at the time of the valuation and are the most sensitive and subject to change. Our purchase price allocation for the Eagle Ford and Western Catarina Midstream acquisitions are presented in Note 3, ‘‘Acquisitions and Divestitures.” Fair value of oil and natural gas properties are presented in Note 7, “Oil and Natural Gas Properties.” A reconciliation of the beginning and ending balances of the Partnership’s asset retirement obligations is presented in Note 9, ‘‘Asset Retirement Obligations.’’

Fair Value of Financial Instruments

Fair value guidance requires certain fair value disclosures, such as those on our debt and derivatives, to be presented in both interim and annual reports. The estimated fair value amounts of financial instruments have been determined using available market information and valuation methodologies described below.

Credit Agreement – We believe that the carrying value of long-term debt for our Credit Agreement approximates its fair value because the interest rates on the debt approximate market interest rates for debt with similar terms. The debt is classified as a Level 2 input in the fair value hierarchy and represents the amount at which the instrument could be valued in an exchange during a current transaction between willing parties. Our Credit Agreement is discussed further in Note 6, “Long-Term Debt.”

Derivative Instruments – The income valuation approach, which involves discounting estimated cash flows, is primarily used to determine recurring fair value measurements of our derivative instruments classified as Level 2 inputs. Our commodity derivatives are valued using the terms of the individual derivative contracts with our counterparties, expected future levels of oil and natural gas prices and an appropriate discount rate. Our interest rate derivatives are valued using the terms of the individual derivative contracts with our counterparties, expected future levels of the LIBOR interest rates and an appropriate discount rate. We did not have any interest rate derivatives as of December 31, 2015. We prioritize the use of the highest level inputs available in determining fair value such that fair value measurements are determined using the highest and best use as determined by market participants and the assumptions that they would use in determining fair value.

Embedded Derivative – The Partnership entered into a contract for the sale of preferred units in October 2015 which contained provisions that must be bifurcated from the contract and valued as a derivative. The embedded derivative is valued through the use of a Monte Carlo model which utilizes observable inputs, the Partnership’s unit prices at various timelines, as well as unobservable inputs related to the weighted probabilities of certain redemption scenarios. We have therefore classified the fair value measurements of our embedded derivative as Level 3 inputs. The Partnership has marked this derivative to market as of December 31, 2015, and incurred approximately $10.0 million loss as a result.

The fair value of the Partnership’s embedded derivative classified as Level 3 as of December 31, 2015 was $193.1 million. Changes in the unobservable inputs will impact the fair value measurement of the Partnership's embedded derivative contract.

The following table sets forth a reconciliation of changes in the fair value of the Partnership's embedded derivative classified as Level 3 in the fair value hierarchy (in thousands):


	Significant Unobservable Inputs (Level 3)
	Year Ended December 31,
	2015		2014
Beginning balance	$	—	$	—
Initial fair value of embedded derivative - bifurcated from mezzanine equity		(183,095)		—
Total (losses) included in earnings		(9,982)		—
Ending balance	$	(193,077)	$	—

(Losses) included in earnings related to derivatives still held as of
December 31, 2015, and 2014	$	(9,982)	$	—