FAIR VALUE OF FINANCIAL INSTRUMENTS

3 Months Ended

Mar. 31, 2020

NOTE 8 - FAIR VALUE OF FINANCIAL INSTRUMENTS

The Company measures the fair value of its financial assets on a three-tier value hierarchy, which prioritizes the inputs used in the valuation methodologies in measuring fair value:



	●	Level 1 - Observable inputs that reflect quoted prices (unadjusted) for identical assets or liabilities in active markets.



	●	Level 2 - Other inputs that are directly or indirectly observable in the marketplace.



	●	Level 3 - Unobservable inputs which are supported by little or no market activity.

The fair value hierarchy also requires an entity to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value.

Determination of the fair values of our derivative contracts incorporates various factors, including not only the impact of our non-performance risk on our liabilities, but also the credit standing of the counterparties involved. The Company utilizes counterparty rate of default values to assess the impact of non-performance risk when evaluating both our liabilities to, and receivables from, counterparties.

Recurring Fair Value Measurements



	Fair Value Measurement Classification
	Quoted Prices in Active Markets for Identical Assets or Liabilities (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total
	(In thousands)
As of March 31, 2020
Oil and natural gas derivative instruments:
Oil and natural gas derivative swap contracts	$	—	$	8,959		$	—		$	8,959
Oil and natural gas derivative collar contracts	—		7,201			—			7,201
Embedded derivative instruments:
Net settlement provisions under ARM sales agreement	—		—			(20,601		)	(20,601		)
Total	$	—	$	16,160		$	(20,601	)	$	(4,441	)
As of December 31, 2019
Oil and natural gas derivative instruments:
Oil and natural gas derivative swap contracts	$	—	$	(3,932	)	$	—		$	(3,932	)
Oil and natural gas derivative collar contracts	—		301			—			301
Embedded derivative instruments:
Net settlement provisions under ARM sales agreement	—		—			(3,238		)	(3,238		)
Total	$	—	$	(3,631	)	$	(3,238	)	$	(6,869	)

Derivative assets and liabilities include unsettled amounts related to commodity derivative positions, including swaps and collars, as of March 31, 2020 and December 31, 2019. The fair value of the Company’s derivatives is based on third-party pricing models which utilize inputs that are either readily in the public market or which can be corroborated from active markets of broker quotes. Swaps and collars generally have observable inputs and these instruments are measured using Level 2 inputs.

In addition, derivative liabilities as of March 31, 2020 include an embedded derivative associated with the ARM sales agreement (see Note 19 - Commitments and Contingencies). The Company recognized a derivative liability of $20.6 million as of March 31, 2020 and an unrealized loss of $17.4 million for the three months ended March 31, 2020. This embedded derivative has fewer observable inputs from objective sources and are therefore measured using Level 3 inputs. The fair value of the net settlement provisions under the agreement was determined based on certain assumptions including (1) forward pricing for crude oil basis differentials, (ii) future LIBOR rates and (iii) the Company’s implied credit rating.

The following table sets forth a reconciliation of changes in the fair value of the Company’s financial assets and liabilities classified as Level 3 in the fair value hierarchy, except for the commodity derivatives classified as Level 2, as disclosed in Note 9, as of March 31, 2020 and 2019:



	Firm Takeaway and Pricing Agreement Net Settlement Provisions
	(in thousands)
Balance at January 1, 2020	$	(3,238	)
Change in fair value of embedded derivative liabilities	(17,363		)
Balance at March 31, 2020	$	(20,601	)



	Firm Takeaway and Pricing Agreement Net Settlement Provisions			Second Lien Term Loan Conversion Features			Total
	(in thousands)
Balance at January 1, 2019	$	—		$	(1,965	)	$	(1,965	)
Fair value of the converted portion of the embedded derivatives associated with the Second Lien Term Loan	—			2,300			2,300
Change in fair value of embedded derivative liabilities	(3,238		)	(335		)	(3,573		)
Balance at December 31, 2019	$	(3,238	)	$	—		$	(3,238	)

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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