Fair Value Accounting

9 Months Ended

Sep. 30, 2011

Fair Value Accounting [Abstract]

Fair Value Accounting

4. Fair Value Accounting

The Company records certain of its assets and liabilities on the consolidated balance sheets at fair value. Fair value is defined 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 (exit price). A three-level valuation hierarchy has been established to allow readers to understand the transparency of inputs in the valuation of an asset or liability as of the measurement date. The three levels are defined as follows:

• Level 1 — Quoted prices (unadjusted) for identical assets or liabilities in active markets.

• Level 2 — Quoted prices for similar assets or liabilities in active markets; quoted prices for identical or similar assets or liabilities in markets that are not active; and model-derived valuations whose inputs or significant value drivers are observable.

• Level 3 — Unobservable inputs that reflect the Company’s own assumptions.

The following table provides a summary of the fair values as of September 30, 2011 of assets and liabilities measured at fair value on a recurring basis:

	Level 1		Level 2		Level 3		Total
Assets
Derivative instruments -
Commodity forward contracts	$	—	$	8,623	$	—	$	8,623
Total assets at fair value	$	—	$	8,623	$	—	$	8,623
Liabilities
Derivative instruments -
Interest rate swap			$	67	$	—	$	67
Total liabilities at fair value	$	—	$	67	$	—	$	67

The Company did not have any transfers of assets or liabilities between Level 1, Level 2 or Level 3 of the fair value measurement hierarchy during the three and nine months ended September 30, 2011.

The following describes the valuation methodologies the Company uses for its fair value measurements.

Cash and cash equivalents

Cash and cash equivalents include all cash balances and any highly liquid investments with an original maturity of 90 days or less. The carrying amount approximates fair value because of the short maturity of these instruments.

Derivative instruments

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 each counterparty, and the Company’s own credit rating. The Company also performs an internal valuation to ensure the reasonableness of third party quotes.

In consideration of counterparty credit risk, the Company assessed the possibility of whether each counterparty to the derivative would default by failing to make any contractually required payments. Additionally, the Company considers that it is of substantial credit quality and has the financial resources and willingness to meet its potential repayment obligations associated with the derivative transactions.

At September 30, 2011, the Company had various types of derivative instruments utilized by the Company, which included costless collars and swaps. The natural gas derivative markets and interest rate swap markets are highly active. Although the Company’s cash flow and economic hedges are valued using public 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.

Credit facility

The recorded value of the Company’s credit facility approximates fair value as it bears interest at a floating rate.

Asset retirement obligations

The Company estimates asset retirement obligations pursuant to the provisions of FASB ASC Topic 410, “Asset Retirement and Environmental Obligations.” The Company uses the income valuation technique to determine the fair value of the liability at the point of inception by taking into account (1) the cost of abandoning oil and gas wells, which is based on the Company’s historical experience for similar work, or estimates from independent third parties; (2) the economic lives of its properties, which is based on estimates from reserve engineers; (3) the inflation rate; and (4) the credit adjusted risk-free rate, which takes into account the Company’s credit risk and the time value of money. Given the unobservable nature of these inputs, the initial measurement of the asset retirement obligation liability is deemed to use Level 3 inputs. There were no asset retirement obligations measured at fair value within the consolidated balance sheet at September 30, 2011.

Concentration of credit risk

Financial instruments that potentially subject the Company to credit risk consist of accounts receivable and derivative financial instruments. Substantially all of the Company’s receivables are within the oil and gas industry, including those from a third party gas marketing company. Collectability is dependent upon the financial wherewithal of each counterparty as well as the general economic conditions of the industry. The receivables are not collateralized. The Company has no past due receivables from any of its counterparties.

The Company currently uses three counterparties for its derivative financial instruments. The Company continually reviews the credit worthiness of its counterparties, which are generally other energy companies or major financial institutions. In addition, the Company uses master netting agreements which allow the Company, in the event of default, to elect early termination of all contracts with the defaulting counterparty. If the Company chooses to elect early termination, all asset and liability positions with the defaulting counterparty would be “net settled” at the time of election. “Net settlement” refers to a process by which all transactions between counterparties are resolved into a single amount owed by one party to the other.