FAIR VALUE OF FINANCIAL INSTRUMENTS

Derivative Financial Instruments

Determination of fair value. Our fair value measurements are estimated pursuant to a fair value hierarchy that requires us to maximize the use of observable inputs and minimize the use of unobservable inputs when measuring fair value. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date, giving the highest priority to quoted prices in active markets (Level 1) and the lowest priority to unobservable data (Level 3). In some cases, the inputs used to measure fair value might fall in different levels of the fair value hierarchy. The lowest level input that is significant to a fair value measurement in its entirety determines the applicable level in the fair value hierarchy. Assessing the significance of a particular input to the fair value measurement in its entirety requires judgment, considering factors specific to the asset or liability, and may affect the valuation of the assets and liabilities and their placement within the fair value hierarchy levels. The three levels of inputs that may be used to measure fair value are defined as:

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

Level 2 – Inputs other than quoted prices included within Level 1 that are either directly or indirectly observable for the asset or liability, including quoted prices for similar assets or liabilities in active markets, quoted prices for identical or similar assets or liabilities in inactive markets, inputs other than quoted prices that are observable for the asset or liability and inputs that are derived from observable market data by correlation or other means.

Level 3 – Unobservable inputs for the asset or liability, including situations where there is little, if any, market activity.

Derivative Financial Instruments. We measure the fair value of our derivative instruments based on a pricing model that utilizes market-based inputs, including, but not limited to, the contractual price of the underlying position, current market prices, crude oil and natural gas forward curves, discount rates such as the LIBOR curve for a similar duration of each outstanding position, volatility factors and nonperformance risk. Nonperformance risk considers the effect of our credit standing on the fair value of derivative liabilities and the effect of our counterparties' credit standings on the fair value of derivative assets. Both inputs to the model are based on published credit default swap rates and the duration of each outstanding derivative position.

We validate our fair value measurement through the review of counterparty statements and other supporting documentation, the determination that the source of the inputs is valid, the corroboration of the original source of inputs through access to multiple quotes, if available, or other information and monitoring changes in valuation methods and assumptions. While we use common industry practices to develop our valuation techniques and believe our valuation method is appropriate and consistent with those used by other market participants, changes in our pricing methodologies or the underlying assumptions could result in significantly different fair values.

Our fixed-price swaps, basis swaps and physical purchases are included in Level 2 and our collars, calls and physical sales are included in Level 3. The following table presents, for each applicable level within the fair value hierarchy, our derivative assets and liabilities, including both current and non-current portions, measured at fair value on a recurring basis:



	September 30, 2014						December 31, 2013
	Significant Other Observable Inputs (Level 2)		Significant Unobservable Inputs (Level 3)		Total		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)		Total
	(in thousands)
Assets:
Commodity-based derivative contracts	$	20,817	$	6,369	$	27,186	$	3,852		$	2,098	$	5,950
Basis protection derivative contracts	—		—		—		74			—		74
Total assets	20,817		6,369		27,186		3,926			2,098		6,024
Liabilities:
Commodity-based derivative contracts	4,079		437		4,516		16,539			987		17,526
Basis protection derivative contracts	81		—		81		5			—		5
Total liabilities	4,160		437		4,597		16,544			987		17,531
Net asset (liability)	$	16,657	$	5,932	$	22,589	$	(12,618	)	$	1,111	$	(11,507	)

The following table presents a reconciliation of our Level 3 assets measured at fair value:



	Three Months Ended September 30,						Nine Months Ended September 30,
	2014			2013			2014			2013
	(in thousands)
Fair value, net asset (liability), beginning of period	$	(6,967	)	$	3,719		$	1,111		$	13,610
Changes in fair value included in statement of operations line item:
Commodity price risk management gain (loss), net	12,758			(3,242		)	3,961			(3,265		)
Sales from natural gas marketing	2			10			(24		)	16
Settlements included in statement of operations line items:
Commodity price risk management gain (loss), net	142			(66		)	882			(5,545		)
Sales from natural gas marketing	(3		)	(5		)	2			(34		)
Loss from discontinued operations, net of tax	—			—			—			(4,366		)
Fair value, net asset end of period	$	5,932		$	416		$	5,932		$	416

Net change in fair value of unsettled derivatives included in statement of operations line item:
Commodity price risk management gain (loss), net	$	11,831		$	(3,296	)	$	673		$	(5,451	)
Sales from natural gas marketing	1			(5		)	(2		)	4
Total	$	11,832		$	(3,301	)	$	671		$	(5,447	)

The significant unobservable input used in the fair value measurement of our derivative contracts is the implied volatility curve, which is provided by a third-party vendor. A significant increase or decrease in the implied volatility, in isolation, would have a directionally similar effect resulting in a significantly higher or lower fair value measurement of our Level 3 derivative contracts.

Non-Derivative Financial Assets and Liabilities

The carrying value of the financial instruments included in current assets and current liabilities approximate fair value due to the short-term maturities of these instruments.

The liability associated with our non-qualified deferred compensation plan for non-employee directors may be settled in cash or shares of our common stock. The carrying value of this obligation is based on the quoted market price of our common stock, which is a Level 1 input.

The portion of our long-term debt related to our revolving credit facility, as well as our proportionate share of PDCM's credit facility and second lien term loan, approximate fair value due to the variable nature of related interest rates. We have not elected to account for the portion of our debt related to our senior notes under the fair value option; however, as of September 30, 2014, we estimate the fair value of the portion of our long-term debt related to our 3.25% convertible senior notes due 2016 to be $158.5 million, or 137.8% of par value, and the portion related to our 7.75% senior notes due 2022 to be $536.3 million, or 107.3% of par value. We determined these valuations based upon measurements of trading activity and broker and/or dealer quotes, respectively, which are published market prices, and therefore are Level 2 inputs.

Concentration of Risk

Derivative Counterparties. Our derivative arrangements expose us to credit risk of nonperformance by our counterparties. We primarily use financial institutions who are also lenders under our revolving credit facility as counterparties to our derivative contracts. To date, we have had no counterparty default losses relating to our derivative arrangements. We have evaluated the credit risk of our derivative assets from our counterparties using relevant credit market default rates, giving consideration to amounts outstanding for each counterparty and the duration of each outstanding derivative position. Based on our evaluation, we have determined that the potential impact of nonperformance of our counterparties on the fair value of our derivative instruments was not significant at September 30, 2014, taking into account the estimated likelihood of nonperformance.

The following table presents the counterparties that expose us to credit risk as of September 30, 2014 with regard to our derivative assets:



Counterparty Name	Fair Value of Derivative Assets
	(in thousands)
Canadian Imperial Bank of Commerce (1)	$	7,171
JP Morgan Chase Bank, N.A (1)	5,812
Wells Fargo Bank, N.A. (1)	5,343
Bank of Nova Scotia (1)	3,470
Key Bank N.A. (1)	2,540
Other lenders in our revolving credit facility	2,844
Various (2)	6
Total	$	27,186

__________

(1)Major lender in our revolving credit facility. See Note 7, Long-Term Debt.

(2)Represents a total of 26 counterparties.