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 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:



	March 31, 2015						December 31, 2014
	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	$	240,670	$	74,817	$	315,487	$	237,939	$	62,356	$	300,295
Basis protection derivative contracts	907		—		907		19		—		19
Total assets	241,577		74,817		316,394		237,958		62,356		300,314
Liabilities:
Commodity-based derivative contracts	616		—		616		742		—		742
Basis protection derivative contracts	—		—		—		25		—		25
Total liabilities	616		—		616		767		—		767
Net asset	$	240,961	$	74,817	$	315,778	$	237,191	$	62,356	$	299,547

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



	Three Months Ended March 31,
	2015			2014
	(in thousands)
Fair value, net asset, beginning of period	$	62,356		$	1,111
Changes in fair value included in statement of operations line item:
Commodity price risk management gain (loss), net	15,189			(1,343		)
Sales from natural gas marketing	1			(22		)
Settlements included in statement of operations line items:
Commodity price risk management gain (loss), net	(2,725		)	119
Sales from natural gas marketing	(4		)	6
Fair value, net asset (liability) end of period	$	74,817		$	(129	)

Net change in fair value of unsettled derivatives included in statement of operations line item:
Commodity price risk management gain (loss), net	$	14,494		$	(1,473	)
Sales from natural gas marketing	—			(5		)
Total	$	14,494		$	(1,478	)

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. There has been no change in the methodology we apply to measure the fair value 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 liability related to this plan, which was included in other liabilities on the condensed consolidated balance sheets, was immaterial as of March 31, 2015 and December 31, 2014.

The portion of our long-term debt related to our revolving credit facility approximates 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 March 31, 2015, 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 $159.2 million, or 138.4% of par value, and the portion related to our 7.75% senior notes due 2022 to be $525.0 million, or 105.0% 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.

The carrying value of our capital lease obligations approximates fair value as it represents the present value of future lease payments.

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 March 31, 2015, taking into account the estimated likelihood of nonperformance.

The following table presents the counterparties that expose us to credit risk as of March 31, 2015 with regard to our derivative assets:



Counterparty Name	Fair Value of Derivative Assets
	(in thousands)
JP Morgan Chase Bank, N.A (1)	$	93,642
Canadian Imperial Bank of Commerce (1)	68,625
Wells Fargo Bank, N.A. (1)	46,899
NATIXIS (1)	43,640
Bank of Nova Scotia (1)	30,479
Key Bank N.A. (1)	24,314
Other lenders in our revolving credit facility	8,795
Total	$	316,394

__________

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

Note Receivable. The following table presents information regarding our note receivable outstanding as of March 31, 2015:



	Amount
	(in thousands)
Note Receivable:
Principal outstanding, December 31, 2014	$	39,707
Paid-In-Kind interest	794
Principal outstanding, March 31, 2015	$	40,501

In October 2014, we sold our entire 50% ownership interest in PDCM to an unrelated third-party. See Note 13, Assets Held for Sale, Divestitures and Discontinued Operations, for additional information regarding the sale. As part of the consideration, we received a promissory note (the “Note”) for a principal sum of $39.0 million, bearing varying interest rates beginning at 8%, and increasing annually. Pursuant to the Note agreement, interest shall be paid quarterly, in arrears, commencing in December 2014 and continuing on the last business day of each fiscal quarter thereafter. At the option of the issuer of the Note, an unrelated third-party, interest can be paid-in-kind (the “PIK Interest”) and any such PIK Interest will be added to the outstanding principal amount of the Note. As of March 31, 2015, the issuer of the Note had elected the PIK Interest option. The principal and any unpaid interest shall be due and payable in full in September 2020, and can be prepaid in whole or in part, at any time, and in certain circumstances must be repaid, without premium or penalty. The Note is secured by a pledge of stock in certain subsidiaries of the unrelated third-party, debt securities issued and certain assets.

Under the effective interest method, we recognized $1.1 million of interest income for the three months ended March 31, 2015, of which $0.8 million was PIK Interest. As of March 31, 2015, the $40.5 million outstanding balance on the Note was included in the condensed consolidated balance sheet line item other assets.