NOTE 9 — FAIR VALUE MEASUREMENTS

The authoritative guidance establishes a hierarchy for inputs used in measuring fair value that maximizes the use of observable inputs and minimizes the use of unobservable inputs by requiring that the most observable inputs be used when available. Observable inputs are inputs that market participants would use in pricing the asset or liability developed based on market data obtained from sources independent of the Company. Unobservable inputs are inputs that reflect the Company’s assumptions of what market participants would use in pricing the asset or liability developed based on the best information available in the circumstances. The hierarchy is broken down into three levels based on the reliability of the inputs as follows:

Level 1:

Quoted prices are available in active markets for identical assets or liabilities;

Level 2:

Quoted prices in active markets for similar assets and liabilities that are observable for the asset or liability; or

Level 3:

Unobservable pricing inputs that are generally less observable from objective sources, such as discounted cash flows models or valuations.

The financial assets and liabilities are classified based on the lowest level of input that is significant to the fair value measurement. The Company’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 Company’s policy is to recognize transfers in and/or out of fair value hierarchy as of the end of the reporting period for which the event or change in circumstances caused the transfer. The valuation policies are determined by the Treasurer and are approved by the President. Fair value measurements are discussed with the Company’s audit committee, as deemed appropriate. Each quarter, the inputs used in the fair value calculations are updated and management reviews the changes from period to period for reasonableness. The Company has consistently applied the valuation techniques discussed below in all periods presented.

The following table presents the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of September 30, 2016 and December 31, 2015 by level within the fair value hierarchy


	Level 1	Level 2		Level 3	Total
September 30, 2016
ASSETS:
Commodity contracts		$	2,196,635		$	2,196,635
LIABILITIES:
Commodity contracts		$	372,480		$	372,480
December 31, 2015
ASSETS:
Commodity contracts		$	5,841,395		$	5,841,395
LIABILITIES:
Commodity contracts		$	1,727,720		$	1,727,720

We use Level 2 inputs to measure the fair value of gas commodity derivatives. Level 2 assets and liabilities consist of commodity derivative assets and liabilities (See Note 8 - Derivative and Hedging Financial Instruments). The fair value of the commodity derivative assets and liabilities are estimated by the Company using income valuation techniques and a discounted cash flow model, which take into account notional quantities, market volatility, market prices, contract parameters, counterparty credit risk and discount rates based on published LIBOR rates. The Company validates the data provided by third parties by understanding the pricing models used, obtaining market values from other pricing sources, analyzing pricing data in certain situations and confirming that those securities trade in active markets. Assumed credit risk adjustments, based on published credit ratings, public bond yield spreads and credit default swap spreads, are applied to the Company’s commodity derivatives.

Assets Measured and Recorded at Fair Value on a Non-Recurring Basis

The Company also uses the income valuation technique to estimate the valuation of asset retirement obligations using the amounts and timing of expected future dismantlement costs, credit-adjusted risk-free rates and time value of money. During the nine months ended September 30, 2016 and 2015, the Company recorded asset retirement obligations of $28,777 and $34,116, respectively. See Note 1 for additional information.

Other financial instruments not measured at fair value on a recurring basis include cash, accounts receivable-trade, accounts receivable due from drilling operator, accounts receivable-related party, advance royalties, prepaid expenses, accounts payable-trade, accounts payable due to operator, accounts payable-related party, accrued expenses, revenue payable, deferred revenue, and the amounts outstanding under the notes payable. With the exception of the notes payable, the financial statement carrying items approximate their fair values due to their short-term nature.