8. FAIR VALUE MEASUREMENTS:

The Company follows FASB ASC 820, Fair Value Measurements and Disclosures, which defines fair value, establishes a framework for using fair value to measure assets and liabilities, and expands disclosures about fair value measurements. The statement 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 flow models or valuations.

Financial assets and liabilities are to be 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 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, 2013 by level within the fair value hierarchy:

	Fair Value Measurements Using
	Level 1		Level 2		Level 3
Commodity derivative assets	$	—	$	940,214	$	161,106
Commodity derivative liabilities	$	—	$	3,879,369	$	6,028,328

The following table presents the Company’s financial assets and liabilities that were accounted for at fair value on a recurring basis as of December 31, 2012 by level within the fair value hierarchy:

	Fair Value Measurements Using
	Level 1		Level 2		Level 3
Commodity derivative assets	$	—	$	450,872	$	1,727,192
Commodity derivative liabilities	$	—	$	5,173,140	$	1,235,168

Fair value of all derivative instruments are estimated with industry-standard models that consider various assumptions, including quoted forward prices for commodities, time value, volatility factors and current market and contractual prices for the underlying instruments, as well as other relevant economic measures. All valuations were compared against counterparty statements to verify the reasonableness of the estimate. The Company’s commodity swaps are validated by observable transactions for the same or similar commodity options using the NYMEX futures index, and are designated as Level 2 within the valuation hierarchy. The Company’s collars, which are designated as Level 3 within the valuation hierarchy, are not validated by observable transactions with respect to volatility. Presently, all of our hedging arrangements are concentrated with six counterparties, five of which are lenders under our Company’s senior secured revolving credit facility.

The following table reflects the activity for the commodity derivatives measured at fair value using Level 3 inputs during the period from January 1, 2013 through September 30, 2013:

	Derivative Asset			Derivative Liability
Beginning net asset (liability) balance	$	1,727,192		$	1,235,168
Net (decrease) increase in fair value	(4,062,935		)	5,310,842
Net realized (loss) on settlement	(586,249		)	(1,559,729		)
New derivatives	3,083,098			1,042,047
Transfers in (out) of Level 3	—			—
Ending net asset (liability) balance	$	161,106		$	6,028,328

As of September 30, 2013, the Company’s derivative commodity contracts are as follows:

Settlement Period	Swap Volume	Fixed Price	Collar Volume	Average Short Floor	Average Floor	Average Ceiling
Oil	Bbl/d	$	Bbl/d	$	$	$
Q4 2013	3,939	93.81	5,022		87.99	101.46

Q1 2014	2,133	96.19	5,617		86.33	97.09
Q2 2014	2,126	96.21	4,846		86.55	96.72
Q3 2014	1,370	94.40	4,326		86.16	96.57
Q4 2014	1,370	94.40	4,326		86.16	96.57

Q1 2014			1,000	60.00	85.00	99.50
Q2 2014			1,000	60.00	85.00	99.50
Q3 2014			1,000	60.00	85.00	99.50
Q4 2014			1,000	60.00	85.00	99.50

FY 2015			1,500	60.00	80.00	98.15

Gas		MMBtu/d		$
Q4 2013		166		6.40

The table below contains a summary of all the Company’s derivative positions reported on the consolidated balance sheet as of September 30, 2013:

Derivatives	Balance Sheet Location	Fair Value
Asset
Commodity derivatives	Current derivative assets	$	620,446
Commodity derivatives	Long-term derivative assets	480,874
Liability
Commodity derivatives	Current derivative liability	(9,613,257		)
Commodity derivatives	Long-term derivative liability	(294,440		)
Total		$	(8,806,377	)

Realized gains and losses on commodity derivatives and the unrealized gains or losses are recorded in other income (expense).

Asset Retirement Obligation—Upon completion of wells and natural gas plants, the Company records an asset retirement obligation at fair value using Level 3 assumptions.

Proved Oil and Gas Properties—Proved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs exceed the sum of the undiscounted cash flows. The Company uses Level 3 inputs and the income valuation technique, which converts future amounts to a single present value amount, to measure the fair value of proved properties through an application of discount rates and price forecasts selected by the Company’s management. The calculation of the discount rate is a significant management estimate based on the best information available and estimated to be 10 percent for the nine months ended September 30, 2013. Management believes that the discount rate is representative of current market conditions and reflects the following factors: estimate of future cash payments, expectations of possible variations in the amount and/or timing of cash flows, the risk premium, and nonperformance risk. The price forecast is based on New York Mercantile Exchange (“NYMEX”) strip pricing, adjusted for basis differentials. Future operating costs are also adjusted as deemed appropriate for these estimates.