Fair Value Measurements

6 Months Ended

Jun. 30, 2014

We value our derivatives and other financial instruments according to FASB ASC 820, Fair Value Measurements and Disclosures, which defines fair value as the exchange price that would be received for an asset or paid to transfer a liability ("exit price") in the principal or most advantageous market for the asset or liability in an orderly transaction between market participants on the measurement date.

We categorize the inputs used in measuring fair value into a three-tier fair value hierarchy. These tiers include:

Level 1 – Observable inputs, such as quoted market prices in active markets, for substantially identical assets and liabilities.

Level 2 – Observable inputs other than quoted prices within Level 1 for similar assets and liabilities. These include quoted prices in markets that are not active or other inputs that are observable or can be corroborated by observable market data. If the asset or liability has a specified or contractual term, the input must be observable for substantially the full term of the asset or liability.

Level 3 – Unobservable inputs that are supported by little or no market activity, generally requiring development of fair value assumptions by management.

Fair value of derivative financial instruments

The fair value of our derivative financial instruments may be different from the settlement value based on company-specific inputs, such as credit rating, futures markets and forward curves, and readily available buyers or sellers for such assets or liabilities. During the six months ended June 30, 2014 and 2013 there were no changes in the fair value level classifications. The following table presents a summary of the estimated fair value of our derivative financial instruments as of June 30, 2014 and December 31, 2013.



	June 30, 2014
(in thousands)	Level 1		Level 2			Level 3		Total
Oil and natural gas derivative financial instruments	$	—	$	(29,802	)	$	—	$	(29,802	)
	December 31, 2013
(in thousands)	Level 1		Level 2			Level 3		Total
Oil and natural gas derivative financial instruments	$	—	$	(6,535	)	$	—	$	(6,535	)

We evaluate derivative assets and liabilities in accordance with master netting agreements with the derivative counterparties, but report them on a gross basis on our Condensed Consolidated Balance Sheets. Net derivative asset values are determined primarily by quoted futures prices and utilization of the counterparties’ credit-adjusted risk-free rate curves and net derivative liabilities are determined by utilization of our credit-adjusted risk-free rate curve or the credit-adjusted risk-free rate curve of Compass. The credit-adjusted risk-free rates of our counterparties are based on an independent market-quoted credit default swap rate curve for the counterparties’ debt plus the London Interbank Offered Rate ("LIBOR") curve as of the end of the reporting period. Our credit-adjusted risk-free rate is based on the blended rate of independent market-quoted credit default swap rate curves for companies that have the same credit rating as us plus the LIBOR curve as of the end of the reporting period. In addition, the credit-adjusted risk-free rate for Compass is based on the cost of debt plus the LIBOR curve as of the end of the reporting period.

The valuation of our commodity price derivatives, represented by oil and natural gas swaps, basis swaps and call option contracts, is discussed below.

Oil derivatives. Our oil derivatives are swap, basis swap and call option contracts for notional Bbls of oil at fixed (in the case of swap and basis swap contracts) or interval (in the case of call option contracts) NYMEX oil index prices. The asset and liability values attributable to our oil derivatives as of the end of the reporting period are based on (i) the contracted notional volumes, (ii) independent active NYMEX futures price quotes for oil index prices, (iii) the applicable credit-adjusted risk-free rate curve, as described above, and (iv) the implied rate of volatility inherent in the call option contracts. The implied rates of volatility were determined based on average NYMEX oil index prices.

Natural gas derivatives. Our natural gas derivatives are swap and call option contracts for notional Mmbtus of natural gas at posted price indexes, including NYMEX HH swap and call option contracts. The asset and liability values attributable to our natural gas derivatives as of the end of the reporting period are based on (i) the contracted notional volumes, (ii) independent active NYMEX futures price quotes for HH for natural gas swaps, (iii) the applicable credit-adjusted risk-free rate curve, as described above and (iv) the implied rate of volatility inherent in the call option contracts. The implied rates of volatility were determined based on average HH natural gas prices.

See further details on the fair value of our derivative financial instruments in “Note 7. Derivative financial instruments”.

Fair value of other financial instruments

Our financial instruments include cash and cash equivalents, accounts receivable and payable and accrued liabilities. The carrying amount of these instruments approximates fair value because of their short-term nature.

The carrying values of our borrowings under the revolving commitment of the EXCO Resources Credit Agreement and Compass Production Partners Credit Agreement approximate fair value, as these are subject to short-term floating interest rates that approximate the rates available to us for those periods.

The estimated fair values of our 7.5% senior unsecured notes due September 15, 2018 ("2018 Notes"), our 8.5% senior unsecured notes due April 15, 2022 ("2022 Notes") and the term loan under the EXCO Resources Credit Agreement ("Term Loan") are presented below. The estimated fair values of the 2018 Notes, 2022 Notes and Term Loan have been calculated based on market quotes.



	June 30, 2014
(in thousands)	Level 1		Level 2		Level 3		Total
2018 Notes	$	772,500	$	—	$	—	$	772,500
2022 Notes	541,250		—		—		541,250
	December 31, 2013
(in thousands)	Level 1		Level 2		Level 3		Total
2018 Notes	$	714,000	$	—	$	—	$	714,000
Term Loan	298,500		—		—		298,500

- Definition

The entire disclosure for the fair value of financial instruments (as defined), including financial assets and financial liabilities (collectively, as defined), and the measurements of those instruments as well as disclosures related to the fair value of non-financial assets and liabilities. Such disclosures about the financial instruments, assets, and liabilities would include: (1) the fair value of the required items together with their carrying amounts (as appropriate); (2) for items for which it is not practicable to estimate fair value, disclosure would include: (a) information pertinent to estimating fair value (including, carrying amount, effective interest rate, and maturity, and (b) the reasons why it is not practicable to estimate fair value; (3) significant concentrations of credit risk including: (a) information about the activity, region, or economic characteristics identifying a concentration, (b) the maximum amount of loss the entity is exposed to based on the gross fair value of the related item, (c) policy for requiring collateral or other security and information as to accessing such collateral or security, and (d) the nature and brief description of such collateral or security; (4) quantitative information about market risks and how such risks are managed; (5) for items measured on both a recurring and nonrecurring basis information regarding the inputs used to develop the fair value measurement; and (6) for items presented in the financial statement for which fair value measurement is elected: (a) information necessary to understand the reasons for the election, (b) discussion of the effect of fair value changes on earnings, (c) a description of [similar groups] items for which the election is made and the relation thereof to the balance sheet, the aggregate carrying value of items included in the balance sheet that are not eligible for the election; (7) all other required (as defined) and desired information.

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