Note 11 - Fair Value Measurements

The Company follows fair value measurement accounting guidance for all assets and liabilities measured at fair value. This guidance defines fair value as the price that would be received to sell an asset or paid to transfer a liability (an exit price) in an orderly transaction between market participants at the measurement date. Market or observable inputs are the preferred sources of values, followed by assumptions based on hypothetical transactions in the absence of market inputs. The fair value hierarchy for grouping these assets and liabilities is based on the significance level of the following inputs:


•	Level 1 – quoted prices in active markets for identical assets or liabilities


•	Level 2 – quoted prices in active markets for similar assets or liabilities, quoted prices for identical or similar instruments in markets that are not active, and model-derived valuations whose inputs are observable or whose significant value drivers are observable


•	Level 3 – significant inputs to the valuation model are unobservable

The following table is a listing of the Company’s assets and liabilities that are measured at fair value in the accompanying balance sheets and where they are classified within the fair value hierarchy as of March 31, 2016:



	Level 1		Level 2		Level 3
	(in thousands)
Assets:
Derivatives ⁽¹⁾	$	—	$	442,328	$	—
Total property and equipment, net ⁽²⁾	$	—	$	—	$	439,942
Liabilities:
Derivatives ⁽¹⁾	$	—	$	86,725	$	—
Net Profits Plan ⁽¹⁾	$	—	$	—	$	6,351

____________________________________________

⁽¹⁾ This represents a financial asset or liability that is measured at fair value on a recurring basis.

⁽²⁾ This represents a non-financial asset that is measured at fair value on a nonrecurring basis.

The following table is a listing of the Company’s assets and liabilities that are measured at fair value in the accompanying balance sheets and where they were classified within the fair value hierarchy as of December 31, 2015:



	Level 1		Level 2		Level 3
	(in thousands)
Assets:
Derivatives ⁽¹⁾	$	—	$	488,411	$	—
Total property and equipment, net ⁽²⁾	$	—	$	—	$	124,813
Liabilities:
Derivatives ⁽¹⁾	$	—	$	8	$	—
Net Profits Plan ⁽¹⁾	$	—	$	—	$	7,611

____________________________________________

⁽¹⁾ This represents a financial asset or liability that is measured at fair value on a recurring basis.

⁽²⁾ This represents a non-financial asset that is measured at fair value on a nonrecurring basis.

Both financial and non-financial assets and liabilities are categorized within the above fair value hierarchy based on the lowest level of input that is significant to the fair value measurement. The following is a description of the valuation methodologies used by the Company as well as the general classification of such instruments pursuant to the above fair value hierarchy.

Derivatives

The Company uses Level 2 inputs to measure the fair value of oil, gas, and NGL commodity derivatives. Fair values are based upon interpolated data. The Company derives internal valuation estimates taking into consideration forward commodity price curves, counterparties’ credit ratings, the Company’s credit rating, and the time value of money. These valuations are then compared to the respective counterparties’ mark-to-market statements. The considered factors result in an estimated exit-price that management believes provides a reasonable and consistent methodology for valuing derivative instruments. The derivative instruments utilized by the Company are not considered by management to be complex, structured, or illiquid. The oil, gas, and NGL commodity derivative markets are highly active.

Generally, market quotes assume that all counterparties have near zero, or low, default rates and have equal credit quality. However, an adjustment may be necessary to reflect the credit quality of a specific counterparty to determine the fair value of the instrument. The Company monitors the credit ratings of its counterparties and may require counterparties to post collateral if their ratings deteriorate. In some instances, the Company will attempt to novate the trade to a more stable counterparty.

Valuation adjustments are necessary to reflect the effect of the Company’s credit quality on the fair value of any derivative liability position. This adjustment takes into account any credit enhancements, such as collateral margin that the Company may have posted with a counterparty, as well as any letters of credit between the parties. The methodology to determine this adjustment is consistent with how the Company evaluates counterparty credit risk, taking into account the Company’s credit rating, current credit facility margins, and any change in such margins since the last measurement date. All of the Company’s derivative counterparties are members of the Company’s credit facility lender group.

The methods described above may result in a fair value estimate that may not be indicative of net realizable value or may not be reflective of future fair values and cash flows. While the Company believes that the valuation methods utilized are appropriate and consistent with authoritative accounting guidance and with other marketplace participants, the Company recognizes that third parties may use different methodologies or assumptions to determine the fair value of certain financial instruments that could result in a different estimate of fair value at the reporting date.

Refer to Note 10 - Derivative Financial Instruments for more information regarding the Company’s derivative instruments.

Net Profits Plan

The Net Profits Plan is a standalone liability for which there is no available market price, principal market, or market participants. The inputs available for this instrument are unobservable and are therefore classified as Level 3 inputs. The Company employs the income valuation technique, which converts expected future cash flow amounts to a single present value amount. This technique uses the estimate of future cash payments, expectations of possible variations in the amount and/or timing of cash flows, the risk premium, and nonperformance risk to calculate the fair value. There is a direct correlation between realized oil, gas, and NGL commodity prices driving net cash flows and the Net Profits Plan liability. Generally, higher commodity prices result in a larger Net Profits Plan liability and lower commodity prices result in a smaller Net Profits Plan liability.

The Company records the estimated fair value of the long-term liability for estimated future payments under the Net Profits Plan based on the discounted value of estimated future payments associated with each individual pool. A discount rate of 10 percent was used to calculate this liability, and is intended to represent the Company’s best estimate of the present value of expected future payments under the Net Profits Plan.

The Company’s estimate of its liability is highly dependent on commodity prices, cost assumptions, discount rates, and overall market conditions. The Company regularly assesses the current market environment. The Net Profits Plan liability is determined using price assumptions of five one-year strip prices with the fifth year’s pricing then carried out indefinitely. The average price is adjusted for realized price differentials and to include the effects of the forecasted production covered by derivative contracts in the relevant periods. The non-cash expense associated with this significant management estimate is highly volatile from period to period due to fluctuations that occur in the oil, gas, and NGL commodity markets.

If the commodity prices used in the calculation changed by five percent, the liability recorded at March 31, 2016, would differ by approximately $1.0 million. A one percent increase or decrease in the discount rate would result in a change of approximately $250,000. Actual cash payments to be made to participants in future periods are dependent on realized actual production, realized commodity prices, and costs associated with the properties in each individual pool of the Net Profits Plan. Consequently, actual cash payments are inherently different from the amounts estimated.

No published market quotes exist on which to base the Company’s estimate of fair value of its Net Profits Plan liability. As such, the recorded fair value is based entirely on management estimates that are described within this footnote. While some inputs to the Company’s calculation of fair value of the Net Profits Plan’s future payments are from published sources, others, such as the discount rate and the expected future cash flows, are derived from the Company’s own calculations and estimates.

The following table reflects the activity for the Company’s Net Profits Plan liability measured at fair value using Level 3 inputs:



	For the Three Months Ended March 31, 2016
	(in thousands)
Beginning balance	$	7,611
Net decrease in liability ⁽¹⁾	(291		)
Net settlements ^{(1) (2)}	(969		)
Transfers in (out) of Level 3	—
Ending balance	$	6,351

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⁽¹⁾	Net changes in the Company’s Net Profits Plan liability are shown in the Change in Net Profits Plan liability line item of the accompanying statements of operations.


⁽²⁾	Settlements represent cash payments made or accrued under the Net Profits Plan.

Long-Term Debt

The following table reflects the fair value of the Senior Notes measured using Level 1 inputs based on quoted secondary market trading prices. The Senior Notes were not presented at fair value on the accompanying balance sheets as of March 31, 2016, or December 31, 2015, as they were recorded at carrying value, net of unamortized deferred financing costs. Please refer to Note 5 - Long-Term Debt for discussion of the Company’s repurchase of a portion of its Senior Notes during the first quarter of 2016.



	As of March 31, 2016				As of December 31, 2015
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
	(in thousands)
6.50% Senior Notes due 2021	$	346,955	$	257,399	$	350,000	$	262,938
6.125% Senior Notes due 2022	561,796		410,813		600,000		440,250
6.50% Senior Notes due 2023	394,985		282,414		400,000		296,000
5.0% Senior Notes due 2024	500,000		344,375		500,000		334,065
5.625% Senior Notes due 2025	500,000		347,500		500,000		326,875
Total Senior Notes	$	2,303,736	$	1,642,501	$	2,350,000	$	1,660,128

The carrying value of the Company’s credit facility approximates its fair value, as the applicable interest rates are floating, based on prevailing market rates.

Proved and Unproved Oil and Gas Properties

Total property and equipment, net, measured at fair value within the accompanying balance sheets totaled $439.9 million and $124.8 million as of March 31, 2016, and December 31, 2015, respectively.

Proved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication the carrying costs may not be recoverable. 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 representative of the current operating environment, as selected by the Company’s management. The calculation of the discount rates are based on the best information available and were estimated to be 10 percent to 15 percent based on the reservoir specific weightings of future estimated proved and unproved cash flows as of March 31, 2016, and December 31, 2015. The Company believes the discount rates are representative of current market conditions and take into account estimates of future cash payments, reserve categories, expectations of possible variations in the amount and/or timing of cash flows, the risk premium, and nonperformance risk. The prices for oil and gas are forecast based on NYMEX strip pricing, adjusted for basis differentials, for the first five years, after which a flat terminal price is used for each commodity stream. The prices for NGLs are forecast using OPIS Mont Belvieu pricing, for as long as the market is actively trading, after which a flat terminal price is used. Future operating costs are also adjusted as deemed appropriate for these estimates. The Company recorded impairment of proved properties expense of $269.8 million for the three months ended March 31, 2016, due to the decline in proved and risk-adjusted probable and possible reserve expected cash flows for the Company’s outside-operated Eagle Ford assets, driven by continued commodity price declines between year-end 2015 and March 31, 2016. As of December 31, 2015, certain of the Company’s proved oil and gas properties in each of its operating regions were measured at fair value.

Unproved oil and gas property costs are evaluated for impairment and reduced to fair value when there is an indication that the carrying costs may not be recoverable. To measure the fair value of unproved properties, the Company uses a market approach, which takes into account the following significant assumptions: future development plans, risk weighted potential resource recovery, and estimated reserve values. The Company recorded abandonment and impairment of unproved properties expense of $2.3 million for the three months ended March 31, 2016, resulting from lease expirations on acreage the Company no longer intended to develop. As of December 31, 2015, certain of the Company’s unproved properties were measured at fair value resulting from lease expirations and acreage the Company no longer intended to develop in light of changes in drilling plans in response to the decline in commodity prices.

Other property and equipment costs are evaluated for impairment and reduced to fair value when there is an indication the carrying costs may not be recoverable. Fair value of other property and equipment is valued using an income valuation technique or market approach depending on the quality of information available to support management’s assumptions and the circumstances. The valuation includes consideration of the proved and unproved assets supported by the property and equipment, future cash flows associated with the assets, and fixed costs necessary to operate and maintain the assets. The Company recorded impairment of other property and equipment expense of $49.4 million for the year ended December 31, 2015, on the Company’s gathering system assets in east Texas. These assets were impaired in conjunction with the impairment of the associated proved and unproved properties, which the Company does not intend to develop during an environment of sustained low commodity prices.

Proved properties classified as held for sale, including the corresponding asset retirement obligation liability, are valued using a market approach, based on an estimated selling price, as evidenced by the most current bid prices received from third parties, if available. If an estimated selling price is not available, the Company utilizes the income valuation technique discussed above. Unproved properties classified as held for sale are valued using a market approach, based on an estimated selling price, as evidenced by the most current bid prices received from third parties. If an estimated selling price is not available, the Company estimates acreage value based on the price received for similar acreage in recent transactions by the Company or other market participants in the principal market. For the three months ended March 31, 2016, write-downs to fair value less costs to sell on certain assets held for sale totaled $68.3 million. These write-downs are included within the net loss on divestiture activity line item on the accompanying statements of operations. Please refer to Note 3 – Assets Held for Sale. There were no assets held for sale recorded at fair value as of December 31, 2015 as the carrying value was below the estimated fair value less costs to sell.

The fair value measurements of assets acquired and liabilities assumed are measured on a nonrecurring basis on the acquisition date using an income valuation technique based on inputs that are not observable in the market and therefore represent Level 3 inputs. Significant inputs to the valuation of acquired oil and gas properties include estimates of: (i) reserves; (ii) production rates; (iii) future operating and development costs; (iv) future commodity prices, including price differentials; (v) future cash flows; and (vi) a market participant-based weighted average cost of capital rate. These inputs require significant judgments and estimates by the Company’s management at the time of the valuation.