Note 6. Fair Value Measurements

The FASC Fair Value Measurements and Disclosures topic defines fair value as the price that would be received to sell an asset or would be paid to transfer a liability in an orderly transaction between market participants at the measurement date (exit price). We utilize market data or assumptions that market participants would use in pricing the asset or liability, including assumptions about risk and the risks inherent in the inputs to the valuation technique. These inputs can be readily observable, market corroborated or generally unobservable. We primarily apply the market approach for recurring fair value measurements and endeavor to utilize the best available information. Accordingly, we utilize valuation techniques that maximize the use of observable inputs and minimize the use of unobservable inputs. We are able to classify fair value balances based on the observability of those inputs. The FASC establishes a fair value hierarchy that prioritizes the inputs used to measure fair value. The hierarchy gives the highest priority to unadjusted quoted prices in active markets for identical assets or liabilities (Level 1 measurement) and the lowest priority to unobservable inputs (Level 3 measurement). The three levels of the fair value hierarchy are as follows:


•	Level 1 – Quoted prices in active markets for identical assets or liabilities as of the reporting date.

•

Level 2 – Pricing inputs are other than quoted prices in active markets included in Level 1, which are either directly or indirectly observable as of the reported date. Level 2 includes those financial instruments that are valued using models or other valuation methodologies. Instruments in this category include non-exchange-traded oil and natural gas derivatives that are based on NYMEX pricing. Our fixed-price swap contracts are valued using a discounted cash flow model based upon forward commodity price curves. Our costless collars and the written put features of our enhanced oil swaps and three-way collars are valued using the Black-Scholes model, an industry standard option valuation model, that takes into account inputs such as contractual prices for the underlying instruments, including maturity, quoted forward prices for commodities, interest rates, volatility factors and credit worthiness, as well as other relevant economic measures. Substantially all of these assumptions are observable in the marketplace throughout the full term of the instrument, can be derived from observable data or are supported by observable levels at which transactions are executed in the marketplace.

•

Level 3 – Pricing inputs include significant inputs that are generally less observable from objective sources. These inputs may be used with internally developed methodologies that result in management's best estimate of fair value. At June 30, 2014, instruments in this category include non-exchange-traded oil derivatives that are based on regional pricing other than NYMEX. The valuation models utilized for enhanced swaps, costless collars and three-way collars are consistent with the methodologies described above; however, since the instruments are based on regional pricing other than NYMEX, the inputs to the valuation are less observable from objective sources. Implied volatilities utilized in the valuation of Level 3 instruments are developed using a benchmark, which is considered a significant unobservable input. A one percent increase or decrease in implied volatility would result in a change of approximately $0.1 million in the fair value of these instruments as of June 30, 2014.

We adjust the valuations from the valuation model for nonperformance risk, using our estimate of the counterparty's credit quality for asset positions and our credit quality for liability positions. We use multiple sources of third-party credit data in determining counterparty nonperformance risk, including credit default swaps.

The following table sets forth, by level within the fair value hierarchy, our financial assets and liabilities that were accounted for at fair value on a recurring basis as of the periods indicated:



	Fair Value Measurements Using:
In thousands	Quoted Prices in Active Markets (Level 1)		Significant Other Observable Inputs (Level 2)			Significant Unobservable Inputs (Level 3)			Total
June 30, 2014
Assets:
Oil and natural gas derivative contracts – long-term	$	—	$	94		$	—		$	94
Total Assets	$	—	$	94		$	—		$	94

Liabilities:
Oil and natural gas derivative contracts – current	$	—	$	(159,707	)	$	(25,747	)	$	(185,454	)
Oil and natural gas derivative contracts – long-term	—		(22,658		)	(13,369		)	(36,027		)
Total Liabilities	$	—	$	(182,365	)	$	(39,116	)	$	(221,481	)

December 31, 2013
Assets:
Oil and natural gas derivative contracts – current	$	—	$	5		$	—		$	5
Oil and natural gas derivative contracts – long-term	—		3,034			6,908			9,942
Total Assets	$	—	$	3,039		$	6,908		$	9,947

Liabilities:
Oil and natural gas derivative contracts – current	$	—	$	(53,822	)	$	—		$	(53,822	)
Oil and natural gas derivative contracts – long-term	—		(3,214		)	(199		)	(3,413		)
Total Liabilities	$	—	$	(57,036	)	$	(199	)	$	(57,235	)

Since we do not use hedge accounting for our commodity derivative contracts, any gains and losses on our assets and liabilities are included in "Commodity derivatives expense (income)" in our Unaudited Condensed Consolidated Statements of Operations.

Level 3 Fair Value Measurements

The following table summarizes the changes in the fair value of our Level 3 assets and liabilities for the three and six months ended June 30, 2014 and 2013:



	Three Months Ended					Six Months Ended
	June 30,					June 30,
In thousands	2014			2013		2014			2013
Fair value of Level 3 instruments, beginning of period	$	(6,097	)	$	—	$	6,709		$	—
Fair value adjustments on commodity derivatives	(33,019		)	3,096		(45,825		)	3,096
Fair value of Level 3 instruments, end of period	$	(39,116	)	$	3,096	$	(39,116	)	$	3,096

The amount of total gains (losses) for the period included in earnings attributable to the change in unrealized gains (losses) relating to assets or liabilities still held at the reporting date	$	(33,019	)	$	3,096	$	(45,825	)	$	3,096

We utilize an income approach to value our Level 3 enhanced swaps, costless collars and three-way collars. We obtain and ensure the appropriateness of the significant inputs to the calculations, including contractual prices for the underlying instruments, maturity, forward prices for commodities, interest rates, volatility factors and credit worthiness, and the fair value estimate is prepared and reviewed on a quarterly basis. The following table details fair value inputs related to implied volatilities utilized in the valuation of our Level 3 oil derivative contracts:



	Fair Value at 6/30/2014 (in thousands)			Valuation Technique	Unobservable Input	Range
Oil derivative contracts	$	(39,116	)	Discounted cash flow	Volatility of Light Louisiana Sweet index for settlement periods beginning after January 1, 2015	13.6% – 19.7%

Other Fair Value Measurements

The carrying value of our Bank Credit Facility approximates fair value, as it is subject to short-term floating interest rates that approximate the rates available to us for those periods. We use a market approach to determine fair value of our fixed-rate debt using observable market data. The fair values of our senior subordinated notes are based on quoted market prices. The estimated fair value of our total long-term debt as of June 30, 2014 and December 31, 2013, excluding pipeline financing and capital lease obligations, was $3,317.4 million and $2,956.8 million, respectively. We have other financial instruments consisting primarily of cash, cash equivalents, short-term receivables and payables that approximate fair value due to the nature of the instrument and the relatively short maturities.