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Significant Accounting Policies (Policies)

12 Months Ended

Dec. 31, 2014

Denbury Resources Inc., a Delaware corporation, is an independent oil and natural gas company with operations focused in two key operating areas: the Gulf Coast and Rocky Mountain regions. Our goal is to increase the value of our properties through a combination of exploitation, drilling and proven engineering extraction practices, with the most significant emphasis relating to CO₂ enhanced oil recovery operations.

Principles of Reporting and Consolidation

The consolidated financial statements herein have been prepared in accordance with accounting principles generally accepted in the United States ("GAAP") and include the accounts of Denbury and entities in which we hold a controlling financial interest. Undivided interests in oil and gas joint ventures are consolidated on a proportionate basis. All intercompany balances and transactions have been eliminated.

Use Of Estimates

Use of Estimates

The preparation of financial statements in conformity with GAAP requires management to make estimates and assumptions that affect the reported amount of certain assets and liabilities, disclosure of contingent assets and liabilities at the date of the financial statements, and the reported amounts of revenues and expenses during each reporting period. Management believes its estimates and assumptions are reasonable; however, such estimates and assumptions are subject to a number of risks and uncertainties that may cause actual results to differ materially from such estimates. Significant estimates underlying these financial statements include (1) the fair value of financial derivative instruments; (2) the estimated quantities of proved oil and natural gas reserves used to compute depletion of oil and natural gas properties, the related present value of estimated future net cash flows therefrom and the ceiling test; (3) future net cash flow estimates used in the impairment assessment of goodwill and long-lived assets; (4) the estimated quantities of proved and probable CO₂ reserves used to compute depletion of CO₂ properties; (5) accruals related to oil and natural gas sales volumes and revenues, capital expenditures and lease operating expenses; (6) the estimated costs and timing of future asset retirement obligations; (7) estimates made in the calculation of income taxes; and (8) estimates made in determining the fair values for purchase price allocations, including goodwill. While management is not aware of any significant revisions to any of its estimates, there will likely be future revisions to its estimates resulting from matters such as revisions in estimated oil and natural gas volumes, changes in ownership interests, payouts, joint venture audits, re-allocations by purchasers or pipelines, or other corrections and adjustments common in the oil and natural gas industry, many of which require retroactive application. These types of adjustments cannot be currently estimated and will be recorded in the period in which the adjustment occurs.

Cash Equivalents

We consider all highly liquid investments to be cash equivalents if they have maturities of three months or less at the date of purchase.

Oil and Natural Gas Properties

Capitalized Costs. We follow the full cost method of accounting for oil and natural gas properties. Under this method, all costs related to the acquisition, exploration and development of oil and natural gas reserves are capitalized and accumulated in a single cost center representing our activities, which are undertaken exclusively in the United States. Such costs include lease acquisition costs, geological and geophysical expenditures, lease rentals on undeveloped properties, costs of drilling both productive and nonproductive wells, capitalized interest on qualifying projects, and general and administrative expenses directly related to exploration and development activities, and do not include any costs related to production, general corporate overhead or similar activities. We assign the purchase price of oil and natural gas properties we acquire to proved and unevaluated properties based on the estimated fair values as defined in the Financial Accounting Standards Board Codification ("FASC") Fair Value Measurement topic. Proceeds received from disposals are credited against accumulated costs except when the sale represents a significant disposal of reserves, in which case a gain or loss would be recognized. A disposal of 25% or more of our proved reserves would be considered significant.

Depletion and Depreciation. The costs capitalized, including production equipment and future development costs, are depleted or depreciated using the unit-of-production method, based on proved oil and natural gas reserves as determined by independent petroleum engineers. Oil and natural gas reserves are converted to equivalent units on a basis of 6,000 cubic feet of natural gas to one barrel of crude oil.

Under full cost accounting, we may exclude certain unevaluated costs from the amortization base pending determination of whether proved reserves can be assigned to such properties. The costs classified as unevaluated are transferred to the full cost amortization base as the properties are developed, tested and evaluated.

Ceiling Test. The net capitalized costs of oil and natural gas properties are limited to the lower of unamortized cost or the cost center ceiling. The cost center ceiling is defined as (1) the present value of estimated future net revenues from proved oil and natural gas reserves before future abandonment costs (discounted at 10%), based on the average first-day-of-the-month oil and natural gas price for each month during a 12-month rolling period prior to the end of a particular reporting period; plus (2) the cost of properties not being amortized; plus (3) the lower of cost or estimated fair value of unproved properties included in the costs being amortized, if any; less (4) related income tax effects. Our future net revenues from proved oil and natural gas reserves are not reduced for development costs related to the cost of drilling for and developing CO₂ reserves nor those related to the cost of constructing CO₂ pipelines, as those costs have previously been incurred by the Company. Therefore, we include in the ceiling test, as a reduction of future net revenues, that portion of our capitalized CO₂ costs related to CO₂ reserves and CO₂ pipelines that we estimate will be consumed in the process of producing our proved oil and natural gas reserves. The fair value of our oil and natural gas derivative contracts is not included in the ceiling test, as we do not designate these contracts as hedge instruments for accounting purposes. The cost center ceiling test is prepared quarterly. We did not have a ceiling test write-down during the years ended December 31, 2014, 2013 or 2012. If oil and natural gas prices were to remain at or near late 2014 and early 2015 levels in subsequent periods, which are significantly lower than our 2014 average first-day-of-the-month oil and natural gas prices, we would likely begin recording write-downs due to the full cost ceiling test in the first or second quarter of 2015, and also in subsequent quarterly periods if prices remain low.

Joint Interest Operations. Substantially all of our oil and natural gas exploration and production activities are conducted jointly with others. These financial statements reflect only our proportionate interest in such activities, and any amounts due from other partners are included in trade receivables.

Tertiary Injection Costs. Our tertiary operations are conducted in reservoirs that have already produced significant amounts of oil over many years; however, in accordance with the SEC rules and regulations for recording proved reserves, we cannot recognize proved reserves associated with enhanced recovery techniques, such as CO₂ injection, until we can demonstrate production resulting from the tertiary process or unless the field is analogous to an existing flood.

We capitalize, as a development cost, injection costs in fields that are in their development stage, which means we have not yet seen incremental oil production due to the CO₂ injections (i.e., a production response). These capitalized development costs are included in our unevaluated property costs if there are not already proved tertiary reserves in that field. After we see a production response to the CO₂ injections (i.e., the production stage), injection costs are expensed as incurred, and once proved reserves are recognized, previously deferred unevaluated development costs become subject to depletion.

Property, Plant, and Equipment Policy

CO₂ Properties

We own and produce CO₂ reserves, a non-hydrocarbon resource, that are used in our tertiary oil recovery operations on our own behalf and on behalf of other interest owners in enhanced recovery fields, with a portion sold to third-party industrial users. We record revenue from our sales of CO₂ to third parties when it is produced and sold. Expenses related to the production of CO₂ are allocated between volumes sold to third parties and volumes consumed internally that are directly related to our tertiary production. The expenses related to third-party sales are recorded in "CO₂and helium discovery and operating expenses," and the expenses related to internal use are recorded in "Lease operating expenses" in the Consolidated Statements of Operations or are capitalized as oil and gas properties in our Consolidated Balance Sheets, depending on the stage of the tertiary flood that is receiving the CO₂ (see Tertiary Injection Costs above for further discussion).

Costs incurred to search for CO₂ are expensed as incurred until proved or probable reserves are established. Once proved or probable reserves are established, costs incurred to obtain those reserves are capitalized and classified as "CO₂ properties" on our Consolidated Balance Sheets. Capitalized CO₂ costs are aggregated by geologic formation and depleted on a unit-of-production basis over proved and probable reserves.

We own certain interests in the Riley Ridge Federal Unit in Wyoming ("Riley Ridge"), which contains helium and CO₂ reserves (non-hydrocarbon resources) as well as natural gas reserves (a hydrocarbon resource). It is not possible to separately identify the capitalized costs related to the development of each product in the commingled gas stream; thus, these costs are allocated to each product based on the relative future revenue value of each product line and classified accordingly on the Consolidated Balance Sheets.

Pipelines and Plants

CO₂ used in our tertiary floods is transported to our fields through CO₂ pipelines. Costs of CO₂ pipelines under construction are not depreciated until the pipelines are placed into service. Pipelines are depreciated on a straight-line basis over their estimated useful lives, which range from 15 to 50 years.

Pipelines and plants include the Riley Ridge gas processing facility in southwestern Wyoming. Individual components of the Riley Ridge gas processing facility are depreciated on a straight-line basis over their estimated useful lives, which range from 20 to 50 years.

Property and Equipment – Other

Other property and equipment, which includes furniture and fixtures, vehicles, computer equipment and software, and capitalized leases, is depreciated principally on a straight-line basis over each asset's estimated useful life. Vehicles and furniture and fixtures are generally depreciated over a useful life of five to ten years, and computer equipment and software are generally depreciated over a useful life of three to five years. Leasehold improvements are amortized over the shorter of the estimated useful life or the remaining lease term.

Leased property meeting certain capital lease criteria is capitalized, and the present value of the related lease payments is recorded as a liability. Amortization of capitalized leased assets is computed using the straight-line method over the shorter of the estimated useful life or the initial lease term.

Maintenance and repair costs that do not extend the useful life of the property or equipment are charged to expense as incurred.

Goodwill and Other Intangible Assets

Goodwill represents the excess of the purchase price over the estimated fair value of the net assets acquired in the acquisition of a business. Goodwill is not amortized; rather, it is tested for impairment annually during the fourth quarter and when events or changes in circumstances indicate that it is more likely than not the fair value of a reporting unit with goodwill has been reduced below its carrying value. The impairment test requires allocating goodwill and other assets and liabilities to reporting units. However, we have only one reporting unit. To assess impairment, we have the option to qualitatively assess if it is more likely than not that the fair value of the reporting unit is less than the carrying value. Absent a qualitative assessment, or, through the qualitative assessment, if we determine it is more likely than not that the fair value of the reporting unit is less than the carrying value, a quantitative assessment is prepared to calculate the fair market value of the reporting unit. If it is determined that the fair value of the reporting unit is less than the carrying value, the recorded goodwill is impaired to its implied fair value with a charge to operating expense. We performed our goodwill impairment assessment as of December 31, 2014. Because our enterprise value (combined market capitalization plus a control premium of 10% and the fair value of our long-term debt) was below the book value of our stockholders' equity and long-term debt as of December 31, 2014, we were required to proceed to step two of the goodwill impairment test.

In the step two quantitative assessment, we assigned the fair value of the reporting unit (enterprise value) to its assets and liabilities and calculated the implied fair value of goodwill as the excess of fair value of the reporting unit over the amounts assigned to the assets and liabilities. Oil and natural gas reserves, which represent the most significant assets requiring valuation, were estimated using the expected present value of future net cash flows method based on December 31, 2014, NYMEX oil and natural gas futures prices for the next five years, adjusted for current price differentials. In addition to future oil and natural gas pricing, the most significant assumptions impacting the projections of future net cash flows include projections of estimated quantities of oil and natural gas reserves, projections of future rates of production, timing and amount of future development and operating costs, projected availability and cost of CO₂, risk adjustment factors applied to probable and possible oil and natural gas reserve cash flows, projected recovery factors of oil and natural gas reserves, and a weighted-average cost of capital discount rate applied to all cash flows. The implied fair value of goodwill calculated in this quantitative assessment significantly exceeded the corresponding book value of goodwill. Therefore, we did not record any goodwill impairment during 2014, nor have we recorded a goodwill impairment historically.

Our intangible assets subject to amortization primarily consist of amounts assigned in purchase accounting to helium production rights at Riley Ridge and a CO₂ purchase contract with ConocoPhillips to offtake CO₂ from the Lost Cabin gas plant in Wyoming and are included in our Consolidated Balance Sheets under the caption "Other assets." We amortize our helium production rights on a unit-of-production basis over the life of the estimated helium reserves and amortize the CO₂ contract intangible asset on a straight-line basis over the contract term. Total amortization expense related to these assets was $2.3 million and $1.3 million during the years ended December 31, 2014 and 2013, respectively. The following table summarizes the carrying values of our intangible assets as of December 31, 2014 and 2013:



In thousands	Helium Production Rights			CO₂ Purchase Contract			Total
December 31, 2014
Intangible asset value	$	55,266		$	34,341		$	89,607
Accumulated amortization	(15		)	(3,625		)	(3,640		)
Net book value as of December 31, 2014	$	55,251		$	30,716		$	85,967

December 31, 2013
Intangible asset value	$	55,266		$	33,931		$	89,197
Accumulated amortization	—			(1,319		)	(1,319		)
Net book value as of December 31, 2013	$	55,266		$	32,612		$	87,878

At December 31, 2014, our estimated amortization expense for our intangible assets subject to amortization over the next five years is as follows:



In thousands
2015	$	2,289
2016	2,488
2017	2,788
2018	2,858
2019	2,833

Impairment or Disposal of Long-Lived Assets, Policy

Impairment Assessment of Long-Lived Assets

The portion of our capitalized CO₂ costs related to CO₂ reserves, CO₂ pipelines, and the Riley Ridge gas processing facility that we estimate will be consumed in the process of producing our proved oil and natural gas reserves is included in the full cost pool ceiling test as a reduction to future net revenues. The remaining net capitalized costs that are not included in the full cost pool ceiling test, and related intangible assets, are subject to long-lived asset impairment testing whenever events or changes in circumstances indicate that the carrying value may not be recoverable.

We perform our long-lived asset impairment test by comparing the net carrying costs of our two long-lived asset groups ((1) Gulf Coast region and (2) Rocky Mountain region) to the respective expected future undiscounted net cash flows that are supported by these long-lived assets which include (1) the production of our probable and possible oil and natural gas reserves and (2) the sale of non-hydrocarbons (CO₂ and helium) to third parties. If the undiscounted net cash flows are below the net carrying costs for an asset group, we must record an impairment loss by the amount, if any, that net carrying costs exceed the fair value of the long-lived asset group.

Given the significant decline in oil prices in the fourth quarter of 2014, we performed a long-lived asset impairment test for both asset groups. Significant assumptions impacting expected future undiscounted net cash flows include projections of future oil and natural gas prices, projections of estimated quantities of oil and natural gas reserves, projections of future rates of production, timing and amount of future development and operating costs, projected availability and cost of CO₂, projected recovery factors of tertiary reserves and risk-adjustment factors applied to the cash flows. The undiscounted net cash flows for our asset groups significantly exceeded the net carrying costs; thus, step two of the impairment test was not required and no impairment was recorded.

Asset Retirement Obligations

In general, our future asset retirement obligations relate to future costs associated with plugging and abandoning our oil, natural gas and CO₂ wells, removing equipment and facilities from leased acreage, and returning land to its original condition. The fair value of a liability for an asset retirement obligation is recorded in the period in which it is incurred, discounted to its present value using our credit-adjusted-risk-free interest rate, and a corresponding amount capitalized by increasing the carrying amount of the related long-lived asset. The liability is accreted each period, and the capitalized cost is depreciated over the useful life of the related asset. Revisions to estimated retirement obligations will result in an adjustment to the related capitalized asset and corresponding liability. If the liability for an oil or natural gas well is settled for an amount other than the recorded amount, the difference is recorded to the full cost pool, unless significant.

Asset retirement obligations are estimated at the present value of expected future net cash flows. We utilize unobservable inputs in the estimation of asset retirement obligations that include, but are not limited to, costs of labor and materials, profits on costs of labor and materials, the effect of inflation on estimated costs, and the discount rate. Accordingly, asset retirement obligations are considered a Level 3 measurement under the FASC Fair Value Measurement topic.

Commodity Derivative Contracts

We utilize oil and natural gas derivative contracts to mitigate our exposure to commodity price risk associated with our future oil and natural gas production. These derivative contracts have historically consisted of options, in the form of price floors, collars or three-way collars, fixed-price swaps and fixed-price swaps enhanced with a sold put. Our derivative financial instruments are recorded on the balance sheet as either an asset or a liability measured at fair value. We do not apply hedge accounting to our commodity derivative contracts; accordingly, changes in the fair value of these instruments are recognized in our Consolidated Statements of Operations in the period of change.

We do not apply hedge accounting treatment to our oil and natural gas derivative contracts; therefore, the changes in the fair values of these instruments are recognized in income in the period of change. These fair value changes, along with the settlements of expired contracts, are shown under "Commodity derivatives expense (income)" in our Consolidated Statements of Operations.

From time to time, we enter into various oil and natural gas derivative contracts to provide an economic hedge of our exposure to commodity price risk associated with anticipated future oil and natural gas production. We do not hold or issue derivative financial instruments for trading purposes. These contracts have historically consisted of price floors, collars, three-way collars, fixed-price swaps, and fixed-price swaps enhanced with a sold put. The production that we hedge has varied from year to year depending on our levels of debt and financial strength and expectation of future commodity prices. For the past several years, we have employed a strategy to hedge a substantial portion of our forecasted production approximately 18 months to two years in the future (from the then-current quarter), as we believe it is important to protect our future cash flow to provide a level of assurance for our capital spending and dividends in those future periods. With the decline in commodity futures prices in late 2014 and early 2015, as of late February 2015, we have deferred entering into new oil derivative contracts since the third quarter of 2014. Therefore, as of February 19, 2015, the percentage of our forecasted oil production that is currently hedged for the fourth quarter of 2015 and calendar 2016 is less than the percentage hedged in recent years. During periods of lower oil prices, we may defer entering into new contracts until futures prices return to levels that we consider economically conducive to our doing so.

We manage and control market and counterparty credit risk through established internal control procedures that are reviewed on an ongoing basis. We attempt to minimize credit risk exposure to counterparties through formal credit policies, monitoring procedures, and diversification, and all of our commodity derivative contracts are with parties that are lenders under our Bank Credit Agreement (or affiliates of such lenders). As of December 31, 2014, all of our outstanding derivative contracts were subject to enforceable master netting arrangements whereby payables on those contracts can be offset against receivables from separate derivative contracts with the same counterparty. It is our policy to classify derivative assets and liabilities on a gross basis on our balance sheets, even if the contracts are subject to enforceable master netting arrangements.

Concentrations of Credit Risk

Our financial instruments that are exposed to concentrations of credit risk consist primarily of cash equivalents, trade and accrued production receivables, and the derivative instruments discussed above. Our cash equivalents represent high-quality securities placed with various investment-grade institutions. This investment practice limits our exposure to concentrations of credit risk. Our trade and accrued production receivables are dispersed among various customers and purchasers; therefore, concentrations of credit risk are limited. We evaluate the credit ratings of our purchasers, and if customers are considered a credit risk, letters of credit are the primary security obtained to support lines of credit. We attempt to minimize our credit risk exposure to the counterparties of our oil and natural gas derivative contracts through formal credit policies, monitoring procedures and diversification. All of our derivative contracts are with parties that are lenders under our bank credit facility (or affiliates of such lenders). There are no margin requirements with the counterparties of our derivative contracts.

Oil and natural gas sales are made on a day-to-day basis or under short-term contracts at the current area market price. We would not expect the loss of any purchaser to have a material adverse effect upon our operations. For the year ended December 31, 2014, three purchasers accounted for 10% or more of our oil and natural gas revenues: Marathon Petroleum Company (31%), Plains Marketing LP (13%), and ConocoPhillips (12%). For the year ended December 31, 2013, three purchasers accounted for 10% or more of our oil and natural gas revenues: Marathon Petroleum Company (33%), Plains Marketing LP (15%), and Eighty-Eight Oil LLC (10%). For the year ended December 31, 2012, two purchasers accounted for 10% or more of our oil and natural gas revenues: Marathon Petroleum Company (39%) and Plains Marketing LP (17%).

Revenue Recognition

Revenue Recognition. Revenue is recognized at the time oil and natural gas is produced and sold. Any amounts due from purchasers of oil and natural gas are included in accrued production receivable.

We follow the sales method of accounting for our oil and natural gas revenue, whereby we recognize revenue on oil or natural gas sold to our purchasers regardless of whether the sales are proportionate to our ownership in the property. A receivable or liability is recognized only to the extent that we have an imbalance on a specific property greater than the expected remaining proved reserves. As of December 31, 2014 and 2013, our aggregate oil and natural gas imbalances were not material to our consolidated financial statements.

We recognize revenue and expenses of purchased producing properties at the time we assume effective control, commencing from either the closing or purchase agreement date, depending on the underlying terms and agreements. We follow the same methodology in reverse when we sell properties by recognizing revenue and expenses of the sold properties until the closing date.

Income Taxes

Income taxes are accounted for using the asset and liability method, under which deferred income taxes are recognized for the future tax effects of temporary differences between the financial statement carrying amounts and the tax basis of existing assets and liabilities using the enacted statutory tax rates in effect at year end. The effect on deferred taxes for a change in tax rates is recognized in income in the period that includes the enactment date. A valuation allowance for deferred tax assets is recorded when it is more likely than not that the benefit from the deferred tax asset will not be realized.

We recognize the tax benefit from an uncertain tax position only if it is more likely than not that the tax position will be sustained upon examination by the taxing authorities, based on the technical merits of the position. The tax benefits recognized in the financial statements from such a position are measured based on the largest benefit that has a greater than 50% likelihood of being realized upon ultimate settlement.

Net Income Per Common Share

Basic net income per common share is computed by dividing the net income attributable to common stockholders by the weighted average number of shares of common stock outstanding during the period. Diluted net income per common share is calculated in the same manner, but includes the impact of potentially dilutive securities. Potentially dilutive securities consist of stock options, stock appreciation rights ("SARs"), nonvested restricted stock and nonvested performance-based equity awards. For each of the three years in the period ended December 31, 2014, there were no adjustments to net income for purposes of calculating basic and diluted net income per common share.

The following is a reconciliation of the weighted average shares used in the basic and diluted net income per common share calculations for the periods indicated:



	Year Ended December 31,
In thousands	2014	2013	2012
Basic weighted average common shares outstanding	348,962	366,659	385,205
Potentially dilutive securities
Restricted stock, stock options, SARs and performance-based equity awards	2,205	3,218	3,733
Diluted weighted average common shares outstanding	351,167	369,877	388,938

Basic weighted average common shares exclude shares of nonvested restricted stock. As these restricted shares vest, they will be included in the shares outstanding used to calculate basic net income per common share (although all non-performance-based restricted stock is issued and outstanding upon grant). For purposes of calculating diluted weighted average common shares, the nonvested restricted stock, stock options, SARs, and performance-based equity awards are included in the computation using the treasury stock method, with the deemed proceeds equal to the average unrecognized compensation during the period, the purchase price that the grantee will pay in the future for stock options, and any estimated future tax consequences recognized directly in equity. Stock options and SARs of 4.8 million, 3.6 million and 4.1 million shares for the years ended December 31, 2014, 2013 and 2012, respectively, could potentially dilute earnings per share in the future, but were excluded from the computation of diluted net income per share as their effect would have been antidilutive.

Environmental and Litigation Contingencies

The Company makes judgments and estimates in recording liabilities for contingencies such as environmental remediation or ongoing litigation. Liabilities are recorded when it is both probable that a loss has been incurred and such loss is reasonably estimable. Assessments of liabilities are based on information obtained from independent and in-house experts, loss experience in similar situations, actual costs incurred, and other case-by-case factors. Any related insurance recoveries are recognized in our financial statements during the period received or at the time receipt is determined to be virtually certain.

Recent Accounting Pronouncements

Revenue Recognition. In May 2014, the Financial Accounting Standards Board ("FASB") issued Accounting Standards Update ("ASU") 2014-09, Revenue from Contracts with Customers ("ASU 2014-09"). ASU 2014-09 amends the guidance for revenue recognition to replace numerous, industry-specific requirements. The core principle of the ASU is that an entity should recognize revenue for the transfer of goods or services equal to the amount that it expects to be entitled to receive for those goods or services. The ASU implements a five-step process for customer contract revenue recognition that focuses on transfer of control, as opposed to transfer of risk and rewards. The amendment also requires enhanced disclosures regarding the nature, amount, timing and uncertainty of revenues and cash flows arising from contracts with customers. The amendments in this ASU are effective for reporting periods beginning after December 15, 2016, and early adoption is prohibited. Entities can transition to the standard either retrospectively to each period presented or as a cumulative-effect adjustment as of the date of adoption. Management is currently assessing the impact the adoption of ASU 2014-09 will have on our consolidated financial statements.

Discontinued Operations. In April 2014, the FASB issued ASU 2014-08, Reporting Discontinued Operations and Disclosures of Disposals of Components of an Entity ("ASU 2014-08"). ASU 2014-08 amends the definition of a discontinued operation under the Discontinued Operations subtopic of the FASC and requires entities to disclose additional information about discontinued operations and disposal transactions that do not meet the discontinued operations criteria. ASU 2014-08 will be applied prospectively for disposals of components of an entity and businesses or nonprofit activities that meet the criteria to be classified as held for sale and occur within annual periods beginning on or after December 15, 2014, and interim periods within those years. The adoption of ASU 2014-08 is currently not expected to have a material effect on our consolidated financial statements.

Fair Value Measurements and Disclosures

The FASC Fair Value Measurement topic defines fair value as the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date (often referred to as the "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 income 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 costless collars and the sold 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. These inputs may be used with internally developed methodologies that result in management's best estimate of fair value. At December 31, 2014, instruments in this category include non-exchange-traded oil derivatives that are based on regional pricing other than NYMEX (e.g., Light Louisiana Sweet). 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, certain inputs to the valuation are less observable. 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 $1.4 million in the fair value of these instruments as of December 31, 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.