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Fair Value Measurements
 6 Months Ended
Jun. 30, 2011
Fair Value, Assets and Liabilities Measured on Recurring Basis [Abstract]  
Fair Value Measurements

Note 5. Fair Value Measurements

 

Fair Value Hierarchy

 

Fair value is 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 (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. These models are primarily 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. 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. Instruments in this category include non-exchange-traded oil and natural gas derivatives that are based on NYMEX pricing.

 

•       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. Instruments in this category include non-exchange-traded natural gas derivatives swaps that are based on regional pricing other than NYMEX (e.g., Houston Ship Channel).

 

We adjust the valuations for nonperformance risk, using our estimate of the counterparty's credit quality for asset positions and Denbury's 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:

 

Note 5. Fair Value Measurements

 

Fair Value Hierarchy

 

Fair value is 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 (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. These models are primarily 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. 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. Instruments in this category include non-exchange-traded oil and natural gas derivatives that are based on NYMEX pricing.

 

•       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. Instruments in this category include non-exchange-traded natural gas derivatives swaps that are based on regional pricing other than NYMEX (e.g., Houston Ship Channel).

 

We adjust the valuations for nonperformance risk, using our estimate of the counterparty's credit quality for asset positions and Denbury's 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:
       Significant      
    Quoted Prices  Other Significant   
     in Active Observable Unobservable   
    Markets  Inputs  Inputs   
In thousands (Level 1) (Level 2) (Level 3) Total
June 30, 2011   
Assets            
 Short-term investments $ 88,220 $ - $ - $ 88,220
 Oil and natural gas derivative contracts   -   30,293   6,638   36,931
Liabilities            
 Oil and natural gas derivative contracts   -   (69,424)   -   (69,424)
  Total $ 88,220 $ (39,131) $ 6,638 $ 55,727
               
December 31, 2010   
Assets            
 Short-term investments $ 93,020 $ - $ - $ 93,020
 Oil and natural gas derivative contracts   -   20,683   16,478   37,161
Liabilities            
 Oil and natural gas derivative contracts   -   (81,162)   -   (81,162)
  Total $ 93,020 $ (60,479) $ 16,478 $ 49,019

The following table summarizes the changes in the fair value of our Level 3 assets for the three and six months ended June 30, 2011 and 2010

    Three Months Ended Six Months Ended
    June 30, June 30,
In thousands 2011 2010 2011 2010
Balance, beginning of period $ 15,346 $ 50,518 $ 16,478 $ -
 Unrealized gains/(losses) on commodity derivative contracts included in earnings   (7,386)   126   (7,076)   14,899
 Commodity derivative contracts acquired from Encore   -   -   -   38,093
 Receipts on settlement of commodity derivative contracts   (1,322)   (10,361)   (2,764)   (12,709)
Balance, end of period   6,638   40,283 $ 6,638 $ 40,283

Since we do not use hedge accounting for our commodity derivative contracts, any gains and losses on our assets and liabilities are included in “Derivatives income” in the accompanying Unaudited Condensed Consolidated Statements of Operations.

The following table sets forth the fair value of financial instruments that are not recorded at fair value in our Unaudited Condensed Consolidated Financial Statements:

    June 30, 2011 December 31, 2010
    Carrying Estimated Carrying Estimated
In thousands Amount Fair Value Amount Fair Value
             
  7½% Senior Subordinated Notes due 2013 $ - $ - $ 224,563 $ 228,375
  7½% Senior Subordinated Notes due 2015   -   -   300,427   310,500
  9½% Senior Subordinated Notes due 2016   238,142   249,942   239,509   249,661
  9¾% Senior Subordinated Notes due 2016   406,354   476,446   404,211   475,380
  8¼% Senior Subordinated Notes due 2020   996,273   1,085,938   996,273   1,080,956
  6⅜% Senior Subordinated Notes due 2021   400,000   400,000   -   -

The fair values of our senior subordinated notes are based on quoted market prices. We have other financial instruments consisting primarily of cash, cash equivalents and short-term receivables and payables that approximate fair value due to the nature of the instrument and the relatively short maturities.