Callon Petroleum Company Quarterly report pursuant to Section 13 or 15(d)

Quarterly report pursuant to Section 13 or 15(d)

Fair Value Measurements

Fair Value Measurements

9 Months Ended

Sep. 30, 2013

The fair value hierarchy outlined in the relevant accounting guidance gives the highest priority to Level 1 inputs, which consist of unadjusted quoted prices for identical instruments in active markets. Level 2 inputs consist of quoted prices for similar instruments. Level 3 valuations are derived from inputs that are significant and unobservable, and these valuations have the lowest priority.

Fair value of financial instruments

Cash, cash equivalents, short-term investments. The carrying amounts for these instruments approximate fair value due to the short-term nature or maturity of the instruments.

Debt. The Company’s debt is recorded at the carrying amount on its Consolidated Balance Sheet. The fair value of Callon’s fixed-rate debt, which is valued using Level 2 inputs, is based upon estimates provided by an independent investment banking firm. The carrying amount of floating-rate debt approximates fair value because the interest rates are variable and reflective of market rates.

The following table summarizes the respective carrying and fair values at:



	September 30, 2013				December 31, 2012
	Carrying Value		Fair Value		Carrying Value		Fair Value
Credit Facility	$	17,000	$	17,000	$	10,000	$	10,000
13% Senior Notes due 2016 (1)	108,220		100,718		110,668		100,112
Total	$	125,220	$	117,718	$	120,668	$	110,112

(1) Fair value is calculated only in relation to the $96,961 principal outstanding of the Senior Notes at each of the dates indicated above, respectively. The remaining $11,259 and $13,707, respectively, which the Company has recorded as a deferred credit, is excluded from the fair value calculation, and will be recognized in earnings as a reduction of interest expense over the remaining amortization period. See Note 4 for additional information.

Assets and liabilities measured at fair value on a recurring basis

Certain assets and liabilities are reported at fair value on a recurring basis (unless otherwise noted below) in the Company’s Consolidated Balance Sheet. The following methods and assumptions were used to estimate the fair values:

Commodity derivative instruments: Callon’s derivative policy allows for commodity derivative instruments to consist of natural gas and crude oil collars, basis swaps, puts, calls and similar commodity instrument structures. The fair value of these derivatives is derived using a valuation model that utilizes market-corroborated inputs that are observable over the term of the derivative contract, and the values are corroborated by quotes obtained from counterparties to the agreements. The Company’s fair value calculations, based on analysis of each contract, also incorporate an estimate of the counterparties’ default risk for derivative assets and an estimate of the Company’s default risk for derivative liabilities. The Company believes that the majority of the inputs used to calculate the commodity derivative instruments fall within Level 2 of the fair-value hierarchy based on the wide availability of quoted market prices for similar commodity derivative contracts. See Note 5 for additional information regarding the Company’s derivative instruments.

The following tables present the Company’s assets and liabilities measured at fair value on a recurring basis for each hierarchy level:



As of 9/30/2013	Balance Sheet Presentation	Level 1		Level 2			Level 3		Total
Assets
Derivative financial instruments - current	Fair market value of derivatives	$	—	$	—		$	—	$	—
Derivative financial instruments - non-current	Other long-term assets	—		36			—		36
Sub-total assets		—		36			—		36

Liabilities
Derivative financial instruments - current	Fair market value of derivatives	$	—	$	1,139		$	—	$	1,139
Derivative financial instruments - non-current	Other long-term liabilities	—		18			—		18
Sub-total liabilities	Other long-term liabilities	—		1,157			—		1,157

Total		$	—	$	(1,121	)	$	—	$	(1,121	)

As of 12/31/2012	Balance Sheet Presentation	Level 1		Level 2			Level 3		Total
Assets
Derivative financial instruments - current	Fair market value of derivatives	$	—	$	1,674		$	—	$	1,674
Derivative financial instruments - non-current	Other long-term assets	—		250			—		250
Sub-total assets		—		1,924			—		1,924

Liabilities
Derivative financial instruments - current	Fair market value of derivatives	$	—	$	125		$	—	$	125
Derivative financial instruments - non-current	Other long-term liabilities	—		116			—		116
Sub-total liabilities		—		241			—		241

Total		$	—	$	1,683		$	—	$	1,683

Assets and liabilities measured at fair value on a nonrecurring basis

Certain assets and liabilities are reported at fair value on a nonrecurring basis in Callon’s Consolidated Balance Sheet. The following methods and assumptions were used to estimate the fair values:

Asset retirement obligations (“ARO”) incurred in current period. Callon estimates the fair value of AROs based on discounted cash flow projections using numerous estimates, assumptions and judgments regarding such factors as (1) the existence of a legal obligation for an ARO, (2) amounts and timing of settlements, (3) the credit-adjusted risk-free rate to be used and (4) inflation rates. AROs incurred during the nine months ended September 30, 2013, including no upward revisions, were Level 3 fair value measurements. See Note 8, Asset Retirement Obligations, which provides a summary of changes in the ARO liability.

Acquisition. In accordance with the acquisition method of accounting, the purchase price of the Company’s acquisition during the period has been allocated to the assets acquired and liabilities assumed based on their estimated fair values on the acquisition date. In valuing the acquired assets and liabilities assumed, fair values were based on expected future cash flows based on estimated reserve quantities; costs to produce and develop reserves; and oil and gas forward prices. The fair value measurements were based on significant inputs not observable in the market and thus represent a level 3 measurement.

- 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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