Quarterly report pursuant to Section 13 or 15(d)

Fair Value Measurements

v2.4.0.6
Fair Value Measurements
 6 Months Ended
Jun. 30, 2012
Fair Value Disclosures [Abstract]  
Fair Value Measurements
Fair Value Measurements

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: 
 
 
June 30, 2012
 
December 31, 2011
 
 
Carrying Value
 
Fair Value
 
Carrying Value
 
Fair Value
13% Senior Notes due 2016 (1)
 
$
112,215

 
$
99,385

 
$
125,345

 
$
110,571


(1) Fair value is calculated only in relation to the $96,961 and $106,961 principal outstanding of the Senior Notes at the dates indicated above, respectively.  The remaining $15,254 and $18,384, 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: The Company's derivative instruments consist of financially settled commodity swap and option contracts with certain counterparties. The Company determines the value of its derivative contracts based on an income approach using a discounted cash flow model for swaps and a standard option pricing model for options. The inputs used in these models are readily available in the markets.

The Company's fair value calculations also incorporate an estimate of the counterparties' default risk for derivative assets and an estimate of the Company's default risk for derivative liabilities. A credit valuation adjustment ("CVA") is made that is based on the default probabilities by year as indicated by market quotes for the Company's or counterparties' credit default swap rates, as appropriate. If credit default rates for the Company or its counterparties are not available, market quotes of credit default rates for similar companies are used. These default probabilities have been applied to the unadjusted fair values of derivative instruments to arrive at the CVA.

The Company has consistently applied these valuation techniques in all periods presented, and believes that these inputs primarily 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.

The following tables present the Company’s liabilities measured at fair value on a recurring basis for each hierarchy level:
As of 6/30/2012
 
Balance Sheet Presentation
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 
 
 
 
 
 
 
Derivative financial instruments - current
 
Fair market value of derivatives
 
$
—

 
$
4,645

 
$
—

 
$
4,645

Derivative financial instruments - non-current
 
Other long-term assets
 
—

 
1,982

 
—

 
1,982

 
 
 
 
 
 
 
 
 
 
 
Liabilities
 
 
 
 
 
 
 
 
 
 
Derivative financial instruments - current
 
Fair market value of derivatives
 
$
—

 
$
—

 
$
—

 
$
—

Derivative financial instruments - non-current
 
Other long-term liabilities
 
—

 
350

 
—

 
350

Total
 
 
 
$
—

 
$
6,277

 
$
—

 
$
6,277

 
 
 
 
 
 
 
 
 
 
 
As of 12/31/2011
 
Balance Sheet Presentation
 
Level 1
 
Level 2
 
Level 3
 
Total
Assets
 
 
 
 

 
 

 
 

 
 

Derivative financial instruments - current
 
Fair market value of derivatives
 
$
—

 
$
2,499

 
$
—

 
$
2,499

Derivative financial instruments - non-current
 
Other long-term assets
 
—

 
—

 
—

 
—

Total
 
 
 
$
—

 
$
2,499

 
$
—

 
$
2,499



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 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 six months ended June 30, 2012, including upward revisions of $0, were Level 3 fair value measurements. See Note 8, Asset Retirement Obligations, which provides a summary of changes in the ARO liability.