Fair Value Measurements

12 Months Ended

Dec. 31, 2019

Derivative Instruments and Hedging Activities Disclosure [Abstract]

We use various methods to determine the fair values of our financial instruments. The fair value of a financial instrument depends on a number of factors, including the availability of observable market data over the contractual term of the underlying instrument. We separate the fair value of our financial instruments into three levels (Levels 1, 2 and 3) based on our assessment of the availability of observable market data and the significance of non-observable data used to determine fair value. Each of the levels are described below:


•	Level 1 instruments’ fair values are based on quoted prices in actively traded markets.


•	Level 2 instruments’ fair values are based on pricing data representative of quoted prices for similar assets and liabilities in active markets (or identical assets and liabilities in less active markets).


•	Level 3 instruments’ fair values are partially calculated using pricing data that is similar to Level 2 instruments, but also reflect adjustments for being in less liquid markets or having longer contractual terms.

The following table presents the carrying amounts and estimated fair values of our financial instruments:



	December 31, 2019				December 31, 2018
	Carrying Amount		Fair Value		Carrying Amount		Fair Value
			(in millions)
Debt obligations:
Debtor-in-possession credit facility⁽¹⁾	$	148	$	148	$	—	$	—
Liabilities subject to compromise⁽²⁾	$	2,780	$	53	$	—	$	—
Current portion of long-term debt⁽¹⁾	$	1,815	$	1,285	$	58	$	44
Long-term debt⁽¹⁾	$	—	$	—	$	4,380	$	2,532

Derivative instruments	$	9	$	9	$	114	$	114


(1)	Current portion of long-term debt includes $315 million of the RBL Facility and the principal balance of the 2024 1.25 Lien Notes and 7.750% Senior Secured Notes due 2026 reflected in current portion of long-term debt on our balance sheet as of December 31, 2019. For a further discussion on our Chapter 11 Cases, reclassification of debt and DIP Facility, see Notes 1A and 8.


(2)	Amount includes the principal balance on the 1.5 lien notes and senior unsecured notes totaling approximately $2,780 million reclassified as liabilities subject to compromise as of December 31, 2019.

For the years ended December 31, 2019 and 2018, the carrying amount of cash and cash equivalents, accounts receivable and accounts payable represent fair value because of the short-term nature of these instruments. Our debt obligations (see Note 7) have various terms, and we estimated the fair value of debt (representing a Level 2 fair value measurement) primarily based on quoted market prices for the same or similar issuances, considering our credit risk.

Oil, Natural Gas and NGLs Derivative Instruments. We attempt to mitigate a portion of our commodity price risk and stabilize cash flows associated with forecasted sales of oil, natural gas and NGLs through the use of financial derivatives. As of December 31, 2019, we had derivatives contracts in the form of fixed price swaps and three-way collars on 14 MMBbls of oil. As of December 31, 2018, we had derivative contracts for 16 MMBbls of oil and 26 TBtu of natural gas. In addition to the contracts above, we have derivative contracts related to locational basis differences on our oil production. None of our derivative contracts are designated as accounting hedges.

As of December 31, 2019 and 2018, all derivative financial instruments were classified as Level 2. Our assessment of the level of an instrument can change over time based on the maturity or liquidity of the instrument, which can result in a change in the classification level of the financial instrument.

The following table presents the fair value associated with our derivative financial instruments as of December 31, 2019 and 2018. All of our derivative instruments are subject to master netting arrangements which provide for the unconditional right of offset for all derivative assets and liabilities with a given counterparty in the event of default. We present assets and liabilities related to these instruments in our consolidated balance sheets as either current or non-current assets or liabilities based on their anticipated settlement date, net of the impact of master netting agreements. On derivative contracts recorded as assets in the table below, we are exposed to the risk that our counterparties may not perform.



	Level 2
	Derivative Assets									Derivative Liabilities
	Gross Fair Value									Gross Fair Value
			Impact of Netting			Balance Sheet Location							Impact of Netting		Balance Sheet Location
			Impact of Netting			Current		Non-current					Impact of Netting		Current		Non-current
	(in millions)									(in millions)
December 31, 2019
Derivative instruments	$	14	$	(5	)	$	9	$	—	$	(5	)	$	5	$	—	$	—

December 31, 2018
Derivative instruments	$	116	$	(2	)	$	101	$	13	$	(2	)	$	2	$	—	$	—

For the years ended December 31, 2019 and 2018, we recorded a derivative loss of $81 million and a derivative gain of $84 million, respectively. Derivative gains and losses on our oil, natural gas and NGLs financial derivative instruments are recorded in operating revenues in our consolidated income statements.

Credit Risk. We are subject to a risk of loss on our derivative instruments that could occur if our counterparties do not perform pursuant to the terms of their contractual obligations. We maintain credit policies with regard to our counterparties to minimize our overall credit risk. These policies require that we (i) evaluate potential counterparties’ financial condition to determine their credit worthiness; (ii) monitor our oil, natural gas and NGLs counterparties’ credit exposures; (iii) review significant counterparties' credit from physical and financial transactions on an ongoing basis; (iv) use contractual language that affords us netting or set-off opportunities to mitigate risk; and (v) when appropriate, require counterparties to post cash collateral, parent guarantees or letters of credit to minimize credit risk. Our assets related to derivatives as of December 31, 2019 represent financial instruments from two counterparties, all of which are lenders associated with our RBL Facility with an “investment grade” (minimum Standard & Poor’s rating of BBB+ or better) credit rating. Subject to the terms of our RBL Facility, collateral or other securities are not exchanged in relation to derivatives activities with the parties in the RBL Facility.

Other Fair Value Considerations. During the years ended December 31, 2019 and 2018, we recorded non-cash impairment charges on our proved properties in NEU and on our proved and unproved properties in the Permian basin. The estimate of fair value of our proved oil and natural gas properties used to determine the impairment was estimated using a discounted cash flow model and other relevant financial and transactional market participant data. These estimates represented a Level 3 fair value measurement. Significant Level 3 inputs associated with the calculation of discounted cash flows used in the impairment analysis include management’s estimate of future crude oil and natural gas prices, production costs, development expenditures, anticipated production of proved reserves, appropriate risk-adjusted discount rates and other relevant data. See Notes 1 and 3 for a further discussion of our impairment charges.

EP Energy LLC 10-K