DCP SOUTHEAST TEXAS HOLDINGS, GP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Years Ended December 31, 2011, 2010 and 2009
liability. These adjustments may include amounts to reflect counterparty credit quality, the effect of our own
creditworthiness, the time value of money and/or the liquidity of the market.
• Counterparty credit valuation adjustments are necessary when the market price of an instrument is not
indicative of the fair value as a result of the credit quality of the counterparty. Generally, market quotes
assume that all counterparties have near zero, or low, default rates and have equal credit quality.
Therefore, an adjustment may be necessary to reflect the credit quality of a specific counterparty to
determine the fair value of the instrument. We record counterparty credit valuation adjustments on all
derivatives that are in a net asset position as of the measurement date in accordance with our established
counterparty credit policy, which takes into account any collateral margin that a counterparty may have
posted with us as well as any letters of credit that they have provided.
• Entity valuation adjustments are necessary to reflect the effect of our own credit quality on the fair value
of our net liability position with each counterparty. This adjustment takes into account any credit
enhancements, such as collateral margin we may have posted with a counterparty, as well as any letters
of credit that we have provided. The methodology to determine this adjustment is consistent with how
we evaluate counterparty credit risk, taking into account our own credit rating, current credit spreads, as
well as any change in such spreads since the last measurement date.
• Liquidity valuation adjustments are necessary when we are not able to observe a recent market price for
financial instruments that trade in less active markets for the fair value to reflect the cost of exiting the
position. Exchange traded contracts are valued at market value without making any additional valuation
adjustments and, therefore, no liquidity reserve is applied. For contracts other than exchange traded
instruments, we mark our positions to the midpoint of the bid/ask spread, and record a liquidity reserve
based upon our total net position. We believe that such practice results in the most reliable fair value
measurement as viewed by a market participant.
We manage our derivative instruments on a portfolio basis and the valuation adjustments described above
are calculated on this basis. We believe that the portfolio level approach represents the highest and best use for
these assets as there are benefits inherent in naturally offsetting positions within the portfolio at any given time,
and this approach is consistent with how a market participant would view and value the assets and liabilities.
Although we take a portfolio approach to managing these assets/liabilities, in order to reflect the fair value of
any one individual contract within the portfolio, we allocate all valuation adjustments down to the contract
level, to the extent deemed necessary, based upon either the notional contract volume, or the contract value,
whichever is more applicable.
The methods described above may produce a fair value calculation that may not be indicative of net
realizable value or reflective of future fair values. While we believe that our valuation methods are appropriate
and consistent with other market participants, we recognize that the use of different methodologies or
assumptions to determine the fair value of certain financial instruments could result in a different estimate of
fair value at the reporting date. We review our fair value policies on a regular basis taking into consideration
changes in the marketplace and, if necessary, will adjust our policies accordingly. See Note 8 Risk Management
and Hedging Activities.
Valuation Hierarchy
Our fair value measurements are grouped into a three-level valuation hierarchy. The valuation hierarchy is
based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date. The
three levels are defined as follows.
• Level 1 — inputs are unadjusted quoted prices for
identical
assets or liabilities in active markets.
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