DCP SOUTHEAST TEXAS HOLDINGS, GP
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)
Years Ended December 31, 2011, 2010 and 2009
• Level 2 — inputs include quoted prices for
similar
assets and liabilities in active markets, and inputs
that are observable for the asset or liability, either directly or indirectly, for substantially the full term of
the financial instrument.
• Level 3 — inputs are unobservable and considered significant to the fair value measurement.
A financial instrument’s categorization within the hierarchy is based upon the input that requires the
highest degree of judgment in the determination of the instrument’s fair value. Following is a description of the
valuation methodologies used as well as the general classification of such instruments pursuant to the hierarchy.
Commodity Derivative Assets and Liabilities
We enter into a variety of derivative financial instruments, which may include over the counter, or OTC,
instruments, such as natural gas contracts.
We typically use OTC derivative contracts in order to mitigate a portion of our exposure to natural gas
price changes. We also may enter into natural gas derivatives to lock in margin around our storage and
transportation assets. These instruments are generally classified as Level 2. Depending upon market conditions
and our strategy, we may enter into OTC derivative positions with a significant time horizon to maturity, and
market prices for these OTC derivatives may only be readily observable for a portion of the duration of the
instrument. In order to calculate the fair value of these instruments, readily observable market information is
utilized to the extent that it is available; however, in the event that readily observable market data is not
available, we may interpolate or extrapolate based upon observable data. In instances where we utilize an
interpolated or extrapolated value, and it is considered significant to the valuation of the contract as a whole, we
would classify the instrument within Level 3.
Each instrument is assigned to a level within the hierarchy at the end of each financial quarter depending
upon the extent to which the valuation inputs are observable. Generally, an instrument will move toward a level
within the hierarchy that requires a lower degree of judgment as the time to maturity approaches, and as the
markets in which the asset trades will likely become more liquid and prices more readily available in the
market, thus reducing the need to rely upon our internally developed assumptions. However, the level of a
given instrument may change, in either direction, depending upon market conditions and the availability of
market observable data.
Nonfinancial Assets and Liabilities
We utilize fair value on a non-recurring basis to perform impairment tests as required on our property,
plant and equipment, goodwill and intangible assets. Assets and liabilities acquired in business combinations
are recorded at their fair value on the date of acquisition. The inputs used to determine such fair value are
primarily based upon internally developed cash flow models and would generally be classified within Level 3,
in the event that we were required to measure and record such assets at fair value within our consolidated
financial statements. Additionally, we use fair value to determine the inception value of our asset retirement
obligations. The inputs used to determine such fair value are primarily based upon costs incurred historically
for similar work, as well as estimates from independent third parties for costs that would be incurred to restore
leased property to the contractually stipulated condition, and would generally be classified within Level 3.
We utilize fair value on a recurring basis to measure our contingent consideration that is a result of certain
acquisitions. The inputs used to determine such fair value are primarily based upon internally developed cash
flow models and are classified within Level 3.
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