5. Fair Value Measurements
Certain of Devon's assets and liabilities are reported at fair value in the accompanying balance sheets. Such assets and liabilities include amounts for both financial and nonfinancial instruments. The following tables provide fair value measurement information for such assets and liabilities as of December 31, 2007 and 2006.
The carrying values of cash and cash equivalents, accounts receivable and accounts payable (including income taxes payable and accrued expenses) included in the accompanying consolidated balance sheets approximated fair value at December 31, 2007 and 2006. These assets and liabilities are not presented in the following tables.
| As of December 31, 2007 | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair Value Measurements Using: | |||||||||||||||
| Carrying Amount |
Total Fair Value |
Quoted Prices in Active Markets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
|||||||||||
| (In millions) | |||||||||||||||
| Financial Assets (Liabilities): Short-term investments |
$ | 372 | 372 | 372 | — | — | |||||||||
| Investment in Chevron common stock | $ | 1,324 | 1,324 | 1,324 | — | — | |||||||||
| Oil and gas price swaps and collars | $ | 12 | 12 | — | 12 | — | |||||||||
| Embedded option in exchangeable debentures | $ | (488 | ) | (488 | ) | — | (488 | ) | — | ||||||
| Debt | $ | (7,928 | ) | (9,055 | ) | (1,140 | ) | (7,915 | ) | — | |||||
| Asset retirement obligation | $ | (1,318 | ) | (1,318 | ) | — | — | (1,318 | ) | ||||||
| As of December 31, 2006 | |||||||||||||||
|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|---|
| Fair Value Measurements Using: | |||||||||||||||
| Carrying Amount |
Total Fair Value |
Quoted Prices in Active Markets (Level 1) |
Significant Other Observable Inputs (Level 2) |
Significant Unobservable Inputs (Level 3) |
|||||||||||
| (In millions) | |||||||||||||||
| Financial Assets (Liabilities): Short-term investments |
$ | 574 | 574 | 574 | — | — | |||||||||
| Investment in Chevron common stock | $ | 1,043 | 1,043 | 1,043 | — | — | |||||||||
| Oil and gas price swaps and collars | $ | 39 | 39 | — | 39 | — | |||||||||
| Interest rate swaps | $ | (6 | ) | (6 | ) | — | (6 | ) | — | ||||||
| Embedded option in exchangeable debentures | $ | (302 | ) | (302 | ) | — | (302 | ) | — | ||||||
| Debt | $ | (7,773 | ) | (8,725 | ) | (1,056 | ) | (7,669 | ) | — | |||||
| Asset retirement obligation | $ | (857 | ) | (857 | ) | — | — | (857 | ) | ||||||
Statement No. 157 (see Note 1) establishes a fair value hierarchy that prioritizes the inputs to valuation techniques used to measure fair value. As presented in the table above, this hierarchy consists of three broad levels. Level 1 inputs on the hierarchy consist of unadjusted quoted prices in active markets for identical assets and liabilities and have the highest priority. Level 3 inputs have the lowest priority. Devon uses appropriate valuation techniques based on the available inputs to measure the fair values of its assets and liabilities. When available, Devon measures fair value using Level 1 inputs because they generally provide the most reliable evidence of fair value. Devon only uses Level 3 inputs to measure the fair value of its asset retirement obligation.
The following methods and assumptions were used to estimate the fair values of the assets and liabilities in the table above.
Level 1 Fair Value Measurements
Short-term Investments — The fair values of these investments are based on quoted market prices. Devon's short-term investments as of December 31, 2007 and 2006 consisted entirely of auction rate securities. All such securities held at December 31, 2007 were collateralized by student loans which are substantially guaranteed by the United States government. Subsequent to December 31, 2007, Devon has reduced its auction rate securities holdings to $153 million. However, beginning on February 8, 2008, Devon experienced difficulty selling certain of the securities due to the failure of the auction mechanism which provides liquidity to these securities. An auction failure means that the parties wishing to sell securities could not do so. The securities for which auctions have failed will continue to accrue interest and be auctioned every 28 days until the auction succeeds, the issuer calls the securities or the securities mature. Accordingly, there may be no effective mechanism for selling these securities, and the securities Devon owns may become long-term investments. At this time, Devon does not believe its auction rate securities are impaired or that the failure of the auction mechanism will have a material impact on its liquidity.
Investment in Chevron Corporation common stock — The fair value of this investment is based on a quoted market price.
Debt — Certain of the fixed-rate debt instruments actively trade in an established market. The fair values of this debt are based on quotes obtained from brokers.
Level 2 Fair Value Measurements
Oil and gas price swaps and collars — The fair values of the oil and gas price swaps and collars are estimated using internal discounted cash flow calculations based upon forward commodity price curves, quotes obtained from brokers for contracts with similar terms or quotes obtained from counterparties to the agreements.
Embedded option in exchangeable debentures — The embedded option is not actively traded in an established market. Therefore, its fair value is estimated using quotes obtained from a broker for trades near the fair value measurement date.
Debt — Certain of the fixed-rate debt instruments do not actively trade in an established market. The fair values of this debt are estimated by discounting the principal and interest payments at rates available for debt with similar terms and maturity. The fair values of floating-rate debt are estimated to approximate the carrying amounts because the interest rates paid on such debt are generally set for periods of three months or less.
Interest rate swaps — The fair values of the interest rate swaps are estimated using internal discounted cash flow calculations based upon forward interest-rate yield curves or quotes obtained from counterparties to the agreements.
Level 3 Fair Value Measurements
Asset retirement obligation — The fair values of the asset retirement obligations are estimated using internal discounted cash flow calculations based upon Devon's estimates of future retirement costs. A reconciliation of the beginning and ending balances of Devon's asset retirement obligation, including a revision of the estimated fair value in 2007 and 2006, is presented in Note 3.