BATTALION OIL CORP 10-Q

ITEM 3. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK Derivative Instruments and Hedging Activity We are exposed to various risks, including energy commodity price risk, such as price differentials between the NYMEX commodity price and the index price at the location where our production is sold. When oil, natural gas, and natural gas liquids prices decline significantly, our ability to finance our capital budget and operations may be adversely impacted. We expect energy prices to remain volatile and unpredictable, therefore we have designed a risk management policy which provides for the use of derivative instruments to provide partial protection against declines in oil, natural gas and natural gas liquids prices by reducing the risk of price volatility and the affect it could have on our operations. The types of derivative instruments that we typically utilize include fixed-price swaps, costless collars, basis swaps and WTI NYMEX rolls. The total volumes that we hedge through the use of our derivative instruments varies from period to period, however, generally our objective is to hedge approximately 65% to 85% of our anticipated production for up to the next 30 months, when derivative contracts are available upon terms and prices acceptable to us and in a manner 41 Table of Contents consistent with at least the minimum requirements that may be in effect from time to time under our Senior Credit Agreement. Our hedge policies and objectives may change significantly as our operational profile and contractual obligations changes. We do not enter into derivative contracts for speculative trading purposes. We are exposed to market risk on our open derivative contracts related to potential non-performance by our counterparties. It is our policy to enter into derivative contracts only with counterparties that are creditworthy institutions deemed by management as competitive market makers. As of June 30, 2021, we did not post collateral under any of our derivative contracts as they are secured under our Senior Credit Agreement. We account for our derivative activities under the provisions of ASC 815, Derivatives and Hedging , (ASC 815). ASC 815 establishes accounting and reporting that every derivative instrument be recorded on the balance sheet as either an asset or liability measured at fair value. See Item 1. Condensed Consolidated Financial Statements (Unaudited) —Note 8, “Derivative and Hedging Activities,” for more details. Fair Market Value of Financial Instruments The estimated fair values for financial instruments under ASC 825, Financial Instruments , (ASC 825) are determined at discrete points in time based on relevant market information. These estimates involve uncertainties and cannot be determined with precision. The estimated fair value of cash and cash equivalents, accounts receivable and accounts payable approximates their carrying value due to their short-term nature. See Item 1. Condensed Consolidated Financial Statements (Unaudited) —Note 7, “ Fair Value Measurements,” for additional information. Interest Rate Sensitivity We are also exposed to market risk related to adverse changes in interest rates. Our interest rate risk exposure results primarily from fluctuations in short-term rates, which are LIBOR and ABR based and may result in reductions of earnings or cash flows due to increases in the interest rates we pay on these obligations. At June 30, 2021, the principal amount of our debt was $165.2 million, of which approximately 1.3% bears interest at a weighted average fixed interest rate of 1.0% per year. The remaining 98.7% of our total debt at June 30, 2021 bears interest at floating and variable interest rates that, at our option, are tied to the prime rate or LIBOR. Fluctuations in market interest rates will cause our annual interest costs to fluctuate. At June 30, 2021, the weighted average interest rate on our variable rate debt was 4.04% per year. If the balance of our variable interest rate at June 30, 2021 were to remain constant, a 10% change in market interest rates would impact our cash flows by approximately $0.7 million per year .