Edgar Filing: PETROLEUM DEVELOPMENT CORP

petro.dev-10Q-3Q11

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UNITED STATES

SECURITIES AND EXCHANGE COMMISSION

Washington, D.C. 20549

FORM 10-Q

T QUARTERLY REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the quarterly period ended September 30, 2011

£ TRANSITION REPORT PURSUANT TO SECTION 13 OR 15(d) OF THE SECURITIES EXCHANGE ACT OF 1934

For the transition period from __________ to _________

Commission File Number 000-07246

PETROLEUM DEVELOPMENT CORPORATION

(Exact name of registrant as specified in its charter)

(Doing Business as PDC Energy)



Nevada	95-2636730
(State of Incorporation)	(I.R.S. Employer Identification No.)

1775 Sherman Street, Suite 3000

Denver, Colorado 80203

(Address of principal executive offices) (Zip Code)

Registrant's telephone number, including area code: (303) 860-5800

Indicate by check mark whether the registrant (1) has filed all reports required to be filed by Section 13 or 15(d) of the Securities Exchange Act of 1934 during the preceding 12 months (or for such shorter period that the registrant was required to file such reports), and (2) has been subject to such filing requirements for the past 90 days. Yes T No £

Indicate by check mark whether the registrant has submitted electronically and posted on its corporate Web site, if any, every Interactive Data File required to be submitted and posted pursuant to Rule 405 of Regulation S-T (§232.405 of this chapter) during the preceding 12 months (or for such shorter period that the registrant was required to submit and post such files). Yes T No £

Indicate by check mark whether the registrant is a large accelerated filer, an accelerated filer, a non-accelerated filer, or a smaller reporting company. See definitions of "large accelerated filer," "accelerated filer" and "smaller reporting company" in Rule 12b-2 of the Exchange Act.



Large accelerated filer £	Accelerated filer x
Non-accelerated filer £ (Do not check if a smaller reporting company)	Smaller reporting company o

Indicate by check mark whether the registrant is a shell company (as defined in Rule 12b-2 of the Exchange Act). Yes £ No T

Indicate the number of shares outstanding of each of the issuer's classes of common stock, as of the latest practicable date: 23,611,160 shares of the Company's Common Stock ($0.01 par value) were outstanding as of October 21, 2011.

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PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

TABLE OF CONTENTS



	PART I - FINANCIAL INFORMATION	Page

Item 1.	Financial Statements	5
	Condensed Consolidated Balance Sheets	5
	Condensed Consolidated Statements of Operations	6
	Condensed Consolidated Statements of Cash Flows	7
	Notes to Condensed Consolidated Financial Statements	8
	1. Nature of Operations and Basis of Presentation
	2. Recent Accounting Standards
	3. Fair Value Measurements and Disclosures
	4. Derivative Financial Instruments
	5. Properties and Equipment
	6. Income Taxes
	7. Long-Term Debt
	8. Asset Retirement Obligations
	9. Commitments and Contingencies
	10. Common Stock
	11. Earnings Per Share
	12. Divestitures and Discontinued Operations
	13. Transactions with Affiliates and Other Related Parties
	14. Business Segments
	15. Acquisitions
	16. Subsequent Events
Item 2.	Management’s Discussion and Analysis of Financial Condition and Results of Operations	26
Item 3.	Quantitative and Qualitative Disclosures About Market Risk	42
Item 4.	Controls and Procedures	46

PART II – OTHER INFORMATION

Item 1.	Legal Proceedings	47
Item 1A.	Risk Factors	47
Item 2.	Unregistered Sales of Equity Securities and Use of Proceeds	47
Item 3.	Defaults Upon Senior Securities	47
Item 4.	[Removed and Reserved]	47
Item 5.	Other Information	47
Item 6.	Exhibits	48

	SIGNATURES	49

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SPECIAL NOTE REGARDING FORWARD-LOOKING STATEMENTS

This periodic report contains forward-looking statements within the meaning of Section 27A of the Securities Act of 1933 ("Securities Act") and Section 21E of the Securities Exchange Act of 1934 ("Exchange Act") regarding our business, financial condition, results of operations and prospects. All statements other than statements of historical facts included in and incorporated by reference into this report are "forward-looking statements" within the meaning of the safe harbor provisions of the United States Private Securities Litigation Reform Act of 1995. Words such as expects, anticipates, intends, plans, believes, seeks, estimates and similar expressions or variations of such words are intended to identify forward-looking statements herein. These statements include: estimated natural gas, natural gas liquids ("NGLs") and crude oil production and reserves; expected operational, midstream and marketing synergies from PDCM's Seneca-Upshur acquisition; anticipated capital expenditures, including our ability to fund our 2011 capital plan; our expected production growth from continuing operations in 2011 and our increased 2011 capital expenditure budget; increased focus on the Wattenberg Field and liquid-rich areas; our divestiture plans of our properties in the Permian Basin, northeast Colorado and other miscellaneous properties in the next six months; the divestiture by PDCM of its Pennsylvania Marcellus acreage; our plans to focus on primarily two regions, the Rocky Mountain and Appalachia; our compliance with our debt covenants and the indenture restrictions governing our senior notes; sufficient liquidity to meet our partnership repurchase obligations; our belief that the acquisition of partnerships will provide us with growth in production and proved reserves; the adequacy of our casualty insurance coverage as managing general partner of numerous partnerships and as operator of our own wells; the impact of decreased commodity prices on future borrowing base redeterminations; the effectiveness of our derivative policies in achieving our risk management objectives; our expected remaining liability for uncertain tax positions; our acquisition of certain Utica Shale acreage and our ability to secure a joint venture partner; the impact of outstanding legal issues; our ability to benefit from crude oil and natural gas price differential; and our strategies, plans and objectives.

The above statements are not the exclusive means of identifying forward-looking statements herein. Although forward-looking statements contained in this report reflect our good faith judgment, such statements can only be based on facts and factors currently known to us. Consequently, forward-looking statements are inherently subject to risks and uncertainties, including known and unknown risks and uncertainties incidental to the exploration for, and the acquisition, development, production and marketing of natural gas, NGLs and crude oil, and actual outcomes may differ materially from the results and outcomes discussed in the forward-looking statements.

Important factors that could cause actual results to differ materially from the forward-looking statements include, but are not limited to:


•	changes in production volumes and worldwide demand, including economic conditions that might impact demand;


•	volatility of commodity prices for natural gas, NGLs and crude oil;


•	changes in estimates of proved reserves;


•	inaccuracy of reserve estimates and expected production rates;


•	declines in the values of our natural gas and crude oil properties resulting in impairments;


•	the future cash flow, liquidity and financial position of the Company;


•	the timing and extent of our success in discovering, acquiring, developing and producing reserves;


•	our ability to acquire leases, drilling rigs, supplies and services at reasonable prices;


•	reductions in the borrowing base under our credit facility;


•	risks incidental to the drilling and operation of natural gas and crude oil wells;


•	the potential for production decline rates from our wells to be greater than expected;


•	the availability of sufficient pipeline and other transportation facilities to carry our production and the impact of these facilities on price;


•	changes in environmental laws, the regulation and enforcement of those laws and the costs to comply with those laws;


•	the impact of environmental events, governmental responses to the events and our ability to insure adequately against such events;


•	the timing and receipt of necessary regulatory permits;


•	competition in the oil and gas industry;


•	the success of the Company in marketing oil and gas;


•	the effect of natural gas and crude oil derivatives activities;


•	the availability and cost of capital to us;


•	the cost of pending or future litigation;


•	our ability to retain or attract senior management and key technical employees; and


•	the success of strategic plans, expectations and objectives for future operations of the Company.

Further, we urge you to carefully review and consider the cautionary statements and disclosures, specifically those under the heading "Risk Factors," made in this report, our annual report on Form 10-K for the year ended December 31, 2010, filed with the United States Securities and Exchange Commission ("SEC") on February 24, 2011, as amended April 21, 2011, and May 18, 2011 ("2010 Form 10-K"), and our other filings with the SEC for further information on risks and uncertainties that could affect the Company's business, financial condition and results of operations, which are incorporated by this reference as though fully set forth herein. We caution you not to place undue reliance on forward-looking statements, which speak only as of the date of this report. We undertake no obligation to update any forward-looking statements in order to reflect any event or circumstance occurring after the date of this report or currently unknown facts or conditions or the occurrence of unanticipated events. All forward-looking statements are qualified in their entirety by this cautionary statement.

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REFERENCES

Unless the context otherwise requires, references to "PDC," "PDC Energy," "the Company," "we," "us," "our," "ours" or "ourselves" in this report refer to the registrant, Petroleum Development Corporation, and its consolidated entities. See Note 1, Nature of Operations and Basis of Presentation, to our condensed consolidated financial statements included in this report for a description of our consolidated entities.

References to "the three months ended 2011" and "the nine months ended 2011" refer to the three and nine months ended September 30, 2011, respectively. References to "the three months ended 2010" and "the nine months ended 2010" refer to the three and nine months ended September 30, 2010, respectively.

References to "quarter-over-quarter" refer to the three months ended 2011 compared to the three months ended 2010. References to "year-over-year" refer to the nine months ended 2011 compared to the nine months ended 2010.

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PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS

PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

Condensed Consolidated Balance Sheets

(unaudited; in thousands, except share and per share data)



	September 30, 2011			December 31, 2010 (1)
Assets
Current assets:
Cash and cash equivalents	$	32,310		$	54,372
Restricted cash	11,065			2,474
Accounts receivable, net	46,723			53,978
Accounts receivable affiliates	37,158			11,448
Fair value of derivatives	56,793			42,953
Prepaid expenses and other current assets	11,483			11,598
Total current assets	195,532			176,823
Properties and equipment, net	1,303,775			1,120,038
Assets held for sale	—			5,191
Restricted cash	21,619			2,601
Fair value of derivatives	39,220			44,464
Accounts receivable affiliates	4,284			8,478
Other assets	26,925			31,440
Total Assets	$	1,591,355		$	1,389,035

Liabilities and Equity
Liabilities
Current liabilities:
Accounts payable	$	63,711		$	47,271
Accounts payable affiliates	9,735			9,605
Production tax liability	18,685			16,226
Fair value of derivatives	21,154			29,998
Funds held for distribution	29,405			29,755
Accrued interest payable	5,798			10,051
Other accrued expenses	21,801			17,723
Total current liabilities	170,289			160,629
Long-term debt	480,238			295,695
Deferred income taxes	191,820			187,999
Asset retirement obligations	28,472			27,797
Fair value of derivatives	20,500			36,644
Accounts payable affiliates	7,093			12,111
Other liabilities	21,738			25,919
Total liabilities	920,150			746,794

Commitments and contingent liabilities

Equity
Shareholders' equity:
Preferred shares, par value $0.01 per share; authorized 50,000,000 shares; issued: none	—			—
Common shares, par value $0.01 per share; authorized 100,000,000 shares; issued: 23,618,831 in 2011 and 23,462,326 in 2010	236			235
Additional paid-in capital	216,562			209,198
Retained earnings	454,644			432,843
Treasury shares, at cost: 7,671 in 2011 and 2,938 in 2010	(237		)	(111		)
Total shareholders' equity	671,205			642,165
Noncontrolling interest in subsidiary	—			76
Total equity	671,205			642,241
Total Liabilities and Equity	$	1,591,355		$	1,389,035

__________

(1) Derived from audited 2010 balance sheet.

See accompanying Notes to Condensed Consolidated Financial Statements

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PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

Condensed Consolidated Statements of Operations

(unaudited; in thousands, except per share data)



	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011			2010
Revenues:
Natural gas, NGL and crude oil sales	$	79,374		$	47,295		$	215,468		$	153,851
Sales from natural gas marketing	17,209			18,337			51,308			53,613
Commodity price risk management gain, net	46,706			19,029			43,361			74,508
Well operations, pipeline income and other	1,693			2,159			5,350			6,896
Total revenues	144,982			86,820			315,487			288,868

Costs, expenses and other:
Production costs	15,846			16,524			56,559			47,489
Cost of natural gas marketing	17,227			18,300			50,427			52,830
Exploration expense	1,666			3,712			5,537			13,960
General and administrative expense	13,683			10,426			47,065			30,975
Depreciation, depletion and amortization	34,316			28,024			99,347			82,427
Gain on sale of properties and equipment	(32		)	(57		)	(32		)	(153		)
Total costs, expenses and other	82,706			76,929			258,903			227,528

Income from operations	62,276			9,891			56,584			61,340
Interest income	36			21			47			60
Interest expense	(9,496		)	(8,174		)	(27,625		)	(23,646		)

Income from continuing operations before income taxes	52,816			1,738			29,006			37,754
Provision (benefit) for income taxes	20,256			(1,156		)	9,825			12,410
Income from continuing operations	32,560			2,894			19,181			25,344
Income (loss) from discontinued operations, net of tax	—			460			2,620			(1,056		)
Net income	32,560			3,354			21,801			24,288
Less: net loss attributable to noncontrolling interests	—			(5		)	—			(66		)
Net income attributable to shareholders	$	32,560		$	3,359		$	21,801		$	24,354

Amounts attributable to Petroleum Development Corporation shareholders:
Income from continuing operations	$	32,560		$	2,899		$	19,181		$	25,410
Income (loss) from discontinued operations, net of tax	—			460			2,620			(1,056		)
Net income attributable to shareholders	$	32,560		$	3,359		$	21,801		$	24,354

Earnings per share attributable to shareholders:
Basic
Income from continuing operations	$	1.38		$	0.15		$	0.82		$	1.32
Income (loss) from discontinued operations	—			0.02			0.11			(0.05		)
Net income attributable to shareholders	$	1.38		$	0.17		$	0.93		$	1.27
Diluted
Income from continuing operations	$	1.37		$	0.15		$	0.81		$	1.31
Income (loss) from discontinued operations	—			0.02			0.11			(0.05		)
Net income attributable to shareholders	$	1.37		$	0.17		$	0.92		$	1.26

Weighted average common shares outstanding:
Basic	23,569			19,250			23,497			19,218
Diluted	23,783			19,406			23,712			19,319

See accompanying Notes to Condensed Consolidated Financial Statements

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PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

Condensed Consolidated Statements of Cash Flows

(unaudited, in thousands)



	Nine Months Ended September 30,
	2011			2010
Cash flows from operating activities:
Net income	$	21,801		$	24,288
Adjustments to net income to reconcile to net cash provided by operating activities:
Unrealized gain on derivatives, net	(32,608		)	(36,056		)
Depreciation, depletion and amortization	99,347			84,086
Amortization and impairment of natural gas and crude oil properties	1,718			6,877
Exploratory dry hole costs	171			4,057
Loss (gain) from sale of properties and equipment	(3,886		)	134
Deferred income taxes	12,387			10,835
Stock-based compensation	7,242			3,845
Amortization of debt issuance costs	5,104			2,671
Other	(168		)	1,078
Changes in assets and liabilities	(5,641		)	14,977
Net cash provided by operating activities	105,467			116,792
Cash flows from investing activities:
Capital expenditures	(241,150		)	(106,795		)
Acquisition of natural gas and crude oil properties, net of cash acquired	(41,372		)	(85,511		)
Advance to PDCM for the acquisition of properties	(28,594		)	—
Deconsolidation/change in ownership effect on cash and cash equivalents	(133		)	(3,472		)
Proceeds from sale of properties and equipment	10,140			23,250
Increase in restricted cash	(19,063		)	—
Net cash used in investing activities	(320,172		)	(172,528		)
Cash flows from financing activities:
Proceeds from credit facility	295,194			244,000
Payment of credit facility	(113,213		)	(222,500		)
Contribution by investing partner in PDCM	12,464			16,173
Other	(1,802		)	(582		)
Net cash provided by financing activities	192,643			37,091
Net decrease in cash and cash equivalents	(22,062		)	(18,645		)
Cash and cash equivalents, beginning of period	54,372			31,944
Cash and cash equivalents, end of period	$	32,310		$	13,299

Supplemental cash flow information:
Cash payments (receipts) for:
Interest, net of capitalized interest	$	26,694		$	28,651
Income taxes, net of refunds	3,171			(26,998		)
Non-cash investing activities:
Change in accounts payable related to purchases of properties and equipment	14,551			7,108
Change in asset retirement obligation, with a corresponding increase to natural gas and crude oil properties, net of disposals	379			2,239

See accompanying Notes to Condensed Consolidated Financial Statements

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PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS

SEPTEMBER 30, 2011

(unaudited)

NOTE 1 - NATURE OF OPERATIONS AND BASIS OF PRESENTATION

PDC Energy is a domestic independent natural gas and crude oil company engaged in the exploration for and the acquisition, development, production and marketing of natural gas, NGLs and crude oil. As of September 30, 2011, we owned an interest in approximately 5,200 wells located primarily in the Rocky Mountain Region and the Appalachian and Permian Basins. We operate through two business segments: (1) natural gas and crude oil sales and (2) natural gas marketing.

The accompanying unaudited condensed consolidated financial statements include the accounts of PDC, our wholly-owned subsidiaries and our proportionate share of PDC Mountaineer, LLC ("PDCM"), a joint venture between PDC Energy and Lime Rock Partners for the acquisition and development of Marcellus Shale properties, and 26 affiliated partnerships. Our accompanying financial statements include our pro rata share of assets, liabilities, revenues and expenses of the entities which we proportionately consolidate. All material intercompany accounts and transactions have been eliminated in consolidation. As of September 30, 2011, PDCM was consolidated at 50% and the 26 partnerships were consolidated at varying percentages.

As of December 31, 2010, PDCM was consolidated at 55.8%, representing our ownership interest. Through a series of capital contributions by our investing partner, our ownership interest in PDCM decreased to 50% as of September 30, 2011. Each change in our ownership interest resulted in a decrease in our proportionate share of net assets and any future earnings. As of September 30, 2011, we concluded that PDCM was no longer a variable interest entity ("VIE") because our voting rights had become proportionately equal to our economic interests and the activities of the entity were being conducted equally for the benefit of both investing partners. The status change of PDCM to a non-VIE did not have an impact on our financial statements, as we continue to proportionately consolidate PDCM.

The following table presents a detailed summary of the 2011 capital contributions made by our investing partner and our resulting ownership interest.



Date	Investing Partner Contribution		PDC's Ownership Interest in PDCM
	(in thousands)

January 1, 2011	$	7,000	53.9%
March 1, 2011	5,000		52.7%
September 23, 2011	11,500		50.0%

In our opinion, the accompanying financial statements contain all adjustments (consisting of only normal recurring adjustments) necessary for a fair statement of our financial statements for interim periods in accordance with accounting principles generally accepted in the United States of America ("U.S. GAAP") and with the instructions to Form 10-Q and Article 10 of Regulation S-X of the SEC. Accordingly, pursuant to such rules and regulations, certain notes and other financial information included in audited financial statements have been condensed or omitted. The information presented in this quarterly report on Form 10-Q should be read in conjunction with our audited consolidated financial statements and notes thereto included in our 2010 Form 10-K. The results of operations for the three and nine months ended 2011, and the cash flows for the nine months ended 2011, are not necessarily indicative of the results to be expected for the full year or any other future period.

Certain reclassifications have been made to prior period financial statements to conform to the current year presentation, specifically related to our discontinued operations. The reclassifications had no impact on previously reported cash flows, net income, earnings per share or shareholders' equity. See Note 12 for additional information regarding our discontinued operations. Additionally, certain reclassifications have been made to correct the prior period disclosures to conform to the current year presentation, specifically related to the

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PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

fair value level classification of certain derivative instruments. The reclassification had no impact on previously reported financial position, cash flows, net income, earnings per share or shareholders' equity. See Note 3 for additional information regarding the fair value classification of our natural gas and crude oil derivative instruments.

NOTE 2 - RECENT ACCOUNTING STANDARDS

Recently Adopted Accounting Standards

Fair Value Measurements and Disclosures. In January 2010, the Financial Accounting Standards Board ("FASB") issued changes related to fair value measurements requiring gross presentation of activities within the Level 3 roll forward, whereby entities must present separately information about purchases, sales, issuances and settlements. These changes were effective for our financial statements issued for the annual reporting period, and for interim reporting periods within the year, beginning after December 15, 2010. The adoption of this change did not have a material impact on our financial statements.

Recently Issued Accounting Standards

Fair Value Measurement. On May 12, 2011, the FASB issued changes related to fair value measurement. The changes represent the converged guidance of the FASB and the International Accounting Standards Board ("IASB") on fair value measurement. Many of the changes eliminate unnecessary wording differences between International Financial Reporting Standards ("IFRS") and U.S. GAAP. The changes expand existing disclosure requirements for fair value measurements categorized in Level 3 by requiring (1) a quantitative disclosure of the unobservable inputs and assumptions used in the measurement, (2) a description of the valuation processes in place and (3) a narrative description of the sensitivity of the fair value to changes in unobservable inputs and the interrelationships between those inputs. In addition, the changes require the categorization by level in the fair value hierarchy of items that are not measured at fair value in the statement of financial position whose fair value must be disclosed. These changes are to be applied prospectively and are effective for public entities during interim and annual periods beginning after December 15, 2011. Early application is not permitted. With the exception of the disclosure requirements, the adoption of these changes is not expected to have a significant impact on our financial statements.

Presentation of Comprehensive Income. On June 16, 2011, the FASB issued changes related to the presentation of comprehensive income. These changes eliminate the current option to report other comprehensive income and its components in the statement of changes in equity. These changes are intended to enhance comparability between entities that report under U.S. GAAP and those that report under IFRS, and to provide a more consistent method of presenting non-owner transactions that affect an entity's equity. An entity may elect to present items of net income and other comprehensive income in one continuous statement, referred to as the statement of comprehensive income, or in two separate, but consecutive, statements. Each component of net income and each component of other comprehensive income, together with totals for comprehensive income and its two parts, net income and other comprehensive income, would need to be displayed under either alternative. The statement(s) would need to be presented with equal prominence as the other primary financial statements. The new requirement is effective for public entities as of the beginning of a fiscal year that begins after December 15, 2011, and interim and annual periods thereafter. Early adoption is permitted, but full retrospective application is required under both sets of accounting standards. We do not expect the adoption of these changes to have a material impact on our financial statements.

NOTE 3 - FAIR VALUE MEASUREMENTS AND DISCLOSURES

Derivative Financial Instruments

Determination of fair value. Fair value accounting standards have established a fair value hierarchy that prioritizes the inputs used in applying a valuation methodology. The valuation hierarchy is based upon the transparency of inputs to the valuation of an asset or liability as of the measurement date, giving the highest priority to quoted prices in active markets (Level 1) and the lowest priority to unobservable data (Level 3). In some cases, the inputs used to measure fair value might fall in different levels of the fair value hierarchy. Financial assets and liabilities are classified in their entirety based on the lowest level of input that is significant to the fair value measurement. Assessing the significance of a particular input to the fair value measurement in its entirety requires judgment, considering factors specific to the asset or liability, and their placement within the fair value hierarchy levels. The three levels of inputs that may be used to measure fair value are defined as:

Level 1 – Quoted prices (unadjusted) in active markets for identical assets or liabilities.

Level 2 – Inputs other than quoted prices included within Level 1 that are either directly or indirectly observable for the asset or liability, including (i) quoted prices for similar assets or liabilities in active markets, (ii) quoted prices for identical or similar assets or liabilities in inactive markets, (iii) inputs other than quoted prices that are observable for the asset or liability and (iv) inputs that are derived from observable market data by correlation or other means.

Level 3 – Unobservable inputs for the asset or liability, including situations where there is little, if any, market activity for the asset or liability.

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PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Derivative Financial Instruments. We measure the fair value of our derivative instruments based on a pricing model that utilizes market-based inputs, including but not limited to the contractual price of the underlying position, current market prices, natural gas and crude oil forward curves, discount rates such as the LIBOR curve for a similar duration of each outstanding position, volatility factors and nonperformance risk. Nonperformance risk considers the effect of our credit standing on the fair value of derivative liabilities and the effect of our counterparties' credit standings on the fair value of derivative assets. Both inputs to the model are based on published credit default swap rates and the duration of each outstanding derivative position. The counterparties to our derivative instruments are primarily financial institutions who are also major lenders in our credit facility agreement. We validate our fair value measurement through (1) the review of counterparty statements and other supporting documentation, (2) the determination that the source of the inputs are valid, (3) the corroboration of the original source of inputs through access to multiple quotes, if available, or other information and (4) monitoring changes in valuation methods and assumptions. While we use common industry practices to develop our valuation techniques, changes in our pricing methodologies or the underlying assumptions could result in significantly different fair values. While we believe our valuation method is appropriate and consistent with those used by other market participants, the use of a different methodology, or assumptions, to determine the fair value of certain financial instruments could result in a different estimate of fair value.

The following table presents, for each hierarchy level, our derivative assets and liabilities, both current and non-current portions, including the derivative assets and liabilities designated to our affiliated partnerships and our proportionate share of PDCM's derivative assets and liabilities, measured at fair value on a recurring basis.



	September 30, 2011						December 31, 2010 (a)
	Level 2 (b)		Level 3 (c)		Total		Level 2 (b)		Level 3 (c)		Total
	(in thousands)
Assets:
Commodity based derivatives contracts	$	72,405	$	23,553	$	95,958	$	72,880	$	14,426	$	87,306
Basis protection derivative contracts	3		52		55		10		101		111
Total assets	72,408		23,605		96,013		72,890		14,527		87,417
Liabilities:
Commodity based derivatives contracts	2,051		142		2,193		16,304		3,758		20,062
Basis protection derivative contracts	39,461		—		39,461		46,573		7		46,580
Total liabilities	41,512		142		41,654		62,877		3,765		66,642
Net asset	$	30,896	$	23,463	$	54,359	$	10,013	$	10,762	$	20,775

__________

(a)

We reclassified our NYMEX-based natural gas fixed-price swaps from Level 1 to Level 2 (decreasing the previously reported net asset in Level 1 by $64.1 million, with a corresponding increase in Level 2), Panhandle Eastern Pipeline ("PEPL") and Colorado Interstate Gas ("CIG") -based natural gas fixed-price swaps, crude oil fixed-price swaps, basis swaps and natural gas physical purchases from Level 3 to Level 2 (decreasing the previously reported net liability in Level 3 by $54.1 million, with a corresponding increase in Level 2). The amounts presented reflect these reclassifications and conform to current period presentation.


(b)	Includes our fixed-price swaps, basis swaps and physical purchases.


(c)	Includes our natural gas and crude oil collars, crude oil puts and physical sales.

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PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following table presents a reconciliation of our Level 3 fair value measurements.



	Nine Months Ended September 30,
	2011			2010 (1)
	(in thousands)

Fair value, net asset, beginning of period	$	10,762		$	15,048
Changes in fair value included in statement of operations line item:
Commodity price risk management gain, net	15,285			15,655
Sales from natural gas marketing	51			493
Cost of natural gas marketing	—			24
Changes in fair value included in balance sheet line item (2):
Accounts receivable affiliates	49			10
Accounts payable affiliates	(568		)	(677		)
Settlements included in statement of operations line items:
Commodity price risk management gain, net	(2,022		)	(11,583		)
Sales from natural gas marketing	(94		)	(289		)
Cost of natural gas marketing	—			(23		)
Fair value, net asset, end of period	$	23,463		$	18,658

Changes in unrealized gains (losses) relating to assets (liabilities) still held
as of period end, included in statement of operations line item:
Commodity price risk management gain, net	$	9,974		15,469
Sales from natural gas marketing	(4		)	187
	$	9,970		$	15,656

__________


(1)	We reclassified our PEPL and CIG-based natural gas fixed-price swaps, crude oil fixed-price swaps, basis swaps and natural gas physical purchases from Level 3 to Level 2 (decreasing the previously reported net liability at the beginning of the period by $44 million). The amounts presented reflect these reclassifications and conform to current period presentation.


(2)	Represents the change in fair value related to derivative instruments entered into by us and designated to our affiliated partnerships.

See Note 4 for additional disclosure related to our derivative financial instruments.

Non-Derivative Financial Assets and Liabilities

The carrying values of the financial instruments comprising current assets and current liabilities approximate fair value due to the short-term maturities of these instruments.

The liability associated with our non-qualified deferred compensation plan for non-employee directors may be settled in cash or shares of our common stock. The carrying value of this obligation is based on the quoted market price of our common stock, which is a Level 1 input. As of September 30, 2011, and December 31, 2010, the liability related to this plan was immaterial.

The portion of our long-term debt related to our corporate credit facility, as well as our proportionate share of PDCM's credit facility, approximates fair value due to the variable nature of its related interest rate. We have not elected to account for the portion of our long-term debt related to our senior notes under the fair value option; however, as of September 30, 2011, we estimate the fair value of our 3.25% convertible senior notes due 2016 to be $92 million and the fair value of our 12% senior notes due 2018 to be $217.7 million. We determined these valuations based upon measurements of broker/dealer quotes and trading activity, respectively.

NOTE 4 - DERIVATIVE FINANCIAL INSTRUMENTS

As of September 30, 2011, we had derivative instruments in place for a portion of our anticipated production through 2015 for a total of 34,986.7 BBtu of natural gas and 2,324 MBbls of crude oil.

Table of Contents

PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following table presents the location and fair value amounts of our derivative instruments on the balance sheets. These derivative instruments were comprised of commodity floors, collars and swaps, basis protection swaps and physical sales and purchases.



			Fair Value
Derivatives instruments not designated as hedges (1):		Balance sheet line item	September 30, 2011			December 31, 2010
			(in thousands)
Derivative assets:	Current
	Commodity contracts
	Related to natural gas and crude oil sales	Fair value of derivatives	$	47,625		$	32,837
	Related to affiliated partnerships (2)	Fair value of derivatives	7,916			8,231
	Related to natural gas marketing	Fair value of derivatives	1,200			1,811
	Basis protection contracts
	Related to natural gas marketing	Fair value of derivatives	52			74
			56,793			42,953
	Non Current
	Commodity contracts
	Related to natural gas and crude oil sales	Fair value of derivatives	32,035			32,270
	Related to affiliated partnerships (2)	Fair value of derivatives	7,093			12,111
	Related to natural gas marketing	Fair value of derivatives	89			46
	Basis protection contracts
	Related to natural gas marketing	Fair value of derivatives	3			37
			39,220			44,464
Total derivative assets			$	96,013		$	87,417

Derivative liabilities:	Current
	Commodity contracts
	Related to natural gas and crude oil sales	Fair value of derivatives	$	813		$	10,636
	Related to affiliated partnerships (3)	Fair value of derivatives	238			1,676
	Related to natural gas marketing	Fair value of derivatives	1,031			1,492
	Basis protection contracts
	Related to natural gas and crude oil sales	Fair value of derivatives	15,095			11,725
	Related to affiliated partnerships (3)	Fair value of derivatives	3,968			4,462
	Related to natural gas marketing	Fair value of derivatives	9			7
			21,154			29,998
	Non Current
	Commodity contracts
	Related to natural gas and crude oil sales	Fair value of derivatives	7			6,231
	Related to affiliated partnerships (3)	Fair value of derivatives	23			(3		)
	Related to natural gas marketing	Fair value of derivatives	81			30
	Basis protection contracts
	Related to natural gas and crude oil sales	Fair value of derivatives	16,129			21,905
	Related to affiliated partnerships (3)	Fair value of derivatives	4,261			8,481
	Related to natural gas marketing	Fair value of derivatives	(1		)	—
			20,500			36,644
Total derivative liabilities			$	41,654		$	66,642

__________


(1)	As of September 30, 2011, and December 31, 2010, none of our derivative instruments were designated as hedges.


(2)	Our balance sheets include a corresponding payable to our affiliated partnerships of $15 million and $20.3 million as of September 30, 2011, and December 31, 2010, respectively.


(3)	Our balance sheets include a corresponding receivable from our affiliated partnerships of $8.5 million and $14.6 million as of September 30, 2011, and December 31, 2010, respectively.

Table of Contents

PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following table presents the impact of our derivative instruments on our statements of operations.



	2011									2010
Statement of operations line item	Reclassification of Realized Gains (Losses) Included in Prior Periods Unrealized			Realized and Unrealized Gains (Losses) For the Current Period			Total			Reclassification of Realized Gains (Losses) Included in Prior Periods Unrealized			Realized and Unrealized Gains (Losses) For the Current Period			Total
	(in thousands)
Three Months Ended September 30,
Commodity price risk management gain, net
Realized gains	$	2,815		$	2,132		$	4,947		$	5,688		$	1,832		$	7,520
Unrealized gains	(2,815		)	44,574			41,759			(5,688		)	17,197			11,509
Total commodity price risk management gain, net (1)	$	—		$	46,706		$	46,706		$	—		$	19,029		$	19,029
Sales from natural gas marketing
Realized gains	$	418		$	88		$	506		$	1,384		$	222		$	1,606
Unrealized gains	(418		)	958			540			(1,384		)	1,624			240
Total sales from natural gas marketing (2)	$	—		$	1,046		$	1,046		$	—		$	1,846		$	1,846
Cost of natural gas marketing
Realized losses	$	(347	)	$	(104	)	$	(451	)	$	(1,169	)	$	(280	)	$	(1,449	)
Unrealized losses	347			(944		)	(597		)	1,169			(1,563		)	(394		)
Total cost of natural gas marketing (2)	$	—		$	(1,048	)	$	(1,048	)	$	—		$	(1,843	)	$	(1,843	)

Nine Months Ended September 30,
Commodity price risk management gain, net
Realized gains	$	9,033		$	1,505		$	10,538		$	19,927		$	18,410		$	38,337
Unrealized gains	(9,033		)	41,856			32,823			(19,927		)	56,098			36,171
Total commodity price risk management gain, net (1)	$	—		$	43,361		$	43,361		$	—		$	74,508		$	74,508
Sales from natural gas marketing
Realized gains	$	1,624		$	516		$	2,140		$	2,078		$	2,392		$	4,470
Unrealized gains (losses)	(1,624		)	1,130			(494		)	(2,078		)	3,266			1,188
Total sales from natural gas marketing (2)	$	—		$	1,646		$	1,646		$	—		$	5,658		$	5,658
Cost of natural gas marketing
Realized losses	$	(1,287	)	$	(525	)	$	(1,812	)	$	(1,752	)	$	(2,402	)	$	(4,154	)
Unrealized gains (losses)	1,287			(1,008		)	279			1,752			(3,055		)	(1,303		)
Total cost of natural gas marketing (2)	$	—		$	(1,533	)	$	(1,533	)	$	—		$	(5,457	)	$	(5,457	)

__________


(1)	Represents realized and unrealized gains and losses on derivative instruments related to natural gas and crude oil sales.


(2)	Represents realized and unrealized gains and losses on derivative instruments related to natural gas marketing.

Concentration of Credit Risk. We make extensive use of over-the-counter derivative instruments that enable us to manage a portion of our exposure to price volatility from producing and marketing natural gas and crude oil. These arrangements expose us to credit risk of nonperformance by our counterparties. We primarily use financial institutions, who are also major lenders in our credit facility agreement, as counterparties to our derivative contracts. To date, we have had no counterparty default losses. We have evaluated the credit risk of our derivative assets from our counterparties using relevant credit market default rates, giving consideration to amounts outstanding for each counterparty and the duration of each outstanding derivative position. Based on our evaluation, the impact of the nonperformance of our counterparties on the fair value of our derivative instruments was not significant.

Table of Contents

PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following table presents the derivative counterparties that expose us to credit risk.



Counterparty Name	Fair Value of Derivative Assets As of September 30, 2011
	(in thousands)

JPMorgan Chase Bank, N.A. (1)	$	37,858
Crèdit Agricole CIB (1)	23,242
Wells Fargo Bank, N.A. (1)	15,372
BNP Paribas (1)	13,612
Various (2)	5,929
Total	$	96,013

________________________

(1)Major lender in our credit facility, see Note 7.

(2)Represents a total of 14 counterparties, including three lenders in our credit facility.

NOTE 5 - PROPERTIES AND EQUIPMENT

The following table presents the components of properties and equipment, net.



	September 30, 2011			December 31, 2010
	(in thousands)
Properties and equipment, net:
Natural gas and crude oil properties
Proved	$	1,674,983		$	1,429,667
Unproved	77,403			79,053
Total natural gas and crude oil properties	1,752,386			1,508,720
Pipelines and related facilities	33,861			34,262
Transportation and other equipment	31,790			32,410
Land, buildings and leasehold improvements	14,476			13,379
Construction in progress	74,875			42,128
	1,907,388			1,630,899
Accumulated DD&A	(603,613		)	(510,861		)
Properties and equipment, net	$	1,303,775		$	1,120,038

NOTE 6 - INCOME TAXES

We evaluate our estimated annual effective income tax rate on a quarterly basis based on current and forecasted operating results and tax laws. The estimated annual effective tax rate is adjusted quarterly based upon actual results and updated operating forecasts; consequently, based upon the mix and timing of our actual earnings compared to annual projections, our effective tax rate may vary quarterly and may make quarterly comparisons not meaningful. A tax expense or benefit unrelated to the current year income or loss is recognized in its entirety as a discrete item of tax in the period identified. The quarterly income tax provision is generally comprised of tax on income or tax benefit on loss at the most recent estimated annual effective tax rate, adjusted for the effect of discrete items.

The effective tax rate for continuing operations for the three and nine months ended 2011 was 38.4% and 33.9% (provisions on income), respectively, compared to 66.5% (discrete benefit on income) and 32.9% (provision on income) for the three and nine months ended 2010, respectively. The effective tax rate for the nine months ended 2011 and 2010 differs from the statutory rate primarily due to net permanent deductions, largely percentage depletion, decreasing the tax provision on pretax income. During the three months ended 2010, we recorded a net discrete tax benefit of $1.6 million due to a reduction of our deferred tax rate which reduced our net deferred tax liability. The rate excluding discrete items for the three months ended 2010 was 25.4% (provision on income). The rate for the three months ended 2011 did not include any material discrete items. However, for reasons noted above, a comparison of the quarter-over-quarter rates would not be meaningful.

As of September 30, 2011, we had a gross liability for unrecognized tax benefits of $0.4 million compared to $1.1 million at December 31, 2010. If recognized, all of this liability would affect our effective tax rate. This liability is reflected in other accrued expenses on our accompanying balance sheet. In June 2011, the Internal Revenue Service ("IRS") completed its examination of our 2007, 2008 and 2009 tax years. During the nine months ended 2011, we reduced our liability by $0.6 million for uncertain tax benefits that were resolved

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PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

without change by the completion of the IRS examination and reduced the liability by $0.1 million due to the expiration of the statute of limitations related to another tax position. During the three months ended 2011, we decreased the liability by $0.2 million due to a change in estimate for tax positions of the current year. We expect our remaining liability for uncertain tax positions to decrease by $0.2 million in the next 12 months as a remaining uncertain tax position is reviewed under the IRS Compliance Assurance Process ("CAP") program.

As of the date of this filing, we are current with our income tax filings in all applicable state jurisdictions and currently have no state income tax returns in the process of examination.

NOTE 7 - LONG-TERM DEBT

Long-term debt consists of the following:



	September 30, 2011			December 31, 2010
	(in thousands)
Senior notes
3.25% Convertible senior notes due 2016:
Principal amount	$	115,000		$	115,000
Unamortized discount	(17,426		)	(20,252		)
3.25% Convertible senior notes due 2016, net of discount	97,574			94,748
12% Senior notes due 2018:
Principal amount	203,000			203,000
Unamortized discount	(1,836		)	(2,053		)
12% Senior notes due 2018, net of discount	201,164			200,947
Total senior notes	298,738			295,695
Credit facilities
Corporate	172,500			—
PDCM	9,000			—
Total credit facilities	181,500			—
Total long-term debt	$	480,238		$	295,695

Senior Notes

3.25% Convertible Senior Notes Due 2016. In November 2010, we issued $115 million of 3.25% convertible senior notes due 2016 in a private placement. The maturity for the payment of principal is May 15, 2016. Interest at the rate of 3.25% per year is payable in cash semiannually in arrears on each May 15 and November 15, which commenced on May 15, 2011. We allocated the gross proceeds of the convertible notes between the liability and equity components of the debt. The initial $94.3 million liability component was determined based on the fair value of similar debt instruments, excluding the conversion feature, with similar terms and priced on the same day we issued our convertible notes. The original issue discount and the deferred note issuance costs are being amortized to interest expense over the term of the debt using an effective interest rate of 7.4%. Upon conversion, the convertible notes may be settled, at our election, in shares of our common stock, cash or a combination of cash and shares of our common stock. We have initially elected a net-settlement method to satisfy our conversion obligation, which allows us to settle the $1,000 principal amount of the convertible notes in cash and to settle the excess conversion value in shares, as well as cash in lieu of fractional shares.

12% Senior Notes Due 2018. In 2008, we issued $203 million of 12% senior notes due 2018 in a private placement. The maturity for the payment of principal is February 15, 2018. Interest at the rate of 12% per year is payable in cash semiannually in arrears on each February 15 and August 15. The senior notes were issued at a discount, 98.572% of the principal amount. The indenture governing the notes contains customary representations and warranties as well as typical restrictive covenants. The original issue discount and the deferred note issuance costs are being amortized to interest expense over the term of the debt using the effective interest method.

We were in compliance with all covenants related to our senior notes as of September 30, 2011, and expect to remain in compliance throughout the next twelve-month period.

Bank Credit Facilities

Corporate Bank Credit Facility. We operate under a credit facility dated as of November 5, 2010, as amended last on May 6, 2011, with an aggregate revolving commitment or borrowing base of $350 million. The maximum allowable facility amount is $600 million. The credit facility is with certain commercial lending institutions and is available for working capital requirements, capital expenditures,

Table of Contents

PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

acquisitions, general corporate purposes and to support letters of credit.

Our credit facility borrowing base is subject to size redetermination biannually based on a valuation of our natural gas and crude oil reserves at December 31 and June 30 and is also subject to a redetermination upon the occurrence of certain events. The borrowing base of the credit facility will be the loan value assigned to the proved reserves attributable to our natural gas and crude oil interests, excluding proved reserves attributable to PDCM and our 26 affiliated partnerships. The credit facility is secured by a pledge of the stock of certain of our subsidiaries, mortgages of certain producing natural gas and crude oil properties and substantially all of our other assets. Neither PDCM nor the various limited partnerships that we have sponsored and continue to serve as the managing general partner are guarantors of the credit facility.

Our outstanding principal amount accrues interest at a varying interest rate that fluctuates with an alternate base rate (equal to the greater of JPMorgan Chase Bank, N.A.'s prime rate, the federal funds rate plus a premium and 1-month LIBOR plus a premium), or at our election, a rate equal to the rate for dollar deposits in the London interbank market for certain time periods. Additionally, commitment fees, interest margin and other bank fees, charged as a component of interest, vary with our utilization of the facility. No principal payments are required until the credit agreement expires on November 5, 2015, or in the event that the borrowing base would fall below the outstanding balance. The credit facility contains covenants customary for agreements of this type.

We have outstanding an undrawn $18.7 million irrevocable standby letter of credit in favor of a third party transportation service provider. This letter of credit reduced the amount of available funds under our credit facility by an equal amount. We pay a fronting fee of 0.125% per annum and an additional quarterly maintenance fee equivalent to the spread over Eurodollar loans (2.5% per annum as of September 30, 2011) for the period the letter of credit remains outstanding. The letter of credit is set to expire on May 22, 2012.

As of September 30, 2011, we had an outstanding balance of $172.5 million on our credit facility compared to no outstanding draws as of December 31, 2010. We pay a fee of 0.5% per annum on the unutilized commitment on the available funds under our credit facility. As of September 30, 2011, the available funds under our credit facility, including a reduction for the $18.7 million irrevocable standby letter of credit in effect, was $158.8 million. The weighted average borrowing rate on our credit facility was 2.2% per annum as of September 30, 2011.

On October 12, 2011, we completed the redetermination of our corporate bank credit facility's borrowing base. See Note 16 for a more detailed discussion.

PDCM Credit Facility. PDCM has a credit facility dated as of April 30, 2010, as amended on April 20, 2011, with an aggregate revolving commitment or borrowing base of $40 million. In addition to the increase in borrowing base, the April 20, 2011, amendment permits PDCM to enter into swap agreements on new properties which were not included in the most recent reserve report and which have been producing for at least 30 days. The credit facility is subject to and secured by PDCM's properties, including our proportionate share of such properties. The credit facility borrowing base is subject to size redetermination semiannually based upon a valuation of PDCM's reserves at December 31 and June 30; further, either PDCM or the lenders may request a redetermination upon the occurrence of certain events. Pursuant to the interests of the joint venture, the credit facility will be utilized by PDCM for the exploration and development of its Appalachian assets. As of September 30, 2011, our proportionate share of PDCM's outstanding credit facility draw was $9 million. As of December 31, 2010, there were no amounts outstanding related to this credit facility. PDCM pays a fee of 0.5% per annum on the unutilized commitment on the available funds under this credit facility. The weighted average borrowing rate on PDCM's credit facility was 1.8% per annum as of September 30, 2011.

As of September 30, 2011, both the Company and PDCM were in compliance with all bank credit facility covenants and expect to remain in compliance throughout the next twelve-month period.

NOTE 8 - ASSET RETIREMENT OBLIGATIONS

The following table presents the changes in carrying amounts of the asset retirement obligations associated with our working interest in natural gas and crude oil properties.

Table of Contents

PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued



	Amount
	(in thousands)

Balance at December 31, 2010 (1)	$	28,047
Change in ownership interest of PDCM	(916		)
Obligations incurred with development activities and assumed with acquisitions	955
Accretion expense	1,212
Obligations discharged with disposal of properties and asset retirements	(254		)
Revisions in estimated cash flows	(322		)
Balance at September 30, 2011	28,722
Less current portion	(250		)
Long-term portion	$	28,472

__________


(1)	Includes $0.2 million as of December 31, 2010, related to assets held for sale.

NOTE 9 - COMMITMENTS AND CONTINGENCIES

Purchase Agreement. On September 23, 2011, PDCM executed a purchase agreement, effective as of July 1, 2011, with an unrelated third party to acquire 100% of the membership interests of Seneca-Upshur Petroleum, LLC ("Seneca-Upshur"), a West Virginia limited liability company, for a purchase price of $152.5 million ($76.2 million net to PDC). The transaction includes all rights and all depths to an estimated 100,000 net acres: 90,000 acres prospective for the Marcellus Shale primarily located in Harrison, Taylor, Barbour, Upshur, Lewis and Randolph counties of north central West Virginia and 10,000 acres prospective for the Huron Shale primarily located in Mingo and McDowell counties in southwest West Virginia. The acreage is held by production from approximately 1,400 wells producing from the shallow Devonian, which were included in the transaction. The acquisition of these assets are complementary to PDCM's existing properties due to their close proximity. The transaction closed on October 3, 2011, see Note 16 for a further discussion.

Utica Shale Leasehold Agreements. During the three months ended 2011, we entered into a series of leasehold agreements with multiple parties for the option to acquire acreage targeting the wet natural gas and crude oil phases of the Utica Shale play throughout southeastern Ohio. Pursuant to the agreements, we have the right, after confirmation of title, to acquire an estimated 30,000 net acres in the prospective Utica Shale play. Should we confirm title on all 30,000 acres, we estimate that the purchase price of these leaseholds will approximate $50 million. Further, subsequent to September 30, 2011, we have entered into additional leasehold agreements giving us the opportunity to purchase an estimated additional 10,000 acres, subject to confirmation of title, for up to $20 million. Currently, we are actively pursuing an industry joint venture partner to participate in and share in funding the growth and development in this play; however, we cannot guarantee we will be successful in securing a partner.

Merger Agreements. On June 20, 2011, pursuant to our previously announced partnership acquisition plan, we entered into separate merger agreements with five of our affiliated partnerships: PDC 2003-A Limited Partnership, PDC 2003-B Limited Partnership, PDC 2003-C Limited Partnership, PDC 2003-D Limited Partnership and PDC 2002-D Limited Partnership (collectively, the "2003/2002-D Partnerships"). We serve as the managing general partner of each of the 2003/2002-D Partnerships. Pursuant to each merger agreement, if the merger is approved by the holders of a majority of the limited partnership units held by limited partners of that partnership not owned by us (the "non-affiliated investor partners"), as well as the satisfaction of other customary closing conditions, we will then acquire such partnerships. If all five partnerships are acquired, we expect to pay an aggregate of approximately $29.5 million to the non-affiliated investor partners for the limited partnership units of these partnerships. Definitive proxy statements were filed with the SEC on September 12, 2011, and first mailed to investors on September 14, 2011. On October 28, 2011, the non-affiliated investor partners of the 2003/2002-D Partnerships approved the applicable merger agreements. We expect to fund the purchase price for these acquisitions in November 2011 through a draw on our corporate credit facility. See Note 16 for further details.

Firm Transportation Agreements. We enter into contracts that provide firm transportation, sales and processing charges on pipeline systems through which we transport or sell our natural gas and the natural gas of working interest owners, PDCM, our affiliated partnerships and other third parties. These contracts require us to pay these transportation and processing charges whether the required volumes are delivered or not. Satisfaction of the volume requirements includes volumes produced by us, volumes purchased from third parties and volumes produced by our joint venture and affiliated partnerships. We record in our financial statements only our share of costs based upon our working interest in the wells; however, with the exception of contracts entered into by PDCM, the costs of all volume shortfalls will be borne by PDC.

As of June 30, 2011, we had a liability in the amount of $3.1 million included in other liabilities on the balance sheet related to an agreement in the Piceance Basin. On July 27, 2011, we entered into an amendment with the unrelated third party subject to this agreement whereby the accrued liability was relieved; consequently, during the third quarter of 2011, the accrued liability was eliminated with a corresponding reduction in the statement of operations line item production costs. The amendment did not extend the expiration date of the original agreement. The table below includes the impact of this amendment.

Table of Contents

PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

The following table presents gross volume information, including our proportionate share of PDCM, related to our long-term firm sales, processing and transportation agreements for pipeline capacity.



	For the Twelve Months Ending September 30,
Area	2012		2013		2014		2015		2016 Through Expiration		Total		Expiration Date

Volume (MMcf)
Piceance Basin	18,000		25,254		37,719		31,910		119,149		232,032		May 31, 2021
Appalachian Basin (1)	7,993		20,152		21,265		22,855		196,312		268,577		September 25, 2025
NECO	3,655		2,285		1,825		1,825		2,285		11,875		December 31, 2016
Total	29,648		47,691		60,809		56,590		317,746		512,484

Dollar commitment (in thousands)	$	13,474	$	22,898	$	29,481	$	26,749	$	133,740	$	226,342

_____________

(1)

Includes a precedent agreement that becomes effective when a planned pipeline is placed in service, currently expected to be September 2012 and represents 873 MMcf of the total MMcf presented for the year ending September 30, 2012, 10,627 MMcf for each of the years ending September 30, 2013 through 2015, respectively, and 73,576 MMcf thereafter. This agreement will be null and void if the pipeline is not completed. In August 2009, we issued a letter of credit related to this agreement, see Note 7.

Litigation. The Company is involved in various legal proceedings that it considers normal to its business. The Company reviews the status of these proceedings on an ongoing basis and, from time to time, may settle or otherwise resolve these matters on terms and conditions that management believes are in the best interests of the Company. There are no assurances that settlements can be reached on acceptable terms or that adverse judgments, if any, in the remaining litigation will not exceed the amounts reserved. Although the results cannot be known with certainty, we currently believe that the ultimate results of such proceedings will not have a material adverse effect on our financial position, results of operations or liquidity.

Royalty Owner Class Action

Gobel et al v. Petroleum Development Corporation, filed on January 27, 2009, in Circuit Court of Harrison County, CA No. 09-C-40-2

David W. Gobel, individually and allegedly as representative of all royalty owners in the Company's West Virginia oil and gas wells, filed a lawsuit against the Company alleging that we failed to properly pay royalties. The allegations stated that the Company improperly deducted certain charges and costs before applying the royalty percentage. Punitive damages were requested in addition to breach of contract, tort and fraud allegations. On October 27, 2010, the state court set a trial date of April 2012.

In April 2011, the Company entered into an oral settlement agreement with respect to this lawsuit, settling all claims between the parties for an aggregate payment of $8.7 million. On June 15, 2011, subject to court approval, a written settlement agreement was signed confirming these terms. On June 30, 2011, the state court granted initial approval of the settlement agreement, subject to notice to class members and final court approval. Initial notice was then sent to the class members. The date for objection by class members was October 24, 2011, with no objections received. The hearing to consider final approval of the settlement is scheduled for December 19, 2011. The total settlement amount of $8.7 million was accrued as of September 30, 2011, and included in other accrued expenses on the accompanying balance sheet. An escrow account was funded on July 22, 2011, for the entire settlement amount and included in restricted cash - current on the balance sheet, with no impact to the accrued liability or statement of operations during the third quarter of 2011.

Environmental. Due to the nature of the natural gas and oil industry, we are exposed to environmental risks. We have various policies and procedures in place to avoid environmental contamination and mitigate the risks from environmental contamination. We conduct periodic reviews to identify changes in our environmental risk profile. Liabilities are accrued when environmental assessments and/or clean-ups are probable and the costs can be reasonably estimated. As of September 30, 2011, and December 31, 2010, we had accrued environmental liabilities in the amount of $1.9 million and $1.7 million, respectively, included in other accrued expenses on the balance sheet. We are not currently aware of any environmental claims existing as of September 30, 2011, which have not been provided for or would otherwise have a material impact on our accompanying financial statements. However, there can be no assurance that current regulatory requirements will not change or unknown past non-compliance with environmental laws will not be discovered on our properties.

Partnership Repurchase Provision. Although we have not sponsored a partnership drilling program since 2007, substantially all of our partnership drilling programs contain a repurchase provision where investing partners may request that we purchase their partnership units at any time beginning with the third anniversary of the respective partnership's first cash distribution. The provision provides that we are obligated to purchase an aggregate of 10% of the initial subscriptions per calendar year (at a minimum price of four times the most recent 12

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PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

months' cash distributions from production), if repurchase is requested by investors, subject to our financial ability to do so. As of September 30, 2011, the maximum annual repurchase obligation, based upon the minimum price described above, was approximately $5.2 million. We believe we have adequate liquidity to meet this obligation. For the nine months ended 2011, amounts paid for the repurchase of partnership units pursuant to this provision were immaterial.

Employment Agreements with Executive Officers. We have employment agreements with our executive officers. The employment agreements provide for annual base salaries, eligibility for performance bonus compensation and other various benefits, including severance benefits.

If, within two years following a change of control of the Company ("change in control period"), either the Company terminates the executive officer without cause or the executive officer terminates employment for good reason, then the severance benefits owed equals three times the sum of the executive's highest annual base salary during the previous two years of employment immediately preceding the termination date and the executive's highest annual bonus paid or, in the case of one executive officer, paid or payable during the same two-year period. For one executive, in this calculation, the target bonus will be used as the minimum value for the first two years of employment. Where the Company terminates the executive officer without cause or the executive officer terminates employment for good reason outside of the change in control period, the severance benefits range from two times to three times, specific to the executive officer, the benefits noted above. For this purpose, a change of control and good reason correspond to the respective definitions of change of control and good reason under Internal Revenue Code ("IRC") Section 409A and the supporting Treasury regulations, with some differences. Under any of the above circumstances, the executive officer is also entitled under his employment agreement to (i) vesting of any unvested equity compensation (excluding all long-term incentive shares), (ii) reimbursement for any unpaid expenses, (iii) retirement benefits earned under the current and/or previous agreements, (iv) continued coverage under our medical plan at the Company's cost for the federal COBRA health continuation coverage period and (v) payment of any earned and unpaid bonus amounts. In addition, the executive officer is entitled to receive any benefits that he would have otherwise been entitled to receive under our qualified retirement plan, although those benefits are not increased or payment accelerated.

In the event that an executive officer is terminated for just cause, we are required to pay the executive officer his base salary through the termination date plus a partial year bonus, incentive, deferred, retirement or other compensation and to provide any other benefits, which have been earned or become payable as of the termination date.

In the event that an executive officer voluntarily terminates his employment for other than good reason, he is entitled to receive (i) his base salary and bonus, provided, however, that with respect to the bonus, for certain executive officers, there will be no proration of the bonus if such executive leaves prior to the last day of the year and, with respect to one executive officer, there will be no proration of the bonus in the event such executive officer leaves prior to March 31 in the year of his termination, (ii) any incentive, deferred or other compensation which has been earned or has become payable, but which has not yet been paid under the schedule originally contemplated in the agreement under which they were granted, (iii) any unpaid expense reimbursement and (iv) any other payments for benefits earned under the employment agreement or our plans.

In the event of death or disability, the executive is entitled to receive certain benefits. For this purpose, the definition of "disability" corresponds to the definition under IRC Section 409A and the supporting Treasury regulations. The benefits will (i) in the case of death be paid in a lump sum and be equal to the base salary that would otherwise have been paid for a six-month period following the termination date and (ii) in the case of disability be up to thirteen weeks of ongoing base salary plus a lump sum equal to six months of base salary.

See Note 13 for a discussion related to the separation agreement entered into with our former chief executive officer during the nine months ended 2011.

Partnership Casualty Losses. As managing general partner of numerous partnerships, we have a potential liability for casualty losses in excess of the partnership assets and insurance. We believe the casualty insurance coverage that we and our subcontractors carry is adequate to meet this potential liability.

NOTE 10 - COMMON STOCK

Stock-Based Compensation Plans

The following table provides a summary of the impact of our outstanding stock-based compensation plans on the results of operations for the periods presented.

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PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued



	Three Months Ended September 30,						Nine Months Ended September 30,
	2011			2010			2011 (1)			2010
	(in thousands)

Total stock-based compensation expense	$	1,693		$	1,624		$	7,242		$	3,845
Income tax benefit	(643		)	(617		)	(2,751		)	(1,461		)
Net income impact	$	1,050		$	1,007		$	4,491		$	2,384

__________


(1)	Includes a total of $2.5 million, pretax, related to a separation agreement with our former chief executive officer.

Stock Appreciation Rights ("SARs")

In March 2011, the Compensation Committee of our Board of Directors (the "Compensation Committee") awarded 31,552 SARs to our executive officers. The SARs will vest ratably over a three-year period and may be exercised at any point after vesting through March 2021. Pursuant to the terms of the awards, upon exercise, the executives will receive, in shares of common stock, the excess of the market price of the award on the date of exercise over the market price of the award on the date of issuance.

The fair value of each SAR award was estimated on the date of grant using a Black-Scholes pricing model using the assumptions presented in the table below. The expected life of the award was estimated using historical stock option exercise behavior data. The risk-free interest rate was based on the U.S. Treasury yields approximating the expected life of the award in effect at the time of grant. Expected volatilities were based on our historical volatility. We do not expect to pay dividends, nor do we expect to declare dividends in the foreseeable future.



	Nine Months Ended
	September 30, 2011

Expected term of the award	6 years
Risk-free interest rate	2.5		%
Volatility	60.2		%
Weighted average grant date fair value per share	$	25.22

The following table presents the changes in our SARs for the nine months ended 2011.



	Number of Shares Underlying SARs		Grant Date Market Price Per Share		Average Remaining Contractual Term (in years)	Aggregate Intrinsic Value (in thousands)

Outstanding at December 31, 2010	57,282		$	24.44	9.3	$	—
Awarded	31,552		43.95		9.7	—
Exercised	(2,814	)	24.44
Forfeited	(35,549	)	31.57
Outstanding at September 30, 2011	50,471		31.61		8.9	—
Vested and expected to vest at September 30, 2011	46,488		31.45		8.9	—
Exercisable at September 30, 2011	10,636		24.44		8.6	—

Pursuant to a separation agreement with our former chief executive officer and the original terms of the award, during the nine months ended 2011, 29,906 SARs were accelerated to vest, resulting in the acceleration of $0.6 million in stock-based compensation expense. The total compensation cost related to SARs granted and not yet recognized in our statement of operations as of September 30, 2011, was $0.5 million. The cost is expected to be recognized over a weighted average period of 1.5 years.

Restricted Stock Awards

Time-Based Awards. For the nine months ended 2011, the Compensation Committee awarded a total of 101,378 time-based restricted shares to our executive officers that primarily vest ratably over three years from date of grant and 23,360 time-based restricted shares to our non-employee directors also vesting ratably over three years from date of grant.

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PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

Pursuant to a separation agreement with our former chief executive officer and the original terms of the award, during the nine months ended 2011, the vesting of 64,442 time-based restricted shares was accelerated, resulting in the acceleration of $1.9 million in stock-based compensation expense. The total compensation cost related to non-vested time-based awards expected to vest and not yet recognized in our statements of operations as of September 30, 2011, was $11.6 million. This cost is expected to be recognized over a weighted average period of 2.5 years.

The following table presents the changes in non-vested time-based awards for the nine months ended 2011.



	Shares		Weighted Average Grant-Date Fair Value per Share

Non-vested at December 31, 2010	525,715		$	25.53
Granted	267,748		34.14
Vested	(235,495	)	27.02
Forfeited	(31,146	)	26.93
Non-vested at September 30, 2011	526,822		29.16



	As of / Nine Months Ended
	September 30, 2011
	(in thousands, except per share data)

Total intrinsic value of time-based awards vested	$	8,615
Total intrinsic value of time-based awards non-vested	10,215
Market price per common share	19.39

Market-Based Awards. The fair value of the market-based restricted shares is amortized ratably over the requisite service period, primarily three years. Generally, the market-based shares vest if the participant is continuously employed throughout the performance period and the market-based performance measure is achieved, with a maximum vesting period of five years. All compensation cost related to the market-based awards will be recognized if the requisite service period is fulfilled, even if the market condition is not achieved.

In March 2011, the Compensation Committee awarded a total of 13,531 market-based restricted shares to our executive officers. In addition to continuous employment, the vesting of these shares is contingent on the Company's total shareholder return ("TSR"), which is essentially the Company’s stock price change including any dividends, as compared to the TSR of a set group of 11 peer companies. The shares are measured over a three-year period ending on December 31, 2013, and can result in a payout between zero and 200% of the total shares awarded. The weighted average grant date fair value per market-based share for these awards granted was computed using the Monte Carlo pricing model using the weighted average assumptions presented in the table below.



	Nine Months Ended
	September 30, 2011

Expected term of award	3 years
Risk-free interest rate	1.1		%
Volatility	74.2		%
Weighted average grant date fair value per share	$	58.53

Expected volatility was based on a blend of our historical and implied volatility. The expected lives of the awards were based on the requisite service period. The risk-free interest rate was based on the U.S. Treasury yields in effect at the time of grant or modification and extrapolated to approximate the life of the award. We do not expect to pay dividends, nor do we expect to declare dividends in the foreseeable future.

The following table presents the change in non-vested market-based awards for the nine months ended 2011.

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PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued



	Shares		Weighted Average Grant-Date Fair Value per Share

Non-vested at December 31, 2010	79,550		$	32.52
Granted	13,531		58.53
Vested	(4,109	)	6.47
Forfeited	(21,927	)	34.32
Non-vested at September 30, 2011	67,045		38.78

Pursuant to a separation agreement with our former chief executive officer and the original terms of the award, during the nine months ended 2011, the vesting of 4,109 market-based restricted shares was accelerated and 21,927 market-based restricted shares were forfeited. The impact on stock-based compensation for the vesting and forfeiture of these market-based restricted shares was immaterial. The total compensation cost related to non-vested market-based awards expected to vest and not yet recognized in our statement of operations as of September 30, 2011, was $0.3 million. This cost is expected to be recognized over a weighted average period of 2.2 years.

Treasury Share Purchases

In accordance with our stock-based compensation plans, employees and directors may surrender shares of the Company's common stock to cover tax withholding obligations upon the vesting and exercise of share-based awards. The shares acquired may be retired or reissued to service awards under our 2010 Long-Term Equity Compensation Plan (the "2010 Plan"). For shares that are retired, we first charge any excess of cost over the par value to additional paid-in-capital ("APIC") to the extent we have amounts in APIC, with any remaining excess cost charged to retained earnings. For shares reissued to service awards under the 2010 Plan, shares are recorded at cost and upon reissuance, we reduce the carrying value of shares acquired and held pursuant to the 2010 Plan by the weighted average cost per share with an offsetting charge to APIC. During the nine months ended September 30, 2011, we acquired 81,051 shares pursuant to our stock-based compensation plans for payment of tax liabilities, of which 8,760 shares were reissued pursuant to our 2010 Plan and the remaining 67,558 shares retired.

NOTE 11 - EARNINGS PER SHARE

The following is a reconciliation of weighted average diluted shares outstanding.



	Three Months Ended September 30,		Nine Months Ended September 30,
	2011	2010	2011	2010
	(in thousands)

Weighted average common shares outstanding - basic	23,569	19,250	23,497	19,218
Dilutive effect of share-based compensation:
Restricted stock	162	109	167	80
SARs	49	39	45	13
Non employee director deferred compensation	3	8	3	8
Weighted average common and common share equivalents outstanding - diluted	23,783	19,406	23,712	19,319

The following table sets forth the weighted average common share equivalents excluded from the calculation of diluted earnings per share due to their anti-dilutive effect.



	Three Months Ended September 30,		Nine Months Ended September 30,
	2011	2010	2011	2010
	(in thousands)
Weighted average common share equivalents excluded from diluted earnings
per share due to their anti-dilutive effect:
Restricted stock	198	130	173	266
Stock options	9	10	10	10
SARs	29	—	23	—
Total anti-dilutive common share equivalents	236	140	206	276

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PETROLEUM DEVELOPMENT CORPORATION

(dba PDC Energy)

NOTES TO CONDENSED CONSOLIDATED FINANCIAL STATEMENTS - Continued

In November 2010, we issued 115,000 convertible senior notes, $1,000 principal amount, that give the holders the right to convert the principal amount into 2.7 million common shares at a conversion price of $42.40 per share. The convertible notes could have a dilutive impact on our earnings per share if the average market share price exceeds the conversion price. The table above does not include those shares issuable upon conversion as the average share price of our common stock did not exceed the conversion price during the three and nine months ended 2011.

NOTE 12 - DIVESTITURES AND DISCONTINUED OPERATIONS

North Dakota. During the fourth quarter of 2010, we developed a plan to divest our North Dakota assets. The plan included 100% of our North Dakota assets, consisting of producing wells, undeveloped leaseholds and related facilities primarily located in Burke County. The plan received approval from our Board of Directors (the "Board") and, in December 2010, we effected a letter of intent with an unrelated third party. Following the sale to the unrelated party, we do not have significant continuing involvement in the operations of or cash flows from these assets; accordingly, the North Dakota assets were reclassified as held for sale as of December 31, 2010, and the results of operations related to those assets have been separately reported as discontinued operations in the accompanying financial statements for all periods presented. In February 2011, we executed a purchase and sale agreement and subsequently closed with the same unrelated party. Proceeds from the sale were $9.5 million, net of non-affiliated investor partners' share of $3.8 million, resulting in a pretax gain on sale of $3.9 million.

Selected financial information related to divested and discontinued operations. The table below presents selected operational information related to discontinued operations. While the reclassification of revenues and expenses related to discontinued operations for prior period had no impact upon previously reported net earnings, the statement of operations table below presents the revenues and expenses that were reclassified from the specified statement of operations line items to discontinued operations. There was no activity recorded for discontinued operations for the three months ended 2011. The three and nine months ended 2010, in addition to the discontinued operations data of our North Dakota assets, includes operations data related to the July 2010 divestiture of our Michigan assets.



	Three Months Ended September 30,		Nine Months Ended September 30,
Statement of Operations - Discontinued Operations	2010		2011			2010
	(dollars in thousands)
Revenues
Natural gas, NGL and crude oil sales	$	1,183	$	447		$	5,719
Sales from natural gas marketing	568		—			3,328
Well operations, pipeline income and other	134		10			536
Total revenues	1,885		457			9,583

Costs, expenses and other
Production costs	409		132			1,988
Cost of natural gas marketing	537		—			3,265
Exploration expense	25		—			25
Impairment of natural gas and crude oil properties	160		—			4,666
Depreciation, depletion and amortization	195		—			1,659
Gain on sale of properties and equipment	—		(3,854		)