Quarterly report pursuant to Section 13 or 15(d)

Derivative Instruments

v3.5.0.2
Derivative Instruments
 9 Months Ended
Sep. 30, 2016
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Instruments
DERIVATIVE INSTRUMENTS

We have entered into the following derivative instruments that are reported at fair value:
•
interest rate swaps to hedge the exposure to volatility in a portion of the floating-rate interest payments under certain of our credit facilities (“Interest Rate Derivatives”);
•
commodity derivatives consisting of natural gas supply contracts for the commissioning and operation of the Liquefaction Project (“Physical Liquefaction Supply Derivatives”) and associated economic hedges (“Financial Liquefaction Supply Derivatives”, and collectively with the Physical Liquefaction Supply Derivatives, the “Liquefaction Supply Derivatives”); and
•
commodity derivatives to hedge the exposure to price risk attributable to future: (1) sales of our LNG inventory and (2) purchases of natural gas to operate the Sabine Pass LNG terminal (“Natural Gas Derivatives”).
None of our derivative instruments are designated as cash flow hedging instruments, and changes in fair value are recorded within our Consolidated Statements of Operations.

SPLNG has elected to account for a portion of the Natural Gas Derivatives as normal purchase normal sale transactions, exempt from fair value accounting. Gains and losses for these physical hedges are not reflected on our Consolidated Statements of Operations until the period of delivery. SPLNG had not posted collateral for such forward contracts as of September 30, 2016 and December 31, 2015.

The following table (in thousands) shows the fair value of our derivative instruments that are required to be measured at fair value on a recurring basis as of September 30, 2016 and December 31, 2015, which are classified as other current assets, non-current derivative assets, derivative liabilities or non-current derivative liabilities in our Consolidated Balance Sheets.
 
Fair Value Measurements as of
 
September 30, 2016
 
December 31, 2015
 
Quoted Prices in Active Markets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Total
 
Quoted Prices in Active Markets
(Level 1)
 
Significant Other Observable Inputs
(Level 2)
 
Significant Unobservable Inputs
(Level 3)
 
Total
SPL Interest Rate Derivatives liability
$
—

 
$
(15,948
)
 
$
—

 
$
(15,948
)
 
$
—

 
$
(8,740
)
 
$
—

 
$
(8,740
)
CQP Interest Rate Derivatives liability
—

 
(12,166
)
 
—

 
(12,166
)
 
—

 
—

 
—

 
—

Liquefaction Supply Derivatives asset (liability)
(105
)
 
(275
)
 
12,480

 
12,100

 
—

 
(25
)
 
32,492

 
32,467

Natural Gas Derivatives asset
—

 
—

 
—

 
—

 
—

 
39

 
—

 
39



We value our Interest Rate Derivatives using valuations based on the initial trade prices. Using an income-based approach, subsequent valuations are based on observable inputs to the valuation model including interest rate curves, risk adjusted discount rates, credit spreads and other relevant data. The estimated fair values of our Natural Gas Derivatives are the amounts at which the instruments could be exchanged currently between willing parties. We value these derivatives using observable commodity price curves and other relevant data.

The fair value of substantially all of our Physical Liquefaction Supply Derivatives is developed through the use of internal models which are impacted by inputs that are unobservable in the marketplace. As a result, the fair value of our Physical Liquefaction Supply Derivatives is designated as Level 3 within the valuation hierarchy. The curves used to generate the fair value of our Physical Liquefaction Supply Derivatives are based on basis adjustments applied to forward curves for a liquid trading point. In addition, there may be observable liquid market basis information in the near term, but terms of a particular Physical Liquefaction Supply Derivatives contract may exceed the period for which such information is available, resulting in a Level 3 classification. In these instances, the fair value of the contract incorporates extrapolation assumptions made in the determination of the market basis price for future delivery periods in which applicable commodity basis prices were either not observable or lacked corroborative market data. Internal fair value models include conditions precedent to the respective long-term natural gas supply contracts. As of September 30, 2016 and December 31, 2015, some of our Physical Liquefaction Supply Derivatives existed within markets for which the pipeline infrastructure is under development to accommodate marketable physical gas flow. Accordingly, our internal fair value models are based on market prices that equate to our own contractual pricing due to: (1) the inactive and unobservable market and (2) conditions precedent and their impact on the uncertainty in the timing of our actual receipt of the physical volumes associated with each forward. The fair value of our Physical Liquefaction Supply Derivatives is predominantly driven by market commodity basis prices and our assessment of the associated conditions precedent, including evaluating whether the respective market is available as pipeline infrastructure is developed. Upon the completion and placement into service of relevant pipeline infrastructure to accommodate marketable physical gas flow, we recognize a gain or loss based on the fair value of the respective natural gas supply contracts as of the reporting date.

As all of our Physical Liquefaction Supply Derivatives are either purely index-priced or index-priced with a fixed basis, we do not believe that a significant change in market commodity prices would have a material impact on our Level 3 fair value measurements. The following table includes quantitative information for the unobservable inputs for our Level 3 Physical Liquefaction Supply Derivatives as of September 30, 2016:
 
 
Net Fair Value Asset
(in thousands)
 
Valuation Technique
 
Significant Unobservable Input
 
Significant Unobservable Inputs Range
Physical Liquefaction Supply Derivatives
 
$12,480
 
Income Approach
 
Basis Spread
 
$(0.35) - $(0.03)

The following table (in thousands) shows the changes in the fair value of our Level 3 Physical Liquefaction Supply Derivatives during the three and nine months ended September 30, 2016 and 2015:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
Balance, beginning of period
 
$
22,434

 
$
440

 
$
32,492

 
$
342

Realized and mark-to-market losses:
 
 
 
 
 
 
 
 
Included in cost of sales (1)
 
(10,567
)
 
32,177

 
(20,482
)
 
32,204

Purchases and settlements:
 
 
 
 
 
 
 
 
Purchases
 
968

 
—

 
968

 
—

Settlements (1)
 
(308
)
 
(71
)
 
(741
)
 
—

Transfers out of Level 3 (2)
 
(47
)
 
—

 
243

 
—

Balance, end of period
 
$
12,480

 
$
32,546

 
$
12,480

 
$
32,546

Change in unrealized gains relating to instruments still held at end of period
 
$
(10,567
)
 
$
—

 
$
(19,763
)
 
$
—

 
    
(1)
Does not include the decrease in fair value of $0.7 million related to the realized gains capitalized during the nine months ended September 30, 2016.
(2)
Transferred to Level 2 as a result of observable market for the underlying natural gas supply contracts.
Derivative assets and liabilities arising from our derivative contracts with the same counterparty are reported on a net basis, as all counterparty derivative contracts provide for net settlement. The use of derivative instruments exposes us to counterparty credit risk, or the risk that a counterparty will be unable to meet its commitments in instances when our derivative instruments are in an asset position.  

Interest Rate Derivatives

SPL Interest Rate Derivatives

SPL has entered into interest rate swaps (“SPL Interest Rate Derivatives”) to protect against volatility of future cash flows and hedge a portion of the variable interest payments on the credit facilities it entered into in June 2015 (the “2015 SPL Credit Facilities”). The SPL Interest Rate Derivatives hedge a portion of the expected outstanding borrowings over the term of the 2015 SPL Credit Facilities.

In March 2015, SPL settled a portion of the SPL Interest Rate Derivatives and recognized a derivative loss of $34.7 million within our Consolidated Statements of Operations in conjunction with the termination of approximately $1.8 billion of commitments under the previous credit facilities.

CQP Interest Rate Derivatives

In March 2016, we entered into interest rate swaps (“CQP Interest Rate Derivatives”) to protect against volatility of future cash flows and hedge a portion of the variable interest payments on the 2016 CQP Credit Facilities. The CQP Interest Rate Derivatives hedge a portion of the expected outstanding borrowings over the term of the 2016 CQP Credit Facilities.

As of September 30, 2016, we had the following Interest Rate Derivatives outstanding:
 
 
Initial Notional Amount
 
Maximum Notional Amount
 
Effective Date
 
Maturity Date
 
Weighted Average Fixed Interest Rate Paid
 
Variable Interest Rate Received
SPL Interest Rate Derivatives
 
$20.0 million
 
$628.8 million
 
August 14, 2012
 
July 31, 2019
 
1.98%
 
One-month LIBOR
CQP Interest Rate Derivatives
 
$225.0 million
 
$1.3 billion
 
March 22, 2016
 
February 29, 2020
 
1.19%
 
One-month LIBOR


The following table (in thousands) shows the fair value and location of our Interest Rate Derivatives on our Consolidated Balance Sheets:
 
 
September 30, 2016
 
December 31, 2015
 
 
SPL Interest Rate Derivatives
 
CQP Interest Rate Derivatives
 
Total
 
SPL Interest Rate Derivatives
 
CQP Interest Rate Derivatives
 
Total
Balance Sheet Location
 
 
 
 
 
 
 
 
 
 
 
 
Derivative liabilities
 
$
(6,376
)
 
$
(5,248
)
 
$
(11,624
)
 
$
(5,940
)
 
$
—

 
$
(5,940
)
Non-current derivative liabilities
 
(9,572
)
 
(6,918
)
 
(16,490
)
 
(2,800
)
 
—

 
(2,800
)
Total derivative liabilities
 
$
(15,948
)
 
$
(12,166
)
 
$
(28,114
)
 
$
(8,740
)
 
$
—

 
$
(8,740
)


The following table (in thousands) shows the changes in the fair value and settlements of our Interest Rate Derivatives recorded in derivative gain (loss), net on our Consolidated Statements of Operations during the three and nine months ended September 30, 2016 and 2015:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2016
 
2015
 
2016
 
2015
SPL Interest Rate Derivatives gain (loss)
 
$
2,557

 
$
(10,872
)
 
$
(13,473
)
 
$
(46,541
)
CQP Interest Rate Derivatives gain (loss)
 
6,626

 
—

 
(12,944
)
 
—



Commodity Derivatives

Liquefaction Supply Derivatives

SPL has entered into index-based physical natural gas supply contracts and associated economic hedges to purchase natural gas for the commissioning and operation of the Liquefaction Project. The terms of the physical natural gas supply contracts primarily range from approximately one to seven years and commence upon the satisfaction of certain conditions precedent, including but not limited to the date of first commercial operation of specified Trains of the Liquefaction Project. We recognize our Physical Liquefaction Supply Derivatives as either assets or liabilities and measure those instruments at fair value. Changes in the fair value of our Physical Liquefaction Supply Derivatives are reported in earnings. As of September 30, 2016, SPL has secured up to approximately 1,982.0 million MMBtu of natural gas feedstock through natural gas supply contracts. The notional natural gas position of our Physical Liquefaction Supply Derivatives was approximately 1,069.0 million MMBtu as of September 30, 2016.

Our Financial Liquefaction Supply Derivatives are executed through over-the-counter contracts which are subject to nominal credit risk as these transactions are settled on a daily margin basis with investment grade financial institutions. We are required by these financial institutions to use margin deposits as credit support for our Financial Liquefaction Supply Derivatives activities.

 Natural Gas Derivatives

Our Natural Gas Derivatives were executed through over-the-counter contracts which were subject to nominal credit risk as these transactions settled on a daily margin basis with investment grade financial institutions. We were required by these financial institutions to use margin deposits as credit support for our Natural Gas Derivatives activities. As of September 30, 2016, we did not have any open Natural Gas Derivatives positions or margin deposits at financial institutions.

We recognize all commodity derivative instruments that qualify for derivative accounting treatment, including our Liquefaction Supply Derivatives and our Natural Gas Derivatives (collectively, “Commodity Derivatives”), as either assets or liabilities and measure those instruments at fair value. Changes in the fair value of our Commodity Derivatives are reported in earnings.

The following table (in thousands) shows the fair value and location of our Commodity Derivatives on our Consolidated Balance Sheets:
 
September 30, 2016
 
December 31, 2015
 
Liquefaction Supply Derivatives (1)
 
Natural Gas Derivatives
 
Total
 
Liquefaction Supply Derivatives
 
Natural Gas Derivatives (2)
 
Total
Balance Sheet Location
 
 
 
 
 
 
 
 
 
 
 
Other current assets
$
1,947

 
$
—

 
$
1,947

 
$
2,737

 
$
39

 
$
2,776

Non-current derivative assets
11,247

 
—

 
11,247

 
30,304

 
—

 
30,304

Total derivative assets
13,194

 
—

 
13,194

 
33,041

 
39

 
33,080

 
 
 
 
 
 
 
 
 
 
 
 
Derivative liabilities
(1,083
)
 
—

 
(1,083
)
 
(490
)
 
—

 
(490
)
Non-current derivative liabilities
(11
)
 
—

 
(11
)
 
(84
)
 
—

 
(84
)
Total derivative liabilities
(1,094
)
 
—

 
(1,094
)
 
(574
)
 
—

 
(574
)
 
 
 
 
 
 
 
 
 
 
 
 
Derivative asset, net
$
12,100


$
—

 
$
12,100

 
$
32,467

 
$
39

 
$
32,506

 
(1)
Does not include collateral of $1.5 million deposited for such contracts, which is included in other current assets in our Consolidated Balance Sheet as of September 30, 2016.
(2)
Does not include collateral of $0.4 million deposited for such contracts, which is included in other current assets in our Consolidated Balance Sheet as of December 31, 2015.

The following table (in thousands) shows the changes in the fair value, settlements and location of our Commodity Derivatives recorded on our Consolidated Statements of Operations during the three and nine months ended September 30, 2016 and 2015:
 
 
 
Three Months Ended
 
Nine Months Ended
 
 
 
September 30,
 
September 30,
 
Statement of Operations Location
 
2016
 
2015
 
2016
 
2015
Liquefaction Supply Derivatives gain
LNG revenues
 
$
374

 
$
—

 
$
368

 
$
—

Liquefaction Supply Derivatives gain (loss) (1)
Cost (cost recovery) of sales
 
(10,416
)
 
32,103

 
(22,680
)
 
32,184

Natural Gas Derivatives gain
Operating and maintenance expense
 
—

 
857

 
174

 
1,317


 
(1)
Does not include the realized value associated with derivative instruments that settle through physical delivery.

The use of Commodity Derivatives exposes us to counterparty credit risk, or the risk that a counterparty will be unable to meet its commitments in instances when our Commodity Derivatives are in an asset position.

Balance Sheet Presentation

Our derivative instruments are presented on a net basis on our Consolidated Balance Sheets as described above. The following table (in thousands) shows the fair value of our derivatives outstanding on a gross and net basis:
 
 
Gross Amounts Recognized
 
Gross Amounts Offset in the Consolidated Balance Sheets
 
Net Amounts Presented in the Consolidated Balance Sheets
Offsetting Derivative Assets (Liabilities)
 
 
 
As of September 30, 2016
 
 
 
 
 
 
SPL Interest Rate Derivatives
 
$
(15,948
)
 
$
—

 
$
(15,948
)
CQP Interest Rate Derivatives
 
(12,166
)
 
—

 
(12,166
)
Liquefaction Supply Derivatives
 
13,740

 
(546
)
 
13,194

Liquefaction Supply Derivatives
 
(2,803
)
 
1,709

 
(1,094
)
As of December 31, 2015
 
 
 
 
 
 
SPL Interest Rate Derivatives
 
$
(8,740
)
 
$
—

 
$
(8,740
)
Liquefaction Supply Derivatives
 
33,636

 
(595
)
 
33,041

Liquefaction Supply Derivatives
 
(574
)
 
—

 
(574
)
Natural Gas Derivatives
 
188

 
(149
)
 
39