Quarterly report pursuant to Section 13 or 15(d)

Derivative Instruments

v3.7.0.1
Derivative Instruments
 3 Months Ended
Mar. 31, 2017
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”) and
•
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 (collectively, the “Liquefaction Supply 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.

The following table (in millions) shows the fair value of our derivative instruments that are required to be measured at fair value on a recurring basis as of March 31, 2017 and December 31, 2016, 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
 
March 31, 2017
 
December 31, 2016
 
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
$
—

 
$
—

 
$
—

 
$
—

 
$
—

 
$
(6
)
 
$
—

 
$
(6
)
CQP Interest Rate Derivatives asset
—

 
16

 
—

 
16

 
—

 
13

 
—

 
13

Liquefaction Supply Derivatives asset (liability)
(2
)
 
—

 
41

 
39

 
(4
)
 
(2
)
 
79

 
73



There have been no changes to our evaluation of and accounting for our derivative positions designated as Level 1 during the three months ended March 31, 2017. See Note 8—Derivative Instruments of our Notes to Consolidated Financial Statements in our annual report on Form 10-K for the year ended December 31, 2016 for additional information.

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 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.

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 March 31, 2017 and December 31, 2016, some of our Physical Liquefaction Supply Derivatives existed within markets for which the pipeline infrastructure is under development to accommodate marketable physical gas flow.

The following table includes quantitative information for the unobservable inputs for our Level 3 Physical Liquefaction Supply Derivatives as of March 31, 2017:
 
 
Net Fair Value Asset
(in millions)
 
Valuation Technique
 
Significant Unobservable Input
 
Significant Unobservable Inputs Range
Physical Liquefaction Supply Derivatives
 
$41
 
Income Approach
 
Basis Spread
 
$(0.345) - $0.081

The following table (in millions) shows the changes in the fair value of our Level 3 Physical Liquefaction Supply Derivatives during the three months ended March 31, 2017 and 2016:
 
 
Three Months Ended March 31,
 
 
2017
 
2016
Balance, beginning of period
 
$
79

 
$
32

Realized and mark-to-market losses:
 
 
 
 
Included in cost of sales (1)
 
(41
)
 
(2
)
Purchases and settlements:
 
 
 
 
Purchases
 
4

 
—

Settlements (1)
 
(1
)
 
—

Balance, end of period
 
$
41

 
$
30

Change in unrealized gains relating to instruments still held at end of period
 
$
(41
)
 
$
(2
)
 
    
(1)
Does not include the decrease in fair value of $1 million related to the realized gains capitalized during the three months ended March 31, 2016.
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.  Our derivative instruments are subject to contractual provisions which provide for the unconditional right of set-off for all derivative assets and liabilities with a given counterparty in the event of default.

Interest Rate Derivatives

SPL had 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”). In March 2017, SPL settled the SPL Interest Rate Derivatives and recognized a derivative loss of $7 million in conjunction with the termination of approximately $1.6 billion of commitments under the 2015 SPL Credit Facilities, as discussed in Note 10—Debt.

During the three months ended March 31, 2017 there were no changes to the terms of our interest rate swaps (“CQP Interest Rate Derivatives”) entered into to hedge a portion of the variable interest payments on the credit facilities we entered into in February 2016 (the “2016 CQP Credit Facilities”). See Note 8—Derivative Instruments of our Notes to Consolidated Financial Statements in our annual report on Form 10-K for the year ended December 31, 2016 for additional information.

As of March 31, 2017, 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
CQP Interest Rate Derivatives
 
$225 million
 
$1.3 billion
 
March 22, 2016
 
February 29, 2020
 
1.19%
 
One-month LIBOR


The following table (in millions) shows the fair value and location of our Interest Rate Derivatives on our Consolidated Balance Sheets:
 
 
March 31, 2017
 
December 31, 2016
 
 
SPL Interest Rate Derivatives
 
CQP Interest Rate Derivatives
 
Total
 
SPL Interest Rate Derivatives
 
CQP Interest Rate Derivatives
 
Total
Balance Sheet Location
 
 
 
 
 
 
 
 
 
 
 
 
Non-current derivative assets
 
$
—

 
$
16

 
$
16

 
$
—

 
$
16

 
$
16

 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative liabilities
 
—

 
—

 
—

 
(4
)
 
(3
)
 
(7
)
Non-current derivative liabilities
 
—

 
—

 
—

 
(2
)
 
—

 
(2
)
Total derivative liabilities
 
—

 
—

 
—

 
(6
)
 
(3
)
 
(9
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative asset (liability), net
 
$
—

 
$
16

 
$
16

 
$
(6
)
 
$
13

 
$
7



The following table (in millions) shows the changes in the fair value and settlements of our Interest Rate Derivatives recorded in derivative loss, net on our Consolidated Statements of Operations during the three months ended March 31, 2017 and 2016:
 
 
Three Months Ended March 31,
 
 
2017
 
2016
SPL Interest Rate Derivatives loss
 
$
(2
)
 
$
(11
)
CQP Interest Rate Derivatives gain (loss)
 
2

 
(10
)


Liquefaction Supply Derivatives

The following table (in millions) shows the fair value and location of our Liquefaction Supply Derivatives on our Consolidated Balance Sheets:
 
 
 
Fair Value Measurements as of (1)
 
Balance Sheet Location
 
March 31, 2017
 
December 31, 2016
Liquefaction Supply Derivatives
Other current assets
 
$
16

 
$
13

Liquefaction Supply Derivatives
Non-current derivative assets
 
28

 
67

Liquefaction Supply Derivatives
Derivative liabilities
 
(4
)
 
(7
)
Liquefaction Supply Derivatives
Non-current derivative liabilities
 
(1
)
 
—

 
(1)
Does not include collateral of $5 million and $6 million deposited for such contracts, which is included in other current assets in our Consolidated Balance Sheets as of March 31, 2017 and December 31, 2016, respectively.

SPL had secured up to approximately 2,051 million MMBtu and 1,994 million MMBtu of natural gas feedstock through natural gas supply contracts as of March 31, 2017 and December 31, 2016, respectively. The notional natural gas position of our Liquefaction Supply Derivatives was approximately 1,214 million MMBtu and 1,117 million MMBtu as of March 31, 2017 and December 31, 2016, respectively.

The following table (in millions) shows the changes in the fair value, settlements and location of our Liquefaction Supply Derivatives recorded on our Consolidated Statements of Operations during the three months ended March 31, 2017 and 2016:
 
 
 
Three Months Ended March 31,
 
Statement of Operations Location (1)
 
2017
 
2016
Liquefaction Supply Derivatives loss (2)
Cost of sales
 
$
39

 
$
4


 
(1)
Fair value fluctuations associated with commodity derivative activities are classified and presented consistently with the item economically hedged and the nature and intent of the derivative instrument.
(2)
Does not include the realized value associated with derivative instruments that settle through physical delivery.
Balance Sheet Presentation

Our derivative instruments are presented on a net basis on our Consolidated Balance Sheets as described above. The following table (in millions) 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 March 31, 2017
 
 
 
 
 
 
CQP Interest Rate Derivatives
 
$
17

 
$
(1
)
 
$
16

Liquefaction Supply Derivatives
 
48

 
(4
)
 
44

Liquefaction Supply Derivatives
 
2

 
(7
)
 
(5
)
As of December 31, 2016
 
 
 
 
 
 
SPL Interest Rate Derivatives
 
$
(6
)
 
$
—

 
$
(6
)
CQP Interest Rate Derivatives
 
16

 
—

 
16

CQP Interest Rate Derivatives
 
(3
)
 
—

 
(3
)
Liquefaction Supply Derivatives
 
82

 
(2
)
 
80

Liquefaction Supply Derivatives
 
(11
)
 
4

 
(7
)