Quarterly report pursuant to Section 13 or 15(d)

Derivative Instruments

v3.10.0.1
Derivative Instruments
 9 Months Ended
Sep. 30, 2018
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 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”).
We recognize our derivative instruments as either assets or liabilities and measure those instruments at fair value. None of our derivative instruments are designated as cash flow hedging instruments, and changes in fair value are recorded within our Consolidated Statements of Income to the extent not utilized for the commissioning process.

The following table 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, 2018 and December 31, 2017, which are classified as other current assets, non-current derivative assets, derivative liabilities or non-current derivative liabilities in our Consolidated Balance Sheets (in millions).
 
Fair Value Measurements as of
 
September 30, 2018
 
December 31, 2017
 
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
CQP Interest Rate Derivatives asset
$
—

 
$
28

 
$
—

 
$
28

 
$
—

 
$
21

 
$
—

 
$
21

Liquefaction Supply Derivatives asset (liability)
(1
)
 
1

 
19

 
19

 
2

 
10

 
43

 
55



There have been no changes to our evaluation of and accounting for our derivative positions during the nine months ended September 30, 2018. 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, 2017 for additional information.

We value our Interest Rate Derivatives using an income-based approach, utilizing observable inputs to the valuation model including interest rate curves, risk adjusted discount rates, credit spreads and other relevant data. We value our Liquefaction Supply Derivatives using a market based approach incorporating present value techniques, as needed, using observable commodity price curves, when available, 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 satisfaction of conditions precedent, including 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.

We include a portion of our Physical Liquefaction Supply Derivatives as Level 3 within the valuation hierarchy as the fair value is developed through the use of internal models which may be impacted by inputs that are unobservable in the marketplace. 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 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.

The Level 3 fair value measurements of our Physical Liquefaction Supply Derivatives could be materially impacted by a significant change in certain natural gas market basis spreads due to the contractual notional amount represented by our Level 3 positions, which is a substantial portion of our overall Physical Liquefaction Supply Derivatives portfolio. The following table includes quantitative information for the unobservable inputs for our Level 3 Physical Liquefaction Supply Derivatives as of September 30, 2018:
 
 
Net Fair Value Asset
(in millions)
 
Valuation Approach
 
Significant Unobservable Input
 
Significant Unobservable Inputs Range
Physical Liquefaction Supply Derivatives
 
$19
 
Market approach incorporating present value techniques
 
Basis Spread
 
$(0.448) - $0.079

The following table shows the changes in the fair value of our Level 3 Physical Liquefaction Supply Derivatives during the three and nine months ended September 30, 2018 and 2017 (in millions):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
Balance, beginning of period
 
$
11

 
$
40

 
$
43

 
$
79

Realized and mark-to-market gains (losses):
 
 
 
 
 
 
 
 
Included in cost of sales
 
4

 
(8
)
 
(5
)
 
(43
)
Purchases and settlements:
 
 
 
 
 
 
 
 
Purchases
 
4

 
(1
)
 
8

 
1

Settlements
 
1

 
(2
)
 
(27
)
 
(8
)
Transfers out of Level 3 (1)
 
(1
)
 
—

 
—

 
—

Balance, end of period
 
$
19

 
$
29

 
$
19

 
$
29

Change in unrealized gains relating to instruments still held at end of period
 
$
4

 
$
(8
)
 
$
(5
)
 
$
(43
)

 
    
(1)    Transferred to Level 2 as a result of observable market for the underlying natural gas purchase agreements.

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.  Additionally, we evaluate our own ability to meet our commitments in instances where our derivative instruments are in a liability 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

We had entered into interest rate swaps (“CQP Interest Rate Derivatives”) to hedge a portion of the variable interest payments on the CQP Credit Facilities, based on a portion of the expected outstanding borrowings over the term of the CQP Credit Facilities. In September 2018, we terminated approximately $1.2 billion of commitments under the CQP Credit Facilities, as discussed in Note 10—Debt. In October 2018, we terminated the CQP Interest Rate Derivatives related to the CQP Credit Facilities, which resulted in a derivative gain of $28 million.

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 “SPL Credit Facilities”), based on a portion of the expected outstanding borrowings over the term of the 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 SPL Credit Facilities.

As of September 30, 2018, 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 shows the fair value and location of the CQP Interest Rate Derivatives on our Consolidated Balance Sheets (in millions):
 
 
September 30,
 
December 31,
Consolidated Balance Sheet Location
 
2018
 
2017
Other current assets
 
$
19

 
$
7

Non-current derivative assets
 
9

 
14

Total derivative assets
 
$
28

 
$
21


The following table 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 Income during the three and nine months ended September 30, 2018 and 2017 (in millions):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2018
 
2017
 
2018
 
2017
CQP Interest Rate Derivatives gain
 
$
2

 
$
1

 
$
13

 
$
—

SPL Interest Rate Derivatives loss
 
—

 
—

 
—

 
(2
)


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 range up to six years, some of which commence upon the satisfaction of certain conditions precedent.

SPL had secured up to approximately 2,755 TBtu and 2,214 TBtu of natural gas feedstock through natural gas supply contracts as of September 30, 2018 and December 31, 2017, respectively. The notional natural gas position of our Liquefaction Supply Derivatives was approximately 2,206 TBtu and 1,520 TBtu as of September 30, 2018 and December 31, 2017, respectively.

The following table shows the fair value and location of our Liquefaction Supply Derivatives on our Consolidated Balance Sheets (in millions):
 
 
Fair Value Measurements as of (1)
Consolidated Balance Sheet Location
 
September 30, 2018
 
December 31, 2017
Other current assets
 
$
11

 
$
41

Non-current derivative assets
 
16

 
17

Total derivative assets
 
27

 
58

 
 
 
 
 
Derivative liabilities
 
(6
)
 
—

Non-current derivative liabilities
 
(2
)
 
(3
)
Total derivative liabilities
 
(8
)
 
(3
)
 
 
 
 
 
Derivative asset, net
 
$
19

 
$
55

 
(1)
Does not include collateral calls of $2 million and $1 million as of September 30, 2018 and December 31, 2017, respectively, for such contracts, which are included in other current assets in our Consolidated Balance Sheets.

The following table shows the changes in the fair value and settlements of our Liquefaction Supply Derivatives recorded in cost of sales on our Consolidated Statements of Income during the three and nine months ended September 30, 2018 and 2017 (in millions):
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
2018
 
2017
 
2018
 
2017
Liquefaction Supply Derivatives gain (loss) (1)
$
10

 
$
(11
)
 
$
(42
)
 
$
(51
)

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

Consolidated Balance Sheet Presentation

Our derivative instruments are presented on a net basis on our Consolidated Balance Sheets as described above. The following table shows the fair value of our derivatives outstanding on a gross and net basis (in millions):
 
 
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, 2018
 
 
 
 
 
 
CQP Interest Rate Derivatives
 
$
28

 
$
—

 
$
28

Liquefaction Supply Derivatives
 
31

 
(4
)
 
27

Liquefaction Supply Derivatives
 
(13
)
 
5

 
(8
)
As of December 31, 2017
 
 
 
 
 
 
CQP Interest Rate Derivatives
 
$
21

 
$
—

 
$
21

Liquefaction Supply Derivatives
 
64

 
(6
)
 
58

Liquefaction Supply Derivatives
 
(3
)
 
—

 
(3
)