Quarterly report pursuant to Section 13 or 15(d)

Derivative Instruments

v3.22.2.2
Derivative Instruments
 9 Months Ended
Sep. 30, 2022
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Instruments DERIVATIVE INSTRUMENTS
We have entered into commodity derivatives consisting of natural gas supply contracts, including those under SPL’s IPM agreement, for the 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”).

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 or fair value hedging instruments, and changes in fair value are recorded within our Consolidated Statements of Operations to the extent not utilized for the commissioning process, in which case such changes are capitalized.

The following table shows the fair value of our derivative instruments that are required to be measured at fair value on a recurring basis (in millions):
Fair Value Measurements as of
September 30, 2022 December 31, 2021
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
Liquefaction Supply Derivatives asset (liability) $ (30) $ (24) $ (5,024) $ (5,078) $ 2  $ (13) $ 38  $ 27 
We value our Liquefaction Supply Derivatives using a market or option-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 observable and unobservable market commodity prices and, as applicable to our natural gas supply contracts, our assessment of the associated events deriving fair value including, but not limited to, evaluation of whether the respective market exists from the perspective of market participants as infrastructure is developed.

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 incorporate significant unobservable inputs. In instances where observable data is unavailable, consideration is given to the assumptions that market participants would use in valuing the asset or liability. This includes assumptions about market risks, such as future prices of energy units for unobservable periods, liquidity and volatility.

The Level 3 fair value measurements of natural gas positions within our Physical Liquefaction Supply Derivatives could be materially impacted by a significant change in certain natural gas and international LNG prices. The following table includes quantitative information for the unobservable inputs for our Level 3 Physical Liquefaction Supply Derivatives as of September 30, 2022:
Net Fair Value Liability
(in millions)		 Valuation Approach Significant Unobservable Input Range of Significant Unobservable Inputs / Weighted Average (1)
Physical Liquefaction Supply Derivatives $(5,024) Market approach incorporating present value techniques Henry Hub basis spread
$(2.495) - $0.677 / $(0.028)
Option pricing model International LNG pricing spread, relative to Henry Hub (2)
91% - 865% / 243%
(1)Unobservable inputs were weighted by the relative fair value of the instruments.
(2)Spread contemplates U.S. dollar-denominated pricing.

Increases or decreases in basis or pricing spreads, in isolation, would decrease or increase, respectively, the fair value of our Physical Liquefaction Supply Derivatives.

The following table shows the changes in the fair value of our Level 3 Physical Liquefaction Supply Derivatives (in millions):
Three Months Ended September 30, Nine Months Ended September 30,
2022 2021 2022 2021
Balance, beginning of period $ (3,456) $ 33  $ 38  $ (21)
Realized and mark-to-market gains (losses):
Included in cost of sales (1,545) 25  (155) 79 
Purchases and settlements:
Purchases (1) 3  4  (4,896) 6 
Settlements (24) (3) (11) (5)
Transfers out of Level 3, net (2) (2) —  —  — 
Balance, end of period $ (5,024) $ 59  $ (5,024) $ 59 
Change in unrealized gains (losses) relating to instruments still held at end of period $ (1,545) $ 25  $ (155) $ 79 
(1)Includes the assignment of an IPM agreement that occurred during the period, as discussed in Note 14—Supplemental Cash Flow Information.
(2)Transferred out of Level 3 as a result of unobservable market for the underlying natural gas purchase agreements.

All counterparty derivative contracts provide for the unconditional right of set-off in the event of default. We have elected to report derivative assets and liabilities arising from our derivative contracts with the same counterparty and the unconditional contractual right of set-off on a net basis. 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, counterparties are at risk that we will be unable to meet our commitments in instances where our derivative instruments are in a liability position. We incorporate both our own nonperformance risk and the respective
counterparty’s nonperformance risk in fair value measurements depending on the position of the derivative. In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of any applicable credit enhancements, such as collateral postings, set-off rights and guarantees.
Liquefaction Supply Derivatives

SPL holds Liquefaction Supply Derivatives which are primarily indexed to the natural gas market and international LNG indices. The remaining minimum terms of the Physical Liquefaction Supply Derivatives range up to 15 years, some of which commence upon the satisfaction of certain events or states of affairs. The terms of the Financial Liquefaction Supply Derivatives range up to approximately three years.

The forward notional amount for our Liquefaction Supply Derivatives was approximately 5,220 TBtu and 5,194 TBtu as of September 30, 2022 and December 31, 2021, respectively, excluding notional amounts associated with extension options that were uncertain to be taken as of September 30, 2022.

The following table shows the effect and location of our Liquefaction Supply Derivatives recorded on our Consolidated Statements of Operations (in millions):
Gain (Loss) Recognized in Consolidated Statements of Operations
 Consolidated Statements of Operations Location (1)
 Three Months Ended September 30, Nine Months Ended September 30,
2022 2021 2022 2021
LNG revenues $ (3) $ —  $ 1  $ — 
Cost of sales (1,625) 10  (2,448) 64 
(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.

Fair Value and Location of Derivative Assets and Liabilities on the Consolidated Balance Sheets

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 Sheets Location September 30, 2022 December 31, 2021
Current derivative assets $ 27  $ 21 
Derivative assets 33  33 
Total derivative assets 60  54 
Current derivative liabilities (1,157) (16)
Derivative liabilities (3,981) (11)
Total derivative liabilities (5,138) (27)
Derivative asset (liability), net $ (5,078) $ 27 
(1)Does not include collateral posted with counterparties by us of $59 million and $7 million, as of September 30, 2022 and December 31, 2021, respectively, which are included in other current assets in our Consolidated Balance Sheets.
Consolidated Balance Sheets Presentation

The following table shows the fair value of our derivatives outstanding on a gross and net basis (in millions) for our derivative instruments that are presented on a net basis on our Consolidated Balance Sheets:
Liquefaction Supply Derivatives
As of September 30, 2022
Gross assets $ 67 
Offsetting amounts (7)
Net assets $ 60 
Gross liabilities $ (5,158)
Offsetting amounts 20 
Net liabilities $ (5,138)
As of December 31, 2021
Gross assets $ 79 
Offsetting amounts (25)
Net assets $ 54 
Gross liabilities $ (33)
Offsetting amounts 6 
Net liabilities $ (27)