Quarterly report pursuant to Section 13 or 15(d)

Derivative Instruments

v3.23.2
Derivative Instruments
 6 Months Ended
Jun. 30, 2023
Derivative Instruments and Hedging Activities Disclosure [Abstract]  
Derivative Instruments DERIVATIVE INSTRUMENTS
SPL has commodity derivatives consisting of natural gas supply contracts, including those under the IPM agreement, for the operation of the Liquefaction Project and associated economic hedges (collectively, “Liquefaction Supply Derivatives”).

We recognize SPL’s derivative instruments as either assets or liabilities and measure those instruments at fair value. None of SPL’s derivative instruments are designated as cash flow or fair value hedging instruments, and changes in fair value are recorded within our Consolidated Statements of Income to the extent not utilized for the commissioning process, in which case such changes are capitalized.

The following table shows the fair value of the derivative instruments that are required to be measured at fair value on a recurring basis (in millions):
Fair Value Measurements as of
June 30, 2023 December 31, 2022
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)
 $ 10  $ 4  $ (2,255) $ (2,241) $ (12) $ (10) $ (3,719) $ (3,741)

We value the 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 the 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 significant portion of the 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 the natural gas positions within the 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 the Level 3 Liquefaction Supply Derivatives as of June 30, 2023:
Net Fair Value Liability
(in millions)
 Valuation Approach Significant Unobservable Input Range of Significant Unobservable Inputs / Weighted Average (1)
Liquefaction Supply Derivatives $(2,255) Market approach incorporating present value techniques Henry Hub basis spread
$(1.733) - $0.585 / $(0.002)
Option pricing model International LNG pricing spread, relative to Henry Hub (2)
119% - 484% / 224%
(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 the Liquefaction Supply Derivatives.

The following table shows the changes in the fair value of the Level 3 Liquefaction Supply Derivatives (in millions):
Three Months Ended June 30, Six Months Ended June 30,
2023 2022 2023 2022
Balance, beginning of period $ (2,502) $ (3,162) $ (3,719) $ 38 
Realized and change in fair value gains (losses) included in net income (1):
Included in cost of sales, existing deals (2) 173  (309) 1,116  63 
Included in cost of sales, new deals (3) 3  —  5  — 
Purchases and settlements:
Purchases (4) —  8  —  (3,549)
Settlements (5) 71  7  340  (8)
Transfers in and/or out of level 3
Transfers out of level 3 (6) —  —  3  — 
Balance, end of period $ (2,255) $ (3,456) $ (2,255) $ (3,456)
Favorable (unfavorable) changes in fair value relating to instruments still held at the end of the period
 $ 176  $ (309) $ 1,121  $ 63 
(1)Does not include the realized value associated with derivative instruments that settle through physical delivery, as settlement is equal to contractually fixed price from trade date multiplied by contractual volume.  See settlements line item in this table.
(2)Impact to earnings on deals that existed at the beginning of the period and continue to exist at the end of the period.
(3)Impact to earnings on deals that were entered into during the reporting period and continue to exist at the end of the period.
(4)Includes any day one gain (loss) recognized during the reporting period on deals that were entered into during the reporting period which continue to exist at the end of the period, in addition to any derivative contracts acquired from
entities at a value other than zero on acquisition date, such as derivatives assigned or novated during the reporting period and continuing to exist at the end of the period.
(5)Roll-off in the current period of amounts recognized in our Consolidated Balance Sheets at the end of the previous period due to settlement of the underlying instruments in the current period.
(6)Transferred out of Level 3 as a result of observable 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 those derivative contracts with the same counterparty and the unconditional contractual right of set-off on a net basis. The use of derivative instruments exposes SPL to counterparty credit risk, or the risk that a counterparty will be unable to meet its commitments, in instances when the derivative instruments are in an asset position. Additionally, counterparties are at risk that SPL will be unable to meet its commitments in instances where the derivative instruments are in a liability position. We incorporate both SPL’s 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 the 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 terms of the Liquefaction Supply Derivatives range up to approximately 15 years, some of which commence upon the satisfaction of certain events or states of affairs.

The forward notional amount for the Liquefaction Supply Derivatives was approximately 5,831 TBtu and 5,972 TBtu as of June 30, 2023 and December 31, 2022, respectively, excluding notional amounts associated with extension options that were uncertain to be taken as of June 30, 2023.

The following table shows the effect and location of the Liquefaction Supply Derivatives recorded on our Consolidated Statements of Income (in millions):
Gain (Loss) Recognized in Consolidated Statements of Income
 Consolidated Statements of Income Location (1)
 Three Months Ended June 30, Six Months Ended June 30,
2023 2022 2023 2022
LNG revenues $ —  $ 4  $ —  $ 4 
Cost of sales 242  (298) 1,502  (823)
(1)Does not include the realized value associated with Liquefaction Supply Derivatives 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 the Liquefaction Supply Derivatives on our Consolidated Balance Sheets (in millions):
Fair Value Measurements as of (1)
Consolidated Balance Sheets Location June 30, 2023 December 31, 2022
Current derivative assets $ 32  $ 24 
Derivative assets 29  28 
Total derivative assets 61  52 
Current derivative liabilities (366) (769)
Derivative liabilities (1,936) (3,024)
Total derivative liabilities (2,302) (3,793)
Derivative liability, net $ (2,241) $ (3,741)
(1)Does not include collateral posted with counterparties by us of $3 million and $35 million as of June 30, 2023 and December 31, 2022, respectively, which are included in margin deposits on our Consolidated Balance Sheets.

Consolidated Balance Sheets Presentation

The following table shows the fair value of the derivatives outstanding on a gross and net basis (in millions) for the derivative instruments that are presented on a net basis on our Consolidated Balance Sheets:
Liquefaction Supply Derivatives
June 30, 2023 December 31, 2022
Gross assets $ 68  $ 57 
Offsetting amounts (7) (5)
Net assets $ 61  $ 52 
Gross liabilities $ (2,325) $ (3,814)
Offsetting amounts 23  21 
Net liabilities $ (2,302) $ (3,793)