Quarterly report pursuant to Section 13 or 15(d)

Derivative Instruments

v3.3.0.814
Derivative Instruments
 9 Months Ended
Sep. 30, 2015
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:
•
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”);
•
commodity derivatives consisting of natural gas purchase agreements and associated economic hedges to secure natural gas feedstock for the Liquefaction Project (“Liquefaction Supply Derivatives”); and
•
interest rate swaps to hedge the exposure to volatility in a portion of the floating-rate interest payments under the 2015 SPL Credit Facilities (and previously the 2013 SPL Credit Facilities) (“Interest Rate 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, 2015 and December 31, 2014.

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, 2015 and December 31, 2014, 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, 2015
 
December 31, 2014
 
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
Natural Gas Derivatives asset
$
—

 
$
470

 
$
—

 
$
470

 
$
—

 
$
1,216

 
$
—

 
$
1,216

Liquefaction Supply Derivatives asset
—

 
—

 
32,546

 
32,546

 
—

 
—

 
342

 
342

Interest Rate Derivatives liability
—

 
(15,738
)
 
—

 
(15,738
)
 
—

 
(12,036
)
 
—

 
(12,036
)


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. We value the 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 substantially all of the 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 the Liquefaction Supply Derivatives is designated as Level 3 within the valuation hierarchy. The curves used to generate the fair value of the 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 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 that include contractual pricing with a fixed basis include fixed basis amounts for delivery at locations for which no market currently exists. Internal fair value models also include conditions precedent to the respective long-term natural gas purchase agreements. As of September 30, 2015 and December 31, 2014, some of the Liquefaction Supply Derivatives existed within markets for which the pipeline infrastructure has not been developed to accommodate marketable physical gas flow. In the absence of infrastructure to accommodate marketable physical gas flow, our internal fair value models are based on a market price that equates 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 the 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 purchase agreements as of the reporting date.

There were no transfers into or out of Level 3 Liquefaction Supply Derivatives for the three and nine months ended September 30, 2015 and 2014. As all of the 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 the Level 3 Liquefaction Supply Derivatives as of September 30, 2015:
 
 
Net Fair Value Asset (in thousands)
 
Valuation Technique
 
Significant Unobservable Input
 
Significant Unobservable Inputs Range
Liquefaction Supply Derivatives
 
$32,546
 
Income Approach
 
Basis Spread
 
$ (0.350) - $0.050

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.  

Commodity Derivatives

We recognize all commodity derivative instruments that qualify for derivative accounting treatment, including our Natural Gas Derivatives and the Liquefaction Supply 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, 2015
 
December 31, 2014
 
 
Natural Gas Derivatives (1)
 
Liquefaction Supply Derivatives
 
Total
 
Natural Gas Derivatives (1)
 
Liquefaction Supply Derivatives
 
Total
Balance Sheet Location
 
 
 
 
 
 
 
 
 
 
 
 
Other current assets
 
$
470

 
$
2,371

 
$
2,841

 
$
1,216

 
$
76

 
$
1,292

Non-current derivative assets
 
—

 
30,657

 
30,657

 
—

 
586

 
586

Total derivative assets
 
470


33,028

 
33,498

 
1,216

 
662

 
1,878

 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative liabilities
 
—

 
(349
)
 
(349
)
 
—

 
(53
)
 
(53
)
Non-current derivative liabilities
 
—

 
(133
)
 
(133
)
 
—

 
(267
)
 
(267
)
Total derivative liabilities
 
—


(482
)
 
(482
)
 
—

 
(320
)
 
(320
)
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative asset, net
 
$
470


$
32,546


$
33,016

 
$
1,216

 
$
342

 
$
1,558

 
(1)
Does not include collateral calls of $0.3 million and $1.1 million for such contracts, which are included in other current assets in our Consolidated Balance Sheets as of September 30, 2015 and December 31, 2014, respectively.

The following table (in thousands) shows the changes in the fair value and settlements and location of our Commodity Derivatives recorded on our Consolidated Statements of Operations during the three and nine months ended September 30, 2015 and 2014:
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
Statement of Operations Location
 
2015
 
2014
 
2015
 
2014
Natural Gas Derivatives loss
Revenues
 
$
—

 
$
—

 
$
—

 
$
(31
)
Natural Gas Derivatives gain (loss)
Operating and maintenance expense (income)
 
857

 
194

 
1,317

 
(64
)
Liquefaction Supply Derivatives gain (1)
Operating and maintenance expense (income)
 
32,103

 
—

 
32,184

 
—


 
 
 
 
 

(1)
There were no physical settlements during the reporting period.

 Natural Gas Derivatives

Our Natural Gas 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 Natural Gas Derivatives activities.

Liquefaction Supply Derivatives

SPL has entered into index-based physical natural gas supply contracts and associated economic hedges to secure natural gas feedstock for the Liquefaction Project. The terms of the physical contracts range from approximately one to seven years and commence upon the occurrence of conditions precedent, including the date of first commercial operation of specified Trains of the Liquefaction Project. We recognize the Liquefaction Supply Derivatives as either assets or liabilities and measure those instruments at fair value. Changes in the fair value of the Liquefaction Supply Derivatives are reported in earnings. As of September 30, 2015, SPL has secured up to approximately 2,156.6 million MMBtu of natural gas feedstock through long-term natural gas purchase agreements, of which the forward notional natural gas buy position of the Liquefaction Supply Derivatives was approximately 1,244.1 million MMBtu, which were recorded as derivatives due to minimum purchase requirements.

Interest Rate Derivatives

SPL has entered into Interest Rate Derivatives to protect against volatility of future cash flows and hedge a portion of the variable interest payments on the 2015 SPL Credit Facilities. The 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 its Interest Rate Derivatives, and we 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 2013 SPL Credit Facilities as discussed in Note 7—Long-Term Debt. In May 2014, SPL settled a portion of its Interest Rate Derivatives and recognized a derivative loss of $9.3 million within our Consolidated Statements of Operations in conjunction with the early termination of approximately $2.1 billion of commitments under the 2013 SPL Credit Facilities.

At September 30, 2015, SPL 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
Interest Rate Derivatives
 
$20.0 million
 
$628.8 million
 
August 14, 2012
 
July 31, 2019
 
1.98%
 
One-month LIBOR


The following table (in thousands) shows the fair value and location of the Interest Rate Derivatives on our Consolidated Balance Sheets:
 
 
 
 
Fair Value Measurements as of
 
 
Balance Sheet Location
 
September 30, 2015
 
December 31, 2014
Interest Rate Derivatives
 
Derivative liabilities
 
$
(7,039
)
 
$
(23,194
)
Interest Rate Derivatives
 
Non-current derivative assets (Non-current derivative liabilities)
 
(8,699
)
 
11,158



The following table (in thousands) shows the changes in the fair value and settlements of the Interest Rate Derivatives recorded in derivative gain (loss), net on our Consolidated Statements of Operations during the three and nine months ended September 30, 2015 and 2014:
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2015
 
2014
 
2015
 
2014
Interest Rate Derivatives gain (loss)
 
$
(10,872
)
 
$
5,379

 
$
(46,541
)
 
$
(89,222
)


Balance Sheet Presentation

Our Commodity Derivatives and Interest Rate Derivatives 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, 2015
 
 
 
 
 
 
Natural Gas Derivatives
 
$
513

 
$
(43
)
 
$
470

Liquefaction Supply Derivatives
 
33,028

 
—

 
33,028

Liquefaction Supply Derivatives
 
(482
)
 
—

 
(482
)
Interest Rate Derivatives
 
(15,738
)
 
—

 
(15,738
)
As of December 31, 2014
 
 
 
 
 
 
Natural Gas Derivatives
 
1,226

 
(10
)
 
1,216

Liquefaction Supply Derivatives
 
662

 
—

 
662

Liquefaction Supply Derivatives
 
(320
)
 
—

 
(320
)
Interest Rate Derivatives
 
11,158

 
—

 
11,158

Interest Rate Derivatives
 
(23,194
)
 
—

 
(23,194
)