Quarterly report pursuant to Section 13 or 15(d)

Derivative Instruments

v3.19.3
Derivative Instruments
 9 Months Ended
Sep. 30, 2019
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 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.

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, 2019 and December 31, 2018, which are classified as derivative 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, 2019
 
December 31, 2018
 
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)
$
(6
)
 
$
(10
)
 
$
(8
)
 
$
(24
)
 
$
5

 
$
(23
)
 
$
(25
)
 
$
(43
)


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 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 evaluating whether the respective market is available as pipeline infrastructure is developed. The fair value of our Physical Liquefaction Supply Derivatives incorporates risk premiums related to the satisfaction of conditions precedent, such as completion and placement into service of relevant pipeline infrastructure to accommodate marketable physical gas flow. As of September 30, 2019 and December 31, 2018, some of our Physical Liquefaction Supply Derivatives existed within markets for which the pipeline infrastructure was under development to accommodate marketable physical gas flow.

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 natural gas positions within 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, 2019:
 
 
Net Fair Value Liability
(in millions)
 
Valuation Approach
 
Significant Unobservable Input
 
Significant Unobservable Inputs Range
Physical Liquefaction Supply Derivatives
 
$(8)
 
Market approach incorporating present value techniques
 
Henry Hub basis spread
 
$(0.618) - $0.056

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, 2019 and 2018 (in millions):
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 
2019
 
2018
 
2019
 
2018
Balance, beginning of period
 
$
34

 
$
11

 
$
(25
)
 
$
43

Realized and mark-to-market gains (losses):
 
 
 
 
 
 
 
 
Included in cost of sales
 
(42
)
 
4

 
(22
)
 
(5
)
Purchases and settlements:
 
 
 
 
 
 
 
 
Purchases
 
(1
)
 
4

 
(4
)
 
8

Settlements
 
1

 
1

 
43

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

 
(1
)
 
—

 
—

Balance, end of period
 
$
(8
)
 
$
19

 
$
(8
)
 
$
19

Change in unrealized gains (losses) relating to instruments still held at end of period
 
$
(42
)
 
$
4

 
$
(22
)
 
$
(5
)

 
(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 the unconditional right of set-off in the event of default. 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. In adjusting the fair value of our derivative contracts for the effect of nonperformance risk, we have considered the impact of netting and any applicable credit enhancements, such as collateral postings, set-off rights and guarantees.

Interest Rate Derivatives

We previously had interest rate swaps (“CQP Interest Rate Derivatives” and, collectively with the CCH Interest Rate Derivatives and the CCH Interest Rate Forward Start Derivatives, the “Interest Rate Derivatives”) to hedge a portion of the variable interest payments on our credit facilities. In October 2018, we terminated the CQP Interest Rate Derivatives related to the 2016 CQP Credit Facilities and realized a derivative gain of $28 million.

Liquefaction Supply Derivatives

SPL has entered into primarily 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 ten years, some of which commence upon the satisfaction of certain events or states of affairs.

SPL had secured up to approximately 4,108 TBtu and 3,464 TBtu of natural gas feedstock through natural gas supply contracts as of September 30, 2019 and December 31, 2018, respectively. The notional natural gas position of our Liquefaction Supply Derivatives was approximately 3,880 TBtu and 2,978 TBtu as of September 30, 2019 and December 31, 2018, 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, 2019
 
December 31, 2018
Derivative assets
 
$
8

 
$
6

Non-current derivative assets
 
29

 
31

Total derivative assets
 
37

 
37

 
 
 
 
 
Derivative liabilities
 
(29
)
 
(66
)
Non-current derivative liabilities
 
(32
)
 
(14
)
Total derivative liabilities
 
(61
)
 
(80
)
 
 
 
 
 
Derivative liability, net
 
$
(24
)
 
$
(43
)
 
(1)
Does not include collateral calls of $10 million and $1 million for such contracts, which are included in other current assets in our Consolidated Balance Sheets as of September 30, 2019 and December 31, 2018, respectively.

The following table shows the changes in the fair value, settlements and location of our Liquefaction Supply Derivatives recorded on our Consolidated Statements of Income during the three and nine months ended September 30, 2019 and 2018 (in millions):
 
 
 
Three Months Ended September 30,
 
Nine Months Ended September 30,
 
 Consolidated Statement of Income Location (1)
 
2019
 
2018
 
2019
 
2018
Liquefaction Supply Derivatives gain
LNG revenues
 
$
1

 
$
—

 
$
2

 
$
—

Liquefaction Supply Derivatives gain (loss)
Cost of sales
 
(55
)
 
10

 
28

 
(42
)

 
(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, 2019
 
 
 
 
 
 
Liquefaction Supply Derivatives
 
$
40

 
$
(3
)
 
$
37

Liquefaction Supply Derivatives
 
(63
)
 
2

 
(61
)
As of December 31, 2018
 
 
 
 
 
 
Liquefaction Supply Derivatives
 
$
63

 
$
(26
)
 
$
37

Liquefaction Supply Derivatives
 
(92
)
 
12

 
(80
)