Annual report pursuant to Section 13 and 15(d)

Derivative Instruments (Notes)

v2.4.1.9
Derivative Instruments (Notes)
 12 Months Ended
Dec. 31, 2014
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 variability in expected future cash flows attributable to the future sale of our LNG inventory (“LNG Inventory Derivatives”);
•
commodity derivatives to hedge the exposure to price risk attributable to future purchases of natural gas to be utilized as fuel to operate the Sabine Pass LNG terminal (“Fuel Derivatives”);
•
commodity derivatives consisting of natural gas purchase agreements to secure natural gas feedstock for the Sabine Pass Liquefaction Project (“Term Gas Supply Derivatives”); and
•
interest rate swaps to hedge the exposure to volatility in a portion of the floating-rate interest payments under the 2013 Liquefaction Credit Facilities (“Interest Rate Derivatives”).

The following table (in thousands) shows the fair value of our derivative assets and liabilities that are required to be measured at fair value on a recurring basis as of December 31, 2014 and 2013, which are classified as prepaid expenses and other, non-current derivative assets and other current liabilities in our Consolidated Balance Sheets.
 
Fair Value Measurements as of
 
December 31, 2014
 
December 31, 2013
 
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
LNG Inventory Derivatives asset (liability)
$
—

 
$
1,140

 
$
—

 
$
1,140

 
$
—

 
$
(171
)
 
$
—

 
$
(171
)
Fuel Derivatives asset (liability)
—

 
(921
)
 
—

 
(921
)
 
—

 
126

 
—

 
126

Term Gas Supply Derivatives asset
—

 
—

 
342

 
342

 
—

 
—

 
—

 
—

Interest Rate Derivatives asset (liability)
—

 
(12,036
)
 
—

 
(12,036
)
 
—

 
84,639

 
—

 
84,639



The estimated fair values of our LNG Inventory Derivatives and Fuel 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 our 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 Sabine Pass Liquefaction’s Term Gas 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 Sabine Pass Liquefaction’s Term Gas Supply Derivatives is designated as Level 3 within the valuation hierarchy. The curves used to generate the fair value of the Term Gas 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 Term Gas Supply Derivative contract may exceed the period for which such information is available, resulting in a Level 3 classification. In these instances, 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 December 31, 2014, the majority of Sabine Pass Liquefaction’s Term Gas Supply Derivatives existed within markets for which the pipeline infrastructure has not been developed to accommodate marketable physical gas flow and our internal fair value models were based on a market price that equated to our own contractual pricing due to the inactive and unobservable market as well as the 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 Term Gas 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. We estimated the fair value of Sabine Pass Liquefaction’s Term Gas Supply Derivatives to be $0.3 million as of December 31, 2014.

There were no transfers into or out of Level 3 for the years ended December 31, 2014 and 2013. As all of our Term Gas 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 (in thousands, except natural gas basis spread) includes quantitative information for the unobservable inputs as of December 31, 2014:
 
 
Net Fair Value Asset
 
Valuation Technique
 
Significant Unobservable Input
 
Significant Unobservable Inputs Range
Term Gas Supply Derivatives
 
$342
 
Basis Spread plus Liquid Location
 
Basis Spread
 
$ (0.350) - $0.035


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.  

Commodity Derivatives

We recognize all commodity derivative instruments, including our LNG Inventory Derivatives, Fuel Derivatives and Term Gas 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:
 
 
 
 
Fair Value Measurements as of
 
Balance Sheet Location
 
December 31, 2014
 
December 31, 2013
LNG Inventory Derivatives asset (liability)
Prepaid expenses and other
 
$
1,140

 
$
(171
)
Fuel Derivatives asset (liability)
Prepaid expenses and other
 
(921
)
 
126

Term Gas Supply Derivatives asset
Prepaid expenses and other
 
76

 
—

Term Gas Supply Derivatives asset
Non-current derivative assets
 
586

 
—

Term Gas Supply Derivatives liability
Other current liabilities
 
(53
)
 
—

Term Gas Supply Derivatives liability
Other non-current liabilities
 
(267
)
 
—



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 years ended December 31, 2014, 2013 and 2012:
 
 
 
Year Ended December 31,
 
Income Statement Location
 
2014
 
2013
 
2012
LNG Inventory Derivatives gain (loss)
Marketing and trading revenues (losses)
 
$
(346
)
 
$
(449
)
 
$
995

Fuel Derivatives gain (loss)
Marketing and trading revenues (losses)
 
(952
)
 
99

 
—

LNG Inventory Derivatives gain
Derivative gain (loss), net
 
1,108

 
476

 
—

Fuel Derivatives gain (loss)
Derivative gain (loss), net
 
281

 
182

 
(622
)
Term Gas Supply Derivatives gain (1)
Operating and maintenance expense
 
342

 
—

 
—


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

LNG Inventory and Fuel Derivatives

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 where our LNG Inventory Derivatives or Fuel Derivatives are in an asset position. Our LNG Inventory Derivatives and Fuel 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 these commodity derivative activities.  Collateral of $5.7 million and $5.9 million deposited for such contracts, which has not been reflected in the derivative fair value tables, is included in the other current assets balance as of December 31, 2014 and 2013, respectively.

Term Gas Supply Derivatives

Sabine Pass Liquefaction has entered into index-based physical natural gas supply contracts to secure natural gas feedstock for the Sabine Pass Liquefaction Project. The terms of these 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 Sabine Pass Liquefaction Project. We recognize Sabine Pass Liquefaction’s Term Gas Supply Derivatives as either assets or liabilities and measure those instruments at fair value. Changes in the fair value of Sabine Pass Liquefaction’s Term Gas Supply Derivatives are reported in earnings.

As of December 31, 2014, the majority of Sabine Pass Liquefaction’s Term Gas Supply Derivatives existed within markets for which the pipeline infrastructure has not been developed to accommodate marketable physical gas flow and our internal fair value models were based on a market price that equated to Sabine Pass Liquefaction’s own contractual pricing due to the inactive and unobservable market as well as the conditions precedent and their impact on the uncertainty in the timing of our actual receipt of the physical volumes associated with each forward. As of December 31, 2014, the forward notional natural gas buy position of Sabine Pass Liquefaction’s Term Gas Supply Derivatives was approximately 1,249.4 million MMBtu.

Interest Rate Derivatives

In August 2012 and June 2013, Sabine Pass Liquefaction entered into Interest Rate Derivatives to protect against volatility of future cash flows and hedge a portion of the variable interest payments on the 2012 Liquefaction Credit Facility and the 2013 Liquefaction Credit Facilities, respectively. The Interest Rate Derivatives hedge a portion of the expected outstanding borrowings over the term of the 2013 Liquefaction Credit Facilities.

Sabine Pass Liquefaction designated the Interest Rate Derivatives entered into in August 2012 as hedging instruments which was required in order to qualify for cash flow hedge accounting. As a result of this cash flow hedge designation, we recognized the Interest Rate Derivatives entered into in August 2012 as an asset or liability at fair value and reflected changes in fair value through other comprehensive income in our Consolidated Statements of Comprehensive Loss. Any hedge ineffectiveness associated with the Interest Rate Derivatives entered into in August 2012 was recorded immediately as derivative gain (loss) in our Consolidated Statements of Operations.  The realized gain (loss) on the Interest Rate Derivatives entered into in August 2012 was recorded as an (increase) decrease in interest expense on our Consolidated Statements of Operations to the extent not capitalized as part of the Sabine Pass Liquefaction Project. The effective portion of the gains or losses on our Interest Rate Derivatives entered into in August 2012 recorded in other comprehensive income would have been reclassified to earnings as interest payments on the 2012 Liquefaction Credit Facility impact earnings. In addition, amounts recorded in other comprehensive income are also reclassified into earnings if it becomes probable that the hedged forecasted transaction will not occur.

Sabine Pass Liquefaction did not elect to designate the Interest Rate Derivatives entered into in June 2013 as cash flow hedging instruments, and changes in fair value are recorded as derivative gain (loss), net within our Consolidated Statements of Operations.

During the first quarter of 2013, we determined that it was no longer probable that the forecasted variable interest payments on the 2012 Liquefaction Credit Facility would occur in the time period originally specified based on the continued development of our financing strategy for the Sabine Pass Liquefaction Project, and, in particular, the Sabine Pass Liquefaction Senior Notes described in Note 9—Long-Term Debt. As a result, all of the Interest Rate Derivatives entered into in August 2012 were no longer effective hedges, and the remaining portion of hedge relationships that were designated cash flow hedges as of December 31, 2012, were de-designated as of February 1, 2013. For de-designated cash flow hedges, changes in fair value prior to their de-designation date were recorded as other comprehensive income (loss) within our Consolidated Balance Sheets, and changes in fair value subsequent to their de-designation date were recorded as derivative gain (loss) within our Consolidated Statements of Operations.

In June 2013, Sabine Pass Liquefaction concluded that the hedged forecasted transactions associated with the Interest Rate Derivatives entered into in connection with the 2012 Liquefaction Credit Facility had become probable of not occurring based on the issuances of the Sabine Pass Liquefaction Senior Notes, the closing of the 2013 Liquefaction Credit Facilities, the additional Interest Rate Derivatives executed in June 2013, and Sabine Pass Liquefaction’s intention to continue to issue fixed rate debt to refinance the 2013 Liquefaction Credit Facilities. As a result, the amount remaining in accumulated other comprehensive income (“AOCI”) pertaining to the previously designated Interest Rate Derivatives was reclassified out of AOCI and into income. We have presented the changes in fair value and settlements subsequent to the reclassification date separate from interest expense as derivative gain (loss), net in our Consolidated Statements of Operations.

In May 2014, Sabine Pass Liquefaction 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 termination of approximately $2.1 billion of commitments under the 2013 Liquefaction Credit Facilities as discussed in Note 9—Long-Term Debt.

At December 31, 2014, Sabine Pass Liquefaction 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 - Not Designated
 
$20.0 million
 
$2.5 billion
 
August 14, 2012
 
July 31, 2019
 
1.98%
 
One-month LIBOR


The following table (in thousands) shows the fair value of our Interest Rate Derivatives:
 
 
 
 
Fair Value Measurements as of
 
 
Balance Sheet Location
 
December 31, 2014
 
December 31, 2013
Interest Rate Derivatives - Not Designated
 
Non-current derivative assets
 
$
11,158

 
$
98,123

Interest Rate Derivatives - Not Designated
 
Other current liabilities
 
(23,194
)
 
(13,484
)


The following table (in thousands) details the effect of our Interest Rate Derivatives included in Other Comprehensive Income (“OCI”) and AOCI for the years ended December 31, 2014, 2013 and 2012:
 
 
Gain (Loss) in OCI
 
Gain (Loss) Reclassified from AOCI into Interest Expense (Effective Portion)
 
Losses Reclassified into Earnings as a Result of Discontinuance of Cash Flow Hedge Accounting
December 31, 2012
 
 
 
 
 
 
Interest Rate Derivatives - Designated
 
$
(21,290
)
 
$
—

 
$
—

Interest Rate Derivatives - De-designated
 
(5,814
)
 
—

 
—

Interest Rate Derivatives - Settlements
 
(136
)
 
—

 
—

December 31, 2013
 
 
 
 
 
 
Interest Rate Derivatives - Designated
 
21,297

 
—

 
5,807

Interest Rate Derivatives - De-designated
 
—

 
—

 
—

Interest Rate Derivatives - Settlements
 
(30
)
 
—

 
166

December 31, 2014
 
 
 
 
 
 
Interest Rate Derivatives - Designated
 
—

 
—

 
—

Interest Rate Derivatives - De-designated
 
—

 
—

 
—

Interest Rate Derivatives - Settlements
 
—

 
—

 
—



The following table (in thousands) shows the changes in the fair value and settlements of our Interest Rate Derivatives - Not Designated recorded in derivative gain (loss), net on our Consolidated Statements of Operations during the years ended December 31, 2014, 2013 and 2012:
 
Year Ended December 31,
 
2014
 
2013
 
2012
Interest Rate Derivatives - Not Designated
$
(119,401
)
 
$
88,596

 
$
679



Balance Sheet Presentation

Our commodity 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
 
Gross Amounts Not Offset in the Consolidated Balance Sheets
 
 
Offsetting Derivative Assets (Liabilities)
 
 
 
 
Derivative Instrument
 
Cash Collateral Received (Paid)
 
Net Amount
As of December 31, 2014:
 
 
 
 
 
 
 
 
 
 
 
 
LNG Inventory Derivatives
 
$
1,140

 
$
1,056

 
$
84

 
$
—

 
$
—

 
$
84

Fuel Derivatives
 
(921
)
 
(921
)
 
—

 
—

 
—

 
—

Term Gas Supply Derivatives
 
662

 
—

 
662

 
—

 
—

 
662

Term Gas Supply Derivatives
 
(320
)
 
—

 
(320
)
 
—

 
—

 
(320
)
Interest Rate Derivatives - Not Designated
 
11,158

 
—

 
11,158

 
—

 
—

 
11,158

Interest Rate Derivatives - Not Designated
 
(23,194
)
 
—

 
(23,194
)
 
—

 
—

 
(23,194
)
As of December 31, 2013:
 
 
 
 
 
 
 
 
 
 
 
 
LNG Inventory Derivatives
 
(171
)
 
(171
)
 
—

 
—

 
—

 
—

Fuel Derivatives
 
126

 
—

 
126

 
—

 
—

 
126

Interest Rate Derivatives - Not Designated
 
98,123

 
—

 
98,123

 
—

 
—

 
98,123

Interest Rate Derivatives - Not Designated
 
(13,484
)
 
—

 
(13,484
)
 
—

 
—

 
(13,484
)