Cheniere Energy, Inc. Annual report pursuant to Section 13 and 15(d)

Annual report pursuant to Section 13 and 15(d)

Financial Instruments

Financial Instruments

12 Months Ended

Dec. 31, 2012

Financial Instruments [Abstract]

Financial Instruments

FINANCIAL INSTRUMENTS

Derivative Instruments

We have entered into certain instruments to hedge the exposure to variability in expected future cash flows attributable to the future sale of our LNG inventory ("LNG Inventory 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"), and to hedge the exposure to volatility in a portion of the floating-rate interest payments under the Liquefaction Credit Facility ("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, 2012 and 2011, which are classified as other current assets, other current liabilities and other non-current liabilities in our Consolidated Balance Sheets.



	Fair Value Measurements as of
	December 31, 2012								December 31, 2011
	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	$	—	$	237	$	—	$	237	$	—	$	1,951	$	—	$	1,951
Fuel Derivatives liability	—		98		—		98		—		1,415		—		1,415
Interest Rate Derivatives liability	—		26,424		—		26,424		—		—		—		—

The estimated fair values of our LNG Inventory Derivatives and Fuel Derivatives are the amount 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.

Commodity Derivatives

Changes in the fair value of our LNG Inventory Derivatives and Fuel Derivatives are reported in earnings because we have not elected to designate these derivative instruments as a hedging instrument that is required to qualify for cash flow hedge accounting. The following table (in thousands) shows the fair value and location of our LNG Inventory Derivatives and Fuel Derivatives on our Consolidated Balance Sheets:



		Fair Value Measurements as of
	Balance Sheet Location	December 31, 2012		December 31, 2011
LNG Inventory Derivatives asset	Prepaid expenses and other	$	237	$	1,951
Fuel Derivatives liability	Other current liabilities	98		1,415

The following table (in thousands) shows the changes in the fair value and settlements of our LNG Inventory Derivatives recorded in marketing and trading revenues (losses) on our Consolidated Statements of Operations during the years ended December 31, 2012, 2011 and 2010:



	Year Ended December 31,
	2012		2011		2010
LNG Inventory Derivatives gain	$	995	$	2,475	$	2,265

The following table (in thousands) shows the changes in the fair value and settlements of our Fuel Derivatives recorded in derivative gain (loss) on our Consolidated Statements of Operations during the years ended December 31, 2012, 2011 and 2010:



	Year Ended December 31,
	2012			2011			2010
Fuel Derivatives gain (loss)	$	(622	)	$	(2,251	)	$	461

The use of derivative instruments exposes us to counterparty credit risk, or the risk that a counterparty will be unable to meet its commitments. Our commodity derivative transactions 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. Collateral of $5.9 million and $5.5 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, 2012, and 2011, respectively.

Interest Rate Swaps Designated as Cash Flow Hedges

In August 2012, 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 Liquefaction Credit Facility.

Sabine Pass Liquefaction has elected to designate these Interest Rate Derivatives as hedging instruments which is required in order to qualify for cash flow hedge accounting. As a result of this cash flow hedge designation, we recognize the Interest Rate Derivatives as an asset or liability at fair value, and reflect changes in fair value through other comprehensive income in our Consolidated Statements of Comprehensive Loss. Any hedge ineffectiveness associated with the Interest Rate Derivatives is recorded immediately as derivative gain (loss) in our Consolidated Statements of Operations. The realized gain (loss) on the Interest Rate Derivatives is recorded as an (increase) decrease in interest expense on our Consolidated Statements of Operations to the extent not capitalized as part of the Liquefaction Project. The effective portion of the gains or losses on our Interest Rate Derivatives recorded in other comprehensive income is reclassified to earnings as interest payments on the 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.

The Interest Rate Derivatives hedge approximately 75% of the weighted average of the expected outstanding borrowings over the term of the Liquefaction Credit Facility. The aggregate notional amount each month follows our expected borrowing schedule under the Liquefaction Credit Facility with an expected maximum swap notional amount outstanding of $2.9 billion in 2017. Based on the continued development of our financing strategy for the Liquefaction Project, in particular the fixed-rate debt as described in Note 19—"Subsequent Events", during the fourth quarter of 2012 we determined it was no longer probable that a portion of the forecasted variable interest payments on the Liquefaction Credit Facility would occur in the time period originally specified. As a result, a portion of the Interest Rate Derivatives were no longer effective hedges and the hedge relationships for this portion were de-designated as of October 1, 2012. Fair value adjustments on this de-designated portion of the Interest Rate Derivatives subsequent to October 1, 2012 are recorded within the Consolidated Statements of Operations. We have continued to maintain the Interest Rate Derivatives (both designated and de-designated) in anticipation of our upcoming financing needs, particularly for the financing of the construction of Train 3 and Train 4 of the Liquefaction Project, and have concluded that the likelihood of occurrence of our variable interest payments has not changed to probable not to occur. As a result, amounts recorded in other comprehensive income related to our designated and de-designated Interest Rate Derivatives will continue to remain in other comprehensive income until interest payments on the Liquefaction Credit Facility impact earnings.

At December 31, 2012, Sabine Pass Liquefaction had the following Interest Rate Derivatives outstanding that converted $20.0 million of the Liquefaction Credit Facility from a variable to a fixed interest rate. Sabine Pass Liquefaction pays a fixed interest rate on the swap and in exchange receives a variable interest rate based on the one-month LIBOR.

Initial Notional Amount

Maximum Notional Amount

Effective Date

Maturity Date

Weighted Average Fixed Interest Rate Paid

Variable Interest Rate Received

Interest Rate Derivatives - Designated

$16.1 million

$2.3 billion

August 14, 2012

July 31, 2019

1.98%

One-month LIBOR

Interest Rate Derivatives - De-designated

$3.9 million

$575.3 million

August 14, 2012

July 31, 2019

1.98%

One-month LIBOR

Interest Rate Derivatives were reflected in our Consolidated Balance Sheets at fair value with the effective portion of the Interest Rate Derivatives' gain or loss recorded in other comprehensive income. Fair value adjustments subsequent to October 1, 2012 on the de-designated portion of the Interest Rate Derivatives were recorded within the Consolidated Statements of Operations. The following table (in thousands) shows the fair value of our interest rate swaps:



		Fair Value Measurements as of
	Balance Sheet Location	December 31, 2012		December 31, 2011
Interest Rate Derivatives - Designated	Non-current derivative liabilities	$	21,290	$	—
Interest Rate Derivatives - De-designated	Non-current derivative liabilities	5,134		—

The following table (in thousands) shows our Interest Rate Derivatives market adjustments recorded during the year ended December 31, 2012:



	Gain (Loss) in Other Comprehensive Income					Gain (Loss) Reclassified from Accumulated OCI into Interest Expense (Effective Portion)				Gain (Loss) Recognized in Income (Ineffective Portion and Amount Excluded from Effectiveness Testing)
	2012			2011		2012		2011		2012		2011
Interest Rate Derivatives - Designated	$	(21,290	)	$	—	$	—	$	—	$	—	$	—
Interest Rate Derivatives - De-designated	(5,814		)	—		—		—		—		—
Interest Rate Derivatives - Settlements	(136		)	—		—		—		—		—

The following table (in thousands) shows the changes in the fair value of our De-designated Interest Rate Derivatives recorded in derivative gain on our Consolidated Statements of Operations during the years ended December 31, 2012, 2011 and 2010:



	Year Ended December 31,
	2012		2011		2010
Interest Rate Derivatives - De-designated	$	679	$	—	$	—

Balance Sheet Presentation

The Company's 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 basis:



	December 31, 2012		December 31, 2011
Commodity Derivatives:
Assets	$	613	$	2,310
Liabilities	474		1,774
Interest Rate Derivatives:
Assets - designated	$	17,512	$	—
Assets - de-designated	4,283		—
Liabilities - designated	38,729		—
Liabilities - de-designated	9,491		—

Other Financial Instruments

The estimated fair value of our other financial instruments, including those financial instruments for which the fair value option was not elected are set forth in the table below. The carrying amounts reported on our Consolidated Balance Sheets for cash and cash equivalents, restricted cash and cash equivalents, accounts receivable, interest receivable and accounts payable approximate fair value due to their short-term nature.

Other Financial Instruments (in thousands):



	December 31, 2012				December 31, 2011
	Carrying Amount		Estimated Fair Value		Carrying Amount		Estimated Fair Value
2016 Notes, net of discount (1)	$	1,647,113	$	1,824,177	$	1,642,418	$	1,650,630
2020 Notes (1)	420,000		437,850		—		—
Liquefaction Credit Facility (2)	100,000		100,000		—		—
2013 Notes (1)	—		—		550,000		555,500
Convertible Senior Unsecured Notes, net of discount (1)	—		—		194,724		186,740
2007 Term Loan (3)	—		—		298,000		292,728
2008 Loans (4)	—		—		282,293		282,293


(1)	The Level 2 estimated fair value was based on quotations obtained from broker-dealers who make markets in these and similar instruments based on the closing trading prices on December 31, 2012 and 2011, as applicable.


(2)	The Level 3 estimated fair value of the Liquefaction Credit Facility as of December 31, 2012 was determined to be the carrying amount due to our ability to call this debt at anytime without penalty.

(3)

The 2007 Term Loan was closely held by few holders, and purchases and sales were infrequent and were conducted on a bilateral basis without price discovery by us. This loan was not rated and had unique covenants and collateral packages such that comparisons to other instruments were imprecise. Nonetheless, we provided an estimate of the fair value of this loan as of December 31, 2011 based on an index of the yield to maturity of CCC rated debt of other companies in the energy sector, resulting in Level 3 categorization. In January 2012, the 2007 Term Loan was paid in full.

(4)

The Level 3 estimated fair value of the 2008 Loans as of December 31, 2011 was determined to be the same as the carrying amount due to our ability to call the debt (other than the debt held by Scorpion) at anytime without penalty or a make-whole payment for an early redemption. In April 2012, Scorpion exchanged all $8.4 million of its loan for 1.7 million shares of Cheniere common stock and $1.4 million cash. In June 2012, the 2008 Loans were paid in full and the credit agreement and related agreements were terminated.