Annual report pursuant to Section 13 and 15(d)

Derivative Instruments

v3.6.0.2
Derivative Instruments
 12 Months Ended
Dec. 31, 2016
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 of our credit facilities (“Interest Rate Derivatives”);
•
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 supply contracts for the commissioning and operation of the SPL Project (“Physical Liquefaction Supply Derivatives”) and associated economic hedges (“Financial Liquefaction Supply Derivatives”, and collectively with the Physical Liquefaction Supply Derivatives, the “Liquefaction Supply Derivatives”);
•
financial derivatives to hedge the exposure to the commodity markets in which we have contractual arrangements to purchase or sell physical LNG (“LNG Trading Derivatives”); and
•
FX contracts to hedge exposure to currency risk associated with operations in countries outside of the United States (“FX 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.

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 December 31, 2016 and 2015, which are classified as derivative assets, non-current derivative assets, derivative liabilities or non-current derivative liabilities in our Consolidated Balance Sheets.
 
Fair Value Measurements as of
 
December 31, 2016
 
December 31, 2015
 
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
SPL Interest Rate Derivatives liability
$
—

 
$
(6,224
)
 
$
—

 
$
(6,224
)
 
$
—

 
$
(8,740
)
 
$
—

 
$
(8,740
)
CQP Interest Rate Derivatives asset
—

 
13,108

 
—

 
13,108

 
—

 
—

 
—

 
—

CCH Interest Rate Derivatives liability
—

 
(86,488
)
 
—

 
(86,488
)
 
—

 
(104,999
)
 
—

 
(104,999
)
Liquefaction Supply Derivatives asset (liability)
(4,483
)
 
(1,474
)
 
79,022

 
73,065

 
—

 
(25
)
 
32,492

 
32,467

LNG Trading Derivatives asset (liability)
2,512

 
(5,309
)
 
—

 
(2,797
)
 
—

 
1,053

 
—

 
1,053

Natural Gas Derivatives liability
—

 
—

 
—

 
—

 
—

 
(66
)
 
—

 
(66
)
FX Derivatives asset
—

 
168

 
—

 
168

 
—

 
—

 
—

 
—



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 estimated fair values of our economic hedges related to the LNG Trading Derivatives and 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 estimate the fair values of our FX Derivatives with a market approach using observable FX rates and other relevant data.

The fair value of substantially all of our Physical 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 our Physical Liquefaction Supply Derivatives is designated as Level 3 within the valuation hierarchy. 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 particular 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. Internal fair value models include conditions precedent to the respective long-term natural gas supply contracts. As of December 31, 2016 and 2015, some of our Physical Liquefaction Supply Derivatives existed within markets for which the pipeline infrastructure is under development to accommodate marketable physical gas flow. Accordingly, our internal fair value models are based on market prices that equate 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 our Physical 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 supply contracts as of the reporting date.

As all of our 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 our Level 3 Physical Liquefaction Supply Derivatives as of December 31, 2016:
 
 
Net Fair Value Asset
(in thousands)
 
Valuation Technique
 
Significant Unobservable Input
 
Significant Unobservable Inputs Range
Physical Liquefaction Supply Derivatives
 
$79,022
 
Income Approach
 
Basis Spread
 
$(0.260) - $(0.003)


The following table (in thousands) shows the changes in the fair value of our Level 3 Physical Liquefaction Supply Derivatives during the years ended December 31, 2016 and 2015:
 
 
Year Ended December 31,
 
 
2016
 
2015
Balance, beginning of period
 
$
32,492

 
$
342

Realized and mark-to-market gains:
 
 
 
 
Included in cost of sales (1)
 
48,218

 
32,150

Purchases and settlements:
 
 
 
 
Purchases
 
538

 
—

Settlements (1)
 
(2,226
)
 
—

Transfers out of Level 3
 
—

 
—

Balance, end of period
 
$
79,022

 
$
32,492

Change in unrealized gains relating to instruments still held at end of period
 
$
48,938

 
$
32,150

 
    
(1)
Does not include the decrease in fair value of $0.7 million related to the realized gains capitalized during the year ended December 31, 2016.
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. Our derivative instruments are subject to contractual provisions which provide for the unconditional right of set-off for all derivative assets and liabilities with a given counterparty in the event of default.

Interest Rate Derivatives

SPL Interest Rate Derivatives

SPL has entered into interest rate swaps (“SPL Interest Rate Derivatives”) to protect against volatility of future cash flows and hedge a portion of the variable interest payments on the credit facilities it entered into in June 2015 (the “2015 SPL Credit Facilities”). The SPL 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 the SPL Interest Rate Derivatives and 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 previous credit facilities.
 
CQP Interest Rate Derivatives

In March 2016, Cheniere Partners entered into interest rate swaps (“CQP Interest Rate Derivatives”) to protect against volatility of future cash flows and hedge a portion of the variable interest payments on the 2016 CQP Credit Facilities. The CQP Interest Rate Derivatives hedge a portion of the expected outstanding borrowings over the term of the 2016 CQP Credit Facilities.

CCH Interest Rate Derivatives

CCH has entered into interest rate swaps (“CCH Interest Rate Derivatives”) to protect against volatility of future cash flows and hedge a portion of the variable interest payments on its credit facility (the “2015 CCH Credit Facility”). The CCH Interest Rate Derivatives hedge a portion of the expected outstanding borrowings over the term of the 2015 CCH Credit Facility. The CCH Interest Rate Derivatives have a seven-year term and were contingent upon reaching an FID with respect to the CCL Project, which was reached in May 2015. Upon meeting the contingency related to the CCH Interest Rate Derivatives in May 2015, we paid $50.1 million related to contingency and syndication premiums, which is included in derivative loss, net on our Consolidated Statements of Operations.

As of December 31, 2016, we 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
SPL Interest Rate Derivatives
 
$20.0 million
 
$628.8 million
 
August 14, 2012
 
July 31, 2019
 
1.98%
 
One-month LIBOR
CQP Interest Rate Derivatives
 
$225.0 million
 
$1.3 billion
 
March 22, 2016
 
February 29, 2020
 
1.19%
 
One-month LIBOR
CCH Interest Rate Derivatives
 
$28.8 million
 
$5.5 billion
 
May 20, 2015
 
May 31, 2022
 
2.29%
 
One-month LIBOR


The following table (in thousands) shows the fair value and location of our Interest Rate Derivatives on our Consolidated Balance Sheets:
 
 
December 31, 2016
 
December 31, 2015
 
 
SPL Interest Rate Derivatives
 
CQP Interest Rate Derivatives
 
CCH Interest Rate Derivatives
 
Total
 
SPL Interest Rate Derivatives
 
CQP Interest Rate Derivatives
 
CCH Interest Rate Derivatives
 
Total
Balance Sheet Location
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Non-current derivative assets
 
$
—

 
$
16,073

 
$
—

 
$
16,073

 
$
—

 
$
—

 
$
—

 
$
—

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative liabilities
 
(4,223
)
 
(2,965
)
 
(43,383
)
 
(50,571
)
 
(5,940
)
 
—

 
(28,559
)
 
(34,499
)
Non-current derivative liabilities
 
(2,001
)
 
—

 
(43,105
)
 
(45,106
)
 
(2,800
)
 
—

 
(76,440
)
 
(79,240
)
Total derivative liabilities
 
(6,224
)
 
(2,965
)
 
(86,488
)
 
(95,677
)
 
(8,740
)
 
—

 
(104,999
)
 
(113,739
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative asset (liability), net
 
$
(6,224
)
 
$
13,108

 
$
(86,488
)
 
$
(79,604
)
 
$
(8,740
)
 
$
—

 
$
(104,999
)
 
$
(113,739
)


The following table (in thousands) shows the changes in the fair value and settlements of our Interest Rate Derivatives recorded in derivative loss, net on our Consolidated Statements of Operations during the years ended December 31, 2016, 2015 and 2014:
 
 
Year Ended December 31,
 
 
2016
 
2015
 
2014
SPL Interest Rate Derivatives loss
 
$
(5,934
)
 
$
(41,722
)
 
$
(119,401
)
CQP Interest Rate Derivatives gain
 
11,478

 
—

 
—

CCH Interest Rate Derivatives loss
 
(15,571
)
 
(161,917
)
 
—



Commodity Derivatives

Liquefaction Supply Derivatives

SPL has entered into index-based physical natural gas supply contracts and associated economic hedges to purchase natural gas for the commissioning and operation of the SPL Project. The terms of the physical natural gas supply contracts primarily range from approximately one to seven years and commence upon the satisfaction of certain conditions precedent, including but not limited to the date of first commercial delivery of specified Trains of the SPL Project. We recognize our Physical Liquefaction Supply Derivatives as either assets or liabilities and measure those instruments at fair value. Changes in the fair value of our Physical Liquefaction Supply Derivatives are reported in earnings. As of December 31, 2016, SPL has secured up to approximately 1,993.9 million MMBtu of natural gas feedstock through natural gas supply contracts. The notional natural gas position of our Physical Liquefaction Supply Derivatives was approximately 1,111.4 million MMBtu as of December 31, 2016.

Our Financial Liquefaction Supply 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 Financial Liquefaction Supply Derivatives activities. The notional natural gas position of our Financial Liquefaction Supply Derivatives was approximately 5.6 million MMBtu as of December 31, 2016.

LNG Trading Derivatives

As of December 31, 2016, we have entered into certain LNG Trading Derivatives representing a long position of 0.2 million MMBtu, and we may from time to time enter into certain financial derivatives in the form of swaps, forwards, options or futures to economically hedge exposure to the commodity markets in which we have contractual arrangements to purchase or sell physical LNG. We have entered into LNG Trading Derivatives to secure a fixed price position to minimize future cash flow variability associated with such LNG transactions.

Natural Gas Derivatives

Our Natural Gas Derivatives were executed through over-the-counter contracts which were subject to nominal credit risk as these transactions settled on a daily margin basis with investment grade financial institutions. We were required by these financial institutions to use margin deposits as credit support for our Natural Gas Derivatives activities. As of December 31, 2016, we did not have any open Natural Gas Derivatives positions or margin deposits at financial institutions.

We recognize all commodity derivative instruments, including our Liquefaction Supply Derivatives, LNG Trading Derivatives and Natural Gas 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:
 
December 31, 2016
 
December 31, 2015
 
Liquefaction Supply Derivatives (1)
 
LNG Trading Derivatives (2)
 
Natural Gas Derivatives
 
Total
 
Liquefaction Supply Derivatives
 
LNG Trading Derivatives (2)
 
Natural Gas Derivatives (3)
 
Total
Balance Sheet Location
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative assets
$
13,535

 
$
6,471

 
$
—

 
$
20,006

 
$
2,737

 
$
640

 
$
—

 
$
3,377

Non-current derivative assets
66,788

 
—

 
—

 
66,788

 
30,304

 
583

 
—

 
30,887

Total derivative assets
80,323

 
6,471

 
—

 
86,794

 
33,041

 
1,223

 
—

 
34,264

 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative liabilities
(7,258
)
 
(9,268
)
 
—

 
(16,526
)
 
(490
)
 
(107
)
 
(66
)
 
(663
)
Non-current derivative liabilities
—

 
—

 
—

 
—

 
(84
)
 
(63
)
 
—

 
(147
)
Total derivative liabilities
(7,258
)
 
(9,268
)
 
—

 
(16,526
)
 
(574
)
 
(170
)
 
(66
)
 
(810
)
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
 
Derivative asset (liabilities), net
$
73,065

 
$
(2,797
)
 
$
—

 
$
70,268

 
$
32,467

 
$
1,053

 
$
(66
)
 
$
33,454


 
    
(1)
Does not include collateral of $6.0 million deposited for such contracts, which is included in other current assets in our Consolidated Balance Sheet as of December 31, 2016.
(2)
Does not include collateral of $10.4 million and $11.0 million deposited for such contracts, which are included in other current assets in our Consolidated Balance Sheets as of December 31, 2016 and 2015, respectively.
(3)
Does not include collateral of $5.5 million deposited for such contracts, which is included in other current assets in our Consolidated Balance Sheet as of December 31, 2015.
The following table (in thousands) shows the changes in the fair value, settlements and location of our Commodity Derivatives recorded on our Consolidated Statements of Operations during the years ended December 31, 2016, 2015 and 2014:
 
 
 
Year Ended December 31,
 
Statement of Operations Location (1)
 
2016
 
2015
 
2014
Liquefaction Supply Derivatives loss
LNG revenues (losses)
 
$
(8
)
 
$
—

 
$
—

Liquefaction Supply Derivatives gain (2)
Cost (cost recovery) of sales
 
(42,172
)
 
(32,503
)
 
(342
)
LNG Trading Derivatives gain (loss)
LNG revenues (losses)
 
(3,580
)
 
1,053

 
—

Natural Gas Derivatives loss
LNG revenues (losses)
 
(5
)
 
(407
)
 
(1,298
)
Natural Gas Derivatives gain
Operating and maintenance expense
 
(174
)
 
(2,065
)
 
(1,389
)
 
(1)
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.
(2)    Does not include the realized value associated with derivative instruments that settle through physical delivery.

The use of Commodity Derivatives exposes us to counterparty credit risk, or the risk that a counterparty will be unable to meet its commitments in instances when our Commodity Derivatives are in an asset position.

FX Derivatives

Cheniere Marketing has entered into FX Derivatives to protect against the volatility in future cash flows attributable to changes in international currency exchange rates. The FX Derivatives economically hedge the foreign currency exposure arising from cash flows expended for both physical and financial LNG transactions and selling, general and administrative expenses related to operations in countries outside of the United States. The total notional amount of our FX Derivatives was $10.8 million as of December 31, 2016.

The following table (in thousands) shows the fair value and location of our FX Derivatives on our Consolidated Balance Sheets:
 
 
 
 
Fair Value Measurements as of
 
Balance Sheet Location
 
December 31, 2016
 
December 31, 2015
FX Derivatives
Derivative assets
 
$
3,744

 
$
—

FX Derivatives
Derivative liabilities
 
(3,576
)
 
—



The following table (in thousands) shows the changes in the fair value of our FX Derivatives recorded on our Consolidated Statements of Operations during the years ended December 31, 2016, 2015 and 2014:
 
 
 
 
Year Ended December 31,
 
 
Statement of Operations Location
 
2016
 
2015
 
2014
FX Derivatives gain
 
LNG revenues (losses)
 
$
118

 
$
—

 
$
—

FX Derivatives loss
 
Derivative loss, net
 
(103
)
 
—

 
—

FX Derivatives loss
 
Other income (expense)
 
(509
)
 
—

 
—



Balance Sheet Presentation

Our derivative instruments 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 December 31, 2016
 
 
 
 
 
 
SPL Interest Rate Derivatives
 
$
(6,229
)
 
$
5

 
$
(6,224
)
CQP Interest Rate Derivatives
 
16,073

 
—

 
16,073

CQP Interest Rate Derivatives
 
(3,020
)
 
55

 
(2,965
)
CCH Interest Rate Derivatives
 
(95,923
)
 
9,435

 
(86,488
)
Liquefaction Supply Derivatives
 
82,116

 
(1,793
)
 
80,323

Liquefaction Supply Derivatives
 
(11,078
)
 
3,820

 
(7,258
)
LNG Trading Derivatives
 
21,363

 
(14,892
)
 
6,471

LNG Trading Derivatives
 
(17,049
)
 
7,781

 
(9,268
)
FX Derivatives
 
5,112

 
(1,368
)
 
3,744

FX Derivatives
 
(3,625
)
 
49

 
(3,576
)
As of December 31, 2015
 
 
 
 
 


SPL Interest Rate Derivatives
 
$
(8,740
)
 
$
—

 
$
(8,740
)
CCH Interest Rate Derivatives
 
(104,999
)
 
—

 
(104,999
)
Liquefaction Supply Derivatives
 
33,636

 
(595
)
 
33,041

Liquefaction Supply Derivatives
 
(574
)
 
—

 
(574
)
LNG Trading Derivatives
 
1,922

 
(699
)
 
1,223

LNG Trading Derivatives
 
(2,826
)
 
2,656

 
(170
)
Natural Gas Derivatives
 
188

 
(254
)
 
(66
)