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 one of our 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”).

None of our derivative instruments are designated as cash flow hedging instruments, and changes in fair value are recorded within our Statements of Operations to the extent not utilized for the commissioning process.

The following table (in millions) 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, 2017 and December 31, 2016, which are classified as other current assets, non-current derivative assets, derivative liabilities or non-current derivative liabilities in our Balance Sheets.



	Fair Value Measurements as of
	September 30, 2017									December 31, 2016
	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
Interest Rate Derivatives liability	$	—	$	—		$	—	$	—	$	—		$	(6	)	$	—	$	(6	)
Liquefaction Supply Derivatives asset (liability)	—		(1		)	29		28		(4		)	(2		)	79		73

There have been no changes to our evaluation of and accounting for our derivative positions during the nine months ended September 30, 2017. See Note 7—Derivative Instruments of our Notes to Financial Statements in our annual report on Form 10-K for the year ended December 31, 2016 for additional information.

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 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 satisfaction of conditions precedent, including 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.

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 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 September 30, 2017 and December 31, 2016, some of our Physical Liquefaction Supply Derivatives existed within markets for which the pipeline infrastructure is under development to accommodate marketable physical gas flow.

The following table includes quantitative information for the unobservable inputs for our Level 3 Physical Liquefaction Supply Derivatives as of September 30, 2017:



	Net Fair Value Asset (in millions)	Valuation Technique	Significant Unobservable Input	Significant Unobservable Inputs Range
Physical Liquefaction Supply Derivatives	$29	Income Approach	Basis Spread	$(0.370) - $0.081

The following table (in millions) shows the changes in the fair value of our Level 3 Physical Liquefaction Supply Derivatives during the three and nine months ended September 30, 2017 and 2016:



	Three Months Ended September 30,						Nine Months Ended September 30,
	2017			2016			2017			2016
Balance, beginning of period	$	40		$	22		$	79		$	32
Realized and mark-to-market losses:
Included in cost of sales (1)	(8		)	(11		)	(43		)	(20		)
Purchases and settlements:
Purchases	(1		)	1			1			1
Settlements (1)	(2		)	—			(8		)	(1		)
Balance, end of period	$	29		$	12		$	29		$	12
Change in unrealized gains relating to instruments still held at end of period	$	(8	)	$	(11	)	$	(43	)	$	(20	)


(1)	Does not include the decrease in fair value of $1 million related to the realized gains capitalized during the nine months ended September 30, 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

We had entered into Interest Rate Derivatives to protect against volatility of future cash flows and hedge a portion of the variable interest payments on the credit facilities we entered into in June 2015 (the “2015 Credit Facilities”). In March 2017, we settled the Interest Rate Derivatives and recognized a derivative loss of $7 million in conjunction with the termination of approximately $1.6 billion of commitments under the 2015 Credit Facilities, as discussed in Note 9—Debt.

The following table (in millions) shows the fair value and location of our Interest Rate Derivatives on our Balance Sheets:



		Fair Value Measurements as of
	Balance Sheet Location	September 30, 2017		December 31, 2016
Interest Rate Derivatives	Derivative liabilities	$	—	$	(4	)
Interest Rate Derivatives	Non-current derivative liabilities	—		(2		)

The following table (in millions) shows the changes in the fair value and settlements of our Interest Rate Derivatives recorded in derivative gain (loss), net on our Statements of Operations during the three and nine months ended September 30, 2017 and 2016:



	Three Months Ended				Nine Months Ended
	September 30,				September 30,
	2017		2016		2017			2016
Interest Rate Derivatives gain (loss)	$	—	$	3	$	(2	)	$	(13	)

Liquefaction Supply Derivatives

The following table (in millions) shows the fair value and location of our Liquefaction Supply Derivatives on our Balance Sheets:



		Fair Value Measurements as of (1)
	Balance Sheet Location	September 30, 2017			December 31, 2016
Liquefaction Supply Derivatives	Other current assets	$	8		$	13
Liquefaction Supply Derivatives	Non-current derivative assets	26			67
Liquefaction Supply Derivatives	Derivative liabilities	(4		)	(7		)
Liquefaction Supply Derivatives	Non-current derivative liabilities	(2		)	—


(1)	Does not include collateral of $2 million and $6 million deposited for such contracts, which are included in other current assets in our Balance Sheets as of September 30, 2017 and December 31, 2016, respectively.

We had secured up to approximately 2,462 TBtu and 1,994 TBtu of natural gas feedstock through natural gas supply contracts as of September 30, 2017 and December 31, 2016, respectively. The notional natural gas position of our Liquefaction Supply Derivatives was approximately 1,549 TBtu and 1,117 TBtu as of September 30, 2017 and December 31, 2016, respectively.

The following table (in millions) shows the changes in the fair value, settlements and location of our Liquefaction Supply Derivatives recorded on our Statements of Operations during the three and nine months ended September 30, 2017 and 2016:



		Three Months Ended				Nine Months Ended
		September 30,				September 30,
	Statement of Operations Location (1)	2017		2016		2017		2016
Liquefaction Supply Derivatives loss (2)	Cost of sales	$	11	$	11	$	51	$	23


(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.

Balance Sheet Presentation

Our derivative instruments are presented on a net basis on our Balance Sheets as described above. The following table (in millions) shows the fair value of our derivatives outstanding on a gross and net basis:



	Gross Amounts Recognized			Gross Amounts Offset in the Balance Sheets			Net Amounts Presented in the Balance Sheets
Offsetting Derivative Assets (Liabilities)	Gross Amounts Recognized			Gross Amounts Offset in the Balance Sheets			Net Amounts Presented in the Balance Sheets
As of September 30, 2017
Liquefaction Supply Derivatives	$	35		$	(1	)	$	34
Liquefaction Supply Derivatives	(8		)	2			(6		)
As of December 31, 2016
Interest Rate Derivatives	$	(6	)	$	—		$	(6	)
Liquefaction Supply Derivatives	82			(2		)	80
Liquefaction Supply Derivatives	(11		)	4			(7		)