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Derivative losses weigh on Cheniere’s financial results as LNG prices soar in Q3 – S&P Global


Company uses instruments to hedge commodity exposure

Supply contracts with upstream gas producers in focus

About $3.5 billion in pretax derivatives losses — mostly non-cash — were booked by Cheniere Energy during the third quarter as forward LNG prices in end-user markets soared, the biggest US exporter of the super-chilled power plant fuel said Nov. 4.

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The company uses derivatives to hedge its exposure to commodity markets in which it has contracts to purchase or sell physical LNG. If prices rise or fall, Cheniere must account for the mark-to-market gain or loss between the derivative and physical positions.

The majority of Cheniere’s derivatives loss in the July-September period was attributable to supply contracts it has with three upstream gas producers. Under the deals, the upstream producers will sell gas to Cheniere. The LNG produced from the gas will be marketed by Cheniere. In turn, Cheniere will pay the upstream producers an LNG-linked price for their gas, based on the S&P Global Platts JKM – the benchmark for spot LNG delivered to Northeast Asia — after deductions for fixed LNG shipping costs and a fixed liquefaction fee.

“This accounting treatment coupled with the significant volumes, long-term duration, and volatility and price basis for certain contracts, and most notably our IPM agreements will result in fluctuations in fair market value from period to period,” Chief Financial Officer Zach Davis said during an investor conference call after the July-September financial results were released.

According to Cheniere, the significant appreciation in forward international LNG commodity curves caused it to incur the derivatives losses. In the most recent quarter, about $400 million of the derivatives loss was realized. The rest of the booked derivatives loss was non-cash, according to Cheniere.

Davis said that operationally Cheniere tries to eliminate commodity risk by matching its natural gas purchases and LNG sales on the same pricing index. Because its long-term LNG sale and purchase agreements do not currently qualify for mark-to-market accounting, the fair market value impact of only one side of the transaction is recognized on Cheniere’s financial statements until the sale of LNG occurs.

Company officials did not disclose Cheniere’s exact positions in the derivatives market. In general, according to people familiar with Cheniere’s activity, if end-user prices drop sharply in the future, Cheniere would expect to book a substantial mark-to-market gain on its derivatives; on the flip side, however, it would earn less for the underlying physical LNG when it is sold.

The JKM spot Asian LNG price rose to a record high of $56.33/MMBtu Oct. 6, while the Dutch TTF day-ahead contract in Europe reached a high of $39.50/MMBtu Oct. 5. Prices have moderated since then, though they remain high.

“I want to highlight that the impact is substantially all noncash and tied to the significant volatility we have experienced in the global LNG market, which has otherwise served as a significant tailwind for our businesses from both the financial and commercial perspective,” Davis said. “The tailwinds are reflected in our increased guidance for 2021 and the 2022 guidance we are rolling out this morning above our normalized run rate ranges.”

By the numbers

For the quarter ended Sept. 30, Cheniere reported a net loss of $1.1 billion on revenue of $3.2 billion, versus a year-ago loss of $463 million on revenue of $1.5 billion.

The company is currently commissioning a sixth liquefaction train at its Sabine Pass terminal in Louisiana.

Next year, Cheniere expects to sanction an up to 10 million mt/year midscale expansion at the site of its three-train Corpus Christi Liquefaction facility in Texas.