At the end of the second segment of Episode 3, you’ll enter a small cavern in the chasm wall that you’re climbing filled with a shallow pool of water. The cocoon is the fleshy sack hanging from the ceiling directly in front of you. You have to destroy it before you can proceed with the level because it is blocking the exit. You can use the combination of a spray bottle and lighter to set it on fire or throw a bottle of flammable liquid at it and then shoot the bottle in mid-air. If you need supplies, there are a large number of bottles and containers floating in the water below the cocoon.