Air Canada 2006 Annual Report Download - page 45

parties as at December 31, 2005 on currency forward contracts and option agreements on US$521 million).
These derivative instruments have not been designated as hedges for accounting purposes. The unrealized
gain has been recorded in “foreign exchange gain (loss)” on Air Canada’s combined consolidated statement of
operations.
The Corporation has entered into currency swap agreements for 16 Bombardier regional jet operating leases
until lease terminations between 2007 and 2011. Currency swaps for five Bombardier regional jet operating
leases, with third parties, were put in place on the inception of the leases and have a fair value at December 31,
2006 of $10 million in favour of third parties ($13 million in favour of third parties as at December 31, 2005),
taking into account foreign exchange rates in effect at that time. Currency swaps for 11 Bombardier regional jet
operating leases with third parties have a fair value as at December 31, 2006 of $3 million in favour of the
Corporation ($3 million in favour of the Corporation as at December 31, 2005). These swaps have not been
designated as hedges for hedge accounting purposes. The unrealized changes in fair value have been
recorded in “foreign exchange gain (loss)” on Air Canada’s combined consolidated statement of operations.
Fuel Price Risk Management
The Corporation enters into contracts with financial intermediaries to manage its exposure to jet fuel price
volatility. As at December 31, 2006, the Corporation had collar option and swap structures in place to hedge a
portion of its anticipated jet fuel requirements over the 2007 and 2008 period. Since jet fuel is not traded on an
organized futures exchange, liquidity for hedging this commodity is mostly limited to a shorter time horizon.
Crude oil and heating oil contracts are effective commodities for hedging jet fuel and the Corporation mainly
uses these commodities for medium to longer term hedges. Refer to section 4 of this MD&A for the
Corporation’s hedging position as at December 31, 2006 and as at February 14, 2007.
Hedge accounting was applied prospectively from October 1, 2005. Under hedge accounting, gains or losses
on fuel hedging contracts are recognized in earnings as a component of aircraft fuel expense when the
underlying jet fuel being hedged is consumed. Prior to the commencement of the Corporation’s hedge
accounting being applied, an unrealized gain of $2 million was recorded in “other” non-operating expense on Air
Canada’s combined consolidated statement of operations.
In 2006, the Corporation recognized a net loss of $43 million as a component of fuel expense on its combined
consolidated statement of operations (net loss of $3 million in 2005) on the settlement of matured contracts and
amortization of deferred costs. The fair value of the Corporation’s fuel hedging contracts as at December 31,
2006 was $24 million (US$21 million) in favour of counterparties ($3 million in favour of counterparties as at
December 31, 2005).
During 2006, the Corporation entered into two three-way collar option structures which are composed of one
short put option, one long call option and one short call option. This structure creates a ceiling on the potential
benefit to be realized by the Corporation if commodity prices increase above the threshold of the short call strike
price. Due to the ceiling in these derivative instruments, this type of derivative does not qualify as a hedging
instrument under GAAP. As at December 31, 2006, one of the three-way collar option structures remains
outstanding. The fair value of these derivative instruments was $1 million in favour of the counterparty and is
recorded in “accounts payable and accrued liabilities” on Air Canada's combined consolidated statement of
financial position.
During 2005, the Corporation de-designated one contract previously under hedge accounting that was
combined into a new net-written option. The net-written option has a fair value of less than zero at the time of
inception and so it does not qualify as a hedging instrument under GAAP. As at December 31, 2006, the fair
value of the net written option was $2 million in favour of the counterparty (less than $1 million in favour of the
counterparty as at December 31, 2005) and is recorded in “accounts payable and accrued liabilities” on Air
Canada’s combined consolidated statement of financial position.
In 2006 the Corporation recognized a net loss of $3 million in “other” non-operating expense on Air Canada’s
consolidated statement of operations for the derivative instruments which do not qualify as hedge accounting.
Concentration of Credit Risk
The Corporation does not believe it is subject to any significant concentration of credit risk. Cash and short-
term investments are in place with major financial institutions, Canadian governments and major corporations.
Accounts receivable are generally the result of sales of tickets to individuals through geographically dispersed
travel agents, corporate outlets or other airlines, often through the use of major credit cards.
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Management's Discussion and Analysis of Results and Financial Condition