Southwest Airlines 2009 Annual Report Download - page 53

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travel, the Company has determined that the period earned is the period in which the Company has fulfilled its
obligation under the contract signed with the particular business partner, which is on a monthly or quarterly
basis, upon sale, as the related marketing services are performed or provided. The vast majority of these
marketing services consist of the access granted, either monthly or quarterly, to various lists of the Company’s
frequent flyer members. The estimated amount that is not associated with free travel is recognized in “Other
revenue” in the period earned.
The Company believes it is unlikely that materially different estimates for the assumptions used in
estimating the liabilities associated with its frequent flyer program would be made based on the conditions
suggested by actual historical experience and other data available at the time estimates were made.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company has interest rate risk in its floating rate debt obligations and interest rate swaps, commodity
price risk in jet fuel required to operate its aircraft fleet, and market risk in the derivatives used to manage its fuel
hedging program. In addition, the sale-leaseback transactions entered into by the Company in December 2008
and in 2009 for a total of 16 aircraft, have lease payments that fluctuate based in part on changes in market
interest rates. The Company purchases jet fuel at prevailing market prices, but seeks to manage market risk
through execution of a documented hedging strategy. The Company has market sensitive instruments in the form
of fixed rate debt instruments and financial derivative instruments used to hedge its exposure to jet fuel price
increases. The Company also operates 97 aircraft under operating and capital leases. However, except for the 16
aircraft that were sold and leased back in 2008 and 2009, the remainder of the Company’s leases are not
considered market sensitive financial instruments and, therefore, are not included in the interest rate sensitivity
analysis below. Commitments related to leases are disclosed in Note 8 to the Consolidated Financial Statements.
The Company does not purchase or hold any derivative financial instruments for trading purposes. See Note 10
to the Consolidated Financial Statements for information on the Company’s accounting for its hedging program
and for further details on the Company’s financial derivative instruments.
Hedging
The Company utilizes financial derivative instruments, on both a short-term and a long-term basis, as a form
of insurance against the potential for significant increases in fuel prices. The Company believes there is
significant risk in not hedging against the possibility of such fuel price increases. The Company expects to
consume approximately 1.4 billion gallons of jet fuel in 2010. Based on this usage, a change in jet fuel prices of
just one cent per gallon would impact the Company’s “Fuel and oil expense” by approximately $14 million per
year, excluding any impact of the Company’s derivative instruments.
As of December 31, 2008, the Company held a net position of fuel derivative instruments that effectively
represented a hedge of approximately ten percent of its anticipated jet fuel purchases for each year from 2010
through 2013. Prior to fourth quarter 2008, the Company had held fuel derivative instruments for a significant
portion of its anticipated fuel purchases for these years; however, due to a precipitous decline in fuel prices, the
Company significantly reduced its hedge in order to minimize fuel hedging losses related to further oil price
declines and to minimize the potential for the Company to provide additional cash collateral deposits to
counterparties. The Company accomplished this reduced hedge by entering into additional derivative
contracts — through selling primarily fixed-price swap derivatives. The Company believes this strategy enabled
it to participate in further price declines via the sold derivatives, which materially offset further declines in value
of the Company’s previously purchased derivatives. Subsequently, in 2009, the Company again added to its
hedging position related to future years’ expected fuel purchases. The total net fair value of outstanding financial
derivative instruments related to the Company’s jet fuel market price risk at December 31, 2009, was a net
liability of $147 million. This balance consists of a net liability of the market value of fuel derivative instruments
totaling $477 million, net of $330 million in cash collateral that has been provided by the Company to its
counterparties. The current portion of these financial derivative instruments, or $32 million, net of cash collateral
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