United Airlines 2010 Annual Report Download - page 140

Aircraft fuel has been the Company’s single largest operating expense for the last several years. In addition,
aircraft fuel is a globally traded commodity with significant price volatility. Aircraft fuel prices fluctuate based
on market expectations of supply and demand, among other factors. Increases in fuel prices may adversely
impact the Company’s financial performance, operating cash flows and financial position as greater amounts of
cash may be required to obtain aircraft fuel for operations. To protect against increases in the prices of aircraft
fuel, the Company routinely hedges a portion of its future fuel requirements, provided the hedges are expected to
be cost effective. The Company uses fixed price swaps, purchased call options, collars or other commonly used
financial hedge instruments based on fuel or closely related commodities, such as heating and crude oils. The
Company strives to maintain fuel hedging levels and exposure generally consistent with industry standards, so
that the Company’s fuel cost is not disproportionate to the fuel costs of its major competitors. The Company does
not enter into derivative instruments for non-risk management purposes.
Prior to April 1, 2010, United’s instruments classified as economic hedges were not designated as cash flow
or fair value hedges under accounting principles related to hedge accounting. All changes in the fair value of
economic hedges were recorded in income, with the offset to either current assets or liabilities in each reporting
period. Economic fuel hedge gains and losses were classified as part of aircraft fuel expense, and fuel hedge
gains and losses from instruments that are not deemed economic hedges were classified as part of nonoperating
income/expense.
Effective April 1, 2010, United designated substantially all of its outstanding fuel derivative contracts as
cash flow hedges under applicable accounting standards. In addition, substantially all new fuel derivative
contracts entered into subsequent to April 1, 2010 by United were designated as cash flow hedges. Continental
applied cash flow hedge accounting for all periods presented in these financial statements.
Accounting pronouncements pertaining to derivative instruments and hedging are complex with stringent
requirements, including documentation of hedging strategy, statistical analysis to qualify a commodity for hedge
accounting both on a historical and a prospective basis, and strict contemporaneous documentation that is
required at the time each hedge is designated as a cash flow hedge. As required, the Company assesses the
effectiveness of each of its individual hedges on a quarterly basis. The Company also examines the effectiveness
of its entire hedging program on a quarterly basis utilizing statistical analysis. This analysis involves utilizing
regression and other statistical analyses that compare changes in the price of aircraft fuel to changes in the prices
of the commodities used for hedging purposes.
Upon proper qualification, the Company accounts for its fuel derivative instruments as cash flow
hedges. All derivatives designated as hedges that meet certain requirements are granted special hedge accounting
treatment. Generally, utilizing the special hedge accounting, all periodic changes in fair value of the derivatives
designated as hedges that are considered to be effective are recorded in accumulated other comprehensive
income (loss) (“AOCI”) until the underlying fuel is consumed and recorded in fuel expense. The Company is
exposed to the risk that its hedges may not be effective in offsetting changes in the cost of fuel and that its hedges
may not continue to qualify for special hedge accounting. Hedge ineffectiveness results when the change in the
fair value of the derivative instrument exceeds the change in the value of the Company’s expected future cash
outlay to purchase and consume fuel. To the extent that the periodic changes in the fair value of the derivatives
are not effective, that ineffectiveness is classified as other nonoperating income (expense).
If the Company terminates a derivative prior to its contractual settlement date, then the cumulative gain or
loss recognized in AOCI at the termination date remains in AOCI until the forecasted transaction occurs. In a
situation where it becomes probable that a hedged forecasted transaction will not occur, any gains and/or losses
that have been recorded to AOCI would be required to be immediately reclassified into earnings. All cash flows
associated with purchasing and settling derivatives are classified as operating cash flows in the statements of cash
flow.
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