Air Canada 2008 Annual Report Download - page 53

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2008 Management’s Discussion and Analysis
53
12. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
As described in section 16 of this MD&A, the Corporation adopted Canadian Institute of Chartered Accountants (“CICA”)
sections 3862 and 3863 effective January 1, 2008. These new standards enhance disclosures with respect to financial
instruments.
RiskManagement
The Corporation is exposed to the following risks as a result of holding financial instruments: market risk, credit risk, fuel
price risk, interest rate risk, foreign exchange risk and liquidity risk. The following is a description of these risks and how they
are managed by the Corporation.
MarketRisk
Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in
market prices.
The Corporation uses derivative instruments to reduce market exposures from changes in foreign currency rates, interest
rates, and fuel prices. The Corporation uses derivative instruments only for risk management purposes and not for generating
trading profit. As such, any change in cash flows associated with derivative instruments is designed to be offset by changes
in cash flows related to the risk being hedged.
CreditRisk
Credit risk is the risk of loss due to a counterparty’s inability to meet its obligations. As at December 31, 2008, the
Corporation’s credit risk exposure consists mainly of the carrying amounts of cash, cash equivalents and short-term
investments and accounts receivable as well as collateral deposits for fuel derivatives extended to counterparties. Cash and
short-term investments are in place with major financial institutions, the Canadian government and major corporations.
Accounts receivable are generally the result of sales of tickets to individuals, often through the use of major credit cards,
through geographically dispersed travel agents, corporate outlets, or other airlines, often through the use of major credit
cards. Credit rating guidelines are used in determining counterparties for fuel hedging. In order to manage its exposure to
credit risk and assess credit quality, the Corporation reviews counterparty credit ratings on a regular basis and sets credit
limits when deemed necessary.
As of January 31, 2009, the Corporation had $158 million in collateral deposits extended to fuel hedge counterparties ($328
million as of December 31, 2008).
In 2008, a counterparty defaulted under a number of derivative agreements with the Corporation. As a result, the Corporation
recorded a loss of $6 million and $2 million related to these foreign exchange and fuel derivatives, respectively. The loss is
recorded in non-operating income (expense).
FuelPriceRisk
In order to manage its exposure to jet fuel prices and to help mitigate volatility in operating cash flows, the Corporation
enters into derivative contracts with financial intermediaries. Throughout 2008, a systematic hedging strategy was applied
by adding hedging positions on a regular basis. There are regular reviews to adjust the strategy in light of market changes.
During 2008, fuel prices experienced extreme volatility and declined from a peak of US$145 per barrel of WTI crude oil in
mid-2008 to US$34 per barrel of WTI crude oil in December 2008, which triggered collateral deposit requirements. The
Corporation does not purchase or hold any derivative financial instruments for trading purposes.
As of December 31, 2008, approximately 35% of the Corporation’s anticipated purchases of fuel for 2009 are hedged at
an average WTI-equivalent capped price of USD$100 per barrel, of which 79% is subject to an average WTI-equivalent
floor price of US$86 per barrel. The Corporation’s contracts to hedge anticipated jet fuel purchases over the 2009 period
is comprised of jet fuel, heating oil and crude oil-based contracts. The Corporation also hedged approximately 14% of its
2010 anticipated jet fuel purchases in crude oil-based contracts at an average capped price of US$110 per barrel and which
are subject to an average floor price of US$103 per barrel.