Air Canada 2014 Annual Report Download - page 127

127
2014 Consolidated Financial Statements and Notes 127 2014 Consolidated Financial Statements and Notes
SUMMARY OF GAIN (LOSS) ON FUEL AND
OTHER DERIVATIVES
2014 2013
Fuel derivatives $ (36) $ (6)
Share forward contracts 31 42
Prepayment option on senior secured notes 2 2
Interest rate swaps 2(1)
FUEL AND OTHER DERIVATIVES $ (1) $ 37
RISK MANAGEMENT
Under its risk management policy, the Corporation
manages its interest rate risk, foreign exchange risk,
share-based compensation risk and market risk (e.g.
fuel price risk) through the use of various derivative
financial instruments. The Corporation uses derivative
financial instruments only for risk management
purposes, 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.
As noted below, the Corporation uses derivative
instruments to provide economic hedges to mitigate
various risks. The derivative fair values represent the
amount of the consideration that could be exchanged
in an arm’s-length transaction between willing parties
who are under no compulsion to act. Fair value of
these derivatives is determined using prices in active
markets, where available. When no such market is
available, valuation techniques are applied such as
discounted cash flow analysis. The valuation technique
incorporates all factors that would be considered in
setting a price, including the Corporation’s own credit
risk and the credit risk of the counterparty.
Market Risks
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. Market risk comprises
three types of risk: foreign exchange risk; interest rate
risk; and other price risk, which includes commodity
price risk for jet fuel.
Fuel Price Risk
Fuel price risk is the risk that future cash flows will
fluctuate because of changes in jet fuel prices. 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. The Corporation uses
derivative contracts based on jet fuel, heating oil and
crude-oil based contracts. The Corporation’s policy
permits hedging of up to 75% of the projected jet
fuel purchases for the next 12 months, 50% for the
next 13 to 24 months and 25% for the next 25 to
36 months. These are maximum (but not mandated)
limits. There is no minimum monthly hedging
requirement. There are regular reviews to adjust the
strategy in light of market conditions.
During 2014:
• The Corporation recorded a loss of $36 in Fuel
and other derivatives related to fuel derivatives ($6
loss in 2013).
• The Corporation purchased crude-oil and refined
products-based call options covering a portion of
2014 and 2015 fuel exposure. The cash premium
related to these contracts was $44 ($39 in 2013
for 2013 and 2014 exposures).
• Fuel derivative contracts cash settled with
a fair value of $24 in favour of the Corporation
($29 in favour of the Corporation in 2013).
As of December 31, 2014, approximately 22% of
the Corporation’s anticipated purchases of jet fuel
for 2015 are hedged at an average West Texas
Intermediate (“WTI”) equivalent capped price of
US$97 per barrel. The Corporation’s contracts to
hedge anticipated jet fuel purchases over the 2015
period are comprised of call options with notional
volumes of 6,267,000 barrels. The fair value of the
fuel derivatives portfolio at December 31, 2014 is
$4 in favour of the Corporation ($20 in favour of the
Corporation in 2013) and is recorded within Prepaid
expenses and other current assets.
Foreign Exchange Risk
The Corporation’s financial results are reported in
Canadian dollars, while a large portion of its expenses,
debt obligations and capital commitments are in
foreign currencies, primarily in U.S. dollars. Foreign
exchange risk is the risk that fluctuations in foreign
exchange rates may have on operating results and
cash flows.
The Corporation’s risk management objective is to
reduce cash flow risk related to foreign denominated
cash flows.
The Corporation’s cash inflows are primarily in
Canadian dollars, while a large portion of its outflows
are in U.S. dollars. This unbalanced mix results in
an annual U.S. dollar shortfall from operations. In
order to mitigate this imbalance, the Corporation
has adopted a program to convert excess revenues
from offshore currencies into U.S. dollars. In 2014,
this conversion generated coverage for approximately
23% of the imbalance.
For the remainder of the currency imbalance (i.e. the
net U.S. dollar shortfall), the Corporation has a target
coverage of 60% on a rolling 18 month basis utilizing
the following risk management strategies: