Air Canada 2014 Annual Report Download - page 59

59
2014 Management’s Discussion and Analysis
12. FINANCIAL INSTRUMENTS AND RISK MANAGEMENT
SUMMARY OF FUEL AND OTHER DERIVATIVES
The following is a summary of fuel and other derivatives included in non-operating income (expense) on
Air Canada’s consolidated statement of operations for the periods indicated:
FOURTH QUARTER FULL YEAR
CANADIAN DOLLARS IN MILLIONS 2014 2013 2014 2013
Fuel derivatives $ (18) $ (9) $ (36) $ (6)
Share forward contracts 24 29 31 42
Prepayment options on senior secured notes 2 2 2 2
Interest rate swaps 1 - 2 (1)
FUEL AND OTHER DERIVATIVES $ 9 $ 22 $ (1) $ 37
RISK MANAGEMENT
Under its risk management policy, Air Canada
manages its interest rate risk, foreign exchange
risk, share based compensation risk and market
risk through the use of various derivative financial
instruments. Air Canada 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, Air Canada engages in derivative
hedging in an effort 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 active markets, where
available. When no such market is available, valuation
techniques are applied such as discounted cash flow
analysis. Where practical, the valuation technique
incorporates all factors that would be considered in
setting a price, including Air Canada’s own credit risk
and the credit risk of the counterparty.
FUEL PRICE RISK MANAGEMENT
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,
Air Canada enters into derivative contracts with
financial intermediaries. Air Canada uses derivative
contracts based on jet fuel, heating oil and crude oil-
based contracts. Air Canada’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.
In 2014:
• Air Canada recorded a loss of $36 million in Fuel
and other derivatives on Air Canada’s consolidated
statement of operations related to fuel derivatives
(loss of $6 million in 2013).
• Air Canada 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 million ($39
million in 2013 for 2013 and 2014 exposures).
• Fuel derivative contracts cash settled with a fair
value of $24 million in favour of Air Canada ($29
million in favour of Air Canada in 2013).
As of December 31, 2014, approximately 22% of
Air Canada’s anticipated purchases of jet fuel for 2015
was hedged at an average West Texas Intermediate
(“WTI”) equivalent capped price of US$97 per barrel.
Air Canada’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 was $4 million in favour of
Air Canada ($20 million in favour of Air Canada in
2013) and is recorded within Prepaid expenses and
other current assets on Air Canada’s consolidated
statement of financial condition.
FOREIGN EXCHANGE RISK MANAGEMENT
Air Canada’s financial results are reported in Canadian
dollars, while a large portion of its expenses, debt
obligations and capital commitments are in foreign