Alaska Airlines and Horizon Air 2007 Annual Report Download - page 160

ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURE
ABOUT MARKET RISK
We have interest-rate risk on our floating-rate
debt obligations and our available-for-sale
marketable investment portfolio, and commodity-
price risk in jet fuel required to operate our
aircraft fleet. We purchase the majority of our jet
fuel at prevailing market prices and seek to
manage market risk through execution of a
documented hedging strategy and other means.
We have market-sensitive instruments in the
form of fixed-rate debt instruments and financial
derivative instruments used to hedge our
exposure to jet-fuel price increases. We do not
purchase or hold any derivative financial
instruments for trading purposes.
Market Risk – Aircraft Fuel
Currently, our fuel-hedging portfolio consists
almost exclusively of crude oil call options. We
utilize the contracts in our portfolio as hedges to
decrease our exposure to the volatility of jet fuel
prices. Call options are designed to effectively
cap our cost of the crude oil component of fuel
prices, allowing us to limit our exposure to
increasing fuel prices. With these call option
contracts, we still benefit from the decline in
crude oil prices, as there is no downward
exposure other than the premiums that we pay to
enter into the contracts. Although to a lesser
extent, we also use collar structures for fuel
hedging purposes. We believe there is risk in not
hedging against the possibility of fuel price
increases. We estimate that a 10% increase or
decrease in crude oil prices as of December 31,
2007 would increase or decrease the fair value
of our hedge portfolio by approximately $35.4
million and $33.4 million, respectively.
Additionally, we have entered into fuel purchase
contracts that fix the refining margin we pay for
approximately 50% of our fuel consumption in
the first quarter of 2008.
Our portfolio of fuel hedge contracts was worth
$112.5 million at December 31, 2007, including
$30.9 million of capitalized premiums paid to
counterparties, compared to a portfolio value of
$68.6 million at December 31, 2006.
We continue to believe that our fuel hedge
program is an important part of our strategy to
reduce our exposure to volatile fuel prices. We
expect to continue to enter into these types of
contracts prospectively, although significant
changes in market conditions could affect our
decisions. For more discussion, see Note 3 to
our consolidated financial statements.
Financial Market Risk
We have exposure to market risk associated with
changes in interest rates related primarily to our
debt obligations and short-term investment
portfolio. Our debt obligations include variable-
rate instruments, which have exposure to changes
in interest rates. This exposure is somewhat
mitigated through our variable-rate investment
portfolio. A hypothetical 10% change in the
average interest rates incurred on variable-rate
debt during 2007 would correspondingly change
our net earnings and cash flows associated with
these items by approximately $2.8 million. In
order to help mitigate the risk of interest rate
fluctuations, we fixed the interest rates on certain
existing variable-rate debt agreements in 2005
and 2006. Additionally, several of our new debt
arrangements in 2006 and 2007 were fixed-rate
arrangements and we converted our variable-rate
$150 million senior notes to equity in 2006. We
continue to enter into both variable-rate and fixed-
rate arrangements in order to diversify our loan
portfolio, so that we mitigate risk of severe
market fluctuations. Our variable-rate debt is
approximately 40% of our total long-term debt at
December 31, 2007 compared to 37% at
December 31, 2006. Subsequent to
December 31, 2007 and through February 15,
2007, we have converted approximately $30
million of our variable-rate debt arrangements into
fixed-rate arrangements and we intend to convert
more in the future.
We also have investments in marketable
securities, which are exposed to market risk
associated with changes in interest rates. If
short-term interest rates were to average 1%
more than they did in 2007, interest income
would increase by approximately $9.2 million.
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