Southwest Airlines 1999 Annual Report Download - page 24

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MARKET RISK
Southwest has interest rate risk in that it holds floating rate debt instruments and has commodity
price risk in that it must purchase jet fuel to operate its aircraft fleet. To the extent the Company does
not have hedges in place, jet fuel will be purchased at prevailing market prices. Southwest also has
market sensitive instruments in the form of the types of hedges it utilizes to decrease its exposure to jet
fuel price increases in addition to its debt instruments. The Company also operates 103 aircraft under
operating and capital leases. However, leases are not considered market sensitive financial instruments
and, therefore, are not included in the interest rate sensitivity analysis below. Commitments related to
leases are disclosed in Note 6 to the Consolidated Financial Statements. The Company does not
purchase or hold any derivative financial instruments for trading purposes.
Airline operators are inherently dependent upon energy to operate and, therefore, are impacted
by changes in jet fuel prices. Jet fuel consumed in 1999 and 1998 represented approximately 12.5 and
11.2 percent of Southwest’ s operating expenses, respectively. Southwest endeavors to acquire jet fuel
at the lowest prevailing prices possible.
Prior to December 1998, the Company hedged its exposure to jet fuel market price risk
primarily with purchased “out of the money,” crude oil call options. In December 1998, in order to take
advantage of historically low jet fuel prices, Southwest increased its fuel hedging activity by entering into
fixed price swap agreements hedging approximately 77 percent and 56 percent of its jet fuel needs in
first and second quarter 1999, respectively. In January 1999, the Company increased its hedging
position for second quarter 1999 to 74 percent. During the second half of 1999, the Company did not
have a significant portion of its fuel purchases hedged as futures prices were substantially higher than
then-current prices.
Since mid-1999, energy markets and prices have changed radically. As a result, the Company
has adjusted its hedge strategy. The Company utilizes financial derivative instruments for both short-term
and long-term time frames when it appears the Company can take advantage of market conditions. At
December 31, 1999, the Company had a mixture of purchased crude oil call options and fixed price
swap agreements in place to hedge approximately 10.1 percent of its 2000 total anticipated jet fuel
requirements. The Company had also entered into fixed price swap agreements to hedge a small
percentage of its 2001 and 2005 anticipated requirements. See Note 7 to the Consolidated Financial
Statements. In January and February 2000, the Company increased its hedging position by adding fixed
price swap agreements and crude oil collars. As of February 24, 2000, the Company’ s total positions