Southwest Airlines 2004 Annual Report Download - page 59

SOUTHWEST AIRLINES CO.
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS Ì (Continued)
ties for hedging jet fuel. The Company has Ñnancial The Company primarily uses Ñnancial derivative
derivative instruments in the form of the types of hedges instruments to hedge its exposure to jet fuel price
it utilizes to decrease its exposure to jet fuel price increases and accounts for these derivatives as cash Öow
increases. The Company does not purchase or hold any hedges, as deÑned. In accordance with SFAS 133, the
derivative Ñnancial instruments for trading purposes. Company must comply with detailed rules and strict
documentation requirements prior to beginning hedge
The Company utilizes Ñnancial derivative instru- accounting. As required by SFAS 133, the Company
ments for both short-term and long-term time frames assesses the eÅectiveness of each of its individual hedges
when it appears the Company can take advantage of on a quarterly basis. The Company also examines the
market conditions. As of December 31, 2004, the eÅectiveness of its entire hedging program on a quar-
Company had a mixture of purchased call options, collar terly basis utilizing statistical analysis. This analysis
structures, and Ñxed price swap agreements in place to involves utilizing regression and other statistical analyses
hedge its total anticipated jet fuel requirements, at crude that compare changes in the price of jet fuel to changes
oil equivalent prices, for the following periods: 85 per- in the prices of the commodities used for hedging
cent for 2005 at approximately $26 per barrel, 65 per- purposes (crude oil, heating oil, and unleaded gasoline).
cent for 2006 at approximately $32 per barrel, over If a derivative instrument does not qualify for hedge
45 percent for 2007 at approximately $31 per barrel, accounting, as deÑned by SFAS 133, any change in fair
30 percent in 2008 at approximately $33 per barrel, and value of that derivative instrument is recorded immedi-
over 25 percent for 2009 at approximately $35 per ately in earnings.
barrel. As of December 31, 2004, the majority of the
Company's Ñrst quarter 2005 hedges are eÅectively During 2004, the Company recognized $13 mil-
heating oil-based positions in the form of option con- lion in additional expense in ""Other (gains) losses,
tracts. For the remainder of 2005, the majority of the net'', related to the ineÅectiveness of its hedges. During
Company's hedge positions are eÅectively in the form of 2003 and 2002, the Company recognized $16 million
unleaded gasoline-based and heating oil-based option and $5 million, in additional income, respectively, in
contracts. The majority of the remaining hedge posi- ""Other (gains) losses, net'', related to the ineÅective-
tions are crude oil-based positions. ness of its hedges. During 2004, 2003, and 2002, the
Company recognized approximately $24 million,
Under the rules established by SFAS 133, the $29 million, and $26 million, respectively, of net ex-
Company is required to record all Ñnancial derivative pense, related to amounts excluded from the Company's
instruments on its balance sheet at fair value; however, measurements of hedge eÅectiveness, in ""Other
not all instruments necessarily qualify for hedge ac- (gains) losses, net''. Hedge accounting, as administered
counting. Derivatives that are not designated as hedges according to SFAS 133, generally results in more vola-
must be adjusted to fair value through income. If a tility in the Company's Ñnancial statements than prior
derivative is designated as a hedge, depending on the to its adoption, due to the changes in market values of
nature of the hedge, changes in its fair value that are derivative instruments and some ineÅectiveness that has
considered to be eÅective, as deÑned, either oÅset the been experienced in fuel hedges.
change in fair value of the hedged assets, liabilities, or
Ñrm commitments through earnings or are recorded in During 2004, 2003, and 2002, the Company
""Accumulated other comprehensive income (loss)'' un- recognized gains in ""Fuel and oil'' expense of $455 mil-
til the hedged item is recorded in earnings. Any portion lion, $171 million, and $45 million, respectively, from
of a change in a derivative's fair value that is considered hedging activities. At December 31, 2004 and 2003,
to be ineÅective, as deÑned, is recorded immediately in approximately $51 million and $19 million, respec-
""Other (gains) losses, net'' in the Consolidated State- tively, due from third parties from expired derivative
ment of Income. See Note 11 for further information on contracts, is included in ""Accounts and other receiv-
Accumulated other comprehensive income (loss). Any ables'' in the accompanying Consolidated Balance
portion of a change in a derivative's fair value that the Sheet. The fair value of the Company's Ñnancial deriva-
Company elects to exclude from its measurement of tive instruments at December 31, 2004, was a net asset
eÅectiveness is required to be recorded immediately in of approximately $796 million. The current portion of
earnings. these Ñnancial derivative instruments is classiÑed as
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