Southwest Airlines 2007 Annual Report Download - page 68

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the production of refined products, and the volatility of
the different types of products the Company uses for
protection. The number of instances in which the Com-
pany has discontinued hedge accounting for specific
hedges and for specific refined products, such as unleaded
gasoline, has increased recently, primarily due to these
reasons. In these cases, the Company has determined that
the hedges will not regain effectiveness in the time period
remaining until settlement and therefore must discon-
tinue special hedge accounting, as defined by SFAS 133.
When this happens, any changes in fair value of the
derivative instruments are marked to market through
earnings in the period of change. However, even though
these derivatives may not qualify for SFAS 133 special
hedge accounting, the Company continues to hold the
instruments as it believes they continue to represent good
“economic hedges” in its goal to minimize jet fuel costs.
As the fair value of the Company’s hedge positions can
fluctuate significantly in amount from period to period, it
is more probable that there will be continued variability
recorded in the income statement and that the amount of
hedge ineffectiveness and unrealized gains or losses for
changes in value of the derivatives recorded in future
periods will be material. This is primarily due to the fact
that small differences in the correlation of crude oil
related products are leveraged over large dollar volumes.
All cash flows associated with purchasing and selling
derivatives are classified as operating cash flows in the
Consolidated Statement of Cash Flows, either as a com-
ponent of changes in Other current assets or Other, net,
depending on whether the derivative will settle within
twelve months or beyond twelve months, respectively.
The following table presents the location of pre-tax gains
and/or losses on derivative instruments within the Con-
solidated Statement of Income.
2007 2006 2005
(In millions)
Fuel hedge (gains)
included in Fuel and
oil expense ......... $(686) $(634) $(892)
Mark-to-market impact
from fuel contracts
settling in future
periods — included in
Other (gains) losses,
net .............. (219) 42 (77)
Ineffectiveness from fuel
hedges settling in
future periods —
included in Other
(gains) losses, net . . . (51) 39 (9)
2007 2006 2005
(In millions)
Realized ineffectiveness
and mark-to-market
(gains) or losses —
included in Other
(gains) losses, net . . . (90) 20 (24)
Premium cost of fuel
contracts included in
Other (gains) losses,
net .............. 58 52 35
Also, the following table presents the fair values of
the Company’s remaining derivative instruments, receiv-
able amounts from settled/expired derivative contracts,
and the amounts of unrealized gains, net of tax, in
Accumulated other comprehensive income related to fuel
hedges within the Consolidated Balance Sheet.
2007 2006
(In millions)
Fair value of current fuel contracts
(Fuel derivative contracts) ..... $1,069 $369
Fair value of noncurrent fuel
contracts (Other assets) ....... 1,318 630
Due from third parties for settled
fuel contracts (Accounts and
other receivables) ............ 109 42
Net unrealized gains from fuel
hedges, net of tax (Accumulated
other comprehensive income) . . . 1,221 584
The fair value of the derivative instruments, depend-
ing on the type of instrument, was determined by the use
of present value methods or standard option value models
with assumptions about commodity prices based on those
observed in underlying markets. Included in the above
total net unrealized gains from fuel hedges as of Decem-
ber 31, 2007, are approximately $556 million in net
unrealized gains that are expected to be realized in
earnings during 2008. In addition, as of December 31,
2007, the Company had already recognized gains due to
ineffectiveness and derivatives that do not qualify for
hedge accounting totaling $180 million, net of taxes.
These gains were recognized in 2007 and prior periods,
and are reflected in Retained earnings as of December 31,
2007, but the underlying derivative instruments will not
expire/settle until 2008 or future periods.
Interest Rate Swaps
During first quarter 2007, the Company executed
interest rate swap agreements relating to its $300 million
49
NOTES TO CONSOLIDATED FINANCIAL STATEMENTS — (Continued)