Southwest Airlines 2008 Annual Report Download - page 43

percent versus 2007. Both the dollar and the
per-ASM increase were driven primarily by a 35.6
percent increase in the average price per gallon for jet
fuel, including the impact of fuel derivatives used in
hedging, and including related taxes. As a result of
the Company’s fuel hedging program and inclusive
of the impact of SFAS 133, the Company recognized
net gains totaling $1.1 billion in 2008 relating to fuel
derivative instruments versus $686 million of net
gains recognized in 2007. Cash settlements realized
from the expiration/settlement of fuel derivatives
were $1.3 billion in 2008 versus $727 million for
2007. The primary reason that gains recognized in
Fuel and oil expense during 2008 were less than the
cash settlement of fuel derivatives was due to the fact
that a portion of the gains associated with these
settlements had already been recognized in earnings
in prior periods, as they were associated with
ineffective hedges or derivatives that did not qualify
for SFAS 133 special hedge accounting. See Note 10
to the Consolidated Financial Statements. The 2008
increase in fuel prices was partially offset by steps
the Company has taken to improve the fuel efficiency
of its aircraft, its aircraft engines, and its flight plans
and procedures. These steps resulted in a 2.1 percent
reduction in fuel gallons consumed per ASM flown
for 2008 versus 2007.
As of December 31, 2008, the Company holds
fuel hedge positions for the years from 2009 through
2013. For each of these years, the Company has a net
fuel hedge position for approximately ten percent of
its currently forecasted fuel consumption for those
periods. As of October 15, 2008, the Company had
more significant fuel derivative positions related to
these future periods, but during fourth quarter 2008,
made the decision to reduce such positions to the
current levels. The Company accomplished this
reduced hedge by entering into additional derivative
contracts — through selling primarily fixed-price
swap derivatives. The Company believes this strategy
enables it to participate in further price declines via
the sold derivatives, which should materially offset
further declines in value of the Company’s
previously purchased derivatives. This decision also
benefitted the Company by reducing its exposure to
cash collateral requirements the Company would be
required to post with its counterparties if market
prices continued to fall. Since, in many cases, fuel
derivatives were sold at lower prices than the
positions that were previously purchased, and
disregarding any future potential activity involving
fuel derivative instruments, the Company has fixed
some losses associated with these instruments and
currently expects to pay higher than market prices for
fuel for these future periods.
Maintenance materials and repairs per ASM
increased 12.9 percent compared to 2007, while
increasing $105 million on a dollar basis. On both a
dollar basis and a per ASM basis, engine expense
accounted for almost 60 percent of the increase and
airframe expense accounted for approximately 40
percent of the increase. The majority of the increase
in engine costs related to the Company’s 737-700
aircraft. For all of 2007 and the first half of 2008,
these aircraft engines were accounted for on a time
and materials basis. During the first half of 2008,
there were significantly more repair events for these
engines than in the first half of 2007. This was due to
the fact that the 737-700 is the newest aircraft type in
the Company’s fleet, and, as this fleet has matured,
the number of engines on these aircraft undergoing
their first major overhaul has increased. As further
discussed below, in June 2008, the Company
transitioned to a new engine repair agreement for
these aircraft and, as noted below, expense is now
based on flight hours associated with 737-700
engines. The expense for 737-700 engines recognized
in the second half of 2008 associated with the current
agreement also exceeded the expense recognized in
the second half of 2007, when repairs were still being
accounted for on a time and materials basis. The
increase in airframe expense primarily was due to
more planned airframe inspection and repair events
than in the prior year. These events, which are
required based on the number of flight hours each
individual aircraft has flown, were higher in number
as well as cost per event.
In June 2008, the Company transitioned from its
previous 737-700 engine repair agreement with GE
Engines Services, Inc. (GE Engines), under which
repairs were done pursuant to a combination of fixed
pricing and time and material terms, to a new
agreement with GE Engines that provides for engine
repairs to be done on a rate per flight hour basis. The
previous agreement was set to expire in 2013, while
the new agreement will expire in 2018. The new
agreement covers all engines currently in the
Company’s 737-700 fleet as well as future firm
deliveries for this aircraft type. Under this new
agreement, the Company has effectively transferred
risk for specified future repairs and maintenance on
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