Southwest Airlines 2009 Annual Report Download - page 48

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associated with the use of the long-lived asset. While the airline industry as a whole has experienced many of
these indicators, the Company has continued to operate virtually all of its aircraft, generate positive cash flow,
and produce operating profits. Consequently, the Company has not identified any impairment related to its
existing aircraft fleet. The Company will continue to monitor its long-lived assets and the airline operating
environment.
The Company believes it is unlikely that materially different estimates for expected lives, expected residual
values, and impairment evaluations would be made or reported based on other reasonable assumptions or
conditions suggested by actual historical experience and other data available at the time estimates were made.
Financial Derivative Instruments
The Company utilizes financial derivative instruments primarily to manage its risk associated with changing
jet fuel prices. See “Quantitative and Qualitative Disclosures about Market Risk” for more information on these
risk management activities and see Note 10 to the Consolidated Financial Statements for more information on the
Company’s fuel hedging program, and financial derivative instruments.
All derivatives are required to be reflected at market (fair value) and recorded on the Consolidated Balance
Sheet. At December 31, 2009, the Company was a party to over 600 financial derivative instruments, related to
its fuel hedging program, for the years from 2010 through 2013. The fair value of the Company’s fuel hedging
financial derivative instruments recorded on the Company’s Consolidated Balance Sheet as of December 31,
2009, not considering the impact of cash collateral deposits provided to counterparties, was a net liability of $477
million, compared to a liability of $992 million at December 31, 2008. The decrease in this liability primarily
was due to an increase in energy prices throughout most of 2009, as well as the expiration (i.e., settlement in
which the Company paid cash to counterparties) of approximately $245 million in fuel derivative instruments
that related to 2009. Of the $477 million liability in fair value of fuel hedging financial derivative instruments at
December 31, 2009, approximately $124 million is expected to settle or expire during 2010. Changes in the fair
values of these instruments can vary dramatically based on changes in the underlying commodity prices, as has
been evident in recent years. During 2008, market “spot” prices for crude oil peaked at a high of over $147 per
barrel and hit a low price of under $35 per barrel — both within a period of approximately five months. During
2009, these same prices ranged from a low of $33 per barrel to a high of $82 per barrel. Market price changes can
be driven by factors such as supply and demand, inventory levels, weather events, refinery capacity, political
agendas, and general economic conditions, among other items. The financial derivative instruments utilized by
the Company primarily are a combination of collars, purchased call options, call spreads, and fixed price swap
agreements. The Company does not purchase or hold any derivative instruments for trading purposes.
The Company enters into financial derivative instruments with third party institutions in “over-the-counter”
markets. Since the majority of the Company’s financial derivative instruments are not traded on a market
exchange, the Company estimates their fair values. Depending on the type of instrument, the values are
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. Also, since there is not a reliable forward
market for jet fuel, the Company must estimate the future prices of jet fuel in order to measure the effectiveness
of the hedging instruments in offsetting changes to those prices. Forward jet fuel prices are estimated through the
observation of similar commodity futures prices (such as crude oil, heating oil, and unleaded gasoline) and
adjusted based on variations of those like commodities to the Company’s ultimate expected price to be paid for
jet fuel at the specific locations in which the Company hedges.
Fair values for financial derivative instruments and forward jet fuel prices are both estimated prior to the
time that the financial derivative instruments settle, and the time that jet fuel is purchased and consumed,
respectively. However, once settlement of the financial derivative instruments occurs and the hedged jet fuel is
purchased and consumed, all values and prices are known and are recognized in the financial statements. In
recent years, because of increased volatility in energy markets, the Company’s estimates of the presumed
effectiveness of its hedges made at the time the hedges were initially designated have materially differed from
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