Southwest Airlines 2009 Annual Report Download - page 77

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NOTES TO CONSOLIDATED FINANCIAL STATEMENTS—(Continued)
December 31, 2009
The Company evaluates its hedge volumes strictly from an “economic” standpoint and thus does not
consider whether the hedges qualified or will qualify for special hedge accounting. The Company defines its
“economic” hedge as the net volume of fuel derivative contracts held, including the impact of positions that have
been offset through sold positions, regardless of whether those contracts qualify for hedge accounting. For 2009,
the Company had fuel derivatives in place related to approximately 27 percent of its fuel consumption. As of
December 31, 2009, the Company had fuel derivative instruments in place to provide coverage on a large portion
of its 2010 estimated fuel consumption at varying price levels. The Company had derivative contracts in place for
approximately 50 percent of its estimated 2010 fuel consumption at prices beginning in the mid-$70 per barrel
range up to approximately $100 per barrel of crude oil. The Company also recently sold some crude oil call
options, which decreased its protection to effectively 20 percent of estimated consumption if market prices settle
in the $100 to $120 per barrel range. The Company also added another layer of purchased crude oil call options
to increase its protection to approximately 40 percent of estimated 2010 consumption if market prices exceed
$120 per barrel. The following table provides information about the Company’s volume of fuel hedging for the
years 2011 through 2013.
Period (by year)
Fuel hedged
as of
December 31,
2009 (gallons
in millions)
Forecasted
% of jet fuel
consumption
2011 ....................................... 559 39%
2012 ....................................... 232 16%
2013 ....................................... 98 7%
Upon proper qualification, the Company accounts for its fuel derivative instruments as cash flow hedges.
All derivatives designated as hedges that meet certain requirements are granted special hedge accounting
treatment. Generally, utilizing the special hedge accounting, all periodic changes in fair value of the derivatives
designated as hedges that are considered to be effective, as defined, are recorded in “Accumulated other
comprehensive income (loss)” (AOCI) until the underlying jet fuel is consumed. See Note 12 for further
information on AOCI. The Company is exposed to the risk that periodic changes will not be effective, as defined,
or that the derivatives will no longer qualify for special hedge accounting. Ineffectiveness, as defined, results
when the change in the fair value of the derivative instrument exceeds the change in the value of the Company’s
expected future cash outlay to purchase and consume jet fuel. To the extent that the periodic changes in the fair
value of the derivatives are not effective, that ineffectiveness is recorded to “Other (gains) losses, net” in the
income statement. Likewise, if a hedge ceases to qualify for hedge accounting, any change in the fair value of
derivative instruments since the last period is recorded to “Other (gains) losses, net” in the income statement in
the period of the change; however, any amounts previously recorded to AOCI would remain there until such time
as the original forecasted transaction occurs at which time these amounts would be reclassified to “Fuel and oil”
expense. When the Company does have sold positions as part of its fuel derivative instrument portfolio, any
subsequent changes in fair value of those positions are marked-to-market value through earnings. Likewise, any
changes in fair value of those positions that were offset by entering into the sold positions are concurrently
marked-to-market through earnings. However, any changes in value related to hedges that were deferred as part
of AOCI while designated as a hedge, would remain until the underlying derivative instrument settles. In a
situation where it becomes probable that a hedged forecasted transaction will not occur, any gains and/or losses
that have been recorded to AOCI would be required to be immediately reclassified into earnings. The Company
did not have any such situations occur during 2009, 2008, or 2007.
Ineffectiveness is inherent in hedging jet fuel with derivative positions based in other crude oil related
commodities. Due to the volatility in markets for crude oil and related products, the Company is unable to predict
the amount of ineffectiveness each period, including the loss of hedge accounting, which could be determined on
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