Southwest Airlines 2010 Annual Report Download - page 89

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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
a derivative by derivative basis or in the aggregate for a specific commodity. This may result, and has resulted, in
increased volatility in the Company’s financial results. Factors that have and may continue to lead to
ineffectiveness and unrealized gains and losses on derivative contracts include: significant fluctuation in energy
prices, the number of derivative positions the Company holds, significant weather events affecting refinery
capacity and the production of refined products, and the volatility of the different types of products the Company
uses in hedging. However, even though derivatives may not qualify for hedge accounting, the Company
continues to hold the instruments as management believes derivative instruments continue to afford the Company
the opportunity to stabilize jet fuel costs.
Accounting pronouncements pertaining to derivative instruments and hedging are complex with stringent
requirements, including the documentation of a Company hedging strategy, statistical analysis to qualify a
commodity for hedge accounting both on a historical and a prospective basis, and strict contemporaneous
documentation that is required at the time each hedge is designated by the Company. As required, the Company
assesses the effectiveness of each of its individual hedges on a quarterly basis. The Company also examines the
effectiveness of its entire hedging program on a quarterly basis utilizing statistical analysis. This analysis
involves utilizing regression and other statistical analyses that compare changes in the price of jet fuel to changes
in the prices of the commodities used for hedging purposes.
All cash flows associated with purchasing and selling derivatives are classified as operating cash flows in
the Consolidated Statement of Cash Flows. The following table presents the location of all assets and liabilities
associated with the Company’s hedging instruments within the Consolidated Balance Sheet:
Asset Derivatives
Liability
Derivatives
(in millions) Balance Sheet location
Fair
Value
at
12/31/10
Fair
Value
at
12/31/09
Fair
Value
at
12/31/10
Fair
Value
at
12/31/09
Derivatives designated as hedges
Fuel derivative contracts* ..................... Other current assets $ 151 $ — $ 16 $ —
Fuel derivative contracts* ..................... Other assets 547 — 88 —
Fuel derivative contracts* ..................... Accrued liabilities 122 122 18 4
Fuel derivative contracts* ..................... Other noncurrent liabilities 71 225 9 10
Interest rate derivative contracts ................ Other assets 73 47 — —
Interest rate derivative contracts ................ Other noncurrent liabilities — — 4 10
Total derivatives designated as hedges ......... $ 964 $ 394 $ 135 $ 24
Derivatives not designated as hedges
Fuel derivative contracts* ..................... Other current assets $ 164 $ — $ 284 $ —
Fuel derivative contracts* ..................... Other assets 212 — 304 —
Fuel derivative contracts* ..................... Accrued liabilities 40 324 222 566
Fuel derivative contracts* ..................... Other noncurrent liabilities 33 302 257 870
Total derivatives not designated as hedges ...... $ 449 $ 626 $1,067 $1,436
Total derivatives ........................... $1,413 $1,020 $1,202 $1,460
* Represents the position of each trade before consideration of offsetting positions with each counterparty and
does not include the impact of cash collateral deposits provided to or received from counterparties. See
discussion of credit risk and collateral following in this Note.
83