Southwest Airlines 2011 Annual Report Download - page 103

that financial derivative instruments in other commodities, such as West Texas Intermediate crude oil (“WTI”),
Brent crude oil (“Brent”), and refined products, such as heating oil and unleaded gasoline, can be useful in
decreasing its exposure to jet fuel price volatility. The Company does not purchase or hold any financial
derivative instruments for trading purposes.
The Company has used financial derivative instruments for both short-term and long-term time frames, and
primarily uses a mixture of purchased call options, collar structures (which include both a purchased call option
and a sold put option), call spreads (which include a purchased call option and a sold call option), and fixed price
swap agreements in its portfolio. Although the use of collar structures and swap agreements can reduce the
overall cost of hedging, these instruments carry more risk than purchased call options in that the Company could
end up in a liability position when the collar structure or swap agreement settles. With the use of purchased call
options and call spreads, the Company cannot be in a liability position at settlement.
The Company evaluates its hedge volumes strictly from an “economic” standpoint and thus does not
consider whether the hedges have qualified or will qualify for 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 2011,
the Company had fuel derivatives in place related to approximately 38 percent of its fuel consumption. As of
December 31, 2011, the Company had fuel derivative instruments in place to provide coverage on a portion of its
2012 estimated fuel consumption. The following table provides information about the Company’s (inclusive of
fuel derivative instruments acquired from Air Tran – See Note 2) volume of fuel hedging for the years 2012
through 2015 on an “economic” basis.
Period (by year)
Fuel hedged as of
December 31, 2011
(gallons in millions)
2012 ............................................... 111
2013 ............................................... 1,000
2014 ............................................... 815
2015 ............................................... 395
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 hedge accounting treatment.
Generally, utilizing hedge accounting, all periodic changes in fair value of the derivatives designated as hedges
that are considered to be effective are recorded in AOCI until the underlying jet fuel is consumed. See Note 13.
The Company’s results are subject to the possibility that periodic changes will not be effective, as defined, or that
the derivatives will no longer qualify for hedge accounting. Ineffectiveness 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
ineffective, the ineffective portion is recorded to Other (gains) losses, net in the Consolidated Statement of
Income. Likewise, if a hedge ceases to qualify for hedge accounting, any change in the fair value of derivative
instruments since the last reporting period is recorded to Other (gains) losses, net, in the Consolidated Statement
of Income 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 has sold derivative positions in order to effectively “close” or offset a
derivative already held as part of its fuel derivative instrument portfolio, any subsequent changes in fair value of
those positions are marked to market 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 originally forecasted transaction occurs. 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,
2010, or 2011.
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