Southwest Airlines 2011 Annual Report Download - page 104

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. The Company also
examines the effectiveness of each individual hedge and 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 fuel derivatives are classified as Other 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:
Balance Sheet location
Asset derivatives
Liability
derivatives
(in millions)
Fair value
at
12/31/2011
Fair value
at
12/31/2010
Fair value
at
12/31/2011
Fair value
at
12/31/2010
Derivatives designated as hedges*
Fuel derivative contracts (gross) ..... Other current assets $ 17 $ 151 $ — $ 16
Fuel derivative contracts (gross) ..... Other assets 542 547 107 88
Fuel derivative contracts (gross) ..... Accrued liabilities 97 122 8 18
Fuel derivative contracts (gross) ..... Other noncurrent liabilities 93 71 24 9
Interest rate derivative contracts ..... Other assets 64 73 — —
Interest rate derivative contracts ..... Accrued liabilities 2 — — —
Interest rate derivative contracts ..... Other noncurrent liabilities — — 132 4
Total derivatives designated as
hedges ....................... $ 815 $ 964 $ 271 $ 135
Derivatives not designated as
hedges*
Fuel derivative contracts (gross) ..... Other current assets $ 124 $ 164 $ 58 $ 284
Fuel derivative contracts (gross) ..... Other assets 26 212 272 304
Fuel derivative contracts (gross) ..... Accrued liabilities 326 40 687 222
Fuel derivative contracts (gross) ..... Other noncurrent liabilities 9 33 122 257
Total derivatives not designated as
hedges ....................... $ 485 $ 449 $1,139 $1,067
Total derivatives ................. $1,300 $1,413 $1,410 $1,202
* 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.
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