Southwest Airlines 2011 Annual Report Download - page 75

AirTran operated a total of 199 aircraft under operating and capital leases. However, except for a small number
of aircraft that have lease payments that fluctuate based in part on changes in market interest rates, the remainder
of the leases are not considered market sensitive financial instruments and, therefore, are not included in the
interest rate sensitivity analysis below. Commitments related to leases are disclosed in Note 8 to the Consolidated
Financial Statements. The Company does not purchase or hold any derivative financial instruments for trading
purposes. See Note 10 to the Consolidated Financial Statements for information on the Company’s accounting
for its hedging program and for further details on the Company’s financial derivative instruments.
Hedging
The Company purchases jet fuel at prevailing market prices, but seeks to manage market risk through
execution of a documented hedging strategy. The Company utilizes financial derivative instruments, on both a
short-term and a long-term basis, as a form of insurance against the potential for significant increases in fuel
prices. The Company believes there is significant risk in not hedging against the possibility of such fuel price
increases. Inclusive of the operations of AirTran, the Company expects to consume approximately 1.9 billion
gallons of jet fuel in 2012. Based on this anticipated usage, a change in jet fuel prices of just one cent per gallon
would impact the Company’s Fuel and oil expense by approximately $19 million for 2012, excluding any impact
associated with fuel derivative instruments held.
As of December 31, 2011, the Company held a net position of fuel derivative instruments that represented a
hedge for a portion of its anticipated jet fuel purchases for each year from 2012 through 2015. See Note 10 to the
Consolidated Financial Statements for further information. The Company may increase or decrease the size of its
fuel hedge based on its expectation of future market prices, as well as its perceived exposure to cash collateral
requirements contained in the agreements it has signed with various counterparties. The gross fair value of
outstanding financial derivative instruments related to the Company’s jet fuel market price risk at December 31,
2011, was a net liability of $44 million. In addition, a total of $226 million in cash collateral has been provided
by the Company to three counterparties associated with these instruments. The fair values of the derivative
instruments, depending on the type of instrument, were determined by use of present value methods or standard
option value models with assumptions about commodity prices based on those observed in underlying markets.
An immediate 10 percent increase or decrease in underlying fuel-related commodity prices from the
December 31, 2011 (for all years from 2012 through 2015) prices would correspondingly change the fair value of
the commodity derivative instruments in place by approximately $400 million. Fluctuations in the related
commodity derivative instrument cash flows may change by more or less than this amount based upon further
fluctuations in futures prices as well as related income tax effects. In addition, this does not consider changes in
cash collateral provided to or by counterparties, which would fluctuate in an amount equal to or less than this
amount, depending on the type of collateral arrangement in place with each counterparty. This sensitivity
analysis uses industry standard valuation models and holds all inputs constant at December 31, 2011 levels,
except underlying futures prices.
The Company’s credit exposure related to fuel derivative instruments is represented by the fair value of
contracts with a net positive fair value to the Company. At such times, these outstanding instruments expose the
Company to credit loss in the event of nonperformance by the counterparties to the agreements. As of
December 31, 2011, the Company had five counterparties in which the derivatives held were a net asset, totaling
$200 million. To manage credit risk, the Company selects and will periodically review counterparties based on
credit ratings, limits its exposure to a single counterparty with collateral support agreements, and monitors the
market position of the program and its relative market position with each counterparty. However, if one or more
of these counterparties were in a liability position to the Company and were unable to meet their obligations, any
open derivative contracts with the counterparty could be subject to early termination, which could result in
substantial losses for the Company. At December 31, 2011, the Company had agreements with all of its
counterparties containing early termination rights triggered by credit rating thresholds and/or bilateral collateral
provisions whereby security is required if market risk exposure exceeds a specified threshold amount based on
the counterparty’s credit rating. The Company also had agreements with counterparties in which cash deposits
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