Southwest Airlines 2012 Annual Report Download - page 106

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as well as the types of derivative instruments held and the strike prices of those instruments. For example, the
Company may enter into “out-of-the-money” option contracts (including catastrophic protection), which may not
generate intrinsic gains at settlement if market prices do not rise above the option strike price. Therefore, even
though the Company may have an “economic” hedge in place for a particular period, that hedge may not produce
any hedging gains and may even produce hedging losses depending on market prices, the types of instruments
held, and the strike prices of those instruments.
For 2012, the Company had fuel derivatives in place for a small portion of its fuel consumption. As of
December 31, 2012, the Company also had fuel derivative instruments in place to provide coverage on a small
portion of its 2013 estimated fuel consumption if prices were to rise from current price levels. The following
table provides information about the Company’s potential volume of fuel hedging for the years 2013 through
2017 on an “economic” basis:
Period (by year)
Fuel hedged as of
December 31, 2012
(gallons in millions)(a)
Hedged commodity type
as of December 31, 2012
2013 ....................... 218 Brent crude oil
2014 ....................... 1,171 WTI crude and Brent crude oil
2015 ....................... 735 WTIcrude and Brent crude oil
2016 ....................... 697 Brent crude oil
2017 ....................... 184 WTIcrude oil
(a) The Company determines gallons hedged based on market prices and forward curves as of December 31,
2012. Due to the types of derivatives utilized by the Company, these volumes may vary significantly as
market prices fluctuate.
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 12. 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 2010, 2011, or 2012.
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
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