Southwest Airlines 2014 Annual Report Download - page 123

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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 fuel 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 2012, 2013, or 2014.
In some situations, an entire commodity type used in hedging may cease to qualify for special
hedge accounting treatment. As an example, during 2013, the Company’s routine statistical analysis
performed to determine which commodities qualify for special hedge accounting treatment on a
prospective basis dictated that WTI crude oil based derivatives no longer qualify for hedge accounting.
This is primarily due to the fact that the correlation between WTI crude oil prices and jet fuel prices
during recent periods has not been as strong as in the past, and therefore the Company can no longer
demonstrate that derivatives based on WTI crude oil prices will result in effective hedges on a
prospective basis. As such, the change in fair value of all of the Company’s derivatives based in WTI
have been recorded to Other (gains) losses subsequent to July 1, 2013, and all future changes in the fair
value of such instruments will continue to be recorded directly to earnings in future periods. The
change in fair value of the Company’s WTI derivative contracts during 2014 was a decrease of
$45 million, which resulted in a loss in the Consolidated Statement of Income. The change in fair value
of the Company’s WTI derivative contracts during the second half of 2013 was an increase of
$15 million, which resulted in a gain in the Consolidated Statement of Income. Any amounts
previously recorded to AOCI will remain there until such time as the original forecasted transaction
occurs in accordance with hedge accounting requirements. The Company will continue to evaluate
whether it can qualify for hedge accounting for WTI derivative contracts in future periods.
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.
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