Southwest Airlines 2014 Annual Report Download - page 35

declined in recent months, it continues to be unpredictable, and even a small change in market fuel
prices can significantly affect profitability. Furthermore, volatility in fuel prices can be due to many
external factors that are beyond the Company’s control. For example, fuel prices can be impacted by
political and economic factors, such as (i) dependency on foreign imports of crude oil and the potential
for hostilities or other conflicts in oil producing areas; (ii) limited domestic refining or pipeline
capacity; (iii) worldwide demand for fuel, particularly in developing countries, which can result in
inflated energy prices; (iv) changes in U.S. governmental policies on fuel production, transportation,
taxes, and marketing; and (v) changes in currency exchange rates.
The Company’s ability to effectively address fuel price increases can be limited by its ability
to increase fares, which can be difficult in challenging economic environments when low fares are
often used to stimulate traffic. The ability to increase fares can also be limited by factors such as the
historical low-fare reputation of Southwest, the portion of its Customer base that purchases travel for
leisure purposes, the competitive nature of the airline industry generally, and the risk that higher fares
will drive a decrease in demand.
The Company attempts to manage its risk associated with changing jet fuel prices by utilizing
over-the-counter fuel derivative instruments to hedge a portion of its future jet fuel purchases.
However, because energy prices can fluctuate significantly in a relatively short amount of time, and
due to the fact that the Company uses a variety of different derivative instruments and at different price
points, the Company is subject to the risk that the fuel derivatives it uses will not provide adequate
protection against significant increases in fuel prices and could in fact result in additional volatility in
the Company’s earnings. The Company is also subject to the risk that cash collateral may be required
to be posted to fuel hedge counterparties, which could have a significant impact on the Company’s
financial position and liquidity.
In addition, the Company is subject to the risk that its fuel derivatives will not be effective or
that they will no longer qualify for hedge accounting under applicable accounting standards, which
could create additional earnings volatility. Adjustments in the Company’s overall fuel hedging
strategy, as well as the ability of the commodities used in fuel hedging to qualify for special hedge
accounting, are likely to continue to affect the Company’s results of operations. In addition, there can
be no assurance that the Company will be able to cost-effectively hedge against increases in fuel
prices.
The Company’s fuel hedging arrangements and the various potential impacts of hedge
accounting on the Company’s financial position, cash flows, and results of operations are discussed in
more detail under “Management’s Discussion and Analysis of Financial Condition and Results of
Operations,” “Quantitative and Qualitative Disclosures About Market Risk,” and in Note 1 and
Note 10 to the Consolidated Financial Statements.
The Company is also reliant upon the readily available supply and timely delivery of jet fuel to
the airports that it serves. A disruption in that supply could present significant challenges to the
Company’s operations, and could ultimately cause the cancellation of flights and/or the inability of the
Company to provide service to a particular airport.
The Company’s low-cost structure has historically been one of its primary competitive
advantages, and many factors have affected and could continue to affect the Company’s ability
to control its costs.
The Company’s low-cost structure has historically been one of its primary competitive
advantages, as it has enabled Southwest to historically offer low fares, drive traffic volume, and grow
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