Southwest Airlines 2014 Annual Report Download - page 87

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types of hedging strategies. The gross fair value of outstanding financial derivative instruments related
to the Company’s jet fuel market price risk at December 31, 2014, was a net liability of $1.0 billion. In
addition, $266 million in cash collateral deposits, $134 million in aircraft collateral, and $250 million
in letters of credit were provided by the Company in connection with these instruments based on their
fair value as of December 31, 2014. 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, 2014 (for all years from 2015 through 2018) prices would correspondingly change the
fair value of the commodity derivative instruments in place by approximately $200 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, aircraft, or letters of credit utilized as 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, 2014
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, 2014, the Company had no counterparties in which the derivatives
held were a net asset. 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, 2014, 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, letters of credit, and/or pledged aircraft are required to be posted whenever the net
fair value of derivatives associated with those counterparties exceeds specific thresholds - cash is either
posted by the counterparty if the value of derivatives is an asset to the Company, or cash, letters of
credit, and/or aircraft could be posted as collateral by the Company if the value of derivatives is a
liability to the Company. Refer to the counterparty credit risk and collateral table provided in Note 10
to the Consolidated Financial Statements for the fair values of fuel derivatives, amounts posted as
collateral, and applicable collateral posting threshold amounts as of December 31, 2014, at which such
postings are triggered.
Due to the terms of the Company’s current fuel hedging agreements with counterparties and
the types of derivatives held, in the Company’s judgment, it does not have significant additional
exposure to future cash collateral requirements. As an example, if market prices for the commodities
used in the Company’s fuel hedging activities were to decrease by 25 percent from market prices as of
December 31, 2014, given the Company’s fuel derivative portfolio, its aircraft collateral facilities, and
its investment grade credit rating, it would likely provide an additional $141 million in cash collateral,
post an additional $319 million in aircraft collateral, and post no additional letters of credit against
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