Southwest Airlines 2015 Annual Report Download - page 112

also dependent on current market prices for that period, 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 at settlement and may even produce hedging losses depending on market prices, the
types of instruments held, and the strike prices of those instruments.
For 2015, the Company had fuel derivative instruments in place for up to 15 percent of its fuel
consumption. The Company also had fuel derivative instruments in place to provide coverage for up to
63 percent of its 2016 estimated fuel consumption, depending on where market prices settle. The
following table provides information about the Company’s volume of fuel hedging for the years 2016
through 2018 on an “economic” basis considering current market prices:
Period (by year)
Fuel hedged as of
December 31, 2015
(gallons in millions) (a)
Derivative underlying commodity type as of
December 31, 2015
2016 1,226 Brent crude oil, Heating oil, and Gulf Coast jet fuel
2017 1,503 WTI crude and Brent crude oil
2018 731 Brent crude oil
(a) Due to the types of derivatives utilized by the Company and different price levels of those contracts, these
volumes represent the maximum economic hedge in place and may vary significantly as market prices fluctuate.
Upon proper qualification, the Company accounts for its fuel derivative instruments as cash flow
hedges. 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 Accumulated other
comprehensive income (loss) (“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 and were de-designated as hedges
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 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 2013, 2014, or 2015.
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