Southwest Airlines 2015 Annual Report Download - page 73

The Company believes it is unlikely that materially different estimates for expected lives, expected
residual values, and impairment evaluations would be made or reported based on other reasonable
assumptions or conditions suggested by actual historical experience and other data available at the time
estimates were made.
Financial Derivative Instruments
The Company utilizes financial derivative instruments primarily to manage its risk associated with
changing jet fuel prices. See “Quantitative and Qualitative Disclosures about Market Risk” for more
information on these risk management activities, and see Note 10 to the Consolidated Financial
Statements for more information on the Company’s fuel hedging program and financial derivative
instruments.
All derivatives are required to be reflected at fair value and recorded on the Consolidated Balance
Sheet. At December 31, 2015, the Company was a party to over 1,200 separate financial derivative
instruments related to its fuel hedging program for the years 2016 through 2018. Changes in the fair
values of these instruments can vary dramatically based on changes in the underlying commodity
prices. For example, during 2015, market “spot” prices for Brent crude oil peaked at a high of
approximately $68 per barrel and hit a low price of approximately $36 per barrel. During 2014, market
spot prices ranged from a high of $115 per barrel to a low of $57 per barrel. Market price changes can
be driven by factors such as supply and demand, inventory levels, weather events, refinery capacity,
political agendas, the value of the U.S. dollar, geopolitical events, and general economic conditions,
among other items. The financial derivative instruments utilized by the Company primarily are a
combination of collars, purchased call options, call spreads, put spreads, and fixed price swap
agreements.
The Company enters into financial derivative instruments with third party institutions in “over-the-
counter” markets. Since the majority of the Company’s financial derivative instruments are not traded
on a market exchange, the Company estimates their fair values. Depending on the type of instrument,
the values are determined by the use of present value methods or standard option value models with
assumptions about commodity prices based on those observed in underlying markets. Also, since there
is not a reliable forward market for jet fuel beyond approximately 24 months, the Company must
estimate the future prices of jet fuel in order to measure the effectiveness of the hedging instruments in
offsetting changes to those prices. Forward jet fuel prices are estimated through the observation of
similar commodity futures prices (such as crude oil, heating oil, and unleaded gasoline) and adjusted
based on variations of those like commodities to the Company’s ultimate expected price to be paid for
jet fuel at the specific locations in which the Company hedges.
Fair values for financial derivative instruments and forward jet fuel prices are estimated prior to the
time that the financial derivative instruments settle and the time that jet fuel is purchased and
consumed, respectively. However, once settlement of the financial derivative instruments occurs and
the hedged jet fuel is purchased and consumed, all values and prices are known and are recognized in
the financial statements. In some periods, because of increased volatility in energy markets, the
Company lost hedge accounting for certain types of commodities, including the periods from July 2013
through July 2015, when the Company lost hedge accounting for West Texas Intermediate crude oil
(“WTI”) instruments. As such, the changes in fair value of all of the Company’s derivatives in WTI
were recorded directly to Other (gains) losses, net in the Consolidated Statement of Income. The
Company did not lose hedge accounting for an entire commodity during any other periods presented.
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