Southwest Airlines 2015 Annual Report Download - page 79

but are not limited to: (i) reduced passenger demand as a result of domestic or global economic
conditions; (ii) significantly higher prices for jet fuel; (iii) lower fares or passenger yields as a result of
increased competition or lower demand; (iv) a significant increase in future capital expenditure
commitments; and (v) significant disruptions to the Company’s operations as a result of both internal
and external events such as terrorist activities, actual or threatened war, labor actions by Employees, or
further industry regulation. Factors which could result in an impairment of owned domestic slots,
holding other assumptions constant, could include, but are not limited to: (i) a change in competition in
the slotted airport; (ii) significantly higher prices for jet fuel; and (iii) increased competition at a nearby
airport.
Item 7A. Quantitative and Qualitative Disclosures About Market Risk
The Company has interest rate risk in its floating-rate debt obligations and interest rate swaps,
commodity price risk in jet fuel required to operate its aircraft fleet, and market risk in the derivatives
used to manage its fuel hedging program and in the form of fixed-rate debt instruments. As of
December 31, 2015, Southwest operated a total of 123 aircraft under operating and capital lease.
However, except for a small number of aircraft that have lease payments that fluctuate based in part on
changes in market interest rates, the remainder of the leases are not considered market sensitive
financial instruments and, therefore, are not included in the interest rate sensitivity analysis below. The
Company also has 78 aircraft under operating and capital lease that have been subleased to another
carrier. Further information about this sublease arrangement is disclosed in Note 7 to the Consolidated
Financial Statements. The Company does not purchase or hold any derivative financial instruments for
trading purposes. See Note 10 to the Consolidated Financial Statements for information on the
Company’s accounting for its hedging program and for further details on the Company’s financial
derivative instruments.
Hedging
The Company purchases jet fuel at prevailing market prices, but seeks to manage market risk through
execution of a documented hedging strategy. The Company utilizes financial derivative instruments, on
both a short-term and a long-term basis, as a form of insurance against the potential for significant
increases in fuel prices. The Company believes there can be significant risk in not hedging against the
possibility of such fuel price increases, especially in energy markets in which prices are high and/or
rising. The Company expects to consume approximately 2 billion gallons of jet fuel in 2016. Based on
this anticipated usage, a change in jet fuel prices of just one cent per gallon would impact the
Company’s Fuel and oil expense by approximately $20 million for 2016, excluding any impact
associated with fuel derivative instruments held.
As of December 31, 2015, the Company held a net position of fuel derivative instruments that
represented a hedge for a portion of its anticipated jet fuel purchases for each year from 2016 through
2018. See Note 10 to the Consolidated Financial Statements for further information. The Company
may increase or decrease the size of its fuel hedge based on its expectation of future market prices, as
well as its perceived exposure to cash collateral requirements contained in the agreements it has signed
with various counterparties, while considering the significant cost that can be associated with different
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, 2015, was a net liability of $1.5 billion. In
addition, $835 million in cash collateral deposits and $250 million in aircraft collateral were provided
by the Company in connection with these instruments based on their fair value as of December 31,
71