Union Pacific 2001 Annual Report Download - page 52

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26
The sensitivity analyses that follow illustrate the economic effect that hypothetical changes in interest rates or fuel
prices could have on the Corporation’s financial instruments. These hypothetical changes do not consider other factors
that could impact actual results.
Interest Rates – The Corporation manages its overall exposure to fluctuations in interest rates by adjusting the proportion
of fixed- and floating-rate debt instruments within its debt portfolio over a given period. The mix of fixed- and floating-
rate debt is largely managed through the issuance of targeted amounts of each as debt matures or incremental borrowings
are required. Derivatives are used in limited circumstances as one of the tools to obtain the targeted mix and hedge the
exposure to fair value changes. In addition, the Corporation obtains flexibility in managing interest costs and the interest
rate mix within its debt portfolio by issuing callable fixed-rate debt securities.
At December 31, 2001 and 2000, the Corporation had variable-rate debt representing approximately 12% and 6%,
respectively, of its total debt. If variable interest rates average 10% higher in 2002 than the Corporation's December 31,
2001 variable rate, which was approximately 3%, the Corporation’s interest expense would increase by less than $5 million
after tax. If variable interest rates had averaged 10% higher in 2001 than the Corporation's December 31, 2000 variable
rate, the Corporation's interest expense would have increased by less than $5 million after tax. These amounts were
determined by considering the impact of the hypothetical interest rates on the balances of the Corporation’s variable-rate
debt at December 31, 2001 and 2000, respectively.
In May and August 2001, the Corporation entered into interest rate swaps on a total of $598 million of debt with
varying maturity dates extending to November 2004. The swaps allowed the Corporation to convert the debt from fixed
rates to variable rates and thereby hedge the risk of changes in the debt's fair value attributable to the changes in the
benchmark interest rate (LIBOR). The swaps have been accounted for using the short-cut method as allowed by Financial
Accounting Standards Board Statement (FASB) No. 133, "Accounting for Derivative Instruments and Hedging Activities"
(FAS 133); and therefore, no ineffectiveness has been recorded within the Corporation's Consolidated Financial
Statements. The effect of a 10% interest rate increase or decrease in 2002 over the December 31, 2001 rates is included
in the preceding or succeeding paragraph disclosure, respectively. The Corporation had not entered into any interest rate
swaps at December 31, 2000.
Market risk for fixed-rate debt is estimated as the potential increase in fair value resulting from a hypothetical 10%
decrease in interest rates as of December 31, 2001, and amounts to approximately $226 million at December 31, 2001.
Market risk resulting from a hypothetical 10% decrease in interest rates as of December 31, 2000, amounted to
approximately $307 million at December 31, 2000. The fair values of the Corporation’s fixed-rate debt were estimated
by considering the impact of the hypothetical interest rates on quoted market prices and current borrowing rates.
Fuel – Fuel costs are a significant portion of the Corporation’s total operating expenses. As a result of the significance
of fuel costs and the historical volatility of fuel prices, the Corporation’s transportation subsidiaries periodically use swaps,
futures and/or forward contracts to mitigate the impact of adverse fuel price changes. The Corporation at times may use
swaptions to secure more favorable swap prices.
As of December 31, 2001, expected rail fuel consumption for 2002 is 44% hedged (or swaptions are in place) at 56
cents per gallon excluding taxes, transportation costs and regional pricing spreads. As of December 31, 2001, expected
rail fuel consumption for 2003 is 5% hedged (or swaptions are in place) at 56 cents per gallon excluding taxes,
transportation costs and regional pricing spreads. For the Corporation's fuel hedges, if rail fuel prices decrease 10% from
the December 31, 2001 level, the corresponding increase in fuel expense would be approximately $20 million after tax.
For the Corporation's swaptions, if rail fuel prices decrease 10% from the December 31, 2001 level, the corresponding
increase in expense would be approximately $4 million after tax.
As of December 31, 2000, the Corporation had hedged approximately 8% of its forecasted 2001 fuel consumption at
68 cents per gallon, excluding taxes, transportation costs and regional pricing spreads. If rail fuel prices had decreased
10% from the December 31, 2000 level, the corresponding increase in fuel expense would have been approximately $5
million after tax.