World Fuel Services 2011 Annual Report Download - page 31

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spreads related to fuel products we sell. The majority of our derivatives are not designated as cash flow
hedges for accounting purposes and therefore changes in the fair market value of such derivatives are
recognized as a component of revenue or cost of revenue (based on the underlying transaction type) in
our consolidated income statement. Our efforts to hedge our exposure to fuel price fluctuations could be
ineffective. For example, there currently is no market for aviation jet fuel futures so we enter into
hedging transactions with respect to our aviation business by trading in heating oil futures. To the extent
the price of aviation jet fuel and heating oil are not correlated, then our attempts to mitigate price risk
associated with our aviation business would not be effective. For purposes of hedging, heating oil is not
a perfect substitute for aviation jet fuel and short-term significant pricing differences may occur. For
example, in the period immediately following Hurricane Katrina in 2005, the price of aviation jet fuel
increased substantially while the price of heating oil remained relatively constant. Certain of our
derivative activities are within the Level II and Level III categories within the fair value hierarchy set out
by accounting guidance for fair value measurements; and as such, require a high degree of subjective
assessment and judgment by management in connection with determining fair value. In addition,
proprietary derivative transactions, by their nature, entail exposure to adverse changes in commodity
prices in relation to the proprietary position. Although we have established limits on such exposure, any
such adverse changes could result in losses. The risks we face because of our use of financial
derivatives can be exacerbated by volatility in the financial and other markets.
In addition, we may fail to adequately hedge our risks or could otherwise incur losses if our employees
fail to comply with our policies and procedures on hedging or proprietary trading, for example by failing to
hedge a specific financial risk or to observe limits on exposure, which could subject us to significant
financial losses that could have a material adverse effect on our business, financial condition, results of
operations and cash flows.
Changes in the market price of fuel may have a material adverse effect on our business.
Fuel prices have been extremely volatile in the recent past, are likely to continue to be volatile in the
future and depend on factors outside the control of the Company, such as:
• expected and actual supply and demand for fuel;
• political conditions;
• laws and regulations related to environmental matters, including those mandating or incentivizing
alternative energy sources or otherwise addressing global climate change;
• changes in pricing or production controls by OPEC;
• technological advances affecting energy consumption and supply;
• energy conservation efforts;
• price and availability of alternative fuels; and
• weather.
A rapid decline in fuel prices could cause our inventory value to be higher than market, resulting in our
inventory being marked down to market or the inventory itself sold at lower prices. If fuel prices
increase, our customers may not be able to purchase as much fuel from us because of their credit limits,
which could also adversely impact their businesses sufficiently enough to cause them to be unable to
make payments owed to us for fuel purchased on credit. They may also choose to reduce the amount of
fuel they consume in their operations to reduce costs or to otherwise comply with new environmental
regulations to obtain incentives associated therewith. There would be no assurance that the volume of
orders from our customers would increase again or that we would be able to replace lost volumes with
new customers. In addition, if fuel prices increase, our own credit limits could prevent us from
purchasing enough fuel from our suppliers to meet our customers’ demands or could require us to use
so much cash for fuel purchases as to impair our liquidity.
We maintain fuel inventories for competitive reasons. Because fuel is a commodity, we have no control
over the changing market value of our inventory. Our inventory is valued using the average cost
methodology and is stated at the lower of average cost or market. Accordingly, if the market value of our
inventory was less than our average cost, we would record a write-down of inventory and a non-cash
charge to cost of revenue. In addition, we may not be able to sell our inventory at the market value or
average cost reflected in our financial statements at any given time.
7