American Airlines 2006 Annual Report Download - page 49

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ITEM 7(A). QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Market Risk Sensitive Instruments and Positions
The risk inherent in the Company’s market risk sensitive instruments and positions is the potential loss arising
from adverse changes in the price of fuel, foreign currency exchange rates and interest rates as discussed below.
The sensitivity analyses presented do not consider the effects that such adverse changes may have on overall
economic activity, nor do they consider additional actions management may take to mitigate the Company’s
exposure to such changes. Therefore, actual results may differ. The Company does not hold or issue derivative
financial instruments for trading purposes. See Note 7 to the consolidated financial statements for accounting
policies and additional information.
Aircraft Fuel The Company’s earnings are affected by changes in the price and availability of aircraft fuel. In
order to provide a measure of control over price and supply, the Company trades and ships fuel and maintains
fuel storage facilities to support its flight operations. The Company also manages the price risk of fuel costs
primarily by using jet fuel, heating oil, and crude oil hedging contracts. Market risk is estimated as a hypothetical
10 percent increase in the December 31, 2006 and 2005 cost per gallon of fuel. Based on projected 2007 fuel
usage, such an increase would result in an increase to aircraft fuel expense of approximately $531 million in 2007,
inclusive of the impact of effective fuel hedge instruments outstanding at December 31, 2006, and assumes the
Company’s fuel hedging program remains effective under Statement of Financial Accounting Standards No. 133,
“Accounting for Derivative Instruments and Hedging Activities”. Comparatively, based on projected 2006 fuel
usage, such an increase would have resulted in an increase to aircraft fuel expense of approximately $528 million
in 2006, inclusive of the impact of fuel hedge instruments outstanding at December 31, 2005. As of December 31,
2006, the Company had hedged, with option contracts, including collars, approximately 14 percent of its estimated
2007 fuel requirements. The consumption hedged for 2007 is capped at an average price of approximately $68
per barrel of crude oil. Comparatively, as of December 31, 2005 the Company had hedged, with option contracts,
approximately 17 percent of its estimated 2006 fuel requirements. A deterioration of the Company’s financial
position could negatively affect the Company’s ability to hedge fuel in the future.
Foreign Currency The Company is exposed to the effect of foreign exchange rate fluctuations on the U.S.
dollar value of foreign currency-denominated operating revenues and expenses. The Company’s largest
exposure comes from the British pound, Euro, Canadian dollar, Japanese yen and various Latin American
currencies. The Company does not currently have a foreign currency hedge program related to its foreign
currency-denominated ticket sales. A uniform 10 percent strengthening in the value of the U.S. dollar from
December 31, 2006 and 2005 levels relative to each of the currencies in which the Company has foreign currency
exposure would result in a decrease in operating income of approximately $117 million and $105 million for the
years ending December 31, 2007 and 2006, respectively, due to the Company’s foreign-denominated revenues
exceeding its foreign-denominated expenses. This sensitivity analysis was prepared based upon projected 2007
and 2006 foreign currency-denominated revenues and expenses as of December 31, 2006 and 2005,
respectively.
Interest The Company’s earnings are also affected by changes in interest rates due to the impact those
changes have on its interest income from cash and short-term investments, and its interest expense from
variable-rate debt instruments. The Company’s largest exposure with respect to variable-rate debt comes from
changes in the London Interbank Offered Rate (LIBOR). The Company had variable-rate debt instruments
representing approximately 33 percent and 32 percent of its total long-term debt at December 31, 2006 and 2005,
respectively. If the Company’s interest rates average 10 percent more in 2007 than they did at December 31,
2006, the Company’s interest expense would increase by approximately $29 million and interest income from
cash and short-term investments would increase by approximately $28 million. In comparison, at December 31,
2005, the Company estimated that if interest rates averaged 10 percent more in 2006 than they did at December
31, 2005, the Company’s interest expense would have increased by approximately $28 million and interest
income from cash and short-term investments would have increased by approximately $18 million. These
amounts are determined by considering the impact of the hypothetical interest rates on the Company’s variable-
rate long-term debt and cash and short-term investment balances at December 31, 2006 and 2005.