American Airlines 2007 Annual Report Download - page 66

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7. Financial Instruments and Risk Management (Continued)
The Company is exposed to credit losses in the event of non-performance by counterparties to these financial
instruments, but it does not expect any of the counterparties to fail to meet its obligations. The credit exposure
related to these financial instruments is represented by the fair value of contracts with a positive fair value at the
reporting date, reduced by the effects of master netting agreements. To manage credit risks, the Company
selects counterparties based on credit ratings, limits its exposure to a single counterparty under defined
guidelines, and monitors the market position of the program and its relative market position with each
counterparty. The Company also maintains industry-standard security agreements with a number of its
counterparties which may require the Company or the counterparty to post collateral if the value of selected
instruments exceed specified mark-to-market thresholds or upon certain changes in credit ratings. The
Company’s outstanding posted collateral as of December 31, 2007 is included in restricted cash and short-term
investments and is not material. A deterioration of the Company’s liquidity position may negatively affect the
Company’s ability to hedge fuel in the future.
Fuel Price Risk Management American enters into jet fuel and heating oil hedging contracts to dampen the
impact of the volatility in jet fuel prices. These instruments generally have maturities of up to 24 months. The
Company accounts for its fuel derivative contracts as cash flow hedges and records the fair value of its fuel
hedging contracts in Other current assets and Accumulated other comprehensive income (loss) on the
accompanying consolidated balance sheets. The Company determines the ineffective portion of its fuel hedge
contracts by comparing the cumulative change in the total value of the fuel hedge contract, or group of fuel hedge
contracts, to the cumulative change in a hypothetical jet fuel hedge. If the total cumulative change in value of the
fuel hedge contract more than offsets the total cumulative change in a hypothetical jet fuel hedge, the difference
is considered ineffective and is immediately recognized as a component of Aircraft fuel expense. Effective gains
or losses on fuel hedging contracts are deferred in Accumulated other comprehensive income (loss) and are
recognized in earnings as a component of Aircraft fuel expense when the underlying jet fuel being hedged is
used.
Ineffectiveness is inherent in hedging jet fuel with derivative positions based in crude oil or other crude oil related
commodities. As required by Statement of Financial Accounting Standard No. 133, “Accounting for Derivative
Instruments and Hedging Activities”, the Company assesses, both at the inception of each hedge and on an on-
going basis, whether the derivatives that are used in its hedging transactions are highly effective in offsetting
changes in cash flows of the hedged items. In doing so, the Company uses a regression model to determine the
correlation of the change in prices of the commodities used to hedge jet fuel (NYMEX Heating oil) to the change
in the price of jet fuel. The Company also monitors the actual dollar offset of the hedges’ market values as
compared to hypothetical jet fuel hedges. The fuel hedge contracts are generally deemed to be “highly effective”
if the R-squared is greater than 80 percent and the dollar offset correlation is within 80 percent to 125 percent.
The Company discontinues hedge accounting prospectively if it determines that a derivative is no longer expected
to be highly effective as a hedge or if it decides to discontinue the hedging relationship. During 2006, the
Company determined that certain of its derivatives settling during the remainder of 2006 and in 2007 were no
longer expected to be highly effective in offsetting changes in forecasted jet fuel purchased. As a result of the
ineffectiveness assessment on these derivatives, changes in market value were recognized directly in earnings,
while previously deferred gains in Other comprehensive income (loss) were deferred and recognized as a
component of fuel expense when the originally hedged jet fuel was used in operations. All of these derivatives
settling after December 31, 2006, were re-designated as hedges on October 26, 2006. Hedge accounting
continues to be applied to derivatives used to hedge forecasted jet fuel purchases that are expected to remain
highly effective.
For the years ended December 31, 2007, 2006 and 2005, the Company recognized net gains of approximately
$239 million, $97 million and $64 million, respectively, as a component of fuel expense on the accompanying
consolidated statements of operations related to its fuel hedging agreements, including the ineffective portion of
the hedges. In addition, in 2006, the Company recognized a loss of $102 million in Miscellaneous – net for
changes in market value of hedges that did not qualify for hedge accounting during certain periods in 2006. The
fair value of the Company’s fuel hedging agreements at December 31, 2007 and 2006, representing the amount
the Company would receive to terminate the agreements, totaled $353 million and $23 million, respectively. Due
to the current value of the Company’s derivative contracts, some agreements with counterparties require collateral
to be deposited with the Company. As of December 31, 2007 the collateral held in short term investments by
AMR from such counterparties was $164 million. The Company held no collateral from such counterparties as of
December 31, 2006.