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65
7. Financial Instruments and Risk Management
Fuel Price Risk Management As part of the Company's risk management program, it uses a variety of financial
instruments, primarily heating oil option and collar contracts, as cash flow hedges to mitigate commodity price
risk. The Company does not hold or issue derivative financial instruments for trading purposes. As of December
31, 2009, the Company had fuel derivative contracts outstanding covering 20 million barrels of jet fuel that will be
settled over the next 24 months. A deterioration of the Company’s liquidity position may negatively affect the
Company’s ability to hedge fuel in the future.
In accordance with U.S. GAAP, the Company assesses, both at the inception of each hedge and on an ongoing
basis, whether the derivatives that are used in its hedging transactions are highly effective in offsetting changes in
cash flows of the hedged items. Derivatives that meet the requirements are granted special hedge accounting
treatment, and the Company’s hedges generally meet these requirements. Accordingly, the Company’s fuel
derivative contracts are accounted for as cash flow hedges, and the fair value of the Company’s hedging
contracts is recorded in Current Assets or Current Liabilities in the accompanying consolidated balance sheets
until the underlying jet fuel is purchased. 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. In assessing effectiveness, the Company uses a regression model to determine the correlation of
the change in prices of the commodities used to hedge jet fuel (e.g., 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 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. Subsequently, any changes in the fair
value of these derivatives are marked to market through earnings in the period of change.
For the years ended December 31, 2009, 2008 and 2007, the Company recognized net gains (losses) of
approximately ($651) million, $380 million and $239 million, respectively, as a component of Aircraft fuel expense
on the accompanying consolidated statements of operations related to its fuel hedging agreements, including the
ineffective portion of the hedges. The fair value of the Company’s fuel hedging agreements at December 31,
2009 and 2008, representing the amount the Company would receive (pay) upon termination of the agreements,
totaled $57 million and ($450) million, respectively, which excludes a payable for both years related to contracts
that settled in December of each year. As of December 31, 2009, the Company estimates that during the next
twelve months it will reclassify from Accumulated other comprehensive loss into earnings approximately $74
million in net losses (based on prices as of December 31, 2009) related to its fuel derivative hedges, including
losses from terminated contracts with a bankrupt counterparty in 2008.
The impact of cash flow hedges on the Company’s consolidated financial statements for the years ending
December 31, 2009 and 2008, respectively, is depicted below (in millions):
Fair Value of Aircraft Fuel Derivative Instruments (all cash flow hedges)
Asset Derivatives as of December 31,
Liability Derivatives as of December 31,
2009
2008
2009
2008
Balance
Sheet
Location
Fair
Value
Balance
Sheet
Location
Fair
Value
Balance
Sheet
Location
Fair
Value
Balance
Sheet
Location
Fair
Value
Fuel
derivative
contracts
$ 126
Fuel
derivative
contracts
$ -
Fuel
derivative
liability
$ 71
Fuel
derivative
liability
$ 528