American Airlines 2010 Annual Report Download - page 72

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69
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, 2010, the Company had fuel derivative contracts outstanding covering 31 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, 2010, 2009 and 2008, the Company recognized net gains (losses) of
approximately ($142) million, ($651) million and $380 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, 2010 and 2009, representing the amount the Company would receive upon termination of the
agreements, totaled $257 million and $57 million, respectively, which excludes a payable for both years related to
contracts that settled in December of each year. As of December 31, 2010, the Company estimates that during
the next twelve months it will reclassify from Accumulated other comprehensive loss into earnings approximately
$121 million in net gains (based on prices as of December 31, 2010) related to its fuel derivative hedges.
The impact of cash flow hedges on the Company’s consolidated financial statements for the years ending
December 31, 2010 and 2009, respectively, is depicted below (in millions):