DERIVATIVES AND RISK MANAGEMENT
Changes in aircraft fuel prices, interest rates and foreign currency exchange rates impact our results of operations. In an effort to manage our exposure to these risks, we enter into derivative contracts and may adjust our derivative portfolio as market conditions change.
Aircraft Fuel Price Risk
Changes in aircraft fuel prices materially impact our results of operations. We actively manage our fuel price risk through a hedging program intended to reduce the financial impact on us from changes in the price of jet fuel. We utilize several different contract and commodity types in this program and frequently test its economic effectiveness against our financial targets. We rebalance the hedge portfolio from time to time according to market conditions, which may result in locking in gains or losses on hedge contracts prior to their settlement dates.
During 2011, we stopped designating substantially all of our new fuel derivative contracts as accounting hedges and discontinued hedge accounting for fuel derivative contracts that had previously been designated as accounting hedges. As a result, we record changes in the fair value of our fuel hedges in aircraft fuel and related taxes. These changes in fair value include settled gains and losses as well as mark to market adjustments ("MTM adjustments"). MTM adjustments are based on market prices as of the end of the reporting period for contracts settling in future periods. Prior to this change in accounting designation, gains or losses on these contracts were deferred in AOCI until contract settlement. At contract settlement, the gains or losses were then reclassified to aircraft fuel and related taxes. As of December 31, 2013, there are no fuel derivative contracts designated as accounting hedges.
The following table shows the impact of fuel hedge losses (gains) for both designated and undesignated contracts on aircraft fuel and related taxes:
|
| | | | | | | | | |
| Year Ended December 31, |
(in millions) | 2013 | 2012 | 2011 |
Airline segment | $ | (444 | ) | $ | 81 |
| $ | (187 | ) |
Refinery Segment | (49 | ) | — |
| — |
|
Effective portion reclassified from AOCI to earnings | — |
| (15 | ) | (233 | ) |
(Gains) losses recorded in aircraft fuel and related taxes | $ | (493 | ) | $ | 66 |
| $ | (420 | ) |
Interest Rate Risk
Our exposure to market risk from adverse changes in interest rates is primarily associated with our long-term debt obligations. Market risk associated with our fixed and variable rate long-term debt relates to the potential reduction in fair value and negative impact to future earnings, respectively, from an increase in interest rates.
In an effort to manage our exposure to the risk associated with our variable rate long-term debt, we periodically enter into interest rate swaps. We designate interest rate contracts used to convert the interest rate exposure on a portion of our debt portfolio from a floating rate to a fixed rate as cash flow hedges, while those contracts converting our interest rate exposure from a fixed rate to a floating rate are designated as fair value hedges.
We also have exposure to market risk from adverse changes in interest rates associated with our cash and cash equivalents and benefit plan obligations. Market risk associated with our cash and cash equivalents relates to the potential decline in interest income from a decrease in interest rates. Pension, postretirement, postemployment, and worker's compensation obligation risk relates to the potential increase in our future obligations and expenses from a decrease in interest rates used to discount these obligations.
Foreign Currency Exchange Rate Risk
We are subject to foreign currency exchange rate risk because we have revenue and expense denominated in foreign currencies with our primary exposures being the Japanese yen and Canadian dollar. To manage exchange rate risk, we execute both our international revenue and expense transactions in the same foreign currency to the extent practicable. From time to time, we may also enter into foreign currency option and forward contracts. These foreign currency exchange contracts are designated as cash flow hedges.
Hedge Position as of December 31, 2013
|
| | | | | | | | | | | | | | | | | | | | |
(in millions) | Notional Balance | Final Maturity Date | Prepaid Expenses and Other Assets | Other Noncurrent Assets | Other Accrued Liabilities | Other Noncurrent Liabilities | Hedge Derivatives, net |
Designated as hedges | | | | | | | | |
Interest rate contracts (cash flow hedges) | $ | 477 |
| U.S. dollars | May 2019 | $ | — |
| $ | — |
| $ | (17 | ) | $ | (26 | ) | $ | (43 | ) |
Interest rate contracts (fair value hedges) | $ | 445 |
| U.S. dollars | August 2022 | — |
| — |
| (2 | ) | (22 | ) | (24 | ) |
Foreign currency exchange contracts | 120,915 |
| Japanese yen | August 2016 | 157 |
| 100 |
| — |
| — |
| 257 |
|
438 |
| Canadian dollars |
Not designated as hedges | | | | | | | | |
Fuel hedge contracts | 4,077 |
| gallons - crude oil, diesel and jet fuel | March 2015 | 428 |
| 29 |
| (127 | ) | (16 | ) | 314 |
|
Total derivative contracts | | | $ | 585 |
| $ | 129 |
| $ | (146 | ) | $ | (64 | ) | $ | 504 |
|
Hedge Position as of December 31, 2012
|
| | | | | | | | | | | | | | | | | | | | |
(in millions) | Notional Balance | Final Maturity Date | Prepaid Expenses and Other Assets | Other Noncurrent Assets | Other Accrued Liabilities | Other Noncurrent Liabilities | Hedge Derivatives, net |
Designated as hedges | | | | | | | | |
Interest rate contracts (cash flow hedges) | $ | 740 |
| U.S. dollars | May 2019 | $ | — |
| $ | — |
| $ | (22 | ) | $ | (48 | ) | $ | (70 | ) |
Interest rate contracts (fair value hedges) | $ | 469 |
| U.S. dollars | August 2022 | — |
| 6 |
| (2 | ) | — |
| 4 |
|
Foreign currency exchange contracts | 119,277 |
| Japanese yen | December 2015 | 62 |
| 63 |
| (1 | ) | (1 | ) | 123 |
|
430 |
| Canadian dollars | | | | |
Not designated as hedges | | | | | | | | |
Fuel contracts | 1,792 |
| gallons - heating oil, crude oil and jet fuel | December 2013 | 511 |
| — |
| (262 | ) | — |
| 249 |
|
Total derivative contracts | | | $ | 573 |
| $ | 69 |
| $ | (287 | ) | $ | (49 | ) | $ | 306 |
|
Offsetting Assets and Liabilities
We have master netting arrangements with all of our counterparties giving us the right of setoff. We have elected not to offset the fair value positions recorded on our Consolidated Balance Sheets. The following table shows the potential net fair value positions had we elected to offset.
|
| | | | | | | | | | | | | | | |
(in millions) | Prepaid Expenses and Other | Other Noncurrent Assets | Other Accrued Liabilities | Other Noncurrent Liabilities | Hedge Derivatives, Net |
December 31, 2013 | | | | | |
Net derivative contracts | $ | 456 |
| $ | 116 |
| $ | (19 | ) | $ | (49 | ) | $ | 504 |
|
December 31, 2012 | | | | | |
Net derivative contracts | $ | 320 |
| $ | 69 |
| $ | (34 | ) | $ | (49 | ) | $ | 306 |
|
Designated Hedge Gains (Losses)
Gains (losses) related to our designated hedge contracts, including those previously designated as accounting hedges, are as follows:
|
| | | | | | | | | | | | | | | | | | | |
| Effective Portion Reclassified from AOCI to Earnings | | Effective Portion Recognized in Other Comprehensive Income (Loss) |
| Year Ended December 31, |
(in millions) | 2013 | 2012 | 2011 | | 2013 | 2012 | 2011 |
Fuel hedge contracts | $ | — |
| $ | 15 |
| $ | 233 |
| | $ | — |
| $ | (15 | ) | $ | (166 | ) |
Interest rate contracts | — |
| (5 | ) | — |
| | 28 |
| 14 |
| (8 | ) |
Foreign currency exchange contracts | 135 |
| (25 | ) | (61 | ) | | 133 |
| 212 |
| 7 |
|
Total designated | $ | 135 |
| $ | (15 | ) | $ | 172 |
| | $ | 161 |
| $ | 211 |
| $ | (167 | ) |
As of December 31, 2013, we have recorded $157 million of net gains on cash flow hedge contracts in AOCI, which are scheduled to settle and be reclassified into earnings within the next 12 months.
Credit Risk
To manage credit risk associated with our aircraft fuel price, interest rate and foreign currency hedging programs, we select counterparties based on their credit ratings and limit our exposure to any one counterparty.
Our hedge contracts contain margin funding requirements. The margin funding requirements may cause us to post margin to counterparties or may cause counterparties to post margin to us as market prices in the underlying hedged items change. Due to the fair value position of our hedge contracts, we received net margin of $65 million and $62 million as of December 31, 2013 and 2012, respectively. Margin received is recorded in accounts payable and margin posted is recorded in prepaid expenses and other.
Our accounts receivable are generated largely from the sale of passenger airline tickets and cargo transportation services. The majority of these sales are processed through major credit card companies, resulting in accounts receivable that may be subject to certain holdbacks by the credit card processors. We also have receivables from the sale of mileage credits under our SkyMiles Program to participating airlines and non-airline businesses such as credit card companies, hotels and car rental agencies. The credit risk associated with our receivables is minimal.
Self-Insurance Risk
We self-insure a portion of our losses from claims related to workers' compensation, environmental issues, property damage, medical insurance for employees and general liability. Losses are accrued based on an estimate of the aggregate liability for claims incurred, using independent actuarial reviews based on standard industry practices and our historical experience. A portion of our projected workers' compensation liability is secured with restricted cash collateral.
