Hedge on fuel prices pays off
What would it be like to pay $2 for a gallon of gasoline when everyone else is paying twice that much?
Southwest Airlines Co. knows, and that’s why many analysts believe it may be one of the few U.S. carriers -- if not the only one -- to post a profit this year while still offering bargain fares.
The airline, one of the largest at Los Angeles International Airport, locked in more than 70% of the fuel it expected to consume this year at about $51 a barrel, far below Thursday’s closing crude price of $126.62 a barrel.
Other large airlines, meanwhile, have only 20% to 30% of their fuel “hedged” this year at an average cost of $100 a barrel.
With the huge cost advantage, Southwest hasn’t had to hike air fares or like other carriers impose new fees, including last week’s decision by AMR Corp.'s American Airlines to charge domestic fliers $15 for checking a single suitcase and to increase other fees.
The advantage won’t last forever because oil prices could plummet, and even if they stayed high the amount of fuel Southwest has been able to hedge in future years diminishes considerably from 55% next year to 30% in 2010.
But because of a calculated risk the airline took last year -- essentially betting correctly that fuel prices would escalate -- Southwest “may be the only one left standing” by the end of 2008, said Terry Trippler, an industry analyst who expects most major carriers to post a loss this year with perhaps a few even going into bankruptcy.
“Southwest is sitting there looking really good,” Trippler said.
The carrier’s aggressive fuel hedging is having a broader effect on fares in the markets it serves, travel experts say.
Tom Parsons, publisher of BestFares.com, said that travelers flying between two cities where there is no competition from Southwest would pay about $340 more round-trip than they did just six months ago.
“The difference today between flying on a short-haul route where air fares are offered only by one of the top six major airlines are reaching ridiculous dollar numbers compared to short-haul routes served by low-cost carriers such as Southwest,” Parsons said.
FareCompare.com, an air fare search service, noticed that American last week dropped the price of a round-trip ticket by an average of $30 on routes also served by Southwest including flights out of San Diego, Seattle and Las Vegas. At the same time American was raising fares by an average of $60 in other markets and imposing the new bag fees, according to FareCompare.
Emboldened with lower fuel costs than its competitors, Southwest has been able to offer promotional one-way fares for as little as $29. Last week, the offer launched with the slogan “Why drive when you can fly . . . ?”
Southwest also has been able to respond to the woes of other airlines with a bit of smugness.
When American said last week that it would begin charging for a single checked bag because of fuel costs, Southwest quickly responded by saying that it was doing “everything” to boost revenue, “but it’s not our goal to nickel and dime our customers.”
“We want to assure you that Southwest Airlines still allows you to check up to two free bags when you travel with us,” the airline said on its website. “We look forward to seeing you onboard very soon. And bring your luggage!”
The cost difference between Southwest and other carriers that don’t hedge as much can be dramatic. Fuel costs were up 20% for Southwest in the first quarter whereas American said its fuel costs were up nearly 50%, which wiped out profit for the nation’s largest airline. On average, Southwest paid about $1.98 for a gallon while American, which hedged about 27% of its fuel use, paid $2.74 a gallon.
Southwest Treasurer Scott Topping, considered the guru on hedging for the airline, said the carrier jumped into hedging in “a big way” in 1999 when oil was at $11 a barrel.
Since then the airline has hedged 70% to 80% of its anticipated fuel use every year, more than any other airline. The airline said it saved $727 million last year by locking in lower fuel prices in prior years.
So far, the carrier hasn’t had a year when it lost money on fuel hedges.
“Knock on wood,” Topping said, noting that opportunities to lock in favorable fuel prices were diminishing. Future prices for crude oil are hovering at $130 a barrel -- even for deliveries several years from now. Much of this year’s fuel prices were locked in early last year when crude prices slipped from the mid-$70s to $50 a barrel, Topping said.
In retrospect, Topping said, he would “have loved” to have hedged a higher percentage of the airline’s estimated fuel consumption next year at $51 a barrel, the same price it got for this year’s fuel purchase. The airline opted to hedge only 55% of its fuel use in 2009.
For now, the fuel cost savings are enabling Southwest to continue to expand -- albeit less aggressively than in the past -- while other airlines are slashing flights.
“We’ve got, I think, the best fuel price protection in the industry,” Southwest Chief Executive Gary Kelly said during a conference call with analysts last month. “Our belief is that we’ll be able to drive revenue growth, protect our fuel prices and the rest of our cost structure, such that we can continue to grow the airline.”