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By John Goff
Southwest
Airlines has long been praised for its aggressive fuel-hedging strategy. And
while the program has certainly smoothed out the ups-and-downs in the carrier’s
operating costs, hedging is starting to become a real drag on the company’s
earnings.
The
Dallas-based airline announced today that revenue for the third quarter fell to
$2.7 billion -- not a bad performance given the state of the airline industry
right now. In fact, excluding one-time items, Southwest actually turned a $23
million profit in the quarter.
Those one-time
items? An employee buyout program and, yep, losses on fuel hedges. The company
recorded charges of $12 million related to a portion of its fuel hedge
portfolio. Southwest saw about $78 million in unfavorable cash settlements from
derivative contracts in the third quarter.
The
Q3 loss on derivatives contracts continues an ugly trend that began in mid-2008.
In the first six months of last year, Southwest realized
over $800 million in cash settlement gains from its hedging program. In fact,
the company reported a $511 million gain in the second quarter alone.
But it’s been downhill from
there. During the second half of the year -- with oil prices unexpectedly
plummeting -- fuel contracts cost the airline $364 million.
Southwest has since shifted
gears, reducing its net fuel hedge portfolio in 2009. In January, CFO Laura
Wright said: “We have not changed our fundamental philosophy that we must
protect our cost structure from market volatility and catastrophic increases.
However, in the current environment, with a very weak economic outlook,
significant deterioration in demand, surplus inventory, and a paralyzed credit
market, we do not believe it is the time to be long on energy.”
Still, the low-cost carrier
remains far more hedged than other U.S. airlines. For 2010, Southwest has
derivatives contracts in place for over 65 percent of its estimated fuel
consumption. Other airlines have fuel hedges that barely cover 10 percent of
their predicted jet-engine fuel purchases next year. Continental Airlines,
which took a $350 million hit from underwater fuel options in 2008, is unhedged
for 2010.
Of course, Southwest’s hedging
program, which is overseen by its audit committee, has served the company well
in the long run. CEO Gary Kelly claims the derivatives have saved the airline
over $4 billion since 2000.
Southwest is one of the few
carriers that has spare cash to park into hedges. The airline is currently
sitting on about $2.4 billion in cash and short-term investments.
But if the low-cost carrier’s
finance department is wrong about fuel prices in 2010, the company will take
another big hit to earnings. If so, the airline’s No.2, CFO Wright, could find
herself in the hot seat – and not the right seat.
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