Airlines hedge against rising fuel costs

Southwest Airlines paid $1.98 per gallon for jet fuel during the first quarter of 2008. The same fuel cost American Airlines $2.73, and United $2.83 per gallon during the same time period.

Southwest Airlines has been hedging fuel costs since 1999 – a practice which has saved the carrier $3.5 billion. At times the hedging has meant the difference between operating at a profit or a loss. In the first quarter of this year, the airline enjoyed hedging gains of $291 million.

Hedging is a strategy that allows a company to protect itself against rising prices for commodities, by locking in pre-set prices.

From trades it has made over the years, Southwest has managed to hedge 70 percent of its anticipated fuel requirements for 2008, at $51 per barrel rather than the current market price of over $140 per barrel.

“We view our program as insurance,” noted Paul Jacobson, Delta Air Lines Inc. treasurer. “Our goal is to minimize the volatility of fuel expenses. To do that, you’ve got to be in the market actively without an opinion as to what energy prices will do.”

Hedging carries risks, however. If fuel prices drop, airlines stand to lose money, and their options will expire.

During the 1990s, most of the major U.S. carriers hedged some of fuel costs, commented Peter Fusaro, chairman of hedge fund advisor Global Change Associates.

The practice changed after the recession of the late 1990s and the terror attacks of 2001, when airlines were plunged into huge losses.

Southwest Airlines was the only major U.S. carrier that remained profitable through the downturn. It was able to keep hedging in they days when oil was at bargain prices.