Southwest locks in fuel costs, a gamble that keeps fares in check

Tag : oil fuel
By freep.com | Sep 28, 2008
As jet fuel prices sent airlines on a stomach-churning ride,spurring new fees and higher prices, Southwest Airlines customershave had a smoother trip.
Southwest, the second-biggest carrier at Detroit Metro's new NorthTerminal, took a gamble on fuel purchasing that has paid off forconsumers. It's been able to keep fare increases much lower thanthose of most carriers because it locked in jet fuel prices beforecrude oil skyrocketed to almost $150 a barrel earlier this year.
That protection is likely to wear off a bit in 2009, but manyanalysts say the Dallas-based airline's strong financial positionwill allow it to remain one of the cheapest deals for travelers.
"Southwest is the price-setter in Detroit," said Tom Parsons, chiefexecutive of bestfares.com. "They are still king of the low-costcarriers."
For instance, the airline advertises that a Friday to Sunday tripto Chicago in late October can be as low as $160. Northwest matchesthat price, but charges for checked baggage. Prices for carrierslike Delta Air Lines, Frontier Airlines and US Airways range from$240 to $330.
Southwest works hard to preserve its image, presenting itself as afun, lower-cost alternative. There is no fee for the first twochecked bags, no fee for aisle and window seats, and no fee forsnacks. When its gates opened in the new North Terminal, Southwestemployees handed out T-shirts and other trinkets to passengers anddecorated its gates with balloon arches.
But the key to Southwest's success has been fuel hedging. With ahedge, the airline enters into a contract with a bank or otherfinancial services firm. The airline bets oil prices will go up;the other side bets they will go down. The loser must pay thedifference to the other party.
With oil hovering about around $100 a barrel, Southwest has comeout on top. For 2008, it has locked in the price for about 70% ofits jet fuel based on oil priced at $51 per barrel. For 2009, ithas locked in 55% of its jet fuel based on that same price.
That makes Southwest, which flies 19 daily nonstops from Detroit,more protected than any other airline if oil prices remain aroundwhere they are now, said Stuart Klaskin, an aviation analyst at KKCAviation Consulting in Coral Gables, Fla.
"No one else is positioned like that. No one else has the cash tohedge with," Klaskin said. "Southwest has the most sophisticatedfuel-hedge operation of any airline ... they have top fuel traderswho work for them."
Southwest officials declined to comment on the airline's strategy.
Darin Lee, a principal at LECG, said Southwest's hedges have beencrucial to its ability to report profits in 2008.
"They probably would have lost money, had they not had the fuelhedges," said Lee, an analyst for the Cambridge, Mass.-based firm.
In the second quarter, Southwest reported net income of $321million, nearly setting a record for its most profitable quarter.Most other airlines were reporting losses in the same period,including Northwest -- Metro's largest carrier -- which posted anet loss of $377 million.
Lee said jet fuel now accounts for nearly 30% of passengercarriers' costs, more than twice what it was in 2000. Crude oilprices have almost quadrupled since then, Lee said.
But even with hedging, Southwest customers have seen fareincreases. The airline has boosted fares about 7% to 14% since thesummer of 2007, said Rick Seaney, chief executive offarecompare.com. But that's about one-third of the increase seenfrom legacy carriers like Northwest, American and United.
Southwest will likely keep fares lower despite having less fuelhedged in the coming years, Seaney said. Its strong financialposition could allow it to continue to lock in fuel prices,analysts say. For 2012, Southwest only has around 15% of its jetfuel locked in based on $63 a barrel.
At Metro, Southwest is just behind Spirit in the number ofpassengers carried so far this year. But Spirit has told the WayneCounty Airport Authority that it expects its number of passengersto fall 30% in fiscal 2009. Southwest predicts a decline of just0.2%. Southwest has three gates in the North Terminal and Spirithas two.
Klaskin said it's unlikely that Southwest would take over all ofthe business Spirit may drop. But filling in the gaps in Detroitwouldn't be out of the question, especially if Delta cuts capacityafter it merges with Northwest, he said. "They know how tocherry-pick the good stuff," Klaskin said about Southwest.
The airline has already done this in Denver. Southwest has addedflights there as United and Frontier have pulled back. By Nov. 2,Southwest plans to have 115 daily flights out of Denver, a ninefoldincrease from mid-2007.
At Metro, Southwest wants more business travelers and those fliersmight be more interested if Northwest drops flights. Southwest alsohas a new alliance with WestJet, a Canadian low-cost carrier. Thatmight spur more interest in Detroit.
"Detroit is a nice logical place to connect out of Canada," Seaneysaid.
However, this isn't the most likely time to see significant growthin the industry, even at Southwest, Seaney said.
"At $120 oil, nobody is in a position to grow very much ... thelikelihood of anything growing is slim," he said.