Southwest Airlines Co. is reworking hedges for future jet-fuel costs as the global collapse in oil prices helps U.S. carriers save money while also creating instability across the industry.
“It’s a scramble,” Chief Executive Officer Gary Kelly said today in an interview at Bloomberg’s New York headquarters. “You unhedge, rehedge. We have a bias to prices going up.”
Southwest, the biggest domestic carrier, has a portion of its fuel needs hedged through 2018, using a mix of financial instruments and involving crude oil and refined products. The Dallas-based airline expects $1 billion in hedged fuel savings in 2015, based on current prices.
Air-travel demand would be at risk if an extended oil-price decline triggers future production cuts, weakening the U.S. energy industry, and exposes the U.S. to economic weakness in China and Europe, said Kelly, 59.
“We have a more comfortable operating cushion” because of lower fuel prices, Kelly said. “But that creates a lot of uncertainty and makes us more cautious. It’s worrisome that the rest of the world has such economic weakness. At some point do we catch that same flu in the U.S.? We don’t live in a vacuum.”
Airlines use financial contracts to hedge against fuel- price fluctuations. When oil rises, the hedges make money to offset the increase. When crude declines, the airlines lose money on the contracts but benefit from cheaper jet kerosene bought on the spot market.
About eight quarters of little-changed fuel prices lulled Southwest into a sense of security, Kelly said, and he was surprised by crude’s free fall. While declining to offer a price forecast, he said he doesn’t believe oil has hit bottom.
Global oil prices have fallen 46 percent since June amid rising supplies — U.S. output is up 68 percent in the past five years — and slower-than-expected demand. The Organization of Petroleum Exporting Countries, which in the past has adjusted production limits in response to price declines, took no action at a Nov. 27 meeting in Vienna.
Brent crude, the global benchmark, fell 2.8 percent to $61.88 a barrel at 1:04 p.m. in New York after the International Energy Agency cut its outlook for global oil demand for the fourth time in five months. Most of the reduction in next year’s outlook is attributable to Russia, where sanctions are hobbling growth, according to the Paris-based IEA.
Southwest builds “some good protection” into its hedging program, Kelly said. As crude oil began plummeting, the airline initially had to deal with being “long,” or expecting prices to rise, as much as 50 percent in some periods, Kelly said.
“You shouldn’t try to catch a falling knife,” he said. “So that’s the problem here; it’s in a plunge, it’s in a free fall. So was $80 the right number? No. Was $70? No. Is $60? Nobody’s trying to be perfect in timing. If we can get comfortable that we can rehedge with the right cost at the right levels, I absolutely will be looking for that opportunity.”
The changing market value of Southwest’s fuel-hedge portfolio shows the turnabout. The airline has said the hedges were a net liability of $235 million on Oct. 17 and that it had posted about $100 million in cash collateral. The market value on Sept. 30 was a net asset of $35 million.
“We’re hedgers,” Kelly said. “We’re looking for opportunities to manage our risk. We’re just looking for a way to do that so we don’t cause more problems for ourselves.”
Southwest has said it expects to pay $2.30 to $2.40 a gallon for jet kerosene in 2015. Jet fuel for immediate delivery in New York Harbor was unchanged yesterday at $2.07, down 34 percent in 2014.
“A low oil price is a good thing so far,” Kelly said. “We will have a great year.”
To contact the reporters on this story: Mary Schlangenstein in Dallas at [email protected]; Dan Murtaugh in Houston at [email protected] To contact the editors responsible for this story: Ed Dufner at [email protected] Andrew Pollack