Given Southwest's track record and strong balance sheet, some analysts wonder why the airline keeps hedging fuel. But the airline is sticking with its strategy.
Southwest Airlines, which clipped its growth plans slightly as oil prices rose earlier this year, will stick to its capacity plans for 2019, even though fuel costs have fallen this month to their lowest levels in months, Gary Kelly, the airline’s CEO, said Friday in an interview.
“No, not at all,” he said in in Los Angeles, where Southwest unveiled a multi-year $500 million renovation of its Terminal 1 at LAX. “We are prepared for $100 a barrel oil, but we will certainly be a lot more prosperous at $50.”
Even for the most sophisticated of prognosticators, oil prices are notoriously difficult to predict. Less than two months ago, airlines were alarmed at fuel prices that had risen roughly 40 percent in less than a year. Many trimmed capacity plans and raised fares, while increasing fees on checked luggage. Southwest still does not have bag fees — a competitive advantage, its executives say — but it has been active in increasing prices, according to Wall Street analysts who track fares. It has also tweaked some of its fees for priority boarding.
On Friday, however, crude oil was trading at roughly $50.50 in New York, roughly $25 less than its Oct. 3 peak of $75.86. Oil hadn’t been that cheap for about one year, though Kelly, whose airline had prepared for even pricier fuel by putting hedges in place, said he is not surprised prices have decreased.
“I was surprised the market tightened up so much in 2018, and I thought that the animal spirits would take place such that if prices went up like that, you would see more oil coming onto the market,” he said. “That’s exactly what has happened and in pretty rapid fashion.”
In the short term, lower fuel prices should lead to more profits for all airlines. But Southwest could gain a little less than its competitors, as it hedges more fuel that most U.S. airlines, some of which don’t hedge at all. The strategy famously insulated Southwest from massive losses when fuel spiked roughly a decade ago, but in recent years, it has caused a drag on earnings. In 2016, the airline said it took a net loss of $820 million as a result of its fuel hedging program.
But Kelly said the airline has a “a more conservative hedge position” now because the airline is different shape than five years ago, with a strong balance sheet and a mature business strategy.
“What we were doing post-2013 is we had a very aggressive hedge because we had a very aggressive business plan and we didn’t want to run into the teeth of very high fuel prices that would put the company in peril,” he said. “But even with paying higher energy prices, in ’15, ’16, ’17, we had record earnings. In other words, the strategy worked. We paid more than we would have had we not had hedging, but we had a very secure plan in place that protected us in case prices went the other way. Today is a prefect example — you never know.”
While the dip in fuel prices won’t affect Southwest’s capacity planning for next year — the airline plans to grow by no more than 5 percent, year-over-year — it makes it more confident about making longer-term business decisions, Kelly said.
“It just gives us more confidence in making these kinds of commitments, making commitments to invest in these airport — the airlines pay these bills one way or the other — and it makes us more confident in committing to fixed delivery schedules with Boeing as we are growing the fleet roughly 20 airplanes a year.”
Much of the airline’s growth next year will come in Hawaii, with Southwest planning to start new flights from Sacramento, San Diego, Oakland and San Jose.
Southwest has been teasing the new service for months, but it won’t start flying until after it receives Federal Aviation Administration approval to fly long overwater flights through a program called ETOPS.
The airline must prove to the government it has plans in place for routes for which there are no logical diversion airports. At one point, it had said it might fly to Hawaii by the end of this year, but that now seems highly unlikely.
Kelly said the FAA has approved Southwest’s plans with comments, and that Southwest has addressed the comments in a reply to the government.
“We are very much on schedule in that sense,” he said. “What remains after those comments are cleared is is to demonstrate to them that we can actually execute our procedures. That’s done in a conference room environment and then we will have proving flights.”
Kelly said he does not know when the airline will receive approval, but executives said Southwest will begin service soon after receiving it.
“All of that can take place within a very short period of weeks, but pinning it down to exactly what date, we are not in total control of it,” he said. “It always takes a little bit longer than you would like. But we are close.”
Photo credit: Southwest Airlines CEO Gary Kelly walks down the aisle of one of his carrier's Boeing 737 Max jets. The airline will benefit from lower fuel costs. Ashlee Duncan Smith / Southwest Airlines