Wednesday, December 24, 2008

Southwest Airlines adjusts fuel-hedging strategy

View: The rise and fall of fuel prices has even caused the leader in jet fuel hedging to change their strategy and hedge only 10% for the next 4 years.
09:45 PM CST on Tuesday, December 23, 2008 By TERRY MAXON

Southwest Airlines Co. – which maintained a competitive advantage by locking in prices when fuel costs soared – has adjusted its fuel-hedging strategy as prices have fallen.

The financial maneuvering means that Southwest's fuel bill next year will be about $1.4 billion less than the Dallas-based carrier projected five months ago.

Southwest also said Tuesday that it reinforced its dropping cash balance by raising more than $700 million through aircraft sales and debt secured by airplanes.

The Dallas-based carrier has been hurt in the second half of 2008 as it held fuel hedges priced well above current market prices for crude oil. As a result, the carrier said it has slashed its fuel-hedging position for the next five years.

In a filing with the Securities and Exchange Commission, Southwest said it is now "essentially" hedged for only 10 percent of its fuel needs for 2009 through 2013.

As recently as mid-October, Southwest had hedged 75 percent of its 2009 fuel usage at the equivalent $73 a barrel of crude oil, 50 percent of 2010's needs at $90 a barrel, 40 percent of its 2011 usage at $93 a barrel and over 35 percent of 2012 fuel at about $90 a barrel.

But energy prices have been in a near free-fall in recent months, with futures prices falling below $40 a barrel. While Southwest had benefited as crude oil prices soared well over $100 a barrel earlier in 2008, it had to put up more cash to cover its hedges toward the end of the year.

Fuel hedges are investments that airlines use to protect themselves from rising fuel costs, often by locking in a price or capping the maximum they may have to pay.

A steady program of hedging had benefited Southwest for years as it had locked in lower fuel prices than most of its competitors. But 2008 marked a turnaround as its low-priced hedges were running out and new hedging had to be done at much higher prices.

While Southwest and other carriers have benefited from lower market prices for jet fuel in recent months, they also have been hurt as the value of their hedges declined.

Southwest said that as of Monday, it has had to post about $230 million in cash as collateral for its hedges. "This collateral balance would have been approximately $600 million higher had the company not taken steps during the fourth quarter to substantially modify its hedge position," Southwest said in its SEC filing.

As recently as Sept. 30, Southwest was holding $2.5 billion in collateral posted by other parties as hedges were working in Southwest's favor.

Southwest said its cash balance on Monday was $1.3 billion, compared with $2.4 billion in cash and cash equivalents on Sept. 30 and more than $4.6 billion on June 30. Including short-term investments, Southwest's Sept. 30 balance was over $3.4 billion and the June 30 balance was more than $5.8 billion.

Southwest also said Tuesday that it agreed to sell 10 of its Boeing 737-700 aircraft to a third-part lessor. The first five were sold Tuesday for $175 million and leased back for 12 years. It said it expects to sell the second five in first quarter 2009 and lease them back for 16 years.

The $1.3 billion cash balance did not include the proceeds from the sale and leasebacks.

Southwest also said that it agreed Monday to borrow $400 million, secured by a pool of 17 airplanes. The deal, expected to close Tuesday, involves three-year notes paying 10.5 percent annual interest.

Southwest also said it modified one of its fuel-hedging agreements to provide that it can use 20 airplanes as collateral if it has to post between $300 million and $700 million.

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