Southwest Airlines Fuel Hedging

In this time of financial crisis, it is no wonder when certain organizations face bankruptcy or difficulty in salvaging the company. Only those who know how to turn things around can rise successfully from the financial mud pit.

In the airline industry, the Southwest Airlines is earning billions. This is because Southwest is involved in hedging, an activity that can help a company especially during financial crisis. Brief Background Initially, Rollin King and his banker, John Parker, thought of establishing an airline company that they would name Air Southwest Co. , and would introduce lower prices and great service to the passengers.Later on Herbert Kelleher, King’s legal advisor, joined them and they established the airline company. They decided to launch the company in Texas which would connect Houston, Dallas, and San Antonio.

These cities are too far apart to be reached through rail or road. In addition, other airlines during the time have expensive ticket fares. The founders of Southwest thought that this could be an area where their airline could prosper (Center for Management Research, n. d.

). Southwest Airlines (SWA), based in Dallas, Texas, is considered as the “largest domestic airline company with a fleet size of 508,” and employs more than 30,000 staff.In 2006, SWA had an estimate of $9. 1 billion annual revenues (Mahalo. com, 2008). One of the reasons why SWA is successful as compared with other companies in the airline industry is because of hedging.

Hedging is a strategy to protect companies, especially oil consumers, from sudden price increases. SWA has been profitable for more than 31 years. The company was even included in Fortune magazine’s list as one of the best companies in America. However, the company is not just interested in making profits.

It is known for having excellent levels of employee satisfaction.Also, SWA established its reputation for building and maintaining relationships, and having a labor force with shared goals, knowledge and respect for each other. These are the characteristics that are distinctive of SWA (Center for Management Research, n. d. ).

In Comparison with Other Airlines Compared with other airlines, SWA has the lowest airline cost. This puts SWA in an advantageous position because passengers look for very easy, fast and inexpensive way to travel. SWA has also designed strategies to attract more passengers, one of which is the idea of returning the plane during the night.Observing that other planes are not full of passengers upon their return during the night, SWA offered much lower prices throughout the night. This proved very successful, especially since night travel costs half the ticket price during the day (Britt et. al.

, 2002). Another advantage that SWA has is the flexibility of the pilots because there are many available flights to various destinations in the United States, which makes it convenient for both the pilots and the passengers. Moreover, SWA does not offer meals while on flight. It only offers beverages and nuts, but passengers are allowed to bring in their own meals.Furthermore, SWA fly in and out of smaller airports which do not have to endure traffic unlike bigger airports.

SWA found out that this strategy works for the airline and the passengers because of the increased flight frequency and the reduction in the costs of departure and landing. Thus, SWA is able to save money at the same time providing passengers with lower ticket prices. Aside from all of these, SWA does not require ticket. Passengers can make their reservations online.

In the airport they just have to present a photo ID and the confirmation number (Britt et. al. , 2002).Fuel Hedging Many companies get involved in hedging, especially during periods of “great volatility” in order to save since jet fuel is very expensive.

Hedging refers to strategies that make use of financial instruments. These strategies can protect companies and organizations from sudden changes in costs such as fuel or interest rates. There are many ways to hedge. One example is this.

An oil consumer engages in a futures contract to purchase oil in the future. For instance, the consumer will buy oil in the next three to six months at a specific price. Thus, the future costs are ‘locked.On the other end of the spectrum, oil producers engage in selling future contract to protect themselves in case there is an event of price decline (Schelling, 2008). Although hedging does not mean that the hedger is free from risks, those who hedge are better performing compared to those which do not hedge.

This is the result of a study conducted for airline hedging practices (Reed, 2008). Despite the financial crisis which threatened the survival of other carriers, SWA is earning money. The secret is said to be hedging, as SWA was known to be “the champion oil price hedger among airlines worldwide. ” SWA has been hedging for a decade now.

This strategy seemed to favor SWA, as the company saved large amounts of money since 1998. SWA was indeed good at hedging. In an article about the airline, it showed that when jet fuel sold at the price of $3. 95 a gallon, SWA paid about $2. 35 a gallon.

This was a big catch compared to the performance of other airlines such as American Airlines, which paid $3. 17 a gallon, and Delta, which paid $3. 13 (Reed, 2008). Airlines consume about 20 billion gallons per year. Because of the increase in oil prices, many airlines are faced with the problem of rising fuel cost. In fact, fuel cost was the leading expense in U.

S. airlines in 2005 alone. Fuel cost accounted for a quarter of the expenses in operating airlines, which is still expected to increase in 2008 (Schelling, 2008). Hedging obviously helped SWA during the important times when other companies lost millions due to the economic downturn from 2001-2005. Through hedging, SWA was able to buy jet fuel for 25% or 35% less. Furthermore, SWA also took the risk of hedging for a larger percentage of its fuel.

This strategy was proven to be beneficial for the company as it remained profitable while the whole airline industry lost large amounts of money (Reed, 2008).