Southwest Airlines (NYSE: LUV), incorporated in 1967, has been one of the most profitable and best-performing airlines in the United States for decades. Southwest has maintained a consistent Investment Grade credit rating from all three ratings agencies, which is rare among airlines. It has been the only airline to consistently return capital to its investors year after year, and in 2018 recorded its 46th consecutive year of profitability.
Besides an innovative point-to-point network and a focus on customer satisfaction, one of Southwest’s key differentiators has been its fuel hedging program, which it started in 1994. The idea was that by locking in prices for its largest variable cost, Southwest could protect itself against upward volatility in fuel. When other airlines were using their cash to pay for runaway jet fuel prices, Southwest would be in a position to invest in new aircraft, improve its operations and take market share.
Southwest’s fuel hedging started slowly – it was outsourced and relatively simple, trading contracts representing just 20 percent to 30 percent of the airline’s fuel needs up to six months in advance. That changed in 1998, as Asian economies melted down and OPEC crashed crude oil prices to $12/barrel. It was at that point that Southwest executives got serious about locking in these extremely low prices and hedging a greater percentage of its overall fuel spend. Over the next five years, Southwest was paying anywhere from 25 percent to 40 percent less for its jet fuel than its competitors, and by 2008, the airline was hedging 70 percent of its fuel needs.
“Being unhedged is the ultimate short position. You’re betting every day that the price of fuel won’t go up,” Barry Siler, a Houston-based commodities trader who consulted with Southwest on fuel hedging, told USA Today.