Thursday, April 16, 2009

Southwest Reports that Fuel Hedging Program Creates More Losses

From Southwest's 10Q, released today.
“We benefited from significantly lower year-over-year economic jet fuel costs in first quarter 2009. Even with $65 million in unfavorable cash settlements from derivative contracts, our first quarter 2009 economic jet fuel costs decreased 16.2 percent to $1.76 per gallon. With oil prices rising, we have begun to rebuild our 2009 and 2010 hedge positions, using purchased call options, to provide protection against significant fuel price spikes. These new positions present no additional exposure to cash collateral requirements. Furthermore, we have modified our major fuel hedge counterparty agreements to allow us to use collateral other than cash to limit our cash collateral exposure to comfortable levels. Based on our second quarter derivative position and market energy prices as of April 14, 2009, we currently anticipate our second quarter 2009 economic jet fuel costs, including taxes, to be in line with first quarter 2009 (or the $1.75 per gallon range).”

The Company has derivative contracts in place for approximately 50 percent of its second quarter 2009 estimated fuel consumption, capped at a weighted average crude-equivalent price of approximately $66 per barrel; approximately 40 percent for the remainder of 2009 capped at a weighted average crude-equivalent price of approximately $71 per barrel; and approximately 30 percent in 2010 capped at a weighted average crude-equivalent price of approximately $77 per barrel. The Company has modest fuel hedge positions in 2011 through 2013. The current market value (as of April 14, 2009) of its net fuel derivative contracts for 2009 through 2013 reflects a net liability of approximately $950 million.
I am partial to the SWA business model and corporate culture. It has proven its competitive advantage in the best of times and the worst of times. Its team members are friendly and motivated, and its management is aggressive in attacking opportunity. Plus...they are active fuel price speculators. Their hedging program has earned them kudos from the national media, and has been written about on this site several times. But unless your fuel price speculation program is run by Bernie Madoff (pre-ponzi), even the best traders and economists are going to lose once in a while.

More importantly for propane and heating oil marketers, though, check out that they bought long dated CALLS to protect their position. They weren't afraid to spend the premium for the insurance that the calls provide. Also, they view their fuel risk position as a portfolio - and seem to be willing to enter into a number of strategies to achieve their goal. Finally, they have a model that they use that can help them plan what costs will be due to the hedging tools they hold in their portfolio. These are the things that every propane and heating oil marketer should be doing to manage their risk and fine tune their business.

If SWA management needs a post 10q pick-me-up, I am sure that they could step on board one of their planes with this industrious and talented flight attendant.

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