The Germans have a wonderful word, schadenfreude. It means, roughly, pleasure in others' misfortunes. We had some this month in the airline world when Southwest Airlines, the US low-fares king, broke its string of consecutive profitable quarters stretching back to 1991 and was forced into a third-quarter deficit. This was because its vaunted fuel hedges, its insurance against high oil prices and the envy of many, had forced the carrier into a loss as oil prices fell.
Southwest recorded a charge of $247 million for the third quarter. Without the charge, it would have earned $69 million on its operations, on flights. But the bottom line, a $120 million quarterly loss, was its worst ever.
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Laura Wright, Southwest's senior vice-president for finance and chief financial officer, says the charges are related to "mark-to-market adjustments on our future-period fuel hedge portfolio". Required under the accounting rules, the "mark-to-market" rules mean a company must account for provisions like hedges at current prices, not the prices it paid for them. That means Southwest suffered a paper loss on the hedges, but a loss that had a real effect because of the rules.
Southwest is not alone in being pushed "under water" by its fuel hedges - Northwest suffered while Continental and United also say their fuel hedging had made their deficits worse.
At United, the loss on the value of the hedges - $519 million - pushed the nation's number two carrier into a loss of $779 million. At Continental, fuel-hedge losses of $63 million combined with the effects of a hurricane that shut down its Houston hub operations and put the carrier into a $236 million net loss. Without the hedge loss, United would have and did lose $252 million, while Continental would have and did lose $145 million. (A year before, United earned $334 million, while Continental posted a profit of $241 million in the year-ago quarter. A dramatically smaller Northwest managed a small profit in its last quarter before disappearing into Delta before its hedges swamped it.)
But Southwest is different: the fuel-hedge losses did not exacerbate an already difficult situation. They exacerbated a profitable situation. Even though the airline's operating profits were down, they were still profits.
All of which goes to show that hedges may be exotic, risky and can disturb the bottom line. But the real lesson is that when you provide a good product and run a good airline that people are willing to pay for, you will make money right up to the edge of the hedge.
Source: Flight International
