Smart fuel strategy means profit for Southwest

DALLAS -- Analysts say Southwest will be the only airline to earn a profit this year. While other carriers are adding fees and plan to slash flights -- some contracting by more than 10 percent -- Southwest expects to expand. The difference between it and all the others isn't just high productivity and lower-ticket sales. It also has been the most successful at controlling fuel costs.

In the first quarter of this year, Southwest paid $1.98 per gallon for fuel. American Airlines paid $2.73, and United paid $2.83 per gallon in the same period. Since 1999, hedging has saved Southwest $3.5 billion.

Most airlines use a combination of strategies to reduce risk, including buying "call options" that give them the right to buy fuel at a certain price, and "swaps," contracts that require them to buy oil or fuel on a certain date at a certain price.

As a result mostly of trades made years ago, Southwest has hedged 70 percent of this year's fuel needs at $51 per barrel instead of the current price of more than $140 per barrel. But the bulk of Southwest's hedges expire by 2012. Replacing them would be very expensive and risky. Unless oil prices stabilize or even decline, the airline could face a crisis covering higher fuel costs in just a few years.

CEO Gary Kelly said the hedges have bought his airline time to adjust to higher energy costs. Now he wants to find $1.5 billion in new revenue to make up for shrinking fuel hedges. Where? Possible sources are higher fares, international service, in-flight entertainment for a charge and selling hotel rooms on its Web site.