Airlines try to hedge against soaring fuel costs

Continental Airlines Inc. reported a loss of $18 million from hedging in the first quarter of 2007. But like Delta, Continental is still hedging.

At one time in the 1990s, most major U.S. airlines hedged some of their fuel costs--even hiring experts from the oil industry to show them the ropes--said Peter Fusaro, chairman of Global Change Associates, an adviser to hedge funds.

That changed after the recession and terror attacks of 2001, which plunged airlines into huge losses. Banks and energy companies that make hedging trades with airlines grew nervous.

"The problem was that most carriers had terrible creditworthiness and couldn't hedge," Fusaro said. "Counter-parties feared the carriers would renege on their trades."

Southwest was the only large U.S. carrier to remain profitable through the downturn. It benefited from higher labor productivity and lower ticket-sales costs. That, and a healthy balance sheet, allowed it to keep hedging when oil was a bargain, compared to today's prices.

Now, Southwest is the only big carrier that has most of its fuel expenses hedged at below-market prices. And analysts say it will be the only one to earn a profit this year.

While other carriers plan to slash flights later this year--some contracting by more than 10 percent--Southwest expects to grow, although more slowly than it would like.

And Southwest has avoided the kind of fees that annoy passengers. It doesn't charge for checking luggage or buying a ticket over the phone, doesn't add a fuel surcharge to the fare, and still gives out free sodas and snacks.

But how long will the joy ride last?

The bulk of Southwest's hedges expire gradually by 2012. Replacing them would be very expensive and risky. One plan under study is to go back to hedging only against catastrophically higher oil prices--say, $200 per barrel.