Hedging their jets

Even as the price of jet fuel hovers near a record high, Southwest Airlines says it saved $64 million on fuel and oil expenditures between Jan. 1 and March 31.

But the cost of jet fuel was rising steadily in the first quarter, and Southwest even reported spending $22 million more on fuel and oil in this year's first quarter than it did in the same quarter in 2003.

How, then, can Southwest claim it saved money on fuel?

The answer is that Southwest cashed in on what it calls its ''insurance policy" against higher fuel prices: oil futures contracts, or hedges. Like homeowners who rely on oil heat, Southwest and other airlines lock in the prices they will pay for oil months or even years in advance by buying contracts for crude and heating oil on the open market. The contracts can then be redeemed for the oil at a later date, when the unrefined oil is then sent to refineries to be processed into jet fuel that the airlines then use. Usually, though, the airlines sell their contracts to the highest bidder, and pocket the profits.

So while crude prices shot past the $40-per-barrel mark, Southwest was locked in with 80 percent of its fuel needs for the year at $24 per barrel.

''We really just want to lock in prices at a level where we think that we can be profitable," said Tammy Romo, Southwest's director of investor relations. ''We're not trying to run the program as a profit center, but indeed it has paid off very well this year."

The strategy is critical to some airlines now, as crude oil and jet fuel prices near all-time highs and the immediate future is fraught with uncertainty. Carriers are protected to the extent that they are hedged. Southwest, for example, will pay market rates for 20 percent of its fuel this year. JetBlue Airways has hedges against 40 percent of its fuel supply for the second half of the year, so it will pay market rates for the other 60 percent.

Delta Air Lines realized $83 million in cost savings from fuel hedges in the first quarter, according to company filings. But it, along with Northwest Airlines, have no further hedges, meaning that all of the jet fuel they buy for the remainder of the year will be at market rates.

On the flip side, hedging is a risky proposition that requires an airline to put up millions of dollars in cash on the notion that jet-fuel prices will be higher in the future. Cash-strapped airlines, then, can end up unhedged and vulnerable to high fuel costs that they can't easily recoup through fare hikes.

''So far, the carriers have been singularly unsuccessful with the fuel surcharges," said Dan Kasper, an aviation industry analyst at consulting firm LECG LLC in Cambridge.

''They'll announce one and then they have to withdraw it because the others just aren't going along," he said. ''Carriers have been eating most of the fuel cost increase."

Even carriers with enough cash to hedge run the risk that jet fuel or oil prices will plunge. The result, especially when oil prices are high, is that airlines must decide whether to risk millions in a wager on an unpredictable commodity or to take their chances, potentially having to face a brutal market later.

''The airlines actually pay for the ability to make the hedge today in cash," said Rahsaan Johnson, a spokesman for Continental Airlines. Continental has locked in 80 percent of its fuel needs for the second quarter at $40 per barrel, and has other hedges that range between $32 and $40 per barrel.

Crude oil closed at $37.54 a barrel on the New York Mercantile Exchange yesterday.

''The question for the airlines is: Do you want to make a huge down payment on a fuel hedge today for oil prices three to six months down the road, when the oil industry experts may be predicting fuel prices will go down?"

At present, that isn't much of a risk. Because Southwest has a fairly large percentage of its fuel needs hedged at a good price, they've put themselves in a better position than many of their competitors, Kasper said.

''Clearly, they're big winners, particularly Southwest, because they're hedged at $24 per barrel. They're going to be in the money for the rest of the year," he said.

Continental's hedges, on the other hand, are somewhat riskier because they lock in higher prices. If crude oil remains below $40 per barrel this year, ''they're out of the money," Kasper said.

And despite how hedged they are, all of the airlines are feeling at least some pain due to the higher fuel prices. At an average of 98 cents per gallon through the first quarter, jet fuel prices are at their highest levels since 1982. Several industry insiders who testified before Congress in hearings this month said high oil prices are still hampering the airlines' fragile recovery. Continental chief executive Gordon Bethune warned of impending job, benefit, and even pension fund cuts if fuel prices don't fall soon.

Gary Chase, senior US airline analyst at Lehman Bros., said in his testimony that every $1 rise in crude oil prices costs the airlines his firm watches an additional $280 million annually, assuming the airlines aren't hedged. Other estimates put the figure at $450 million for every dollar increase industrywide. ''In the current revenue environment, the airlines cannot pass these additional costs on to consumers," he said.

Airlines have been finding other ways to cut back on fuel costs. Southwest has ordered several new jets with so-called blended-winglets, which are small upward-pointing tips on the ends of the planes' wings. The winglets will decrease fuel consumption by 3 to 4 percent per plane, per year, Romo said. JetBlue pilots are reportedly using only one of their planes' two engines for runway taxiing, and American Airlines planes flying across the Atlantic are carrying less emergency fuel.

But the airlines won't be quick to pass on any savings from their hedges, either, Kasper said.

''At most, it tends to be an indirect benefit to the consumer. Obviously, the carrier that's hedged is in an advantageous position," he said. ''The question becomes what's the most I can get out of this? If I don't adjust my prices and simply cash my hedge, I can do better."

Keith Reed can be reached at reed@globe.com. Material from the Associated Press was used in this report.