Coming as the carrier’s next major policy change to cut costs, Southwest Airlines has disclosed it has dropped its fuel hedging policy after stating that the exercise in the forward buying of aviation fuel was no longer proving to be economically viable for the company.

Fuel hedging is an insurance policy of sorts, designed to save an airline millions of dollars by contracting with a provider to forward purchase aviation fuel at a fixed rate per gallon for a fixed term. If the published price of fuel rises in that time, the risk and liability rests with the fuel company, and the airline ‘wins’ the gamble. However, should the published price of aviation fuel drop below the fixed price at any time in that period, then the airline remains contractually obliged to pay the agreed fixed price and hence loses out.   

Airlines can structure their hedging in various ways, however, although schemes typically set a price ceiling on their fuel, thereby insulating themselves from potential spikes in fuel prices, often caused by world events. Hedging can provide companies with added certainty for financial planning and forecasting purposes when the price of fuel is relatively stable. However, when markets become destabilized, the airline can lose out and such schemes can also become unwieldy and expensive to manage, as in Southwest’s case.

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