Southwest's Profitable Hedge

Southwest\'s oil hedge
Soutwest Airlines apparently has less to worry about in the recent spike in oil prices than its competitors. Why? Because they used futures markets to hedge the risk of rises in future oil prices. So, when the price of oil goes up, the cost of running airplanes gets more expensive, but their futures contracts become much more valuable. One exec quipped that he wasn’t sure whether he was hoping for oil prices to go up or down…down would be cheaper for refueling, but up screwed their competitors with no added costs to SW.

This is what futures markets are really good at, when those who have risk actually use markets to hedge them, and those who speculate take those risks on. This makes it difficult if not impossible to extract out those people (whom I earlier argued should be ousted from oil futures trading) using oil futures as investment vehicles. I would normally say that perhaps what’s missing are more stories about the real-world benefits of speculation and hedging, but actually if you look more closely at the graphic, you can see that part of the problem is that no other airline was doing this at all. In the article, they note that many airlines were ‘too busy’ with other stuff (merge! dominate!) during better days to worry about oil prices and whatnot.

As an aside, my uncle Steve (who teaches courses on markets in the Business Institutions Program at Northwestern) pointed me to an intrepid student of his once, who did a senior thesis on the potential use of weather futures by Wrigleyville merchants to hedge against rainouts during summers when Cubs games dramatically affect their businesses. To my knowledge no one uses them in this way, and they didn’t really even seem receptive to this kind of analysis.

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