Fuel Hedging in the Airline Industry: The Case of Southwest Airlines

33 Pages Posted: 21 Aug 2004

See all articles by David Carter

David Carter

Oklahoma State University - Stillwater - Department of Finance

Daniel A. Rogers

Portland State University - School of Business Administration

Betty J. Simkins

Oklahoma State University - Stillwater - Department of Finance

Date Written: July 2004

Abstract

Set in June 2001, the case places the student in the role of Scott Topping, Director of Corporate Finance at Southwest Airlines. Scott is responsible for the airline's fuel hedging program. The case describes the importance of jet fuel hedging in the airline industry, the volatility of jet fuel prices, hedging strategies available to manage jet fuel price risk, and related issues. [Note: The time period of the case allows the instructor to discuss additional issues not specifically addressed in the case such as the impact of September 11th, 2001 terror attacks on the airline's hedging strategy and the collapse of Enron (e.g., counterparty credit risk in hedging).]

Southwest Airlines has a business model based on being a low cost provider and has been very successful at offering the lowest airfares in the industry. This business strategy has effectively resulted in a consistently increasing market share over the years. A dominant factor on the expense side of its business is the cost of fuel. Fuel is the second largest expense behind labor. Most recently, fuel costs have reached the highest annual average over the six-year period from 1994 to 2000 at $0.7869 per gallon in 2000. This fact has led to the increased importance of minimizing fuel cost for 2001 and beyond. To mitigate the sensitivity to fuel prices, Southwest has consistently hedged its fuel usage but wants to reevaluate the strategies it employs. As listed in the case, the student is asked to evaluate the following hedging strategies: (1) doing nothing, (2) hedge using plain vanilla swaps, (3) hedge using options, (4) hedge using zero cost collars, and (5) hedge using futures contracts.

The case is intended for use in an advanced corporate finance course or risk management at the graduate level. However, the case can also be used in an undergraduate risk management course.

Keywords: Risk management, hedging, airline industry, case study

JEL Classification: A2, G31, G39

Suggested Citation

Carter, David A. and Rogers, Daniel A. and Simkins, Betty J., Fuel Hedging in the Airline Industry: The Case of Southwest Airlines (July 2004). Available at SSRN: https://ssrn.com/abstract=578663 or http://dx.doi.org/10.2139/ssrn.578663

David A. Carter (Contact Author)

Oklahoma State University - Stillwater - Department of Finance ( email )

Spears School of Business
Stillwater, OK 74078-4011
United States
405-744-5104 (Phone)
405-744-5180 (Fax)

Daniel A. Rogers

Portland State University - School of Business Administration ( email )

P.O. Box 751
Portland, OR 97207-0751
United States
503-725-3790 (Phone)
503-725-5850 (Fax)

Betty J. Simkins

Oklahoma State University - Stillwater - Department of Finance ( email )

336 Business Building
Stillwater, OK 74078-4011
United States
405-744-8625 (Phone)
405-744-5180 (Fax)

HOME PAGE: http://spears.okstate.edu/~simkins

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