Oil price drop a mixed blessing for some airlines

CHICAGO Mon Oct 27, 2008 5:23pm EDT

CHICAGO Oct 27 (Reuters) - The stunning third-quarter drop in jet fuel prices left several airline executives red-faced as they tried to explain how the much-needed decline in costs could also result in millions of dollars in accounting losses.

The simple answer: It was worth it.

"Low fuel prices is a good thing for Southwest Airlines and this is an opportunity that we'll want to take the best advantage of that we can," said Gary Kelly, chief executive of Southwest Airlines Co (LUV.N) on Oct. 16.

Southwest wrote down $247 million in noncash losses, related to hedges that were designed to blunt the impact of more expensive fuel. For years, however, Southwest's fuel hedges have been the envy of the airline industry that was battered severely by high fuel costs and low-fare competition.

As the price of fuel fell, hedges at Southwest and other airlines lost value and may have forced some airlines to pay more than market prices. Top carriers wrote down almost $2 billion in the quarter in noncash mark-to-market losses.

It was a situation that had been brewing since July when crude oil -- which influences the price of jet fuel -- fell from a record high of nearly $150. By the end of the quarter, oil had declined by more than 30 percent.

But experts agree the drop in oil prices -- 57 percent from its peak as of Monday -- is welcome relief for the industry. They say the noncash writeoffs are minor compared with the money carriers stand to save on cheaper fuel.

"If you had the choice, you'd take the noncash charge," airline consultant Robert Mann said. "Obviously, the lower fuel prices are a big plus."

THE CROWD CHEERS

Airline executives unanimously cheered the drop in oil prices -- if not the economic downturn responsible for the decline.

"While oil prices are lower in recent weeks, they continue to be volatile," Glenn Tilton, chief executive of United Airlines parent UAL Corp UAUA.O, told employees last week.

"That said, the convergence of falling oil prices with our capacity flexibility, strong improvement on costs and competitive revenue put us in a position to make our margin and return United to profitability," he said.

UAL suffered a $779 million third-quarter net loss on soaring fuel costs, as well as the drop in fuel prices that lowered the value of the company's fuel hedges. The company reported a one-time noncash loss of $519 million due to the diminished value of its hedges.

Northwest Airlines Corp NWA.N wrote down $410 million due to the falling value of fuel hedges. US Airways Group Inc LCC.N wrote down $488 million for the same reason.

In fact, US Airways, which hedged 44 percent of its total fuel consumption in the third quarter, is rethinking its hedging strategy, said Chief Financial Officer Derek Kerr.

"We suspended our fuel hedge program in the middle of the third quarter due to concerns about the impact collapsed environments could have on our liquidity resulting from the significant decline in the price of oil," Kerr said on a conference call last week.

Southwest's Kelly also expressed interest in a new hedging strategy to accommodate falling oil, while still guarding against a price rebound.

"Right now, in October, prices have no bottom, and so we've got to -- we can't be oblivious to that," Kelly said. "At some point, we'll want to adjust our strategy and continue to be adequately hedged into the future." (Editing by Patrick Fitzgibbons and Andre Grenon)

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