Traders celebrating a record-setting day of shorting volatility.

Southwest Airlines’ four fuel traders have saved the carrier $1.2 billion this year, the FT reported.
The airline’s hedging program has helped blunt the impact of soaring energy prices.
Southwest’s treasurer compared the challenge of hedging fuel to flying with a 6-month-old baby.

A crack team of four fuel traders at Southwest Airlines have saved the company a whopping $1.2 billion this year, the Financial Times reported this week.

Southwest’s hedges have slashed its estimated fuel costs by 70 cents to between $3.30 and $3.40 a gallon this quarter, the carrier disclosed in a recent trading update. It pegged the fair market value of its fuel-derivative contracts for this year at $1.2 billion.

The company’s treasurer, Chris Monroe, and his team trade crude-oil derivatives as a proxy for jet fuel. They deal with Goldman Sachs, JPMorgan, and seven more of Wall Street’s shrewdest commodity-trading desks, the FT said.

“Send me your most arrogant person on the Street and have them come work for us in the fuel hedge, and we will humble them in about 10 minutes,” Monroe told the newspaper.

Hedging jet fuel is as fraught with danger as flying with a 6-month-old baby, Monroe said. Their caretaker may have fed them, made sure they’ve napped, and done their best to make them comfortable, he continued.

“But anybody that’s flown with a small baby knows that something can go wrong,” Monroe noted, adding that the baby will let everyone know they’re upset, and their guardians won’t know exactly how to stop the screaming.

Hedging is paying off

Southwest began hedging its fuel costs in the early 1990s after crude prices spiked during the first Gulf War. It now stands with Alaska Airlines as the only two US carriers still in that business, the FT said. Fuel costs account for a third of its operating costs, meaning any savings can provide a significant boost to its profits.

While Southwest lost money on its hedges between 2015 and 2017, they’re in the green this year as Russia’s ongoing invasion of Ukraine has disrupted supply chains and driven oil prices skyward.

Pandemic-related disruptions and the global economy’s reopening have also played a part; the price of jet fuel on the US Gulf of Mexico has more than quadrupled in the past two years to $4 a gallon, Energy Information Administration data shows.

“The current energy environment is exactly why we hedge fuel,” Southwest CFO Tammy Romo said on the carrier’s first-quarter earnings call, according to a transcript on Sentieo, a financial-research site.

“Our fuel hedge is providing excellent protection against rising energy prices and significantly offsets the market price increase in jet fuel in first quarter 2022,” Romo added.

Southwest’s fuel traders aim to hedge at least 50% of Southwest’s fuel costs each year, and exclusively use call options and call spreads, Monroe told the FT.

He described the approach as an “insurance policy” given the calls — which grant the right to buy crude at a fixed price by a certain date — typically increase in value if crude prices rise.

Read the original article on Business Insider