Southwest Cash Position Declines Due to Hedging

(MoneyWatch)  Southwest filed an 8-K last week (thanks for the heads up, Things in the Sky) saying that their cash position had dropped precipitously. At first look, it seemed alarming, but thanks to some people with a far greater understanding in this area, I now see that it's not a cause for concern. It all comes down to hedging.

When Southwest was doing well with its hedges, it had cash in the bank that it was holding as collateral for the hedges from its counterparties in the hedging agreement. That amounted to $2.5 billion at the end of the third quarter. Now that fuel prices have dropped so dramatically, Southwest not only gave back the collateral, but it had to post $230 million of collateral itself since the hedges were now at prices above the market value. That's why the cash balance has now plunged to $1.3 billion, but it actually has nothing to do with how Southwest runs the airline.

On the hedging front, the airline has really backed off its previously aggressive hedging stance. It now has only 10 percent of its fuel hedged for each year through 2013. Previously, it had 75 percent hedged for 2009 at about $73 a barrel with declining amounts from there. This seems to be a very big swing. On one hand, it's good news, because Southwest is now predicting its fuel bill for next year will be $1.4 billion less than previous projected. On the other hand, it casts a bad light on their previous hedging "strategy."

Most importantly, as I noted above, this whole fuel hedging thing has nothing to do with them actually running their business. Yes, they received a temporary honeymoon on fuel prices due to some lucky hedges but now it's turning around to bite them. In the end, it just makes it harder to decipher their financial statements to understand exactly how well (or poorly) the business is operating.