* If You Ignore The BIG Hit The Airline Took On Fuel Hedges

Fuel hedges are wonderful for airlines when oil prices are high, as they were this summer... but when the price of oil falls, those hedges are a noose around an airline's fiscal neck. Just ask Southwest Airlines.

On Thursday, Southwest proudly boasted of its 70th consecutive quarterly profit... while at the same time admitting a Q3 2008 net loss of $120 million, or 16 cents per share. That compares to net income of $162 million, or $.22 per diluted share, for third quarter 2007. The airline's net income also fell, with Q3 2008 income of $69 million -- compared with $156 million last year -- on record quarterly revenues of $2.9 billion.

So... how can Southwest say it made money? The airline's claim of profitability lies in the phrase "excluding special charges" -- namely, the $120 million financial hit the carrier has taken since oil prices dropped from a high of $147 per barrel in July, to just under $70 this week.

Southwest has nearly all of its fuel hedged at $51 per barrel through 2009... meaning the lower the price of oil goes, the less competitive Southwest's position is relative to other airlines paying the market rate. And even while Southwest is still getting a deal, that discrepancy hits the books sooner or later.

As an example of that hit, Southwest earned $121 million, or 16 cents per share, in the second quarter of this year. That profit excluded special items... but included profits from fuel hedges, which have since largely evaporated. And that number was significantly less than the $287 million profit Southwest made in Q2 2007.

Southwest CEO Gary Kelly (below) chose to focus on the positive aspects of his airline's report.

"Our third quarter 2008 operating revenues of $2.9 billion were a record performance, increasing a strong 11.7 percent, or 9.3 percent per available seat mile (ASM)," said Kelly. "Since August, our revenue trends have strengthened, with September operating revenue per available seat mile (RASM) increasing 11.0 percent and October month-to-date RASM increasing approximately 14 percent, versus the respective year-ago periods."

Kelly also pointed out that fuel hedging policies aren't meant to be consistent profit-makers... but merely to smooth out the highs and lows of the marketplace.

"The dramatic drop in energy prices since July is a significant overall benefit for Southwest Airlines, of course, even though the fuel hedge portfolio dropped over the last three months," Kelly said. "Even with the drop in prices, our fuel hedge remains 'in the money.'"

FMI: www.southwest.com