Efficiency, lower fuel costs reduce Southwest’s unit cost by 4%

Southwest Airlines (LUV) enjoyed a decrease in its operating expenses from $4,042 million in 4Q13 to $4,007 million in 4Q14. Excluding the impact of special items, the airline’s unit cost decreased by 3.8%, driven primarily by lower fuel cost. Total fuel expense for the quarter decreased by ~15% and fuel price per gallon decreased by 14% from $3.05 per gallon to $2.62 per gallon.

Delta Air Lines’s (DAL) and United Continental Holdings’s (UAL) fuel price per gallon also decreased ~14% to $2.62 per gallon and $2.67 per gallon, respectively, while Alaska Air Group’s (ALK) fuel price decreased by ~18% to $2.64 per gallon.

The decrease in fuel cost in 4Q14 was mainly driven by lower crude oil prices, which resulted in improved performance of airlines and ETFs such as the iShares Transportation Average ETF (IYT) and the SPDR S&P Transportation ETF (XTN). Almost all airlines use derivatives to hedge the risk against rising crude oil prices. The unanticipated plunge in crude oil prices resulted in fuel hedging losses amounting to $15 million, or $0.03 per gallon in 4Q14. Because fuel hedges incur losses in a scenario of declining prices, Southwest’s response to this drop in its fuel price is to square off hedge positions and remain unhedged for 2015.

With this, Southwest’s management estimates that the company can participate in 90% of the price drop. The offsetting hedge positions that Southwest took for 1Q15 resulted in a loss of $0.10. For the first quarter of 2015, Southwest expects its fuel price per gallon to be $1.90, ~38% lower than $3.08 per gallon in 1Q14. Fuel cost savings for the full year of 2015 is expected to be $1.7 billion, as jet fuel’s price ranges between $1.95–$2.05 per gallon.

With continuing fleet modernization initiatives, Southwest also improved its fuel efficiency considerably. Fuel efficiency measured by available seat miles (or ASM) per gallon increased 6.3% from 68.5 ASM per gallon to 72.8 ASM per gallon in 2014.