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No Love in the Air For Southwest

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Low-fare carrier lands at a loss for first time since 1991.

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Southwest Airlines (LUV) goofed.

For the first time since 1991, the company posted a net quarterly loss. The reason: adjustments to the value of fuel hedges that had shielded the nation's largest low-fare carrier from rising fuel prices in previous quarters.

Southwest reported a third quarter loss of $120 million, or 16 cents a share, compared with net income of $162 million, or 22 cents, for the same period a year ago. Excluding the fuel hedges and other one-time items, Southwest earned $69 million, or 9 cents a share. Revenue grew 12% to $2.89 billion.

The average price of jet fuel has fallen since peaking July 3rd. This forced the airline to reverse gains made in prior quarters as fuel prices rose.

For contracts settling in future periods, derivative contracts generally result in recording unrealized gains when fuel costs are rising. But during periods of decreasing fuel prices, the contracts generally result in recording unrealized losses. As a result, the $247 million in charges for the third quarter of 2008 generally reversed a large portion of mark-to-market gains recorded in prior periods. The unexpected charges led to the net third-quarter loss.

However, Southwest says the actual cash settlement gains realized in third quarter 2008 from Southwest's hedging activities were $448 million, compared with $189 million in third quarter 2007.

Southwest's fuel costs, its largest expense, jumped 52% in the third quarter. The airline paid an average of $2.60 a gallon for jet fuel. The average cost on the spot market in New York was $3.53 a gallon.

While other airlines have been cutting flights or dropping destinations, Southwest announced this month that it will begin flying to Minneapolis.

However, the airline delayed delivery or several new planes. It has shifted aircraft to faster-growing markets such as Denver and eliminated some less profitable flights.

Southwest has attempted to snag customers from competitors by advertising its lack of fees for services, including checking a first or second piece of baggage. But changes in the industry may challenge Southwest's down-home and heretofore profitable philosophy of one size fits all.
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