Southwest Airlines 2008 Annual Report Download - page 30

Southwest’s operating expenses, respectively, and,
for 2008, constituted the largest expense incurred by
Southwest. As a result, fuel costs have factored
significantly into Southwest’s growth decisions.
Fuel availability can also affect fuel prices and
is impacted by political and economic factors beyond
Southwest’s control. Therefore, although Southwest
does not currently anticipate a significant reduction
in fuel availability, future availability is difficult to
predict. Fuel availability can be impacted by factors
such as dependency on foreign imports of crude oil
and the potential for hostilities or other conflicts in
oil producing areas, limited refining capacity, and the
possibility of changes in governmental policies on jet
fuel production, transportation, and marketing.
Significant disruptions in the supply of jet fuel could
adversely affect Southwest’s results of operations.
Southwest’s profitability is impacted in part by
its ability to adjust fares in reaction to fuel price
volatility. Southwest’s ability to increase fares can be
limited by factors such as Southwest’s low fares
reputation, the percentage of its Customer base that
purchases travel for leisure purposes, and the
competitive nature of the airline industry generally.
Fare increases are even more difficult to achieve in
uncertain economic environments, as low fares are
often used to stimulate demand. Additionally,
Southwest has historically entered into fuel derivative
contracts to protect against rising fuel costs. These
contracts produced cash settlement gains of $1.3
billion (on a cash basis, before profitsharing and
income taxes) for the full year 2008. In response to
the recent drop in energy prices, Southwest
significantly reduced its net fuel hedge position in
place for 2009 and beyond and is therefore less
protected against future increases.
Changes in Southwest’s overall fuel hedging
strategy, the ability of the commodities used in fuel
hedging (principally crude oil, heating oil, and
unleaded gasoline) to qualify for special hedge
accounting, and the effectiveness of Southwest’s fuel
hedges pursuant to highly complex accounting rules,
are all significant factors impacting Southwest’s
results of operations. Southwest’s fuel hedging
arrangements are discussed in more detail under
“Management’s Discussion and Analysis of Financial
Condition and Results of Operations” and in Note 10
to the Consolidated Financial Statements.
The airline industry is particularly sensitive to
changes in economic condition; continued
negative economic conditions would likely
continue to negatively impact Southwest’s results
of operations and its ability to obtain financing
on acceptable terms.
Southwest’s operations and the airline industry
in general are particularly sensitive to changes in
economic conditions. Unfavorable general economic
conditions, such as higher unemployment rates, a
constrained credit market, housing-related pressures,
and increased business operating costs can reduce
spending for both leisure and business travel.
Unfavorable economic conditions can also impact
Southwest’s ability to raise fares to counteract
increased fuel, labor, and other costs. Demand for air
travel waned during the fourth quarter of 2008, which
Southwest believes can be primarily attributed to the
crisis experienced in worldwide credit markets and
the domestic recessionary environment that became
evident during the year. Therefore, a continued
economic recessionary environment would likely
continue to negatively impact Southwest’s results of
operations. Southwest continues to be cautious of
current domestic economic conditions, as
recessionary fears have continued to proliferate.
Factors such as continued unfavorable economic
conditions, a significant decline in demand for air
travel, or continued instability of the credit and capital
markets could result in future pressure on credit
ratings, which could trigger credit rating provisions in
Southwest’s credit card transaction processing
agreements, outstanding debt agreements, and some
hedging counterparty agreements (as discussed in
more detail in “Item 7A. Quantitative and Qualitative
Disclosures About Market Risk”). These factors could
also negatively impact (a) Southwest’s ability to obtain
financing on acceptable terms, (b) Southwest’s
liquidity generally, and (c) the availability and cost of
insurance.
Southwest’s business is labor intensive;
Southwest could be adversely affected if it were
unable to maintain satisfactory relations with its
Employees or its Employees’ Representatives.
While the airline business is labor intensive and
the Company’s results are subject to variations in
labor-related job actions, Southwest has historically
maintained positive relationships with its Employees
and its Employee’s Representatives. Salaries, wages,
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