So, why aren't other airlines doing the same? "They'd love to be hedging," says Raj Mahajan, president of New York-based energy risk software vendor Kiodex, "but no one will give them much credit because there's a lack of belief that they'll be able to pay the bills." Hedging is a fine treasury art–one that some CFOs and treasurers will privately admit is steered more by gut feelings than consistent strategy. At its best, hedging should be about stepping back, deciding on a level of risk that can be tolerated and then hedging away everything else. At its worst, it's a piecemeal use of derivatives taken out on apparently riskier purchases or deals. Unlike Southwest Airlines, many companies hedge based on developing market conditions or specific transactions. Southwest, in contrast, has chosen to smooth its ride over several years by setting prices it can live with and consequently plan for. The danger: Southwest will lock in a price that turns out to be higher than market prices. The advantage: Southwest has the possibility of gaining a competitive edge through lower prices and the definite benefit of being able to better predict its future expense from energy. Although simple futures contracts can be bought on exchanges, the most effective way for companies to hedge large portions of their energy exposure for years in advance is to arrange transactions on a bilateral basis directly with one or more derivatives dealers–normally banks or energy companies. These transactions don't always require large upfront payments, but they do always require the dealer to accept the hedger's credit risk, which the dealer will invariably try to mitigate by requiring margin payments in the form of cash or securities. Airlines don't look like a good credit risk at the moment, and they don't have the cash on hand to satisfy margin calls either. "American Airlines was very nominally hedged for the second half of 2005 and for 2006," says spokesman Tim Wagner. The company managed to lock in prices of $48 a barrel for 8% of its consumption in the second half of 2005 and at $45 for 5% of its needs for 2006. "We unwound a great deal of our fuel hedges in the first half of 2003 as the company worked to rebuild a precarious cash position," Wagner says.

Compounding the problem is the fact that fuel prices are now sky-high and show little inclination to fall back, which means that dealers can charge through the nose any would-be hedger that wants to lock in below-market rates. As much as American might like to pay less for its fuel over the next year, "there are not a lot of attractive opportunities," says Wagner. And the same gripe can be heard at other struggling carriers, which are exposed to further increases in fuel costs.

The financial constraints that have prevented more airlines from following Southwest's example are also at play in other companies with sub-investment grade ratings. But cash and credit constraints don't have to be the end of the story, insists Catherine Flax, a managing director and head of power and gas origination with JPMorgan Chase in New York. The bank has been expanding its energy trading team this year and is playing to its strengths, says Flax. As a big lender, JPMorgan is used to measuring and managing credit risk, and she says that much of her work this year has involved finding ways to be "innovative" when dealing with financially constrained hedgers. For instance, in the case of a commodity producer, the bank might accept an offsetting exposure, she says–pledging the company's product at a guaranteed price against the bank hedge for gas at a certain price. The bank's payoff would be the profit from resale of the commodity. In other cases, the bank has waived the traditional requirement for cash collateral by accepting instead a lien on physical assets–a rare occurrence in derivatives markets because physical assets aren't always easy to value. But Flax says that the team at JPMorgan has accepted claims on assets like power plants in lieu of cash or securities.

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Derivatives aren't the only way to secure cheap energy, she stresses. Companies can also try to buy energy at below-market rates for a fixed period by giving the energy provider the right to continue supplying the company for a subsequent period at a higher rate. The strategy is equivalent to selling a put option. The question is whether doing nothing is a smart alternative. "It's unfortunate that credit-constrained companies often feel they can't use their resources [to hedge]," Flax says. "In many cases, setting up something systematic would grant them more money and time [for] their core business." Take the case of American Airlines: While it lost $153 million in the third quarter of 2005, a good chunk of that can be blamed on a $526 million year-over-year increase in fuel expenses. If the airline had been able to buy fuel at 2004 prices, a healthy profit was there for the taking.