Energy risk-management tools can help Alaska businesses: stabilize operating costs during oil's wild ride.

• Author: Milam, Mike
• Position: ENERGY & FINANCE

Southwest Airlines is a success story in an industry where success has been rare in recent years. Of course the airline built its business in many ways, but in this decade, its earnings story has been driven by an aggressive risk-management strategy that has helped control the industry's least controllable cost--jet fuel.

Because of this strategy, Southwest is paying $51 per barrel of fuel for 70 percent of what it will use in 2008--far below the roller-coaster $100 to $150 per barrel oil prices other airlines and companies are coping with in today's market. While other airlines have hedged their fuel purchases too, none have done so in such a strategic and sustained way as Southwest, which started in 1999 when oil was $11 per barrel.

Southwest's positive earnings have netted the airline a huge marketing advantage that has resulted in its holding fares more steady and avoiding the introduction of fees for checked baggage this year. Over several years this decade, Southwest has earned more by fuel-hedging than by selling tickets.

For many industries, energy risk factors such as international conflicts, diminishing supplies, rising extraction costs and aging refinery infrastructure are creating anxiety and increasing price volatility.

ALASKA BUSINESSES NEED TO STABILIZE ENERGY COSTS

Businesses in Alaska that rely on large energy supplies--including energy intensive manufacturing companies, hospitals, universities and large retail distribution networks--should consider energy risk-management tools to stabilize costs.

Many companies cannot pass along rising energy costs to their customers. As one example, grocery business margins are so thin that increases in trucking costs hit these retailers hard.

Nevertheless, energy risk-management tools are becoming increasingly common and important to some industries. The hospital that locks in today's price for heating oil that will be delivered in the future to protect against price hikes is using an energy risk-management tool. So is the fishing or mining company that locks in energy prices early to ensure an affordable energy supply for the busier times ahead.

These are forward contracts, and they constitute a basic form of energy risk-management, based on derivatives. Any financial instrument whose value is derived from an underlying asset is a derivative. As with any financial instrument, using derivatives requires special expertise and a clear understanding of risks and benefits. Importantly...