Southwest Faces Labor Test

Southwest Airlines Co. will sit down with its pilots next month to negotiate a new contract in a test of the carrier’s ability to respond to growing cost pressure.

Hedging fuel purchases has enabled Southwest to undercut most rivals with cheaper fares and still deliver strong profit. But with the fuel hedges gradually unwinding, the leading U.S. discount airline faces the difficult task of reining in already lean costs.

“They’re a company in great transition right now,” said Stuart Klaskin, a partner at KKC Aviation Consulting. “It’s going to be a tumultuous couple of years.”

Reworking its pilot contract, which becomes amendable Friday, is key because Southwest’s pilots have become the highest paid in the industry after generous past contracts and the no-frills airline has few other areas to reduce spending.

“I don’t know that they can go in and trim enough savings out of other areas to compensate and offset the increase in fuel costs,” said Andrew Siebert, senior portfolio manager at S&T; Wealth Management.

The fuel hedges will be hard to offset. Last quarter, the company booked $225 million cash benefit from its fuel hedges. Its net income was $333 million.

The contract negotiations, which are due to begin in the third week of September, according to the Southwest Airlines Pilots’ Assn., come as the airline experiments with ways to trim costs.

That’s tough to do because Southwest is one of the industry’s leanest operators. Last quarter, its cost per available seat excluding fuel expenses -- a measure of airline efficiency -- was 6.68 cents per mile, almost a penny less than those of competitors American Airlines and United Airlines.

In recent months, Southwest has tested new scheduling options in an attempt to get its pilots -- already the most frequent fliers in the industry -- to fly even more hours.

That experiment, however, led to an unexpected increase in pilot overtime costs last quarter, the Dallas-based company said.

Southwest has historically had strong relations with its employees, and there are few signs that talks with pilots will become adversarial this time.

“We’re very aware of market conditions,” said Carl Kuwitzky, vice president of the Southwest pilots association. Higher pay is “not a top bargaining objective.”

“Attitudes seem pretty positive so far,” Southwest spokeswoman Marilee McInnis said.

Southwest’s pilots are the highest paid in the industry after legacy carriers such as United and American cut wages after the Sept. 11, 2001, terrorist attacks led to a long recession in the airline industry.

Southwest pays its pilots $186 an hour, according to JPMorgan. American is the next highest at $161 an hour.