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What Goes Down Will Come Up

Fossil-fuel betas put energy risk in its place.

Like conventional market betas, FFβs measure percentage changes in expected returns subject to another variable. Positive betas flag companies that tend to mute consequences of higher oil prices or even convert increases to added profits. Negative betas signal earnings more vulnerable to rising fuel prices. “It is not good or bad, per se, to have a positive or negative FFβ,” Sundaram says. “But it may be strategically sensible for a company to decouple its core business from fossil-fuel prices in the long run by gravitating to a zero beta.” Neutral FFβs can furnish a target for managers who want to insulate core earnings from fossil-fuel price fluctuations. Using the same scale, managers might instead adjust betas to accommodate any risk appetite or energy outlook.

An FFβ expresses the expected change in a company’s excess market capitalization for every 1 percent change in the price of fossil fuel. The change in market capitalization divided by the number of shares forecasts an imputed share-price impact of a change in fossil-fuel cost. When combined with consensus analyst estimates of the forward P/E ratio, it produces an earnings-per-share equivalent impact. This equivalent impact does not drive actual earnings up or down in a given quarter, as sales would. Instead, it imputes an energy toll (or bonus) to EPS subject to many other influences.

Take, for example, two package-delivery rivals, FedEx and United Parcel Service. Both spend enough on fuel to affect bottom lines and, hence, market values. UPS reported to the CDP that 6 percent of its 2007 operating expenses assigned $2.8 billion to fuel. FedEx reported a $3.5 billion fuel bill, or 11 percent of its total operating costs. Although both deliver packages, their excess earnings respond differently to changes in fossil-fuel prices.

What did the different sensitivity mean for shareholders of UPS (FFβ 0.0576) and FedEx (FFβ -0.1411)? Enough to nudge earnings in opposite directions by several cents a share. A 10 percent increase in the cost of fuel, Sundaram estimates, would strip the equivalent of 10 cents a share from FedEx. That, in combination with a P/E ratio of 12.2, relinquished an imputed $1.22 in share price, a penalty that a different energy policy might have offset. Conversely, a 10 percent drop in fuel prices should boost earnings in equal measure.

By maintaining a neutral FFβ, closer to zero, UPS delivers 3 cents of implied excess earnings, or 41 cents in share price (applying a P/E of 15.9). This net difference of $1.63 in the stock prices of two rivals resulting from a 10 percent change in fossil-fuel prices highlights why a fossil-fuel beta might help managers frame savvy questions around energy consumption. One explanation might lie in UPS’s aggressive pursuit of conservation initiatives, such as more fuel-efficient facilities, minimizing miles flown or driven, and converting 25 percent of its truck fleet to lower-emission vehicles.

Even steeper differences separated rivals in other industries. The imputed market impact of a 10-cent rise on petroleum producer Apache Inc. (FFβ 0.0657) was 71 cents a share; on Valero Energy Corp. (FFβ 0.5351), $3.75 a share. All 13 oil producers in the roster have neutral-to-positive FFβs, an outcome consistent with classical economics, says economist Robert Hansen, director of Tuck School’s Allwin Initiative. “This is the likely result of an increase in the demand for energy over this period, combined with rising asset values associated with the energy firms’ fossil-fuel reserves.”


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