environment putting a price on carbon: risk or opportunity for banks? u of t environmental finance...

EnvironmentEnvironment

Putting a Price on Carbon: Putting a Price on Carbon: Risk or Opportunity for Banks?Risk or Opportunity for Banks?

U of T Environmental Finance Workshop

Sandra Odendahl,

Senior Manager, Environmental Risk Management December 9, 2004


Overview

About RBC RBC’s Carbon Risk Management Project

– Impacts of Climate Change– Impacts of the Kyoto Protocol, or other climate

change mitigation policies– Greenhouse Gas Emissions trading

Opportunities – Financing GHG Reductions– Case studies

Risk or Opportunity?


About RBC Financial Group

Founded in Halifax in 1864 1311 branches, 4151 bank machines,

60,000 employees, 12 million customers Canada, US and 28 other countries $448 billion in assets Market Capitalisation $40.9 billion Profits in 2004: $2.84 billion “Canada’s Most Socially Responsible Corp”


RBC Financial Group

Environmental Risk Management Environmental Risk Management group

within Corporate Risk Management– Lead and oversee corporate environmental

management programs– Develop lending policies – Advise on transactions– Expertise in corporate environmental affairs– Identify and communicate emerging

environmental risk issues


Carbon Risk – Emerging Risk issue?

Global Climate Change poses risks and opportunities to business and investors based on two factors

1. Impacts of physical effects of Climate Change, and

2. Impacts of policy initiatives to curb emissions of CO2

Shareholders/Investors started asking companies, including banks, to disclose their exposure to Carbon Risk


RBC’s Carbon Risk Management Project

Launched in May 2002 Climate Change Risks and Opportunities

1. Climate change impact on sectors

2. Mitigation policy (i.e. Kyoto) impacts on RBC portfolio- Portfolio exposure to Kyoto-type policy- carbon risk in credit risk assessment - Impact of carbon credits and renewable

energy credits on wind project financials

3. Emissions Trading – Risks and Opportunities


Carbon Risk Management Project

1. Climate Change Effects Literature review of info on Extreme and

Unpredictable Weather Events Red flag sectors:

- Ag (good and bad effects; extreme dry or wet)- Forestry (drought, new pests, fires, species)- Tourism (tourists will adapt, but capital?)- Property Insurance (catastrophe-related losses

were 15X higher in 1990s than in 1960s), - Fisheries (sea levels up, lakes down; habitat

change thus species changes), - Hydroelectric power (changing water levels)


Carbon Risk Management Project – Climate Change Analysis of Risks

Credit Risk – Business interruption in some industry

sectors Insurance Risk

– Property and casualty insurers adversely affected by adverse weather events.

Operational Risk– Risk that offices and branches could be

damaged by more extreme weather events.



2. Kyoto Policy Impact on Portfolio Collaboration among Environmental Risk,

Sector Risk and Economics Impacts on Sectors considered a function of

energy intensity and ability to pass on costs Impacts on Countries considered a function of

per capita income and and energy use per $ GDP.

Results presented to Board in January 2003


Carbon Risk Management Project – Kyoto Policy Impact

Analysis of Risks Credit Risk

– Uncertain costs of new technology– Cash flow impacts of new penalties for non-

compliance with CO2 targets– Carbon as asset or liability?

Operational Risk– Complex Kyoto accounting rules

Regulatory Risk– Canada’s federal plan and initiatives to reduce CO2

emissions are incomplete



3.Greenhouse Gas Emissions Trading EU GHG trading to start next month Canada’s ET system is slated to begin around

2007– Est. 700 firms in thermal electricity, oil and gas,

mining, and manufacturing sectors GHG emissions trading expected to be > $1.6

billion/yr market in Canada Identified 5 different business opportunities for

Capital Markets trading Build on existing client relationships


RBC’s Carbon Risk Management Project – GHG Trading Analysis of Risks

Regulatory Risk– Canada’s incomplete Plan; evolving rules

Operational Risk– experienced staff?

Market Risk– low liquidity in new markets

Credit risk– counterparty risk, country risk


Opportunities:Financing GHG Emission Reductions

Opportunities must meet same business case and risk criteria as any other financial transaction

– i.e. must meet risk and return criteria

Three key financing opportunities:1. Venture Capital

2. Structured Loans

3. Project Finance


Financing GHG Emission Reductions:

Examples of initiatives that result in lower GHG emissions: Develop a new technology that makes

alternative energy work better Offer a package of retrofits to reduce energy

consumption at a third party’s facilities Build a facility to divert waste from landfill and

generate electricity with lower emissions Develop Wind Power projects


GHG Reduction Initiative #1New Technology for Power Generation

Characteristics of the Company:– Very small and relatively new, privately-held– New technology– Some manufacturing capability– Initial growth or expansion stage– Unstable revenue and cashflow– No established management team– Needs money to grow, expand, and profit

This company needs VENTURE CAPITAL


What is Venture Capital?

Financing for privately-held companies Generally, investment by VC in the form of equity

(a share in the company) Sometimes invest using long-term convertible

debt (loans that can be turned into a share in the company)

Venture capitalists raise money and distribute it within a portfolio of companies (“a fund”)

Financing possible at many stages, from “idea” stage to just before company goes public


Venture Capital

Available “Products” RBC Capital Partners’ Alternative Energy

Technology Fund (US$50 million)– <25% of company, usually convertible pref– Support company in developing business plan

(if necessary), management team, strategic planning, recruitment etc.

– Sell share after 3-5 years; Target ROI is 35% RBC Ventures’ Clean Tech Venture Fund

– Direct investment into earlier stage tech companies with efficiency or replacement technologies


GHG Reduction Initiative #2

Energy Use Reduction Characteristics of the Company:

– Small Energy Management Firm (< C$10 million/year)

– Designs, implements, and monitors energy efficiency projects for big companies

– Established management team– Profitable– Needs money to fund big GHG reduction

project for a public sector client This company needs a specially-structured

BANK LOAN


Energy Management Firm

Description of Project Canadian Municipality wants to reduce energy

use in public buildings (libraries, fire stations, arenas, etc.)

Energy Management Firm (EMF) proposes improvements such as lighting, motors, HVAC, controls, water use, etc.

Capital cost of project is $1.5 million, and City will see a payback over 9-10 years.

City pays the $1.5 million back to the EMF over 9-10 years, using the money saved

Problem: high fees and balance sheet issues for small company to borrow that much $


Energy Management

Cashflows Over Time

ConstructioConstructionn

Energy conservation Energy conservation savingssavings

t = 0t = 0

BankBank

Public Sector Client of EMFPublic Sector Client of EMFEMFEMF t = 10t = 10


GHG Reduction Initiative #3Enhanced Wood Waste Power Generation

Trans Canada Pipelines– Plan 35 MW plant in Northern Ontario– 2/3 of power from 300,000 t/y wood residues

that would normally be landfilled– Long term contracts for wood waste– Project displaces CH4 from wood

decomposition – Generates ½ GHG emissions per unit energy

compared to traditional electricity generation– Long term “take or pay” contracts for electricity

PROJECT FINANCE


What is Project Finance?

Any asset or group of assets financed on a stand-alone basis, where cash flow from that asset is the primary source of repayment

Limited recourse to equity participants/ sponsors

Often separate legal structure for project Usually complex structure very specific to

particular project


Wood Waste Power Project

Cashflows Over Time


Power Plant OperationPower Plant Operation

t = 0t = 0

BankBank

Power Plant OperatorPower Plant OperatorSponsorSponsor

t = 2t = 2


GHG Reduction Initiative #4Wind Power Projects – Project Finance

Three different deals: UK, Italy, Texas 23 wind farms 415 MW total power generated Incentives ranged from 45% to 71% of

power price. Not viable without incentives. Incentives affect borrower’s projected cash

flows, which in turn affect debt service coverage ratios, risk assessment, project returns, and ability to finance projects


GHG Reduction Initiative #4 - Wind Power Projects Project Finance Finance type and terms:

– Long term loans– Limited Recourse to Parent Co.– Incentives guaranteed for most of the term– Long term power purchase agreements with

utilities


Wind Power Projects

Cashflows Over Time


Wind Farm OperationWind Farm Operation

t = 0t = 0

BankBank

Power UtilityPower Utility

SponsorSponsor

t = 3t = 3


Putting a Price on Carbon

Risk or Opportunity?

Both, of course! Top 3 Risks:

– Regulatory uncertainty– Liquidity in Carbon markets– Credit Risk, esp if small players enter clean energy

business Top Opportunities:

– Venture Cap/Clean Tech?– Emissions trading and advisory services?– Wind Power finance in Canada?– Other? Insurance products?


Thank You!

www.rbc.com/environment

environment putting a price on carbon: risk or opportunity for banks? u of t environmental finance...

Documents

operational risk risk

carbon risk slide

sector risk

corporate risk management

kyototype policy carbon

credit risk assessment

climate change risks

carbon credits