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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
EnvironmentEnvironment
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?
EnvironmentEnvironment
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”
EnvironmentEnvironment
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
EnvironmentEnvironment
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
EnvironmentEnvironment
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
EnvironmentEnvironment
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)
EnvironmentEnvironment
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.
EnvironmentEnvironment
Carbon Risk Management Project
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
EnvironmentEnvironment
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
EnvironmentEnvironment
Carbon Risk Management Project
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
EnvironmentEnvironment
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
EnvironmentEnvironment
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
EnvironmentEnvironment
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
EnvironmentEnvironment
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
EnvironmentEnvironment
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
EnvironmentEnvironment
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
EnvironmentEnvironment
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
EnvironmentEnvironment
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 $
EnvironmentEnvironment
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
EnvironmentEnvironment
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
EnvironmentEnvironment
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
EnvironmentEnvironment
Wood Waste Power Project
Cashflows Over Time
ConstructioConstructionn
Power Plant OperationPower Plant Operation
t = 0t = 0
BankBank
Power Plant OperatorPower Plant OperatorSponsorSponsor
t = 2t = 2
EnvironmentEnvironment
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
EnvironmentEnvironment
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
EnvironmentEnvironment
Wind Power Projects
Cashflows Over Time
ConstructioConstructionn
Wind Farm OperationWind Farm Operation
t = 0t = 0
BankBank
Power UtilityPower Utility
SponsorSponsor
t = 3t = 3
EnvironmentEnvironment
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?
EnvironmentEnvironment
Thank You!
www.rbc.com/environment
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