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Putting a Price on Carbon:
Risk or Opportunity for Banks?
U of T Environmental Finance Workshop
Sandra Odendahl,
Senior Manager, Environmental Risk Management
December 9, 2004
Environment
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?
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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”
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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
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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
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RBC’s Carbon Risk Management
Project

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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
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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)
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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.
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Carbon Risk Management Project
2. Kyoto Policy Impact on Portfolio
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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
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Carbon Risk Management Project – Kyoto Policy Impact
Analysis of Risks

Credit Risk
–
–
–

Operational Risk
–

Uncertain costs of new technology
Cash flow impacts of new penalties for noncompliance with CO2 targets
Carbon as asset or liability?
Complex Kyoto accounting rules
Regulatory Risk
–
Canada’s federal plan and initiatives to reduce CO2
emissions are incomplete
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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
–
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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
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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
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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
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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
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GHG Reduction Initiative #1
New 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
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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
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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
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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
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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 $
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Energy Management
Cashflows Over Time
Construction
t = 0 EMF
Energy conservation savings
Public Sector Client of EMF
t = 10
Bank
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GHG Reduction Initiative #3
Enhanced 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
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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
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Wood Waste Power Project
Cashflows Over Time
Power Plant Operation
Construction
Sponsor
t=0
Power Plant Operator
t=2
Bank
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GHG Reduction Initiative #4
Wind Power Projects – Project Finance
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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
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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
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Wind Power Projects
Cashflows Over Time
Power Utility
Sponsor
t=0
Construction
t=3
Wind Farm Operation
Bank
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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:
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Venture Cap/Clean Tech?
Emissions trading and advisory services?
Wind Power finance in Canada?
Other? Insurance products?
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Thank You!
www.rbc.com/environment
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