1. Environment 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

2. 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?

3. Environment 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”

4. Environment 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

5. Environment 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 CO 2  Shareholders/Investors started asking companies, including banks, to disclose their exposure to Carbon Risk

6. Environment 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

7. Environment 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)

8. Environment 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.

9. Environment 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

10. Environment 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 CO 2 targets –Carbon as asset or liability?  Operational Risk –Complex Kyoto accounting rules  Regulatory Risk –Canada’s federal plan and initiatives to reduce CO 2 emissions are incomplete

11. Environment 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

12. Environment 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

13. Environment 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

14. Environment 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

15. Environment 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

16. Environment 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

17. Environment 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

18. Environment 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

19. Environment 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 $

20. Environment Energy Management Cashflows Over Time Construction Energy conservation savings t = 0 Bank Public Sector Client of EMF EMF t = 10

21. Environment 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

22. Environment 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

23. Environment Wood Waste Power Project Cashflows Over Time Construction Power Plant Operation t = 0 Bank Power Plant Operator Sponsor t = 2

24. Environment GHG Reduction Initiative #4 Wind 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

25. Environment 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

26. Environment Wind Power Projects Cashflows Over Time Construction Wind Farm Operation t = 0 Bank Power Utility Sponsor t = 3

27. Environment 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?

28. Environment Thank You! www.rbc.com/environment