Climate Change Policy in Canada: Impacts on Sectors and Firms

Climate Change Policy in Canada: Impacts Climate Change Policy in Canada: Impacts on Sectors and Firmson Sectors and Firms

U of T Environmental Finance WorkshopU of T Environmental Finance Workshop

May 11, 2007May 11, 2007

Sandra Odendahl, Senior DirectorCIBC Environmental Risk ManagementCorporate Risk and Insurance Services, TRM

2U of T Environmental Finance May 2007

OutlineOutline

• About CIBC

• The Legislative Framework

• Impacts on Banks

• Impacts on Sectors, Clients and Portfolio

• Opportunity Drivers

• Summary and Conclusion


About CIBCAbout CIBC

• Assets ~ $304 billion; market capitalization $33.6 billion.

• Approximately 37,000 employees worldwide.

• 1,061 branches; more than 3,800 ABMs

• Business areas:

– CIBC Retail Markets (~76% of revenue)

• retail markets (everyday banking, borrowing, mortgages and investing), wealth management and credit cards

– CIBC World Markets (~24% of revenue)

• wholesale banking arm of CIBC, providing a range of integrated credit and capital markets products, investment banking and merchant banking


About CIBCAbout CIBC

Environmental Risk Management GroupEnvironmental Risk Management Group

• Oversight responsibility for Environmental Management at CIBC– Oversight of adherence to CIBC environmental policy and other

environmental requirements and commitments

– Corporate environmental footprint

– Environmental credit risk management

• Established in 1992 as part of TRM, Corporate Risk and Insurance Services

– Originally driven by enactment of environmental legislation in Canada and the U.S. in the early 1990s that raised the possibility of significant credit and legal risk to banks associated with lending activities

• Three full-time permanent staff:– Sandra Odendahl, Senior Director

– Tony Basson, Senior Manager

– Bill Christmas, Senior Manager


Risks Arising from Environmental IssuesRisks Arising from Environmental Issues

• Credit Risk– Ability of borrower to repay debt is impacted by problems associated with

contaminated property and/or inadequate client environmental management systems, for example:

• Revenue or net income affected by clean up costs, fines and penalties

• Business operation curtailed due to regulatory orders

• Value of collateral security much lower than appraised value, due to contamination, financial ratios are adversely impacted, and credit risk is higher

• Legal Risk– Direct liability of bank for clean-up costs, possibly exceeding the amount of the loan

or investment, following foreclosure or bankruptcy

• Operational Risk– Risk of loss due to inadequate environmental management (fuel tanks, asbestos,

etc) in bank’s own operations

• Reputation Risk – Damage to bank reputation caused by association with environmentally damaging

company or issue


Climate Change Climate Change An Emerging Risk IssueAn Emerging Risk Issue

Risks for a bank:

Credit Risk

Operational Risk

Reputation Risk

Arising From:

Physical effects

Regulations to mitigate


Physical Effects of Climate ChangePhysical Effects of Climate Change

In general:

– Extreme temperatures

– Change in precipitation

– Increased storm frequency and intensity

– Rising sea levels

In Canada:

– Shifting permafrost,

– Hotter & drier summers,

– Wetter winters,

– Stormier coastline,

– Rising sea levels


Climate ChangeClimate Change

The Legislative FrameworkThe Legislative Framework

• Objective is to stabilize concentrations of GHGs at levels that will stabilize human-induced climate change

• Targets at international, national, regional and/or provincial level

• Most systems embrace emissions trading, which allows reduction targets to be met at lowest cost

• Participants are issued allowances to cover targeted amount of emissions

• To meet targets, participants can:

– Reduce emissions internally

– Buy the right to emit more GHGs (allowances)

– Buy proof that GHGs have been reduced somewhere else (credits)

International

National

Regional

Installation

Provincial State


Impacts of Climate Change on Banks

Impacts People Assets (Operations) Business Activities

Physical Aspects

Adverse health effects on employees

• Higher insurance premiums

• Operational Risk: Physical damage from storms

• Higher cooling needs; lower heating needs

• Higher business continuity management costs

• Increased credit risk of clients in certain weather-dependent sectors

– Business interruption

– Capital & operating costs

– Revenues

• Opportunity to finance infrastructure development

Regulatory Aspects

• Earn tradable offset credits through projects

• Higher cost for energy

• Increased credit risk if clients face new costs or penalties associated with regulations

• New carbon market products and services

• Renewable energy finance

• Reputational risk


Impact on BanksImpact on Banks

Physical EffectsPhysical Effects

Risks

• Human resources impacts– Effect of more respiratory problems = absenteeism?

• Higher insurance costs for CIBC premises in some regions

• Increased cooling requirements in summer

• Business interruption due to major storms, power availability in Ontario, etc.

• Credit risk due to impacts on clients’ sectors– (Especially agriculture, forestry, fisheries, tourism, food & beverage, etc)

– Increased capital & operating costs to clients

– Increased business interruption to clients

– Increased cost for (or unavailability of) insurance

Opportunities

• New products and services

• Lower building heating costs in northern areas


Impacts on BanksImpacts on Banks

Regulatory AspectsRegulatory Aspects

Risks• Operational Risk

– Increased cost for purchased energy if power producers pass on new regulatory costs

• Credit risk – Clients face new regulations, new costs, climate change litigation and other

• Reputation Risk– Stakeholders increasingly demanding action from banks and other firms to

mitigate emissions, avoid lending to high CO2 emitters, and manage supply chain

Opportunities• New products and services

• Earn Offset Credits from energy conservation projects


Impact of Regulations on Industry SectorsImpact of Regulations on Industry Sectors

• Companies will need to select one or a combination of strategies to meet carbon dioxide targets, including:

– investment in internal abatement measures,

– the purchase of credits on national or international carbon markets, and

– investment in projects that will offset carbon dioxide emissions

• Completed a study in 2006 to look at the impacts of GHG regulations on 3 levels:

1. Industries

2. Clients

3. Portfolio


1. Impact of GHG Regulations on Sectors1. Impact of GHG Regulations on SectorsMethodMethod

• Modified Porter Model to identify key factors that determine how much a sector will be affected by new regulations:

– Government policy

• Policy can have uneven effects on different sectors

– Energy Intensity

• Input costs likely to rise

– Emissions Intensity (emissions per unit output)

• More emission intense industries may face higher absolute emission reductions

– Ability to pass along costs

• Can mitigate impacts of new regulation in that sector

– Opportunities to abate

• Are low cost abatement opportunities still be available to sector?


Impact of GHG Regulations on SectorsImpact of GHG Regulations on SectorsAs a function of 2 key variablesAs a function of 2 key variables

Ability to Pass on Costs

Em

iss

ion

s I

nte

ns

ity

Pulp & Paper

Mining

Steel

Cement

Aluminumproducts

PetroleumRefining

Chemicals

Oil & GasPipelines

Highest Risk

Lowest Risk

Oil Sands

Smelting/refining

Low High

Electricity


Impact of GHG Regulations on SectorsImpact of GHG Regulations on SectorsAs a function of 4 variablesAs a function of 4 variables

““CIBC WM Carbon Cap Vulnerability Index”CIBC WM Carbon Cap Vulnerability Index”

Variable Weighting

Energy Intensity 15%

Emissions Intensity (per dollar output) 30%

Ability to pass along costs 30%

Opportunities to abate 25%


CIBC WM Carbon Cap Vulnerability Index

-1 0 1 2 3 4

Elect.-coalOil sands

Metal smelting/ refiningCrude oilAluminum

SteelCement

ChemicalsPetrol.refiningElect.-nat gas

GlassPulp & paperMetal mining

Oil gas pipelines


2. Impact of GHG Regulations on CIBC Clients2. Impact of GHG Regulations on CIBC ClientsMethodMethod

• Identified companies likely to face GHG regulation

• Forecasted future emissions and compared to probable targets

• Emissions – target = CO2 asset or liability

• Calculated cost of compliance for companies in a liability position (i.e. unable to meet their regulated target)

– Cost for abatement through new technology

– Cost to buy CO2 allowances in the marketplace under different price scenarios

– Cost to buy CO2 allowances from federal government at $15/tonne

• Assessed ability of sectors and firms to pass on costs of compliance to customers

• Determined annual cost of compliance on an absolute and percentage of net income basis


Impact of GHG Regulations on CIBC ClientsImpact of GHG Regulations on CIBC ClientsResultsResults

• Impacts of new regulations vary among clients within a sector

• GHG regulations, as articulated in Canada’s “Project Green”, would have placed a fairly modest financial burden on most of CIBC’s large clients; however, a few clients faced potentially material impacts.

• Clients in coal fired power generation and aluminum faced largest compliance costs.

• Majority of Single Names faced some costs to meet GHG regulations, but 18% of firms likely to face no cost to comply with GHG regulations

• For most Single Names, carbon compliance costs were a very small percentage of annual net income: representing under 1% of profit in 90% of cases

• Analysis will be updated using details of new federal GHG regulations


3. Impact of GHG Regulations on CIBC’s Portfolio3. Impact of GHG Regulations on CIBC’s PortfolioMethodMethod

• Top-down approach:

– Percentage of loans in portfolio that are to all clients in industrial sectors likely to be regulated, and that are to sub-investment grade clients (i.e. clients least likely to have financial means to meet new regulatory targets for greenhouse gases)

• Bottom-up approach:

– Use client info to determine sector average Loss in Event of Default (LIED) and Obligor Default Ratings (ODRs). Combine with loan exposure and apply a stress factor for impact of carbon regulations

– Determine potential loss in each sector and then as a percent of portfolio


Impact of GHG Regulations on PortfolioImpact of GHG Regulations on PortfolioResultsResults

• Portfolio impacts of proposed GHG regulations would have been very low, affecting clients representing less than 7% of CIBC’s net loans and acceptances.

• Almost 90% of the clients that would be regulated were investment-grade

• Climate change-related loan losses, under our worst-case scenario, were estimated to be <0.009% of total portfolio

• Analysis must be updated when details of new regulations are released


Opportunities Opportunities

Opportunity Drivers

I. Emissions Trading

II. Abatement measures

III. Project Development

IV. Adaptation


I. Emissions Trading OpportunitiesI. Emissions Trading Opportunities

• Governments of Annex 1 Countries that have to meet Kyoto targets– For example, Italy, Denmark and Netherlands active in CDM through investment in World Bank

carbon funds

• Capped Corporations– Will have to meet targets under Kyoto or under National emission schemes like the EU ETS

– Buying allowances from other firms and CERs or offsets from projects

• Non-regulated companies– Investing in large GHG emission reduction projects and taking credits as output

– Purchasing "green" credits (buy low, sell high; or retire the credits for good PR)

– Creating offset credits by making permanent emission reductions; sell the credits

• Carbon Funds – Pools of capital that invest in credit-producing projects

• Financial Intermediaries: brokers, banks, hedge funds– JP Morgan Chase in 2005; Morgan Stanley in October 2006

• Individual traders and investors– Directly or indirectly through investment derivative products created specifically to take

advantage of the growth of the CO2 market


II. Abatement Opportunities II. Abatement Opportunities (1 of 3)(1 of 3)

Abatement Initiative Resulting Activities & Opportunities

Building energy efficiency improvements

• Improved HVAC systems and system controls

• Insulation upgrading

• Lighting technology and control

• Water heating systems

• Energy management consulting/advisory servcies

Better vehicle fuel efficiency • Clean technology add-ons to traditional technology

• New automobile engine technology

• New manufacturing lines

• Ethanol addition to fuel


Abatement Opportunities Abatement Opportunities (2 of 3)(2 of 3)


Switch to Biofuels • Increased demand for ethanol and biodiesel

• Flex fuel engines

• Growth of agri-energy giants

Industrial reductions of non CO2 GHGs

• Technology changes

• Feedstock change

• End-of-pipe treatment

Lower Carbon Energy supply • Nuclear Power

• “Clean” Coal

• Increased demand for natural gas

• Large Hydro


Abatement Opportunities Abatement Opportunities (3 of 3)(3 of 3)


Carbon Capture and Storage, Enhanced oil recovery

• Clean coal plant development

• Coal plant conversion

• CO2 Pipelines

• Development of storage sites

Renewable energy • Run of river hydro development

• Onshore and offshore Wind Power development

• Landfill gas capture

• Geothermal

• Photovoltaic


III. Project Development OpportunitiesIII. Project Development Opportunities

Project Examples Opportunities

• Landfill gas capture

• Biomass to energy (Peru)

• Fuel switch from coal to gas

• CH4 & N2O reductions from manure management (Brazil)

• PFC reduction by continuous feeding of Aluminum plant (India)

• Cogeneration

• Coal-bed CH4 for utilisation in power generation (China)

• Creation of a pilot corridor with exclusive bus lanes (Mexico)

• Engineering/tech firms

• Consulting

• Investment funds (to purchase and aggregate credits)

• Financial advisory services

• Brokerage

• Project finance

• Commercial Banking services to non-traditional sector (LCs, Escrow, FX, trade advisory services...)

• etc.


IV. Adaptation-Related OpportunitiesIV. Adaptation-Related Opportunities

Physical Impact Adaptation Initiatives and Opportunities

Shifting permafrost New roads and pipelines in Northern Canada

Hotter & drier summers Increased demand for air conditioning; upgrades to municipal water treatment; development of drought-resistant crops

Lower inland water levels new irrigation systems; dredging navigation channels, etc.

Wetter winters dams, weirs and drainage canals to manage flooding


SummarySummary

• Emitting CO2 and other GHGs will soon bear a price – already does in the EU and some regions of the world

• Global and regional markets are being established to trade CO2 emissions

• Business response to new legislation and new carbon markets is creating new risks, but also opportunities for many industry sectors, including financial services

• Adaptation measures (mostly by government) are also sources of risk and opportunity

• To understand risks and realize opportunities and respond, need to:

1. Understand international emission markets (Kyoto, Kyoto Part II?), regulations and GHG markets in regions where a company does business, and how regional and international markets fit together

2. Follow (or forecast) how governments, firms, and individuals are responding to new markets and rules

• Once regulatory framework is established in Canada, may be possible to quantify opportunities (and risks)

Climate Change Policy in Canada: Impacts on Sectors and Firms

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