October 22, 2019

Cleantech VC failed before — and it risks failing again

There has been a chronic lack of successful venture investing in the energy sector. With few other paths for innovation, this has led to a near complete lack of meaningful progress towards any of our global climate goals.

This sector is projected to be worth $4.3 trillion by 2030, more than any other sector.

It is also the sector with the greatest opportunity to turn around our carbon crisis. So why are we stalled despite the prize and the urgency?

In 2016, MIT published a post-mortem on the cleantech industry that argued venture capital simply doesn’t make sense in energy. But it’s clear you can build enormous businesses in energy, and they don’t all have to be focused on highly capital-intensive extraction and distribution.

For example, Sonnen recognized the emerging need for residential storage in the German market, where solar had relatively high penetration. They sold to Shell for $180 million.

Another well known example is in the oilfield services market. The Schlumberger brothers spotted the opportunity to quantify the level of oil held in rock and have since built a $48 billion company.

The best way to build a high-growth business in the energy sector is by identifying and addressing constraints and bringing together existing technology to address market inefficiencies.

In order to successfully transition to a clean energy future, here are the lessons we must heed.

Why cleantech VC in the 2000s failed

At the turn of the century there was a flurry of venture capital that went into various cleantech plays, from battery factories and new photovoltaic materials to algal biofuels and solar roads. Cumulative funding of an estimated $25 billion culminated in a bust after the global economy crashed in 2008.

The timing was unfortunate, coming as it did just after one of the deepest recessions in living memory, but that wasn’t the root of the issue. Rather, these startups were premised on a faulty set of hypotheses and backed by investors with limited understanding of the space.

There were far too many assumptions made concerning the speed of regulatory implementation and the value of carbon-pricing mechanisms, which proved to be slower and lower than many expected.

Looking back we can identify the failures from this period as the results of chasing the wrong approaches and ignoring structural limitations. These are foremost among the sorts of mistakes we risk repeating during the current renaissance of investment into energy and clean technology.

Chasing the wrong approach

In the case of photovoltaics (aka solar power), the focus was on developing novel technologies that improved cell efficiency, i.e. the percentage of the sun’s energy that is converted into electricity.

Despite big bets on CIGS, perovskites, quantum dots, thin films, polymers and many other technologies, the vast majority of solar cells manufactured and sold continue to use crystalline silicon.

The key enabler? A pre-existing industry that had perfected the manufacture of crystalline silicon for semiconductors, allowing production to be scaled rapidly. The key driver then became reducing manufacturing costs rather than improvements in materials science. Crystalline silicon cells are now a commodity item, and it’s unlikely they’ll be displaced without a fundamental breakthrough.

One company, Oxford PV, could prove to be a counter-example here. It has found success in developing a novel photovoltaic cell with efficiencies of up to 28%, raising £145 million to date. However, its intention to licence production will require continual investment into R&D in order to maintain its technology advantage.

Underweighting structural limitations

Startups aiming to produce third-generation biofuels were among some of the most notable failures of the previous cleantech boom and bust. Biofuels offered the promise of carbon neutral liquid fuels that could be integrated into the internal combustion engine value chain.

A major issue with biofuels derived from crops such as sugar cane, palm oil, or corn is that they displace food crops and provide economic incentives for deforestation. In an attempt to address these problems, third-generation biofuels companies used algae to produce biodiesel that could be produced in any location, at a much higher density without the aforementioned downsides.

As with photovoltaic materials, it’s a compelling approach. One with a major oversight.

At the technical limit of production, algal-derived biofuels would still be four times more expensive than diesel. There was no incentive for consumers to switch to these fuels without fiscal policy support, or oil prices exploding past $200 per barrel.

Repeating the same mistakes

Hydrogen is widely seen as an essential energy carrier to decarbonize many industrial processes and for long-term storage. Companies such as Bloom Energy are betting on their edge in fuel cell technology to recover from a disappointing post-IPO period and reach profitability.

However, the trend here is similar to what we saw in the solar industry. The Chinese government has incentivised manufacturers to increase production capacity of fuel cells, which will likely eliminate Bloom’s technology advantage.

The winners in the hydrogen sector will be startups that can capture value regardless of the electrochemical stack employed, instead of owning and manufacturing the equipment directly.

Our last shot

Climate change is our biggest existential threat. This is the energy sector’s last chance to get clean tech right.

However it’s clear these past mistakes that hope and new technology alone won’t be enough to bend our climate trajectory.

The key constraint for any venture-backable company in the energy sector is the requirement it can succeed in the economic status-quo. Rising oil prices, imposition of carbon taxes, or other external factors should serve to strengthen the business case, not justify it in the first place.

The path forward is to bring together technical founders who can directly address the constraints in the energy sector and support these teams to build high impact ventures.

Alistair Owen, a materials science and nuclear engineer, is Associate Director for Energy at Deep Science Ventures (DSV) where he is helping to build a cohort of companies that will accelerate the transition to a low-carbon economy. Prior to joining DSV, he spent six years at BP where he focused on developing and commercializing energy technology.