Lessons From The Cleantech Debacle
The cleantech investment boom was the ur-wave of investing in climate and sustainability. It didn’t go well, to put it mildly. Amasia Fellow Daniel Tan and I took a tour through the history and extracted a few lessons. We have a short reading list at the end.
TL;DR:
For investors: cleantech, as originally defined, is fundamentally different from software. Really.
For policy makers: consider a carbon tax.
For entrepreneurs: stay out of spaces where you’re going to get clobbered by low cost providers.
For Amasia, the lesson is simple: stick to what we know — namely software-led companies that catalyze behavioral change rather than explore capital-intensive technology frontiers.
What happened?
First, a definition. The cleantech bubble mainly refers to the bubble formed in and around renewable power generation (especially in solar and wind energy). Renewable energy is where the bulk of the losses were sustained.
What happened was this: Firms lost over half of the $25 billion they invested in cleantech startups from 2006 to 2011. As a result, between 2011 to 2016, VC cleantech investment plummeted almost 30 percent, from $7.5 billion to $5.24 billion.
Damn, this sounds like a bleak wasteland!
Well, not quite. Although cleantech has not fared well with venture capitalists, the industry as a whole has progressed rather well in the last decade. According to BloombergNEF’s 2019 New Energy Outlook, since 2010 the costs of solar, wind, and biofuels have respectively dropped 85 percent, 49 percent, and 85 percent -- bad news for VCs, but GREAT news for customers. In addition, the report finds that wind and solar are now the cheapest sources of energy across more than two-thirds of the world. Separately, a report by McKinsey states that from 2009 to 2014, the cost of super-efficient LED lights fell by more than 85 percent, and from 2009 to 2012, the cost of electrical storage fell by about half, from $1,000 per kWh to $500 per kWh. Taken together these are milestone changes.
In short, we need to distinguish between venture capital investments and the current state of cleantech (and non VC investments in the area). When people refer to the ‘cleantech bust’ or ‘cleantech bubble,’ they are specifically referring to its relatively tiny venture capital component.
Now back to the bubble
The leaders of the cleantech boom were not unsophisticated investors. Legends of the VC business launched cleantech funds worth $500 million and $1 billion respectively. The nation’s largest pension fund, the California Public Employees’ Retirement System (CalPERS), chipped in with $460 million (its CIO would later quip that cleantech investments proved “a noble way to lose money”). In fairness to these investors, as Steve Jobs famously observed, “You can't connect the dots looking forward; you can only connect them looking backwards.”
A perfect convergence of four key factors gave rise to investor optimism. Understanding these factors provides important context:
High oil prices
The cost of gas reached a peak of $4.11 per gallon in 2008, driven by the first major decline in non-OPEC supply since 1973 and an unprecedented hike in global demand. As oil prices surged, Americans began to question the overall efficacy of non-renewable energies; not only did they pollute the environment, they were fast becoming too expensive and volatile. Clean tech promised a more dependable source of energy immune from the terror of global supply shocks.
Heightened public awareness of climate change
In 2006, former Vice President and Democratic nominee Al Gore released the seminal documentary, An Inconvenient Truth, intended to spur people to take action on climate change. It highlighted ‘the inconvenient truth’ that fighting global warming would require substantial behavioral changes (I agree with Gore on this matter, and behavioral change is central to Amasia’s investment focus). Eventually, the film won an Oscar for best documentary, topped $45 million at the box office, and sold 1 million DVDs. It was a monumental success that underscored the gravity of the climate crisis and thrust the issue into the public eye.
Silicon Valley idealism
In a famous 2007 TED talk, John Doerr declared that “Green Technology… is bigger than the Internet. It could be the biggest economic opportunity of the 21st century.” Doerr’s proclamations carried weight; his track record included Google, Amazon, Compaq, and Sun Microsystems. This was going to be that perfect win-win scenario that pervades modern thinking about “impact investing”: an invisible (capitalist) hand benefiting society through self-interest.
U.S. government support
Amid global energy shocks in 2005, Congress passed tax credits for solar, wind, and other renewable energy sources. Following the financial crisis in 2009, President Obama’s stimulus legislation provided $100 billion to support clean energy through grants, loans, and tax incentives.
According to the Los Angeles Times, Tesla, alone, received $4.9 billion in government subsidies. Promising cleantech startups collected staggering amounts of tax credits and could borrow cheaply off the government’s dime.
The bubble bursts, or hindsight is 20-20…
In 2008, venture capital cleantech investments exceeded $5 billion, but by 2013 funding had dropped to $2 billion and has stagnated since. 75 cleantech companies were founded in 2007, and only 24 cleantech companies were founded in 2013.
Looking back, we can identify some of what went wrong. The easiest areas to identify were exogenous events of which two stand out as particularly influential.
The glut of Chinese investment
A 2007 study by the World Bank estimated that air pollution led China to lose one to four percent of GDP per year and caused 350,000 to 400,000 Chinese people to die prematurely. Pressed by the need for cleaner technologies, China invested $34.6 billion in renewable energy in 2009, surpassing the U.S. for the first time. In 2016, over two-thirds of solar panels were produced in China, whose playbook of ruthless cost-cutting and governmental assistance drove many U.S. solar firms to bankruptcy, including the once-promising companies SolarWorld and Suniva.
Steep declines in oil and natural gas prices
The unexpected U.S. shale oil and gas boom coincided with lower energy prices. The price of natural gas has steadily declined since its peak in 2005 and the price of oil dropped to about $53 per barrel in 2015 and has not climbed above $80 since. These trends undercut the competitiveness of renewable energy.
Lessons for Investors, Policymakers, and Entrepreneurs
Investors: most cleantech is fundamentally different from software
Cleantech business models are radically different from software. This may seem obvious but was not necessarily clear to investors inside the bubble. Here is a simplistic view:
It is not that cleantech sectors are unsuitable for investments in general. It is that the traditional 10 year fund life model, with the promise of many capital efficient bets, is not suited to cleantech.
Breakthrough Energy Ventures (BEV) is an example of a fund that appears better-suited for the specific challenges of capital-intensive cleantech startups. It recognizes that cleantech startups require “patient capital,” and -- for now -- says that it is fine with waiting 20 years for a return.
For VCs who cannot afford to wait decades, researchers at MIT divided cleantech into five categories, and found -- SURPRISE! -- that cleantech software startups generated the highest returns. In fact this was the only category to generate a positive aggregate return, returning about three and a half times the capital that A-round VCs invested. On the other hand… cleantech startups commercializing fundamentally new materials and processes lost the greatest amount for investors.
Policymakers: price-in the costs of using non-renewable energy
It is now astounding clear that the use of non-renewable energy has high costs because of its contribution to accelerating climate change. namely the acceleration of climate change. A 2018 report by U.S. government scientists suggests that in the absence of action, climate change could cost the country $500 billion annually by 2090. Because the market does not correct for this negative externality, policymakers need to close that gap by putting a price on carbon that accurately reflects its social cost.
In an interview with the authors of the 2018 book, Renewed Energy: Insights for Clean Energy's Future, former Secretary of Energy and Nobel laureate Stephen Chu says:
“The price can start low, but it needs to rise steadily in the coming decades. The CEO of Exxon Mobil has proposed that by 2030, the price should be $60 per ton of CO2, and $80 per ton by 2040. His proposal gives industry time to find low-cost paths, and I believe it will stimulate incredible innovation. Without a clear price on carbon, there is very little economic incentive to develop technologies to capture carbon emissions.”
Besides leveling the playing field between cleantech and traditional sources of energy, the pressure of a price on carbon forces large companies to take a closer look at cleantech startups with innovative technologies that can help large companies avoid steep carbon penalties.
Entrepreneurs: avoid commodity markets (duh!)
To avoid the next ‘cleantech bubble,’ today’s entrepreneurs need to avoid cutthroat commodity markets competing solely on price. This is especially true when there is hardware somewhere in the stack.
The most prominent victims of the cleantech debacle were US solar companies. These were initially successful at bringing down manufacturing costs until they were crushed by low prices from China, bankrupting once-promising companies like Solyndra. The authors of Renewed Energy rightly suggest that these companies might have been better off pursuing business models designed around solar services and finance rather than manufacturing, where China dominates on a pure cost basis.
Peter Thiel, in his book Zero to One: Notes on Startups, or How to Build the Future, talks about Tesla, arguably the most successful cleantech startup today and one of the few to escape escathed from the bubble. Here is what Thiel considered to be Tesla’s ‘secret’ (p. 169):
“Tesla knew that fashion drove interest in cleantech. Rich people especially wanted to appear ‘green,’ even if it meant driving a boxy Prius or clunky Honda Insight. Those cars only made drivers look cool by association with the famous eco-conscious movie stars who owned them as well. So Tesla decided to build cars that made drivers look cool, period—Leonardo DiCaprio even ditched his Prius for an expensive (and expensive-looking) Tesla Roadster. While generic cleantech companies struggled to differentiate themselves, Tesla built a unique brand around the secret that cleantech was even more of a social phenomenon than an environmental imperative.”
There is something there even for companies with no hardware in the stack, especially companies that have a consumer-facing product. And all climate/sustainably startups would do well to consider market niches in which there are opportunities to create value aside from low prices.
And for Amasia, the answer is…
The lessons of the cleantech debacle reinforce our focus on companies catalyzing behavioral change. We take a market-driven approach that begins with changes in consumer behaviors and works backwards to find companies that help bring about these changes. This stands in contrast to the technology-first approach that marked the cleantech wave.
Select companies might fit the old definition of “cleantech” and Amasia’s “5 Rs” of behavioral change (which is our ontology for the sectors we are interested in). Obvious examples include
Reducing emissions
Pollution sensor platforms
Re-use and recycling
Water resource management software
Replacing bricks with bytes
Energy management software, IOT appliances
Rationalizing resources
Smart grid software
Reducing consumption
Smart building software
The Best of What We Read
Zero to One by Peter Thiel: Chapter 13, “Seeing Green”. Thiel devotes a chapter of his book to explain why Tesla, arguably the most successful cleantech startup, succeeded while most cleantech startups failed.
“Venture Capital and Cleantech: The Wrong Model for Clean Energy Innovation” : Researchers at MIT offer an empirical study (= lots of good data!) of why VC-backed cleantech startups failed to deliver returns,
“Myths and realities of clean technologies”: McKinsey explains how poor VC returns on cleantech do not imply that cleantech has regressed in technology and usage. Indeed clean technologies have seen high growth rates in installed capacity and dramatically lower prices.