Cleantech Venture Capitalists Beware – What You Don’t Know About Energy Can Kill You

Oil prices quietly (at least in the cleantech world), slipped below $80 last week, off some 50% from its highs a few months ago. Did I say 50%? Yes 50%. And gas has slipped, too, as with some variations, natural gas historically trades at a roughly 10:1 price ratio of Barrels to MCF.

It’s easy to get caught up in the cleantech hype and forget that only 10 years ago this year oil prices fell two thirds caught between rising supply from a decade of drilling and nasty Asian flu, triggered in part by, wait, a financial debt crisis, that time in emerging markets. Sound familiar? And oil hit less than $11 per barrel, less than 1/13th of its recent high, with people talking $6.

And it’s easy to forget that the half decade following 1998 the not yet named as such cleantech investment sector hyped fuel cells, microturbines and distributed generation on the back of clean cheap natural gas, which was the fuel of the future.

And it’s easy to forget that rising commodity prices wiped 99% of those business cases (only a few billion in value, though!) off the map until not a single cleantech venture investor today discusses distributed generation at all. But after a short hiatus, solar and ethanol exits on the back of some huge subsidies came through and cleantech was boomed.

And it’s easy to forget that only a couple of years ago we as an industry debated the viability of hybrids and biofuels – because of a breakeven at $40-50/barrel or higher (the oilman’s breakeven in Saudi Arabia is maybe $5/bbl)? Breakeven at $40 in biofuels? Corn ethanol maybe, cellulosic, dream on. But the switch from MTBE to ethanol came through on the policy side and unforeseen Chinese demand growth pushed oil prices stratospheric. And the corn ethanol plant owners built hundreds of plants at 5% of the size of average refinery, made hay and traded at tech multiples. Only to get crushed when corn prices, driven up by (gasp!) demand and higher natural gas and oil drove up their feedstock, fertilizer and transport costs and margins down. Welcome to refining, freshman.

And it’s easy to forget that the core economic value proposition for solar has the ever present cost escalation analysis – “lock in your power costs, energy prices have risen x% per year, if they continue to do so you’ll be paying 2.5x your current power prices in 30 years”. And that the solar industry quietly ignores that energy prices will decline not rise with economic turmoil. But the ITC and feed in tariffs came through paying more than half the cost and so the party goes on.

It’s easy to forget that energy is about commodity prices. And commodity prices are about cycles, supply AND demand. And that demand is GDP growth driven in energy. And that in our global markets GDP growth is more interlinked than ever, making it more, not less subject to cycles.

And that alternative energy is called alternative because it’s the most expensive form of energy, meaning it’s the swing producer, the type of guys who get killed in cycles (subsidies aside, of course).

And that the big fortunes made in cleantech investing todate have not been made on high risk early stage technology bets, but on 10 or 20 year old technologies who were in the right place at the right time when the policies came in. Or the low cost manufacturers of mature known technologies (think corn ethanol or wind developers and Chinese solar manufacturers) who moved fast when policies moved, making hordes of “that’s not a venture” bets. Disruptive technology has never been the winner.

In energy, there is no disruptive technology, only disruptive policy that makes some technologies look disruptive after the fact. In energy, the risk is in the scale up, not the R&D, and the end application is so massive, so capital intensive, and so utterly dependent on commodity prices, that you can’t invest in it like you invest in IT. It takes longer, 10x as much money, and the ante up to play the game for one project is the size of your largest fund. At scale, there is no capital efficient strategy in energy.

But we are Silicon Valley and we smash open gates with technology, and we know better than those energy dinosaurs in Houston, London, and Abu Dhabi, right? They just don’t get it, right? One game changing technology can force the oil companies and power companies to their knees. The one I’ve found really is new and different. This entrepreneur has discovered something new. And it can be *cheaper* than oil (if you define cheaper right).

Beware Silicon Valley, the great fortunes, wars, and economic crises of the world for 100 years are not technology ones, they were energy made. Half the schools you went to were built by oil money. And the entreprenuerial spirit in this industry was born in the hardscrabble oilfields of Pensylvania and Texas, and grew up in the far reaches of the globe. And the oil companies those entrepreneurs founded have forgotten more about technology in energy than you even know existed.

Be forewarned, you do not have a comparative advantage here. The oil men invented risk taking, AND risk management. The oil men are bigger, faster, smarter, richer, have more scientists and more entreprenuerial spirit than you, AND they know energy.

So while you fight the good fight to develop technology to change the world, don’t forget, be humble, learn what can be learned, build what can be built, and walk softly, because the elephant in this room floats like a butterfly and stings like a bee, and he has yet to take the field.

. . .

The little guys whose pension funds are paying you a cushy 10 year guaranteed contract are counting on you to put aside your hubris.

Neal Dikeman is a partner at Jane Capital Partners and the CEO of Carbonflow. He is the Chairman of Cleantech.org and edits Cleantech Blog. He is from Houston, is a Texas Aggie, and believes in both energy and the power of technology to change the world.

10 replies
  1. Sean
    Sean says:

    “At scale, there is no capital efficient strategy in energy.” This is a truism. The energy business is mammoth, especially cf. venture. Venture investors can, however, make venture returns in capital efficient companies within the cleantech space–the returns just may not derive from core game changing technology adoption. This is one reason the $/transaction in cleantech energy deals is so much higher than cleantech “other” deals (water, ag, carbon).

  2. Andrew Neilson
    Andrew Neilson says:

    Neal,Thanks for another thoughtful (and provocative) piece. Agree with many of your points…but…"not a single cleantech venture investor today discusses distributed generation at all"…Really? Well, the big energy companies certainly are. According to PWC's 2008 global survey of utilities (115 utility companies across 37 countries), 49% of utilities expect technological developments in distributed generation to have the greatest impact on power generation and supply in the next 10 years. (The figure for Combined Heat and Power was 52%. Energy savings and efficiency was 79%)Yes some earlier DG / fuel cell plays were premature. But maybe the next wave will be sponsored by the utilities not the VC funds?regardsAndrew

  3. Seamas
    Seamas says:

    Really hope progress to mainstream solar isn't too damaged/retarded by this latest dive in the cycle. Some of the few good things to come out of soaring oil prices was a motivation to reduce and look for alternatives.If there are venture capitalists left looking to invest in cleaner energy technologies I'd agree they have to be cautious and smart about what they bet on.Still, I think there will be a 'Google' of clean energy with a new angle on the technology and a dramatic implementation/growth plan (if it's not Google itself).

  4. Anonymous
    Anonymous says:

    Neal,Either Peak Oil is real or its not.If its not real, then the oil companies will continue to have quite a bit of sway for sometime to come.If it is real, then we are ALL freshman.Sure, economic turmoil may disrupt demand, but peak production will dog economic growth until and unless we get off of oil.

  5. cliff
    cliff says:

    I read your op ed piece in "Inside Cleantech". I am a veteran of the conventional energy area having spent a career managing technology at Chevron and starting its venture capital group in the late '90s before departing from Chevron in 2004. Your piece says many things that need to be said, particularly about the scale and capital requirements for energy technologies and projects. While we will need many of the newer technologies that may emerge from the current explosion of "cleantech" venture investing, including the efforts going on within existing energy companies, I have long thought that venture capital investors had a simplistic and naive understanding of the energy business that would come back to haunt them.Recently, some of the more prescient vc's have realized the scale requirements and commodity markets issues affecting a number of their clean tech investments. However, as you point out there is not enough capital in conventional vc to build out an energy technology to scale. The smarter vc's are recognizing that they need to create syndicates that can put hundreds of millions of dollars of capital to work on a project. The problem is that such an approach changes the characteristics of risk and its management from the vc portfolio risk management model to a project risk basis, and one which may not be compatible with the venture capital investment model. Typically such a large capital commitment has gone to projects in which the technology and market risks have been eliminated, but this is not the case for new cleantech technologies that are barely out of the laboratory.

  6. ARTURO
    ARTURO says:

    NEAL SAYS: "One game changing technology can force the oil companies and power companies to their knees. The one I've found really is new and different. This entrepreneur has discovered something new. And it can be *cheaper* than oil (if you define cheaper right)." YEAH! I FOUND IT: AGAVE PRODUCES 6 TIMES MORE EHANOL THAN YELLOW CORN AT 25% OF ITS COST. BESIDES IT PRODUCES 3 TIMES MORE CELLUOSE THAN GMO POPLAR TREE (CAPTURING 3 TIMES MORE CO2). THIS IS IT! EVERY YEAR ONE ACRE OF AGAVE PRODUCES 2,000 GALLONS OF ETHANOL AND 22.7 TONNES OF CELLULOSE.THE BOMASS OF 2,500 ACRES CAN GENERATE 5MW/H OF ELECTRICITY.OVER 45 BIOPRODUCTS, BIOMATERIALS AND BIOFUELS CAN BE DERIVED FROM AGAVE (BIOPLASTICS, FRUCTOSE SYRUP, METHANOL, ENZYMES, PHENOL, ACIDS, PRESSED BOARDS AND MOULDED FURNITURE… AMAZING UHU, NEAL?OIL ECONOMY IS DYING, BIOECONOMY RISESagaveproject@gmail.com

  7. Greg Magnus
    Greg Magnus says:

    Excellent observation Neil – warning and words well written. I imagine many of the successful energy startups intend to be gobbled up. And, of course, for the price projected in their 5-year exit strategy. Yes, the established energy companies have fat wallets and virtually endless resources but what they don't have is the flexibility to change quickly with rapidly changing times. For example, Philips Lighting has spent $4.2 billion in LED company acquisitions over the past two years according to a recent WSJ article – LEDs use 85% less energy and last 30 times longer. Think about it, 85% less demand for the same amount of light. Also, Philips has a significant R&D budget, the brains and the brand power.New technologies that advance energy conservation have the potential to cause serious heartburn for the big energy companies. VCs are wise to seriously look at conservation. An area of energy investing that can have the greatest potential impact on demand is a very large target market.

  8. TJC
    TJC says:

    The standard innovation model for hi-tech for years has been that the "big guys" like IBM, HP, Dell, and Sun buy it. They are constantly acquiring small, innovative, VC-funded startups that have added value in some piece of the IT puzzle. In another example, Chrysler claims to be now trying this model for automobiles. Why not the energy business?

  9. mds
    mds says:

    Distributed Solar PV will quickly become the new behemoth. Look at the growth rate. Look at the price advantage. Nanosolar can profitably sell their CIGS PV at $0.99/Wp. Get installation down to $1.00/Wp (easy) and you have $2.00/Wp, which works out close to 8 cents/kWh in Southern Califoria were the average price is closer to 20 cents/kWh. …and on your house, or in your yard, no transmission lines are required. That's a factor of two cheaper, an economists definition of disruptive. The PV manufacturing is being built and expanded. PV price will drop significantly when supply catches up with demand. In the mean time, and even when this happens, many new thinfilm PV companies will be very profitable. Oil companies will purchase the good ones like IBM purchased Microsoft. Not!Many small commodity type investments (purchases) are more powerful than a few large ones. You are thinking the way many in the fossil fuel industry probably do. The large scale of investment required by the older energy technologies is an achilles heel, not a survival advantage, as you say.9 of 10 new PV companies will fail, as is always true for startups, but the survivors will kick big oil's butt. Obviously, old timer!;-)btwIBM, HP, and SUN are from the initial IC revolution. They were startups and became big in a totally new field. Dell is from the PC revolution and has not been bought out. Many others made fortunes before being purchased.Same will happen with PV. Some of the little PV startups will make it big. GE, IBM, HP, and maybe a few other big guys, are trying to get into the PV game and may succeed. The big oil companies are already very late to the party.Within thirty years solar will be the world's largest source of power. More power is available from the sun's rays falling on the earth, than from any other source and the economics are now here. (Well, when production catches up and can keep up with demand.)PV has been growing at more than 40% each year since 2002. i.e. It's been doubling every two years, right through the raw silicon shortage. Current predictions are for PV growth to increase significantly for the next few years. Amazing!Move over big oil, big solar is here.Thanks for provoking me. 😉

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