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Why is it So Hard to Make Money in New Battery Technology?

Energy storage is still the rage in cleantech.  But after the collapse of A123 and Beacon, and the spectacular failure on the Fisker Karma in its Consumer Reports tests, fire  in Hawaii with Xtreme Power’s lead acid grid storage system and with NGK’s sodium sulphur system, and now battery problems grounding the Boeing Dreamliners, investors in batteries are again divided into the jaded camp, and the koolaid drinker camp.   Not a perjorative, just reality.  New batteries and energy storage is still one of the juiciest promised lands in energy.  And still undeniably hard.  Basically, investors are relearning lessons we learned a decade ago.

Batteries are just hard.  Investing in them is hard.  Commercialization of batteries is hard. So why is it so difficult to make money in new battery technology?

Above and beyond the numbers, there are a number of commonalities related to the commercialization and venture financing life cycle of battery technologies that seem to differ to some degree from other venture investments in IT or even other energy technologies.  Having looked at probably 100+ deals over the years, and on the back of an deep study we did a couple of years ago on benchmarking valuations in energy storage, here’s our take on the why.

Timing – Battery technology commercializations have historically tended to be one of the slower commercialization cycles from lab stage to market.  Startups and investors in batteries have a long history of underestimating both the development cycle, capital required, and the commercialization cycle, as well as underestimating the competitiveness of the market.

Special chemistry risk – There is significant risk in launching a technology in newer battery chemistry.  There have been only a limited number of new chemistries succeed, and when they do, as in the case of NiMH and Energy Conversion Devices, they are typically either co-opted by larger competitors obviating a first mover advantage (that advantage is typically much weaker in this field than others) or requiring expensive patent suits.  Also as in the case of NiMH, there is no guarantee the chemistry will have legs (just when it is hitting its stride, NiMH is already becoming eclipsed by Li-On.  This risk has proven to be especially high for new chemistries (like Zn type) that are not as widely researched, as the supply chain development does not keep pace.  In addition, the battery field is highly crowded, and research is old enough that and despite new chemistry in most cases truly defensible patent positions are extremely hard to come by, or provide only discrete advantages (ability to supply a range of quality product cheaply in high volumes (or with value add to the product) seems to be the primary competitive advantage).  Few battery technologies of any chemistry end up their commercialization cycle with anywhere near as sustained an advantage as their inventors expected.

High capital costs – In any case, almost all battery startups will require extremely large amounts of capital (on the order of US$50 to 100 mm+) to achieve commercialization (much higher for real manufacturing scale), and the end product margins tend not to be particularly high.  Even with stage gate, a very large portion of this investment (US$10-50 mm+), is generally required to be spent while the risk of technical and economic failure is still high.  In addition, during the manufacturing scale up phase post R&D, capital investment required per $1 of revenue growth tends to be linear, making these technologies capital intensive to grow.

Degradation of initial technical advantage – In many technology areas one can expect the performance of the final manufactured product to improve over the performance in initial lab results, In part because of the low cost target, high reliability, high volume requirements of this product type however, promising battery technologies, are often forced to make compromises in the scale up, manufacturing, and commercialization stages that mean the performance of actual product might be expected to fall from levels or rates seen in lab scale experiments (though cost may go the other way).    At the same time, battery performance of standard technologies, while mature, is a moving target, and during the time frame for commercialization, will often improve enough to obviate the need for the remaining technical advantages.

Size matters – Most battery products (whether batteries or components like anode or cathode materials or electrolyte), are sold to large customers with very large volume requirements, and highly competitive quality and performance requirements.  As a result, breaking into new markets generally is extremely hard to do in niche markets, and means a battery startup must prove itself and its technology farther and for a longer period of time than other technology areas (see capital costs, timing and down rounds).  Many battery components technology developers as a result will be relegated for early adopters to emerging customers with high risks in their own commercialization path.

Lack of superior economics from licensing – As a result of these size, capital cost, timing, and commercialization risk issues most battery technologies will command much lower and more short-lived economics than anticipated from licensing (or require expensive patent lawsuits to achieve), and will require almost as late a stage of development (ie manufacturing operating at scale with proof of volume customers) and commensurate capital requirements, as taking the product to market directly.

Propensity for down rounds – In addition, battery technology companies tend to have down rounds in much larger numbers in the post A rounds (Series B through D+) than other venture investment areas, as these challenges catch-up to investors and management teams who overestimated the scope of work, capital and timing required in the seed, A and B rounds.  In particular, battery investors have tended to invest in seed, A and B stage battery technologies (pre-scaled up manufacturing process or even lab and prototype scale) with expectations of typical venture style timing and economics.  Quite often instead, it is the B, C, or D investor group that post cram-down rounds achieve the Series A economics (even when the technology IS successful), and the seed, A and B investors suffer losses or subpar IRRs.

How About A Sane Energy Policy Mr. Obamney?

It’s Presidential Election year.  Ergo, time to discuss our 40 year whacked out excuse for an energy policy.  Royally botched up by every President since, umm?

Objectives:

Make US energy supply cheap for the US consumer and industry, fast growing and profitable for the American energy sector, clean, widely available and reliable, and secure, diversified, environmentally friendly and safe for all of us.

or

Cheap, Clean, Reliable, Secure, Energy

 

An Energy Policy that leaves us more efficient than our competitors

An Energy Policy that leaves us with more and more diversified, supply than our competitors

An Energy Policy that leaves us more reliable than our competitors

An Energy Policy that makes us healthier and cleaner than our competitors

An Energy Policy that makes us able to develop adopt new technologies faster than our competitors

An Energy Policy that makes it easy for industry to sell technology, energy, and raw materials to our competitors

An Energy Policy that keeps $ home.

A Sane Energy policy

 

Think more drilling, less regulation on supply, lower tariffs, more investment in R&D, tighter CAFE and energy efficiency standards, simpler and larger subsidies for new technologies, less regulation on infrastructure project development.

 

A couple of key action items:

  • Support the development of new marginal options for fuel supply, and support options that improve balance of payments, whether EVs ethanol, solar et al
  • Make crude oil, refined products, Gas, LNG and coal easy to import and export
  • Drive energy efficiency like a wedge deep in our economy
  • Support expansion and modernization of gas, electric, and transport infrastructure
  • Support long term R&D in both oil & gas, electric power, and renewables
  • Reduce time to develop and bring online new projects of any type (yes that means pipelines, solar and wind plants, offshore drilling, fracking and transmission lines).
  • Support policies and technology that enable  linking of energy markets
  • Challenge the OPEC cartel like we do EVERY OTHER cartel and break the back of our supply contraints
  • Support the export of our energy industry engineering, services and manufacturing  sectors overseas
  • Incorporate energy access into the core of our trade policy
  • Support deregulation of power markets
  • Support long term improvement in environmental and safety standards
  • Broadly support significant per unit market subsidies for alternatives like PV, wind, biofuels, fracking as they approach competitiveness

Or we could do it the other way:

  • Leave ourselves locked into single sources of supply in a screwy regulated market that involves sending massive checks to countries who’s governments don’t like us because that’s the way we did it in the 50s?
  • Keep massive direct subsidies to darling sectors so the darling sectors can fight each other to keep their subsidies instead of cutting costs?
  • Keep a mashup of state and federal regulatory, carbon and environmental standards making it virtually impossible to change infrastructure when new technology comes around?
  • Promote deregulation in Texas, and screw the consumer in every other market?
  • Every time there’s a crisis, we can shoot the industry messenger in the head, stop work, and subsidize something.
  • Continue the Cold War policy of appeasing OPEC so they can keep us under their thumb for another 30 years
  • And drop a few billion here and there on pet pork projects

Come on guys, stop the politics, let’s get something rational going.  Oh wait, it’s an election year.  Damn.

And in the meantime how about making energy taxes (a MASSIVE chunk of your gasoline and power prices) variable, so they go DOWN when prices go up.  Then at least the government’s pocket book has an incentive to control cost, even if they’re incompetent at putting together a policy that does so.

Wild Is The Wind

Late May, the wind industry flocked to Anaheim for its annual gathering, Windpower, hosted by the American Wind Energy Association (AWEA).  For the first time in quite awhile, attendance was down from the previous year – estimated at 14,000, compared to a reported 25,000 in Dallas in 2010.  At least part of the reason was geographic:  it’s simply more time-consuming and expensive for many to travel to the West Coast as opposed to the center of the country.  However, there’s no doubt that the vibe was more subdued.

I returned from the show ruminating on several questions:

When will new players stop entering the wind turbine market?   I am not exaggerating when I estimate the number of companies with turbine products on display at 50.  I have never heard of many of these companies, but somehow they must be able to somehow scrounge up what clearly is a significant amount of capital to amass the tooling, fabricate at least a few units, and design and staff fancy and massive booths.  A number of these no/new-name companies are Asian, presumably with lots of excess cash and considerable naivete on how to penetrate the North American wind market.  The rush is probably five years too late and clearly unsustainable – but it seems to be getting more acute rather than better.  As the old adage from the financial sector says, “the market can stay irrational much longer than you can stay solvent.”   If any of these “who-dat?” companies were public, I’d recommend shorting them.

How will consolidation unfold?  Many wind turbine manufacturers are enormous corporations with solid balance sheets, unaccustomed to being something other than a top three player.   It’s a “who’s who” of Fortune 100 companies, including the usual suspects GE (NYSE: GE) and Siemens (NYSE: SIE), newcomer United Technologies (NYSE: UTX) via its December 2010 acquisition of Clipper, mega-corporates from France Alstom (Euronext: ALO) and Areva (Euronext: CEI), the Spanish armada of Gamesa (BMAD: GAM) and Acciona (BMAD: ANA), Japanese Mitsubishi, the Koreans Daewoo, Hyundai and Samsung, Chinese Sinovel, Goldwind and other ambitious entrants, and on and on.  Indeed, this impressive list doesn’t include industry-leader Vestas, the former high-flyer Suzlon from India, and some excellent German producers including Enercon, Fuhrlander, Kenersys, Nordex and RePower.  Most of these firms have the appetite to play for keeps, and the funding to enable it for an extended period, so it will be an interesting game of musical chairs in the coming years – and a good opportunity forthcoming for M&A investment banking in the wind sector.  There’s no way they can all be successful and remain in the market.  It’s just way too crowded.

What will happen to the production tax credit (PTC)?  It’s been shown vividly that the wind industry suffers from booms-and-busts in cycles as the dominant U.S. policy pertaining to wind, the PTC, is allowed to expire and then is extended (typically for no longer than the two year duration of a House member).  It’s due to expire (again) at the end of 2012, and while the industry is optimistic about a good 2011 and 2012, after that is a guessing game – particularly in the current political climate and budget woes.  The only consensus is that the PTC won’t be addressed at all until the lame duck session after the 2012 election, but it may not be dealt with at all until 2013 – in which case the North American wind industry will experience a big setback (again).

What about domestic manufacturing for wind?  Over the years, a major force for political support to the wind industry has been the participation – both actual and potential – of American manufacturing in the supply chain.  Based on some murmurings of industry insiders, it appears that the American supply chain is in fact getting more stressed and less competitive relative to foreign (mainly, you guessed it, Chinese) sources.  If American manufacturing continues to lose ground in the wind sector, one of the most important pro-wind voices will stop throwing its considerable weight around – and the North American wind market will be the worse for it.  Stay tuned for domestic content debates, and/or examples of “reshoring” production of components back to the U.S.A., to patch this potential hole in the wind dyke.

How will onshore wind co-exist with offshore wind?  In Europe, this has been a non-issue, because the wind industry basically had to move offshore as all the plausible sites onshore had been developed.  Not so straightforward in the U.S.:  the vast majority of the wind industry remains focused on still-ample onshore wind opportunities and doesn’t want to see any resources or policies diverted from its objectives in order to support the emergence of a new segment of the wind industry offshore.  For those who are interested in accelerating the potential of offshore wind (such as myself), especially in places of the U.S. east of the Mississippi River where most of the demand and transmission exists but good onshore wind opportunities are much more limited, the competing interests of the more well-established onshore wind industry is a frustrating source of tension.  It’s a microcosm of the U.S. economic system:  protecting the near-term by minimizing the long-term.  This dilemma is the main reason that the Offshore Wind Development Coalition was established, so that offshore wind interests could independently express themselves in the corridors of D.C.  Alas, the distinction between onshore wind and offshore wind is lost among most public officials, so the existence of multiple organizations that seemingly are operating in parallel in advocacy and education is not a helpful fact to both segments of the wind industry.

It’s never easy to make it in a sector that must fight entrenched incumbents with economic advantages, but the next couple of years in the U.S. wind market will likely be an especially bumpy ride.