by David L. Levy

Despite the mounting evidence of severe climate change, there is a funding crisis for potential solutions. The Department of Energy released data at the beginning of November showing that global emissions of CO² rose 6% in 2010, despite the ongoing economic recession. This trajectory is higher than the worst case projections from the Intergovernmental Panel on Climate Change (IPCC) in it’s 2007 Fourth Assessement Report. The impacts are already being felt. A new IPCC report concludes that climate change is causing more extreme weather, especially heat waves, heavy precipitation, and coastal flooding (though the super-cautious IPCC hedged on hurricanes).

Yet November also witnessed setbacks for two key clean energy technologies. Beacon Power, a Boston-area developer of flywheel energy storage and power management systems for the grid, filed for bankruptcy the same week that the DoE released the grim emissions data. Just a few days later, the FutureGen 2.0 project, the leading US effort to develop commercial scale Carbon Capture and Storage (CCS) technology, suffered a major setback when the Midwestern power company Ameren announced that it could not provide an old power plant for the project due to financial difficulties. (Update: While Ameren will no longer be financially involved in the project, they are currently negotiating how the power plant may still be utilized for the project).

One important lesson is that public policy must be based on a clear understanding of the challenges facing the clean energy sector and the impact of regulation and programs on investment decisions and corporate business models. In the absence of a global framework for regulating emissions, the future of the planet largely rests on choices by private firms and investors regarding which technologies to pursue and commercialize. The clean energy sector, however, faces a host of risks that make investors wary. The risk is not that climate change is going away as a long-term driver; the problem is that there are large market uncertainties regarding the future of regulation and subsidies, which technologies will emerge as large-scale, low-cost, low-carbon alternatives, how consumers will respond, and how competitors will react.

Despite the woeful underfunding of clean energy research in the US, there is still a plethora of exciting technologies being developed in the laboratories of universities, government centers, and the private sector. For more mature technologies, large subsidies are flowing to commercial installations of solar and wind, perhaps too large, according to a critical New York Times article last week. While these subsidies are reducing costs by accelerating the technologies down the learning and scale curves, they tend to reinforce the dominance of early, low-cost “winners” in the marketplace, and provide little help for less mature but promising emerging technologies, such as Solyndra’s CIGS thin film glass tubes. As a result, these subsidies also tend to suck in a lot of low-cost Chinese imports rather than stimulate US production or research.

A structural problem, as Daniel Goldman wrote in an earlier Climate Inc. post, is the proverbial “valley of death” between lab research and commercial production, where “neither government, venture capital firms nor capital markets have tended to bear the risks associated with providing equity capital, which can amount to hundreds of millions of dollars, for initial deployment of capital intensive new clean energy technologies at commercial scale – described here as “first project commercialization.”  The US venture capital model evolved primarily to support the emergence of the software industry, which has relatively low capital intensity, but there is not currently an adequate private (or public) sector solution for clean energy. It’s far too early to know whether, for example, flywheel technology is better than batteries or compressed gas for power storage – and maybe there is a role for each of them, to meet different needs in different locations. But a market-based system that relies on private sector funding is failing us if it cuts off development of promising technologies before they even reach commercial scale testing.

Beacon Power has not yet closed its doors, and is trying to continue operating under bankruptcy. Since the summer, it has been testing a 20-megawatt flywheel plant in Stephentown, N.Y., which can absorb and supply power from the grid very rapidly, and is therefore valuable in frequency regulation. Another installation is planned for Pennsylvania. The more intermittent wind and solar that is connected to the grid, the greater the need for short-term storage solutions. Flywheels are able to deal with rapid fluctuations and match supply and demand more effectively and reliably than batteries, such as those from A123, or gas-fired plants (while reducing emissions from rapid cycling of gas plants). A few of the the 200 flywheels in Stephentown have experienced problems, but the system has performed well overall.

Until recently, Beacon Power has not been able to monetize the full advantages of flywheel storage. It was only on October 20^th that the Federal Regulatory Energy Commission (FERC) approved a change in regulations that makes grid operators pay, not just for the amount of power in reserve, but also for its effectiveness in grid stabilization. According to Bloomberg, this could double Beacon Power’s revenue and make it easier to find financing. But the ruling, which has been in the works since February, was too late to keep Beacon solvent. If we are to rely on price and market mechanisms, we need to build them to serve the planet.

The lack of a clear regulatory framework has also hurt offshore wind power in the US. Even now that the 450 MW Cape Wind project is most likely moving ahead, the damage from more than a decade of delays and uncertainty, resulting in millions of dollars in costs and legal fees, have probably dampened investors’ enthusiasm. The latest delay stems from a court ruling that the FAA needs to take another look at aviation hazards. With further financing still required for the $2.6 billion project and the company still negotiating to sell half the power output, the future is not yet secure. Meanwhile, the European Wind Energy Association expects annual investments in the European offshore wind industry to triple to reach 10 billion Euros by 2020.

Given the urgency of the situation, public policy needs to shape the market context in order to steer private investment decisions. We are not heading in the right direction, however. In the short term, the ongoing recession appears to be diverting attention from the climate issue and draining government, business, and consumers of resources. A new Ernst and Young report estimates that the recession could lead governments to cut spending on climate change by tens of billions of dollars. It’s more important than ever to focus government resources, and commercialization of carbon-reducing technologies is a critical area. But in addition to financial support, the problems facing Beacon Power, FutureGen and Cape Wind highlight the importance of reducing regulatory uncertainty.

While public policy and the media tend to focus on technological innovation as the key to addressing climate change and boosting clean energy, business model innovation (BMI) offers a path to rapid deployment of existing technologies. The concept was popularized and given its current acronym by Mark Johnson, Clayton Christensen, and Henning Kagermann in their Dec. 2008 Harvard Business Review article “Reinventing Your Business Model.” They point out that “Low-cost U.S. airlines grew from a blip on the radar screen to 55% of the market value of all carriers. Fully 11 of the 27 companies born in the last quarter century that grew their way into the Fortune 500 in the past 10 years did so through business model innovation.”

The potential for BMI in the development of the cleantech sector is only just beginning to be appreciated. Rob Day, a partner with Black Coral Capital in Boston, recently wrote about a new wave of startups that run lean and require less capital to scale up, so are less likely to founder in the infamous Valley of Death: “Some of this next wave of startups will be hardware, but many will be software and/or services…  Business model innovation will often be stressed over technological innovation.  They will sometimes marry energy-related market opportunities with Web2.0 and social media business models and platforms.”

A closer look reveals that BMI holds particular promise for unlocking the potential of clean energy and promoting economic competitiveness, investment and employment in high-cost regions. In addition to helping keep startups lean and capital efficient, BMI can develop systemic solutions that overcome some of the many market failures and institutional barriers to energy efficiency and clean energy. McKinsey’s famous Marginal Abatement Curve heralds the good news that about one-third of needed emissions reductions appear to have positive ROI with current technologies. The bad news is that about one-third of needed emissions reductions appear to have positive ROI – yet the necessary investments are not happening, due to these many hurdles. As with Zipcar, BMI provides ways to monetize the ancillary benefits of cutting emissions, and create business models that focus on features that people are willing to pay for.

BMI-based cleantech businesses are also more likely to keep jobs in high wage regions such as the US Northeast and California. Clean energy manufacturing jobs have been moving astonishingly quickly to China, even while there is still rapid technological evolution. Evergreen Solar and A123 Batteries, both based here in Massachusetts, are cases in point. Business model innovation often focuses on software and services, developing strong relationships with customers and building on existing capabilities in the region, so jobs are more likely to stay local. These factors also help to create barriers to entry, protecting the business model. Zipcar’s network of parking spots, for example, negotiated over several years with hundreds of companies and local authorities, would not be easy to replicate.   

Better Place is a powerful example of how BMI can overcome systemic barriers to technology deployment. The company is developing a national replaceable battery infrastructure for pure electric vehicles in Israel, Denmark, and elsewhere that transforms the business model for car ownership and fuel supply. Consumers buy a car without the expensive batteries, then contract with Better Place for battery replacement as a service, which is done in just a few minutes at a network of service stations. This model overcomes the physical limitations of batteries, in terms of range and charging time, and dramatically reduces the cost of new cars for consumers. As with Zipcar, governments are willing to subsidize the operation because it contributes toward reducing congestion and greenhouse gas emissions – again, monetizing ancillary benefits.

Energy efficiency and smart grid provide many opportunities for BMI. EnerNOC’s core business model, for example, is demand response and energy management, using sophisticated software and remote monitoring and control. Enernoc links the utilities, who are willing to pay for energy efficiency and for peak-period demand reduction, to a network of customers. Energy service companies like Ameresco are increasingly offering turnkey projects and performance contracts that reduce risks, capital requirements, and uncertainty for customers. Similarly, companies like Nexamp, Tioga Energy and Borrego offer renewable power purchase agreements based on DBOOM services – a complete package where the company designs, builds, owns, operates and manages the renewable energy installation, while the customer only pays for power.

Not surprisingly, then, these BMI-based companies are among the fastest growing businesses in the cleantech sector. Kevin Doyle, a Principal of Green Economy and Co-Chair of the New England Clean Energy Council’s Workforce Development Group, has pointed to the large number employment opportunities at a range of cleantech companies, a number of which are in energy services and software. As a result, they are not just looking for engineers, but also for a range of business and professional skills and expertise – which highlights the purpose of our new clean energy programs at the University of Massachusetts, Boston!

by David L. Levy

When most people think about clean energy, solar and wind are the first things that spring to mind. Markets for these renewable energy sources have exhibited rapid growth of about 25-30% annually, and these sectors have attracted the lion’s share of venture capital funding and investor interest. They also tend to dominate the various Exchange Traded Funds (ETFs) that track clean energy. Yet the clean energy economy extends far beyond renewable energy technologies, including everything from power controls and storage, carbon software and trading, and energy efficiency. In transportation, while auto companies chase expensive dreams of electric cars, more economically viable opportunities lie in mass transit, bicycles, and innovative car rental services such as Zipcar. Clean energy is also generating a vast range of engineering, professional, and financial services. The transition to a clean energy economy will therefore change the employment landscape (see Green Jobs Booming and Training the “Green and White” Collar Workforce). At the same time, it’s creating new investment opportunities to rival electronics and biotech. The best investment opportunities are the unsung heroes that lie in the more cloistered parts of the evolving cleantech economy.

There are two core principles involved in understanding which green sectors have the most potential and which are overhyped. The first is that successful investing requires better insights than the average market investor. Share prices for many cleantech companies already reflect the expectation of rapid growth – companies (or sectors) have to outperform these expectations to generate significant returns. Second, the market is not rational – the efficient market thesis does not hold. This means that share prices do not accurately reflect all the information out there. To complicate matters, these two principles are somewhat contradictory: What is the point of better knowledge, if the market is arbitrary?

Well, the market is not completely arbitrary – to some degree, it’s Predictably Irrational, to use the title of Dan Ariely’s book. Investors exhibit herd behavior, leading to macro market distortions – share prices (and P/E ratios) can expand in frothy bubbles or become mired in gloom, with prices detached from underlying profits and cash flows. There are similar distortions at the sector and individual company level. When a new sector is fashionable, investors pile in, the media provides glossy rationalizations, and even policymakers can jump to support the ‘next big thing’. Many investors don’t care about underlying value and try to ride these waves of momentum, but this market-timing strategy requires nerves of steel and considerable luck.

Eventually, reality catches up and capital move on. Interest in fuel cell powered vehicles, for example, has collapsed while biofuels are on the wane. But distinguishing ‘reality’ from conventional wisdom is a considerable challenge, even within the expert community. Ford and GM’s disastrous experiments with electric vehicles in the 1980s and 1990s created a firm belief in the US auto industry there was no future for electric vehicles of any kind, even hybrids. The institutionalization of this view led US car manufacturers to scoff at the prospect of Toyota and Honda introducing hybrids (HEVs) in the late 1990s, and now the hobbled US companies trail far behind (see my 2002 paper on the auto industry and climate change). Similarly, the failure of concentrating solar thermal pioneer Luz in 1991 put the sector in the freezer for over a decade. For HEVs,  the technologies were premature for commercialization, but CST suffered from capricious public policy and the association with low-tech solar hot water (hard to patent the technology) in comparison with high-tech solar PV.   

Tom Konrad, of AltEnergyStocks.com fame, recently presented a model clean energy investment portfolio that tries to identify undervalued sectors with the best prospects. It is notable for the absence of solar, and the dominance of efficiency, transportation, and electric grid.

In fact, the portfolio substantially diverges from the current market cap of various clean tech sectors given in a BofA Merrill Lynch Global Research report. Solar and wind dominate the pie chart, with each having about one-third of the total market cap. Popular clean energy ETFs are similarly overweighted  in solar and wind.

Konrad assesses each sector in terms of several criteria:
1. How big a role will this sector play in our energy future?
2. How large is the market cap of current firms in the sector?
3. Is the industry likely to be disrupted by new entrants and technologies?
4. Are there underlying enabling technologies that will benefit from the sector’s growth, or constraints that will hold it back?

By these criteria, wind and solar PV are poor investments because although they can play major roles in our clean energy future, they already have large market caps – the growth expectations are already “baked in”. Wind at larger scale is constrained by the lack (and cost and planning issues) of long distance transmission. Even worse for solar PV, the sector is at risk from technological disruption and new entrants, particularly from concentrating solar thermal (CST) or new variants of solar PV.

Konrad identifies transmission, smart grid, and storage as the key enabling technologies for the clean energy infrastructure, which have been somewhat overlooked but now seem ready to catch a wave of investor attention. Despite the recent success of lithium ion battery producer A123’s IPO, Konrad is pessimistic about plug-in vehicles due to their cost and inherent limitations of the technology, leaving automotive batteries highly vulnerable to disruptive innovation (also see John Petersen on this).

Konrad’s basic approach is very sound, especially for those who prefer a sectoral approach to the risks of individual stocks. It provides a useful framework for discussing particular technologies. For example, I would favor CST as a sub-sector because of its prospects to scale up at reasonable cost, the lower technological risk compared with PV, and the prospects for integrating thermal storage (also see this on SolarReserve). The offshore wind sector could also benefit from the $125 billion plan to build up to 25 GW of capacity, for which initial contracts were announced in early January.

I’m less sanguine than Konrad about the prospects for mass transit and high-speed rail, at least in the US, as it requires a level of governmental investment and coordination that seems unlikely in the current financial and political context. I fully concur regarding the outlook for efficiency. A McKinsey report points to the economic attractiveness of efficiency investments and a vast market potential of over $500 billion in the US over the next decade. Pike Research recently issued a report supporting a positive outlook, projecting that the Energy Service Company (ESCO) business in the US would increase from $5.6 billion in 2009 to nearly $20 billion by 2020. Utility demand side management programs are a major stimulus for this growth. The Pike Research report also noted opportunities at the intersection of energy efficiency and information/communications technology.

Although this is not the place for a discussion of particular stocks and mutual funds, it’s worth noting that investing in efficiency tends to be tougher than other sectors, because there are few public pure-play companies or dedicated ETFs. On the one hand, there are many small privately held companies, and on the other, some very large industrial companies for whom energy control systems and services are a relatively minor part of their business, such as Honeywell International and Siemens. The situation is similar with clean energy related professional services and software. Pike Research estimates that the market for carbon software management and services was a modest $380 million global market in 2009, but is poised for growth of more than 40% a year. This neglected part of the clean energy market has a few small players, but is increasingly dominated by the large accounting, management consulting, and enterprise software companies.

The urgency of Daniel Goldman’s proposal to create a The Clean Energy Accelerator Corp. (see previous post) is reinforced by an article in the Financial Times today,  Cash Crunch Could Stain Clean Technology. Richard Waters writes that:

The lack of capital, however, is preventing many companies in the alternative energy world from reaching the scale at which they claim they can start to drive down unit costs of production to a level that could eventually make them competitive with traditional sources of energy.

Even companies that have been able to find a market – often due to government subsidies or other mandates that guarantee them a market, in spite of a lack of direct cost competitiveness – are struggling because of the lack of capital.

Though venture capital investments in clean tech have been picking up recently, “traditional project finance markets are still largely closed, and the public equity markets….remain closed to companies that have yet to prove long-term viability.”

Government fiscal stimulus funds have significant sums for environmental goals, but the problem is that current government funding mechanisms are inadequate, temporary, and somewhat arbitrary. The investments required for a transition to a low-carbon economy amount to several hundred billion dollars a year over a more than a decade – far beyond the timescale and scope of current government projects. The proposed energy legislation in the US envisages a revolving clean energy loan fund of just $30 million, and that is being fought bitterly.

The FT article points to one company left on the sidelines:

Quallion, a private maker of cells for advanced batteries, was one of those passed over this month as the US government announced plans for $2.4bn in support for battery makers – one of the first signs that green stimulus money is finally starting to flow.

Quallion had sought $220m to build a factory for truck and car batteries, but must now contend instead with better-financed rivals that have been given a leg-up by the taxpayer.

“When someone comes along and slaps down $300m for a new factory for my competitor, that changes the dynamics of the market,” says Paul Beach, Quallion’s general counsel and head of business development.

The structure of the proposed The Clean Energy Accelerator Corp. would help leverage private capital to generate a larger investment pool and ensure its independence from political pressures, allowing it to focus on more commercial and scientific project criteria.

This guest contribution is by Daniel Goldman, Executive Vice President & Chief Financial Officer of GreatPoint Energy and co-founder of the early stage investment group, Clean Energy Venture Group. He has managed and invested over $4bn in energy technologies and projects and is a vocal advocate of financial solutions for overcoming technology commercialization challenges.

Commercialization of new low/zero carbon energy technologies is essential to addressing job creation, climate change, energy independence, economic competitiveness and long-term energy affordability. Historically, public sector dollars and venture capital investments have funded promising clean energy technologies from laboratory through demonstration scale deployment (i.e., in commercial-like conditions but not at the size necessary for economic commercial operation). Private equity and project finance debt capital markets have historically funded projects and manufacturing facilities once commercially proven.  However, neither government, venture capital firms nor capital markets have tended to bear the risks associated with providing equity capital, which can amount to hundreds of millions of dollars, for initial deployment of capital intensive new clean energy technologies at commercial scale – described here as “first project commercialization”

Courtesy of Paul Maeder, Highland Capital Management

Consequently, many promising clean energy technologies that have been proven at pilot or demonstration size are unable to secure financing for commercial scale deployment.  Examples include utility-scale concentrated solar projects, geothermal technologies, biomass and fossil advanced gasification with carbon capture and sequestration, cellulosic ethanol, other biofuels and clean energy manufacturing facilities (e.g. new wind turbine blade manufacturing).  Proving out such technologies at commercial scale would enable deployment of multiple, large-scale facilities, financed by existing market participants (equity and debt), leading to hundreds of billions of dollars of investment, a material and more rapid impact on climate change, and ability to address other essential policy goals such as energy security, job creation and global economic competitiveness.  Two examples of “shovel ready” technologies on the cusp of commercialization are shown below:

As one solution to this oft-recognized problem, often termed the “commercialization valley of death,” the federal government should establish a new corporation, proposed here as the “Clean Energy Accelerator Corp.”, or “CEAC”, as an agency of the US government on the model of the Overseas Private Investment Corporation (OPIC).  Just as OPIC successfully provides support for the creation of privately-owned and managed investment funds in response to the critical shortfall of private equity capital in developing countries, CEAC would support the creation of domestically-oriented, privately-owned and managed investment funds focused on providing critical equity capital that is otherwise unavailable for first project commercialization. Just as the impact of OPIC’s support of funds that invest in emerging market companies has a multiplier effect (attracting additional investment and financing in companies), so too would the CEAC’s support have a multiplier effect in the following ways:

• Attracting additional private capital to commercialization of clean energy technologies;
• Accelerating the deployment of clean energy technologies and promoting a large market opportunity for follow-on funding; and
• Addressing policy objectives, such as job creation, global economic competitiveness, climate change, economic development, re-tooling of the supply chain infrastructure and energy affordability.

CEAC would provide support for privately-managed funds in a manner similar to the approach of OPIC, which typically provides debt (10-12 year maturities) to funds and also earns a profit participation component; these low-cost loans provided by CEAC, which are backed by the full faith and credit of the US Government, are sold to US eligible institutional investors.  CEAC’s participation in multiple private sector funds, where a minimum of $5 billion could be deployed, would rapidly catalyze private sector investment.  Moreover, like OPIC, the CEAC would establish pre-defined “scoring criteria” for each fund so that Office of Management and Budget could readily ensure that appropriate reserves are maintained based on the risk profile inherent in the portfolio of projects.  Characteristics of the CEAC should include:

• Transparent investment criteria and an independent board that would include appropriate agency secretaries and other senior government officials as well as representatives from the private financial, technology and energy policy communities;
• Management stability, flexibility, agility and experience overcoming traditional federal agency obstacles and enabling effective fund management of complex financial transactions leading to rapid deployment and commercialization;
• Financially self-sustaining as returns on investments revolve to allow for continuing re-investment;
• Ability to accelerate and scale capital formation by mitigating risks facing investors in the deployment of clean energy technologies and increasing the amount and rate of private capital deployed in a time frame that is consequential;
• Use of a proven fund model with funds managed by highly qualified investment managers having a proven track record in equity investing and possessing deep sector expertise, private sector institutional/corporate investors providing equity, and governance over project investments enabling rational exit and liquidation strategies to be implemented; and
• Leverage historical precedent which indicates that the United States has customarily availed its balance sheet for long-term multi-generational national priorities.

A significant number of projects have been identified which would be appropriate for investment by privately managed funds leading to commitments of several billion dollars in a short time frame and providing an immediate springboard for implementation. The CEAC would address a distinct problem within the DOE loan guarantee program (Section 1703), which attempts to ensure pre-commercial projects with innovative technologies have access to private sector debt but leaves the challenge of attracting equity capital unresolved.

With the nation hungry for clean energy solutions and a large number of VC-funded technologies needing help to get through the commercialization bottleneck, the time is now for bold, intelligent and targeted government action to spur the private capital sector to invest in first commercial projects using the existing and successful OPIC model.  While the OPIC model appears to offer the best analogy, other options, such as the Small Business Administration’s SBIC loan structure could also be considered.

The CEAC concept, which has been widely vetted within the investment community and clean energy industry, has received strong support and will naturally attract a broad coalition of interested constituencies including venture capital funds, private equity/project finance market participants, environmental advocates, economic policy makers, industrial, commercial and retail consumers and national security policy makers.  Prominent members of the finance and clean energy technology community are committed to supporting policy makers to make this idea a reality through existing mandates or in new legislation as energy and climate change bills are introduced.