MIT Energy Initiative: Venture Capital and Cleantech — The Wrong Model for Clean Energy Innovation

Date of Source: 01 Jul 2016

Summary:
Venture capital (VC) firms spent over $25 billion funding clean energy technology (cleantech) start-ups from 2006 to 2011 and lost over half their money; as a result, funding has dried up in the cleantech sector… We conclude that the VC model is broken for the cleantech sector, which suffers especially from a dearth of large corporations willing to invest in innovation… If a new and more diverse set of actors avoids the mistakes of the cleantech VC boom and bust, then they may be able to support a new generation of cleantech companies. […]

Editor’s Analysis:
This report might be aptly named “How Abundant Oil and Natural Gas Killed Cleantech — It’s the returns, dumb-dumb!”. It authors lament how venture capital (VC) investments into so-called “clean tech” have languished from the peak in 2008. They conclude that it’s not technology or people that failed, but rather the VC model that failed. They then decide that government intervention, funding, and subsidies are the only way to make the future of cleantech work.

The authors cited that VC investments into cleantech failed for four reasons: 1) the investment were illiquid, tying up capital for longer than the preferred 3-5 year time horizon; 2) the investment were expensive to scale; 3) companies competed in commodity markets with razor-thin margins; and 4) potential acquirers—utilities and industrial giants—were unwilling to pay a premium when better returns were available elsewhere. In other words, long lag times between R&D and commercialization, high rates of failure, and unrealistic expectations doomed the initial wave of investment capital. In other other words, it was the returns, dumb-dumb!

What amounted in the report to a tacit admission of defeat, but which is critically important in this story, is the abundance of domestic oil and gas which was being produced starting in 2007/2008 due to advances in production technology (e.g., hydraulic fracturing, seismic modeling, horizontal drilling, et cetera). For the first time in decades, domestic oil and gas could produce attractive, short-cycle returns. In short, conventional forms of energy — natural gas is still, by most standards, clean — prevailed due to the emergence of more attractive and predictable returns elsewhere in the sector.

I will admit that the United States’ federal government did play a role in bringing hydraulic fracturing to the market. In general, the government is better suited to investing in “pure research” — i.e., long tail projects which promise to benefit the national interest irrespective of near-term returns on capital. But to pretend that capitalism is fundamentally broken because early adopters got crushed by ol’ fashioned economics is just wishful thinking — the early adopter saga usually unfolds this very way. There is a future for cleaner technologies, and the economics will eventually bear out due to resource depletion… if we let it happen. But allowing climate alarmists to distort that economic reality is short-sighted… weening the cleantech industry on government life support is guaranteed to handicap the future innovations in cleaner energy and materials technologies.

Note: a good précis of the report by one its authors can be found on the Council for Foreign Relations Blog.

Report Source: MIT Energy Initiative. Venture Capital and Cleantech: The Wrong Model for Clean Energy Innovation (An MIT Energy Initiative Working Paper). Featuring: Dr. Benjamin Gaddy, Dr. Varun Sivaram, Dr. Francis O’Sullivan. Date of publication: 01 Jul 2016. Original content accessible: http://energy.mit.edu/wp-content/uploads/2016/07/MITEI-WP-2016-06.pdf


Updates to the Read List are meant to keep readers informed of significant news stories and analytical highlights from third party sources. Content that was recommended prior to 2017 is accessible through the Read List Archives.