Erb Perspective Blog

Stevenson, Erb ’14

by Sam Stevenson
Presentation sponsored by the Environmental Law and Policy Program.

Clean tech is tough right now. Vestas pulled out of the U.S. A123 went bankrupt. Solyndra is a bust. Carbon legislation is the new living dead. Low natural gas prices have killed the financials of utility scale solar and wind. The predominant narrative from the investment community and media is: first, clean tech is a bubble that burst with the end of easy money in 2008. Second and specific to venture capital, VC financing is not the right model for the capital intensive needs of clean tech.  If anything, PE and project finance is, but even that is tough right now. Clean tech needs to scale quickly if we’re going to calm climate change, so all of this is not good. When I heard that a partner from Kleiner Perkins Caufield & Byers (KPCB) was speaking at the Law School, I took a break from finals and was fortunate enough to hear one of the most succinct and real discussions on the state of clean tech from the view point of John Denniston (John is currently an Erb Strategic Advisory Council Member and a 1983 U Michigan Law School grad). I want to share this because John’s views run counter to the predominant narrative. And when you have someone running a $1B clean tech growth fund talk about their rationale for investing, I am all ears. All ears because VCs need explosive growth within a decade to get their 10, 20, 40x returns and therefore VC dollars are ultimately the strongest vote of confidence that clean tech can scale in a short timeframe. Really quickly, some background on KPCB. KPCB is THE venture capital firm that started it all off in the Valley 30 years ago.  It’s one of the largest VC firms with a top notch record. Two hundred of their 600 investments have IPO’ed which is a heck of a lot better than what the industry is returning. KPCB currently has 70 investments in clean tech including hot ticket items such as Clean Power Finance and OPower. Now for the wisdom of John Denniston (I’m basing the following off of my notes, mostly paraphrased from his talk).

John’s Investment thesis: Clean tech’s value is based on resource scarcity. This thesis works well economically and is grounded in reality.

  • The 20th century was defined by resource abundance. The price of a large basket of goods (energy, food, etc.) dropped 70% (inflation adjusted) from 1900-1999 despite a huge economic and population explosion.
  • That same basket of goods has risen to negate last century’s 70% drop in the first 12 years of the 21st century. Lets remember that this occurred within a timeframe that includes the most severe financial crisis since the 1930s.
  • We are in a period of hyper inflation driven by resource scarcity. This hyper inflation is occurring before the global explosion of the middle-class.  Three billion new citizens will enter the middle-class within the next 18 years. It’s the most momentous demographic event in the history of the human race. (My note: for some perspective, US per capita CO2e emissions is roughly 20 tonnes/year vs lowest per capita countries are 1 tonne. Thats a huge difference in terms of energy demand.)

Therefore, we’re seeing a massive upward shift in the demand curve for natural resources.

Simultaneously, the cost curve for energy is going up and is not coming back down.
  • 20 years ago, the marginal cost of drilling for a barrel of oil was $10/barrel (inflation adjusted). Today, its $70-$90/barrel.
  • Natural gas - At $2-3 / mmbtu today, the folks fracking are losing money. Why are they producing NG at these prices? They need to drill given their contracts and royalty payments owned to landowners. This is not sustainable, and NG prices will go up.

In short, the price floor of energy has dramatically risen and continued demand driven by the growth of the global middle class will not bring this price floor down again. That is why the 21st century is about resource scarcity… clean tech is about exploiting/addressing this opportunity.

John answered some questions from the crowd. Here are some highlights:

Question 1: All the headlines are about clean tech having poor returns. Can you address that.

  • Its too early to tell. Remember that clean tech only got hot only in 2006. Thats two years before the financial crisis. Our portfolio companies are doing great, and we’re looking at several IPOs in the next few years (I assume he is talking about CPF).
  • Solar industry is now a $50B industry. I challenge you to find another industry that has had that kind of value creation in such a short period of time
  • China has continually subsidized clean tech companies. As a result, they command 60% market share. Estimates range in the $1.2B in direct subsidies but no one really knows. We’re losing.
  • Investments in solar are about the companies focusing on financial innovation. Five years ago, the value proposition for putting on a solar panel on your roof was this. [Salesman walks up to your door] “Would you like to have solar panels on your roof?”. Homeowner, “Yes”. “Great, in that case you owe $20-$30k upfront”.  Today, companies like CPF have changed the value proposition vastly. Its now, “Would you like solar on your roof, you don’t have to pay a cent for the installation or the panels. You currently pay PG&E 20-25 cents per KWh. We’ll charge 15-18 cents. You’ll get lower electricity bills, reliable green power, and have a great conversation starter for your dinner parties.”
  • KPCB mostly invests in open source systems. They stay away from the vertical integrated companies (Solar City).

Question 2: Role of PUC/FERC. Do we need them for clean tech to succeed?

  • John’s recently been to numerous policy conferences where the FERC/PUC folks are pulling their hair out because they can’t get their respective utilities to invest in power plants because of the high volatility in policy and energy prices. There is a shortage of financing.  Where the federal government has fallen short on carbon, FERC and PUC are doing some great new thinking on the issue (Did not go into specifics).
  • John just had a conversation with Senator Bingaman as well. No outlook for carbon legislation. Another nail in the coffin…
Question 3: Role of government to pick winners and losers.
  • John said he gets this question a lot. His reply is: The NIH has funded research in life sciences to cure human diseases for the last 30 years. Yes, they did not have a 100% success rate. But they have been successful in curing many human diseases that the human race has benefited from greatly. Government is filling a gap in private sector finance where necessary. DARPA is the same way.  Their research led to the creation of the internet. Can you beat that?
  • In the context of clean tech. A123 and Solyndra did fail as companies.  But with climate change as a reality, these are necessary failures that lead us to successes. While KPCB stays away from companies that are reliant on government subsidies, John supports the government loan program in the clean tech sector because of the positive spillovers.

*Thanks to the Law School for hosting this event and to John who made the trek out here to share his views.*
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