It’s suddenly the most exciting time to invest in clean energy and sustainability in years. The day that many in the industry had given up on would ever come has finally arrived Inflation Reduction Act of 2022 (“InfRA 22”) and its $369 billion dedicated to supporting climate solutions. Massachusetts also passed its own landmark climate law. And earlier this week, California regulators approved the ban on all gasoline cars until 2035.
This is clearly a major inflection point for clean energy markets and creates an even bigger snag for these fast-growing industries because nothing of this magnitude has ever happened before in US climate policy. Although it’s an unprecedented scale, we’ve seen this movie before. Amidst all the understandable excitement, those of us who have lived through the hype cycle of the mid-2000s and the more recent clean energy investment frenzy of 2021 know there are a few things to expect now:
Many large venture capital and private equity firms will become long-term climate investors overnight
In the mid-2000s, when it looked like major climate legislation was going to pass, I can easily remember being in rooms full of VCs from large general venture firms all excitedly talking about how they were going to use the coming wave of government and market support to revolutionize the world . I remember even as a very junior investor getting calls from managing partners at some of the biggest venture firms in the world asking me to send them deals that were too big for my small business. I remember many prominent venture capitalists declaring that greentech would the greatest economic opportunity of the 21st century. Never wrong, but often early.
This is likely to happen again now and is generally a good thing. Bringing the minds and resources of the smartest venture investors (and this time, private equity more broadly) to our sector will lead to big wins. Both for their supporters and for the economy as a whole. And most of these new entrants will be eager to work with experienced industry specialists, leading to some really promising opportunities that will get orders of magnitude more capital and visibility than they would otherwise. This is all great.
However, if past history is any guide, it is also likely to lead to investments driven by hubris and claims of expertise that will be a bit much. Grandiose. Should be fun to watch.
Some very exciting but slow moving opportunities will be quickly overinvested
Everyone loves the idea of investing in something that will change the world. Venture capital and especially small investors love stories about revolutionary technological innovations.
Some cleantech industries have the potential for such revolutionary change, but have historically moved relatively slowly. We can look at hydrogen for transportation, advanced nuclear power generation, and carbon capture and storage as a few examples. In many such cases, the issue of speed of adoption is not just a question of how quickly the technological innovation itself can be developed, commercialized and proven. It is also a matter of market acceptance established infrastructurelong project development cycles, regulatory hurdles and market design.
Maybe this time it will be different (famous last words). However, historically innovative sectors with such revolutionary potential but requiring large capital and significant time to develop tend to be overcapitalized before they are ready when things take off. As we enter a period where things like this take off, expect amazing stories of massive investment rounds in world-changing technology…years before actual returns.
Remember, this is still a very good thing. Yesterday’s failures often lead to tomorrow’s potential breakthroughs, especially in the energy and transportation markets. But timing these breakthroughs can be a real challenge for investors. And also for companies that take in a ton of capital at the height of the excitement, spend a lot of money, still fall short of the sales before they need to raise more money, and then fall prey to disillusionment.
It will be greenwashed
Whenever investor enthusiasm peaks around sustainability and clean energy, we see a lot of good ideas finally get the funding they need. But we also always see over-aggressive claims about how sustainable a new solution really is, because entrepreneurs raising capital will have to make a case to capitalize on that excitement. So, for example, we already see a lot of claims about cryptocurrencies being useful for clean energy, some of which have some value and many of them don’t (at least not yet).
Many investors like myself believe it is important to support solutions and companies that are legitimately on the right side of climate and sustainability trends. If you believe that the regulatory and economic burden of climate-unfriendly business practices will increase over time, then at the very least you want to avoid the soon-to-be-disadvantaged companies that engage in such practices, no matter how successful their greenwash may be . will appear in the near future.
A key concept investors should keep in mind is “complementarity”. This is mostly used today in the context of carbon offsets, but has wider applicability. “Are there environmental benefits that would not have occurred without this innovation?” That’s one question. But also: “Does this innovation support an activity that is not climate-friendly and that will have a greater negative effect than the direct environmental benefits?
For example, early in my investment career I was offered the opportunity to invest in a new, more energy efficient design of an oil rig. …we went through.
A wave of IPOs and acquisitions will be ready once Wall Street settles down
It’s clear that even before the advent of clean energy Christmas, many public equity investors were holding back on clean energy and clean transportation. Witness the excitement and activity of investors in 2021 around SPAC for climate solutions.
What is less well known, but perhaps more important, is that this wave of investor interest, by paving the way for promising companies to IPO (whether they were ready for an IPO or not is another question…), also spurred a lot of M&A activity that continues to this day.
There is such a thing as $300 billion in “dry powder” already sits in private infrastructure fundseven last year many of these investors were begins to move upstream into the acquisition of sustainability project developers as a way to capture project flow. On the corporate side, prior to the economic downturn, many large industrial companies became more active in acquiring companies that would otherwise have waited longer.
The looming economic downturn and a bad 1H22 on Wall Street slowed down all these activities. And as long as financial markets overall remain unbalanced, they will likely continue to do so.
But once the IPO window opens, get ready. We are likely to see another wave of sustainable IPOs and exit activity. Maybe not SPAC powered this time. However, the conditions are now set for public equity and corporate acquisition investors looking to jump on this train before it leaves the station.
The next 12 months will be exciting for clean energy entrepreneurs, project developers and investors. Enjoy the ride! Also, enter with your eyes wide open.