GreenGold: 2010

Tuesday, November 30, 2010

Election Does Not Spell Cleantech Doom

With the recent “shellacking” (as President Obama referred to the election results) of the Democratically controlled Congress, much of the buzz in the cleantech space has been doom and gloom. Is cleantech doomed to a new dark age? I do not believe so.

Energy policy is one area where there is an overlap of goals between the parties. Members of both parties largely agree that energy is critical to our economic and national security. And most Republicans do not dismiss out of hand the risks of global warming.

I suspect that energy policy will be a topic where this Congress will get something done especially with the President’s increased desire to work across party lines. It won’t be exactly what the president wants and it won’t be exactly what the Republicans want. It will be an old-fashion compromise that may actually result in some policies and that will have greater long-term impact on cleantech than most of the short-term handout programs that were put in place under the largely ineffective cleantech stimulus bill.

So, where can the Democrats and Republicans potentially agree when it comes to cleantech?

1) Energy efficiency. Republicans and Democrats have demonstrated their ability to find common ground here. George Bush signed the law from a Democratic Congress that will end the life of the incandescent bulb and that increases the fuel efficiency standards for vehicles by 40% by 2020. Democrats like tax credits for installing energy efficiency improvements, and Republicans like reducing taxes. Reads like a match made in heaven.

2) Renewable energy standards. Many states have put in place such standards with support of both parties. Some Republicans in Congress have previously voiced their support. If the definition of “renewable” were expanded to include nuclear as an acceptable alternative, I suspect there would be broad support in Congress. A renewable energy standard is exactly the kind of long-term macro-economic policy needed to drive change and create more sustainable demand for renewable energy and energy efficiency. Utilities putting big dollars into development of renewable energy power sources and energy efficiency will drive much more industry growth and relieve issues around debt financing to a much greater degree than the government’s ineffectual efforts to play banker. And if the definition of “renewable” were expanded to include nuclear, then I suspect the base of support would broaden even more. Given that most renewable energy sources can’t serve as base load, it would be the right environmental and national security move to include nuclear in the energy mix.

3) R&D. Republicans have long been supporters of government R&D. Although there will be an issue around funding offsets for the R&D, I believe there will be broad consensus on the need to invest in our energy future. What will happen, I suspect, is that the focus of this R&D will shift more to early stage disruptive technologies rather than the late-stage grants and government loans which are already proving to be failures. Even the Administration has internally begun to question the effectiveness of these programs. If the scope of cleantech R&D is expanded to include clean coal technologies and next-generation nuclear, I believe the support base will broaden even more. The most effective way to ramp up disruptive R&D funding is likely through the new ARPA-E and possibly to the few federal labs that do not have their roots in our nuclear weapons programs (e.g. the National Renewable Energy Laboratory). By funding ARPA-E, most of the research would take place in our universities and private companies where the potential for real product development and technology transfer is much greater than in our defense oriented federal labs. The biggest challenge will be finding the funds given the need to reduce the deficit. One possible solution would be to take the funds already appropriated to later stage projects/loans that have yet to be awarded and redirect them to disruptive R&D. Another would be a…

4) Gas Tax. Cap and trade is likely dead. And given that such a program would have been a largely ineffectual mess (see my previous post, Cap and Trade: Right Debate, Wrong Solution) that is not necessarily bad. As I pointed out, the area where there is the greatest overlap between environmental, national security and economic objectives is with gas/diesel, which most cap and trade proposals largely wouldn’t have touched. The co-chairs of President Obama’s bi-partisan tax commission recently included a gas tax as a piece of its budget solution and two key Senators (one Republican, one Democrat) recently recently wrote the commission encouraging them to consider even bigger increases. A heftier tax phased in over time may be possible by using the concept of a “tax and dividend”, whereby a tax is levied to increase its price and much or all of the revenue is distributed back to consumers. If the money raised from this tax is largely given right back to the consumers in the form a rebate, then it’s not a tax increase but rather a tax incentive to reduce consumption of gasoline/diesel. Increasing the cost of gasoline/diesel to drive market demand for alternative fuels and energy efficient vehicles can help Republicans and Democrats achieve their desire of enhancing our national and economic security while reducing carbon emissions.

5) Government Procurement. The government is a large consumer of many items. One of the best ways to accelerate market adoption is by creating a market for the product/service. For example, the Federal government’s decision to require all new buildings to be LEED certified is accelerating a shift in the building industry to green buildings. The government purchases a large amount of energy for buildings, vehicles, airplanes and ships. Policies that drive increased purchases of domestic energy sources based on non-fossil fuels can provide a significant lift to multiple cleantech industries. The Department of Defense understands the critical nature of this issue, especially around liquid fuels. The Pentagon’s concern provides the nexus of an opportunity for collaboration between Democrats and Republicans on government procurement policies.

Even if you believe we will see a stalemate in Washington on cleantech, the global macro-economic trends will not change. Consumption of fossil fuels is accelerating as the world, especially heavily populated China and India, dramatically increase the number of automobiles, power plants and factories. It is a certainty that the price of these commodities will, on average, increase over time. The next spike in oil prices, I suspect, won’t be too many years away and, worst case, whatever lull in cleantech enthusiasm that may occur will be quickly washed away.

The essence of any government policy with the goal of accelerating cleantech is simply an effort to narrow the time between today and the inevitable day when fossil fuels become expensive enough that various renewable energy and energy efficiency solutions become compelling without any government involvement. If you’ve read my previous posts, you know that I do not believe that we will achieve our cleantech goals through massive grant or loan programs to the private sector. Policies that target the underlying macroeconomic environment will ultimately have a much greater impact than handout programs. Many of the policies that lie in the zone of potential cooperation between Democrats and Republicans such as gas tax, national renewable energy standards, and federal procurement policies can help drive steady long-term demand for renewable energy and energy efficiency. I am optimistic that these are areas where real progress can be made.

Thursday, October 14, 2010

Meet the Rodney Dangerfield of Cleantech

Wind turbines stand tall and mesmerize with their motion. Solar cells bask in the sparkling sun. Meanwhile, hidden down in the dark dirty underworld, a compelling technology sits quietly and gets no respect. Once installed it largely goes unseen and, it seems, it’s equally invisible in the world of clean technology press, venture funding and government R&D funding. Yet this technology provides some of the most intriguing economic returns available for reducing a building’s net energy consumption and I would welcome the right opportunity to fund an exciting business in this category.

What is this Rodney Dangerfield of cleantech? Geothermal heat pumps, also referred to as ground source heat pumps or geoexchange. Anyone who has gone down a hundred feet or so in a cave on a hot day probably noticed how nice and cool it was down there. That is because in most geology, a zone of nearly constant 55-degree Fahrenheit temperature exists 50-200 feet below the ground we walk on. Even at shallower depths the temperature hovers within a much narrower range than on the surface. Geoexchange is technology that uses the constant temperature and huge heat sink that the earth represents to generate heat in the wintertime and to cool in the summer time. They leverage technology inside the house that has similarities to your refrigerator (which is, itself, a heat pump). (more detailed explanation of geoexchange here).

Much like solar and wind, this is not a new technology; it’s been around and used for decades. Although the economics of a geoexchange system vary from location to location based on geology, local energy rates, and the need for heating/cooling, in most places the payback on a geoexchange system for a home or commercial building beats solar or small-scale wind -- usually sizably. Whereas solar or wind generate electricity, geoexchange reduces the consumption of energy for space heating and cooling and also can be utilized to generate hot water. It has near year-round benefit, working when the sun doesn’t shine and when the wind doesn’t blow. It is “base load” energy savings for a building. A $1,000-$2,500 annual savings in energy costs for a middle class home is fairly typical, and the CO2 reduction is roughly equal to taking two cars off the road – permanently.

(Table from Climate Master)

In many markets, a geoexchange system can be installed with paybacks of 10-15 years without any government incentives. By comparison, except in the best markets (high sun, high electricity cost and high state tax incentives on top of federal incentives), solar still struggles today to provide 10-15 year paybacks with government subsidies.

And here’s where it get’s really exciting: The cost of installing the technology can pay itself back in as little as three years. A geoexchange system isn’t like that of a solar or small-scale wind system, which almost always has a 100% incremental cost because no existing system is being replaced. In most climates, buildings need either heat or air conditioning to be usable 365 days a year, and in many climates they need both. Those systems age and need to be replaced (a 20-year lifetime is typical). So for a building needing new HVAC equipment, the relevant cost is the incremental cost of the geoexchange system. Netting out the cost that would have been spent on traditional HVAC replacement equipment in most cases drops the payback calculation down to six-12 years. Add the current federal 30% tax rebate off the full system cost, and the buyers payback can be an incredible three to six years.

(Source: Cleantech Consulting Services)

27 Case Studies of Residential Ground Source Heat Pump Paybacks

(Oregon Institute of Technology)

So why is it that solar has received about 33% of all venture capital investment in cleantech and around $1B in government R&D funding over the past ten years while virtually no federal funding or venture capital has gone to geoexchange? There are several contributing factors:

· Each geoexchange installation is an “art” project. This is a challenge that the solar industry used to face, when every system required fairly extensive design, engineering and coordination of a potpourri of vendors. Solar has largely overcome this by better productizing their offerings and streamlining installation; at the same time, the number of solar-focused installation companies has proliferated. Geoexchange has yet to mature in this manner, and many of the companies in the space are largely traditional HVAC vendors that can do geoexchange.

· Out of sight, out of mind. One might think this is a good thing, but I suspect that it hurts geoexchange. Your neighbor who spent $25k on his solar system is proud to have it on his roof, advertising that he’s green. But no one knows about the neighbor who invested in a geoexchange; after the drilling rigs leave, nobody can see the good deed being done for the environment.

· Fragmented, unfocused installers. Geoexchange systems are installed by a hodgepodge of mostly small HVAC contractors. Because most don’t focus exclusively on geoexchange, there isn’t a strong marketing and sales engine to streamline the sales and installation process.

· A misconception that geoexchange is “low tech.” What technology advancement could there be in putting pipes into trenches or holes to capture or dissipate heat? The common view is “not much.” But the process of heat transfer is a complex engineering challenge that could include advanced materials, fluids and designs to enable increased efficiencies, reduced materials and reduced installation costs for a given performance level. I believe that technological advancements and economies of scale could result in a reduction in geoexchange system costs of 20-50% with a directly corresponding drop in payback time.

On the last point, it is truly a shame that there isn’t any federal R&D spending going to innovative technologies in this area. I would love to find an innovative geoexchange company with compelling technology advantages, innovative financing tools and a great management team that could build a large national business to invest in. If you know of any, send them my way. I promise I’ll show them some respect even if I can’t promise that we’ll invest in them.

Friday, September 17, 2010

Cleantech Stimulus Still Not Stimulating

The stimulus bill along with the $31B cleantech element focused on grants and loan guarantees through the Department of Energy was passed into law over 18 months ago. About a year ago I wrote about how the cleantech stimulus was not very stimulating to our economy. I suggested at that time that the goals of stimulus and of long-term investment are largely incompatible, and the evidence is bearing that out. At the time, I felt like a bit of an outcast for having such a critical view and yet being an ardent supporter of clean technologies and the need to wean our nation off fossil fuels. On the anniversary of my first post on this topic it seems appropriate to take a fresh look at where things stand.

While stimulus supporters and the press love to focus on the selection of award winners for grants and loans, funds appropriated but sitting in the U.S. Treasury have zero potential to stimulate the economy irrespective of whether a winner has been selected. As of September 10, 2010 and about 19 months after the stimulus became law, according to the Obama Administration’s Recovery Act web site, recovery.gov, the Department of Energy had paid out just over 23% of the $31B of funds appropriated to the department for various cleantech activities under the stimulus bill. At that rate it will take roughly six years for all funds to be dispersed. According to DOE’s more detailed numbers, in the past 12 months, the department has awarded (i.e. selected winners) for about $14B in grants. Less than 10% of that amount has actually been disbursed to date. In addition, there are over 730 awards representing $1.2B that were made in 2009 for which no funds have been paid out at all. Many of these likely still are trying to get their contracts in place, an often-arduous process that can take many months.

In the Smart Grid segment of stimulus, where stimulus actually slowed spending because utilities stopped work to wait and see whether they would win a grant, less than 8% of the over $4B appropriated has been paid out. People in the utility industry who have received grants have told me about calls from DOE staff “virtually begging them” (in the words of one source) to spend money against the grants that have been awarded more quickly. In other words, the government seems more concerned about optics of getting the money spent than having it spent wisely.

As stated on recovery.gov, the goal of the Recovery Act was to “… jumpstart our economy, save and create millions of jobs, and put a down payment on addressing long-neglected challenges so that our country can thrive in the 21st century.” It’s amusing that the recently released Administration Report on the Recovery Act emphasized that its focus would be only on “the ‘Reinvestment’ part of the Recovery Act” and completely avoids any comment on the stimulus’ impact on the economy or jobs. Seems like quite a testament to failure of the recovery spending to provide stimulus in any meaningful way.

If the focus of the cleantech “stimulus” was really on reinvestment, then the government would be careful and diligent about naming grant/loan winners rather than rushing to make awards as fast as possible (which is motivated by stimulus). Yet, while money has been slow to flow from DOE, award winners have been selected for virtually all of the $31B from the recovery program. As I said earlier this year in a Cleantech Forum debate with DOE Renewable Energy Grants Advisor Sanjay Wagle, the government is simply incapable of both getting grant/loan money out the door quickly and spending it wisely. I still maintain that programs like Cash for Clunkers and energy efficiency tax credits (whether you agree with the specific policy or not) have a rapid positive impact on the economy. The evidence on the government’s own recovery site seems to bear that out: by comparison, 77% of all tax-related stimulus benefits (only some of this cleantech-related) have been paid out to recipients in the form of reduced tax obligations. While one can debate the degree of impact those funds may have, funds awarded but not transferred from the federal treasury have no chance of stimulating the economy.

Much of the press focus on the cleantech stimulus has been on the Advanced Research Projects Agency – Energy (ARPA-E) funding into early stage cleantech technologies with “game changing” potential. The government has long played a role in funding early stage research and such a program has worthy goals. Yet, ARPA-E represents only about 1.3% of DOE’s stimulus funding with most other funding going to much less disruptive grant/loan programs in which the government is trying to play business person and has a notoriously bad track record of doing so. And ARPA-E’s appropriation for 2011 is likely to be less than 2010 with the House number passed at a 50% reduction.

The unfortunate reality is that by using the stimulus bill as a vehicle for pushing funds through the slow and ineffectual government bureaucracy rather than focusing on stimulative policies that would have had greater impact on the economy, the Administration may very well have lost the opportunity to enact macro-economic policies affecting the cost structure for energy that could have had much more far-reaching and long-term positive impacts on the goal of reducing our consumption of fossil fuels. I believe time will bear out that many of the grant/loan awards made in such a hurry will turn out to be a waste of money.

Conversely, the macroeconomics of energy are certain to change as finite fossil fuels continue to be consumed… it is only a question of over what time period. It is that reality which is driving the private sector investments that must be the backbone of any sustainable change in our energy economy. Careful federal policy around carbon-based fuels could have provided greater visibility into the time frame and degree of increase in the market cost of fossil fuels even if there was a very slow phase in of such a policy to avoid collapsing the economy. The result would have been greater clarity of when (and shorter time horizons for when) clean technologies could become cost competitive. This would have resulted in a corresponding increase in investment by the private sector in building those businesses to profit from the impending change. And that would have been extremely stimulative to our economy without needing to borrow a penny to fund it.

Wednesday, June 30, 2010

Cleantech is a Bunch of Hot Air!

While renewable energy often captures most of the cleantech headlines, if anyone doubts why energy efficiency must play a significant part in the cleantech effort – as significant, if not more so, than the role of renewable energy -- just examine the energy flow graphic developed by McCall and Bassett and reprinted in the June edition of Technology Review. At least half of U.S. energy consumption goes to nothing more than creation of hot air through waste heat. And, when one realizes that much of the 13.9% of electricity output from power plants shown in the graphic also ends up as hot air from our computers, lights, etc., the portion of energy consumption going up in hot air is actually greater than 50%.

Couple this with the following facts… According to the Energy Information Administration (EIA), on a worldwide basis renewable energy currently supplies roughly 10% of the energy consumed. Over the next 25 years the EIA forecasts worldwide energy consumption to grow by more than 50%. They also forecast a 100% increase over that period in the supply of renewable energy, which, in isolation sounds modestly impressive. But this would equate to less than 15% of all energy being consumed because consumption would have increased 50%. Worldwide renewable energy production would have to increase upwards of four fold to equal just about 25% of the energy consumption forecasted for 25 years from now. Meanwhile, with 50% growth in consumption, the other 75%, representing fossil fuel consumption, would still equal more fossil fuel than the world consumes annually today!

Energy efficiency not only saves on total energy consumption today but also is magnified as consumption increases because the additional devices consuming energy will consume less if they are more efficient. For example, increasing the average efficiency of all vehicles on the road an average of 50% (e.g., from 20 mpg to 30 mpg…not such a high hurdle) would reduce overall U.S. energy consumption by over 9%...that’s 9% of today’s consumption and tomorrow’s increased consumption because all the additional miles forecast to be driven would also be in more fuel efficient vehicles. To achieve that same impact with renewable energy would require about a 150% increase in U.S. renewable energy production and about a 225% increase to achieve the same offset in 25 years.

I’m not diminishing the role of renewable energy as an important piece of the long-term equation. Disruptive development of cost effective renewable energy sources will need to be a key piece of the long-term equation for removing our addiction to fossil fuels. However, energy efficiency often doesn’t receive as much press as renewable energy because it isn’t as sexy. Yet, energy efficiency provides leverage that renewable energy does not because the benefits automatically scale as consumption increases. To say it another way, if we can figure out how to clear up some of the hot air, we can have a tremendous impact on fossil fuel consumption!

(See Larger Image)

Tuesday, April 27, 2010

How to Build a Cleantech Company Without Huge Investment Capital: A Case Study

While many cleantech companies require very large amounts of capital in order to get to market, there is a quiet group of cleantech companies bucking that trend. Companies like Heartland Biocomposites (Green Building Materials), RealTech (Water Testing) and TerraLUX (LED Lighting) all built significant and growing businesses with compelling intellectual property and did so initially without multi-millions in capital from venture funds (let alone tens or hundreds of millions). Because TerraLUX is one of our portfolio companies and I therefore know them best, their story is one I am able to share.

TerraLUX boasts customers like Cooper Lighting, Phillips, GE Healthcare, Snap-On Tools and many others. It has six awarded patents and eight more filed. Dr. Anthony Catalano founded the company in 2003 and, with exceptional technology smarts, creative boot-strapping and some of his own capital, he built a business with significant revenues, exciting gross margins and deep intellectual property – all without a penny of outside investment capital. And now, only after all those accomplishments, has TerraLUX closed a $5.6M financing from Emerald Technology Ventures and Access Venture Partners.

How did TerraLUX pull this off? The story starts with an entrepreneur focused first and foremost on how to create revenues. Catalano, who has a PhD from Brown in physical chemistry and is a previous director of the NREL Photovoltaic (solar cell) Division, had the technical acumen to create a business in a number of cleantech sectors but he wisely chose the LED market. He did so because he saw the industry’s explosive growth. His dream was to create LED lighting for buildings that could have a disruptive impact on lighting energy consumption. But Catalano realized he couldn’t just create a science project; he had to be able to sell innovative products quickly to create cash flow.

Seeing that in 2003 the cost/benefits of LED’s were not yet compelling for the large general lighting market he knew he had to turn to a more ready market – portable lighting. While this market is an order of magnitude smaller than general lighting, it is still a multi-billion dollar market and, most importantly, the benefits of higher brightness, extended lifetime and increased durability have premium value for users of products like flashlights, work lights and surgical lights. The portable lighting market was (and is) willing to pay a premium for those benefits and, as a result, even with the high cost of LED chips in 2003, TerraLUX was able to create real products and real customers.

I suspect some entrepreneurs would have turned up their noses at the thought of launching a flashlight business when their goal was the much bigger general lighting market. But Catalano didn’t let his ego get in the way of doing what was needed to get the business off the ground. Instead, he went to market with LED drop-in replacements for existing flashlight bulbs and was soon off and running. From there the company grew into multiple portable lighting product lines and well beyond just flashlights. As it turned out, creating high-performing portable LED products is, in many ways, more challenging than designing for general lighting. Limited space, challenging heat sink options, and a non-constant power source (e.g. batteries) create a plethora of challenges. But Catalano together with his VP-engineering, Dan Harrison (brilliant Caltech guy), used their considerable technical talent to create innovations to solve these problems. The result has been the creation of a deep intellectual property portfolio around temperature control, optics and circuitry, and the ability of TerraLUX to deliver LED products with unparalleled performance.

Success begets success, and TerraLUX’s flashlight products created awareness in the market. A few years later, TerraLUX’s phone began ringing with calls from other portable lighting manufacturing companies desiring to create LED versions of their lighting products. These companies needed something they could plug or screw into their existing products to turn them into high-performing LED versions. TerraLUX was one of the few companies that could deliver such results, and virtually no competitors could do so with the brightness, lifetime and light quality that they were able to achieve. The company responded to this market demand by leveraging its core intellectual property to create LED Embedded Light Modules (self-contained modules that can be screwed or plugged into other manufacturers’ products) on an OEM basis for manufacturers of a variety of portable lighting products.

As the years progressed, LED chip prices compared to their performance continued to drop rapidly and began to open up the potential in the general lighting market. TerraLUX then got the call it had wanted for years. A key executive at a large general lighting company had bought a TerraLUX flashlight retrofit kit and was impressed with its performance and extremely compact size. That company had obtained LED products from numerous potential suppliers, but none could meet TerraLUX’s brightness, consistency and quality requirements. TerraLUX’s intellectual property around thermal controls, circuitry and optics that grew out of the portable lighting business gave them a fantastic edge. Since TerraLUX already had years of experience manufacturing LED Embedded Light Modules (albeit for portable lighting), the general lighting company had confidence in TerraLUX’s ability to deliver. And, with that, TerraLUX became the general lighting company that Catalano dreamed of when he founded the company.

Now TerraLUX was in a position to explode into the general lighting market. Although the company had built a growing business with compelling intellectual property, it lacked the polish that venture capitalists typically look for. At Access Venture Partners we have a soft spot for entrepreneurs that build companies by finding customers. We like to work with companies that have the foundation of a great business, but may have a few rough edges, to help them get to the next level. In late 2008, we saw the potential that TerraLUX had as a business and worked with Catalano to define the things that were needed to enable TerraLUX to raise the capital it now could use to further accelerate its growth. These included refining the go to market strategy, enhancing company operations, enabling professional accounting, implementing the company’s first financial plan and recruiting Jim Miller, (formerly VP-sales, Global Geographic Regions for Phillips Lumileds), to join the company as CEO. The last item was a step taken with Catalano’s full support, and he remains a key member of the management team as Chief Technology Officer and a member of the board. To accomplish this we made a modest bridge investment and with those tweaks, TerraLUX was in a position to raise a meaningful round of venture capital to even further accelerate its growth and did just that.

Now with $5.6M in growth capital, TerraLUX is able to invest in the sales, marketing and R&D that will enable it to take a strong growing business with deep intellectual property and grow it even faster. But this growth comes from a foundation built without the large sums of venture capital that get much of the cleantech press that we read about. Building a company by bootstrapping may not be as sexy as raising a large venture round right out of the shoot. But the discipline it instills to focus on customers and revenues can create some of the most exciting real businesses in the long run.

Wednesday, March 31, 2010

Cap and Trade: Right Debate, Wrong Solution

As we have seen in just the past few years, fossil fuel prices can vary dramatically over very short periods of time. Creating greater certainty regarding steady increases in fossil fuel prices over the coming decade would have an enormous impact on private sector investments in both alternative energy and energy efficiency. Cap and trade is the right debate to be having because it focuses the discussion on how to change the fundamental economics of fossil-based energy. But ultimately cap and trade is the wrong solution; superior means exist to achieve the results we need not only for the environment but also for national security and our economy. A better solution is a strategically targeted “ceiling” tax on carbon combined with a tax dividend.

Cap and trade sounds good on the surface. Seemingly it would allow the market the freedom to choose among implementing technologies that reduce greenhouse gas emissions, paying to use existing technologies that emit greenhouse gases, or paying for offsets from another entity. But cap and trade is inherently flawed in its complexity and the slow rate at which it can propel change. The potential for loopholes and corruption, both through the specifics of how the law is implemented and the trading markets that will be created, are enormous. If you have read my blog previously, you may be surprised to hear me come out against a seemingly market-based solution like cap and trade. Many assume that because cap and trade worked for acid rain, it will work for greenhouse gases. But for markets to work well there needs to be transparency around both price and what actually is being purchased. As the graphics shown help illustrate, the complexity of greenhouse gases are enormous compared to the simplicity of sulfur emissions from coal plants. The challenges around accurate and transparent accounting of how much carbon is emitted or “re-sequestered” through an offset is fairly daunting. There have already been significant challenges around carbon offsets with the European cap and trade efforts. So far in Europe, the impact on greenhouse gas emissions has been much less than desired

upcoming book by Roger Pielke). Because of these factors, not only does cap and trade create risk of corruption because of the challenges around defining exactly what has been emitted or how much an offset has recaptured, but its ability to actually achieve the desired reduction in greenhouse gases also falls into question.

Efforts to implement a cap and trade system that would be truly comprehensive would treat all long-lived greenhouse gases as equal. To make any meaningful difference, the price of carbon must be set high enough to move the meter significantly on the cost of fossil fuels. Many experts estimate that price to be as much as ten times the current price in Europe. As a result, if a cap and trade system is actually going to result in a meaningful reduction in greenhouse gas it will have an enormous impact on the economy given the scope of activities that generate greenhouse gases. In addition, the sheer process of requiring businesses to account for their emissions would lead to significant wasteful administrative costs beyond the cost of the carbon emissions themselves. Such a requirement would, however, create a great jobs program for accountants, attorneys and even investment bankers who would get paid to navigate the complicated mess that would result. This reality is why many cap and trade proposals end up being limited to areas of highly concentrated emissions that are easy to track. This effectively means focusing on power plants, which represent about 39% of the impact-weighted greenhouse gas emissions (of which 85% is from coal-fired plants). And most proposals generally leave transportation -- which produces about 33% of the impact-weighted U.S. greenhouse gases – largely unaffected.

       “So what?” you say. Let’s focus on reducing the 39% that is largely from coal-fired plants, right? From an environmental perspective it does not matter where we reduce emissions – just that they are reduced. But from an economic and national security standpoint it matters significantly. The U.S. is home to roughly 25% of the world’s coal and supplies virtually all the coal Americans consume. Meanwhile, the U.S. imports the majority of petroleum that we consume. Reducing consumption of coal will not strengthen our national security, and the most immediate effect on our economy will be negative. Even if one doesn’t believe those are important factors (hard for me to fathom but I know some feel that way), I suspect that everyone would agree that the political ability to implementsomething that moves the meter is critical. And a policy that appeals to the left and right of the political spectrum holds the best promise.

       Tax and dividend, whereby a tax is placed on carbon and some, if not all, of the proceeds are distributed back to those who paid the tax, is a concept that has begun to receive discussion as a potential alternate solution. Such a system taxes based on consumption but the dividends are paid out without respect to specific consumption. So, the motivation to move to alternative fuels or implement energy efficiency remains because the dividend will still be received even if tax payment is reduced. Yet, the sting of the tax is reduced by receipt of the dividend. Tax and dividend eliminates many of the problems associated with the complexity and lack of transparency with cap and trade and it largely leverages systems already in place to tax things like gasoline, coal, etc. However, it still is flawed in that it treats all carbon as being equal. Again, while all emitted CO2 is equal from an environmental standpoint, it is not from an economic or national security standpoint. In addition, the greater the scope of the tax, the more interest groups it will upset and the less likely it is that it can ever pass Congress to become law.

         The better solution, both from an efficacy and political standpoint, than cap and trade or tax and divided is a strategically placed “ceiling” tax on carbon combined with a tax dividend. Our greatest opportunity lies at the nexus where greenhouse gases are reduced, national security is strengthened and our economy is at least not harmed. As a result, the first element of the solution should focus on petroleum consumption, which is predominantly consumed in vehicles and the first strategic place for a “ceiling” tax is on CO2 emissions from fossil-based transportation fuels used in automobiles and trucks. This is effectively a gas tax, except it would apply to gasoline, diesel and any future form of fossil-based fuel sold for ground transportation and would be based on the amount of non-renewable CO2 emitted upon combustion. In addition, the tax rate would be determined by the difference between the price the retailer/vendor pays for the fuel and a pre-determined fixed maximum charge to the consumer (individuals and businesses alike). If the ambient price of the fuel commodity increases, the tax that is charged would decrease. Thus, it creates a “ceiling” on the tax where there is an ambient price at which the tax would no longer be charged. Implementing the tax in this manner accomplishes several objectives:

It creates clarity, certainty and stability around the price that alternatives will need to compete with.
It sends a clear political message that this tax is not forever; it has a built-in mechanism to end when the ambient market price catches up with the artificial price created by the tax.
It puts a limit on the pain inflicted at the pump. If fuel prices spike, the tax will diminish and even go to zero if the maximum charge to consumers is exceeded.

Now, what to do with the revenue? We must ensure that the negative impact on our economy is minimized as much possible. In addition, we have to be realistic and create something that can fly politically. As a result, the tax revenue should be sent right back to the consumers who paid it. For individuals, the amount received could be based on the size of the family to reflect the likely increased transportation needs. Economically speaking, the dollars received by each family will be much more meaningful to a low-income family. Yet, the payment is not based on income – something for Democrats and Republicans to celebrate. For businesses, we must endeavor to avoid making specific businesses non-competitive. If a business has a transportation intensive business, the cost increase could be substantial. So, distribution to companies could be based on their fuel consumption for transportation over a multi-year period prior to enactment of the tax. That way, transportation-intensive companies will receive a much larger share than those that use little transportation directly in their business.

What about the impact on the oil industry? No doubt that such a tax would have an impact on oil consumption and therefore production. It may even be politically required to dividend some of the tax proceeds back to the oil industry. After all, democracy is the art of the possible. This would likely mean a smaller oil industry to the extent that the industry doesn’t redirect its efforts to other profitable business efforts (e.g., geothermal, solar, etc.). However, with a tax on transportation fuels, there would be a clear economic upside to the change. The clarity provided with respect to future prices of gasoline and diesel would provide significant impetus and support for private sector investments in renewables as well as vehicle energy efficiency. In addition, such clarity would spur significant economic growth in the automotive industry as consumers become eager to find energy efficient or alternative energy vehicles. One need only look at what happened with the sales of hybrid vehicles when gas prices spiked a few years ago. The auto industry would see a boom as consumers looked to switch to vehicles that consume less fossil fuels.

President Obama’s desired goal is a 17% reduction by 2020 from 2005 emission levels. If the tax is set at a high enough level, studies indicate it would drive significant change in buying decisions and driving behavior of consumers. A key to the success of the tax is that it creates long-term certainty with consumers regarding the likely price of gasoline and diesel. A Congressional Budget Office Study found that a 10% long-term increase in fuel prices would result in roughly a 4% reduction in fuel consumption (through a combination of reduced driving as well as purchase of different vehicles). If the ceiling tax were set based on a target price of $5 per gallon retail price for gasoline, this would create long term visibility into a price increase and would imply we could see a reduction in fuel consumption (and corresponding emissions) of 40%-50% representing a 13%-17% reduction in overall greenhouse gas emissions. The U.S. consumes more than 6x the gasoline per capital than Europe and one reason is that gasoline costs 2-3x as much at the pump than the U.S. What the CBO study did not take into account (given the challenge of doing so) is what happens to petroleum consumption when alternative fuel vehicles then become cost-competitive. I would suggest that the accelerated innovation that would occur in such vehicles once businesses knew they would be competing with a $5/gallon price would drive even greater reductions in greenhouse gas emissions and petroleum consumption well beyond 17% in 10 years.

Clearly, such reductions are much less meaningful from an environmental perspective if carbon emissions elsewhere were to increase. Given that electric vehicles are a probable future for some vehicles, we must address the emissions created by electricity production. Otherwise, we will simply push CO2 creation from the tailpipe to the smokestack. But rather than a complex loophole- and scandal-fraught cap and trade system, a strategically placed ceiling tax on CO2 emissions and corresponding dividend should also be used in the utility industry. The challenge here is that just like cap and trade, in order to have a meaningful impact regarding the business decisions made on utility plants, the price of carbon must be set fairly high. Because electricity costs impact every person and business in the nation, a carbon tax applied to power plants significant enough to be meaningful would have a broad-based negative impact on the economy. Everything would become more expensive.

Instead of a blanket tax, the ceiling tax on CO2 from electricity production should be much more strategic. First, the tax placed on existing plants should be fairly modest and intended primarily to generate tax revenue that would be utilized specifically to provide funding to the coal industry for clean coal and sequestration technologies. That is not only the politically correct move; it is economically smart given our vast coal resources. A tax of just $2 per million metric tons of carbon would generate roughly $5 billion a year in tax revenue (U.S. utilities generate roughly 2,400 million metric tons per year). Yet, it would add an average of about one tenth of a cent to the cost of every kilowatt-hour (U.S. total electricity production is roughly 4,100 billion kilowatt hours per year) or roughly a .01% increase in retail price. Second, the tax on new plants built after a couple-year grace period for those already being constructed, should be set at a much higher level that ramps up over time to a capped amount. An initial tax rate of roughly $30 per metric ton would equate into a cost increase of about 3 cents per kilowatt-hour for the worst offending coal-powered electricity generation. However, the specific amount of the tax should also vary based on the price of the underlying commodity (e.g., coal or natural gas). That way, if there were a spike in a commodity price (like with natural gas a few years ago), the tax is automatically reduced or eliminated, thereby eliminating excessive spikes in electricity prices.

To make a carbon tax on utilities achieve the desired goal of driving a change in decisions regarding which type of plants to build, it is critical that utilities are not allowed to work the tax into their rate base - they must eat the tax cost or implement new plants that emit less or no CO2. In addition, when plants reach a set time frame after the end of their depreciation period, they would begin to be subject to the higher tax on new plants. The incentive must be squarely placed on utilities to implement low carbon or no carbon means – all of which they can work into their rate base. That means implementing renewable, nuclear, sequestration and likely some additional natural gas. Given that the incremental plants will, by and large, create more expensive electricity than the base coal plants, utilities will have increased incentives to promote energy efficiency and implement the smart grid. Until technology innovation allows otherwise, most incremental electricity load above the current base will likely cost more to deliver. Such a tax, if set high enough on new plants, would likely create something akin to a cap on any increases in carbon emissions by utilities. As aging plants are replaced or retrofitted, reductions in emissions would begin. In 10 years, if the vast majority of new electricity production beyond what was currently being built has been low- or no carbon and if just 15% of aging coal plants are replaced with low or no-carbon emitting alternatives, we would see a reduction from 2005 utility emissions of 3%-6% on top of the at least 13%-17% reductions from action on transportation fuels but without a severe negative impact on the economy. And the clean coal and sequestration technologies developed from the R&D generated through the taxes would hopefully enable an acceleration in reductions as they are able to be implemented in the following years.

In making decisions about how to reduce green house gas emissions, as a nation we cannot and should not focus solely on the issue of global warming while ignoring the equally important goals of maintaining our national security and economic strength. We must implement a system that changes the economics of energy in a way that supports all of these goals. Not only will cap and trade be unable to achieve these three goals, but without an extremely high price on carbon that likely cripples our economy it won’t even have a significant impact on the single goal of reducing green house gas emissions. A system that does not focus first on our consumption of petroleum has little chance of strengthening our economy or national security. In addition, to be successful, we must create greater clarity over long-term fuel price that the alternatives must compete with in order to provide the impetus for private sector investment in energy efficiency and alternative energy. Cap and trade cannot give this clarity and the government cannot simply buy our way out of this problem. We must have the innovation, creativity and financial power of the private sector motivated to making the scale of change that is required. A strategically targeted ceiling tax on carbon with focused use of the dividends could create the log term clarity needed in the market and will motivate the private sector to dramatically increase investment in the type of innovation and change that is the source of ours (and the world’s) prosperity.

Tuesday, February 9, 2010

Cleantech Economics 101: Higher Fossil Fuel Prices; More Cleantech

With all the complexities of cleantech policy and technologies, there is only one simple thing needed for an explosion of competitive clean technologies – increased price of fossil fuels.

The amount of R&D expenditures that will need to be invested in clean technology in order for it to hurdle the bar into competitiveness is much greater with low fossil fuel prices. And, the lower those prices, the less appetite the private sector has for making such investments. This leaves a much-increased burden on the back of government through grants and subsidies– a back that is close to being broken from debt. While clean technology development is absolutely necessary, technology development takes time and, often, a long time. And technology development is fraught with uncertainty…nobody ever knows a priori whether such efforts will be successful and how long they will take. Believe me…every venture fund in the world would love to be able to know that! But they don’t. However, virtually every venture fund and researcher will tell you that significant advances usually take much more time and more money than expected. In an environment of relatively low fossil fuel prices with high price volatility, grants and subsidies for an amount of time and at a level that will make any permanent and meaningful difference are simply unsustainable. So, for all the focus on “cleantech stimulus” the most important thing that government can do is to affect change in the cost of the fossil fuel alternatives.

If we had higher fossil fuel prices or even just clearer visibility and certainty about future increases, the free market would make dramatic increases in investment in clean technology. When the free market sees an opportunity to make a profit, it moves extremely fast. Government actions that put in motion increases in the cost of fossil fuel alternatives, even if those increases are phased in over many years, can have an enormous impact on the money invested by the private sector in alternatives (and a corresponding decrease in need for government subsidies and grants). This, in turn, will further accelerate technology advances, leading to a more rapid convergence of the time when various technologies can competitively reach the mass market.

Given the reality that fossil fuels are a finite resource, it is a fait accompli that eventually alternative energy and energy efficiency technologies will become so compelling that they will dominate the market. But the future of fossil fuel prices in the relatively near term (e.g., the next decade or two) is far from certain as both general economic conditions and new discoveries such as those in Venezuela’s Orinoco Belt play a role. If we didn’t care about global warming, national security or economic security, there would be little need to do anything but let the market take its course. Unfortunately, irrespective of your personal policy hot button, most of us would agree that we do not have the luxury of the amount of time that this transition would likely take on its own.

The government has a role to ensure that externalities that are important to the public are accounted for in the market. But the government cannot subsidize our way there nor simply mandate that the market use a specific technology. Should it be surprising that the U.S. government “mandated” that 100 million gallons of cellulosic ethanol be produced this year and the EPA estimates that only 6.5 million will be produced? The government sank $150M into Range Fuels’ cellulosic ethanol plant expecting it to produce over 10 million gallons, but Range will only produce about 2.5 million gallons this year. How silly is it to try to “mandate” use of biofuels – did we not learn anything from the economic demise of the Soviet Union about government controlled economies? If oil had remained at over $100/barrel since 2008, I would suggest to you that biofuels production would be much higher this year without any government mandate.

The government does need to take action and do so in a way that does not crush our economy. There are important societal externalities associated with continued use of fossil fuels that are not accurately reflected in the price of the commodities in the market. Cap and trade is the right debate to be having… albeit likely the wrong solution. More on that in my next post.

Thursday, January 14, 2010

Will 2010 Be the Year of Cleantech Revenues, IPOs and, Maybe, Even Profits?

As a “gearhead” (engineer) I must admit I truly enjoy looking at all the cool technologies being developed by cleantech companies. The promise of cleantech hinges, in part, on these innovations. So it is not surprising that so much focus in the blogosphere and the press is given to the funding and development of these new technologies. Much like the dot-com buzz in the mid-90s, today we celebrate the amazing innovations that are taking seed.

But for cleantech to avoid the fate of synfuels of the ‘70s or that of many of the early dot-coms, we must create real companies that generate revenue, margins and profit. In a tough economic climate some cleantech companies are showing such success. Demand energy management companies EnerNoc and Comverge had exceptional growth in 2009, and EnerNoc turned the corner to positive net income (see data below). Both are early venture funded cleantech success stories. LED manufacturer Cree continued its exciting revenue and profit growth. And while finances of the much more numerous privately held cleantech companies are typically held close to the vest, I can say that our own LED lighting portfolio company, TerraLux, not only had exceptional revenue growth but also showed its first period of positive cash flow.

2010 has the potential to be a breakout year for certain categories of cleantech. The IPO market is heating up and this could be the year where we see our first significant wave of cleantech IPOs. A123 blazed a trail with its successful IPO during the tough 2009 market. In 2010 we could see the IPOs of Tesla Motors (electric vehicles), Silver Spring Networks (smart grid), Solyndra (solar), Codexis (biofuels), as well as others. If we see a string of successful IPOs, momentum for cleantech venture investing should experience further pick-up, and we should see increased interest from institutions willing to back venture capital funds.

All of this plays out for 2010 to potentially be a big year for real cleantech businesses – those with exciting revenue growth, IPOs and, yes, some even with profits.

One major variable in the 2010 forecast: Legislation around cap and trade will undoubtedly be a hotly discussed item this year. The passage of any legislation that has the impact of increasing the price of fossil-based energy sources will provide additional market momentum and increase the ability of cleantech companies to compete in the open marketplace. Even if the provisions of such legislation do not go into effect for several years, I suspect the market will begin to react to the pending changes fairly rapidly. But more on this next time.

EnerNoc

Comverge

Cree

(Financial Data from Google Finance)