Venture Capital and Climate Change: Limitations and Potential

The Intersection of Technology and Global Politics

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COP26 and the Private Sector's Role in Climate Action

The COP26 conference held in Glasgow this month successfully prevented a major crisis, but also highlighted the essential contribution of the private sector in addressing climate change. Beyond several key political achievements concerning methane emissions and renewed economic collaboration, it was the new pledges from businesses that potentially offer the greatest hope.

Early Venture Capital in Clean Technology

In 2006, Al Gore’s documentary “An Inconvenient Truth” spurred approximately $25 billion in venture capital investments into clean technology, primarily focusing on solar and ethanol. However, despite initial investor confidence, a significant portion of this funding was lost within a few years.

Consequently, many venture capital firms largely avoided clean tech investments for over a decade.

Optimism and Realism Regarding Venture Capital

Building upon the lessons learned from the initial wave of clean tech investment, there is a natural sense of optimism regarding the potential of venture capital to finance and expand innovative clean technology solutions.

As the world increasingly depends on the swift implementation of clean tech to combat climate change, and following the outcomes of COP26, it is vital to assess both the capabilities and the constraints of venture capital.

Understanding VC's Potential

• VC funding can accelerate the development of crucial technologies.
• It’s important to acknowledge the limitations of VC as a sole solution.
• A comprehensive approach is needed to effectively address climate change.

Successfully navigating the challenges of climate change requires a nuanced understanding of the role venture capital can play.

The Advantages of Venture Capital

The venture capital model, when functioning optimally, empowers nascent businesses to embrace risk in emerging technologies and champion innovation in ways that established corporations often cannot. It may seem paradoxical, but venture-funded startups frequently exceed the expenditures of larger, more financially stable organizations – beyond the impact of their exceptional founders and teams.

For a period of ten years, Tesla, while still in its early stages, surpassed Volkswagen, Ford, and other traditional automotive manufacturers in investment and ingenuity concerning the engineering, design, and production of electric vehicles (EVs). Likewise, companies like Joby Aviation and Lilium are demonstrating superior progress compared to Boeing and Airbus in the development of electric vertical takeoff (eVTOL) aircraft, and QuantumScape is at the forefront of next-generation solid-state battery technology.

Short-Term Focus Hinders Large Companies

Chief Executive Officers (CEOs) of large corporations, constrained by short-term objectives, prioritize incremental growth and cost reduction, alongside other “market-driven” necessities. This often prevents them from accepting the risks inherent in the development and commercialization of groundbreaking innovations. Despite numerous historical examples illustrating the impact of disruption, leadership within established companies remains lacking.

Consequently, opportunities continue to emerge where extended timelines, substantial risks, and a dearth of leadership are uniquely suited to venture capital investment. A notable illustration is the continued existence of such opportunities in the electrification of transportation, even two decades after Tesla’s emergence. For example, as the EV revolution gains momentum, the necessity of recycling EVs and their batteries is becoming paramount for sustained growth; Redwood Materials, a startup, currently holds a leading position in this developing battery recycling sector.

VC’s Role in Disrupting Legacy Industries

Venture investors are uniquely positioned to accelerate climate-positive disruption across numerous established industries. Consider the chemical and manufacturing sectors. Incumbent companies in these and other resource-intensive industries are typically slow to respond and lack the agility to effectively address disruption.

Venture capital is facilitating the development of technologies that will compel these companies to adapt, such as sustainable hydrocarbon sourcing through the use of renewable energy to separate hydrogen from water and carbon from air, ultimately creating the chemicals currently derived from coal, oil, and gas. Companies such as Electric Hydrogen and Twelve are actively pursuing this approach.

Funding Experimental Technologies

Venture capital is also ideally suited to finance experimental technologies, notably fusion energy. With minimal involvement from governmental entities, there are virtually no established companies in this field. The absence of adjacent businesses willing to capitalize on the opportunity leaves the sector reliant on startups.

This year, several startups, including Helion Energy and Commonwealth Fusion Systems, have each secured over $500 million in investment capital.

The Limitations of Venture Capital in Addressing Climate Change

While optimism regarding our potential impact is warranted, it’s crucial to acknowledge that technology, and specifically venture funding, represents just one component in tackling climate change. Achieving the necessary acceleration of clean tech solutions demands a pace that venture capital, as a sector, isn’t optimally structured to facilitate.

The Scale of Capital Required

Substantial capital deployment is essential, exceeding current VC levels, and must be directed towards established solar, wind, and storage technologies. This is particularly vital in nations with less stable currencies and elevated financing expenses, contrasting with the favorable capital access enjoyed in the United States.

Our assessments indicate that over $30 trillion – more than 10% of global investable capital – needs to be allocated over the next decade, targeting returns of only a few percent. Without this, the widespread adoption of clean infrastructure will lag, hindering our ability to counteract the escalating effects of climate change.

Reallocating Existing Capital

Currently, significant capital remains invested in bonds yielding returns lower than those achievable in renewables. A key challenge of this decade involves incentivizing other financial sectors to redirect these funds, especially within emerging markets experiencing rapid growth in demand for power, transportation, materials, and food.

Venture capital, with its emphasis on high returns and limited capital scale, will have a minimal influence on this critical infrastructure challenge and the associated opportunities.

The Role of Impact Investing

Some suggest impact investing as a solution. In our early stages, we often provided the sole capital for startups, granting us leverage to demand strong returns while simultaneously investing in high-impact initiatives.

However, with the influx of new funds pursuing clean tech opportunities, balancing impact and return has become increasingly difficult. Recognizing the potential conflict between high returns and substantial impact is vital.

Maintaining Value and Focus

VCs must now demonstrate unique value to justify a higher cost of capital and maintain discipline amidst the current enthusiasm. The temptation to pursue trending opportunities and prioritize mainstream technologies is strong.

From my perspective, clean tech remains ripe for groundbreaking innovation. The most effective VCs will adopt a contrarian approach, concentrating on areas that are currently unpopular and lack sufficient capital at the initial stages.

The Necessity of Government Intervention

The importance of government intervention cannot be overstated. The market isn’t compelling established players in the energy and industrial sectors to transition away from polluting, fossil fuel-based systems quickly enough.

Despite net-zero commitments and increasing shareholder accountability, government mandates are likely necessary to accelerate this transition.

Philanthropy’s Contribution

Philanthropy also plays a crucial role. I am proud to have helped launch MethaneSAT, a nonprofit dedicated to monitoring methane leaks from oil and gas operations globally using satellite imagery.

Its function as an impartial policy enforcement tool is not suited to a for-profit venture, highlighting the need for funding and support for other impactful nonprofit initiatives.

A Holistic Approach to Climate Change

Supporting iconic companies and technologies in clean tech has been a privilege. However, enabling these technologies and their associated startups is only one aspect of our fight against climate change.

We must avoid letting excitement about new technology overshadow the immense infrastructure tasks that lie ahead. A significant portion of global financial capital must focus on this area, alongside the deployment of social, political, and philanthropic resources, to ensure a stable future for generations to come.