The previous highpoint for venture capital investment in energy technologies in 2008 was led by renewables. notably solar. It is now transportation that is getting all the attention, mostly electric vehicles. Shutterstock photo.
Venture capital investment in energy technologies is flourishing
This article was published by the International Energy Agency on Sept. 5, 2018.
Investments are leading indicators of the direction of change in the energy sector. This is particularly true for investments in innovation and digitalization, so-called “intangible assets” that will shape the technologies for supplying and using energy in the decades to come.
Across the economy, investments in long-lasting intangible assets – including software, R&D, data, management efficiency, branding – are growing and will be among the biggest sources of future productivity.
In Europe, intangible investments are rising as a share of GDP, while those in more traditional, tangible capital assets are declining. In the United States, intangibles are already in the lead according to some estimates.
The International Energy Agency brings together the best global data on energy investments in its World Energy Investment report and Tracking Clean Energy Progress web platform, including investments in innovation.
Innovative energy technologies will be crucial to tackling environmental problems associated with energy use, as well as reducing consumer costs and increasing prosperity around the world.
Both the public and private sectors play central roles in driving energy innovation, with private money flowing to new commercial opportunities, supported by government-backed markets that provide direction to innovative activities and government investment in novel, risky technology areas.
To deliver the goals agreed by the 23 country signatories (plus the European Commission) of Mission Innovation, understanding the trends in the spending and the strategies of the private sector will be vital.
Electric mobility is leading an energy venture capital boom
The latest data on investments in start-ups from i3 shows a booming venture capital sector globally for energy technologies. Venture capital investors provide capital to multiple small companies with new ideas about how to deploy energy technologies, often combining technologies in novel ways in the hope of disrupting existing markets and delivering huge returns within five years if one of them is successful.
While venture capital generally does not fund the underlying research, it is a good indicator of where people think there is scope for new technologies to meet customers’ unsatisfied needs and unseat the existing energy order.
Venture capital investment in energy technologies is flourishing, with more money flowing in 2018 than in the first two quarters of any previous year.
But whereas the previous highpoint in 2008 was led by renewables – notably solar – it is now transportation that is getting all the attention, mostly electric vehicles. To complete the switch from supply-side to demand-side technologies, funding for energy efficiency (especially related to connected-buildings technology) has been higher than for renewables so far in 2018.
As we have previously noted, several factors underpin this trend.
First, innovation in clean energy hardware and venture capital are often not well matched. The timeframe needed to establish the viability of energy projects can be too long, the capital requirements for technology demonstration too high and the consumer value too low.
Although there is a much more established market for solar panels today, compared to 2008, there is a still a serious need to deliver better renewable technologies to the market.
Secondly, while the upswing of investments is striking, the total number of deals was actually falling until this year, when it saw an 18 per cent increase compared to the first half of 2017.
What has changed is the willingness of investors – especially in Asia – to place a small number of very large bets on electric vehicle companies, which represent the hottest part of the market today.
Energy is still far from joining the ranks of biotechnology and software as a hundred-billion-dollar venture capital market. However, by combining spillovers from rapid digital technology advances with expectations of revolution in the transport system, it is currently in a growth phase.
If consumers respond favourably, some of these digital and mobility ideas could be deployed at scales of millions of units relatively quickly; at such a scale new generations would be developed each year and performance improved dramatically.
But is unclear whether the excitement around, for example, batteries for electric mobility could stimulate venture capital investment in electricity storage for the grid or whether venture capital will play a significant role in energy supply technology development.
Markets for stored electricity are not poised to deliver such high returns in the near term and venture capital is not usually patient.
Changes and new entrants in corporate energy innovation strategy
Corporate venture capital can take a slightly more long-term view, but still more short-term than traditional corporate R&D programmes. High levels of technological uncertainty in today’s energy sector, coupled with rising competition between firms in different regions and, increasingly, different sectors, support a shift in the patterns of corporate innovation funding.
We estimate that global corporate spending on energy R&D grew 3 per cent in 2017, to USD 88 billion, but is still lower than it was in 2014, before the oil price slumped.
Over recent decades, these budgets have become less centralized and more integrated with product development in individual business units. Many major companies devote no more than one-tenth to one-third of their total R&D budgets to new technologies, with the bulk of spending going to incremental improvements of existing technologies.
Given the high expectations for fundamental changes in the energy system and uncertainty about the timing and technologies involved, firms are trying to make their research budgets work as hard as possible.
Digitalization, in particular, enables companies to place more small bets on emerging technologies and to be open to changing direction quickly. New technologies for software and digital-based products have shorter innovation cycles and can be brought to the market quicker.
They require less investment and fewer consumables, and they can be prototyped more quickly and tested in a variety of environments simultaneously and do not need costly manufacturing facilities or value chains to be deployed.
The result can be a lower unit cost of innovation. But it also opens energy companies up to competition from firms with core competences in information and communication technologies (ICT).
In 2017, total investment in energy technology start-ups by corporations – i.e. companies primarily engaged in making and selling non-financial products – reached USD 6.1 billion.
This was a big increase compared to 2016, and was driven largely by investments by ICT companies alongside more traditional energy sector companies, including oil and gas and utilities and automakers.
As with energy venture capital in general, the overall trend underpinned by several very large deals, especially in Asia. Notable deals in 2017 included Tencent and Baidu’s investments in Tesla, NIO and WM Motors; Intel’s investment in Volocoptor electric helicopters; Qualcomm’s investment in CargoX truck logistics; and China Mobile’s investment in Ninebot electric scooters.
In some cases, the entry of firms from sectors such as ICT into parts of the energy industry is forcing companies to change their perceptions of who they should consider their competitors to be.
There are several reasons large established companies provide capital to early-stage technology companies. They might see it as a good investment on a purely financial basis, but more commonly it is seen as an investment in learning about a technology, acquiring human capital, and building a relationship with the technology owner that would smooth the path to licensing or buying the technology if it is successful.
In general, this approach is used with technologies that are currently outside the core competence of the corporate investor but that could add significant value to existing businesses if the market developed in that direction.
Given the value of innovation to many large energy companies, corporate venture capital (CVC) finance and even growth equity (a type of private equity investment) can cost less and involve less risk than developing a technology in-house.
It can also shield the developers from the strict evaluations placed on internal R&D projects housed in existing business units. For a start-up company, a CVC investor can provide access to expertise and customers that can give it a better chance of maturing quickly.
Among oil and gas companies, a noticeable recent trend is a shift away from technology areas that complement their existing infrastructure – such as bioenergy, CCUS and fossil fuel supply technologies – and towards technologies that could complement their broader capabilities or let them explore new business areas.
Utilities have also increased their funding of energy technology start-ups. Worldwide, they spent a record USD 0.7 billion in 2017, surpassing the previous high of 2013 and the tail end of the clean tech boom.
Solar power, electricity storage and, to a lesser extent, smart-grid technologies have been the main focus of utility funding in recent years, but growth in 2017 was driven largely by transport technologies, which took one-half of the total, and wind power technologies, which took one-quarter.
As innovation evolves, the IEA is helping policies to adapt
A growing number of energy companies are separating the teams that are focused on innovation outside their core competences, and that could in some cases undermine their existing businesses, from the governance structures of typical corporate R&D.
Rather than having large budgets for research linked to sustaining existing businesses, these teams generally pursue a wider range of innovation management activities, often with lower capital requirements.
These activities include VC funding, internal innovation competitions, pilot testing of competing options and more strategic partnerships with firms outside their traditional sectors.
To manage risks in highly uncertain and unfamiliar technology areas, collaboration with technology suppliers, customers or across business units tends to play a larger role than in traditional corporate R&D.
Changes to the ways that new energy technologies are developed and commercialized by the private sector can require changes in the ways that governments incentivize and track innovation.
Having a strong ecosystem of research institutions and energy entrepreneurs can be more valuable than tax breaks and R&D funding for making a country attractive to a large company as a place to undertake novel projects. Absolute corporate expenditure on R&D may become less closely linked to the pace of corporate innovation in low-carbon technologies.
The need to collaborate to rapidly test and scale up ideas can reduce companies’ incentives to create and defend in-house intellectual property.
Policy makers may need to ensure that their national or regional policies also support the improvements to capital-intensive hardware solutions needed to tackle climate change. In these areas, patient government capital for higher-risk technologies could become even more vital.
The IEA takes this public policy challenge seriously and is strengthening its work on innovation around the world. For example, on 30 September 2018, we signed a Memorandum of Understanding with India on collaboration on clean energy innovation as part of our Clean Energy Transitions Programme. We are also enhancing collaboration with Brazil and other key partner countries.
Through this programme, plus our ongoing close cooperation with Mission Innovation and our leading network of Technology Collaboration Programmes, the IEA aims to support countries to have the best data and analysis on public and private sector energy R&D at their fingertips and apply international best practice in policy making.