The world has undergone significant change since 2010 — and even since 2016 when the Paris Agreement came into existence. In this installment of my energy investment thesis, I’m taking a closer look at the energy transition. If you want to catch up, start with my intro, take a look at how the changes in oil prices impacted my thinking throughout the past decade, and review my take on unconventional oil and gas. Consider these critical elements and how they work within the greater picture to determine how my investment thesis has grown over the last few years. Where would you put your money?
Thesis #3: The Energy Transition
As cited before, I am a firm believer in Warren Buffet’s investment methodology as written in his 1996 letter to his shareholders: “If you aren’t willing to own a
stock for ten years, don’t even think about owning it for ten minutes.” As a (corporate) venture capitalist, we invest using a theoretical 10-year investment horizon. My SURGE investment funds work like a traditional VC model whereby each fund has a 10-year life with the ability to extend for one or multiple years. If the energy transition itself was an investment/startup, the last 10 years have been that recurring nightmare that I show up to work without any clothes. Question: is the CVC the court jester of the corporation? Too many metaphors: court jester, no clothes, not funny.
In 2010, the energy transition primarily being run out of California lacked momentum around its key stakeholders: society, investors, governments, customers, and entrepreneurs. Cleantech investors and entrepreneurs who were interested in building a new energy world apart from the oil and gas and utility industries were winding down due to a lack of support from regulators and poor economics. The cleantech accelerators were closing shop. Many startups were unable to raise initial seed funding, could not get their hands on growth capital, and became part of the walking dead. While many lessons were learned including never investing in this space again, it was unclear whether the dots were connected that there will be no energy transition without the existing energy industry that has spent over 100 years understanding it. Know thy enemy, right Sun Tzu? (I am damaged and live in analogies, metaphors, bad movie references, and in this case, (de)motivational quotes).
By 2011, the funds allocated towards cleantech investments started to plummet. According to an MIT study conducted in 2016, venture capital firms lost more than $10 billion on cleantech ventures leading up to 2011. This was the huge disconnect. There were entrepreneurs that still wanted to change the energy system. And there was a growing generation that desired to live in a cleaner world. However, there was a lack of capital, millennials, while being billed as many things including digitally dependent and environmentally supportive, lacked the authority to do anything about it, and the energy industry itself was never truly involved and seen a public enemy #1.
At the same time, an energy transition primarily based from within started to take shape as renewed corporate interest from the industry, deregulation of energy markets, and subsidized infrastructure projects added new fuel. In 2010, there was hope and excitement building. The US utility space had inspirational leaders like David Crane, who started a renewable business and launched EvGo, a fast-charging EV network, inside of NRG. The Texas energy market led the roll-out of smart meters (the important technology to enable localized/distributed energy markets) followed quickly by other markets as regulators encouraged/supported this capital investment.
While Houston was already swarming as the unconventional oil & gas revolution was kicking into gear, it was also the home of the deregulated electricity industry in the US as many of its largest players are located here. It was not hard to find a large installed base of experts that understood both industries. And most importantly, the largest trading houses of oil, natural gas, and electric power from both physical and financial players were also located in Houston (and traders know more about these markets than anyone else). Houston was booming with “energy” (oil & gas, power, traders) customers, experts, investors, and entrepreneurs.
The only position of credibility for an early-stage energy fund was to hang out in Houston and focus on “energy technology” and listen to the industry itself as it explained the largest problems. It wasn’t about “clean energy technology.” It was about the ability to generate energy that was affordable, abundant, reliable, and clean as long as it didn’t disrupt affordable, abundant, and reliable. We all still need to charge our iPhones, Teslas, iPads, and keep the temperature at 70 degrees Fahrenheit. What about the 16% (~1.2B) of the world that does not have access to electricity? Complicated. The energy solution required all sources: oil, gas, and renewables. Houston understood this.
The only thing missing in Houston was the technology entrepreneurs and knowledgeable technology investors. And this is why we started SURGE and one of the reasons why it was so successful at that time. There were no more Cleantech 1.0 funds nor accelerators for entrepreneurs to raise funds. And while Houston had deep expertise in private equity to fund oil & gas projects, oilfield service companies, wind development, and retail electricity providers, it lacked a technology venture capital ecosystem.
SURGE was incredibly well-received when we launched our first program in 2011. We invested in oil & gas focused technology entrepreneurs, energy trading entrepreneurs, smart grid entrepreneurs, and many other entrepreneurs offering new ideas that cut across the entire value chain. We worked closely with all of the largest customers across the value chain. The mantra at the time was that the world needed Affordable, Abundant, and Reliable energy… and Clean if it was sustainable over the long-term (sorry for being repetitious but this is important).
Caution: while we were optimistic at the momentum and excitement in 2011, we also knew that this was still a hypothesis and experiment. Very few could have imagined how the next few years would play out…
The 2016 Situation
By 2016, oil prices reached its lowest levels sending Houston into the nuclear winter… David Crane was fired from NRG representing a retreat for the industry as a whole. Investors did not believe in his direction and I have described this social responsibility before. The Texas market and most markets in the US also stopped innovating after the smart meter roll-out. Why, unlike being paid to roll-out smart meters and pass the costs along to you and me, new investments into renewables, distributed energy resources, localized energy markets, etc…would only compete against a utility’s revenue model. And the big energy startups were still part of 1.0: Tendril, EnerNoc, Bloom, BrightSource to name a few. New energy startups were not showing the growth we expected. 2016 was a tough year and a reminder of why the larger SURGE fund was too early.
At the same time, in April of 2016, 195 countries signed the Paris Agreement outlining goals to reduce greenhouse gas emissions. The Paris Agreement seeks to hold the increase in the global average temperature to well below 2 °C above pre-industrial levels and to pursue efforts to limit the temperature increase to 1.5 °C above pre-industrial levels. This led to the 20/20/20 targets:
- Reduce carbon dioxide emissions by 20%
- Increase renewable energy’s share of the market to 20%
- Create a 20% increase in energy efficiency
While inspirational, the agreement was too early to make a sizable bet on expected future free cash flows. And many of us were also bruised and kicked to the curb like our compadres on the West Coast. This is hard…
While the Paris Agreement seeks to ultimately decrease global warming impact (and, overall, create a better foundation for renewable energy), unfortunately, the world simply is not on track to meet those goals. Look it up. No fake news here. This means a number of key things for investors and entrepreneurs alike.
Oil and gas will remain the intermediate energy source. Chances are, it will take a decade(s) or more to reach a point where oil and gas are no longer necessary. Even after that, they may serve a significant role. This means that oil and gas needs to be improved to meet the world’s energy demands due to increasing regulatory pressure to make operations lower-emission and ultimately carbon neutral. You can read more about the underlying hypothesis in my previous note.
Within the oil and gas industry, operators are seeing significant pressure to increase commitment towards climate control. This includes independent operators. Per the IEA, methane emissions from energy (largely oil and gas development) are the second-largest source of human-caused potent greenhouse gas output. The only bigger source is agriculture.
In 2010, funding for startups existed almost exclusively outside of the industry leaders and customers. Today, corporations have taken over the leadership role in funding new energy startups. The energy industry itself is starting to embrace and pour capital into new advances which is a sign that returns can be generated in clean.
Take a look at some of these important advances:
- Shell has chosen to focus on sourcing energy from multiple sources, from burning natural gas — which Shell notes as the cleanest-burning hydrocarbon — to using wind and solar energy to help advance energy production in a renewable manner.
- Enel, which is Europe’s biggest energy network, has already decreased energy emissions considerably. 48% of its power production is emissions-free. By 2021, Enel hopes to have 62% emission-free power generation. Along with that goal, the company continues to seek out new green energy technologies.
- Engie maintains a strong commitment to renewable energy, including a commitment to doubling its installed renewable energy generating capacity by 2025. The company uses wind energy, solar energy, and biomass-generated energy to provide clean, green energy to many of its users.
- Total’s renewable energy ambition focuses heavily on solar energy generation. The company also continues to invest in wind and hydraulics in an effort to diversify clean energy investments.
- Duke Energy doesn’t just provide many opportunities for customers to generate their own energy through renewable sources, including credits for solar energy. It also continues to invest in renewable energy measures that are dedicated to ensuring the energy generation its customers need.
- Berkshire Hathaway Energy is developing renewable energy sources across their primarily (87%) regulated portfolio, generating returns, and being rewarded for building a moat against the competition. In BHE’s 2018 annual report, it states, “all of MidAmerican Energy’s wind-powered generating facilities in-service at December 31, 2018, are authorized to earn over their regulatory lives a fixed rate of return on equity ranging from 11.0% to 12.2%…”
These companies are examples of businesses’ social responsibility in this energy transition. However, the capital markets will ultimately decide which ones did too much and which ones didn’t do enough. Now as an investor, you must also (1) be skeptical (It is possible that the entire industry is destroying capital by investing too much, too early, not enough), (2) realize that it might be too late as prices for assets are exceeding its value (when everyone is already at the table…you may be the last sucker invited), (3) be opportunistic (as everyone leaves oil & gas, maybe its your time to jump in while prices become affordable).
As it stands now, we possibly stand on the verge of a worldwide energy crisis if you believe the assumptions outlined in my previous post. Within a few short years and without these advances, we could find ourselves scrambling for the energy needed to power homes and businesses around the world: affordable, abundant, reliable, and clean(er). It sounds like a great time to invest, right?
There is a lot of capital seeking both clean energy and a return on their cost of capital. This means that there will be winners and losers. More money and stiffer competition in clean vs. less money and more opportunity to produce extraordinary returns in traditional. You decide.
I’ve covered only 3 of the important trends that shape the all-important investment thesis: oil prices, unconventional oil & gas, and the energy transition. If you’re interested in learning more about how the energy industry’s outlook has changed over the last several years, check out the next of this series, coming soon.