Emerging Private Sector Solutions to Bridge the Clean Energy “Valley of Death”
Abstract
Over the past decade, researchers have identified two major obstacles blocking the progress of energy innovation, known as the early-stage “Technological Valley of Death” and the later-stage “Commercialization Valley of Death.” (Jenkins and Mansur 2011) This pair of barriers are common among all innovative technologies, but they are particularly critical in the energy sector. These two obstacles have resulted in major challenges for entrepreneurs to succeed in developing and scaling new clean energy technologies, even though there is a huge market need for such innovation. Historically, there are three major categories of financing solutions that could support cleantech startups — government programs, venture capital, and project finance. This paper discusses the limitations of these existing solutions in order to explore why they are not to effectively bridge the valley death over the past decade. Next, I will introduce several emerging private sector solutions that potentially could help bridge the Technological and Commercialization Valley of Death, including: 1) impact or strategic venture capital, 2) family offices and other patient, mission-driven investors, and 3) creative insurance products that de-risk new technologies in project finance. This paper uses a case study approach to explore the merits and concerns associated with these nascent financing solutions. Finally, I will conclude with key lessons learned, recommended future pathways, and suggestion for future research topics.
I. Introduction
Cleantech has historically been a very difficult area for successful innovation. It is costly to develop and test new energy technologies during initial stages, and many lab-proven technologies turn out to be extremely difficult to operate at scale. Additionally, clean energy startups have to face the uncertainty of building businesses in a commodity-driven industry with low margins and intense competition. Given these challenges, the cleantech sector suffered a major downturn recently when a wave of startups founded between 2005 and 2010 nearly all failed, even those with groundbreaking technical advancements, such as A123 and Solyndra. (Silverberg 2015)
The 2011 report “Bridging the Clean Energy Valley of Death” pointed out that there are two major obstacles block the progress of energy innovation, known as the early-stage “Technological Valley of Death” and the later-stage “Commercialization Valley of Death.” (see Figure 1) This pair of barriers is endemic to most innovative technologies yet is particularly acute in the energy sector. As a potential solution to the problem, the report provided various public policies and government programs to provide capital for clean energy entrepreneurs to meet the nation’s energy innovation imperative. Select programs include The Department of Energy’s Advanced Research Projects Agency-Energy (ARPA-E), regional clean energy innovation consortia, Clean Energy Deployment Administration (CEDA) and National Clean Energy Testbeds (N-CET). (Jenkins and Mansur 2011)
Figure 1. Illustration of the Clean Energy Valley of Death (Jenkins and Mansur 2011)
Since 2011, the “Valley of Death” problem in clean energy innovation has not seen significantly effective solutions despite various public policy efforts. Government programs, although helpful in supporting nascent energy technologies, are usually resource constrained. Federal and state level programs are not able to satisfy the large capital need from all promising clean energy startups, especially those that require heavy upfront investment to commercialize at scale. Furthermore, as a result of the Trump Administration’s preference for fossil fuels, many federal grant and investment programs to support cleantech have been reduced or eliminated. (Mooney and Mufson 2018) This change in energy policy from the Obama period has inevitably exacerbated the lack of public funding for cleantech innovation in the US.
On the private side, project finance is the most popular solution for accessing debt capital markets in the commercialization of energy technologies. Project finance model has been successfully implemented in almost all types of clean energy resources, including solar, wind, hydro, biomass, and geothermal. But project finance investors typically have very low tolerance for technological risks given the “old and boring is good” mentality. (Raikar 2018) This bias usually prevents new technologies from getting selected for assets that are project financed and presents a significant roadblock in the commercialization of cleantech. Venture capitalists, on the other hand, have high level of risk appetite and expertise to invest in early stage startups. However, traditional venture capital investments are not a good fit for clean energy innovation given long investment payoff period, capital-intensive business model, lower historical returns, and limited exit opportunities. (Gaddy, Sivaram and O’Sullivan 2016) A quick comparison of various private sector financing solutions are provided in Figure 2.
Figure 2. Private Sector Actors in the Energy Innovation Cycle (Jenkins and Mansur 2011)
As the clean energy sector evolves over the past seven years, there are several emerging private sector solutions that potentially could help bridge the Technological and Commercialization Valley of Death. Several of these new solutions will be introduced and evaluated using a case study approach. Emerging solutions discussed in this paper include: 1) impact or strategic venture capital, 2) family offices and other patient, mission-driven investors, and 3) creative insurance products that de-risk new technologies in project finance. Of note, there are other solutions to the cleantech Valley of Death, such as crowdfunding platforms and philanthropic programs, which are not the focus of this paper.
The emerging solutions to bridge the Valley of Death are important to entrepreneurs seeking funding for their cleantech ventures, especially those who have no or limited access to government funding programs. The viability of these private sector solutions is also crucial to investors pursuing opportunities in clean energy while assessing risks and competitiveness. Additionally, policy makers would also benefit from this analysis in order to plan the most effective policies to encourage private sector investments in clean energy.
II. Literature Assessment
Over the past decade, scholars have studied financing solutions for clean energy innovation from several different aspects, including university research, public policy and government programs, and venture capital investments. As mentioned hereinbefore, Jenkins and Mansur focused mainly on state and federal level government incentives and incubator programs that could help bridge the Valley of Death. (Jenkins and Mansur 2011) The report also mentioned several reasons why private investors, venture capital or private equity, are not best fit for cleantech investments. This point is anchored in the paper published by Gaddy, Sivaram and O’Sullivan in 2016, where the researchers took a data analytics approach to illustrate the unsuccessful track record of venture capital investments in cleantech. (Gaddy, Sivaram and O’Sullivan 2016) Additionally, in their 2017 report, Saha and Muro discussed the particular challenge in financing cleantech led by concentration of available capital in a few major regions, such as Silicon Valley and the Greater Boston Area. (Saha and Muro 2017)
However, in terms of the emerging solutions discussed in this paper, there is a significant lack of scholarly reports examining these new financing options. The distinction between traditional venture capital and strategic or impact venture capital within the clean energy sector is not yet well defined in existing research. Furthermore, the strategic or impact venture capital model is quite nascent. Even major players, like Breakthrough Energy Ventures, do not yet have more than three years of track record investing in clean energy startups. As a result, there is currently no credible research papers examining whether strategic or impact venture capital would be a good solution to bridge the Valley of Death.
In terms of new insurance products focused on de-risking clean energy project finance, the California Clean Energy Fund analyzed potential benefits of these insurance products as a general category under hypothetical scenarios in 2011. (California Clean Energy Fund 2011) At the time, there was very limited product offering in the insurance market focused on technical risks in energy project finance. There has not been any updated research incorporating performance data from insurance products that are available today.
As a mitigant to limited public research on the emerging solutions, I have conducted primary research with investment professionals from Breakthrough Energy Ventures, Energy Impact Partners, PRIME Impact Fund, and State Street Bank. Also, a case study approach is used in this paper to examine the benefits and limitations of each emerging solution, where information is collected through company websites, news releases, and interviews. For future research in this area, more data-oriented methods should be applied as these solutions gradually scale and accumulate relevant data.
III. Challenges with Traditional Public and Private Solutions to Clean Energy Innovation
Government Programs
As pointed out in the “Bridging the Clean Energy Valley of Death” report, government funding has historically been a major source of support behind many great American technology breakthroughs in the energy sector. As a potential solution to the Valley of Death problem, the report provided various public policies and government programs to provide capital for clean energy entrepreneurs to meet the nation’s energy innovation imperative, which include The Department of Energy’s Advanced Research Projects Agency-Energy (ARPA-E), regional clean energy innovation consortia, Clean Energy Deployment Administration (CEDA) and National Clean Energy Testbeds (N-CET). (Jenkins and Mansur 2011) These policy initiatives could be very effective in de-risking investments in early stage energy ventures and helping unlock significant private sector financing.
The biggest challenge with government sponsored programs is resource constraint. Existing federal level programs are not able to meet the large capital need from all promising clean energy startups, especially those that require heavy upfront investment to commercialize at scale. Local or state funding is available in certain states with more aggressive climate change agenda, such as California and Massachusetts; but overall state level support is quite limited based on FY2017 data. (Bipartisan Policy Center 2018) University funding could usually support initial R&D in clean energy, but once a technology is lab-ready and published, continuing support from academic institutions for commercialization would be minimal. Thus, relying on public funding to overcome the clean energy Valley of Death and facilitating the successful transition into a low-carbon economy is almost impossible.
Furthermore, as a result of the Trump Administration’s preference for fossil fuels, many federal grant and investment programs to support cleantech have been reduced or eliminated. Trump’s 2019 federal budget proposal asked Congress to appropriate $575.5 million for the Department of Energy’s Office of Energy Efficiency and Renewable Energy, a 72% drop from the previous fiscal year. Trump’s federal budget also proposed reducing research funding for fuel efficient vehicles and electric cars by 82% and funding for solar energy technology by 78%. (Mooney and Mufson 2018) In addition, the Administration proposed to eliminate the Loan Program Office at DOE, which has $41 billion in remaining loan-making capacity for clean energy and transportation projects. (Noll 2018) This change in energy policy from the Obama period has inevitably exacerbated the lack of public funding for cleantech innovation in the US.
Project Finance
Project finance is a method of financing in which the lenders to a project have either no recourse or only limited recourse to the parent company that develops or sponsors the project. As a unique model that provides transparency and targeted risk-return profiles for developers, operators, off-takers, and investors, project finance has been the most popular financing solution for commercialization of energy technologies. (Groobey, et al. 2010) Project finance model has been successfully implemented in almost all types of clean energy resources, including solar, wind, hydro, biomass, and geothermal. With various state and federal tax incentives for building renewable energy generation, project finance has enabled the most effective way to monetize these benefits through tax equity structures.
Securing project finance can prove to be a critical step in the path to commercialization given the capital intensive nature of clean energy technologies. But project finance investors typically have very low tolerance for technology risks due to the “old and boring is good” mentality among risk-averse underwriters and fixed income investors. (Raikar 2018) Project finance investors are typically seeking to avoid or mitigate technology risk by choosing proven products and established suppliers. For example, new solar panels, such as bifacial panels and frameless panels, have demonstrated higher efficiency and better aesthetic features. While startups that came up with these products are facing a hard time getting selected for large-scale projects as they lack track record of successful operations. As pointed out in the WSGR Project Finance Primer, project finance lenders almost never want to be the first to finance an unproven technology. (Groobey, et al. 2010) This risk-averse bias in project finance usually prevents nascent technologies or new vendors from getting selected, presenting a significant roadblock in the commercialization of clean energy innovation.
Additionally, project finance models work most effectively when there are long-term off-take agreements with high quality counterparties to minimize credit default risk. Power purchase agreements with utilities or large industrial and commercial buyers are most desirable as off-take contracts. Project developers and technology vendors typically have to go through extremely competitive bidding processes to win off-take contracts. Young cleantech startups are rarely able to establish close relationships with large off-takers and compete against incumbents in the open bidding processes. This industry practice has imposed additional difficulty to commercialize new energy technologies.
Venture Capital
Venture capital is the most common source of financing for early-stage technology companies. Since 1970s, the venture capital industry has seen a steadily increase in capital deployed and number of companies backed. Many established Silicon Valley venture capital firms are known for both their deep pockets and extensive networks of industry experts that portfolio companies could leverage to accelerate growth. For entrepreneurs in fast-growing sectors, such as software, biotech and consumers, venture capital seems to be the most attractive source of funding from seed stage through expansion period.
However, research has pointed out that venture capital is likely not the most suitable model for funding clean energy innovations. Between 2011 and 2016, VC cleantech investment declined by nearly 30 percent, from $7.5 billion to $5.24 billion. In addition to a lower total amount invested, the number of deals fell from 649 in 2011 to 455 in 2016. Additionally, cleantech VC investment is biased toward late-stage deals and a few technology areas, with energy efficiency, solar, and transportation attracting more than half of the funding. (Saha and Muro 2017) Overall, traditional venture capital investments are not a good fit for clean energy innovation given long investment payoff period, capital-intensive business model, lower historical returns, and limited exit opportunities. (Gaddy, Sivaram and O’Sullivan 2016)
In terms of time horizon, venture capital funds typically have term limits of 10–12 years, which implies an investment period of 3–5 years and a harvesting period of 5–7 years. (Gaddy, Sivaram and O’Sullivan 2016) Most clean energy innovations require much longer time for development and commercialization compared to other sectors that have attracted venture capital investments, such as software and consumers. The sales cycles with large scale energy technologies are also much longer given they are largely business-to-business (“B2B”) models in a highly regulated sector. As a result, it is very challenging for venture capital investors to navigate in the clean energy sector within their term constraints. Venture capital backed cleantech startups are typically pressured to achieve cash flow breakeven as soon as possible, which usually results in under-investment during the R&D phase or pivoting to more consumer facing business models.
Cleantech innovations are not ideal targets for venture capital also because of the capital intensive nature of energy businesses. Unlike internet or consumer products, most non-software cleantech innovations involve extensive R&D, complicated testing and large-scale manufacturing. In order to support a cleantech startup from development to commercialization, the investors have to consistently deploy large amount of funding. Although the average fund size for top tier venture capital firms have increased significantly in the recent years, most venture capital investors do not have the ability to participate in all follow-on rounds a cleantech startup needs, which could add up to hundreds of millions. (Gaddy, Sivaram and O’Sullivan 2016)
Furthermore, based on historical data, cleantech investments yielded substantially lower returns compared to medical or software technologies over the same investment period. After 2007, cleantech investments delivered internal rates of return (IRR) much lower than those offered by the other sectors. One particular cleantech company funded in 2010, Nest, delivered very attractive returns as it was sold to Google for $3.2 billion in 2014. But Nest’s core product is a thermostat that intelligently regulates indoor temperature to save consumers money. This IoT business model allows Nest to enjoy characteristics of software companies instead of traditional cleantech startups. (Gaddy, Sivaram and O’Sullivan 2016) The vast majority of cleantech investments failed to return capital to investors (see Figure 3).
Figure 3. Risk and Reward for Cleantech Investors Compared to Software and Medical Technologies (Gaddy, Sivaram and O’Sullivan 2016)
IV. Case Studies of Emerging Solutions to the Clean Energy “Valley of Death”
As discussed in Section II, the three major categories of financing solutions, government programs, venture capital, and project finance, all have significant challenges in supporting cleantech startups. In this section, I will introduce several emerging private sector solutions that could potentially help bridge the Technological and Commercialization Valley of Death given their unique strategies or performance metrics. These solutions including: 1) impact or strategic venture capital, 2) family offices and other patient, mission-driven investors, and 3) creative insurance products that de-risk new technologies in project finance.
Impact or Strategic Venture Capital
Case Study #1: Breakthrough Energy Ventures
Breakthrough Energy Ventures (“BEV”) is a $1 billion venture capital fund targeting breakthroughs in energy technology that can effectively fight climate change. BEV was formed by Bill Gates in 2016 and backed by a group of 21 billionaire investors, including Silicon Valley venture capitalists John Doerr and Vinod Khosla, Alibaba founder Jack Ma, Amazon founder Jeff Bezos, SoftBank founder Masayoshi Son, LinkedIn co-founder Reid Hoffman, Virgin founder Richard Branson and former New York mayor Michael Bloomberg. BEV brings together individuals with the capital, the commitment, and the relationships to navigate the exceptionally complex process of developing and deploying clean energy technologies (Fehrenbacher 2016)
The first key differentiation of BEV is its 20-year fund term. As discussed in Section II, venture capital investors with 10–12 fund terms are unlikely going to succeed in clean energy. With a 20-year term, BEV has much more time to help portfolio companies scale their technologies without the pressure to reach cash flow breakeven as soon as possible. BEV is able to allow for a much longer fund term mainly because all the limited partners in the fund are high net worth individuals who believe in the fund’s mission and have no need to return their capital within a short period of time.
Based on conversations with Carmichael Roberts, the Chief Investment Officer of BEV, the team chose a 20-year fund term because they would like to demonstrate the possibility to achieve attractive financial returns from cleantech venture capital investments while allowing the companies enough time to grow. An evergreen structure would provide more patient capital, but it would make it almost impossible to generate a comparable return profile to other venture capital investors in cleantech. Carmichael also pointed out that BEV is not concerned that startup founding teams would feel less motivated to meet product development timeline given the 20-year term, because the urgency does not come from investors, but the dire need to find climate change solutions. (Roberts 2018)
Additionally, BEV is willing to take extremely high technology risk in companies the fund invests in. In September 2018, BEV announced its investment in Commonwealth Fusion System (“CFS”), a newly formed startup company targeting to build the next-generation fusion nuclear reactor with superconducting magnets. (John 2018) CFS has established a strong technical team in collaboration with the MIT Fusion and Plasma Science Center, but fusion nuclear is still facing lots of challenges from both physics and engineering perspectives. (Chandler 2018) Most venture capital investors are not equipped with the technical expertise to evaluate a startup like CFS, and they are not willing to take such a high level of risk. In addition to CFS, BEV also invested in Zero Mass Water (capturing water from air) and CarbonCure (carbon dioxide utilization), both of which presents extremely high risks in technological advancement and commercialization. (John 2018)
Highlighted by the BEV case study, impact venture capital funds could potentially help bridge the Valley of Death because they could allow more time for the startups to develop and deploy their new energy technologies given longer terms. These patient investors have the ability to support startups from R&D through commercialization without having to return capital within a 10-year fund term. In addition, investors like BEV have higher tolerance for technology risk in nascent clean energy areas. This differentiation has made it possible for large-scale, groundbreaking technologies to be privately funded by impact venture capital funds and no longer have to rely on limited government research funding.
There are currently very limited number of impact venture capital funds like BEV, driven primarily by the lack of high net worth individuals who are willing to lock in substantial amount of capital to support clean energy technologies. However, there are additional efforts in investor education and impact advocacy done by non-profits like the PRIME Coalition. The PRIME Coalition is dedicated to mobilize charitable funding as an alternative source of capital for long-term investments in high-risk cleantech startups. The PRIME Impact Fund has a term of 15 years and a focus on early stage climate change solutions. They hope to support the startups through technology development and pass on to larger, traditional venture capital investors when the investments are relatively de-risked. (Wolfson 2018)
Case Study #2: Energy Impact Partners
Energy Impact Partners (“EIP”), a New York-based investment fund, raised $531 million in equity from utilities and $150 million in debt from the U.S. Small Business Administration to invest in technologies that could shape future of energy. As a unique strategic investment vehicle for 14 of the world’s largest utilities, EIP provides capital, operational support and customer access to startups developing a wide range of next-generation utility technologies and business models. (Energy Impact Partners 2018) According to CEO Hans Kobler, EIP invests in three types of companies: 1) what helps utilities with their core businesses, 2) what takes utilities closer to customers, and 3) distributed and disruptive energy technologies. (John, Energy Impact Partners’ $681M Fundraising, By the Numbers 2018) Figure 4 illustrates the competitive advantages EIP enjoys and what the fund could leverage to succeed in cleantech investing.
Figure 4. Energy Impact Partners Coalition Leverage
EIP is able to successfully navigate early-stage investments in the clean energy sector primarily because their unique strategic partnerships with utilities. In addition to funding, the utility partners could also provide sourcing channels, technical expertise and direct customer access to support EIP’s portfolio companies. (Energy Impact Partners 2018) For example, EIP invested in Opus One Solutions, a software engineering and solutions company with the vision of a connected distributed energy network. As an early step to commercialize its cutting-edge technology, Opus One launched a distributed service platform as a pilot program in New York with National Grid, one of EIP’s utility partners. This is a very effective way to support early stage cleantech companies to overcome the challenges in scaling their products. (John, National Grid and Opus One Launch a Distributed Service Platform Test for New York REV 2016)
Another advantage EIP enjoys as a cleantech investor is that the fund focuses on a very well defined range of industry verticals for venture capital investments. EIP’s key focus areas include distributed energy, grid intelligence, integrated resources planning, EV charging, microgrids, energy efficiency, and utility customer connectivity. (Energy Impact Partners 2018) Compared to most venture capital funds that take a generalist approach, EIP is able to concentrate their research efforts and develop strong sector expertise in these key focus areas. This investment style could help EIP evaluate clean energy startups within target verticals more accurately given deep understanding of the technologies and markets.
The EIP case study has demonstrated that close partnerships with key industry players and well-defined sector focus could help strategic venture capital investors to succeed. Backed by large utilities or major energy companies, these strategic venture capital funds are well-funded and tech-savvy, which allows them to provide sufficient capital and technical support to portfolio companies. In terms of commercialization, the industry partners could serve as direct customer channels for cleantech startups to pilot their technologies. This collaborative investment model has great potential in helping bridge the Valley of Death.
Although EIP is currently the only venture capital fund that invests in early stage cleantech startups on behalf of large utilities, there are several major oil and gas companies that have also taken a strategic venture capital approach to support innovation. For example, Shell Venture’s investment focus includes oil & gas technologies, renewable energy deployment, and electrification of the transportation sector. Shell Ventures led a $31 million investment in Ample, a startup providing a rapidly deployable and widely accessible platform that delivers a full charge to any electric car in minutes. (Ample 2018)
Family Office and Other Patient, Mission-Drive Investors
Case Study #3: Treehouse Investments
Treehouse Investments, LLC (“Treehouse”) is a privately owned fund dedicated to supporting long-term sustainable and scalable solutions that address some of the most critical global challenges. For each investment, Treehouse considers whether the company: 1) reduces greenhouse gas emissions, 2) empowers women, and 3) catalyzes a shift of capital to sustainable industries and business models. (Treehouse Investments 2017) Investment managers that serve multiple limited partners usually have to pre-define an investment mandate and act accordingly to fulfill their fiduciary duty over the commitment period. As a single family office, Treehouse has significantly more flexibility in terms of investment criteria and capital allocation as they only have to report to one stakeholder. As a result, Treehouse represents a unique category of mission-driven, patient investors who are willing to support clean energy innovations.
Unlike traditional investors, Treehouse believes that all investments have social and environmental impacts and these must be evaluated and considered in equal measure with financial risk and return. (Treehouse Investments 2017) This investment philosophy enables Treehouse to support clean energy startups even though they have historically demonstrated lower returns than other technology sectors such as software and biotech. The mission-driven investment approach also requires Treehouse to specifically evaluate the environmental impact each clean energy project would be able to create. By actively measuring and monitoring impact, Treehouse has utilized a new investment management framework that could help indirectly reduce technology and commercialization risks.
In mid-2000s, Treehouse chose wind energy as their first step moving into the clean energy investing from their original business in real estate. The family soon realized that renewable energy technologies are extremely complicated and wind farm ownership presents a high barrier to entry. According to Raoul Slavin Juliá, the Director of Treehouse, due diligence for wind projects resembles that of industrial real estate, but clean-power plants often require a different sort of financial and regulatory sophistication. (Eckhouse 2018) However, Treehouse is uniquely positioned as a single family office to represent the most patient type of investors without any pressure to return capital fast.
Treehouse was given the opportunity to gradually educate themselves about clean energy investments. The team started as a minority investor in wind projects to understand how the technology works; then, they participated in an auction for a wind farm that is already operating to access the financials. Next, Treehouse decided to invest in a project finance deal as the lead investor who is responsible for evaluating technology and credit risks. Finally, the team was ready to participate in all aspects of development, operations and financing of wind farms. This educational, trial and error process took Treehouse almost a decade, which is likely beyond the time horizon most fund investors are looking for. (Eckhouse 2018)
Treehouse is a successful case because the family office has a clear mission-driven investment approach as well as extremely long-term investment horizon. Family offices or other patient investors, such as endowments or foundations, could consider taking the same approach to participate in clean energy investing, even though they have no prior experience in this sector. Treehouse has proved that it is possible to step out of their comfort zone and break into a very complicated area of investments involving technological, financial and regulatory challenges with the right step-by-step learning process.
Creative Insurance Products that De-risk New Technologies in Project Finance
Case Study #4: ArgoGlobal Clean Energy Risk Solutions
Argo International Holdings Ltd. (“ArgoGlobal”), a member of Argo Group, specializes in underwriting property, marine, energy, and specialty liability insurance through Syndicate 1200. (ArgoGlobal 2017) ArgoGlobal recently formed a dedicated team of underwriters, technicians and risk management professionals to support the product development and global distribution of clean energy technology performance risk solutions. (ArgoGlobal 2018) There are several types of clean energy products that are covered by the ArgoGlobal clean energy risk solutions, such as solar panel performance, solar project/system performance, fuel cell system performance, energy storage performance, and bioconversion system performance. (ArgoGlobal 2018)
Each type of technology selected for a project would be assigned an expected performance yield, and ArgoGlobal will indemnify losses if any of the insured perils causes the actual yield to fall below insured level. The insured perils may cover extensive clouding, component performance and availability, project design losses, and specific operations and maintenance related losses. The indemnification is calculated based on pre-agreed fixed dollar per kWh rate. Figure 5 lists key elements and coverage of a sample bio-conversion plant performance cover case study. (ArgoGlobal 2018)
Figure 5. Bio-Conversion Plant Performance Output Insurance Sample (ArgoGlobal 2018)
Historically, project finance investors have to bear both vendor technology risk and off-taker credit default risk, which results in relatively high cost of capital for renewable energy development to be financed. ArgoGlobal’s clean energy risk solutions offer an innovative insurance product that could backstop performance of new clean energy technologies so that project finance investors are guaranteed a certain level of cash flow payments from project power generation. This insurance package is effectively taking performance risk away from project finance. (Raikar 2018) As a result, project finance investors who have the “old and boring is good” mentality would be more willing to choose nascent technologies.
Clean energy is a niche within the insurance sector, and products like the ArgoGlobal clean energy risk solutions are currently quite rare. However, as early as 2011, the California Clean Energy Fund (“CalCEF”) has already discussed the importance of insurance as a key way to stimulate investments in early stage clean technologies. These instruments would provide investors reassurance for cost recovery if a new technology’s commercial deployment performs below expectations. According to CalCEF, insurance products and policy solutions that could reduce the cost of developing energy projects using new technologies by 10–20%. (California Clean Energy Fund 2011)
ArgoGlobal is able to successfully offer the clean energy risk solutions mainly because the company has established a team of experts who have been assessing green technology risks for a combined 50+ years and have underwritten a combined more than 35 GW of clean energy performance risks since 2009. (ArgoGlobal 2018) Without deep sector expertise, clean energy insurance products would be extremely challenging to structure and price properly, especially because there is a significant lack of benchmark products in the current market. If the ArgoGlobal clean energy risk solutions prove to be successful, we might see other clean energy insurance products becoming available for project finance investors.
Additionally, there are many different factors that could impact clean energy project performance, such as weather conditions, installation quality, and operational efficacy. The underwriter has to accurately evaluate each of these contributing factors in order to set reasonable premiums for various insurance products. Prior to ArgoGlobal clean energy risk solutions, there have already been other insurance products that focus on weather risks associated with renewable energy generation assets. Weather risks are highly uncorrelated with other market security risks, which is attractive to investors who would like to diversify their exposure. However, ArgoGlobal is trying to insure fundamental technology risks, which are much harder to structure and sell.
V. Limitations of the New Solutions
I have discussed three main categories of emerging solutions to help bridge the clean energy Valley of Death. The case studies included hereinbefore have demonstrated recent success with these nascent solutions and key lessons learned from each category. However, there are also several limitations and uncertainties worthy of note.
First, there is a significant lack of track record with all of these solutions in terms of success rate, financial returns, or environmental impact. These solutions are all relatively new and unique. We have very limited data available to evaluate any of them in a systemic way. For example, although BEV takes a venture capital investment approach, there is no other cleantech venture capital fund with a 20-year fund term that could be benchmarked against. And ArgoGlobal is the first insurance product that covers all aspects of technology risks in clean energy project finance, which makes its pricing and performance difficult to be measured and compared to. It would take many more years for the emerging solutions in each of the three categories to establish successful track record data for more systemic and quantitative analyses.
Second, given these solutions are quite new, some of the investors or underwriters may not have sufficient sector expertise to fully evaluate the risks and returns associated with cleantech innovations. As demonstrated by the massive failures within cleantech venture capital in the 2000s, it is extremely hard to develop sector expertise in clean energy given high technical barrier to entry, low margin business models, and complex regulatory environment. For example, the Treehouse team has to spend eight years learning how wind farm projects work step by step, from technology selection to land permitting. If other companies or investment funds would like to follow any of the successful case studies discussed in Section III and establish similar solutions, it is uncertain whether they are all able to develop necessary expertise to succeed.
Last, it is very concerning whether any of these solutions are scalable enough to bridge the clean energy Valley of Death and help us meet the need for the successful transition into a low-carbon economy. For example, EIP is set up for success because the fund is backed by 14 of the largest utilities worldwide; however, it is unlikely that there will be more than a couple of funds similar to EIP given the very limited number of strategic partners within the power and utility space globally. BEV is also not quite scalable beyond the $1 billion commitment, mainly because it is nearly impossible to find a different group of 21 billionaires who can allocate so much capital for an impact venture fund dedicated to solving climate change. Without the ability to fully scale these solutions and mobilize capital to support new clean energy technologies, it would be very difficult to solve the Valley of Death problem.
VI. Conclusion
Technological and commercialization Valley of Death have caused major problems for entrepreneurs to succeed in developing and scaling new clean energy technologies. Based on historical track record and current market conditions, we have concluded that traditional ways of supporting clean energy innovation — government programs, venture capital and project finance — are not sufficient to bridge the clean energy Valley of Death. We have turn to new solutions that have emerged over the past couple of years to support cleantech innovations.
With longer fund terms, higher risk tolerance and more impact-driven investment mandates, impact or strategic venture capital could overcome the weaknesses of traditional venture capital investments and succeed in cleantech. Family offices and other patient, mission-driven investors would also be able to participate in clean energy financing as long as they are willing to dedicate time and resources to develop sector expertise and establish industry network. Additionally, creative insurance products have the potential to de-risk deployment of new clean energy technologies in order to attract more institutional investors and reduce the cost of capital for clean energy project finance.
This paper used a case study approach to demonstrate existing success with each of these emerging solutions to bridge the clean energy Valley of Death. However, there are also limitations and uncertainties that we have to recognize. There is a significant lack of performance track record to systematically evaluate these solutions. It is also uncertain whether the underwriters and investors all have necessary sector expertise to execute on these new ideas. Additionally, we are not sure whether any of these solutions are scalable enough to support the successful transition into a low-carbon economy.
Of note, there are several other emerging solutions that could help bridge the clean energy Valley of Death, such as crowdfunding platforms, ESG investing funds and venture philanthropy (or social venture capital). There are successful case studies supporting the implementation of these additional solutions. Even though they are not the focus of this paper, they could be potential topics of discussion in future research on this topic.
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