What you don't know about energy can kill you

In order to understand investing in cleantech, you have to know energy and the energy markets. And beware, Silicon Valley: The great fortunes, wars, and economic crises of the world for 100 years were not technology-driven, they were energy-made.

Half the schools you went to were built by oil money. And the entrepreneurial spirit in this industry was born in the hardscrabble oilfields of Pennsylvania and Texas. The energy companies those entrepreneurs founded have forgotten more about technology in energy than you even know existed.

When it comes to cleantech and energy, what you don’t know can kill you.

Oil prices quietly (at least in the cleantech world) slipped below $80 last week, off some 50 percent from the highs a few months ago. And natural gas has fallen in sympathy, as it generally does. But no one’s talking about it.

It's easy to get caught up in the cleantech hype and forget that, only 10 years ago, oil prices fell by two-thirds, triggered in part by a rising supply from a decade of drilling, a nasty Asian flu, and a financial debt crisis, that time in emerging markets. Sound familiar? Oil then sank to less than $11 per barrel, less than one-thirteenth of its recent high.

And it's easy to forget that, during the half-decade following 1998, the not-yet-named cleantech investment sector hyped fuel cells, microturbines and distributed generation on the back of clean, cheap natural gas, which was the fuel of the future.

Rising commodity prices wiped 99 percent of those business cases off the map, until not a single cleantech venture investor discussed distributed generation at all. But after a short hiatus, solar and ethanol exits—on the back of some huge subsidies—came through, and cleantech boomed.

Only a couple of years ago, we as an industry debated the viability of hybrids and biofuels because of a break-even at $40 to $50 a barrel or higher (the oilman's break-even in Saudi Arabia is maybe $5 a barrel). Break-even at $40 in biofuels? Corn ethanol, maybe; cellulosic, dream on.

But the switch from methyl tertiary butyl-ether (MTBE) to ethanol came through on the policy side, and unforeseen growth in Chinese demand pushed oil prices to the stratosphere. The corn-ethanol plant owners built hundreds of plants at 5 percent of the size of an average refinery, made hay, and traded at tech multiples, only to get crushed when corn prices were driven up by (gasp!) demand. Then, higher natural gas and oil prices drove up their feedstock, fertilizer and transport costs and drove margins down.

Welcome to refining, freshmen.

It's easy to forget that the core economic value proposition for solar has the ever-present cost escalation analysis: "Lock in your power costs. Energy prices have risen x-percent per year. If they continue to do so you'll be paying 2.5-times your current power prices in 30 years." And that the solar industry quietly ignores the fact that energy prices will decline, not rise, with economic turmoil.

But the ITC and feed-in tariffs in the U.S. and Europe have come through, paying more than half the cost. And so the party goes on.

Energy is about commodity prices. Commodity prices are about cycles, supply AND demand. That demand is driven by GDP growth. In our global market, GDP growth is more interlinked than ever, making it more, not less, subject to cycles.

Alternative energy is called 'alternative' because it's the most expensive form of energy, meaning it's the swing producer, the type that will get killed in cycles (subsidies aside, of course).

The big fortunes made in cleantech investing to-date have not been made on high-risk, early-stage technology bets, but on 10- or 20-year-old technologies that were in the right place at the right time when the policies came in. Or, the low-cost manufacturers of mature, known technologies (think corn ethanol, wind developers and Chinese solar manufacturers) who moved fast when policies moved, making hordes of "that's not a venture" bets.

Disruptive technology has never been the winner.

In energy, there is no disruptive technology, only disruptive policy that makes some technologies look disruptive after the fact. In energy, the risk is in the scale-up, not the R&D, and the end application is so massive, so capital-intensive, and so utterly dependent on commodity prices, that you can't invest in it like you invest in IT.

It takes longer, 10-times as much money, and the ante-up for one project is the size of your largest fund. At scale, there is no capital-efficient strategy in energy.

But we are Silicon Valley, and we smash open gates with technology, and we know better than those energy dinosaurs in Houston, London, and Abu Dhabi. Right? They just don't get it, right? One game-changing technology can force the oil companies and power companies to their knees. "The one I've found really is new and different. This entrepreneur has discovered something new. And it can be cheaper than oil."

Be forewarned: You do not have a comparative advantage here. The oil men invented risk taking and risk management. The oil men are bigger, faster, smarter, richer, have more scientists and more entrepreneurial spirit than you, AND they know energy.

So while you develop technology to change the world, don't forget: Be humble, and learn what can be learned, because the elephant in this room floats like a butterfly and stings like a bee, and he has yet to take the field.

Neal Dikeman is a founding partner at Jane Capital Partners, a boutique merchant bank advising strategic investors and startups in cleantech. He's also the CEO of Carbonflow and founding contributor of Cleantech Blog.

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