The Herd Mentality: Uncertain Returns Raise Questions About the Payback for Cleantech Investment

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Using tax credits, low-interest loans and grants, the Obama Administration plans to invest more than $50 billion in electric vehicles, renewable energy and other clean technology — or “cleantech” — ventures by the end of next year, reports Bloomberg BusinessWeek magazine. Such huge, unprecedented government spending is also encouraging private capital to continue flowing into the sector, not least because many federal programs — which include rebates, grants and loan guarantees — require private matching funds. The most recent example of investor interest was Google’s announcement last week that it will spend $200 million on a transmission project to harvest electricity from wind farms off the mid-Atlantic coast. The project is expected to cost $5 billion overall.

As a result, total cleantech venture investment in North America, Europe, India and China between January and September this year was $5.7 billion, slightly up from the $5.6 billion invested in all of 2009, according to the Cleantech Group, a research and networking company.

But to what extent is today’s fast-paced investment in cleantech a victim of irrational exuberance and the herd mentality often associated with venture capitalism? Quite a lot, say experts at Wharton and in the larger investment community, who also warn that the flurry of activity is no guarantee that cleantech investment will pay off as handsomely as some predict. “There’s a danger of ‘faddishness’ as people chase what they perceive to be the next big thing,” says Eric Orts, Wharton professor of legal studies and business ethics. “There could be a lot of money chasing not as many good ideas.”

This isn’t just a concern in the U.S. China, for example, is also “priming the pump” with a host of subsidies of its own, he says. These include $15 billion for a number of electric car pilot projects, and various rebates to individual consumers when they make green purchases. According to New York Times columnist Thomas Friedman, “China Inc. just named its dream team of 16 state-owned enterprises to move China off oil and into the next industrial growth engine: electric cars.” As other countries hop on the bandwagon, Orts — who is also director of Wharton’s Initiative for Global Environmental Leadership — wonders about the relative strength of the business cases underpinning all the new cleantech investments.

‘The Dirty Stuff’

Experts also note that subsidies shouldn’t be the only way governments can support cleantech. For instance, given the widespread outrage over the Gulf of Mexico oil spill, the timing could be right for legislators to increase taxes on oil and coal. “You tax the dirty stuff so the clean stuff has an automatic pricing advantage,” says Orts. But he acknowledges the Herculean task of getting such legislation approved given upcoming mid-term elections and potentially heavy lobbying on Capitol Hill.

That doesn’t mean discussions should stop there, however, notes Lise Dondy, president of the Connecticut Clean Energy Fund, which promotes clean energy development on behalf of state utility rate payers. “This country has not taken a stand on carbon, and unless you can put a price on carbon in some way, renewables end up dependent on those subsidies,” she says. “It’s anathema to investors not to have a consistent policy over the long term.”

What’s more, she points out, “subsidies come and go.” A case in point: the federal income tax credit (of up to $2,000) that applies to 50% of an electric car charger purchase, which expires December 31. With lame-duck House and Senate sessions starting in November, it is unlikely that the tax break will be renewed, which could potentially be a heavy blow to the country’s nascent electric vehicles development.

Raffi Amit, Wharton professor of entrepreneurship, makes the point that cleantech startups — unlike, say, new Internet ventures — “require large amounts of capital before they yield a return for investors…. When fixed costs are very high, it presents a different level of risk.” Nonetheless, cleantech investments are tantalizing, he says, because “the return is enormous if some of these investments pan out. There is no doubt that we’ll be making a gradual change from fossil fuels to wind, sun and water.”

Earth, Wind, No Fire

Last year, 10% of electricity consumed in the U.S. was generated by renewable sources. The U.S. Energy Information Administration (EIA) of the Department of Energy projects that the amount will increase to 17% in the next 25 years. It also forecasts a 41% increase in U.S. non-hydro renewable electricity generation between 2008 and 2035, while installed wind energy capacity grows rapidly, more than doubling between 2008 and 2013, to around 50 gigawatts. Meanwhile, the American Solar Energy Society says that grid-connected solar power — having grown 40%, to 435 megawatts, in 2009 from the previous year — could increase between 50% and 100% this year alone.

Amid that growth, the prospect of legislation — or, failing that, new and tougher regulations — is likely to keep sustainability on the front burner for corporate America for a long while. Democratic Senator Jeff Bingaman of New Mexico, chairman of the Senate Energy and Natural Resources Committee, introduced a bill aimed at reducing utility-generated greenhouse gas in early September, which could get attention during the forthcoming lame duck session. And even without such legislation, the Environmental Protection Agency is moving ahead with regulatory measures to, for example, limit factory emissions.

The strong interest in the sector is a goad for companies to raise the profile of their green strategies and as a result, introduce a new post in the executive suite — the chief sustainability officer (CSO), according to Jason Wingard, vice dean of executive education at Wharton. Companies ranging from Alcoa to Cisco to DuPont already have CSOs focusing on, among other things, how and when to invest in cleantech. Wingard says Wharton is planning to launch a new program sometime this year for such officers, expecting demand for CSOs to grow as “more and more companies want to engage in sustainability practices and are scrambling to get people trained.”

In for the Long Run

The growing challenge for both the corporate and larger investor communities is sifting through the hype. Amid what he sees as a “herd phenomenon,” Wharton’s Amit says that “cleantech investment, with former [Vice President] Al Gore and others involved, is fashionable. You have a lot of companies zeroing in on this space because it’s politically correct. The implication is a lot of capital getting involved in a relatively small number of investment opportunities.”

And a lot of those opportunities depend on which way the wind is blowing, with capital moving into whatever people are talking about most. At the moment, that includes biofuels, says Samhitha Udupa, a cleantech analyst at Lux Research in Boston. “It’s trendy right now because everyone’s talking about the [Gulf] oil spill. A very large amount of money is being thrown at the area without much idea of how long it will take for these businesses to become commercially viable.” Some types of biofuels are still in the research phase — they need to prove themselves in the lab before they reach the level “where it makes sense to scale up to production.” But cleantech investors want returns in seven to 10 years, she says, and that won’t happen with most of these technologies.

Other biofuel ventures are just plain tricky, she notes. For example, while algae fuel is a “huge area of opportunity,” it is a particularly challenging technology to commercialize — startup costs are high, the development time is long and currently, not enough algae appropriate for biofuel use is being produced. “It will never be economically viable,” she says. “The costs are preposterous, and it will never be at parity with petroleum.”

Biofuels Digest reported in March this year that less than 25 of the 80 algae companies worldwide have demonstrated proof of concept to investors beyond the lab stage. “Few have been able to convince investors to risk placing $1 million or more to make this necessary transition [from initial production to proof of concept],” according to the magazine. “If an algae venture is not a) able to demonstrate and prove its technology works on a small scale, or b) produce more than 1,000 tons of algal biomass or at least 100 gallons of algal oil with its partners, it is unlikely investors will take serious notice.”

Advanced algae has, nonetheless, attracted prodigious private capital investment. Last year, that included a $10 million deal between BP and Maryland-based algae producer Martek Biosciences and a $600 million collaboration between ExxonMobil and Synthetic Genomics in La Jolla, Calif. Two other California startups, Solazyme and Sapphire Energy, have each received more than $100 million of investments to develop biofuels from algae.

Greg Neichin, managing director of the Cleantech Group, notes that much of the pessimism and caution around cleantech stem from “huge investments in solar and biofuels that haven’t panned out.” A few bad investments shouldn’t taint the whole sector, however. “Characterizing cleantech as one monolithic investment is pretty difficult,” Neichin says. “The capital needs of these companies are very different.” Cleantech is a big field, he adds, with diverse offerings from wind and solar to software for energy management in homes and businesses. And investments related to future energy needs and water infrastructure are very promising, he says, though “these aren’t overnight businesses.”

Meanwhile, Google isn’t expected to be the only company interested in cleantech. “Some of the world’s smartest investors,” including Microsoft chairman Bill Gates and Berkshire Hathaway CEO Warren Buffett, in addition to Google CEO Eric Schmidt, “are getting in on the ground floor of cleantech,” says Dan Becker, director of the Safe Climate Campaign, which lobbies for global warming legislation and more environmentally friendly cars in Washington, D.C. “For our planet’s and economy’s sake, I’d sure hate to bet that they’re wrong.”

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