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Energy and resources are not a game of invention, they are a game of infrastructure. - Scott Jacobs, Generate Capital
- Where is the bottleneck in scaling sustainable energy and resources?
- So if there is enough capital and enough technology, why has the bottleneck around project development persisted?
- What are the success stories in scaling renewable infrastructure?
Where is the bottleneck in scaling sustainable energy and resources?
In its “Roadmap to 2050” analysis, IRENA estimates that to put the world on track with the objectives of the Paris Agreement, cumulative investment in renewable energy infrastructure needs to reach $27 trillion in the 2016-2050 period.
Achieving this would imply almost 2x growth ($662 billion / year) from the amount of planned annual investment in renewables infrastructure.
This squares with the napkin math done in this analysis by Lacuna Sustainable Investments, which estimated an annual spending need of around $420b in infrastructure spending vs. current spending levels that are just over half of that.
With this scope, our assumption is that any project without ambitions to deploy €10b+ in renewable and/or sustainable infrastructure is sub-scale.
The deficit is not due to lack of technology or capital interested in supporting sustainable infrastructure. Instead, the most serious bottleneck is at the Project Development phase of the supply chain.
The “barbelled” funding flows to different parts of the supply chain also highlight this breakdown.
- At one end, technology companies seem to be relatively well funded thanks to efforts like Breakthrough Energy, the growth of climate focused funds, and the interest from traditional VCs.
- At the other end of the barbell are the owners and operators of mature projects. This is the domain of large-scale asset managers like Brookfield Renewable Partners, a $30B fund that buys and holds assets like solar and wind farms that have already been developed and have long-term cash flows under contract.
These two ends of the barbell consumed nearly 80% of all private capital allocated to renewable energy in 2020.
Building on Lacuna’s analysis, James Edwards highlighted the challenges faced by today’s “new industrialists”:
If solar panels are today’s oil wells, then Sunrun and First Solar are today’s Standard Oil. But the state of venture capital in Silicon Valley in 2020 is such that I would find it easier to raise $10M for an idea-stage moonshot than $1M for a new industrial startup, even if the latter offered a higher risk-adjusted return both financially and in terms of climate impact.
Generate Capital founder Scott Jacobs makes a similar argument:
The business model of solving climate change is an infrastructure business model — it is about projects.
So if there is enough capital and enough technology, why has the bottleneck around project development persisted?
- Project Size.Traditional project financiers are comfortable developing large projects (say $300m+), which makes sense for conventional infrastructure like coal plants or transmission lines. But their model doesn’t work for the highest leverage projects — namely, the deployment of distributed technologies that are best at delivering the most compelling, affordable, and reliable energy and resources to customers.
- Fragmented “ground game”. Development assets require very careful, specialized underwriting which usually calls for educating oneself on local laws, grid considerations, permitting, regulatory environment, subsidies, labor markets, etc. Cookie-cutter approaches usually fail as each situation tends to be different than the last.
- Supply chain specialization. The divergent areas of expertise, capital bases, and time horizons across the infrastructure supply chain have forced most firms to specialize. Few project developers have the capacity to truly underwrite new technology, no early stage technology investor has the incentives or experience to go from technology to project to mature asset operation, etc.
Effectively, the transaction and coordination costs are too high to account for the risk and return profile of these projects. Few companies have found scale advantages and most strategies are capital constrained, creating a challenging discovery problem for large financiers hoping to deploy significant capital.
The factors above are limiters on capital coming into project development from the large asset manager side of the market (Brookfield, etc.).
On the other side, the lack of perceived “venture scale” upside and economic profile limits risk capital from participating. There is a perception that companies at that phase lack proprietary technology and also lack compounding advantages (ex. network effects).
What are the success stories in scaling renewable infrastructure?
Some companies, most notably NextEra, have shown that the limitations can be overcome.
The incumbent new industrial company is NextEra. NextEra is the world’s largest producer of wind and solar energy. It didn’t get there through network effects but rather through superior execution and capital allocation. As its scale and reputation grew, it became the developer and asset owner of choice for utility scale renewable energy projects, and its sheer size and financial strength now enable it to take on larger and more complex projects than its competitors, feeding a flywheel of growth. At the time of writing, its market cap is $157 billion.
If you look at NextEra, they were a utility / project developer that rode the backs of two major waves (deregulation and renewables) to crush the competition. It is likely that there are going to be tech-enabled developers that ride the wave of batteries, which are really hard for traditional developers to underwrite and do generate increasing returns to scale as a result of better access to DR markets with the more load you manage and better data to inform trading operations.
Generate Capital provides an example of another approach, going full stack on the renewables supply chain.
- Deep understanding of the technology allowing for both better risk assessment and advantaged project productivity.
- Capacity to own and operate the project over the lifecycle, thus exerting operational controls and allowing for flexibility if new technologies or approaches can be implemented.
- Holding company / permanent capital structure minimizing structural limitations.
Compared to half a billion dollars, many of the projects Generate looks at are half a million dollars. We’re set up to build, own, operate, and finance those smaller-scale assets which traditional financiers are incapable of financing or operating. It’s a simple math problem. Low-risk projects deliver low returns, which means low revenues. But these investors have expensive bankers, lawyers, investment professionals, and accountants - in other words, high transaction costs. Low revenue, high cost sounds like a low margin business which needs to do a lot of volume to make money. For smaller-scale assets, we’ve reduced those transaction costs in order to deliver a compelling economic proposition to our customers. We built the whole business for small projects, because we know that’s where infrastructure is going, because we know that’s what the customer wants or needs.
A conclusion to draw from above is that we are unlikely to move the needle on root problems in energy and resources if we only focus on the R&D / technology phase of the value chain.
Instead, the highest leverage point in the value chain is more likely around project development — winning the cost of capital game to accelerate the pace of renewable deployment.
Doing this means a firm/company must have a holistic view and deep expertise across the entire renewables supply chain — ranging from scientific discovery to technology company development, to project building and financing, to long term asset operations.
If executed well, these capabilities feed off of one another — similar to full stack approaches in other markets.
Rough set of questions and jumping off points around getting involved at the infrastructure level..
- What ways can a company generate cost of capital advantage to scale supply (shortening cycle time) in advance of at-scale deployment?
- Leveraged to compounding demand tailwinds (divergent view on “what won’t change”?, where is there deep structural undersupply or capital mismatch?)
- Upstream → scientific/technological insight driving faster/better/cheaper buildout
- Downstream → demand channels / early buyers / operational capacity
- Long time scales and small margins
- Where does platform potential come from?
- Where is the best jumping off point in terms of generating ecosystem control?
- Where should “full stack” stop? Does the approach need to encompass the entire supply chain or focus on specific elements?
- “Big capital, big corporate, big government” (coordination problem)
- How does the value of data compound in such a fragmented market, either in the direction of better operations and risk modeling or in insight generation for developing technology companies?
- What kinds of companies or projects might fall within the scope of such a project? Infrastructure / Natural Capital (Project Development)
- Renewable energy (solar, storage, microgrids, HVAC, fuel cells)
- Sustainable mobility (EV, charging infrastructure, fleets)
- Waste, water, agriculture (food waste, water treatment, regenerative farmland, desalination)