There are two critical roles for energy efficiency in upcoming 2009 federal legislation.  But you almost never hear about them. First of all, energy efficiency is shovel-ready.  In other words, if you're looking to have an immediate impact on both green-collar jobs creation and cost-effective carbon emissions reductions, you absolutely have to include energy efficiency retrofits into the equation.  For example, look at commercial building energy efficiency retrofits:  The technology is available already; The nature of the work is service-oriented and building controls and HVAC and lighting are readily "trainable" for new recruits; and the economics often make perfect sense, if only regulatory support would help address the upfront capital cost hurdle. And yet what I hear from folks battling inside the Beltway right now is that energy efficiency support has been one of the items on the chopping block in all the Stimulus Package horsetrading.  Apparently the CBO came out with a report saying that much of the energy efficiency incentives put into the bill wouldn't have an effect until 5 years out?  I haven't had a chance to review the specifics, but I would find that hard to swallow if true. And while I'm also a big supporter of renewables, it's hard to make a case that regulatory support for solar panel manufacturing (for example) would be something that would have a 2009 jobs impact, and in fact much of that market will eventually go overseas.  I'm not arguing against support for solar panel manufacturing, we have technology leadership reasons for wanting to pursue that as well, and good green manufacturing jobs should be encouraged in any case.  But if your metric is jobs creation in 2009, it's tough to make the argument that renewables should be prioritized over energy efficiency.  And yet, apparently, that's what the pencil-pushers are doing. Secondly, energy efficiency could play a critical role in any climate change regulation that comes out. To begin with, from a "wedges" perspective we cannot afford to ignore the role energy efficiency must play in any comprehensive climate change effort.  It's not sufficient, but it sure is necessary. Also, from a timing perspective, once again energy efficiency shines versus alternatives like sequestration and renewables.  It's reductions we can do immediately, not after further waited-for innovations. Finally, and most tactically, energy efficiency based carbon offsets may be very powerful in bringing key Senators "onsides" with carbon cap-and-trade regulation.  As we all watch how critical it is to reach 60 votes in the Senate, it's important to recognize that major regions of the country consider themselves to be at a severe disadvantage in a cap-and-trade scheme, because (rightly or wrongly) they feel they lack the renewable generation potential (solar, wind, geothermal, etc.) of other regions.  Specifically, the US southeast feels disadvantaged versus the west or northeast.  It would be very easy for regional blocks to stand in the way of effective cap-and-trade regulation. But of course, one potential "resource" that the US southeast has is lots and lots of inefficient air conditioners.  It's an easily mined source of offsets to help them meet their requirements -- if energy efficiency-based offsets are included as a key source. Energy efficiency does face some technical challenges (for example, establishing accurate baselines and proving "additionality") if it's to be included effectively in any scheme.  It gets complex quickly. We'll talk another time about these complexities and possible ways to deal with them. But it's worth wrestling with these details, because otherwise it's tough to see how we get to 60.  And without that, the political efforts of a lot of people who are currently ignoring energy efficiency may be wasted anyway.

We talked about Q2 numbers a while back, but Ernst & Young's Q2 release this past week is particularly useful to look through because of the depth of data they released -- a great breakdown by stage, category, etc. with historical data.  Inclusive not only of energy, but also other cleantech sectors often ignored.  The E&Y data was worth the wait... The headline which you've probably already seen is that it was a record quarter for U.S. cleantech venture capital, at $962mm, way up from Q1 and the biggest quarter since 2002 (barely beating out Q3 2007). Of course, that's on a dollar basis.  The NUMBER of deals was big, yes, at 41, but that only puts the quarter at the 3rd most active quarter E&Y tracked since 2002.  Not fewer deals, really, but certainly bigger deals. What's driving this?  Two big trends are clear in looking through the data: 1.  Solar continues to bring in the dollars.  $487mm, or more than 50% of the quarterly total.  But only 14 out of 41 deals.  In terms of dollars, this was only the 4th biggest quarter since 2002 for non-solar cleantech deals.  It's all solar, all the time these days. 2.  Overall deal size is up.  Because E&Y very helpfully breaks out deals by stage in their analysis, we can see that "First Round" deals averaged $12mm in size, up from an average of $10mm last year...  But "Second Round" deals averaged $37mm for the second quarter in a row, hugely up from 2007's average size of $23mm.  There's evidence of deal size inflation at all stages, but it's most strongly felt in second round deals. It would be easy to look at the second point above and conclude that valuations are up.  It's only indicative, but generally speaking bigger round sizes will mean a bigger valuation. But it's unclear how much deal size inflation is being felt across the non-solar portions of the sector.  Let's compare to 2007 totals. 1.  The average deal size for a solar deal (note: inclusive of all round stages, unfortunately even E&Y doesn't break out the full crosstabs) was $35mm in Q2.  That's 45% higher than 2007's average solar deal size of $24mm. 2.  The average deal size for a non-solar deal was $17.6mm, 25% higher than 2007's average non-solar deal size of $14mm. 3.  In 1H08, 61% of cleantech deals were "Second Round" or "Later Stage", up from an already high 46% for 2007. So it's hard to argue that deal sizes are up across the rest of the sector.  While non-solar deal sizes are up, it's unclear how much of that is driven by the general shift toward later-stage investing. Solar and later-stage investing are driving the bus right now, and showing no signs of slowing down. What does the data tell us in terms of "what's next"?  Notably, energy efficiency deals and deal sizes are up in a big way.  Other than that, other sectors looked down or flat for the most part.

First of all, comes the news today (from Jonathan Shieber at VentureWire) that Element has done a first close on their latest fund at $270mm, and that it's likely they'll "fly past" their $400mm stated target. A very good example of how the sector continues to shift toward later stage: One LP (LACERS) reports that Element plans to allocate only 20% of the fund to early stage investments, with the rest going to expansion stage and later stage. They're far from alone, and this news is proof of the continued strong LP interest in the sector. Secondly, on the topic of biofuels and food prices (headline stuff these days), stay tuned for an upcoming report from New Energy Finance on the subject... As a preview, there's the following passage:

New Energy Finance has analysed food price increases between January 2004 and April 2008, breaking them down into their constituent drivers: input costs, dollar depreciation, supply-demand factors and speculative activity (see Figure 2). We conclude that increased biofuels production has been a meaningful driver of food price inflation, particularly in certain crops and geographies, but it is far from the dominant factor. Increases in input costs have played a much larger role, as have changes in consumption habits and increases in global population which, for the first time in decades, have not been offset by increases in agricultural yields, particularly in grains (see Figure 3). Furthermore, where biofuels have had significant impacts, this has been due to overly-rapid application of support schemes and protectionism, rather than to the impact of production on land use itself.

Thirdly, I thought this passage from Tim Healy's (EnerNOC) Chairman's Letter was also worth quoting:

I believe that energy is one of every company’s five basic inputs, along with land, labor, raw materials and tools. (Information Technology, the realm of the CIO, is a subset of tools.) But in most cases, energy is the only one that is not actively managed. Corporations invest time and talent in assessing and developing land; in managing and motivating labor; in forecasting and negotiating the price and supply of raw materials; and in sourcing and procuring equipment and tools. Energy hasn’t normally received a similar level of senior executive attention. For example, US corporations spent an estimated $129 billion per year on telecommunications in 2007, and all of them also invest in advanced products and services to actively manage these systems. But less than one per cent of companies make a significant investment in advanced technology to manage electricity, even though electricity spending was greater at approximately $194 billion per year.

Are the above three notes sobering? Encouraging? Readers will judge for themselves. Deals from the past few days:

• SmartSynch, a smart meter technology developer, raised $20mm in expansion funding from Credit Suisse. This follows on their $10mm insider Series D last year.

• Principle Power, a green power developer based in San Francisco, announced that they raised a $2.3mm convertible note seed round from a variety of angels including members of the Keiretsu Forum.

• CamSemi, a UK developer of energy efficient power controllers, expanded their Series C by $8mm, with BankInvest Group providing the financing.

• CrystalQ, a Dutch developer of sapphire wafers for use in white LEDs, raised an undisclosed amount of financing from Sustainable Energy Technology Fund (SET Fund), EPT / Benno Wiersma and E2 Cleantech.

• Speaking of Element Partners, they provided $29mm in financing to ECORE, a provider of products made from cork, recycled rubber and other green materials.

Cleantech investors in the news:

• Cleantech.com is reporting that Craton Equity Partners closed their debut fund at $191.5mm.

• Kurt Falhauber, who had been active in the Austin cleantech cluster as part of the Austin Clean Energy Incubator, has joined Macquarie's cleantech private equity team.

• Another brand-name cleantech venture partner: James Woolsey has joined VantagePoint, as has Dave Edwards (formerly with Morgan Stanley).

Other news and notes: Jeffries reports that the cleantech IPO backlog is starting to build... Bill Aulet has some pretty interesting thoughts about decoupling energy and water... Also worth checking out, a good interview by Neal: Marc Stuart on the REAL story of carbon offsets... For those who may have seen the VCJ's kind write-up about this blog (and its author) in the latest issue, a couple of small corrections -- no, I don't live in Connecticut and drive to Boston every day; and no, M2E Power isn't putting flashlights into cell phones, they're developing innovations to power the cell phone (and other devices) altogether. But yes, this site does lack in personality at times, it's true...  Finally, this will be fun to watch.

In the cleantech market there are a lot of very smart, worthy ideas for energy techs aimed at residential applications: energy efficiency plays, distributed generation and backup power plays, etc. It's important to remember that there are two very different markets for these kinds of applications -- new homes and retrofits. In sales to new homes, the key target customer is the builder. Installation issues are relatively lessened, costs are more easily bundled into the overall house value, and it's a single corporate sale rather than multiple individual homeowner sales. Nevertheless, the retrofit market is significantly larger and in many cases critical to the upside revenue potential for any new technology, product or service. So the retrofit market is the key. Unfortunately, in the retrofit market there are serious obstacles standing in the way of widespread adoption of even winning residential energy technologies. This fall, our family decided to switch our New England home from oil heat to natural gas heat. A low-tech decision. In this region (as well as many others), the cost of natural gas is currently less than half that of heating oil (on a $ per mmBtu basis, wholesale). And besides the economics, it also brought some benefits in terms of better heating and ability to use gas-fired appliances, etc. Someone tell Bob Catell (CEO of KeySpan Energy, our natural gas provider) to give me a call. Because just like my similar experience installing new insulation, the implementation of this change was far from easy. And that's hurting his business. First of all, the information for us to make an informed decision about our various choices wasn't there for us. We had some non-specific information self-searched from the internet, and a KeySpan-sponsored contractor who spun us with best-case economic scenarios, hadn't even heard of most of the newer innovations I asked him about, but assured us that "My guys are professionals. They're not kids. They're men." Alrighty then. And other potential contractors weren't helpful either. A chimney sweep helpfully informed us that the switch from oil to natural gas would require installing a new stainless steel chimney liner for the low price of a few thousand dollars, or suffer dire consequences. And then the KeySpan guy told us that the chimney sweep was blatantly lying, and we had to (hopefully) confirm it with other information after much additional web searching. Basically, homeowners don't have impartial, accurate, specifically useful information to turn to. Secondly, the economics were challenging. Even with some discounts from KeySpan (which also greatly limited our equipment choices), and the much lower fuel costs going forward, it was still several thousand dollars by the time all was said and done (even without a new stainless steel chimney liner) and that makes the payback period about 4 to 6 years or so. All up front cash, too. There may be financing options we could have used, but they weren't presented to us by the service providers. Thirdly, the cast of characters involved was quite long. KeySpan had to come hook up our house with gas. A contractor sold us on the job. He brought in a subcontractor ("Digger", a great guy) who actually did the installation of the new equipment and removed the old boiler. KeySpan had to then come back and hook up the pipe to the boiler. An inspector then came by and growled at Digger for a while. And then someone else had to come back and remove the oil tank. With so many players involved, planning suffered, and different perspectives meant re-directs midstream. Without ever talking to him directly, we were informed that the inspector said that we're going to have to get the chimney sweep to come clean out the boiler's flue, sign a piece of paper certifying that it's clean, fax that to the general contractor, have them cross out any disclaimers and take on liabilities that the sweep isn't willing to take on, and then get that back to the inspector. Yeesh. Finally, it was a royal pain during implementation. The research on the front end (including competitive pricing) took too much effort. Digger was here for three days, requiring one of us to be at home during the process. The whole chimney sweep issue has been frustrating to say the least. And now our home stinks of heating oil, as a result of the tank removal process. All of these problems can be pretty easily fixed. Massachusetts should be providing better incentives for this kind of retrofit -- it just makes economic sense for the state. KeySpan should be making it a lot less painful with better project management and by mandating better and more consistent processes (and really, this is a critical top-line business issue for them, they need to cannibalize the oil heat market as a first priority for growth, so it's pretty amazing it's managed this way). And some entrepreneur should be making the information and competitive pricing readily available for us to do this with a one-stop-shop approach -- and perhaps taking on even more of this challenges. But the challenges remain un-fixed. I find it hard to recommend this decision to my neighbors. And this was an example with a very well-understood technology choice with relatively well-understood economics (albeit challenging). Imagine taking on a new technology as part of this kind of process? Without any incentives in place? Without even the limited information we had available? You start to understand why energy and water techs aimed at residential applications, even those with a really compelling story to tell, face huge challenges in market adoption. And thus why it's a challenging market for venture investors to get into. The opportunity is worth investigating, but the challenges must be acknowledged, and addressed. [2/13/08 update: Wanted to make sure and include an update on the flue liner question... After the KeySpan guy said that the chimney sweep was lying, but the sweep insisted he wasn't, we spoke with a house inspector and got his take -- that indeed you do need a new liner if you're installing a high-efficiency gas-fired heater and pumping the flue gas out your old heating oil exhaust flue, because it does create acidity issues that will degrade the old liner. He said that if your new furnace is 85% or more efficient, it could be an issue. "Fortunately" it turns out that the "high-efficiency" furnace we got through KeySpan's rebate program is actually only 80% efficient. So we're supposedly safe. We will continue to monitor it, however. Also useful to note is that the inspector explained that we would be just fine with an aluminum liner, not a stainless steel or even a new clay liner, and that therefore it should only be "a few hundred bucks" and not the couple of thousand the sweep had told us. ...In all, just more fodder for the argument I made in this column at the time. rd]

This week has already seen several new deal announcements and other developments in energy-efficient lighting:

• Element Labs, a provider of LED-based products for entertainment, architecture and signage applications, has raised a $12.75mm Series B (note: link opens pdf), led by Expansion Capital Partners, who contributed $10mm of the round. Existing investor Sierra Ventures and lender Gold Hill also participated in the round.

• Meanwhile, Ceelite, another developer of LED solutions for signage and other "highlight" lighting applications, announced a $4mm round of financing, with half coming from the Musser Group and the other half from undisclosed investors.

• Orion Energy Systems, a manufacturer of energy-efficient lighting solutions for "high-bay" (ie: high-ceilinged) environments, had a very successful IPO today (although it's been drifting back down this afternoon), demonstrating the exit potential for energy efficient lighting (and overall energy efficiency) investments. (self-promotion alert: yours truly was involved in Expansion Capital's initial investment in Orion)

• Pretty busy week over at Expansion Capital -- they also announced this week that they and Advantage Capital Partners had co-led SensorTran's new $8mm round of financing (VWire reported that the first tranche of the Series B round was $5mm), with other existing investors WHEB Ventures and Stonehenge Capital also participating (self-promotion alert: yours truly served briefly as an observer on the SensorTran board during my time at Expansion Capital)

• The other cleantech deal announced this week was a $25mm Series C announced by Purfresh, the ozone-production device manufacturer formerly known as Novazone. Lots more details in this GTM article; the round included Chilton Investment Co., Foundation Capital, Grauer Capital, Chrysalix and one "strategic investor to be named."

Other news and notes: Here's an interesting attempt to track cleantech-related patent issuances... The new energy law is in the books, but not everyone's pleased... Nick Parker's Eight for 2008... Here's a well-done article linking climate change and water shortages... Finally, here's a sign of the times, regarding the polysilicon shortage.

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First-year MBA student readers -- here's the final notice of @Ventures' Summer Associate opportunity

Some light reading for those of you doing some heavy digesting this weekend (Happy Thanksgiving!): Regular readers of this site will know that we're generally big on energy efficiency and demand response, and more and more investors seem to be getting on board with these sentiments. So when we learned that a smart colleague in the field was leaving his position on the utility side, it seemed like a good opportunity to pick his brain as part of our Five Questions series... Brett Feldman recently left NSTAR after 3 years as an energy efficiency program manager to pursue another opportunity in the field. At NSTAR, he managed energy efficiency and demand response programs for commercial and industrial customers. Prior to NSTAR he was with energy consulting firms for four years and also earned his MBA. 1. What are generally the biggest business priorities for electric utilities these days? How do conservation and demand response/ negawatts rank in terms of prioritization of “mindshare??? among utility execs, in general? I only worked at one particular utility, but there are certainly commonalities no matter what the company or regulatory environment. Investor owned utilities are always responsible to their shareholders, however to best serve them. There is a lot of M&A action going on currently. Billions of dollars in Transmission and Distribution investments will be required in the next decade to upgrade an aging system. Most utilities are not proactive in promoting conservation; some may try to preempt impending regulation, while the bulk are reactionary. These days, climate change is a bigger issue for utility execs. I heard NSTAR's CFO say that the senior team watched "An Inconvenient Truth" together this year, and that type of thing never would have happened before 2007. 2. What’s your perspective on the pace of adoption of demand response (DR) and peak shifting among electric utilities? Is it too slow, too fast, or “just right???? The pace of DR adoption is slow. There are a lot of factors that come to play: rate structures that disincentive it; expensive metering requirements that need rate recovery; lack of good estimates of the benefits of DR on pricing and the T&D infrastructure; proven technologies to perform the DR: and customer education and engagement. 3. What do you think could be done, and by whom, to most effectively accelerate the roll-out of large-scale energy efficiency (EE) programs? There are many different levels of action that could be taken to accelerate EE. Many people are waiting for some kind of federal carbon regulations or trading scheme to set things in motion. Some states do not want to wait for federal action and have begun their own statewide or regional programs. Other people believe that municipalities should take the lead on the local level, and high-intensity targeted grassroots community initiatives are the best method. I believe that the private sector financial industry needs to take a closer look at the economics of energy efficiency and realize its potential for investing and lending. Returns can be high and projects can be low-risk. It's a matter of getting to a scale that is meaningful for investors. 4. What do you think could be done, and by whom, to most effectively accelerate the roll-out of demand response programs? There are two basic kinds of demand response: large commercial and industrial controls and mass market (small commercial and residential) direct load control. Both markets will require similar advances: new time-of-use (hourly or real-time pricing) rate structures that encourage DR; metering, communication, and control equipment that cost-effectively provide services; and customer education on the societal needs for and individual benefits of DR. For the large C&I market, the competitive suppliers or utilities could offer the services. For the mass market, the utility is the most likely party. 5. What’s the biggest “unmet need??? you see for electric utilities these days? Is there a missing or under-performing technology area where an entrepreneur should be focusing their efforts? Metering and communications are huge opportunities for technology advances. These are the keys in being able to measure and promote EE, DR, and distributed generation (cogeneration, solar, wind). Controls are always improving: remote energy monitoring and management, daylighting, different types of occupancy sensors. Of course any kind of more efficient end-use equipment such as lighting (LEDs), HVAC, motors, compressed air. ----------------------- Other news and notes:

• SolFocus extended their Series B/ Series A (incl. funding for a European subsidiary) by $11.6mm from an unnamed hedge fund.
• Stonybrook Water Purification took in a second, $1mm tranche of their milestoned Series A.
• Akermin, which is developing technology for the use of enzymes as replacements for precious metal catalysts (for example, for fuel cells), raised a $4.96mm insider Series A-2. Investors include Prolog Ventures, OnPoint, Chrysalix, and St. Louis Arch Angels.
• Cleantech investors in the news: VentureWire reported this week that Firelake Capital is anticipating closing a $100mm new fund in January.

Interesting commentary on the status of the ongoing silicon shortage... OPEC launching a $750mm cleantech fund?... Cleantech investing ramps up in India... Finally, it's well worth checking out Dan Primack's analysis of 4,300 venture capital "busts" since 1990.

In response to various blog ramblings by yours truly, there have been quite a few very thoughtful comments emailed to me and posted on this site over the past few weeks, and it might be good to bring up a few as useful points for discussion... Nathanael Greene, who authors one of the best environmental policy insider blogs (Switchboard), wrote in response to a recent post on the possibility of a bubble in solar:

I would be interested in your thoughts on the potential for a significant dip in one part of the cleantech world to take the steam out of the entire sector. I speculated that this would be worst case outcome of the dropping price for ethanol in this post but of course a day later there were a at least two reports that ethanol prices would rebound towards the end of next year. I would guess that entirely depends on what happens with the energy bill, but regardless it’s still an interesting question as to whether the cleantech sector is large enough and cohesive enough to rise and fall based on the fortunes of any given segment.

It's an interesting question indeed. But the answer is simply that the cleantech sector is disjointed enough, and the broader investment thesis compelling enough, that a dramatic downturn in any one sector like biofuels probably wouldn't infect investor opinions about other cleantech sectors. What drives the attractiveness of biofuels (high oil prices and favorable fuel policies) doesn't really impact the drivers for rapid adoption of solar (high electricity prices, neglected T&D, and different policies), and neither are very connected to other sectors like water tech and materials efficiency. As we've talked about here before, oil prices get all the press, but they really don't impact most clean technology markets. It sure doesn't seem like our looming natural resource shortages are going away anytime soon. At least for cleantech-specialist venture capital investors, there's probably enough recognition of the disconnects between the various cleantech subsectors that one subsector's fortunes won't overly impact the others'. But there are still some macro factors that could dampen investor interest across the board: A collapse of the U.S. and/or Chinese economies would temporarily dry up the rampant growth in demand for natural resources (and thus affect commodities pricing overall) that is at the heart of the cleantech investment thesis. And if the IPO window shuts for tech plays in general, that would probably scare off those investors who are jumping into the space late to get on that bandwagon... But the ups and downs of stock prices for publicly-traded non-cellulosic ethanol stocks probably won't impact the intentions of investors who are looking more broadly and further down the road. ...At least not THIS investor's intentions. ----- MIT's Bill Aulet wrote in response to a recent post (itself a reply to his Xconomy column) on the management challenges in cleantech:

I like your phrase that “it takes a village??? to do good energy starts up. From what we are seeing, this is the right approach and the facts you cite about syndicating deals (which seems more prevalent in energy) make sense. Let’s keep an eye on this because we need to find a solution. We all agree that it is significantly different than most other industries.

Scott Meinzen then added to the same post:

What’s notable also is that unlike in enterprise software, there is a trend that adopters of clean-technology solutions see energy and resource conservation as an issue that everyone needs to address. As a result, the people involved with implementing such solutions have (so far) been less proprietary about their choice of adopted technology. I work for a smart-water management company and many of our customers willingly become subjects of success stories and are eager to refer their solution-of-choice to others, even their competitors, in an effort to encourage the adoption of proven, demonstrable resource-saving solutions. It seems like I can’t look through a magazine without reading about XYZ Company and their “Green Manager??? that implemented ABC solution and the results that they are realizing (or failures, see BusinessWeek’s “Little Green Lies???). This may be more of a reflection on the characteristics of people that are taking on the role of “chief responsibility / sustainability officer???, but it is encouraging that, at present, companies are taking the view that “going green??? is something everyone should do and sharing / touting their efforts as opposed to viewing their actions as a competitive advantage that needs to be guarded.

----- In response to a post on the barriers to adoption of building energy efficiency and DR technologies, Paul Grover added the following:

You mention the study that indicates that people over estimate the cost of green buildings. I can’t really comment on new construction, but can for retrofits. One of the problems is that most utilities and energy companies use an “average cost per kWh??? as the measure for evaluating electricity savings. While this is convenient, it is often quite inaccurate. The amount that is inaccurate depends on the interaction of the building’s electricity use with the tariff. We’ve seen some instances where using average cost per kWh can introduce payback inaccuracies of 3x………..which is why it is necessary to model the tariff/building signature before and after the proposed retrofit. Doing so, as a regular practice, would give owners and managers of buildings far more accurate numbers upon which to make investments.

In an email exchange later, Paul reminded me of Jevons Paradox... Which may be as applicable today as it was in the time of James Watt... ----- Finally, in response to my six questions to ask in Toronto, Oliver Morton wanted to know what the answer to question #1 was... Sorry, Oliver, we'll all have to wait and find out. But the answer to question #6 was a very disappointing "No".