Big news today in the state of Massachusetts, where state officials announced a plan to pour $2.2B into energy efficiency measures, including a target of tripling the number of home energy audits, etc.  On a per capita basis, at least, it would put Massachusetts ahead of any other state in the U.S.  A terrific example, a great initiative...  Great to see!  It will make Massachusetts an even more attractive region for energy efficiency startups, tech or otherwise.

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On other policy topics... I haven't spoken much about feed-in tariffs here in this column.  For one thing, the economist in me tends to favor simple tax-based solutions rather than mandates or price setting, so I've never seen FITs as particularly attractive intellectually.

But recent conversations with those in the project finance industry have been changing my mind... a bit.

If policymakers want to see big roll-outs of renewable energy technologies, project finance is a vital player.  No matter what incentive scheme is put into place, someone is going to have to pay for the project.  According to New Energy Finance's figures, clean energy "asset finance", at $92B globally, dwarfs the dollars going into venture capital, government and corporate R&D, IPOs and other public issuances, etc.  No matter how many technologies are invented and introduced to the market, unless project financiers are willing to bankroll actual steel in the ground, the new generation capacity will never be built.

As we've discussed on this site in the past, project finance is very different from venture capital and other investment asset categories.  Project financiers typically target returns much lower than what VCs target.  To make that work on a risk-reward basis, the investment must have absolute minimized risk.  This is why there is a big capital gap between the venture capitalists and the project financiers:  The VCs see their role as getting the company to a point where the technology has been successfully commercialized.  The project financiers will wait even further, however, until all details of implementation are completely understood and underwritable. So the VCs will fund only a new tech up through project #1, and the project financiers still see too much implementation risk at that point, and projects number 2, 3, and 4 have a hard time getting built built.

What kinds of risks do they care about?

• Input / supply risk
• Technology risk
• Demand risk
• Offtaker credit solvency risk
• Offtake price risk

To address the capital gap, various government policies are there to help juice the returns for investors.  Investment or production tax credits, 48C manufacturing tax credits, etc.  And there are also mandates out there such as renewable portfolio standards.  These certainly help and have their merits.  But they don't really address the above risks.  And even if the returns are enhanced through the incentives and mandates, project financiers are not used to having to assess such risks in this way.

A feed-in-tariff can directly address three of the above risks.  In most applications, the FIT is a requirement for the local utility to purchase whatever power is produced by the targeted technology, at a set price (this is obviously a simplified version of a FIT).  This means that, to a project financier assessing a FIT-driven project, the demand risk is taken care of -- the utility is required to buy the power.  The offtaker credit solvency risk is minimized, since most large utilities are very credit-worthy.  And the offtake price risk is obviously intended to be set.

I've spoken with a few project financiers who say that they are much more likely to invest in a region where there's a FIT in place, than in a region where there are tax incentives, even if the impacts on project IRRs are comparable.  The FIT just creates a lot more certainty for the investor.

Certainly FITs aren't a panacea.  Setting the price right is a challenge and prone to political inefficiency, for one.  The requirement for utilities to purchase power at such a high price also means that they'll have to pass that price along to consumers or otherwise get government support to cover the difference -- it's not a big deal when the volume of FIT-driven power purchases are low in relation to the overall generation mix, but of course the idea is to dramatically drive up that volume, so it can get costly in a hurry.  And it being a politically-driven system, when things get costly there's danger that the FIT price is reduced much sooner than expected by the market.  This crushed the solar market in Spain, and is also happening now in Germany.  It's critical, therefore, that any FIT be designed so that if there are future FIT price reductions existing projects are grandfathered in, otherwise project financiers won't perceive the policy as truly addressing the above risks for any given project.

But if policymakers want to see dramatically accelerated rollout of clean energy generation technologies, project financiers will have to be the ones supplying the lion's share of the capital required.  And if project financiers are to do this, FITs are definitely worth giving serious consideration.

Here's a link to much better thinking on the topic by the good people at NREL.

Happy new year, everyone!  If you haven't yet done the readers' prediction survey, please click here and do so, it'll take all of 30 seconds.  Lots of good responses so far...

So at midnight on the 31st, the U.S.'s $1/gallon biodiesel tax credit expired because the Senate couldn't get their act together to extend it.  Already, some biodiesel plants are shutting down, hoping for a legislative fix soon so they can restart.  But emphasis on "hoping".

My point isn't to defend subsidies or biodiesel, we've talked about those in other posts, and regular readers know my take on both is somewhat mixed.  No, my point is that if you're a lawmaker and you decide you DO want to incent the growth of an emerging industry by providing tax credits, the very WORST thing you can do is to set the timeframes short and then fail to re-up them in time.

We've talked a lot here about the project finance gap in cleantech, where traditional energy project financiers aren't willing to put money into "new" technologies.  And I put quote marks around "new", because some technologies that project finance remains leery of probably seem old hat by now to readers of this column.  But the traditional project finance model isn't designed to take on much risk at all.  And so it's tough to get project financiers to put capital into building out production capacity when the technology still is being tweaked, or when inputs aren't secure, or when demand isn't secure. 

So when someone wants to build a biodiesel plant, or a wind farm, etc., and they approach project financiers, a volatile incentive system is EXACTLY OPPOSITE of what you want if you want to encourage broad roll-out of a technology.  And yet in the U.S., Congress insists upon not only relatively short-term incentives that need to be renewed or else lapse, then they regularly fail to meet the deadlines for renewal!

Here's a chart of what such treatment of the Production Tax Credit has done to the U.S. wind industry, courtesy of the AWEA (via Cleantechnica):

Of course, the ARRA included an extension of the PTC -- for 3 years for wind, to the end of 2012.  If you're a project financier, when you're evaluating a wind project, do you have faith that Congress will re-up the incentive by that deadline so that there will be no gaps?

It's all good that we're providing loan guarantees, working on Green Energy Bank legislation, and all that.  But whether the incentives for clean technologies are to be heavy or light, the greatest sin that Congress regularly commits is to create massive instability in the market by working with relatively short timeframes (10 years is a much more appropriate timeframe for such things), and especially to have the default action be a lapse of incentives without official renewal, instead of a more reasonable design which would have a grace period where the default was to CONTINUE an incentive if Congress can't get their act together by the deadline.

Because they rarely seem to be able to do so.

Thank goodness there are almost no revenue-producing algal biodiesel producers out there to be hurt by this lapse, huh?  I kid.  But lest I be perceived as promoting one clean transportation solution over the others, let me also wrap up with this inspired piece of marketing for the Chevy Volt:

 

Enjoy!

Some random items, including some administrative housekeeping:

 

1.  If you haven't seen it, it's worth reading DOE Secretary Chu's op-ed on weatherization and all of the governmental support being thrown toward that part of energy efficiency.  Heady times for residential and commercial energy efficiency efforts.  Side note:  The Secretary of Energy is publishing his op-eds in the Huffington Post now?  Wow, this Internet thingy might actually be catching on.

 

2.  How the government "picks winners and losers" is a topic of much conversation these days, re: cleantech and otherwise.  It's especially a topic given the structure of some of the programs being used to accelerate commercialization and adoption of clean technologies -- such as the DOE loan guarantee program, etc.  See, for example, this interesting editorial in the Washington Post that a colleague pointed out to me today, and the very good discussion we had on the PE Hub panel on the topic here in Boston this week (note: link may disappear behind subscriber wall soon).  It's tough, though, to come up with strong alternative solutions to what's being done.  There are gaps that need to be specifically addressed, especially at the seed / very early stage (where ARPA-E is intended to aim) and at the "first of a kind" project finance stage (which is where the loan guarantee is intended to aim).  There isn't enough funding to support every deserving effort, nor would we necessarily want that (define "deserving"?).  I've seen proposals to do it more hands-off, by having the money go in some form to private sector investors who would make the decisions, perhaps as matching funds to provide leveraged returns for private LPs in the fund, to fix the risk v. reward imbalance that created the capital gap.  Some of these ideas have merit, but even then some government body needs to be determining which funds would receive the leveraging support and which wouldn't.    Broader market-based systems (including cap and trade, carbon taxes, ITCs, PTCs, etc.) are more diffuse in impact and harder to target at specific capital gaps.  And doing nothing is not an option.  So I'll let the debate go on, but my feeling is that you simply have to design the best policy you can, hope the DOE can attract the best decision-makers that they can (and I've seen some really smart people go into the DOE over the past year or so), and accept a necessarily imperfect process.  Easy to say, hard to stomach. 

 

3.  Speaking of policy issues, a few days back I wrote about a study which examined coal-fired generators in the U.S. and concluded that there could be a relatively low natural limit on carbon prices under a cap and trade scheme.  I mentioned a few gaps I saw in the analysis, and for you wonks out there like me, a reader wrote in and pointed out another important one:  Elasticity of demand means that some of the costs on the generators will be passed downstream, so that they would require higher carbon prices than indicated in the study before making the decision that shutting down is worth it.  Of course, generators would also be able to pass some of the costs upstream as well, in all likelihood.  It's still a very intriguing study conceptually, but between failure to address elasticities of demand in the electricity value chain, and the other factors I mentioned in the post, I'm not sure I would want to do any significant investment planning around the specific price limits they indicate.

 

4.  An administrative note:  Over the 4+ years of writing this column, I've attempted (not always successfully) to hew to the most rigorous of blogosphere rules regarding notification of self-interest, in that I've tried to note whenever I've mentioned a company in which I have some stake in their success.  But in my current position that's becoming impossible, due to the breadth of indirect investment activities involved.  I can't reveal self-interest in many cases without possibly revealing some fund's confidential information, and I can't mention some companies and not others because then the occasional obvious failure to mention a deal becomes an indicator by itself.  So my choices are either to never mention any companies at all ever again, or simply to ask you all to trust me that I won't too horribly pump up a company or fund where I have a significant self-interest, without noting that.  I may still mention self-interest sometimes if I can, but not always.  Is that okay?  Tough call, and I've wrestled with it for a while.  Flames, suggestions, etc. are all welcomed in the comments or via email.

 

5.  Another administrative note:  Yes, I know I'm horribly behind on listing deals that get announced in the sector.  Apologies, but still, no one seems to have complained yet.  Maybe I can stop that practice?  Or maybe a smart Sloan student reader wants to help me with it?

Okay, so maybe I jokingly tried to start an "ARPA-E" chant at Obama's MIT speech on Friday, simply because I thought it might be the only crowd ever wonky enough to get it.

But acronymical joking aside, it's a potentially valuable DOE program that could end up helping one of the major capital gaps that's emerging in cleantech venture capital:  Seed stage and early stage development of ideas that are promising but will take too long to commercialize than most VCs can handle.

So it's great to see the news release today with $151M of grants to 37 efforts.  Including:

• Sadoway's liquid-metal batteries
• Low-cost LED crystals
• 1366's "mono-equivalent silicon" wafers
• FloDesign's smaller-format wind turbines
• Foro Energy's drilling technology
• And several direct sunlight-to-fuels efforts

On a completely different note, I recently re-read an old 2000 article (I can't find a direct link, but you can access it through this site) from Environmental Finance back in April 2000, where the authors (Byron Swift and Aldyen Donnelly) argued that there's enough inefficient coal-fired generation out there in the U.S. that under a cap-and-trade system there will be a natural limit on CO2 credit prices at around $5-7/ton.  I'm interested in reader reactions, critiques, corrections, etc., please email or use the comments to share with alll...

Swift and Donnelly simply look at the implied financial worth of the generating assets of companies like AEP, Southern Company, and Cinergy (remember, this was from 2000), and then divide that by their CO2 emissions in terms of earnings per ton of CO2.  And therefore, they argue, if you're AEP and you can make more money by shutting down an inefficient plant and selling the avoided emissions, you would do so, and that would be triggered at around the $5-7/ton level.  They also looked at it from another perspective -- market capitalization for each of the companies, estimating how much of that was attributable to the fossil fuel generation fleet, and then dividing by emissions to get a value for perpetual stream of carbon allowances (discounted). Both methods came out with about the same value.

Now, what they don't account for, as far as I can tell, are three crucial additional factors:  1) the shut-down costs associated with mothballing a generation facility to sell off the avoided emissions; b) the incremental cost of replacing that generation capacity with something else with much lower carbon impact, such as gas-fired generation (although they acknowledge this as an open question); and c) short-term volatility as separate from long-term average prices -- it's tougher to shutter a generation plant because of temporarily-high carbon prices, so there could certainly be significant price spikes above the limits Swift and Donnelly indicate. 

But I find it a fascinating analysis, given the policy discussions going on right now (which include possible hard caps on carbon credit prices under a cap-and-trade plan), in that it suggests there may be a lower natural price limit than many expect.  There's definitely precedent from elsewhere in the electricity business for electricity customers to curtail their demand and sell the capacity back to the utility -- see EnerNOC, or in an early example, Kaiser Aluminum (note: pdf). Why couldn't some power plants shut down and re-sell their credits for greater profit?  Whether you love or hate the idea as an electricity consumer, it does open up a new business dimension for anyone in the powergen industry to consider...

Curious to get readers' thoughts.

Had the honor of being invited to Obama's speech at MIT today.  Thanks to the Clean Economy Network and the Renewable Energy Business Network, we were able to bring 50 local green businesspeople to the event (thanks, CEN!).  You can read the transcript here and some coverage here.

The President got a few demonstrations of technology MIT researchers are working on, before giving the speech, and then he spoke for 15 minutes or so to an auditorium full of 750 students, green entrepreneurs, researchers, cleantech investors, politicians, and other key stakeholders. 

A few points from his speech that particularly stuck out for me (paraphrasing):

• Energy tech innovators and entrepreneurs are this generation's pioneers.  Pioneers made this country great -- they expanded our boundaries, took us to the skies and to the moon.  Now energy tech pioneers are expanding our horizons in a new direction.

• There is a global race going on among countries vying to be the hubs of the next great energy technologies, and the country that wins this race will be the global economic giant of the 21st century.

• Energy is a security issue as much as it's an environmental issue.  The Department of Defense has said that reliance upon foreign oil endangers American security.

• We're going to need to use all domestic sources of energy we can find.  So we also need to find efficient ways of using our coal, oil and natural gas resources, not just solar and wind et al. 

I put up some pics on Flickr, for those interested.  It was great to see so many strong cleantech entrepreneurs and innovators in one place (fantastic networking, I might add).

Whether you're "fer" or "ag'in" the individual in your political persuasions, it was great to see someone in that high office have such a strong commitment to seeing cleantech continue to grow and thrive, and with a broad perspective on what cleantech means.

You may or may not have heard of the World Resources Institute before, but for anyone interested in environmental data, green business best practices, and policy analysis, it's a hugely valuable institution. Of course, I'm a bit biased, having had the privilege of starting my career there.  But I was reminded again of the value of WRI's work at a breakfast meeting here in Boston yesterday, where Jonathan Lash -- WRI's President -- gave a terrific presentation covering the top environmental stories to watch in 2009.  You can read and see some of the presentation here. A few points from the talk really stuck out for me: 1.  Climate change effects are being seen and felt even more rapidly than had been expected, emissions are growing faster than expected, and temperature changes are accelerating.  Taken together, these trends reaffirm that the situation is much more alarming than most public debate and news reporting would have us believe.  Jonathan pointed out that the significant effects already being felt are all the result of only 0.8 degrees C in temperature increase so far -- and even if we perform herculean efforts and achieve all our most aggressive goals for addressing climate change, expectations are that temperatures will rise another 3x or so before leveling off.  That's a best case.  And it's frightening enough by itself.  There's a reckoning coming, in other words, and our choices are about how best to manage it -- will we suffer a "climate crash", or do can we mobilize and do our best to contain the damage?  Remember this basic fact, when the Senate starts debating climate change legislation, and the inevitable horse-trading and watering-down start happening... 2.  Speaking of that, we've talked a bit here about some likely scenarios for climate change legislation in the Senate (and Jonathan mentioned that in the House, Waxman has promised to get legislation out of his committee by Memorial Day), and the importance of this being a "purple" legislation, to try to get to 60 votes.  I think it'll be important to provide carve-outs for emissions offsets from energy efficiency and international imports (ala Clean Development Mechanism projects under the Kyoto process), to try to get some of the southern senators on board...  But Jonathan points out that there is a "Gang of 16" Democratic senators who also have expressed reservations about climate change legislation (and they tend to come from the states where coal-based electricity dominates the supply mix).  Winning them over will also require some creative bargaining as well, likely around funding for "Clean Coal" for example.  Getting to 60 on any kind of aggressive climate change regulation is therefore a daunting task.  In my opinion, entrepreneurs and investors should hope for the best, but plan for a likely weak outcome... 3.  The stimulus bill had a number of great programs in it, from a cleantech and green jobs perspective.  One thing to note, however, is that while the DOE was given something like $40B to spend, it'll be an organizational challenge for the Department to get that disbursed productively and quickly.  After all, the DOE has historically been very slow at putting money out the door -- 24 months after Congress approved a major loan guarantee program to help build biofuel and other facilities, for example, not one dollar has been paid out.  Steve Chu and his team seem very committed to changing this... But it will still require a major change.  This dovetails with anecdotal evidence I keep hearing from across various states, where federal, state and local energy program managers know they're getting a big slug of money for "shovel-ready" infrastructure projects and energy efficiency programs, etc... but have no idea when, or what they're going to be able to do, much less how to put the money out there.  It's a great thing to see all these efforts getting ramped up, but entrepreneurs and investors need to recognize and plan around a likely slow process for getting money out of these programs. 4.  Jonathan talked about a pretty interesting use of advanced technology for monitoring illegal logging and then, in conjunction with a revison of the Lacey Act to allow prosecutions of mills that take in illegal wood.  It's an interesting development for the forestry industry.  But even more important from my perspective is the demonstration of how advanced monitoring technologies will be increasingly enabling more effective environmental regulations in the future.  For a great example on a completely different set of environmental issues, see Planet Hazard, a potentially powerful tool -- it allows easy access to Toxic Release Inventory data for air emissions in your hometown (if you live in the U.S., of course).  Take a look at the major emitters in your area, and think about what your neighbors might think about that information.  Technology innovations and smart regulations can be very effective together, and information itself can be a really powerful tool.  We need a TRI for carbon emissions... Those were just some of the important take-aways for me from Jonathan's talk.  WRI tracks a tremendous amount of environmental data from around the world, and does a lot of really innovative work to develop innovative policies, to work with the private sector on key issues, and to address environmental challenges all over the world.  Innovative efforts like the Global Impact Fund, an internal venture fund to develop new programmatic activities, help the organization stay at the forefront of policy and engagement efforts.  Their publications are great educational resources as well.  So I encourage readers to check them out. . .

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.