How to finance innovations in energy technology – a disruptive view

Jeremy Biggs at Narec Capital takes a disruptive view of how to finance innovations in energy technology.

Whilst the debate on the impact of our current energy demands on climate change continues, few are able to deny that the world is facing a growing global energy crisis. As the scale of the challenge unfolds it is likely to produce a requirement for innovation on an unprecedented scale as we aspire to develop alternative sustainable energy solutions, limit our future demand requirements and reduce our reliance on centralized network monopolies. Although the requirement may be evident, many of the companies developing pioneering technologies are facing severe funding gaps as the typical venturing approach struggles to meet the challenges of this emerging sector. Thought must be given to how we can create a new, sustainable approach to funding innovative energy technologies within a structure that optimizes the risk versus reward ratio for early stage investors.

It would appear that despite the scale of the opportunity before us, investors have found it nearly impossible to pick promising technologies that match their risk and return parameters. The sector is often heavily capital-intensive, open to extreme swings in government policy and driven by the requirements of large industrial players. Venture funds typically lack both the skill and the will to invest confidently in this sector and hence choose to shy away until more predictable returns can be evidenced. Whilst some may consider this approach prudent, it is also prone to missing an immense amount of value. To extract value whilst minimizing investment risk, future venture funds must possess an in-depth understanding of the market need and commercial application for the technology, they must align themselves with multiple industrial partners to assess the market demand and implement a robust process for accelerating chosen technologies through to commercialization. Working closely with public-sector funding initiatives and integrating insurance arrangements will also provide additional layers of risk mitigation for early stage investment. The scarcity of early-stage capital means that good value investments can be found, if a venture team have the capability and domain expertise to nurture them safely through to commercialization.

For early stage venturing to happen effectively financiers can no longer sit in isolated, city-based offices pontificating on the performance of distant companies listed on spreadsheets. There is a new role to be played in leading a collaboration of entities whose sole objective is to facilitate the commercial introduction of new technologies to the market. Efforts must focus on creating an entire ecosystem for the commercialization of emerging technologies. Venture funds must understand the integral components of the target technologies’ industrial value chain, be able to assimilate and articulate the issues off each component and optimize appropriate solutions for the end client. Only by aligning its funding approach with the strategy of key industrial partners will a fund be able to make informed investment decisions, control the commercialization process and manage early exit strategies for its future portfolio companies.

Forming a collaboration of industrial partners is the key ingredient for early-stage funding success. Many venture funds in this sector have already created a partnership with a leading utility, however this normally only serves to make the fund hostage to a single-investor strategy. Similarly, some utilities have created internal corporate venture capital units, although many have struggled to realize their full potential, as venturing is not deemed a core activity of the business. Far more value can be achieved by aligning a venture fund alongside multiple industrial parties, not as investors but as interested parties. This provides the fund with a balanced view of the market and creates a broad, demand-led environment for promising technologies to be accelerated through to commercialization. The utilities benefit from being exposed to a more diversified product range and sharing early-stage adoption risk with their competitors. It also serves to stimulate the supply chain and creates exit strategies for the fund, as companies look to ‘buy in’ to the technologies in order to sell effectively to their utility clients. Most utilities will openly admit that they would prefer to buy from a large supply chain partner than an entrepreneur.

Investment risk can also be mitigated by integrating with public-sector funding initiatives and insurance arrangements. Energy and innovation are key areas for public support and as such there are many funding initiatives that can be used to ‘match’ private funding schemes, where public investment is unlocked by the provision of an element of private capital. Often these funds are underspent as the companies that apply struggle to find the private funding match. At the same time, the public sector is not necessarily incentivized to picking commercial ‘winners’ and requires experienced investors to lead the way. A fund that can work in conjunction with these initiatives can provide leverage to private capital, often on a one-for-one basis.

Understanding how a technology can impact the end-developers’ or operators’ insurance is a key element to ensuring that the technology is adopted by its intended market. By their very nature, technologies that intend to disrupt processes will often inadvertently invalidate the insurance of the underlying operation or pose significant additional cost. As an example the average cost of insurance for an offshore wind farm is 26 per cent of OPEX (operating expenditure), mainly due to the risk involved from unproven technologies and methodologies being utilized. The rising cost of project insurance is impacting the propensity of developers to adopt new technologies. Introducing insurance underwriters at an early stage will help to determine whether the technology can be insured itself and any likely impact it may have on the operators’ insurance policy. This can help to reduce insurance cost and mitigate barriers to entry for the new technology. Often insurers will require an experienced partner to help them understand the various dynamics of the technology in order to write cost-effective policies. The combination of insurance and public funding support can provide a significant risk-reduction effect for an early stage investment.

Dynamic changes in utilities’ global business models will produce substantial scope for finding attractive clean technology investments. Public policy and regulation is starting to impact the centralized generation model for utilities. The cost of maintaining centralized infrastructure breaks down as fewer customers pay to utilize the network as they move to produce their own electricity in an effort to avoid rising energy bills. Last year RWE blamed renewable energy sources and the move to decentralized generation (DG) for its lacklustre annual results. It has now adapted its business model to help customers manage and integrate renewable energy rather than invest in centralized generation. The US electric utilities industry group, Edison Electric Institute, recently identified DG as the largest disruptive threat to utilities business models and financial health as their customer base becomes more and more self-reliant. The more forward-thinking utilities are already starting to work out where they can derive future value by using their scale and access to centralized networks but will require a host of new technologies to facilitate this move, if they want to maintain a competitive advantage. Localized energy storage solutions, grid reliability technologies and community generation schemes will all be key areas of growing future demand for utilities.

Similarly, whilst solving utility problems there will be a great deal of innovation required on the consumer side. Accelerated by rocketing energy bills and an increased awareness of sustainability, more consumers are becoming motivated to change their lifestyles. Passive houses (or houses that produce net zero energy requirements) are now becoming a commercial reality. An emerging UK technology and design company have produced prefabricated houses that comply with Level 6 of the Code for Sustainable Homes as standard. With a predicted rise in household fuel bills of 40 per cent by 2030, these houses will save consumers from their reliance on energy purchased from centralized networks, whilst enabling them to benefit from the revenue streams associated with net energy production and government support mechanisms.

It is unlikely that we will rid ourselves of the requirement for fossil fuels for some time although efforts are being made to reduce consumption. BHP Billiton CEO (Andrew Mackenzie) suggested at a recent US conference that more than 70 per cent of the world’s energy will continue to come from fossil fuels until 2030. Whilst one of the world’s largest fossil fuel producers would be expected to say this, other more independent sources are predicting anywhere between 40–76 per cent. Integrating biomass alongside coal for incineration, or co-firing, is one way that large power stations such as Drax are looking to reduce their reliance on fossil fuels. However, the addition of biomass into the co-firing process is still extremely inefficient. Burning at different temperatures, differing calorific values, safe storage and logistics all impact on the cost and efficiency of power production. A new technology is now reaching commercialization that can dry both biomass and low-rank coals to produce a product that will burn at consistent temperatures, enable safe storage and reduce the logistics costs from transporting wet feedstock. This new technology can enhance the calorific value by up to 80 per cent, reduce CO2 emissions and make co-firing a more viable process for power producers to consider, thereby helping to reduce our overall consumption of fossil fuel.

Great change is upon us as the global energy industry looks to adapt its future business model to balance increasing consumer demand with more sustainable sources of power generation. Further decentralization of the grid will see utilities moving towards a service provision model as they struggle to hold onto an increasingly mobile customer base. The need for innovation to enable this change to occur is growing increasingly acute and significant investment opportunities can be harvested by those who are willing to take a different approach to standard venturing models. Leading a collaborative effort between multiple industrial partners, that are aligned but not integral to the investment manager, implementing a robust commercialization process, integrating with public-sector funding initiatives and insurance partners will be the only way to identify real opportunity and manage the inherent risk of early stage investment. Although there will be plenty of disruptive technologies to choose from, it will be a new disruptive approach to funding that will enable investors to capture the true value of this emerging sustainable energy sector.

Jeremy Biggs, CEO of Narec Capital
jbiggs@nareccapital.com020 3036 0440