Climate-Tech: The 0 to 1 Journey

This is the first in a series of posts about the climate-tech landscape, covering funding trends, emerging green technologies, startup success stories, innovative business models and more.

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In the 1960s, Soviet astronomer Nikolai Kardashev developed a measure of a civilisation’s level of technological advancement based on the amount of energy it is able to leverage. So, a Type 1 civilisation is able to harness all the energy available on its home planet; a Type 2 civilisation can access the energy of an entire star; and a Type 3 civilisation can capture all of the energy produced by an entire galaxy. The scale is obviously hypothetical and has been extrapolated in either direction to cover a Type 0 (harnessing just about 1MW of energy) to a Type 4 (controlling energy from the entire observable universe) and even beyond that. Humanity’s current level has been characterised as being somewhere around 0.73-0.75.

Despite recent successes in quelling, or at least advocating against, the most egregiously rampant practices in consumerism and alternatively adopting lifestyles that foster sustainability, the arc of human progress will tend towards an increase in overall energy demand for the foreseeable future as access, information, and opportunities expand beyond their usual shores. Predominantly sustenance-driven communities in developing countries— invariably at the cusp of breaking into an aspirational middle class—will gradually demand their historically denied, fair share of the energy pie, even as developed nations continue to put onerous demands on the existing energy pool while refusing to abide by their obligation to supply relevant technological and monetary resources to the developing world. As we collectively move forward from a 0.73 to a 0.8 or even Type 1 to meet our impending energy demands, capital providers and private companies, especially start-ups, will have to play an increasingly important role in making sure that this 0 to 1 journey is successful in decoupling the link between growth in the usable energy pool and an increase in environmental degradation, as has been the case since the beginning of the Industrial Age.

An earnest attempt towards this objective was made a few years ago. The mid-2000s saw a wave of VC activity in the cleantech space with a host of investors betting billions of dollars on advancements in renewable energy. Most investments went bust for a variety of reasons including:

i) Unrealistic expectations by VC investors of rapid, hockey-stick growth in technologies that usually have relatively longer gestation periods

ii) Uncertain early market demand for cleantech products and compromised margins due to difficulties in establishing product differentiation

iii) Inconsistency in policy and regulatory signals, especially in the North American markets.

Like most bubbles, however, the silver lining to the cleantech bubble was the accompanying over-investment in new infrastructure. The capital infusions at the time helped realise critical R&D breakthroughs and cost reductions propelling the sector forward today. Moreover, climate-tech, cleantech’s more mature, and wider-scoped avatar, has now reached an inflection point with more amenable risk/return profiles of concerned companies and the greater presence of economically viable, revenue generating business models. Broadly, climate-tech covers companies or innovations falling under one or more of the following major sector-agnostic functions—reduction or removal of emissions, adaptation to the impacts of climate change, and enhancement of capabilities to better understand, measure, and assess climate-related phenomena. Over the past few years, an array of tailwinds has aligned for the sector:

1. Building blocks for the technologies leading the transition have achieved impressive cost reductions. Solar PV module costs have dropped by ~90%, battery pack costs by ~90%, and LEDs by ~85% over the last decade. Further R&D is in whirlwind mode, with aggressive grants and generous provisioning of incubatory support. The late 20th century saw the axis of innovation shift “from atoms to bits’, signifying the digitalisation juggernaut. Now, the trend seems to be playing out in reverse, with a range of deep tech interventions targeting functional performance increments in physical R&D assets and solving for hardware. While deep innovations tend to have long gestation periods, and sometimes even longer go-to-market roadmaps, the rewards for perseverance are outsized with impressive moats—often backed by IP protections—and massive margins.

2. Massive government support has been catalysed for climate-friendly innovations. The FAME I and II policies, National Missions for production linked incentive (PLI) schemes for advanced chemistry cell (ACC) battery storage, solar PV modules, white goods, electronics manufacturing, and drones and drone components are broadcasting unambiguous signals regarding the Government’s inclinations. Start-ups have a head-start to prepare for the oncoming seismic shift and can accordingly reframe their value chains, and shore up their production and inventory capacities.

3. The pandemic followed by recent geopolitical upheavals on account of the Russia-Ukraine war have given a heightened sense of urgency to the demands of the transition, especially with sustained and legitimate fears around the worsening situation for energy access in Europe. Even as investments in climate progressive technologies have temporarily suffered and transition relevant minerals’ commodity prices have seen a sharp increase, these should be seen as short-term aberrations. Over the long haul, the conflict’s effect on the global energy markets should bring forward peak oil, help incrementally synthesise investments in fossil fuel alternatives and, with specific reference to India, positively influence popular opinion on building indigenous, resilient new-energy linked value chains. Previously locked pools of patient capital such as sovereign wealth funds and pension funds are also seeing a gradual uptick in activity.

4. Climate-tech is now a hot-spot for top tech talent. In a survey conducted in the US, 43% of tech workers considered a prospective company’s environmental impact to be a “very important” factor when looking at a new job. Climatebase, a talent directory for climate jobs has helped more than half a million individuals find and apply for green jobs. Stalwarts such as Bill Gates and Chris Sacca have founded climate related funds Breakthrough Energy and Lowercarbon Capital respectively. C-suite executives are also increasingly inclined to invest their energies in the climate domain; Mike Schroepfer made headlines back in March 2022 when he stepped down as CTO of Meta to focus on addressing the climate crisis.

With a host of narrative, policy, and corporate support measures, climate and sustainability are the new digital: aspects intrinsic to the very existence of an organisation, much like early ICT technologies were at the start of the millennium. As Larry Fink, the CEO of BlackRock, has suggested, the next 1,000 unicorns will not be search engines or social media companies, but sustainable, scalable companies which will help the world “decarbonise and make the energy transition affordable for all consumers.”

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Crunching numbers: Funding Matters

Global climate-tech VC funding has grown more than 4x since 2019, with venture capital infusion at over USD 70 billion for CY2022. India experienced an extraordinary increase in climate-tech funding in 2022—an uptick of nearly 10x over the previous year. (see Figure 1).

The investment split across climate-tech sub-sectors (see Table 1) reveals that mitigation-oriented innovations in energy and transportation dominate the funding landscape, making up for 60% of the deals’ volume, and nearly 80% of the cumulative value of all deals. This is in line with global trends where investments in energy storage and electric vehicles have dwarfed those in other climate-tech domains.

In terms of the number of deals, there is a strong skew towards early-stage rounds and small ticket sizes; the median deal size is about USD 2 million. In terms of value, however, a small number of Series B and later-stage rounds, accounting for less than 15% of the deals, make for more than 60% of the total equity infusion.

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Four aspects become conspicuous from the funding trends:

1. India galvanised USD 3.7 Bn in climate-tech VC funding in 2022, almost double the amount for the last five years combined. Notwithstanding the recent upsurge, India still trails the US, China, and other geographies such as Sweden, Germany, and the UK when it comes to climate-tech venture funding over the past half a decade or so. In a report by Dealroom, India was ranked ninth globally with about USD 1 billion in VC funding in climate-tech between 2016 and 2021; the ranking was topped by the US (USD 48 billion), followed by China (USD 18.6 billion). Even with 2022 being India’s best year on record, it still received considerably less in VC funding than the US (USD 28.6 billion) or China (USD 10.7 billion). India needs to quickly, and drastically, ramp up its inflows of private climate finance, especially at the early stage for it to substantially offset its emissions and mitigate the worst effects of climate change through innovation. According to an estimate by Unitus Capital and Climake, India needs more than USD 1 trillion in climate finance by the end of the decade to abide by its emissions targets for 2030 (see Figure 2). Further, there is a need for faster unlocking of patient capital comprising green bonds, pension funds, sovereign wealth funds etc.
   
   

2. There seems to be a gap in funding for start-ups in the “missing middle”—start-ups wishing to go from the first grants or pre-seed/seed rounds (~USD 30,000-65,000) to the intermediate rounds (~USD 250,000-650,000) to bring their minimum viable product to the market and acquire scale through paying customers—which is of particular significance in capital intensive sectors such as renewable power or water management. According to a report by Climate Trends, start-ups in this “missing middle” struggle to raise enough funding to manage their working capital requirements even as they look to scale on the basis of their initial prototype. Note that this is a global phenomenon with the much maligned term, “valley of death” being used to refer to this phase of inadequate funding for climate-tech startups (see Figure 3). In fact, several prominent investors have highlighted the “absence of Pilot/FOAK infrastructure funding and a dearth of Series B capital”, especially for startups with a sizeable hardware constituent.  The global funding requirement for such pilot/prototype facilities working up to create their respective first-of-a-kind(FOAK) plants has been pinned at USD 150-190 Bn, several orders of magnitude higher than what is currently available for start-ups in the space.
   

3. Sustainable mobility dominates other sectors in terms of funding. This trend holds true even if we consider a slightly longer time horizon (see Figure 4). Sustainable mobility, and the EV space in particular, has achieved a technological maturity threshold with proven products and stable revenue lines notwithstanding some recent valuation dips. It also helps that they constitute one of the few climate-tech interventions to enjoy widespread stakeholder and consumer buy-in. The resultant stability has perhaps convinced investors that this is the climate-tech sub-sector most likely to replicate the returns profile they are familiar with when dealing with technology/IT companies. This is both expected and, as mentioned earlier, in line with global trends. Going forward, India Inc. should like to catalyse similar levels of capital for deep-tech, high-capex, high-R&D companies, especially in certain “hard to abate” sub-sectors (see Figure 5). Adjacencies at the intersection of waste heat capture and industrial residue management, for instance, or innovations focusing on the built environment or improved grid management will need significant amounts of capital investment over the coming years.

4. Globally, there has been a discernible trend towards an increase in investments directed at technologies targeting energy distribution, demand control, and end-use efficiency. However, India has seen relatively muted activity in this space, arguably due to the “highly regulated and subsidised nature of the electricity retail sector.” But things are changing; India is undertaking a range of measures to gradually open up its electricity sector, provide more robust market signals for power dispatch, and make its grid more flexible and demand responsive. Recent interventions include the introduction of time-of-day (ToD) tariff, announced in June 2023 and expected to come into effect in a phased manner from April 2024. Funding patterns closely follow patenting activity; a recent publication in Nature shows that patenting activity by low-carbon energy technology startups in India has been “concentrated in the mobility sub-sector, in contrast to global trends where patenting in grid management and RES [renewable energy sources] sub-sectors is higher than that in the mobility sub-sector.”

To conclude, climate-tech is at an incredibly exciting crossroads with rapid advances in technology converging with positive policy and market shifts. The most important change, however, has come in the form of an industry-wide narrative disruption and a coterminous reorganisation of markets around climate conscious businesses. Consumer sentiment has reinforced itself to create a strong demand pull for climate conscious consumption. Investment flows are also unequivocally catalysing towards responsible and sustainable technologies, enterprises, and practices (see Figure 7). The shift marks tacit investor buy-in of what economists Gernot Wagner and Martin Weitzman wrote in their 2015 book Climate Shock, describing climate change as “almost uniquely global, uniquely long term, uniquely irreversible, and uniquely uncertain”. To add to their claim, the returns from early backing of durable, field-tested, and socially acceptable climate-tech solutions should arguably turn out to be uniquely robust.