Tapping The Trillion Dollar Market
Most investors get excited when the market for a new enterprise reaches a billion dollars. For alternative energy sources that replace fossil fuels, potential market sizes reach into trillions - yet venture investment so far has been relatively low compared to other technologies ($1.2 billion in 2003, out of $18 billion).
That's now old news. Several weeks ago, the largest investor in the world, CalPERS, announced a new program that will start with $200 million for alternative energy-related venture funds. Investing in the area has been growing more than 8% a year. After several false starts in the late 80's and mid 90's, is now the time to invest in alternative energy?
Scaling Hubbert's Peak
Every decade, some group of scientists predicts an oil shortage. So far, thankfully they have been wrong. However, each generation of scientists becomes more sophisticated in their analyses. M. K. Hubbert (Shell Oil scientist and USGS geophysicist) used a clever calculation to incorporate economic principles. He determined the energy it takes to extract a barrel of oil and pointed out that when it takes more energy than it generates, production will cease. "Hubbert's Peak" is the point at which oil extraction costs increase enough to cause a decrease in oil production. Specifically, the peak will be defined as the first year in which production is lower than the previous year due to the costs of extraction. In the real world, this will be the time world oil prices rise, forcing alternative energy into the limelight.
In reality, the NYMEX oil futures market will cause oil prices to rise well in advance, making investment in alternative energy economic well before the peak. Venture funds are busy trying to time their investments so that they will be ready for the market when oil prices begin to rise.
Hubbert correctly predicted this peak for US oil production. For world oil production, Hubbert's own estimates placed this at around 1995, though further reserve discoveries and improved extraction technologies have extended that to 2008 by some calculations. Known reserves themselves are increasing at a decreasing rate, however, so this cannot push back the date indefinitely. Hubbert's Peak is a physical reality, but when we reach it is an issue of some debate among scientists. Among investors, the oil futures market shows a cheaper price for oil in 2010 than today, so they are clearly (in aggregate) betting that further advances will push that date out again.
Power to the People
Some factors are moving that date towards us, however. China and India's economic success will have the largest impact. One byproduct of billions of people moving out of poverty is that they want the same things you and I have: heating systems, air conditioners, cars, and refrigerators. All of these use energy, and oil continues to be among the the cheapest ways to produce it (absent environmental costs not priced in to oil). China in particular is facing power shortages this summer as a new generation of middle-class Chinese make air conditioning standard in homes. Increased demand for oil is moving Hubbert's Peak closer to us.
At the same time, technological advances in oil extraction are pushing the other direction. Investors are busy trying to sort through these factors so that the technologies they choose are ready for the market just as the oil prices begin to rise. For an increasing number, that time is now.
Geopolitics Hits Home
Even without concerns about Hubbert's Peak, the geopolitical situation is having a direct impact on oil prices today. Increased demand from China and India is leading to higher prices immediately. Iraq's oil has yet to start flowing and instability there leads to concerns in the oil market that it won't for some time to come. Those higher oil prices are spurring further investment in petroleum research, but are also making alternatives economic now. Wind power, for example, has now become inexpensive enough to compete with coal for power generation.
Finally, populations are pressuring governments to require clean technology for those plants built in their own backyards. While there are technologies that allow coal and oil to pollute less, these increase the cost of production compared to other sources. Rich countries in particular value clean environments and have been steadily expanding regulations requiring clean energy.
Make the World Cleaner; Make Lots of Money
All of these factors combined with massive amounts of capital to invest are leading VCs to expand activities in alternative energy. Last week, the CleanTech conference in San Francisco brought the billion-dollar venture funds in touch with promising new technologies. The hard-headed investors have suddenly become environmentalists; there's money to be made in saving the world.
You are right, the massive firehose of venture capital has not been pointed in the direction of alternative energy well enough. Does the world really need more enterprise software companies? It does need an alternative to fossil fuels. It would solve so many of the world's problems it is not even funny. I have personally been focusing on an area I call "software meets alternative energy", franky a VERY small piece of the pie. Most alternative energy investments are of the material science variety since that is where the greatest amount of invention is needed. But there will be software ideas. Many of them. I just need to find them.