What’s Wrong With Energy Investing? Part II

10/15/07Follow @BillAulet

I had the good fortune to receive a substantial amount of feedback on my first post on this subject a few weeks ago. The feedback was productive and helped to clarify key points and in general reinforced my conviction laid out in the Part I entry. In that article, I advanced the idea that while “we should and must invest in renewables and alternative energy for the future,” to do so to the exclusion of hydrocarbons means “we are majoring in minors.”

My point was simply that a more balanced approach to our energy investments should be pursued that focuses as well on the hydrocarbon reality we face for the foreseeable future. While we develop alternatives for the longer term, I argued, we must simultaneously invest in making hydrocarbons a cleaner, more efficient form of energy—as well as energy efficiency initiatives. “Just to put this in perspective,” I wrote, “…If we could find a way to reduce CO2 emissions from automobiles by 1 percent it would be, from a quantitative and practical point of view, thousands of times more positively impactful than increasing solar energy production by a hundred times.”

The post generated a lot of comments, but the numbers behind my argument are quite compelling in the end, so I can’t say that my view has changed. My second installment on this subject will be regarding a topic that is much harder to qualify. But I believe it is another fundamental, yet often-overlooked factor that has to be dealt with more realistically if energy investing is to succeed: our critical shortage of energy entrepreneurs. Clearly, money for energy innovation is no longer an issue, but the entrepreneurs to effectively put that capital to work will prove to be a system constraint.

People in many industries will whine and complain about how their industry is so unique and more difficult than others, and so one has to sort through this groaning to find the truth. After some close analysis, though, I have concluded that for energy, unfortunately, it is definitely true. Energy entrepreneurship is much harder than entrepreneurship in other sectors, and I believe most investors have yet to come to grips with this fact.

To explain my case, I will break the discussion down into some key points (which follow below). These are general points about energy ventures and so may not apply specifically to individual cases—but in aggregate I believe them to be true. They present a real challenge for the energy sector today and into the near future.

All Entrepreneurs Are Not Alike, or Energy Entrepreneurs Are A Rare Breed Indeed

When new industries arise (e.g., computer hardware, software, telecom, internet, wireless, medical, biotech), they have their own unique characteristics. Obviously, the technical talent required differs greatly in these industries, but so do the entrepreneurial skills required. Entrepreneurs are the change agents who commercialize the disruptive invention, and the inventor (a technologist or some sort of visionary) needs them to create a meaningful new venture. The entrepreneur is the great integrator and the propeller of the new venture.

An entrepreneur who is successful in software usually is particularly skilled at identifying market opportunities and then executing a market-pull, customer-intimate, product strategy in a rapid fashion—getting innovations to market quickly and then iterating to improve the products. These skills are clearly transferable to Web 2.0 venture creation but are not as relevant, and, in fact, may be counterproductive, in a biotech entrepreneurial venture. Biotech entrepreneurs need to have a much more methodical approach over a longer period of time than Web entrepreneurs, and they must possess a distinct ability to manage a company and a project through significant regulatory obstacles. Similarly, as I will explain further, Energy Entrepreneurship is much different than any brand of entrepreneurship we have seen to date. In fact, I would argue that being an entrepreneur in the energy arena is unquestionably the hardest form of entrepreneurship by at least one order of magnitude.

While it’s easy for me to say that energy entrepreneurship is harder than entrepreneurship in other sectors, it’s a bit presumptuous of me to estimate how much tougher it is. I do so, however, to make the point that there is a big gap between it and other fields that people are underestimating right now. Let’s look at all the attributes or dimensions of expertise that an Energy Entrepreneur needs:

1. Multi-dimensional knowledge of science and engineering disciplines. While the entrepreneur is most often not the technologist or inventor, he (note: I use “he” and “his” in the gender neutral sense) does need to understand the core scientific drivers of the market as well as the technology or science drivers behind his various product offerings. For many new Energy Ventures that could well mean possessing an understanding of aspects of chemistry, biology, engineering, biotechnology, environmental science, computer science, and production systems, to name just a few. Does that make energy entrepreneurship unique amongst technology sectors? To the magnitude that such expertise is required, yes.

2. Longer time frame. While there are exciting exceptions like EnerNOC (NASDAQ: ENOC), the time frame required for an energy company to get traction is much longer than with companies in most other sectors. Ann Winblad, the software venture capitalist, said at the recent MIT Technology Review Emerging Technologies Conference that her companies took a long time to bear fruit—an average of 6.2 years. While for Ann that may seem long, most energy companies, even poster success stories like EverGreen Solar, can only dream of such short time horizons. While the current enthusiasm for energy companies is compressing the time before they bear fruit, the historical starting point (for good reasons) is significantly greater than 10 years. Indeed, if the time required for energy companies to bear fruit could be reduced to an average of 10 years, it would be a substantial improvement (Which raises a question as to how venture capitalists with 10-15-year funds can handle energy investing, but we must keep moving and stick to the main topic…). The persistence and patience that Ann said is so difficult to find for typical software startups is a fraction of what is required for energy companies. Biotech companies are similar in this regard, but in general, energy is far outside the bounds of other sectors.

3. Bigger scope and scale from a financial standpoint. Just from a financial standpoint, a typical energy new venture requires large amounts of capital. Investors have to make significant initial bets and then be ready to follow them up with even bigger bets. While energy is not unique (biotech, telecom, and now wireless—see Helio—come to mind as similar stories), it does add another dimension of required sophistication.

4. Ability to deal with public perception and often-intense emotion. Energy is inextricably tied to controversial natural resources, public safety, and environmental issues—not to mention questions about economic impact. Part and parcel with this come public politics and emotion. Some of it is clearly justified, and some of it is not. But, as ex-football coach Bill Parcells said, “it is what it is,” and the energy entrepreneur needs to be adept at dealing with it. (See the comments on my first post for evidence of this tendency.)

5. Adroitness in governmental affairs. Energy is not just emotional—it is politically charged with a significant policy dimension. If one chases down the full value chain of energy-related products, he or she will almost always find that they are directly affected by governmental actions. This action can be regulation (such as utility rate setting in the U.S.), subsidies (e.g, U.S. or Brazil ethanol production or Germany’s solar industry) or price setting (think OPEC). This is generally something entrepreneurs (and venture capitalists) hate. It’s not unique to the energy sector: the medical and biotech arenas have similar considerations. Strong capability and comfort in dealing with government affairs relating to policy and economic issues is absolutely critical to the successful energy entrepreneur.

Any one of these factors alone adds complexity to the already challenging task an entrepreneur faces, but the challenge becomes particularly daunting when the compounding effect is considered.

Numerous Routes for Attackers in Other Fields, Not in Energy

In addition to these traits, there is another important and challenging market condition that exists in energy that is fundamentally different from other high tech industries today. It is the imperative to effectively deal with (e.g., by partnering, collaborating, or at least neutralizing) the very people you are trying to disrupt. To a much greater degree than in other sectors the existing hierarchy in energy cannot be ignored.

Entrepreneurs thrive as “attackers” armed with disruptive technologies, business models, or other ideas that they bring to bear against the “defenders”—specifically the entrenched, resource-endowed hierarchy that is being threatened. Since the demise of IBM’s monopoly (Isn’t it hard to fathom that less than 25 years ago the biggest concern IBM had was anti-trust suits because it dominated the computer market so completely?), there have been multiple options for technology-based entrepreneur-attackers to create new products and to get to market. There has not been a dependence on a real or de facto monopoly on the defender side. It has been relatively easy to bypass the defender completely, or use defenders against each other to get the disruptive innovation to market.

For example, when Lotus came up with its breakthrough 1-2-3 spreadsheet, it did NOT have to work with IBM to have it fit into IBM’s closed mainframe architecture. It could operate on the open personal computer platform. Today, when Web 2.0 companies arise, there are no monopolies controlling the infrastructure that they need to deliver their offerings to customers.

Contrast this to the entrepreneur who wants to harness wind energy in the Dakotas and finds that there is no grid available to deliver the energy to the customer. To solve this problem would require dealing with numerous de facto monopolies (including utility companies but also state, local, and federal governments) that ultimately make the problem essentially intractable.

Energy entrepreneurs, especially those in energy production, don’t enjoy the luxury of having numerous possible routes to market—because it is almost always the case (even though they try to avoid it if they can and a few succeed) that they must deal with the existing hierarchy, which controls the infrastructure.

This is a difficult challenge in general because existing successful hierarchies are very content in homeostasis and resist significant changes (as Clayton Christensen details in The Innovator’s Dilemma). In energy, it is even significantly more challenging because those controlling the infrastructure are notoriously (and appropriately) conservative beyond what would be seen in other industries. While renewable and energy efficiency entrepreneurs might complain about utilities (sometimes with justification), they don’t have an option but to deal with them. Building a parallel grid is not a viable option. They must find extremely creative ways of working with the controllers of the infrastructure. Likewise, to be a player in the massive oil and gas industry, entrepreneurs usually need to find a way to work with those who control that infrastructure. The costs of the infrastructure are just so high in energy that having multiple options is much less likely than in other industries. It is not simply a barrier that was created because someone “built a brand”—there are huge costs required to build the infrastructure which cannot be overcome with a marketing program.

In Summary, Thoughts and Action on the Solution

As Albert Einstein said, “seek simplicity and distrust it.” The model I am proposing is not relevant for all energy startups, but it is for the majority of impactful new ventures that should and need to be created. The energy entrepreneur has to be able to manage significant technical resources to address the multidimensional science, engineering, and systems challenges which alone would exceed the entrepreneurial requirements for any other industry. If that were all, it would be enough—but it is not.

Aulet model of energy entrepreneursLike the most elite high-tech entrepreneurs, the Renaissance Energy Entrepreneur must have these multi-disciplinary science and technology skills like an elite high-tech entrepreneur, represented in the “Seed Innovators” circle in the model to the right. These include understanding and building innovative business models to optimize monetization, as well as a keen awareness of the standard successful new venture creation process. This must be managed over a long period of time while simultaneously addressing the other two circles shown in the diagram—the “Government” (policy and public relations) circle and the “Big Players” circle (representing the need to diplomatically and effectively “massage the existing controllers of the infrastructure”). This combination is what makes this an exponentially more difficult task. The Energy Entrepreneur today who can do this is very rare indeed and in huge demand.

First, we need to openly recognize the challenge in front of us and not believe there are simple solutions. I recently heard a very smart venture capitalist say that he plans to “take successful entrepreneurs from other industries who want to give back now and put them in energy.” In general, I find this approach sorely lacking. For a sports analogy (which is a bit of a stretch I know, but it makes my point), transferring Michael Jordan’s extremely prodigious mental and physical athletic talents from basketball to baseball didn’t really work—nor will it generally work in energy entrepreneurship. The idea of transferring entrepreneurs from other industries and putting them in energy may be our only option in the short term, but they risk getting whiplash as they seek to master steep learning curves in multiple dimensions.

At MIT, starting in our “Energy Ventures” class, we seek to build this new renaissance energy entrepreneurship capability by having multi-disciplined teams working off the model above. We have selected a number of the most talented and passionate students at MIT from multiple science disciplines and coupled them with top policy graduate students and MBAs with significant energy background and put them into teams to work on building new energy companies. We are watching the experiment with great interest. The full results are not in, but we do know that it is much different and much harder than most people realize.

There are many other efforts to cultivate energy entrepreneurship in organizations such as the MIT Energy Club, MIT Enterprise Forum, TIE (The Indus Entrepreneurs), and the like. We plan to create a unified competition platform (the MIT Energy Prize) with significant support for prospective energy entrepreneurs inside and outside our community to help audition and improve their skills in a highly constructive, networking environment. It will be a learning process for everyone.

While there is still much to learn, we do know that in time, through these efforts (and many others), a new breed of entrepreneurs, the energy entrepreneurs, will arise to meet the challenges of the energy sector. When that day comes, another major bottleneck to resolving the energy challenge will be removed. But until then, we must recognize the limit in the system and act appropriately.

Bill Aulet is a senior lecturer at MIT’s Sloan School of Management and Entrepreneur in Residence at the MIT Entrepreneurship Center. He is currently teaching a new class at MIT called Energy Ventures.

Bill Aulet is the managing director of the Martin Trust Center for MIT Entrepreneurship and a senior lecturer at the MIT Sloan School of Management. He is also the author of “Disciplined Entrepreneurship: 24 Steps to a Successful Startup”, published by Wiley, which was released in August 2013. Follow @BillAulet

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  • Jay Fiske

    Bill – thanks for an insightful second post on energy entrepreneurship.

    In general, I agree that the energy entrepreneur is a special breed and that many energy companies have unique challenges. However, I believe all the excitement around energy innovation these days is fantastic, as it is attracting a large amount of needed talent from other areas into energy. Many of these talented people can learn quickly, so I don’t think a background in energy is a prerequisite for success. It is important to have someone, though, who does recognize the unique challenges of energy.

    Also, there are many companies that can be classified as “cleantech” that don’t necessarily share all the same challenges that you described which can make energy entrepreneurship so difficult. For example, I’m currently reviewing a software company that could have a substantial impact on the efficiency of a utility’s operation. While the software is complex, it does not have the challenges of manipulating silicon (or carbon nanotubes or bacteria, etc) to make novel energy generating or energy storing devices. The “clockspeed”, to use a term from MIT’s Charlie Fine, of this company is much higher than many other energy companies, so it may be a closer to fit to the traditional venture model for a company.

    There are also energy companies that apply known energy technologies in clever ways to solve important problems. Seahorse Power, one of our investments, is a great example of this. They’ve engineered a smart solution that marries PV with a battery and some clever power electronics to make a device — a cordless trash compactor — that cuts down on street litter and substantially reduces a municipality’s rubish collection costs by cutting the number of garbage truck rolls by a factor of 4-8. There is real value here — in terms of both money and energy efficiency — and Seahorse Power is capturing this value well with known technology.

    Regards,
    -Jay

  • http://www.benshartley.com Mark Hartley

    Reversing Bill’s “five laws of difficulty” for energy investing gives us a good map for how to spot energy investments with a high percentage of success:

    1. Single-dimensional solution.

    The more fields of study a solution has to interact with — and compete with — in the market, the harder it is to predict success.

    2. Shorter time frame.

    The longer your technology takes to reach fruition, the more likely your solution will be obsolete by then.

    3. Smaller scope and scale.

    Larger operations have more government hurdles, have more competition from corporations, and take longer. Leave the home runs to Manny and Big Papi; think Wade Boggs single up the middle.

    4. No public perception issues.

    Invest in wallflower technologies that are subtly game-changing, but don’t cause a stir. You want companies that can focus on their technology and their customers, not their PR.

    5. No governmental conflicts.

    Look for companies spending their money on sales people, not lobbyists.

    All of this means we may be entering the era of “wiki-energy,” where the energy problems of today will be solved, not by one giant corporation with a silver bullet, but by a thousand startups with narrowly focused, well executed solutions.

  • http://bznotes.wordpress.com Bilal Zuberi

    Bill- an excellent article. Thank you.
    I started a company 3.5 yrs ago (GEO2 Technologies) that has developed filter technologies for emission control to enable ‘clean diesel’. Essentially we aim to promote a greater use of highly fuel efficiency diesel engines (25-40% more efficient than gasoline) in the US while keeping any tailpipe emissions to be below today’s gasoline standards.
    I did a quick back of the envelope calculation based on your point that without tackling the hydrocarbon economy’s efficiency problems, we would be “majoring with the minors”. In the near term, you are quite right!
    US population traveled roughly 3 trillion miles last year that emitted 984 million tons of CO2. If we went the direction of Europe and used ‘clean diesels – for even just 50% of our transportation usage – a conservative estimate would show us gaining 12-13% reduction in CO2 emissions. If we also chose to follow EU that is recommending 120g/km of CO2 emissions in 2012, then we will observe a conservative estimate of 20-22% reduction in CO2. That is more than 200 tons of CO2 from just the transportation sector alone. And this technology is available now! Not tomorrow and not dependent on improvements in battery technologies or massive changes in our infrastructure.

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  • http://www.nthpower.com Brian Walsh

    Thanks for Post II, Bill!

    I think your skills list / model is very appropriate for a class teaching energy-related entrepreneurship…perhaps even for a book? (hint, hint). Many energy ventures will not face all of the difficulties you describe, however (some will not face any, in fact), but the bulleted ‘dimensions’ serve as a great educational tool for aspiring entrepreneurs looking at the energy space. There certainly are peculiarities common to many energy ventures….my background before MIT Sloan was in hydrogen and fuel cells, so I learned many of these first hand and early on.

    Not to be neglected, however, are the core tenets of technology (brick & mortar) entrepreneurship that Ken Morse, you, John Preston and all the MIT E-Center practitioners have institutionalized at MIT. MIT’s focus on quantifying the value proposition, proving the market pull (list your first 10 customers), surrounding yourself with the best and brightest, etc should also be a part of your class. I also hope that the teaching method that I found so valuable – ‘learning from the tribal elders’ and ‘mens et manus’ – is used…I am sure that it is.

    So, my general comment is that the model of needed skills for energy entrepreneurs is great and insightful, but is most valuable as ‘icing’ after the core technology entrepreneurship lessons have been taught and demonstrated. As an energy venture capitalist, I see WAY too many smart people neglecting the basics and putting ‘energy’ behind ideas that have little chance of succeeding (in my humble opinion)….often because of poor technology entreprenership skills, but also because of, as you have skillfully illustrated, common peculiarities of energy entrepreneurship.

    All the best & see you in April for the 2008 MIT Energy Conference.

    Brian

  • James Schwartz

    Bill,

    Interesting article. As an aspiring energy entrepreneur (and a student in said class) I agree with your description and analysis of the additional challenges facing entrepreneurs in the energy field. Perhaps the implication is that entrepreneurs and investors need to redefine and re-prioritize the sources of value in the energy space. While in most industries the standard new venture pitch starts out with how much does it increase revenue/save costs, who’s going to buy it, and who cares, perhaps in energy the space the first items to address are why the utility/infrastructure incumbent can’t stop you from doing it and why you won’t be in locked in a public hearing process for 5 years before your first project can be built. Those two risk factors probably have a bigger impact on a new energy venture’s NPV than your standard technology and execution risks that dominate other industries.

    James

  • Susan Whoriskey

    Bill: I enjoyed reading your recent posting. Coming from the biotechnology space, I immediately felt right at home listening to you defend that your field is “is much harder than entrepreneurship in other sectors”. With that said, I do appreciate the unique features to energy entrepreneurship. Regarding your model: Your thoughts drive me to speculate that, precisely due to all of the complexities, perhaps that the single most important criteria in a Renaissance Energy Entrepreneur is that, at the outset, the entrepreneur perseveres with a well communicated vision that ignites a passion in each of your three constituencies (Government, Seed Innovators, Big Players) driving them to continuously cross fertilize/integrate (particularly when the going gets tough) to achieve a win/win/win solution for all. What I see is that the second anyone of your constituencies is outside the overlap of the three circles that fine line will be crossed from tasting wild success to everything becoming an insurmountable boulder. SUSAN

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  • Tom Sikorski

    Bill:

    You seem to understand the subject thoroughly, though I was looking for references to Vito Harlow or Saul Caso.

    The one area you don’t touch on is nuclear — low cost, carbon free, baseload — any impressions on this?

  • Bill Aulet

    Tom,

    You like a number of other people who have communicated with me off line have brought up this point. I have not addressed nuclear in any depth and would say it merits a good deal more consideration and discussion that I am not ready to engage in yet. I believe that is part of the solution. When looking at nuclear, I think it should be viewed through the same general prism but I am sure there are numerous other significant factors as well that are very significant (e.g., public perception and policy) in the case of nuclear. I would love to hear a perspective from a nuclear expert. My sense is that nuclear is not a good venture capital investment or even private equity but now with private equity investments getting so big, maybe it is.

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  • http://www.newenergytimes.com Joseph Fine

    Bill,

    For a research area which needs a second and third look, please visit the newenergytimes website and read over the current updates covering the area of Low Energy Nuclear Reactions (LENR).

    http://www.newenergytimes.com and
    http://www.infinite-energy.com

    The 14th International Conference on Condensed Matter Nuclear Science (ICCF-14) will be held from the 10th through the 15th of August 2008 at the Hyatt Regency Hotel on Capitol Hill in Washington DC. The purpose of this scientific conference is to present and discuss new results on low energy nuclear reactions (LENR), which originally went by the name “cold fusion.”

    This should be an interesting meeting.

    Joseph

  • http://www.p2pfoundation.net/Transfinancial_Economics Robert Searle

    You may find my developing project of TRANSFINANCIAL ECONOMICS of interest at the p2p foundation.

    RS

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