Venture Capital and Energy Innovation
November 10th, 2008 by Steven Stoft, BerkeleyIn May 2008, the Boston Globe reported, “Many of the North American and European investors who sunk $5.2 billion into “cleantech” companies last year—up [629%] from $714 million in 2001, according to Cleantech Group LLC—are alumni of the last high-tech boom and bust.” One story of venture capital and energy innovation holds particular interest—the story of the race between lithium-ion batteries and hydrogen fuel cells.
General Motors and Toyota would both love to make a practical electric car. To hedge their bets, they’ve been looking into both battery cars and fuel-cell cars. Batteries need to be recharged with electricity every night, while fuel-cells make their own electricity from hydrogen. So fuel-cell cars need hydrogen filling stations and super-high-pressure “gas tanks.”
Batteries are expensive, as are fuel cells and hydrogen tanks. So engineers and scientists have been racing to bring down the cost. GM and Toyota have been waiting to see who wins. Starting in about 1999, Amory Lovins and the Ballard fuel cell company claimed fuel cells were about to break the price barrier. The nuclear industry, always a fan of the hydrogen economy, jumped on the bandwagon. The government finally joined the party on January 9, 2002, when it launched the FreedomCar Partnership.
By then the hydrogen bubble had burst and Ballard’s stock had fallen from a high of $93 to $52. But governments are slow to catch on, so a year later with Ballard’s stock down to $18, President Bush announced his $1.2 billion Hydrogen Fuel Initiative in his 2003 State of the Union address. Ballard’s stock price continued its slide to the low single digits.
By 2008, federal government spending was up to about $400 million a year for hydrogen cars. But there’s still no price breakthrough in sight for fuel cells.
In the fall of 2001, just as the hydrogen craze was peaking, A123 Systems was founded in Watertown, Massachusetts. It quickly raised about $12 million for what proved to be the hopeless idea of making self-assembling batteries. But in 2002, Yet-Ming Chiang, one of the founders, discovered a way to make lithium-ion batteries release their power more quickly—a benefit for improving a car’s acceleration. The company’s Killacycle, an electric motorcycle, is now the fastest electric vehicle in the world in the standing-start quarter mile, sprinting it in under eight seconds.
In 2003 A123 met with representatives of Black and Decker, who wanted better power-tool batteries, and by 2006, Black and Decker’s customers were buying power tools sporting A123 batteries. DeWALT’s best power tools soon followed suit. The new battery design makes the batteries quicker to charge, less likely to catch fire, and longer lasting. A123 has now raised about $150 million in capital, and General Motors is planning to use A123 batteries in the Volt, its plug-in hybrid scheduled for production in 2010.
Now $150 million is a lot less than the federal government can spend, and about ten times less than the government has thrown into hydrogen cars. But in 2008, the Wall Street Journal quoted GM’s Vice Chairman Bob Lutz saying, “Why do you need fuel cells? We are nowhere [near] where we need to be on the [fuel-cell] costs curve.” So it looks like little A123 may win the race against the federal FreedomCAR initiative, which started backing hydrogen just as the bubble was bursting.
Why did A123 win? There’s some luck involved, but there is also an important principle. I’ll let venture capitalist Vinod Khosla explain. He’s a cofounder of Sun Microsystems, and a major funder of Google and Amazon. He has degrees in electrical and biomedical engineering as well as an MBA from Stanford.
“Taking risk with your own money, which venture capitalists do, is much better talked through than the risk that government will take. They [government officials] listen to pundits and pontificate without understanding the technology. ”
—Vinod Khosla, 2008
Notice the key phrase “with your own money.” The DOE is spending your money, and Khosla is spending his money. He says the “risk … is much better talked through” when he’s spending his money. Having spent several years at a national laboratory funded by DOE, I would have to agree. While I always found that DOE’s employees were trying to spend our money wisely, I was never impress by their ability to do so. In fact, as Khosla suggests, DOE discussions are not always well informed technically, and DOE’s perspectives on risk and payback is none to clear.
This shows up in the race between hydrogen cars and battery cars. The government’s decision in favor of hydrogen cars was made by listening to pundits, just as Khosla expects. Unfortunately pundits get revved up only when a craze is in full swing. By the time, the government catches on it’s usually too late—and often it made little sense anyway. Of course, venture capitalists make similar mistakes, but the best capitalists are much quicker, as well as more thoughtful. To see just how hard it is to get the government to change course, consider the efforts of the National Academy of Sciences.
When the National Academy was brought in to review the federal hydrogen program in 2004, it warned DOE to “keep a balanced portfolio of R&D efforts,” because “if battery technology improved dramatically, for example, all-electric vehicles might become the preferred alternative.” In a second review, published in 2008, the Academy remarked “there seems to be a lack of urgency in finalizing and executing the R&D plan for plug-in hybrid vehicles [battery-powered cars].” DOE had been listening to politics, not to the experts they had asked for advice.
Khosla’s remarks reflect a consensus within both the private investment community and the economics profession. When your money is at risk, you think much harder about how to spend it than when you are just part of a bureaucracy spending taxpayer’s money. Not only that, but if you don’t think hard, you will soon lose your money. So the venture capitalists like Khosla, who remain in the business and have the most too invest, tend to be quite talented.
Steve Stoft
These are excerpts from chapter 21 of my forthcoming book Carbonomics.
November 13th, 2008 at 3:56 pm
Dear Steve Stoft,
I remember the report of the NAS’08 about hydrogen concluded that, in the medium-term (until 2030), plug-in hybrids and biofuels will be doing better than any other alternative to reduce oil consumption and CO2 emissions in the transports. Although, the same report states that hydrogen and fuel cells can achieve better results after then.
The same report again confirm that the price of fuel cells came down, almost becoming competitive with gasoline ICE cars in today’s conditions. Nevertheless, the NAS pointed out the storage of hydrogen onboard as a critical problem far from resolution.
In my point of view, we can analyze this multi-technology competition with 2 distinct approaches. The first one, is the Khosla one (the one you mentioned). It consists to say that governments don’t make good decisions concerning the technology policy because they are pressured by lobbyist. This position is well-known by the term “the technology pork barrel” after the book with the same title of Cohen and Noll (1991). The second approach tries to open the ‘black-box” and understand the nature of each technology. For this we can refer to the work in innovation and technical change that was done by specialists such as Rosenberg, Arrow or Nelson.
The point here is that the two technologies are not in the same phase of development. Batteries is a mature technology that can be already improved. Hydrogen and fuel cells is a technology in the pre-market stage. Apart all theories on the technical limits of the one and another, I would like to focus in the economical incentives of each innovation. For that, we remember the problem of the appropriability of the benefits of the innovation. It means that when the innovator can’t appropriate all the benefits of the innovation, the investment will be sub-optimal. We understand this problem is more likely to happen for technologies in the pre-competitive stage, were the knowledge produced becomes available for all the competitors and the chances to get profits from the market are restrained, compared to improvements in innovations that are already commercialized. For the latter, the innovator can more easily commercialize its innovation in the market and get profit from it. So, it is not surprising there are more companies willing to invest in batteries rather that in fuel cells. Thus, it is the role of the government to support basic R&D.
Despite all the criticisms, it is interesting to note that the 1.2 billion of USD spent in hydrogen and fuel cells in the last 5 years in the US have produced some positive effects. The NAS report ’08 is clear in noting that hydrogen technologies have remarkably progressed and they are ready to scale up the production in 5 to 10 years.
Finally, the Meridian International Research came out in May with an interesting study titled ‘The trouble with lithium 2′. They concluded that the realistic increase of the production of lithium in the world in the next years could supply enough material to produce 8 million of hybrid cars like the GM Volt, in the best scenario. Apparently, the electric revolution is not around the corner yet.
Bests,
Nuno
November 13th, 2008 at 6:01 pm
Dear Nuno Bento,
I agree with everything you say, with one tiny exception. The basic point you make about the advance-research market failure is present in the full chapter 21, Crash Program. You can now download the full book at stoft.com. There you will also find a short paper on Hydrogen car rersearch in which I agree that the government should fund advanced fuel cell research.
My tiny disagreement is that the progress on fuel cells is probably much less than it seems because much of the drop in cost was caused by changing the specifications from a non-hydrogen to a pure hydrogen fuel cell, and the quoted costs are based on extremely hypothetical calculations that scale up lab-units to high production levels. The progress is likely far from remarkable, but we don’t know.
Thanks for the new information on the lithium shortage problem. There is a similar platinum problem for fuel cells.
Best regards,
Steve
April 19th, 2009 at 12:24 pm
Dear Steven Stoft,
I agree with the ideas developed in this article about how venture capitalists spend their money more wisely and carefully than governments. On the one hand, we can be sure that private investors will pay great attention to the way their cash is spent on promising technological projects and how it will ensure them sufficient internal rates of return. On the other hand, some other technologies will never be developed to their full potential and reach the customer because of too long R&D time requirements and too big capital needs that will make them financially unattractive to investors.
Combining these two sources of financing may therefore appear as the best way to benefit from both the State’s large funding resources and the expertise and more accurate “sense of business” of venture capitalists. The implementation of indirect governmental incentives can be a good means to enable private money to reach a whole new set of technological projects that would have been considered non-profitable otherwise.
A good illustration of such practice can be found in the field of photovoltaic solar energy in Spain. The Spanish government has played a critical role in the development of the photovoltaic industry by implementing feed-in tariff policies. These tariffs are currently at around 0,32€/kWh (fixed by Royal Decree, September 28th 2008). Such public policy proved to be outstandingly effective: the 2010 initial objectives of capacity installed (371 MWc) have been reached as early as in 2007! Besides, in 2008, no less than two thirds of large-scale photovoltaic installations in operation were connected to the Spanish grid (source: analysis of international trends in photovoltaics at the PV industry forum, February 23rd 2009 – http://www.pvindustry.de). There have also been an increase in the availability of modules and a reduction in prices. The reason to this is that the Spanish indirect public financing made the photovoltaic solar energy generation activity attractive to a number of firms and encouraged several entrepreneurs to start businesses in this field. Then competition drove costs down and increased the efficiency of solar panels.
However, one major problem is the determination of the right level of incentives by a government in order to stimulate correctly the development of new technologies. Too generous subsidies, tax rebates or feed-in tariff policies may slow down the pace of innovation and productivity improvement whereas incentives fixed at too low levels will not stimulate anything. Constant adjustments are thus necessary. The Spanish government well understands this fact and have proved it by decreasing the level of its incentive policy over the years.
August 1st, 2011 at 3:32 pm
Steven, really good article and really good book. I’m using your book to better undrestand all around electric cars, hybrids, hydrogen fueled cars,… I’m woking on an essay for my school, so your book was quite helpful in that regard.
August 3rd, 2011 at 8:07 am
Thanks, Aljosa.
Glad you liked the book.
-Steve