Climate Tech Investing in Deep Decarbonization - Shayle Kann Flashcards
This episode features host an interview by Azeem Azhar, entrepreneur, investor, and host of Exponential View, with Shayle Kann on the role of venture capital in deep decarbonization climate tech, Partner at Energy Impact Partners.
You have, with your partners, just announced a new fund that is tackling frontier technologies that will help us on this part of decarbonization. You’ve called it Deep Decarbonization, and you laid out five challenges. How do you think those challenges help us think through the steps to getting to that 2050 target, when your newborn son turns 28?
Deep Decarbonization is looking past the near future. So, as an example, the IPCC just put out a new report that’s a pretty seminal report. There’s a great chart in the Summary for Policymakers, which is usually the document that is most readable in IPCC reports. It has in it basically like a list of 30+ technologies and approaches to decarbonize and the relative magnitude of the impact they can have on greenhouse gas emissions by 2030. There’s some clear winners, and it’s solar and wind, forestry and land management. We can do all that stuff and have a pretty big impact in a very short period of time at very low cost. What we’re looking at with Deep Decarbonization is the next level.
Feb 2023
08/03/24
There’s that famous quote from Marc Andreessen, software is eating the world, that kind of underpinned the entire thesis for Andreessen Horowitz’s Venture Capital strategy. And the idea there was, software will kind of go one by one through every major sector of the economy and transform it over time. And that I think has generally proven to be true. I think you can say something similar about climate in the sense that emissions come from nearly every major sector of the economy. And if we’re truly going to decarbonize, then basically every one of those industries needs to transform in some way or another in order to decarbonize. So, climate I think will end up eating the world in a different way from how software did, but it’s a similar idea.
Another investor who I’m sure you know, Andrew Beebe at Obvious Ventures, he said to me a couple of years ago, “Well, I think of climate tech a little bit like dotcom. There was a point in ’98, ’99, where every company had to be a dotcom. And then by 2003, every company was a dotcom but they didn’t say they were.” And he said, “It’s going to be like that with climate tech.” Everything will be kind of inherently at its heart a sort of a climate tech company. Climate tech is just a consistent theme across many different sectors. It’s not a single technology or suite of technologies.
You have your Deep Decarbonization and you have your five themes. Will you just run through them for us?
The problem with climate change in part in wrapping your head around is this is really complex. There’s lots of interdependencies. It crosses all these different sectors. I boiled it down to five core challenges.
The 1st thing that we need to do is what we already discussed, which is solve electricity basically. And that means we need electricity on a global scale to be low cost, abundant, reliable, ubiquitous, and zero carbon most importantly. That’s no small task but I think may be, of these five challenges, the one that we have the clearest pathway toward.
The 2nd thing we need to do is we need to figure out how to solve the biggest industrial emitters, which are energy-related emissions, but they are generally not electricity. So, these are things like steel and cement and chemicals, which emit a ton of greenhouse gases. It’s about a third of all GHG emissions, so it’s huge. Those are very difficult to solve. Electricity may be a solution for some of them directly or indirectly via stuff like green hydrogen. Go after the big industrial emitters: steel, cement, chemicals, aluminum.
The 3rd thing we need to do is solve transportation. There’s multiple components to that. I think light duty transportation is probably the most solvable via electrification. but that doesn’t solve all of transportation. There is still heavy duty transportation which is shipping, aviation, trucking and most freight. Those are harder to solve and where there are multiple pathways that everybody is pursuing. All of it needs to get to net zero if we’re going to solve the whole problem.
The 4th thing we need to do is we need to build a carbon management industry, basically from zero. That’s going to involve capturing CO2 both from point sources, from emitters, but probably even more than that ultimately, removing carbon from the atmosphere. That’s an industry that basically does not exist today but needs to be in the tens to hundreds of billions, perhaps even a trillion dollar market, by mid-century. So, that’s a massive undertaking
The final thing is we need to decarbonize Maslow’s basic needs. Two of Maslow’s hierarchy of human needs on the very base of the pyramid are major sources of emissions, which is food and agriculture, and buildings. So we need to solve for emissions in buildings and emissions in our food. If we can solve all of those five things, then you can add that all up and we’re probably 90 to 95% of the way to deep decarbonization.
There are some fantastic ones in your Energy Impact Partners portfolio. One of the ones I found really fascinating was the battery storage company called Form Energy. Form was the first investment that we made out of this frontier fund. I’ve known the CEO, Mateo Jaramillo, for over a decade. He, prior to founding Form with a few co-founders, he was at Tesla and he was a big part of building Tesla’s stationary energy storage business. So what is now the Powerwall and the Powerpack before they were called that. I got to know him then. He’s just an incredible founder, really great person. His co-founders are amazing. It’s the team you would design in a lab to solve this problem.
What they’re going after is a real problem that is emerging and will only get stronger, as you add more and more wind and solar to the grid, you start to face issues with their intermittency. But that intermittency comes in different time scales. I’m in California. So, this is a market where we’re adding more and more solar all the time. There are two ultimate big timescale problems, the first is diurnal, so on a daily basis. If we’re a grid that is heavily reliant on solar, how do we deal with the fact that we’re going to generate a ton of power during the day and very little at night? That is a problem that can be solved via a combination of kind of baseload clean resources and probably more importantly batteries that we’re familiar with, lithium ion batteries, because they’re well suited to providing energy storage that lasts say 4-12 hours at a time.
But you also face a problem on longer time scales. If you have multiple days at a time, for example, where there is no sun, you have a cloudy set of days. That’s a problem that lithium ion batteries are not well suited to because the costs scale pretty linearly as you add more duration to the storage. So if you wanted to deliver multiple days of energy storage, it’d be really, really expensive. So the only way to solve that with a battery is you need a battery that can last hundreds of hours at a time for which the capital cost is basically a tenth of the capital cost of lithium ion, and that’s what Form is doing. The challenge is finding a much, much more cost effective battery chemistry.
Form has an approach that is an iron-air battery. The benefit of an iron-air battery is that the cost entitlement is extremely low, especially relative to lithium ion. So if they can scale up the technology as we hope that they will, then they can deliver energy storage at a 10th the cost of lithium ion, which is exactly what you need if you’re going to try to deliver 100 hours of energy storage instead of 12.
Iron as an active material is abundant, well produced. It’s not hard to get your hands on, it is well understood, and it’s just very cheap. And so that as the active anode material is sort of perfect if you’re trying to build a very, very, very cheap battery.
Give us a flavor for what a Form battery will look like and how much is it going to end up adding to the cost of my electricity?
Hopefully it’s going to reduce the cost of your electricity ultimately, not add to the cost, because what it’s going to do is in various versions for various applications, it is going to balance out the really, really cheap, renewable energy that we can now add at high volumes, but make that renewable energy available all the time instead of available some of the time. So from a cost perspective, it should be beneficial. What it’s going to look like is this is going to be industrial scale. So this is not intended to power your house. This is intended to go on the grid at large scale. It’s going to look like a big industrial battery.
The renewable grid starts to change from being a linear directed approach into something that is much more web like, a lot more internet like. One of my friends runs a company which strings together the lithium ion batteries in electric vehicles into a big virtual battery so that actually as a consumer, I can also become a producer not simply through say solar feeding but by lending some of the spare charge in my car’s battery to my next door neighbor or to the grid itself on a day when it’s cloudy or when it’s not so windy. And that to me is a really fascinating opportunity to rethink the nature of the grid from this very industrial one way process to something that is a little bit more distributed, a bit more dynamic and more two-way.
The blurring of the lines between demand and supply in electricity is probably the biggest transition that that market is undergoing. It comes both from the fact that batteries are both. They’re both demand and they are supply on the grid. And as you said, we’re now seeing end customers who can be both through their electric vehicles or maybe the batteries that they’ve got at their house, or they can be a sort of form of demand that is actually more flexible and can operate in accordance with the needs of the grid by just things like smart thermostats and shifting their load around. So if we can fully leverage the resources that we are adding to their maximum, then I think it’s going to be a real paradigm shift in the world of electricity.
But if they have to do the latter, then we’re asking quite a lot of a young management team? Not only do they have to bring this really difficult technology to market that’s got to be 10X better than its competitors, but they also have to sort of figure out all this business model and regulatory value changes that they’re going to have to put their products into.
They recognized very early on that if you’re going to introduce an entirely new kind of resource into this market, you can’t just trust the market to immediately recognize exactly how it should be used, where it should be placed, what it should displace and so on. So, what Form did from the very early days is they built out this ultimately really sophisticated analytical suite that they call Formware which is a suite of modeling tools to help model out grid scenarios that are really complicated and that the traditional grid modeling tools are actually not well suited to modeling.
Where would it fit on the grid? Where does it make sense economically? Where does it not? What should it displace and what shouldn’t? So, they started very early on saying we can’t just let the market come to us, we have a resource that we think is going to have enormous value. We need to show where that value is going to be. And along the way, we need to actually prove to our future customers that this kind of thing is going to have a lot of value to them and that they can recognize where that they should use it. But to your point, it’s a really high bar for a team that knows how to navigate. The difficulties of selling into the electricity market, in the first place, notoriously difficult, dealing with the regulatory construct, and particularly doing so with an entirely new class of resource. So, in the case of Form, I feel incredibly confident that they can do it, but it is really difficult.
You have 75-80 companies in your portfolio, many of which will face the same sort of scale of challenges, which brings me to one of your thesis, this idea that we need to build a carbon management industry from scratch. Now, I guess carbon management includes everything from being able to count, analyze, optimize emissions, figuring out where we’re going to store it once it’s been taken out of the atmosphere. And it’s definitely not hyperbole to say that we’ve got quite far to go with developing a full carbon management industry. What are the things that make you feel optimistic about us being able to deliver that in the next 20 or 30 years?
Just to put a number on it for you, so carbon removal, total volume of transacted purchases for carbon removal credits, which is basically how these things get monetized, in 2021 was under $50 million, pretty safely under $50 million. It’s been bigger this year. But that was the total volume last year. The size of the market in 2050 if we are going to hit a 1.5 degree celsius, future needs to be in the sort of gigatons scale, which is billions of tons. And if you figure it’s $100 a ton roughly speaking, that’s hundreds of billions of dollars. Could be as much as a trillion dollars.
What makes me think that we are going to at least head down the right road is I think generally speaking, increasing recognition among the scientific community, amongst some in the tech community who are kind of forming the early purchasers. It’s gaining a lot of attention and a lot of investment.
There is this increasing collective belief that carbon removal is going to be really critical part of the solution. One of the consequences is that more and more investors from an asset allocation perspective are starting to see carbon and carbon credits as a tradable and investible asset class. And of course, these credits are then going to be supplied by some kind of industry. It’s incredibly fledgling right now, but they will start to see that there are already buyers that are out there. So that’s the first thing, and for me that kind of constructs a flow of money into the market.
The second aspect to all of this also comes from the finance world, which is that risk is starting to already be priced. Climate risk is being priced into the cost of capital for different types of projects. One of my previous podcast guests, Michele Della Vigna, he runs a Carbonomics research program at Goldman Sachs, made the point that it’s already 5-7% per annum more expensive to fund a coal plant than to fund a solar plant.
Europe has a regulated carbon market, the EU ETS, those are tradable carbon credits. They’re traded. It’s a $700 billion annual volume. The way that it’s working is just bilateral purchases. So there’s not really a lot of trading of credits. What’s happening is a buyer who needs to be a net zero is purchasing a strip of credits from a project. Could it become tradable and with sort of commodity pricing? Potentially, though I think we’re ways from that because the market is still very messy. There’s still very low supply of these credits. They’re not actually commodities. They differ on some key characteristics like permanence, for example. I think there’s a long way to go for there to be this like tradable liquid market.
That’s what the financial services industry does. It’s what they did with things like credit default swaps. It’s what we’re starting to do on the retail side with ETFs where we start to bundle all sorts of other assets and stick them into these things called ETFs. I mean, if the financial services industry, the banking industry is good at one particular thing, it’s that idea of being able to enable markets and create the conditions for which a market can therefore emerge.
Where are we going to get this billion tons of carbon removal from? Well, it’s going to probably come from a variety of different sources. But if it’s direct air capture, for example, which is maybe the most scalable thing that we’ve got, it’s a machine that captures CO2 from the air. So, you can put that machine anywhere. But the challenge is, it’s pretty energy intensive.
If you want to do that at the gigaton scale, particularly if you’re going to power using electricity, most of these systems are electrochemical, it will add up to a monumental amount of land use and transmission and all other constraints that we face. So, there are interrelated challenges in scaling up at least portions of carbon removal. I don’t think you’re wrong to be optimistic, but I just think it’s going to be a long road.
You are a venture capitalist with Energy Impact Partners. I am curious about whether you as a firm looking at this opportunity like a traditional venture capitalist only care about the financial measures, the IRR, the internal rate of return or the MOIC, the multiple on invested capital or the cash-on-cash return. Are you solely driven by the financial metrics or do you have some kind of double or triple bottom line reporting where you think about your carbon or sustainability impact as well?
We are a financial fund and we have financial investors that are in it for the return. They believe this is going to be a good investment as I do as well. But there’s a heavy filter at the front end for things that can have a significant impact on climate change. I think of that as being a financial filter as much as anything else. If this isn’t going to have a big impact on decarbonization, it’s not a fit for us. But with that said, the metrics that we care about ultimately are traditional venture capital metrics. We expect to have above market returns and we’re not sacrificing on that in exchange for anything. We do look at greenhouse gas emissions abatement potential of every investment that we make. We then also measure, and we have fairly actually sophisticated ESG team that does a bunch of really detailed measurement of actual emissions impact of everything in our portfolio once we do invest. We just view that as being a part of our core financial investment thesis as opposed to saying, well, we’re going to make a trade off on pure financial returns perspective by adding this additional layer.
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There is a new IPCC report that came out, that sort of new update, and one of the lead authors, Sarah Burch said, “For the first time, we’re seeing evidence of real sustained decreases in greenhouse gas emissions from some countries, that a low carbon economy can create more jobs that last, that there’s really promising signals on renewables. But on the other hand, a negative side, GHG emissions have been the highest in human history and we’re not on track to limit warming to less than 1.5 degrees.” One of her key items was that the flow of finance needs to go up by 300 to 600% to spur the scale of action that’s needed. How do you think we go about untapping the very large pools of capital that are yet to flow into decarbonization?
To be honest with you, 300 to 600% does not sound that intimidating to me. Like I think that’s going to happen because I think the way that you unlock larger flows of capital is by showing returns from the earlier flows of capital.
I’d like to go forward to 2050. Let’s imagine that we do make really, really great progress. Your son will be 28 years old in 2050. When you think out to that and you look at this new economy that has been decarbonized, what do you think that means for the kind of choices that he will have?
Every time the IPCC comes out with a new report, we basically say the same thing. There’s this really exciting progress, but we are not moving fast enough. And I think that’s going to keep happening. It’s going to keep becoming more and more urgent. So, his childhood is going to be marked by, I think, some really challenging times probably driven by increasing recognition that climate change is like a global calamity. But if we are painting the optimistic picture of the future, we’re going to see these dramatic transformations of major sectors of the economy toward new technologies that are cleaner but also ultimately should be cheaper and as you said, could create more jobs.
