v1.1, January 1st, 2021

Key Takeaways

1. Climate action is happening and a >$50 trillion overhaul of the global economy has begun.
2. Unlike Cleantech 1.0 (2006 - 2010), the present opportunity is supported by emerging political will, technological maturity and declining cost curves.
3. Investment is pouring into the mitigation of GHGs in every sector with unprecedented innovation… driven by necessity.
4. Already, more than 1,000 software and data companies - what we call the Climate Cloud - are facilitating this transition.
5. While not an alternative to underlying hardware & materials, this Climate Cloud offers the potential for significant impact and returns.

Introduction

Addressing climate change is an overwhelming endeavor, but for those who study the problem, even superficially, they learn that the solutions are well defined. We know what we have to do.

Yes, we need to solve some big technical problems, such as how to more efficiently store electricity. Yes, overhauling substantially all global infrastructure is dizzying. No, we don’t have much time: net zero emissions by 2050, at the latest. But it can be done, and the transition will create massive disruption along with commensurate economic opportunities.

The heavy lifting of addressing climate change will be borne by the hard sciences: the physics of solar, the chemistry of batteries, and the stoichiometry of carbon sequestration. But these innovations still require deep lab-based research, long development timeframes and large amounts of capital. This onerous work is being funded by a new class of exceedingly patient “tough tech” investors, governments and strategic corporate investors. Once burned, traditional VCs remain hesitant to participate.

But software is an exception. SaaS is capital light, scalable, inherently profitable, and provides short investment horizons.

Importantly, software plays a critical role in enabling climate solutions by:

• reducing emissions by shifting electrical loads off peak demand;
• reducing electricity demand by optimizing energy efficiency;
• supporting the marketing, sale and deployment of infrastructure;
• reducing infrastructure costs through improved O&M; and,
• managing risk to unlock cheaper, more abundant financing.

The broader SaaS industry continues to innovate in software development and cloud deployment.  This rapid refinement creates a beneficial spillover effect for the Climate Cloud. As SaaS gets better, the Climate Cloud is ever more viable.

But when it comes to addressing climate change, haven't we seen this movie before?

Despite prior false starts on climate change, there is a strong argument to be made that the present opportunity is different. Past impediments to addressing climate change were:

• a lack of political will resulting from a “boiling frog” sense of urgency;
• opposition from beneficiaries of the status quo (e.g. fossil fuel industry); and,
• the trillions of dollars in capital required to retool the world economy.

But these barriers are eroding, as:

• fires, storms and floods have made climate change a real and present danger;
• renewable energy and electric vehicle cost curves decline steeply; and,
• the COVID recession and a Biden victory increase potential for green stimulus.

Even before headwinds shifted to tailwinds, business leaders and a growing cadre of impact entrepreneurs had been building climate solutions within transportation, electricity generation, industrial operations, the built environment and food production. Now the pace is accelerating.

The next twenty years will produce a torrent of innovation and new venture creation; in particular, SaaS and software-enabled climate tech with attractive business models and a groundswell of global support.  

The Climate-Change Solution

Addressing climate change in full requires mitigation and adaptation.

Adaptation acknowledges that significant damage has already been done, so we must adapt not only to current consequences, but what is yet to come.  A hotter climate, fiercer storms and persistent drought necessitate a better understanding of our changing Earth, new risk management models, and systems to optimize around resource constraints.

Mitigation - It’s Not Just Clean Energy

Climate change mitigation can be broken down across the five major sectors that drive GHG emissions: transportation, electricity, industry, buildings, and food & land use. The respective GHG contribution of each sector, and highly simplified solutions, are presented below in Exhibit A.

Exhibit A: Mitigation Sectors & Solutions

Adaptation - A Rare Certainty

Even as our understanding of climate change improves every year, what remains unclear is how quickly we will make progress on mitigation and what further damages we can avoid. However, the Earth is warming and we must acknowledge the new normal.

As a result, a certainty of climate change is that we will have to adapt.

While a mental image of adaptation might be constructing seawalls or resettling refugees, the fact is that much of adaptation comes down to software and data-driven assessments of our changing Earth: From monitoring changing ocean temperatures, to underwriting wildfire risk, to predicting defaults on home mortgages in flood zones.

Regulatory and market changes are already underway. Under pressure from investors and banks, companies are pursuing sustainable business practices at a record pace. Near term, software and data opportunities in the adaptation category center around measuring risk to support business decisions, especially in finance, insurance and investing.

Even the United States Federal Reserve sees the clear connection to the world of finance from climate. Seeing substantial new risk posed by climate change, Federal Reserve Governor Lael Brainard called for increased transparency through standardized reporting on climate risks. Strategic allies are thinking the same way, with New Zealand and the United Kingdom going so far as to mandate such reporting.

Mapping the Climate Cloud

We have identified more than 1,000 software and software-enabled companies with a mission to mitigate or adapt to climate change. Our methodology consisted of filtering Crunchbase data to identify all companies that received venture funding since 2015, and which sell to end customers within one or more of the GHG mitigation sectors, or provide a service that supports adaptation.

We then dug deeper to categorize each company into subsegments within each sector. Exhibit B provides a useful illustration of the various sectors and segments we identified through this exercise.  We describe each sector and segment below.

Transportation

Futuristic new vehicles will grab the lion's share of public attention, and battery improvements will be the critical governor of progress, but software will play a critical role in enabling next-generation transportation.

In fact, today’s EV industry resembles the computer industry’s evolution: features such as self-driving capabilities improve with each new software update delivered to a static hardware platform.

Beyond vehicles, software will support the infrastructure that makes emission-free vehicles possible.  Examples include:

• EV Systems. From the artificial intelligence behind self-driving systems to battery management, software is the core of any EV.
• Charging Network Management. Manage EV charging operations, maintenance, and billing for utilities, buildings and businesses.
• Fleet Management. Enable acquisition, maintenance and tracking of a fleet of vehicles operated by a company, or other organization.
• Traffic Management. Responsive traffic routing and controlling traffic infrastructure through signal adjustment for optimal flow.
• Ride Sharing & Alternatives. Uber and Lyft revolutionized livery, but the need for lower emmissions will drive continued innovation.

Electricity

Electricity production represents roughly 27% of GHG emissions and has been a primary focus of climate tech innovation and government mandates. Increasingly, however, wind and solar projects are being driven by pure market forces as the cost of renewables continues to decline.

New-build, unsubsidized solar and wind generation now present an LCOE that is competitive with the marginal cost of existing combined-cycle natural gas plants, and is substantially cheaper than coal plants.

Ironically, the parallel success of EVs and green hydrogen trucking will dramatically increase demand for electricity, shifting transportation emissions to electricity demand. The scale of the required transition is unprecedented and will accelerate in the coming years.

While we typically associate renewable energy with gleaming solar arrays and towering wind turbines, the Climate Cloud plays a behind-the-scenes role, including:

• Renewable Energy Deployment. Managing the siting, development, construction, operations and maintenance of renewable energy assets.
• DERMS. Managing and integrating local, small-scale or off-grid energy generation and storage resources.
• Smart Grid Optimization. Improve the transportation, distribution and supply/demand balance of the electrical grid while addressing the intermittency of renewable energy.
• Customer Experience & Marketplaces. Streamlining customer acquisition and management as distributed energy resources create more consumer choice.
• Energy & Project Finance. Innovating systems and marketplaces to unlock trillions of dollars in funding for new energy projects.

Buildings

The built environment - residential homes, commercial buildings, municipal buildings, etc. - are responsible for roughly 12% of GHG emissions. Heating, cooling, lighting and otherwise powering the buildings where we live, work, play and learn creates emissions both locally and remotely (where electricity is produced).  

This built environment represents some of the lowest hanging fruit in emissions abatement across all GHG sectors.

The Climate Cloud will support the reduction of GHG emissions in the built environment through:

• Construction & Design. Systems for designing and constructing net-zero emission buildings and homes.
• Retrofit Enablement. Tools for managing the sale, project management and procurement of building retrofit projects.
• Energy Efficiency. Systems for monitoring and adjusting energy use in a building to meet health and comfort requirements while reducing energy use.
• Demand Response. Smart Grid integration enabling participation in demand response programs that compensate for lower energy use during peak periods.
• Project Finance. Tools and programs to finance improvements to homes and buildings, such as energy efficiency upgrades and rooftop solar.

Food & Land Use

Food-related emissions must reach net zero by 2050, while feeding a world population forecasted to reach almost 10 billion people.

This challenge is complicated by more frequent intense-weather events, such as storms and droughts. Climate change and globalization have also introduced more menacing pests. On a positive note, the agriculture and forestry industries are unique in their ability to capture and sequester carbon in soil and trees, which creates additional economic opportunity.

The Climate Cloud will support the reduction of GHG emissions in food production and land use through:

• Agriculture Monitoring & Analytics. Data collection, analysis and decision making through IoT, AI and ML to improve crop yields and resiliency.
• Animals & Aquaculture. More efficient management of protein production to reduce methane emissions and sustain fisheries.
• Supply Chain & Ecommerce. Marketplaces and supply chain applications that improve the efficiency and velocity of food supply chains, reducing transportation and food waste.
• Forests & Carbon Sequestration. Measurement and verification of regenerative agriculture and forest management to support carbon offset markets.
• Agrifinance. Tools and marketplaces for farmers to access capital during volatile conditions, and support investments in new technology and infrastructure.

Adaptation

While not a GHG-emitting sector, our need to adapt presents an entirely new set of Climate Cloud opportunities. We must manage what is coming by figuring out how to adapt to life on a planet that is changing in a non-linear fashion.

Adaptation isn’t optional - it’s the new normal requiring a regular reconciliation with changes to the environment in which we live.

The Climate Cloud supports climate change adaptation in areas such as:

• Earth Analytics. Data collection and analytics to understand how our climate is changing, including forests, oceans, and weather.
• Risk Management. Data and analytics to support banks and insurance underwriters as the measure and price risks related to capital and insurance.
• Sustainability Reporting. Workflow, integration and analytics systems to help companies measure, track and report on emissions and sustainability goals.
• Investment Analytics. Data and analytics to support portfolio managers as they incorporate climate change into their investment strategies.
• Water Use. Tools for tracking and optimizing the use of water at the municipal, commercial and residential levels.

Why Now?

The concept of GHG warming was introduced in 1856 by Eunice Newton Foote, an American scientist, inventor, and women's rights campaigner from Seneca Falls, New York.

Concern about the effects of climate change accelerated during the 1990s, and achieved widespread attention after the release of An Inconvenient Truth in 2006. Nevertheless, climate action has been repeatedly delayed by competing priorities -- terrorism, health care, and the Financial Crisis -- as well as consistent, well-coordinated denials from the fossil fuel industry and others who have benefited from the status quo.

The case made by these Merchants of Doubt was enabled in large part by the low costs of fossil fuels and internal combustion engines relative to clean alternatives. It was difficult to convince most people to pay more money to stave off a distant threat. Even more so, that threat was rooted in science they didn’t fully understand.  

But this is all changing, and with rapid acceleration.

Now, Most People Get It

Today, after years of misinformation and debate, more than 80% of Americans recognize anthropogenic climate change. Recent fires, storms and floods are increasing the intensity concern.

According to Pew Research, climate change is approaching the forefront of US voters’ minds. Six in ten American adults now view climate change as a major threat to the well-being of the U.S. up from 44% in 2009.

The same study found that 68% of Biden voters felt climate change policy was “very important” to their vote, and another 23% indicated it was “somewhat important.” Of course, only 40% of Trump voters agreed with one of those two statements.

And it’s not just voters; the US government is taking an active role in seeding climate tech innovation.

Globally Politicians are Reacting

China, once an indifferent polluter seeking growth at all costs, has changed course and invested billions of dollars in renewable energy technology, manufacturing and deployment.  Subsequently, they invested billions of dollars in renewable energy technology, manufacturing and deployment.

Aside from mitigating environmental risk, China’s leadership recognizes:

1. the massive economic upside of leading this transition;
2. the freedom of shedding its dependence on foreign coal and natural gas; and,
3. the opportunity to enhance its reputation globally.

As a result, China intends to dominate the solar, wind, energy storage and EV value chains from design to manufacturing to end markets. [As an aside, those who seek to make America great again should consider the global competitive dynamics of clean energy and transportation, as well as the economic dominance that will accrue to the winner.]

In addition to immediately rejoining the Paris Climate Accord, key elements of the Biden plan will include:

• modernizing transportation and energy transmission infrastructure;
• supporting the U.S. auto industry in the EV market;
• incentivising a carbon-free power sector by 2035;
• investmenting in energy efficiennt buildings;
• investmenting in clean energy innovations; and,
• supporting sustainable agriculture and conservation.

The Biden Administration will connect these climate initiatives with the administration's social and environmental justice mandate. At the same time, the Biden plan will likely reflect the President-Elect's pragmatism in promoting legislation with a higher probability of becoming law.

Business is Leading

Even before most people and politicians woke up to climate change, forward thinking businesses recognized the threat and the opportunity. The most visible of these companies -- Tesla, Enphase, Beyond Meat -- are high-flying pure plays on transitions in transportation, energy and food.

Investors large and small appear to agree. In Q2 2020 alone, investors contributed more than $71 billion in ESG funds, bringing total ESG AUM to over $1 trillion, according to Morningstar. For context, consider that between 2015 and 2017, ESG net inflows were almost zero.

But the shift toward corporate sustainability goes much deeper and is increasingly driven by pressure from shareholders and large financial firms. The most notable example was a letter in January 2020 from BlackRock’s CEO, Larry Fink, in which he outlined how he would use his firm’s $7.5 trillion in AUM to pressure corporate leadership to address climate change in their businesses.

In the letter, Fink highlighted key economic risks to municipal finance, home mortgages, inflation and physical assets. He demanded that public companies adopt emerging sustainability disclosure standards such as the Sustainability Accounting Standards Board (SASB) and the Task Force on Climate-related Financial Disclosures (TCFD). Other leading asset managers and banks, such as State Street and Goldman Sachs have taken similar climate action.

The Math Works

Clean energy technologies for solar, wind, storage, and electric mobility are maturing to the point of being cost competitive. In 2018, renewable energy sources represented 63% of new electricity generating capacity additions as the LCOE for solar and wind (onshore) declined to $0.08 and $0.05, respectively.

Newly deployed renewable energy generation will prove more cost effective than existing coal and natural gas plants by 2030. Most countries will reach that point by 2025.

Exhibit C: Lazard LCOE Comparison—Renewable Energy versus Marginal Cost of Selected Existing Conventional Generation

Wind and solar technologies are now affordable, financeable and productive, in large part due to the low cost of Chinese manufacturing. The pipeline of cost and efficiency innovations is fairly well defined, much like Moore’s Law predicted improvements in semiconductors over four decades. Energy storage has proven more difficult to advance, but is progressing on a similar, albeit less steep, curve.

Tough tech advances in green hydrogen, small-modular nuclear reactors and alternative protein sources all offer reasons to be optimistic well beyond the near-term successes of renewable energy.

COVID

The COVID-19 pandemic provided a significant, albeit ephemeral, reduction in emissions as travel ground to a halt early in 2020 and has yet to fully recover. However, a shifting focus toward healthcare and pressing social issues raised concern that climate action may take a back seat.

Unprecedented wildfires in California arrived just in time, reminding everyone that climate change didn’t go into lockdown with the rest of us.

COVID showed that a sudden reduction of GHG emissions didn’t put a dent in the atmosphere's long-term CO₂ problem. Meanwhile, the pandemic recession provides justification for a massive stimulus to support the transition to clean energy.  

In fact, according to The Potsdam Institute for Climate Impact Research October study in Science Daily, the hiatus only reinforced the power (and detriment) of a post lockdown rebound:  

With the exception of a continuing decrease of emissions stemming from the transportation sector, by July 2020, as soon as lockdown measures were lifted, most economies resumed their usual levels of emitting CO₂. But even if they remained at their historically low levels, this would have a rather minuscule effect on the long-term CO₂ concentration in the atmosphere.

-- Science Daily Oct 14, 2020

What better way to stimulate the economy than investing trillions of dollars in averting human extinction?

Climate Tech Investing

Despite the groundswell of support for climate action, we still have complex technological problems to solve. For example, the intermittency of renewable energy necessitates higher-density, longer-duration and cheaper energy storage (i.e. batteries). This was painfully clear during the summer of 2020 when California experienced rolling blackouts during periods of peak demand.

Solving these problems requires investment -- some more than others. Unfortunately, investing in nascent, tough-tech innovations has traditionally been difficult due to long research timeframes, onerous capital requirements, and end markets that were not yet motivated to adopt.

The Clean Tech Debacle (2006 - 2010)

After the clean tech bust, venture capital funding of hardware, materials and other tough-tech start-ups declined dramatically. However, the need for such innovations never went away. In fact the problems only became more acute, while technological evolutions in computing, material science and related fields improved viability.

For these research-intensive ventures, a new breed of patient investor has emerged with longer investment horizons and deep scientific bonafides. Examples include Breakthrough Energy Ventures and the Prime Coalition. Moreover, traditional fossil fuel companies such as BP and Total have emerged as active investors in alternative energy technologies.

From Clean Tech to Climate Tech

Increasingly, there is ample evidence that we are entering a new phase of climate-related investing that expands the scope of Clean Tech beyond the energy sector. Climate Tech is now the term applied to ventures that seek to address climate change across the full range of GHG emitting sectors.

PwC’s The State of Climate Tech 2020 calculates that Climate Tech venture investment grew from $418 million per year in 2013 to $16.3 billion in 2019. The authors claim this growth is five times the growth of venture investing overall, and even three times the growth of investment in artificial intelligence.

Previously nascent technology is now more proven, and the focus is shifting to commercialization. Intersect that with growing demand from climate action and the market is once again attractive to venture capitalists.

There are numerous examples in technology markets where being the first mover is a disadvantage. Customers’ pain may not yet be severe enough, enabling technology may be immature, and infrastructure may not exist to support wide scale deployment. Often, the second mover -- or the second wave of investment -- is the big winner.

Nowhere is this more apparent than the growth of the Internet economy. The first wave of dot com companies such as Alta Vista, Friendster and RealTV largely failed for these reasons, but the second wave brought us Google, Facebook and Netflix (Amazon represents an obvious exception).  

Today, the existential nature of climate change is apparent, technologies are 10 to 15 years more advanced, and infrastructure spending is being readied. There is reason to believe that Climate Tech will succeed where Clean Tech fell short.

Software - The Most Favored Category

Amidst the carnage of Clean Tech, one segment stood out as more attractive than the rest, and continues to attract ample investment: software. The software industry has provided outstanding returns to investors since it decoupled from hardware in the 1980s. It is attractive for a number if reasons, including:

• Shorter timeframes. Today, software entrepreneurs get products to market in just months. Critical infrastructure is available in the Cloud (e.g. Amazon AWS), so engineers focus on their unique “business logic” (not trivial, of course).
• Lower capital costs. Writing software requires little more than a laptop, and even at scale there is no manufacturing, while server infrastructure is simply rented (again, from the likes of AWS).
• Scalable business models. With recurring revenue, low variable costs and efficient distribution over the Internet, scaling a software company largely becomes an exercise in sales and marketing.
• Attractive spillover effects. The open source software movement leads to critical innovations being shared, improved and adopted (co-opted) by cloud providers, such that Climate Tech entrepreneurs can benefit from general Cloud innovation.
• Data proliferation. The explosion in data from low-cost sensors, drones, satellites and mobile devices has provided a wealth of data for new software to analyze, leading to more sophisticated and useful applications.

For these reasons, software represents the most attractive business model for Climate Tech venture investment. And while absolute dollar investments may be larger in more capital-intensive ventures (e.g. EVs, hydrogen-based trucking), the Climate Cloud will likely represent the largest volume of new ventures funded by venture capital.

New VC Targets the Climate Cloud

Venture firms investing in the Climate Cloud include the “usual suspects” (GV, Khosla, Sequoia and Y Combinator) and pure-play impact VCs (Obvious Ventures, DBL Partners). Recently, we’ve seen new entrants focused more specifically on the Climate Cloud and what it portends. Examples include:

• Buoyant Ventures is raising its first fund with an early stage focus on digital solutions for climate risk and digital infrastructure.
• Blue Bear Capital is investing at an early stage in technology related to the clean energy transition, digital infrastructure, and climate industries.
• The Lightsmith Group is a growth equity fund focused solely on adaptation, with an emphasis on climate risk analytics.

These specialist funds won’t have the market to themselves. More traditional venture capital firms are today at the table, growth stage investors and private equity funds are getting involved in earlier stage deals to get exposure, and corporate players from oil majors and global consumer goods companies to Big Tech are playing important roles as strategic investors.

Major corporations have pledged billions of dollars into this including Amazon’s $2 billion ‘Climate Pledge’ venture fund, Microsoft’s $1 billion Climate Innovation Fund, and Unilever’s €1 billion climate funds.

And with familiar names showing up (Sequoia, GV, Kosler, Horizons, YC, and USV) it appears the trend is accelerating - VCs are investing 5 times faster into climate tech when compared to overall VC activity in other sectors.

Simply put, it is becoming sound investing to worry, care and invest in solutions to climate change and sustainability generally.

Conclusion

While it is easy to think of the Climate Cloud as a collection of futuristic and forward thinking entrepreneurs, it is, today, something much more down to earth: Companies and people profiting from the groundwork of economic incentives to mitigate further climate damage, adapt where necessary and monetizing it along the way with robust, reliable and proven software solutions.

If you’ve read this far, “Hi mom.”

And if you return to this blog or subscribe to our newsletter, you’ll find Deep Dives into specific Climate Cloud investment themes and market opportunities. We will have Conversations with entrepreneurs and investors in the Climate Cloud.