Climate Cloud
Climate Cloud

A blog about software's critical role in mitigating climate change and adapting to the irreversible damage that is already underway.

Don Fornes
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Climate Cloud

The Climate Cloud Thesis

Software and data will play a critical role in mitigating climate change and adapting to the irreversible damage underway. For entrepreneurs and investors, this Climate Cloud represents an opportunity to turn back the most pressing threat to humanity, while being rewarded for their commitment.

Photo by William Bout on Unsplash

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:

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:

But these barriers are eroding, as:

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.

Mitigation refers to reducing harm. Reduce and then eliminate GHG emissions into the atmosphere across all human activity sectors: From power generation to transportation to waste management. This applies not only to CO2, but also more nefarious GHGs, such as methane from natural gas wells or food waste.

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

Data Source: United States Environmental Protection Agency, Sources of Greenhouse Gas Emissions, 2018

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

At 28% of GHG emissions, transportation represents the largest GHG emitting sector of the global economy. While Tesla and EVs have taken center stage in the renewable energy transition, the scope of transportation extends well beyond consumer automobiles. We will need carbon-neutral vans, trucks, ships, and eventually, airplanes. Smaller vehicles will be powered by electric batteries, but larger vehicles are more likely to use hydrogen and fuel cells.

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:

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:

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.

Energy efficiency improvements to building shells, HVAC systems and lighting all represent substantial reductions in GHG emissions, while also reducing energy costs for buildings owners and tenants.

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

Food & Land Use

Humans have innovated in food production since the beginning of agrarian society, but rapid population growth and climate change are driving an increased urgency in this sector. Unfortunately, food production and waste accounts for roughly 10% of GHG emissions, including methane, which readily absorbs heat and is initially 84x times more damaging than carbon emissions after the first two decades of its initial release.

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:

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.

On a positive note for investors, this need opens up a sizable new category of software and data services. The EU created an adaptation strategy in 2013 to subsidize initiatives locally, regionally and nationally based on the fact that “well planned, early adaptation action saves money and lives later.”

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

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.

Recent research highlighted the importance of considering not only these individual opinions, but also second-order beliefs -- what people believe others believe about climate change. One individual may believe in climate science, but their propensity to act could be fettered by their belief that others will not. While initially discouraging, implicit in this argument is a theoretical tipping point where evidence of broad belief in climate science and willingness to act drives a groundswell of new climate action.

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

As in prior conflicts, our battle with climate change has seen the US Department of Defense shift its attention, and considerable funding mass, to confront these emerging challenges. If fact, climate change is now listed as one the DoD’s primary threats and seen as a very real obstacle to completing its global missions.

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 the West, the European Union has led the way on climate action. The “European Green Deal” targets net-zero emissions by 2050, with a near-term goal of emissions 55% below 1990 levels by 2030. According to Goldman Sachs, meeting these goals will translate into €7 trillion in investment.

The EU has gone so far as to threaten fines of up to €28 billion on automobile manufacturers who fail to meet a 2021 fleet average of 95g/km of CO2, 21% below the 2018 average of 120.5g/km.

Over the last few years under the Trump Administration, the United States had largely disengaged from global climate action. Yet despite this active hindrance, 30 states have created their own renewable energy portfolio standards (and emissions mandates, in certain states). California has gone even further, with Governor Gavin Newsom ordering that only 100% zero-emission vehicles can be sold in California as of 2035. Sixteen other states have zero-carbon or carbon-neutral goals in place.

Meanwhile, with the election of Joe Biden to the Presidency, we will have a goal of net zero emissions by 2050, $1.7 trillion in federal investment (still not enough), and a range of new mandates, subsidies and penalties.

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

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

Source: Lazard Levelized Cost of Energy V14.0 

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)

In just five years between 2006 and 2011, Clean Tech venture investors learned this the hard way. Traditional VC funds invested $25 billion in Clean Tech and lost over half of that amount. Their cleantech portfolio companies required more capital and more time than expected, as well as manufacturing expertise that had largely migrated offshore. Combine that with the Chinese government’s massive investment in solar and wind technology, and U.S. Clean Tech start-ups failed badly.

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:

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:

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.

We look forward to evolving this thesis with our community and encourage you to participate. Please feel free to Contact Us.
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