With 2022 in retreat, investors have made no secret that they’re looking for safe investments. In a challenging market with higher interest rates, that’s no surprise, but what might raise eyebrows is where investors think those quality investments lie. Increasingly, it’s in climate tech.
The sector had a crazy 2021, and while 2022 may not soar past those heights, it’s not had a bad year at all. To date, venture capitalists have invested $24.9 billion in climate tech startups, compared to the $31.9 billion invested in 2021, according to PitchBook data. While many observers think 2021 was an outlier, it’s possible that this year’s dip might be more unusual given the sector’s potential. Five years from now, PitchBook expects climate tech to be a $1.4 trillion market.
As much as venture capitalists like to say their investment decisions are unswayed by political and geopolitical developments, it’s likely that next year’s deal flow will be driven by just that.
The trends that started taking hold this year will really sink their teeth into the market. The year kicked off with Russia’s decision to invade Ukraine, and it took an unlikely but welcome turn this summer with the passage of the Inflation Reduction Act (IRA). Together, those two developments have done more to shape the recent climate tech landscape than any other.
So with more investors looking to dip their toes in the climate world, let’s take a look at where they’re likely to put their money to work.
Software to deploy and manage renewable power
Russia’s invasion of Ukraine drove many countries to embargo the aggressor’s oil and gas. It also sent them searching for alternatives. While renewables can’t replace that sort of demand in a few months, the self-imposed shortage caused many economies to reconsider their reliance on fossil fuels. That, in turn, has sparked a surge of interest in wind and solar power and, more importantly, large batteries to ensure those intermittent sources can provide continuous, stable electricity to the grid.
The IRA further reinforced renewable power’s strong position. The law extended tax credits — set to expire at the end of the year — through 2032, giving developers breathing room to propose and implement new projects on a large scale. As a result, Deloitte expects the IRA to spur up to 550 gigawatts of utility-scale clean power by the end of the decade.
As renewable projects grow more sophisticated — made possible in part thanks to batteries — developers will need software and platforms to manage them. In the coming year, I expect we’ll see growing investor interest in startups with software solutions that are focused on renewables and grid-scale batteries.
Direct air capture
In addition to renewables, the IRA gives carbon capture projects a boost through enhanced tax credits. While all forms of carbon capture benefit from this, I suspect investors will be paying the most attention to direct air capture, which, instead of absorbing carbon dioxide from an exhaust stream, draws it directly from the atmosphere. The IRA offers a tax credit of up to $180 per metric ton, a significant increase from the $50 per metric ton offered previously.
DAC is still a nascent technology and there are ample opportunities to improve its efficiency and cut costs. I’ve heard investors expressing renewed interest in the space, and I suspect the field’s early stage, coupled with the attractive tax outlook, will drive significant investment.
Green hydrogen
Today, most hydrogen is made by pumping steam into methane gas, and the combination of heat, steam and pressure breaks hydrogen atoms off the methane molecules and combines them into H2. Called “gray” hydrogen, this has long been the cheapest way to do it, but the process releases carbon dioxide. Plus, its reliance on methane creates its own problems since the fossil fuel is a potent greenhouse gas.
The IRA, though, turns those economics on their head by offering a $3/kg tax credit for “green” hydrogen, which is made using renewable electricity to split water into hydrogen and oxygen — no carbon dioxide, no methane. The credit could make green hydrogen cheaper than the methane-derived form.
Green hydrogen startups have been inching along for years, but the IRA credits are likely to kick things into a higher gear. Look for investors to put their money to work funding startups specializing in green hydrogen, from electrolyzers that split the water to plant developers and end users.
Home renovation contractor software
This may seem like an odd fit for a climate tech article, but the IRA is about to unleash a wave of home energy efficiency renovations that’ll generate enormous demand for renovation contractors. The law includes tax credits for windows, doors, insulation, air sealing, electric vehicle chargers and heat pumps.
There’s likely a lot of pent-up demand for these upgrades — they’re the sort that people often delay since they don’t offer the same level of gratification as a new kitchen or bathroom.
But as utility energy-efficiency programs have shown, people will jump at the opportunity to make these subtle but significant changes if the price is right. Now that these upgrades will be more attractive, contractors are going to be busy keeping up with demand.
To help streamline the process and keep contractors working instead of bothering with office busywork, I’m guessing we’ll see a number of SaaS startups entering the space to help with everything from customer acquisition to project management, billing and even education.
Critical minerals mining
Even before the IRA was debated, everyone expected it would include an extension or expansion of the popular electric vehicle tax credit. What people weren’t expecting were Senator Joe Manchin’s demands: half the credit requires made-in-America batteries using materials from the U.S. or friendly countries.
That provision sent automakers and their suppliers scrambling to build factories and secure mineral offtake agreements. Of the two, sourcing enough minerals will be the more challenging. As a result, investors are likely looking to fund startups that have new ways of finding and extracting the range of minerals required by EVs, including lithium, nickel, cobalt and rare earths.
Fusion power
This was the development to end the year with a bang — literally. Earlier this month, researchers at the Lawrence Livermore National Laboratory said they’d produced a controlled nuclear fusion reaction that had generated more energy than the facility’s lasers put into it. We’re still a long way from commercial fusion power plants, but the breakthrough means that net-positive fusion power is no longer hypothetical.
Investors have been bullish on fusion for the last several years. It’s the sort of high-risk, high-reward technology that once defined the sorts of bets that made venture capital an influential source of capital. Recently, a confluence of factors has given the once moribund field momentum, and the new development is likely to spark a wave of startups and investors hoping that their solution will be the one to bring the power of the sun down to earth.
Another hot year?
As 2022 draws to a close, the market remains unsettled. It’s possible the economy will slip into recession, though there’s a chance it won’t. One certainty, though, is the changing climate. Scientific evidence continues to pile up that climate change is not only happening, but that the consequences could arrive sooner and be more dire if action isn’t swift.
Governments around the world are taking an increasingly hawkish stance on climate change, too, which has tipped laws and policies toward action. Investors are taking note, with some even calling climate tech “recession proof.”
That may or may not be hyperbole, but it does have a whiff of truth about it. It seems the world has woken up to the fact that if it wants to minimize climate change, it’ll need to spend more money. Will 2023 be the inflection point that marks the start of exponential growth? I suspect we’ll know more around this time next year.
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