If there was any question as to whether the Biden administration is serious about the electrification of the U.S. economy, this week’s announcement of new automotive emissions regulations should put that to rest — along with any doubts investors have about where they should direct their investments.
The Environmental Protection Agency is proposing new rules that would take effect in 2027 and pave the way for a new vehicle market dominated by EVs. By 2032, two-thirds of car and light truck sales will have to be zero emitting along with 46% of medium-duty vehicles like delivery vans, half of all buses and one-quarter of all heavy-duty trucks. The regulations are technology agnostic, meaning that green hydrogen vehicles would qualify, but in reality, the vast majority of those sales will be battery powered.
The climate impacts promise to be significant. Just the light-duty emissions limits alone will slash 15.5% of U.S. carbon pollution, the EPA estimates.
The new regulations set targets that are significantly more stringent than those put forth in Biden’s 2021 executive order, which calls for 50% of light-duty vehicles to be electric by 2030. The other difference is the relative stickiness of the two. Executive orders can be easily rescinded by future administrations. EPA regulations, though, are harder to roll back once they’ve been implemented. States’ attorneys general and future administrations might try to sue or scale them back, but well-written, already implemented regulations are much harder to overturn.
The EPA was no doubt emboldened by actions taken in recent years by states and other countries to ban fossil fuel vehicles in the not-so-distant future. By 2035, polluting light-duty vehicles will be banned in several U.S. states and at least 20 countries, representing 25% of worldwide light-duty vehicle sales. (The agency literally devotes two paragraphs of the proposal to the trend.)
In other words, automakers have to be prepared regardless of what the EPA does. So why not make the move now so they have more certainty and are better positioned for success?
Historically, the U.S. hasn’t been a leader in electric vehicles; China and the EU are leagues ahead. But let’s be honest: The U.S. seldom likes to lead. It seems to be much happier sitting on the sidelines until it’s obvious which way the wind is blowing. When it does decide to get in the game, though, it doesn’t tend to half-ass things.
There’s also some wisdom in moving quickly, now, while the market is shifting. The U.S. runs the risk of being left behind in the transition to EVs if it doesn’t commit. If that were to happen, the country would cease to be a player in high-value automotive production, mostly producing hand-me-down models using older technology.
The Inflation Reduction Act has helped limit some of that downside risk by spurring automakers and battery manufacturers to quickly plan and break ground on dozens of gigafactories. The sheer volume of batteries that will be pumped into the market circa 2030 will make EVs a much more palatable option than they are today, both for automakers and consumers alike. Politically, the IRA has placed the administration on firmer ground, too, thanks to the wave of gigafactories and automotive plants that are springing up in typically conservative states.
But without a market signal, the incentives won’t be enough to make those investments worthwhile. EVs have been gaining market share in the U.S.: nearly 6% of the light-duty vehicle market today compared with 2.2% in 2020. That’s progress, but not enough to justify the hundreds of billions that manufacturers are staking on the transition.
Despite that, many automakers will bristle at the new regulations. Change is hard; I get it. But as Tesla has proven, there’s money to be made in being an early mover who executes well. Some legacy automakers have been rethinking their EV strategy, and the depth of their commitment will be tested over the next few years. Who decides to criticize the EPA, who decides to sue, and who decides to roll with it will be revealing and ultimately, I think, predictive of who will come out ahead as the industry shifts to battery power.
Investors should take note. Many have decided to jump in the game themselves, betting significant sums that technologies being developed today will be ready in time to ride the wave five to 10 years from now. But far more are content investing in incremental, quick-to-value companies that are aimed at increasingly narrow markets. How many venture-backed software companies should be SMBs instead?
The EPA’s new regulations are another sign that it’s time for investors, and venture capitalists in particular, to dive deep into climate tech. Yes, there are many already in the space. But the opportunities are so massive and broadly distributed that few firms should pass them by. If I were to be raising a fund, here’s where I’d be looking:
Batteries, batteries, batteries
With all the gigafactories being built, you’d think the moment to innovate in batteries has passed. But you don’t have to look far to realize that there’s still ample opportunity.
Silicon anodes, which have promised higher capacities and charging rates for years, are only just being commercialized at small scales. The real opportunity in the battery market is automotive, and silicon is just around the corner. Sila, for example, raised a $590 million Series F in 2021 in part to build a gigafactory in Washington State to pump out its proprietary battery materials. Competitor Group 14 wrapped a $614 million Series C in December.
All those batteries will need minerals, too. The Inflation Reduction Act provides incentives to automakers who can source battery packs and materials from the U.S. or countries with which it has free-trade agreements. By default, that eliminates a large portion of the world’s cobalt, putting pressure on battery manufacturers to find alternative chemistries. Between that and the unflagging need for lithium, there are plenty of opportunities for founders and investors.
There are also more creative ways to package existing battery types or use others that had previously been discounted. Our Next Energy is perhaps the best example here. The company pairs cheap, durable lithium-iron-phosphate cells with higher-performance but less durable manganese cells, letting each one’s strengths offset the others’ weaknesses.
Chargers, chargers, chargers
All those EVs will need places to charge. The charging technology itself is advancing rapidly, keeping ahead of batteries’ abilities to accept ever greater amounts of current, so that’s not the play. Rather, the rest of the experience around charging today kind of sucks. Service equipment is frequently broken or malfunctioning, and the locations leave a lot to be desired. If there’s one part of the EV experience that’s screaming for attention, it’s charging.
Apps and SaaS
I know, I know, I just threw software under the bus a few paragraphs ago, but hear me out. EV apps, like charging, still leave a lot to be desired. The potential here isn’t incremental but monumental.
Unlike fossil fuel vehicles, EVs are almost universally designed from the start to be connected vehicles. That means there’s a wealth of data available to OEMs and customers, as well as a range of ways to interact with it and the vehicle itself. Software that helps manage charging, like that offered by WeaveGrid or Synop, are good examples here of what can be done, but there’s still plenty of room for newcomers.
EV parts
The parts market for internal combustion engines is about as mature as it gets, but the EV market is only just getting started. Though electric motors have been around for over a century, there’s still plenty of room for innovation. One pioneering company, YASA, refined the axial flux design to the point where Mercedes came knocking. The founders and investors sold for an undisclosed sum in 2021, and the company is now a wholly owned subsidiary of the German OEM.
Because many EVs are clean-sheet designs, there’s a chance to redesign more prosaic parts like the wiring harness. As fossil-fuel vehicles have accumulated more chips and sensors, their harnesses have grown significantly. Now, they’re usually several miles long and incur a decent weight penalty. One company, CelLink, has redesigned the wiring harness to save space and weight, claiming its solution requires 75% less mass and 90% less space. The startup raised $250 million in February 2022.
More to come
With only 6% share in the U.S., the EV market is still fresh. There’s ample opportunity for founders and investors alike. The first round has been focused on batteries, but subsequent rounds will start to unlock the possibilities enabled by clean-sheet designs, fully electric powertrains and a vehicle fleet that’s always connected. Regulations in other countries are heading this way, but with the world’s largest economy getting in the game, the stakes are going up. Time to jump in.
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