Decarbonizing the global economic machine is as much an engineering challenge as an investment one.
Transformation of this magnitude requires a colossal amount of capital, in the order of more than $100 trillion dollars over the coming decades. It begs the question: Is sufficient capital being channeled into this space?
Let's start with the good news. In 2022, global energy transition investment totaled $1.1 trillion, up 31% from the prior year and approximately five times the level a decade ago. The bad news? The world needs more than three times that every year, for the rest of this decade, to have a realistic shot of achieving net zero.
This challenge requires long-term investors with an ownership mindset, which casts private equity investors at the forefront of providing much-needed funding to address climate change. Compared to public equity markets, where the vast majority of transactions involve merely ownership rights reshuffling (hence no funding provided to the underlying businesses), many private equity investments, in particular venture capital investments, directly inject cash to investee companies to support, for example, the development of technologies or scaling up the manufacturing capability.
Asset owners are also increasingly interested in climate solutions as more of them sign up for net-zero goals. It can be a powerful way to prevent greenwashing allegations as a provider of primary funding with quantifiable impact.
However, most investors are not in the space of providing concessionary capital for the sake of positive impact. The private equity community is drawn to the climate solutions space by the prospect of monetizing significant opportunities created by the transition to a low-carbon economy. It is reminiscent of, as some argue, the digital revolution that began four decades ago, which still has a profound impact on wealth creation.
We are experiencing a rapid acceleration. The number speaks for itself. Climate solution startups raised a record level of $55 billion in 2022 from their private equity backers, beating the record of $54 billion set just a year ago. And this record was set against a backdrop of a slowing fundraising and capital deployment in the entire private equity industry.
Overoptimism and "tech boosterism" often cloud investment judgment. Before we get too excited about doing well while doing good in the climate space, let's address the elephant in the room first.
In the mid- to late 2000s, there was an explosion of U.S. venture capital investment in clean technology (e.g., renewable energy), colloquially known as Clean Tech 1.0.
Fast forward to 2011, solar manufacturer Solyndra failed, causing an immense political backlash. The global financial crisis also led to a tightening of credit and a decline in investor confidence, which exacerbated the market correction in clean tech. Overall, investors lost about $25 billion when the sector crashed. Money dried up fast. For years, clean tech was a dirty word in venture capital.
That said, there is a strong case to argue that this time is indeed different. Unprecedented policy support, new consumption norms created around sustainability, major technological advance, and numerous lessons learned in terms of backing businesses that are compatible with the private equity model, all point to a brighter future for climate solutions investing.