Massachusetts Institute of Technology PRESIDENT S ADVISORY COUNCIL ON REGIONAL ENGAGEMENT Energy Summit @ MIT SCALING UP THE REGION S CLEAN ENERGY INDUSTRY October 21, 2010 Summary of Discussion * I. Overview Countries around the world are investing heavily in the development of clean energy technologies in an effort to become global leaders in this emerging, growing industry. National policies around clean energy and energy innovation are critical for achieving significant carbon emission reductions in the country while also building a globally competitive industry. However, while national policy is an essential component in reaching these objectives, so too is the innovation and policy development that is taking place at the regional level. Regions like New England and Silicon Valley are leading the world in the creation of new technologies and companies that serve regional, national and global markets. In an effort to focus on the important role regions can play in developing the clean energy industry, MIT convened approximately 50 industry leaders drawn from New England to discuss how to grow this emerging industry in the region. The meeting was convened under the auspices of President Susan Hockfield s Advisory Council on Regional * Prepared by Elisabeth Reynolds and Richard Lester, Industrial Performance Center, MIT
Engagement. The specific topic for the day was the challenge of financing the post- demonstration/first commercial scale deployment of new energy technologies. But the discussion was wide ranging and covered a number of important issues related to creating a clean energy innovation system in the region, including innovation in small and large companies, early adoption and building new markets, manufacturing, and public policy. Several themes on which there was broad agreement emerged from the meeting: The Massachusetts region is good at invention and incubating new companies but a major challenge lies in enabling these companies to grow to medium and large scale while remaining in the region. Conventional venture capital is not well suited to making the kinds of investments that are needed to grow clean energy companies beyond the early stage. Other sources of traditional and non- traditional financing need to be part of the solution. Emerging companies need to follow the money and the market, which for many of them is largely outside of the U.S and frequently in Asia. While comparisons to other industries are important, clean energy differs from the communications or biotech industries in that it generally lacks large players within the industry who are interested in acquiring either new technologies (particularly disruptive technologies) or companies, which could provide exit strategies for investors. The low cost structure in Asia makes it hard for companies to manufacture in the U.S. and be cost competitive. It is approximately 30% cheaper to manufacture in China, financing is more accessible, and large customers in the form of state- owned companies help create demand. Companies, and the region as a whole, cannot wait for government, whether at the state or federal level, to lead in the development of this industry in the U. S. The private sector must work collectively to advance the industry. That being said, the country needs a national energy policy and the private sector needs to advocate for supportive public policies. 2
The cheapest energy is the energy not used. There are significant opportunities to improve demand- side energy efficiency that will benefit emerging companies and the region as a whole. II. Financing and Development of the Regional Clean Energy Industry Several participants described how their companies had developed. Venture capitalists have typically been crucial investors at the early stages. But growth has often taken longer and required more capital than was expected, and few VCs are well positioned to invest the significant additional amounts of capital that are required once companies enter the pilot stage. While the number of venture- backed clean energy technology companies continues to increase, the ability of these companies to deploy their proprietary processes and products at scale is often constrained by the large capital requirements and a risk- return profile which does not easily fit into existing capital allocation models. Several companies have raised capital through the public markets, while others have been creative in seeking capital elsewhere a consortium of large multinationals, Asian investors, high net- worth individuals. The following points were also made: Patient capital is important; companies should be patient for growth and impatient for profits. If you can t get through the valley of death, go around it by finding smaller, more manageable problems that can be addressed with lower capital requirements (such opportunities are more likely to be found on the demand side.) Much of the $6 billion that has been invested in the clean energy industry in the last 10 years has not performed well. A lot of early- stage clean tech fund investments are being diluted. In Germany, millions of dollars have been poured into the solar industry by the government, but publicly traded companies are not performing well today. Some believe debt is an underutilized source of capital; with limited guarantees from government, significant amounts in debt capital could be unleashed, though this is a risky form of financing for emerging companies that are not yet profitable. 3
Non- traditional sources of capital with potentially longer time horizons should be explored, e.g., Global Impact Investing Network, Middle Eastern sovereign wealth funds, high net- worth individuals outside the U.S. There is no one to carry the ball forward after the VCs have invested no corporate players or private equity investors are willing to make the follow- on $50 to $100 million investments. The challenge of growing companies in the region is more fundamental than just profitability; we need to understand why the region isn t getting its fair share of venture capital investment; the region is not doing enough, even with respect to small companies. III. Competition in Asia The enormous growth of the industry in Asia is providing tremendous opportunities for U.S. clean energy companies. Chinese investors willingness to provide immediate and large sums of capital to growing companies, foreign as well as Chinese, is making it difficult to compete within the parameters of the U.S. market. A few examples: Evergreen Solar could not get a $75m loan against receivables in the U.S.; ultimately it got a $33m loan from Chinese investors very quickly; its largest competitor, Suntech, received a $7.9 billion loan agreement to expand from the China Development Bank. Compare this single investment to the total amount of $6 billion of venture capital invested in the U.S. across thousands of clean tech firms. (Evergreen Solar has since moved to China). China supports the clean tech industry by creating a clear path to end- use markets, such as wind energy. American Superconductor received substantial orders from five Chinese companies who are serving the growing wind industry in China. The risks can be managed faster and with lower costs in China; the Chinese provided one company with $500m to build a plant; Blackstone and KP are not investing in these type of facilities. Elsewhere, Korea Electric Power Company (KEPCO) is going to be the first adopter of technologies developed and demonstrated in the U.S., as was the case in LCD and 4
telecommunications technologies. While U.S. utilities had to pull back on capital expenditures during the economic downturn, KEPCO has invested in technology deployment such as high capacity, high efficiency superconductor power cables. KEPCO is forming a national smart grid that is providing a market for clean tech companies to sell into. We will see increasing acquisition of U.S. technologies for deployment in China. They will be brought back to the U.S., but they will be owned by Chinese companies. Other examples: o Asia will take as much of ARC Energy s product as it can produce o American Superconductor s sales are 90% outside US The exchange rate is also an important factor that can make it difficult to sell into the Chinese market, so U.S. companies need to set up operations in China and, importantly, write contracts such that their sells to Chinese companies are in RMB. American Superconductor has done this and now benefits as an American company as the RMB strengthens against the dollar because translation of RMB back into dollars for reporting quarterly revenues provides a natural boost to the reported revenues. IV. Learning from Other Industries A number of participants have been heavily involved in the growth of other industries, such as semiconductors, IT, communications, biotech. Many parallels were drawn with these industries, but also many differences: The ecosystem on the west coast is larger and drives a lot more activity (thought the current economic climate in California has presented some challenges); moreover, in New England a number of larger companies have been sold such that the cascading network effect involving the outgrowth of smaller companies has not happened. The semiconductor industry created SEMATECH, a collaborative effort among the big players in the industry; it received some modest support from the government; it learned the secrets of Japanese manufacturing. This helped to turn the industry 5
around and now the U.S. semiconductor industry has more than 50% world market share; there is also a big focus on funding research at universities. There have been attempts in the battery industry to do something similar to SEMATECH but the three large players would not participate and lobbied against it. Why isn t the clean energy industry following the successful model of IT, where large companies acquired a lot of new technologies? In clean energy, there are no oil companies or utility companies leading the way, no large anchor businesses, and no clear market in the country. Biotech is not necessarily a great model. VCs have failed in biotech; have not been profitable overall. With life sciences, the region has all components of the value chain present, critically including the customers. This suggests a model for clean energy. However, the model in biotech now has evolved into one in which companies work with a strategic partner upfront. In biotech, the IP is not enough; you need clinical trials; in clean energy you need a pilot or demonstration project; we don t know how to fund that yet. V. Innovation Innovation is the critical driver behind the emergence of the industry in New England and what will keep it here over time. The region is very good at innovation (or more precisely - - in the view of one participant at invention) and in incubating companies, although pressure from China is making it more challenging to get new companies established before their technological advantage is diminished by the cost competitiveness of Chinese products. A major challenge facing emerging innovators is the lack of innovation in medium and larger- scale companies that are their potential customer base. The latter view disruptive technologies as just that disruptive. A few additional points were made: A number of industries that are either directly involved in energy production or in energy consumption - - e.g., in transportation, oil and gas, food and beverage - - have 6
been slow to adopt or are resistant even to trying new clean energy technologies. Utilities are willing to explore new technologies but work on a very slow timeline. The best way to introduce an innovative product is through pilots. Companies and or industries in other countries might provide some examples of how to promote earlier adoption among large players (i.e., the Emerging Technology Initiative in the UK); regulatory regimes have also played a role (in the UK, regulation requires utility companies to dedicate a portion of R&D spending to clean energy). If you are talking to a company you think isn t innovating, it s because you are not solving a big enough problem for them. The rapid scale- up of manufacturing in China has reduced their production costs such that the technological advantages claimed by U.S. start- ups can sometimes become obsolete before they have become commercial (good example in solar). However, if IP is protected, there are examples of companies that are manufacturing in China and competing with a better technology/product at a more competitive price. Start- ups need to pick technological targets that are far enough ahead that they will not be overtaken by the commoditization of manufacturing in China and elsewhere; if it takes 8 years to commercialize a new product, a 50% advantage in cost may not be sufficient. This requires us to rethink how we approach innovation; companies may need to focus on importing engineering innovations from other sectors into the energy sector to create new technologies that can be commercialized more rapidly. Spinning out science- based innovations from universities presents challenges to some investors; turning an academic process into a commercially viable industrial technology takes a long time (10 to 12 years) and lots of money. Some VCs are looking at corporate R&D labs to see if there are opportunities for which the science is further advanced. VI. Manufacturing and Multiplier Effects 7
Several participants noted that one of the goals for the region should be to capture more of the multiplier effects associated with inventing new technologies. Job creation was of primary concern to many of the participants. To what extent can the region capture the downstream activities such as pilot and demonstration sites, manufacturing, and beyond? The region is home to growing industries in which the manufacturing is largely based in Asia (LEDs) but there is enormous demand for the technologies being developed in this region (there are 40 LED- related companies in New England today as well as the North American HQs of Philips and Sylvania). There are other examples, such as biotech, in which the entire value chain is represented in Massachusetts. Where does clean energy fit on this spectrum and what could be done to hold on to more of the value chain? According to a number of participants, U.S. and European investors in clean tech companies are skeptical of any U.S.- based clean energy company s ability to manufacture in the U.S. due to the relatively high cost structure. China is cheaper not only based on labor, but infrastructure as well, and the government is also providing loans in the billions to Chinese (not foreign) companies to expand in that country and to build export businesses. Many of the regional companies represented at the meeting have made large manufacturing investments in Asia. There is still some manufacturing presence in the region, though it is unclear how long this will last. Some of the challenges of locating manufacturing in the region lie in the cost and availability of land and infrastructure. In Michigan, one can pay $3 a square foot for a 300,000 square foot existing building. Product engineering will become a larger fraction of the total cost of delivery. Several participants commented on the importance of teaching world- class manufacturing engineering in the region VII. Public Policy Participants recognized that federal and state public policies are even more important to the development of the clean energy industry than to other industries. State policies are 8
important and can make a difference in the trajectory of growing clean energy companies, but the leadership at the federal level is critical. While several participants argued that the private sector could not afford to wait for the federal government to develop more supportive policies for the industry, others felt that there was an important advocacy role for the private sector in shaping and influencing public policy at both the state and federal levels. For example: The US needs a national energy policy; leaders in the region need to advocate for change at the national level. Current federal policies are cumbersome and expensive; the DOE loan guarantee program is a good example. Penalties of 25 cents per gallon if ethanol is not blended in will not change the behavior of the oil companies. They will simply take the penalty. A better approach would be to give the first 100 million gallons of biofuels that are produced a $5 dollar per gallon subsidy; policies today are not conducive to getting the first few things built in the industry. This is the key; once this occurs, cost reduction will follow. Governments at the state and local levels should be early adopters of both new technologies and innovative business models. Other large consumers such as universities and hospitals could also lead. The media have not historically been supportive of the region s efforts. The state has often run for cover from the press for making investments in clean technology companies. Compare this to what happens in China. More positive communications would help. There should be a booster club for the industry in the state; there are mixed views on how aggressive the state has been in working with companies to invest in the region. However, the state was praised for its leadership in the energy efficiency arena. Overall, VC investments in the region have been declining as a percentage of the overall VC investment portfolio across all industries; need to understand what the dynamic is that is driving this. 9
VIII. Next Steps A large part of the discussion focused on what could be done in the region, led by MIT and/or others, to deepen and grow the clean energy industry here. There were calls for action by several participants. If we don t make any changes by the time we walk out of here tonight, then shame on us, said one. Overall, there seemed to be general agreement that we are at a crossroads in the U.S. and the private sector needs to take the lead. This document summarizes a number of issues that regions, and the country as a whole, face in growing the clean energy industry in the U.S. It is by no means comprehensive, but underscores many of the challenges that are being discussed today in Washington, as well as in Boston and elsewhere. A separate document outlines many of the suggestions that were raised around next steps and directions for the region generally, and MIT specifically. A strategy for taking these forward is being developed and will be disseminated in further communications. 10