When tech investor Abe Yokell heard about the $369 billion bill to fund climate investment in the US, he almost fell out of his seat.
Yokell, a managing partner at Congruent Ventures, wasn’t alone. Climate tech investors and advocates were shocked by the agreement between Senators Joe Manchin and Chuck Schumer that, if passed, would be the largest investment in decarbonization the US has ever made.
Just weeks ago, the Democrats’ push to fund climate initiatives seemed dead. Now, with Arizona Senator Kyrsten Sinema’s support, the bill appears poised to pass.
If it does make it all the way to President Biden’s desk, the package will supercharge an already strong environment for climate tech investment. US VC funding for climate tech has been on a tear in recent years, topping $16 billion in 2021, more than double the previous year, according to PitchBook data. And leading private equity firms from TPG to Brookfield Asset Management have raised billions to finance green projects.
“The Inflation Reduction Act is probably a bigger deal for our actual climate than it is for the climate tech community. But it’s still a very big deal for the investing community,” Yokell said.
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Investors say the bill will reduce the green premium on expensive technologies, speed up the network effect of electric vehicles and renewable electricity, and provide capital that goes where VCs won’t. In short, it’s Christmas for climate tech.
At a high level, the bill aims to reduce energy costs and emissions, increase energy security, and invest in environmental justice and rural communities. The breadth of the spending provisions reflects this broad mandate.
Together, the combination of direct investment, tax credits and loan programs seek to reduce US greenhouse gas emissions by 40% of 2005 levels by 2030.
Risk and project capital moves technology from the lab to the pilot plant
Humans already have most of the technology we need to decarbonize the economy. But we don’t have all of it. And some of the most ambitious and worthwhile efforts are hugely capital intensive and will take a decade or more to realize.
Those qualities mean plenty of early-stage projects are a bad fit for VC. But needless to say, the climate doesn’t care about hurdle rates and holding periods.
The Inflation Reduction Act addresses the financing gap in a few ways. It allocates $2 billion to national labs for energy research. There is also $10 billion for investment tax credits to build cleantech manufacturing facilities, as well as several loan guarantee programs.
Combined, this money helps research projects become venture-backable businesses, and later-stage companies access non-equity capital to scale production.
“The ecosystem is healthy today, but it definitely needs more risk capital,” said Dan Goldman, managing director at Clean Energy Ventures. “I think this bill has the potential to bring more technologies out of labs, universities and incubators, and get them ready for private sector funding.”
Many green premiums are reduced, others are eliminated
The largest slugs of money are going to accelerate adoption of mature technologies like solar energy and electric vehicles. But there are also significant incentives for technologies that are in embryonic stages of development.
Two standout beneficiaries within the emerging tech set are carbon capture and low-carbon hydrogen production.
The bill increases the tax credits for carbon capture across the board and rewards the most difficult and valuable process, direct air capture and sequestration, with up to $180 per ton. Importantly, the rules are agnostic to the techniques involved.
“You need a way to kickstart those industries, and you want to do it in a way that is not necessarily technology specific,” said Gabriel Kra, managing director and co-founder of Prelude Ventures.
Hydrogen producers are eligible for production tax credits of up to $3 per kilogram based on their emissions footprint. That goes a long way to making green hydrogen more competitive with hydrogen made from natural gas, which is cheap but carbon intensive.
Natural gas-derived hydrogen currently costs less than $2 per kilogram, whereas hydrogen made using renewable electricity and water costs between $3 and $8 per kilogram, according to the International Energy Agency.
With the right investment, some investors believe green hydrogen—which uses renewable electricity to mine hydrogen from water—can eventually fall below $2 per kilogram.
The network effect of clean technologies is expanded
One way to think of the bill’s impact on emerging technologies is that it creates a network effect that will have second- and third-order effects for technologies that feed into that network, investors said.
Consider electric vehicles. Currently they represent about 5% of new car sales in the US. That share could rise rapidly in the coming years, both because of organic trends and the bill’s many incentives for producers and consumers.
As electric vehicles increase, the infrastructure to support them grows in lockstep. That means better economics for charging networks, the potential for vehicle-to-grid energy storage and a more near-term need for battery recycling facilities.
The same is true for renewable energy and the grid. As more energy resources come online, the need for technology to connect and orchestrate them rises. That should benefit marketplaces of distributed energy resources, smart electric panels, software to orchestrate the electric grid and other nascent technologies.
“The smart, connected, cheap infrastructure deployment is going to enable the entire venture ecosystem to pile into this,” Yokell said.
Long live carried interest
Carried interest, the cockroach of tax breaks, has survived another assault.
In a compromise to win the support of Arizona’s Sinema, a provision that would have increased the holding period requirement to qualify for the lower carried interest tax rate was reportedly struck from the bill.
Put another way, large public corporations and their 15% minimum tax are paying for substantially all of the investment that will go towards avoiding the worst effects of climate change and allowing humanity to achieve economic growth without greenhouse gases.
Private fund managers keep their tax breaks but can’t claim any of the credit. (Save those who invest in climate solutions.)
For what it’s worth, none of the climate tech investors I spoke with raised concerns about the proposed carried interest change.
“I will lose every last penny of my carried interest for this climate bill,” Yokell said.
Featured image by Jenna O’Malley/PitchBook News