While Sen. Lamar Alexander is stumbling towards principled distinctions regarding which energy technologies merit public investment and which do not, Jim Manzi offered a useful way of thinking about the issue in Cato Unbound in August of 2008:
One obvious approach is to have the government fund technology research directly. The danger here, of course, is that we end up back in the failed game of industrial policy. Such dangers are not merely theoretical. The federal government was the key sponsor of, for example, the shale oil and large-scale wind turbine debacles in response to the energy crisis thirty years ago. Setting the right scope for such a program and managing the funding process carefully would each be essential to prevent it from becoming corporate welfare.
We should limit government investments to those topics that meet specific criteria. They should be related to detecting or ameliorating the effects of global warming, should serve a public rather than a private need, and should provide no obvious potential source of profit to investors if successful.Important examples include improved global climate prediction capability, visionary biotechnology to capture and recycle carbon dioxide emissions, or geo-engineering projects to change the albedo of the earth’s surface or atmosphere. On the other hand, most technologies that would contribute to the ongoing long-run transition of the economy away from fossil fuels, like more efficient fuel cells for autos or lower-cost solar power sources, need no government funding, since there is ample profit motive to develop them. As evidence, massive amounts of venture funding and large-company internal capital allocations are flowing to these opportunities right now. Government attempts to direct such development would almost certainly destroy value through political allocation of resources. [Emphasis added]
To implement such a policy, Manzi recommends the creation of a DARPA-like agency and the use of large prizes. E-ARPA is an attempt in that direction, though motivated by a very different vision of what the role of government support can and should be.
Solyndra has become a scandal because it went bust, but one could argue that government shouldn’t be in the business of supporting potentially viable for-profit enterprises, which should be able to attract private investment. Rather, government should be supporting the kind of over-the-horizon, highly ambitious breakthrough technologies Jim describes.
In the years since 2008, the massive amount of venture funding Jim described seem to have evaporated, a theme that Peter Thiel has discussed on a number of occasions. Much of it may have been chasing the promise of government subsidies, and it is possible that the defeat of cap-and-trade has dampened enthusiasm in this space. The following are top-level thoughts from the Founder Fund manifesto:
A lot of money has poured into clean technologies. Investments that have focused on efficiency improvements have done well as a financial matter, but investments in alternative technologies for actually generating energy have not produced particularly good returns. We believe that this is because many companies pursue the wrong model – they seek to be almost as good as the default product, rather than (as should be the case generally) so much better than the default that customers will rush to switch. Imagine, if you will, if Amazon.com were somewhat less convenient than going into, and offered similar prices to, a bricks-and-mortar store. Would you use it? Probably not – people only flocked to Amazon when it became substantially better, in selection and convenience, than physical retailers. What we need are companies developing sources of energy that are as good as, or better than, conventional sources at lower prices and at scale. Unfortunately, relatively few companies research such sources, preferring instead incremental improvements on long-established alternative technologies (wind, solar) whose physical limitations mean they cannot satisfy these requirements. But there is no reason to believe that we can’t invent an alternative to alternatives.
Founders Fund believes an essential problem in the energy space is risk aversion and a lack of ambition. We seem to have a shortage of daring geniuses in this space, and using public funds to expand the ecology of clean energy rent-seekers doesn’t seem like the right way to solve that problem.
Recently, energy analyst Robert Rapier reported on an exchange between Thiel and green energy investor Vinod Khosla:
This past week PayPal co-founder Peter Thiel — who was also an early investor in Facebook — made headlines when he declared that “Cleantech is an increasingly large disaster that people in Silicon Valley aren’t even talking about any more. The failure in energy and transportation points to a larger failure in clean energy — we aren’t moving any faster, literally, than we were when modern airplanes first came out.”
Khosla reply was telling:
Over the last 12 months, Khosla has generated more than $1 billion in profits from three IPOs and will “probably” see six more IPOs over the next 12 to 18 months, if the markets hold up, he said. “That $1 billion in profits over the last year is way more than most venture funds have done in IT in the last ten years cumulatively,” Khosla said. “I challenge anybody to claim clean-tech done right is a disaster.”
Rapier explains the divide:
It is clear that these two are talking about entirely different metrics for success. Thiel’s metric seems to be the actual production of cost-competitive energy. Thiel noted that investment dollars in Cleantech are falling — and yet even after billions in investments these companies are still not producing cost-competitive energy. Thus, Thiel is correct with respect to the metric he is using to measure the industry.
But Khosla points out that his investors have made money. By his metric, he claims that the industry is a success. So which metric should we use?
As Rapier makes clear, investors and executives can fare well without advancing some larger societal interest in achieving clean energy breakthroughs:
I simply don’t think that the fact that one can talk up a company and then IPO it at a profit is the proper metric for success. Some of those companies that have been IPO’d are grossly overvalued. Many of them won’t be around for long. (In fact, I wrestled hard this week with a decision to short one of them; I ultimately decided not to — but not because I don’t think the company is grossly overvalued). So is a company that is IPO’d, makes initial investors some money, and then ultimately goes bankrupt without producing energy a success? Not for the general public it isn’t. Those “successes” do not help wean us off of oil.
I would also question whether Khosla is counting up the losses when he claims to have made $1 billion in profits. We know investors lost a lot of money in Range Fuels. In fact, I was told this week by someone in Silicon Valley that the actual number is quite a bit higher than what has been publicized because the stake of the initial investors was never made public. The amount I was told is unconfirmed, so I won’t repeat it. But it is a fact that the overall investment in Range Fuels has never been published (to my knowledge); all we know is that the publicly announced funding was more than $300 million.
So, by the measures that matter to most people: Increased energy security, more supplies of clean energy, displacement of oil — Thiel is correct. Clean Tech has not delivered. And for that matter, energy companies have never been high flying investments. They are in a very competitive, low-margin business, and their low PE ratios reflect that. So I don’t believe that Clean Tech stocks can be expected to behave like technology stocks in the long term. They aim to sell commodities, and that just isn’t a high growth business.
Rapier’s observations don’t contradict Jim’s, in my view. The analyses are complementary. Understood more broadly, large companies, e.g., Wal-Mart, have invested enormous amounts in making their supply chains more efficient. Proven efficiency-enhancing technologies are being widely deployed. The kind of technologies that have grown dependent on subsidies seem not to have fared as well.
I am more sympathetic to the idea, which Alexander seems to share, that there is an appropriate place for system-wide investments that would facilitate the deployment of electric vehicles, perhaps along the lines of Peter Huber’s recent proposal:
The free-market path to getting grid electricity to our wheels hinges on giving every company that already owns, or cares to invest in, any part of the electron pipeline—electric utilities certainly included—the freedom and flexibility to invest new capital, set prices, recover costs, and earn profits commensurate with the risks, while working closely with car companies, car owners, municipalities, employers, mall owners, parking garages, individual homeowners, and others. The free-market policies that will mobilize private capital to deliver broadband electricity to our wheels will, by and large, resemble those that unleashed private capital to deliver broadband bits to our computers, PDAs, and wireless phones.
But that’s another issue.